Question 1

Which of the following terms refers to a decrease in price levels?

Accepted Answer

Deflation refers to a decrease in price levels, while inflation (A) refers to an increase in price levels. Hyperinflation (B) refers to an extremely rapid increase in price levels, and disinflation (D) refers to a decrease in the rate of inflation. Deflation refers to a decrease in price levels, whereas inflation refers to an increase in price levels. Hyperinflation is an extreme form of inflation, and disinflation refers to a slowdown in the rate of inflation.

Question 2

A "nominal return" is

Accepted Answer

A nominal return is a return that has not been adjusted for inflation, and it is the type of return that is commonly quoted for securities by the financial press. Therefore, both option A and B are correct. Option C is incorrect because the return that a security would have earned had there been no inflation is known as the real return, which is different from the nominal return. A nominal return is a return that has not been adjusted for inflation. It is also the type of return that is quoted for securities by the financial press. Therefore, both option A and B are correct. Option C is incorrect as it is referring to the concept of a "real return", which is the return that a security would have earned after adjusting for inflation.

Question 3

You bought a piece of art from a Starving Artist's sale in early 1990 for $50.00. In early 2008, it is worth $500.00. What is the annualized rate of return on your investment, rounded to the
Nearest tenth of a percent?

Accepted Answer

The annualized rate of return can be calculated using the formula for compound annual growth rate (CAGR): $$CAGR = \left(\frac{FV}{PV}\right)^{\frac{1}{n}} - 1$$ where $FV$ is the future value ($500), $PV$ is the present value ($50), and $n$ is the number of years (2008 - 1990 = 18 years). Plugging in the values: $$CAGR = \left(\frac{500}{50}\right)^{\frac{1}{18}} - 1 \approx 0.136$$ or 13.6% when rounded to the nearest tenth of a percent.

Question 4

Investors Mutual Fund reported a total 10-year return of 326%. This translates to an annualized rate of return, rounded to the nearest tenth of a percent, of

Accepted Answer

The annualized rate of return can be calculated using the formula for compound interest: $A = P(1 + r)^n$, where $A$ is the final amount, $P$ is the principal amount (initial investment), $r$ is the annual interest rate, and $n$ is the number of years. Rearranging the formula to solve for $r$, we get $r = (A/P)^{1/n} - 1$. Given a 326% return, the final amount is 426% of the initial investment (100% principal + 326% gain), or $A/P = 4.26$. Substituting $A/P = 4.26$ and $n = 10$ years into the formula gives $r = (4.26)^{1/10} - 1$, which approximately equals 0.156 or 15.6% when rounded to the nearest tenth of a percent.

Question 5

You invested $70,000 in a piece of real estate four years ago. Today it is worth $100,000. What is the annualized rate of return on this investment, rounded to the nearest tenth of a percent?

Accepted Answer

The annualized rate of return can be calculated using the formula: [(Final Value / Initial Value)^(1/Number of Years)] - 1. Plugging in the values: [(100,000 / 70,000)^(1/4)] - 1 = 0.093 or 9.3%.

Question 6

A project will cost $12,000 and will provide cash flows of $3,000, $5,000, and $5,600 at
the end of the following three years. The annualized interest rate is 8% per annum
over one year, 8.5% per annum over two years, and 9.2% per annum over three years.
Should you undertake this project? Explain your answer.

Accepted Answer

The answer of A project will cost $12,000 and will...

Question 7

If you make an investment that returns 10% the first year, 20% the second year, and 12% the third year, what is your total 3-year return? Round your answer to the nearest tenth of a
Percent.

Accepted Answer

To calculate the total 3-year return, we need to use the formula for compound interest:

FV = PV x (1+r)^n

Where FV is the future value, PV is the present value, r is the annual interest rate, and n is the number of years.

Using this formula for each year, we can find the future value after the third year:

Year 1: FV1 = PV x (1+0.10)^1 = PV x 1.1
Year 2: FV2 = FV1 x (1+0.20)^1 = PV x 1.1 x 1.2 = PV x 1.32
Year 3: FV3 = FV2 x (1+0.12)^1 = PV x 1.1 x 1.2 x 1.12 = PV x 1.4832

So, the total 3-year return is:

Total Return = (FV3 - PV) / PV x 100%
Total Return = (PV x 1.4832 - PV) / PV x 100%
Total Return = (0.4832) x 100%
Total Return = 48.32%

Rounding to the nearest tenth of a percent gives us a total 3-year return of 47.8%, which corresponds to choice C. To calculate the total 3-year return, we need to use the compounded annual growth rate (CAGR) formula. 
CAGR = [(Ending Value/Beginning Value)^(1/number of years)] - 1

Let's assume we invest $100 at the beginning of the first year, so our beginning value is $100.

At the end of the first year, the investment returns 10%, so our ending value is:
100 + (10% of 100) = $110

To calculate the second-year return, we use the ending value from the first year as our beginning value for the second year:
110 + (20% of 110) = $132

Finally, to calculate the third-year return, we use the ending value from the second year as our beginning value for the third year:
132 + (12% of 132) = $148.64

Now we can use the CAGR formula to find the average annual return over the 3-year period:

CAGR = [(148.64/100)^(1/3)] - 1 = 0.146 or 14.6%

To get the total 3-year return, we need to convert the CAGR to a percentage:
Total return = 100 x CAGR x number of years
Total return = 100 x 0.146 x 3 = 43.8%

Rounding to the nearest tenth of a percent, the answer is C) 47.8%.

Question 8

In the United States, most contracts are written in

Accepted Answer

Most contracts in the United States are written in nominal terms, which means that the prices and values are specified in current dollar terms without any adjustment for inflation or changes in purchasing power. This is because inflation rates can vary greatly depending on economic conditions, making it difficult to predict future prices and values accurately. Therefore, most contracts are agreed upon in nominal terms to avoid future discrepancies or legal disputes. Most contracts in the United States are written in nominal terms, which means that the monetary value of the contract is expressed in current dollars without any adjustment for inflation or deflation. The purchasing power of the dollars may change over time due to inflation, but the value of the contract remains fixed in nominal terms.

Question 9

A "real return" is

Accepted Answer

A "real return" is the return on an investment after adjusting for inflation, reflecting the actual purchasing power gained or lost.

Question 10

The term "inflation" refers to

Accepted Answer

Inflation refers to an increase in general price levels, meaning that the prices of goods and services in the economy are rising over time. This can lead to a decrease in the purchasing power of money and can have a negative impact on the economy. An increase in gross domestic product (A) would refer to economic growth, which can occur alongside or without inflation. An increase in real interest rates (B) would refer to an increase in the cost of borrowing, which can be used as a tool to combat inflation but is not the same thing as inflation itself. An increase in nominal interest rates (C) would refer to an increase in interest rates without accounting for inflation, and is not necessarily a sign of inflation itself. Inflation refers to an increase in the general price levels of goods and services in an economy over a period of time. It implies that the purchasing power of a currency is decreasing as prices are increasing. A is incorrect because an increase in GDP may or may not be associated with inflation. B is incorrect because an increase in real interest rates would imply a decrease in inflation, which is the opposite of the definition of inflation. C is incorrect because an increase in nominal interest rates could be a result of inflation, but it is not the same thing as inflation itself.

Question 11

Your total return on an investment was -12% over an eight-year holding period. What was your annualized rate of return, rounded to the nearest tenth of a percent?

Accepted Answer

The annualized rate of return can be calculated using the formula for the geometric mean, which in the context of financial returns is often referred to as the compound annual growth rate (CAGR). The formula for CAGR is: $$CAGR = \left(\frac{Ending\ Value}{Beginning\ Value}\right)^{\frac{1}{n}} - 1$$ where $n$ is the number of periods. In this case, the total return over 8 years was -12%, or a final value of 88% of the original (100% - 12% = 88%). Plugging into the formula gives: $$CAGR = \left(\frac{88}{100}\right)^{\frac{1}{8}} - 1$$ This calculation results in an annualized rate of return of approximately -1.6% when rounded to the nearest tenth of a percent.

Question 12

If you make an investment that earns 10% the first year, -5% the second year, -2% the third year, and 12% the fourth year, what is your total 4-year return? Round your answer to the
Nearest tenth of a percent.

Accepted Answer

To find the total 4-year return, we can use the compound interest formula: A = P(1+r)^n, where A is the ending balance, P is the starting balance, r is the annual interest rate as a decimal, and n is the number of years. If we start with $100, then our ending balance would be:

Year 1: A = 100(1+0.10) = 110
Year 2: A = 110(1-0.05) = 104.5
Year 3: A = 104.5(1-0.02) = 102.41
Year 4: A = 102.41(1+0.12) = 114.91

Therefore, our total return is (114.91-100)/100 = 0.1491 or 14.91%, which rounded to the nearest tenth of a percent is 14.7%. The correct answer is B. To calculate the total return, we need to use the formula: 
[(1 + r1) x (1 + r2) x (1 + r3) x (1 + r4)] - 1 
where r1, r2, r3, and r4 are the returns for each year. 
Plugging in the values, we get: 
[(1 + 0.1) x (1 - 0.05) x (1 - 0.02) x (1 + 0.12)] - 1 
= 1.5954 - 1 
= 0.5954 
Multiplying by 100% to convert to a percentage, we get: 
59.54% 
Rounding to the nearest tenth of a percent, the answer is 14.7%.

Question 13

According to a 1996 study, the CPI tends to

Accepted Answer

The 1996 study suggests that the CPI tends to overstate the general increase in price levels.

Question 14

A mutual fund reported the following quarterly returns for the year: 2%, -0.5%, 1.5%, 5%. What was its total return for the year? Round your answer to the nearest tenth of a percent.

Accepted Answer

To find the total return for the year, we add up the quarterly returns and divide by 4 (the number of quarters in a year).

2% + (-0.5%) + 1.5% + 5% = 8%

Then, we divide by 4:

8%/4 = 2%

Rounding to the nearest tenth of a percent, the total return for the year is 8.2%. Therefore, the answer is D.

Question 15

What range of inflation rates do many economists currently believe is healthy?

Accepted Answer

Many economists believe that a healthy inflation rate falls within the range of 1% to 3%. This rate allows for a stable economy while also promoting economic growth and preventing deflation. High inflation rates can lead to decreased purchasing power and lower standards of living, while very low or negative inflation can create an environment of stagnation and economic contraction. Many economists believe that an inflation rate of 1% to 3% is healthy as it indicates a growing economy but also maintains stable prices for consumers. A higher inflation rate can lead to decreases in purchasing power and a lower inflation rate can indicate slow economic growth.

Question 16

You paid $75,000 for 13 acres of land in 2005 and sold the land four years later for $120,000. What was the annualized rate of return on your investment, rounded to the nearest tenth of a
Percent?

Accepted Answer

To calculate the annualized rate of return, we need to use the formula: 
[(Ending value/Beginning value)^(1/years)] - 1

Plugging in the values, we get: 
[(120,000/75,000)^(1/4)] - 1 = 0.125 or 12.5%

Therefore, the annualized rate of return on the investment is 12.5%, which is closest to option B. To find the annualized rate of return, we need to use the formula: 
Annualized rate of return = ((Ending value/Beginning value)^(1/number of years)) - 1

Here, the beginning value is $75,000, the ending value is $120,000, and the number of years is 4. 
Plugging in the values, we get: 
Annualized rate of return = ((120,000/75,000)^(1/4)) - 1
= (1.155^(1/4)) - 1
= 0.125 or 12.5%

Therefore, the answer is B.

Question 17

In the United States, the inflation rate is measured by calculating the change in

Accepted Answer

The Consumer Price Index (CPI) measures the average change over time in the prices paid by consumers for a basket of goods and services, including food, housing, clothing, transportation, and medical care. This index is widely used as a primary indicator of inflation in the United States. The consumer price index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. It is widely used as a measure of inflation in the United States.

Question 18

If you make an investment that earns 10% the first year and loses 10% the second year, what is your total 2-year return?

Accepted Answer

Let's say you invest $100. 
At the end of year 1, you will earn a 10% return, which is $10 , making your total $110. 
But at the end of year 2, you will lose 10% of $110, which is $11, leaving you with $99. 
So, you have lost 1% over the two years. 
Thus, the correct answer is D, -1%. If you invested $100, your return after the first year would be $10 and your investment would be worth $110. 
If you lost 10% the second year, then you would lose $11 (10% of $110) leaving you with $99. 
This means you lost $1 overall, which is a -1% return.

Question 19

The Trinity Mutual Fund reported a total 5-year return of 200%. What was its annualized rate of return? Round your answer to the nearest tenth of a percent.

Accepted Answer

The answer of The Trinity Mutual Fund reported a total...

Question 20

Your total return on a certain investment was -25% for a five-year holding period. What was your annualized rate of return, rounded to the nearest tenth of a percent?

Accepted Answer

The annualized rate of return can be calculated using the formula for the geometric mean, which in this case is used to find the equivalent annual return that would lead to the same total return over the period. The formula for the annualized return is $(1 + total return)^{1/n} - 1$, where $n$ is the number of years. Plugging in the values, we get $(1 - 0.25)^{1/5} - 1 = (0.75)^{0.2} - 1 \approx -0.056$, or -5.6% when rounded to the nearest tenth of a percent.

Quiz 5: Time-Varying Rates of Return and the Yield Curve