Multiple Choice Questions
1. Which one of the following is an example of "global" consumption smoothing?
A. Borrowing to buy a car
B. Borrowing to buy a home
C. Saving to send children to college
D. Saving during your working years for retirement
Answer: D. Saving during your working years for retirement
2. Inflation has an adverse effect on your savings because:
I. It erodes the purchasing power of the dollars you have saved.
II. It increases the real rate of return on the dollars you save.
III. Unless sheltered, it increases the taxes owed on investment income.
A. I only
B. II and III only
C. I and III only
D. I, II, and III
Answer: C. I and III only
3. If you want to tilt your savings toward later years, you might be well advised to purchase
which of the following types of readily available insurance?
A. Career failure insurance
B. Disability insurance
C. Unemployment insurance
D. Moral hazard insurance
Answer: B. Disability insurance
4. Which one of the following represents local consumption smoothing?
I. Saving during your working years for retirement
II. Borrowing money to buy a car
III. Putting off a vacation for a year until you can afford it
A. I only
B. II and III only
C. I and II only
D. I, II, and III
Answer: B. II and III only
5. In a private defined benefit pension plan the ___________ bears the investment risk, and in
a private defined contribution plan the ____________ bears the investment risk.
A. plan sponsor; employee
B. employee; plan sponsor
C. U.S. government; plan sponsor
D. plan sponsor; U.S. government
Answer: A. plan sponsor; employee
6. A decrease of 1% in both your tax exemption and your income tax rate would, on net,
_______________.
A. make you better off
B. make you worse off
C. make you neither better off nor worse off
D. make you either better or worse off depending on your age
Answer: A. make you better off
7. Tax shelters __________________.
A. postpone payment of tax liabilities
B. decrease investment risk
C. increase the pretax rate of return earned
D. benefit the government more than the investor
Answer: A. postpone payment of tax liabilities
8. The tax effect of a traditional retirement plan is to _____ taxes.
A. evade
B. postpone
C. erase
D. avoid
Answer: B. postpone
9. The U.S. income tax code is generally _____.
A. regressive
B. progressive
C. flat
D. peaked
Answer: B. progressive
10. Contributions to a _____________ are not tax deductible.
A. traditional retirement plan
B. Roth retirement plan
C. 401k plan
D. 403b plan
Answer: B. Roth retirement plan
11. No taxes are paid on withdrawals made during retirement from a _________.
A. traditional retirement plan
B. Roth retirement plan
C. 401k
D. 403b plan
Answer: B. Roth retirement plan
12. You earn 6% on your corporate bond portfolio this year, and you are in a 25% federal tax
bracket and an 8% state tax bracket. Your after-tax return is _____. (Assume that federal taxes
are not deductible against state taxes and vice versa).
A. 4.5%
B. 4.14%
C. 4.02%
D. 3.12%
Answer: C. 4.02%
(6%)(1 - .33) = 4.02%
13. You work for Fun-A-Rama Corporation and receive stock options as an incentive for your
performance on the job. You are counting on the stock options to provide the funds you'll
need for your retirement. This is called _____________.
A. adverse selection
B. a 529 plan
C. a moral hazard
D. a Texas hedge
Answer: D. a Texas hedge
14. You can tax-shelter only one-half of your retirement savings. You want to invest one-half
of your savings in bonds and one-half in stocks. How much of the bonds and how much of the
stocks should you allocate to the tax-sheltered investment?
A. Stock and bond investments should be equally invested in both tax-sheltered and
nonsheltered accounts.
B. You should place all the stocks in tax-sheltered accounts and all the bonds in nonsheltered
accounts.
C. You should place all the bonds in tax-sheltered accounts and all the stocks in nonsheltered
accounts.
D. It makes no difference how you allocate your stock and bond investments among tax
sheltered and nonsheltered accounts.
Answer: C. You should place all the bonds in tax-sheltered accounts and all the stocks in
nonsheltered accounts.
15. Social Security is ____________.
A. a pension plan only
B. an insurance plan only
C. a combination of a pension and insurance plan
D. an involuntary intergenerational transfer
Answer: C. a combination of a pension and insurance plan
16. The Social Security system _______________.
A. is financed in a regressive way
B. is regressive in the way it allocates benefits
C. is progressive in the way it is financed
D. is fully funded for the foreseeable future
Answer: A. is financed in a regressive way
17. Total annuity income is positively correlated with:
I. Longevity
II. Durability of marriage
III. Expected length of your base (Social Security) annuity
A. I only
B. I and II only
C. II and III only
D. I, II, and III
Answer: D. I, II, and III
18. The solvency of Social Security is threatened by ______________.
A. increasing population longevity
B. above-replacement growth of the U.S. population
C. alternative tax shelters
D. the growth of competing defined contribution plans
Answer: A. increasing population longevity
19. A person in poor health trying to buy supplemental health insurance is an example of
________.
A. moral hazard
B. adverse selection
C. a Texas hedge
D. actuarial error
Answer: B. adverse selection
20. A person in excellent health with a long life expectancy chooses a lifetime annuity. This is
an example of _________.
A. moral hazard
B. adverse selection
C. a Texas hedge
D. actuarial error
Answer: B. adverse selection
21. It would be costly to provide wage insurance because of the ___________ problem.
A. moral hazard
B. adverse selection
C. Texas hedge
D. actuarial error
Answer: A. moral hazard
22. You earned 8% on your corporate bond portfolio this year, and you are in a 15% federal
tax bracket. If over your holding period inflation was 3%, your real after-tax rate of return
was _____.
A. 6.8%
B. 3.69%
C. 4.91%
D. 4.25%
Answer: B. 3.69%
After-tax return before inflation = 8% × (1 - .15) = 6.8%
Real after-tax return = 1.068/1.03 - 1 = 3.69%
23. As you get older, you decide to reduce the risk level of your retirement portfolio because
your portfolio is nearing your minimum acceptable level. As the portfolio does better, you
reallocate funds into higher-risk categories. You are practicing a form of ____________.
A. manipulating tax shelters
B. involuntary intergenerational transfers
C. excessive savings
D. dynamic hedging
Answer: D. dynamic hedging
24. Tilting your retirement savings plan toward your later years should only be done by
investors _____________.
A. who are sufficiently risk averse
B. who are more tolerant of risk
C. who are unsure if their income growth will keep up with inflation
D. who want to retire early
Answer: B. who are more tolerant of risk
25. Employers commonly match at least some portion of employee contributions to:
I. 401k plans
II.403b plans
III. Self-directed retirement plans
A. I only
B. I and II only
C. II only
D. I, II, and III
Answer: B. I and II only
26. A saver who expects to have a higher tax rate after retirement would prefer a ______.
A. Roth retirement plan
B. traditional retirement plan
C. 401k plan
D. 403b plan
Answer: A. Roth retirement plan
27. A retirement plan that offers a tax shelter will defer ______________ taxes on
contributions and investment earnings.
A. income
B. sales
C. property
D. estate
Answer: A. income
28. A study by Spivack and Kotlikoff (1981) showed that a marriage contract increases the
dollar value of lifetime savings by as much as _____.
A. 5%
B. 10%
C. 25%
D. 50%
Answer: C. 25%
29. Taxes are applied to the _______________________.
A. real value of sheltered investment income
B. nominal value of unsheltered investment income
C. nominal value of sheltered investment income
D. real value of unsheltered investment income
Answer: B. nominal value of unsheltered investment income
30. One feasible way to hedge labor income is to ____________________.
A. diversify your investment portfolio away from the industry in which you work
B. save for retirement only from investment income
C. change careers every 7 years
D. invest heavily in the stock options provided by your firm
Answer: A. diversify your investment portfolio away from the industry in which you work
31. Which one of the following is not likely to be subject to adverse selection?
A. Health insurance providers
B. Lifetime annuity providers
C. Life insurance providers
D. Social Security
Answer: D. Social Security
32. Average Indexed Monthly Earnings are used to compute ___________.
A. the consumer price index
B. your Social Security retirement benefits
C. your maximum 401k contribution
D. your maximum retirement plan contribution
Answer: B. your Social Security retirement benefits
33. The Social Security Primary Insurance Amount formula favors ______.
A. older workers
B. high-income workers
C. younger workers
D. low-income workers
Answer: D. low-income workers
34. Contributions to a traditional retirement plan are __________, and contributions to a Roth
retirement plan are ____________.
A. not tax deductible; not tax deducible
B. tax deductible; tax deductible
C. tax deductible; not tax deductible
D. not tax deductible; tax deductible
Answer: C. tax deductible; not tax deductible
35. How many years of Social Security contributions count for determination of benefits?
A. 25
B. 35
C. 45
D. All yearly contributions count.
Answer: B. 35
36. Under current rules most workers will have ________ of their salary deducted to pay for
Social Security retirement benefits and _______ toward Medicare.
A. 1.45%; 6.2%
B. 6.2%; 1.45%
C. 7.65%; 1.45%%
D. 15.3%; 4.9%
Answer: B. 6.2%; 1.45%
37. In 2012, the income cap on Social Security taxes was set at _____ with an exemption of
_____.
A. $200,000; $10,000
B. $153,600; $7,600
C. $110,100; $0
D. $96,000; $10,000
Answer: C. $110,100; $0
38. If your marginal tax rate is 15%, your capital gains tax rate on a stock you have held for
10 years would be ___.
A. 5%
B. 15%
C. 20%
D. 27.5%
Answer: A. 5%
39. A tax shelter that allows for tax-exempt saving for higher education is called a _____.
A. Roth savings plan
B. 403b
C. 401k
D. 529 plan
Answer: D. 529 plan
40. Withdrawals from a traditional retirement plan prior to age ___ are taxable and must pay a
___ tax penalty.
A. 59½; 10%
B. 62; 5%
C. 65; 7½ %
D. 63½; 5%
Answer: A. 59½; 10%
41. In planning for retirement, an investor decides she will save $2,000 every year for 25
years. At a 7% return on her investment, how much money will she have at the end of 25
years?
A. $119,015
B. $125,316
C. $126,498
D. $128,420
Answer: C. $126,498
42. In planning for retirement, an investor decides she will save $11,000 every year for 40
years. At an 11% return on her investment, how much money will she have at the end of 40
years (to the nearest hundred thousand dollars)?
A. $1,400,000
B. $2,800,000
C. $4,900,000
D. $6,400,000
Answer: D. $6,400,000
43. An investor plans to retire at age 60 with total savings of $1,000,000. If she is currently 35
years old, has no savings, and expects to earn 8% per year on her investments, how much
money must she set aside every year?
A. $15,546
B. $13,679
C. $11,892
D. $10,324
Answer: B. $13,679
44. An insurance company plans to sell annuities to investors. Based on actuarial calculations,
an investor has a 15-year life span, and he wants a $30,000-per-year annuity, payable at the
end of each year. If the insurance company uses a 4% assumed investment rate, how much
should the annuity cost?
A. $296,928
B. $312,236
C. $333,552
D. $353.982
Answer: C. $333,552
45. A safe driver who drives faster as a result of purchasing collision car insurance would be
an example of the ___________ problem.
A. moral hazard
B. adverse selection
C. Texas hedge
D. actuarial error
Answer: A. moral hazard
46. A worker plans to retire in 20 years. He needs $20,000 per year in retirement income in
today's dollars. If inflation is forecast at 3.5% per year, what annual income should he plan to
receive in the first year of retirement in order to maintain the purchasing power on $20,000?
A. $30,353
B. $34,159
C. $37,398
D. $39,796
Answer: D. $39,796
47. An insurance company plans to sell annuities to investors. Based on actuarial calculations,
an investor has a 20-year life span, and she wants a $50,000-per-year annuity, payable at the
end of each year. If the insurance company uses a 3% assumed investment rate, how much
should the annuity cost?
A. $696,928
B. $743,874
C. $833,552
D. $953.982
Answer: B. $743,874
48. A worker plans to retire in 30 years. He hopes to receive $65,000 per year in retirement
income. If inflation is forecast at 2.5% per year, what annual income should he plan to receive
in the first year of retirement in order to maintain the purchasing power on $65,000?
A. $65,000
B. $76,159
C. $98,398
D. $136,342
Answer: D. $136,342
49. An investor must decide between putting $2,000 into a regular retirement plan or putting
$1,440 into a Roth retirement plan. If the investor's tax rate is 28% now and in retirement, and
she expects to earn 12% per year over the next 20 years, which will produce more cash in the
end?
A. The investment in the regular retirement plan.
B. The investment in the Roth retirement plan.
C. Both investments will have the same future value after taxes.
D. The answer cannot be determined from the information given.
Answer: C. Both investments will have the same future value after taxes.
50. A regular retirement plan requires that taxes be paid at the time the money is removed
from the plan. What is the after-tax value of a $5,000 deposit into a retirement plan today that
generates an 8% return for 20 years if the investor is taxed at the 28% level?
A. $16,779
B. $20,135
C. $21,685
D. $23,305
Answer: A. $16,779
51. What is the value of a $2,500 deposit into a retirement plan if the investment earns 12%
per year for 15 years?
A. $12,174
B. $13,684
C. $14,652
D. $15,523
Answer: B. $13,684
52. The employees of a firm complain that they cannot afford to contribute $8,000 per year to
a 401k because of the loss of $8,000 of take-home pay. In fact, how much will the take-home
pay be reduced if all taxes combined total 33%?
A. $5,360
B. $6,340
C. $7,637
D. $8,000
Answer: A. $5,360
Take-home pay reduction = $8,000(1 - .33) = $5,360
53. An employee uses her firm's 401k plan. If she decides to contribute $11,000 per year and
pays an effective tax rate for all items of 28%, what is the reduction in her take-home pay
each year?
A. $3,080
B. $4,210
C. $7,920
D. $11,000
Answer: C. $7,920
Take-home pay reduction = $11,000(1 - .28) = $7,920
54. An investor has an effective tax rate on all items of 30%, and he decides to put $8,000 into
a 401k. The future value of the investment that results from the deferral of taxes over 30 years
at an 8% return equals _____________.
A. $2,400
B. $8,000
C. $10,400
D. $24,150
Answer: D. $24,150
55. Withdrawals after retirement from a traditional retirement plan are __________, and
withdrawals after retirement from a Roth retirement plan are ____________.
A. taxable; not taxable
B. not taxable; taxable
C. tax deductible; not tax deductible
D. not tax deductible; tax deductible
Answer: A. taxable; not taxable
56. If you start saving for retirement only in your later years and your income growth from
that point is rapid, then ________________________.
A. a traditional retirement plan is probably a better choice than a Roth retirement plan
B. a Roth retirement plan is probably a better choice than a traditional retirement plan
C. a SEP is probably a better choice than Medicare
D. a 401k is probably a better choice than a 403b
Answer: B. a Roth retirement plan is probably a better choice than a traditional retirement
plan
57. Which one of the following statements about 401k plans is not correct?
A. The employer will typically match some portion of an employee's contributions to a 401k.
B. A 401k plan is a defined contribution plan.
C. Allowable contributions to 401k plans are limited.
D. Withdrawals from 401k plans are not taxed upon retirement.
Answer: D. Withdrawals from 401k plans are not taxed upon retirement.
58. Suppose you have maxed out your allowable contributions to your tax-sheltered
retirement plans and you still want to shelter income. The best choice of investment for you to
minimize the tax bill is to invest in _________.
A. a bond portfolio
B. stocks with high dividend yields
C. a blended stock and bond portfolio containing zero-coupon bonds
D. stocks with low or zero dividend yields
Answer: D. stocks with low or zero dividend yields
59. A bond portfolio and a stock portfolio both provided an unrealized pretax return of 8% to
a taxable investor. If the stocks paid no dividends, we know that the ________.
A. after-tax return of the stock portfolio was higher than the after-tax return of the bond
portfolio
B. after-tax return of the bond portfolio was higher than the after-tax return of the stock
portfolio
C. after-tax income of the stock portfolio was equal to the after-tax income of the bond
portfolio
D. after-tax income of the stock portfolio could have been higher or lower than the after-tax
income of the bond portfolio, depending on the marginal tax rate of the investor
Answer: A. after-tax return of the stock portfolio was higher than the after-tax return of the
bond portfolio
60. Statistics show that life expectancy at age 66 for males is about _____ additional years
and for females is about _____ additional years.
A. 15; 20
B. 16; 19
C. 18; 22
D. 19; 24
Answer: B. 16; 19
61. Currently, the maximum combined taxable income of a retired household that avoids
having to pay any taxes on a portion of their Social Security benefit is ______.
A. $15,000
B. $32,000
C. $45,000
D. $75,000
Answer: B. $32,000
62. An investor can earn a 6% nominal rate of return, but inflation is expected to be 3%. If the
individual invests $2,000 per year for 20 years, the real future value of this investment is
________. (All investments occur at year-end).
A. $73,571
B. $66,334
C. $53,251
D. $48,732
Answer: C. $53,251
63. An individual wants to have $95,000 per year to live on when she retires in 30 years. The
individual is planning on living for 20 years after retirement. If the investor can earn 6%
during her retirement years and 10% during her working years, how much should she be
saving during her working life? (Hint: Treat all calculations as annuities.)
A. $9,872
B. $8,234
C. $7,908
D. $6,624
Answer: D. $6,624
64. If you plan for a bequest for your children, your grandchildren, their children, and so on,
your planning horizon becomes _____.
A. equal to the life span of your children
B. 100 years, or your lifetime, whichever ends first
C. infinite
D. double what it would have been without the bequest
Answer: C. infinite
65. You want to minimize your current tax bill by maximizing your contributions to your
_____________.
A. taxable bond portfolio
B. Roth retirement plan
C. 401k or 403b plan
D. taxable savings account
Answer: C. 401k or 403b plan
66. Sharon decides to put $5,000 into her retirement plan at the age of 25. She will continue to
invest the same amount for a total of 6 years and then stop contributing. Assume 10% annual
return.
How much money will Sharon have in her retirement plan after 6 years?
A. $30,000
B. $35,575
C. $38,578
D. $41,451
Answer: C. $38,578
67. Sharon decides to put $5,000 into her retirement plan at the age of 25. She will continue to
invest the same amount for a total of 6 years and then stop contributing. Assume 10% annual
return.
How much money will Sharon have in her retirement plan when she is ready to retire at age
62?
A. $554,856
B. $623,245
C. $740,480
D. $1,311,805
Answer: C. $740,480
68. A nonprofit organization offers a 5% salary contribution to John's 403b plan regardless of
his own contributions, plus a matching 5% when John contributes 5% of his salary. John
makes $56,000 a year.
What is the amount of the total contribution to his 403b if John contributes 5% of his own
money?
A. $5,600
B. $8,400
C. $11,200
D. $12,500
Answer: B. $8,400
Total contribution % = 5% + (2 × 5%) = 15%; $56,000 × 15% = $8,400
69. A nonprofit organization offers a 5% salary contribution to John's 403b plan regardless of
his own contributions, plus a matching 5% when John contributes 5% of his salary. John
makes $56,000 a year.
What is John's effective salary reduction if he is in the 25% tax bracket?
A. $2,100
B. $2,800
C. $5,600
D. $8,400
Answer: A. $2,100
John contributes .05 × $56,000 = $2,800; his net contribution is $2,800(1 - .25) = $2,100.
70. A nonprofit organization offers a 5% salary contribution to John's 403b plan regardless of
his own contributions, plus a matching 5% when John contributes 5% of his salary. John
makes $56,000 a year.
What is John's total cost of his 5% contribution?
A. $2,100 cost
B. $2,800 cost
C. $700 benefit
D. $3.500 benefit
Answer: C. $700 benefit
John's contribution net of taxes is $2,100, (.05 × $56,000 = $2,800; net contribution =
$2,800(1 - .25) = $2,100). The employer's total contribution of .1 × $56,000 = $5,600 is also
saving taxes for John. The tax saved is .25 × $5,600 = $1,400. So John's total cost is $2,100 1,400 = $700. The short formula is $56,000[.05 - .05(1 - .25)] = $700.
71. The fact that the U.S. government provides deposit insurance to banks creates a form of
___________, which is at least partially offset by requiring banks to hold more capital if they
are riskier.
A. moral hazard
B. adverse selection
C. risk aversion
D. interest rate risk
Answer: A. moral hazard
72. An investor in the 34% tax bracket would be indifferent between a corporate bond with a
before-tax yield of 8% and a municipal bond with a yield of _________.
A. 3.91%
B. 6.15%
C. 5.28%
D. 10.72%
Answer: C. 5.28%
(8%)(1 - .34) = 5.28%
73. An investor who is in the 35% federal tax bracket and the 5% state bracket buys a 6.5%
yield corporate bond. What is his after-tax yield? (Assume that federal taxes are not
deductible against state taxes and vice versa).
A. 3.9%
B. 4.75%
C. 6.5%
D. 9.9%
Answer: A. 3.9%
(6.5%)(1 - .35 - .05) = 3.9%
Test Bank for Essentials of Investments
Zvi Bodie, Alex Kane, Alan Marcus
9780078034695, 9789389957877, 9781264140251, 9781260316148, 9780073382401, 9780078034695, 9781260013924, 9780077835422
