Deck 6: Inflation

Question 1

Fixed-income securities incur an additional risk related to inflation known as ____ risk.
A) interest-rate

A) reinvestment
B) purchasing-power
C) exchange-rate

Answer 1

C

Question 2

When inflation is relatively high, there is ____ for stock returns to be either relatively high or low.

A) a strong record
B) a strong tendency
C) a slight tendency
D) no tendency

Answer 2

D

Question 3

The CPI market basket is developed based on interviews of

A) retired persons.
B) rural and urban families of four.
C) young, married couples.
D) urban households.

Answer 3

D

Question 4

Cost of living indexes

A) automatically adjust for changes in product quality.
B) are based on a fixed package of goods and services.
C) do not include housing costs.
D) recognize that consumers will substitute lower for higher priced items.

Question 5

If inflation rises more than expected over the next year,

A) the short-term borrower benefits.
B) there is no effect on the borrower or lender since the rate is preset.
C) the lender gains purchasing power.
D) the short-term lender benefits.

Question 6

From 1926-1990, the real annual return on a diversified portfolio of common stocks averaged approximately

A) 8%.
B) 6%
C) .14%.
D) 2%.

Question 7

The present market basket used in the CPI consists of approximately

A) 180 goods and services.
B) 5000 goods and services.
C) 100 services.
D) 40 goods and services.

Question 8

One shortcoming of a cost-of-living index using a basket of goods to represent price levels is that

A) it does not adjust prices to a base year.
B) changes to the quality of the basket items are not measured.
C) the index may not measure inflation over a given period of time.
D) too many adjustments are made in the mix as relative prices change.

Question 9

For the decade of the 1980's, the average annual growth rate of the Consumer Price Average averaged approximately

A) 4%.
B) 7%.
C) -2%.
D) 10%.

Question 10

If in 1992 the CPI were 200, this would indicate that prices have doubled since the current base period of

A) 1956-58.
B) 1982-84.
C) 1988-89.
D) 1974-75.

Question 11

The _____ rate of interest is the rate at which the investor can trade current money for future money.

A) risk-adjusted
B) real
C) nominal
D) future spot

Question 12

The Consumer Price Index is calculated monthly by

A) Bureau of Labor Statistics.
B) FDIC.
C) Federal Reserve System.
D) Treasury Department.

Question 13

When investors are concerned with returns, stock prices will be priced such that nominal returns will include

A) the expected rate of inflation
B) the historical rate of inflation
C) individual income tax rates
D) the current rate of inflation

Question 14

The largest component area of the CPI is

A) transportation.
B) medical.
C) housing.
D) college tuition.

Question 15

The level of short-term nominal interest rates is measured by the return on

A) treasury bills.
B) certificates of deposits.
C) corporate bonds.
D) pork belly futures.

Question 16

The average annual growth rate for the Consumer Price Index is calculated by finding the

A) standard deviation.
B) geometric mean.
C) arithmetic mean.
D) median.

Question 17

Cost of living indices tend to ignore

A) increasing prices.
B) interest rate increases.
C) the substitution effect.
D) interest rate decreases.

Question 18

If an investor forecasts a future inflation rate of 5% and requires a 3% real return, he will require a nominal return of

A) 2%.
B) 15%.
C) 8%.
D) 16.7%.

Question 19

To estimate the real return for the year, one would take

A) nominal return + inflation.
B) nominal return/inflation.
C) inflation/nominal return.
D) nominal return - inflation.

Question 20

From 1926-1990, the real average annual return on treasury bills averaged approximately

A) 4%.
B) 2.5%.
C) -3%.
D) .5%.

Question 21

Studies show that the short-term relationship between inflation rate changes and nominal stock return changes is

A) strongly positive.
B) moderately inverse.
C) strongly inverse.
D) not statistically significant.

Question 22

An indexed bond

A) will pay the same nominal interest each year.
B) reduces the interest each year that the CPI rises.
C) increases purchasing power risk for the purchaser.
D) will pay the same real interest each year.

Question 23

The FASB 33 experiment required large firms to inflation adjust all but

A) plant.
B) interest.
C) inventories.
D) property.

Question 24

The inventory method that comes closest to replacement cost accounting is

A) Sum of the Years Digits.
B) LIFO.
C) Weighted Average.
D) Straight Line.

Question 25

The rate typically used as a basis to adjust the rate paid on a variable rate security is

A) treasury bill
B) tax-exempt bond
C) common stock
D) corporate bond

Question 26

An investor’s portfolio earned a 10% average compound annual return over the last six years. The average compound annual inflation rate over this period was 3%. Her portfolio was worth $20,000 at the beginning of the period six years ago. How much is the portfolio worth now, expressed in beginning-of-period dollars?

A) $30,014
B) $31,821
C) $35,432
D) $29,674

Question 27

When actual inflation exceeds expected inflation,

A) short-term borrowers benefit more than long-term borrowers.
B) long-term lenders benefit more than short-term lenders.
C) long-term borrowers benefit more than short-term borrowers.
D) there is no effect on borrowers or lenders.

Question 28

You purchase a one-year security with an expected real pretax return of 5%. You forecast a 7% rate of inflation and are in the 28% tax bracket. Your after-tax nominal return would be

A) 2.6%.
B) 5.4%.
C) 4.3%.
D) 8.9%.

Question 29

If the CPI in 1970 was 140 and in 1992 it is 332, the average annual compound growth rate was

A) 4%.
B) 2.8%.
C) 6.5%.
D) 3%.

Question 30

You purchase a one-year security with an expected real pretax return of 6%. You forecast a 4% rate of inflation and are in the 35% tax bracket. Your real after-tax return would be

A) 6.1%.
B) 1.4%.
C) 2.6%.
D) 7.0%.

Question 31

Assume the CPI in 1980 was 100 and it was 200 in 1992. The average annual compound inflation rate was

A) 6%.
B) 8.3%.
C) 9%.
D) 5.2%.

Question 32

Present depreciation methods

A) are based on replacement costs.
B) are based on historic costs
C) are required to use the capital consumption adjustment.
D) always overstate earnings.

Question 33

You purchase a one-year security with an expected real pretax return of 5%. You forecast a 7% rate of inflation and are in the 28% tax bracket. Your real after-tax return would be

A) 1.8%.
B) -1.2%.
C) 4.3%.
D) 2.7%.

Question 34

Under the 1992 tax law, federal income taxes are levied on the investment returns that are

A) real after-tax
B) nominal
C) CPI adjusted
D) nominal after-tax

Question 35

In the U.S. economy, the largest borrower of funds is

A) home purchasers.
B) federal government.
C) credit card users.
D) state and local governments.

Question 36

Over 1926-1990

A) neither treasury bills nor common stocks have had a positive real return.
B) the real return on treasury bills averaged 5%.
C) common stocks have had a larger real return than treasury bills.
D) the real return on common stock averaged 3.5%.

Question 37

If the rate of inflation rises at a lower rate than expected for the next year,

A) there is no effect on the borrower or lender.
B) the lender benefits.
C) the nominal rate will rise.
D) the borrower gains purchasing power.

Question 38

Using the nominal interest expense as a deduction tends to

A) understate earnings.
B) reflect the purchasing power of earnings.
C) understate the true interest expense.
D) overstate earnings.

Question 39

Assuming inflation, present accounting methods tend to

A) adjust EPS for the inflation.
B) overstate the material expense.
C) forecast future costs of inventory.
D) overstate real EPS.

Question 40

During the 1970's, disintermediation occurred when

A) banks had nominal ceilings, others didn't.
B) nominal rates were low and consumers saved heavily.
C) savings and loans paid the highest real rates.
D) mortgage loan money was very available.

Question 41

Which of the following statements does NOT explain why the returns on bonds are found to be negatively correlated with unexpected inflation?

A) Bonds offer a stream of nominal interest and principal payments that vary with respect to the inflation rate.
B) Unexpected inflation causes inflation expectations to rise causing required returns to increase as well.
C) To provide higher returns, bond prices must fall producing principal losses for current bondholders.
D) Bonds are non-indexed, fixed income securities that will not adjust the payment stream for price changes.

Question 42

Investment returns can be indexed by tying security payments to

A) changes in the nominal rate of interest.
B) changes in the price level.
C) the Treasury bill rate of interest.
D) the change in purchasing power risk.

Question 43

Empirical studies have determined that over short periods of time, the average returns for stocks are

A) not correlated to either actual or expected rates of inflation.
B) directly correlated to the expected rate of inflation.
C) inversely correlated to both actual and expected inflation.
D) directly correlated to the historical rate of inflation.

Question 44

Which one of the following statements does NOT explain why some stocks of some companies are better hedges against inflation than others?

A) Their earnings are less-inflation sensitive.
B) Defense contractors are well-equipped to pass along price changes.
C) Electric utilities are very free to pass along cost increases despite the regulatory aspects of the business.
D) Electric utilities are constrained in their ability to pass along price changes due to the regulatory nature of the business..

Question 45

Which of the following statements represents a problem associated with fully inflation-indexed securities?

A) During periods of inflation, much of the interest payments represent real increases in purchasing power.
B) The government will tax only the inflation-adjusted payments.
C) After-tax returns to bondholders will be adversely affected by price changes.
D) The interest payments will be taxed by the government thereby reducing the return to bondholders.