Question 1

At an interest rate of 6 percent, what would be the present value of receiving $22,000 twelve years from now?

Accepted Answer

The present value (PV) can be calculated using the formula PV = FV / (1 + r)^n, where FV is the future value ($22,000), r is the annual interest rate (6% or 0.06), and n is the number of years (12). Plugging these values in gives PV = $22,000 / (1 + 0.06)^12, which calculates to approximately $10,934.

Question 2

Recall the Application about opting for a lump sum of $500,000 for your retirement or $35,000 per year for the rest of your life to answer the following question(s).
-Assume the retiree had a third option: receive a lump sum of $750,000 five years from now. If the interest rate is 4 percent, approximately how much is the future $750,000 to be received in 5 years worth today?

Accepted Answer

To find the present value of $750,000 to be received in 5 years at an interest rate of 4 percent, we use the formula for the present value: $PV = \frac{FV}{(1 + r)^n}$, where $PV$ is the present value, $FV$ is the future value, $r$ is the annual interest rate, and $n$ is the number of years. Plugging in the values, we get $PV = \frac{750,000}{(1 + 0.04)^5}$, which approximately equals $616,445.

Question 3

Scenario 12.1: Jennifer has decided to give up her pack-a-day smoking habit and invest the money she would have spent on cigarettes in a retirement account. At $6.00 a pack, Jennifer is currently spending $2,190 per year on cigarettes. Jennifer is 25 years old and plans to retire in 35 years, at age 60. She has chosen a retirement account that will earn a long-term average return of 5 percent per year. Jennifer is currently earning $40,000 annually. Assume that the average annual inflation rate will be 5 percent per year, that the cost of cigarettes will increase with inflation, and that Jennifer's income will also rise with the inflation rate.
-Refer to Scenario 12.1 At the assumed annual inflation rate of 5 percent, approximately how much will the $6.00 pack of cigarettes cost in 10 years, when Jennifer reaches the age of 35?

Accepted Answer

To find the future cost of a $6.00 pack of cigarettes in 10 years with an annual inflation rate of 5 percent, you can use the formula for future value in terms of inflation: Future Value = Present Value * (1 + inflation rate)^number of years. Plugging in the values gives: Future Value = $6.00 * (1 + 0.05)^10 ≈ $9.77, which rounds to approximately $10.

Question 4

Recall the Application about opting for a lump sum of $500,000 for your retirement or $35,000 per year for the rest of your life to answer the following question(s).
-This Application addresses the economic concept of

Accepted Answer

This application is related to the concept of present value, which involves calculating the value of an amount of money in the present, based on projected future income and interest rates. The decision between taking a lump sum or an annuity for retirement is a classic example of present value calculations. In this case, the better choice depends on the interest rate used to calculate the present value of the annuity payments. If the interest rate is higher than the rate used to discount the lump sum, then the annuity payments would be worth more in present value terms, and vice versa. However, assuming similar interest rates, the lump sum is usually the better choice, as it provides more flexibility and control over the money.

Question 5

Recall the Application about opting for a lump sum of $500,000 for your retirement or $35,000 per year for the rest of your life to answer the following question(s).
-If the interest rate is 4 percent, how much interest would the retiree earn the first year if she opted for the lump sum payment, and chose to invest the entire payment at this interest rate?

Accepted Answer

The interest earned in the first year on a lump sum of $500,000 invested at an interest rate of 4 percent is calculated as $500,000 * 0.04 = $20,000.

Question 6

Suppose you have $400 to invest at a nominal interest rate of 7 percent, and the investment's term to maturity is 1 year. If the inflation rate is 2 percent, then the real return on your investment is approximately

Accepted Answer

The nominal return is 7% of $400, which is $28. The real return is the nominal return minus the inflation rate, so $28 - (2% of $400) = $28 - $8 = $20.

Question 7

If the nominal interest rate is 2 percent and the inflation rate is 4 percent, then the real rate of interest is

Accepted Answer

The real rate of interest is calculated by subtracting the inflation rate from the nominal interest rate. Thus, the real rate of interest in this case is -2 percent (2 percent - 4 percent = -2 percent). This means that the purchasing power of the money invested is decreasing by 2 percent per year.

Question 8

If the nominal interest rate is 4 percent and the inflation rate is 1 percent, then the real rate of interest is

Accepted Answer

The real rate of interest is calculated by subtracting the inflation rate from the nominal interest rate. Therefore, the real rate of interest in this scenario is 4% - 1% = 3%. The correct answer is B.

Question 9

Nominal interest rates are the

Accepted Answer

Nominal interest rates are simply the interest rates quoted in the market, without any adjustments for inflation.

Question 10

The real-nominal principle can be stated as

Accepted Answer

The real-nominal principle is the idea that what matters to people is the purchasing power of money or income, not the actual amount in nominal terms. In other words, inflation can reduce the actual value of money, so people care more about what they can buy with their money (real value) rather than simply how much money they have (nominal value). Option A is related to the concept of production generating income, but not directly related to the real-nominal principle. Option B is related to calculating GDP, but not specifically related to the real-nominal principle. Option D is too narrow and incorrect; the production of services is also counted in GDP.

Question 11

Scenario 12.1: Jennifer has decided to give up her pack-a-day smoking habit and invest the money she would have spent on cigarettes in a retirement account. At $6.00 a pack, Jennifer is currently spending $2,190 per year on cigarettes. Jennifer is 25 years old and plans to retire in 35 years, at age 60. She has chosen a retirement account that will earn a long-term average return of 5 percent per year. Jennifer is currently earning $40,000 annually. Assume that the average annual inflation rate will be 5 percent per year, that the cost of cigarettes will increase with inflation, and that Jennifer's income will also rise with the inflation rate.
-Refer to Scenario 12.1. Assume Jennifer gave up smoking for only one year and invested that money ($2,190)at the 5 percent interest rate. How much would the investment be worth in 35 years?

Accepted Answer

To calculate the future value of a single investment over time, you can use the formula for compound interest: FV = PV(1 + r)^n, where FV is the future value, PV is the present value (initial investment), r is the annual interest rate, and n is the number of years. Plugging in Jennifer's investment of $2,190 at a 5% interest rate over 35 years gives: FV = $2,190 * (1 + 0.05)^35 ≈ $12,080.

Question 12

If the real interest rate is 4 percent and the inflation rate is 3 percent, then the nominal interest rate is

Accepted Answer

The nominal interest rate can be approximated by adding the real interest rate to the inflation rate, which in this case is 4 percent + 3 percent = 7 percent.

Question 13

Scenario 12.1: Jennifer has decided to give up her pack-a-day smoking habit and invest the money she would have spent on cigarettes in a retirement account. At $6.00 a pack, Jennifer is currently spending $2,190 per year on cigarettes. Jennifer is 25 years old and plans to retire in 35 years, at age 60. She has chosen a retirement account that will earn a long-term average return of 5 percent per year. Jennifer is currently earning $40,000 annually. Assume that the average annual inflation rate will be 5 percent per year, that the cost of cigarettes will increase with inflation, and that Jennifer's income will also rise with the inflation rate.
-This Scenario addresses the economic concept of

Accepted Answer

This scenario addresses the economic concept of present value, as Jennifer is comparing the present value of her annual cigarette spending to the future value that it can earn in a retirement account with a long-term average return of 5 percent per year. She is also taking inflation into account, which affects both the cost of cigarettes and her income.

Question 14

Real interest rates are the

Accepted Answer

Real interest rates are calculated by subtracting the inflation rate from the nominal interest rate. This is because the nominal interest rate includes the effect of inflation, while the real interest rate is adjusted for inflation to reflect the actual purchasing power of the interest earned or paid.

Question 15

If the real interest rate is 4 percent and the nominal interest rate is 7 percent, this implies an expected inflation rate of

Accepted Answer

Real interest rate = Nominal interest rate - Inflation rate
Given, Real interest rate = 4%
Nominal interest rate = 7%
Substituting the values, we get:
4% = 7% - Inflation rate
Therefore, the expected inflation rate = 7% - 4% = 3%. 
Hence, the correct answer is choice A) 3 percent.

Question 16

Scenario 12.1: Jennifer has decided to give up her pack-a-day smoking habit and invest the money she would have spent on cigarettes in a retirement account. At $6.00 a pack, Jennifer is currently spending $2,190 per year on cigarettes. Jennifer is 25 years old and plans to retire in 35 years, at age 60. She has chosen a retirement account that will earn a long-term average return of 5 percent per year. Jennifer is currently earning $40,000 annually. Assume that the average annual inflation rate will be 5 percent per year, that the cost of cigarettes will increase with inflation, and that Jennifer's income will also rise with the inflation rate.
-Refer to Scenario 12.1. By what approximate percentage will Jennifer's income increase from age 25 to age 60?

Accepted Answer

Assuming an average annual inflation rate of 5 percent, Jennifer's income will increase by approximately 452 percent from age 25 to age 60. This is calculated using the formula: (1 + inflation rate)^number of years = (1 + 0.05)^35 = 4.52, or a 352 percent increase. However, since Jennifer's current annual income is $40,000, the increase to her income over 35 years will be from $40,000 to $180,800 ($40,000 x 4.52), which is a 452 percent increase.

Question 17

Which of the following equations is correct?

Accepted Answer

The correct equation for calculating the real interest rate is real interest rate = nominal interest rate - inflation. This equation subtracts the expected inflation rate from the nominal interest rate, resulting in the real interest rate.

Question 18

Scenario 12.1: Jennifer has decided to give up her pack-a-day smoking habit and invest the money she would have spent on cigarettes in a retirement account. At $6.00 a pack, Jennifer is currently spending $2,190 per year on cigarettes. Jennifer is 25 years old and plans to retire in 35 years, at age 60. She has chosen a retirement account that will earn a long-term average return of 5 percent per year. Jennifer is currently earning $40,000 annually. Assume that the average annual inflation rate will be 5 percent per year, that the cost of cigarettes will increase with inflation, and that Jennifer's income will also rise with the inflation rate.
-Refer to Scenario 12.1 At the assumed annual inflation rate of 5 percent, approximately how much will the $6.00 pack of cigarettes cost in 30 years, when Jennifer reaches the retirement age of 60?

Accepted Answer

To calculate the future cost of a $6.00 pack of cigarettes in 30 years with an annual inflation rate of 5 percent, you can use the formula for future value in terms of inflation: Future Value = Present Value * (1 + inflation rate)^number of years. Plugging in the values gives: Future Value = $6.00 * (1 + 0.05)^30 ≈ $25.97, which rounds to approximately $26, not an exact match to the provided options. However, the closest provided option to the calculated future value is $33, indicating a possible mistake in the calculation or in the interpretation of the options. The correct approach with precise calculation or rounding might lead to a different choice if the options were accurately reflective of typical outcomes of such a calculation.

Question 19

If the real interest rate is 5 percent and the nominal interest rate is 2 percent, this implies an expected inflation rate of

Accepted Answer

The Fisher equation relates the nominal interest rate (i), the real interest rate (r), and the inflation rate (π) as follows: i = r + π. Given that the real interest rate is 5 percent and the nominal interest rate is 2 percent, solving for the inflation rate gives π = i - r = 2% - 5% = -3%.

Question 20

If the real interest rate is 7 percent and the inflation rate is 7 percent, then the nominal interest rate is

Accepted Answer

The nominal interest rate can be approximated by adding the real interest rate to the inflation rate, which in this case is 7 percent + 7 percent = 14 percent.

Quiz 12: Investment and Financial Markets