Question 1

Historically,U.S.government securities have been considered the safest,lowest-risk investment available.

Accepted Answer

This is true, as U.S. government securities are backed by the full faith and credit of the U.S. government, making them a very low-risk investment.

Question 2

The nominal rate of interest that investors demand will increase with an increase in the expected rate of inflation.

Accepted Answer

When the expected rate of inflation increases, investors will demand a higher nominal rate of return to compensate for the loss of purchasing power caused by inflation.

Question 3

You purchase shares of XYZ company at the beginning of the year for $20 per share.After receiving dividends of $2 per share,you sell the stock for $24 per share at the end of the year.What is your rate of return of the stock for the year?

Accepted Answer

The total return can be calculated by adding the percentage increase in share price to the percentage of dividends received. 
Increase in share price = (24-20)/20 * 100% = 20%
Dividend yield = (2/20) * 100% = 10%
Total return = 20% + 10% = 30%

Question 4

The real rate of return is the rate of return earned on an investment without any adjustment for inflation.

Accepted Answer

The real rate of return is the rate of return earned on an investment after adjusting for inflation, reflecting the actual purchasing power of the earnings.

Question 5

Interest rates are closely tied to the rate of inflation.

Accepted Answer

When inflation increases, central banks may raise interest rates to help stem inflation by reducing the amount of money in circulation. Conversely, a decrease in inflation may lead to a decrease in interest rates to stimulate economic growth. Therefore, there is a close relationship between interest rates and inflation.

Question 6

If you are too conservative with your investments,they may not keep up with inflation.

Accepted Answer

Inflation decreases the purchasing power of money over time. If your investments have low returns due to being too conservative, they may not provide enough growth to keep up with inflation, leading to a reduction in their real value.

Question 7

Diversification eliminates all the risk from your portfolio.

Accepted Answer

While diversification can reduce risk by spreading investments across different asset classes and sectors, it is not foolproof and cannot eliminate all risk. Market-wide events, economic downturns, and other factors can still have an impact on investments, even those that are diversified.

Question 8

Market risk is the risk of fluctuations in security prices due to changes in the market interest rate.

Accepted Answer

Market risk is the risk of fluctuations in security prices due to changes in the overall market, not just the market interest rate.

Question 9

If the nominal rate is 10% and inflation is 3%,the real rate of return is 7%.

Accepted Answer

The real rate of return is calculated by subtracting the inflation rate from the nominal rate. Therefore, 10% - 3% = 7%.

Question 10

During times of rising inflation,investments with fixed returns like a bond or bank CD are attractive investments to own.

Accepted Answer

During times of rising inflation, investments with fixed returns like bonds or bank CDs have a lower purchasing power due to the devaluation of the currency. Investors may look for other options like stocks or commodities that have the potential to provide higher returns to stay ahead of inflation.

Question 11

The risk associated with the use of debt by the firm is business risk.

Accepted Answer

The risk associated with the use of debt by the firm is referred to as financial risk, not business risk. Business risk is related to the firm's operations.

Question 12

You purchase shares of BH Inc.at the beginning of the year for $30 per share.After receiving dividends of $4 per share,you sell at the end of the year for $20 per share.What is your one year rate of return?

Accepted Answer

To calculate one year rate of return, we need to subtract the initial cost of the shares from the total amount received at the end of the year and divide the result by the initial cost.

Initial cost = $30 per share 
Dividends received = $4 per share 
Amount received at the end of the year = $20 per share

Total return = dividends received + amount received at the end of the year
= $4 + $20 = $24 per share

One year rate of return = (total return - initial cost)/initial cost x 100
= ($24 - $30)/$30 x 100
= -$6/$30 x 100
= -20%

Therefore, the correct answer is B, which represents a negative rate of return of 20%.

Question 13

The higher your marginal tax bracket,the less attractive tax-free investments become.

Accepted Answer

Tax-free investments become more attractive as your marginal tax bracket increases because they allow you to avoid paying higher taxes on investment income.

Question 14

The real rate of return can never be a negative number.

Accepted Answer

The real rate of return can be negative if the nominal return is less than the rate of inflation, effectively reducing the purchasing power of the investment returns.

Question 15

The real rate of return is the nominal rate of return adjusted for inflation.

Accepted Answer

The real rate of return takes into account the impact of inflation on the nominal rate of return, which means it adjusts for inflation. Therefore, the real rate of return is the nominal rate of return adjusted for inflation.

Question 16

One of the most important types of risk associated with real estate is the liquidity risk.

Accepted Answer

Liquidity risk refers to the risk of not being able to sell an asset quickly enough to meet financial obligations or take advantage of other investment opportunities. Real estate, especially if it is a unique or specialized property, may not be easily sold or may take a long time to sell, making it a particularly high-risk asset in terms of liquidity.

Question 17

Some types of investments expose you to multiple sources of risk.

Accepted Answer

Many types of investments, such as stocks and mutual funds, are exposed to multiple sources of risk such as market risk, inflation risk, interest rate risk, and company-specific risk.

Question 18

Market risk deals with the inability to sell a security quickly at fair market value.

Accepted Answer

Market risk, also known as systematic risk, refers to the risk of losses in investments due to factors that affect the overall performance of the financial markets, such as economic downturns, political instability, or changes in interest rates, not the inability to sell a security quickly at fair market value, which is more closely related to liquidity risk.

Question 19

When it comes to tax advantages,capital gains and dividend income are taxed at a lower rate than ordinary income.

Accepted Answer

Capital gains and dividend income are subject to a lower tax rate compared to ordinary income. This is intended to incentivize investment and encourage long-term financial growth.

Question 20

The nominal rate of return is simply the real rate of return minus the inflation rate.

Accepted Answer

The nominal rate of return is the amount of money generated by an investment before adjusting for inflation, whereas the real rate of return is the nominal rate adjusted for the effects of inflation.

Quiz 11: Investment Basics