2013 Personal Finance Final: Savings Vehicles

2.

Jacob has $5,000 that he has saved from doing odd jobs around the neighborhood. When he graduates from college in four years, he would like to have $10,000 to use as a down payment on a new car. If Jacob is going to realize his dream, what interest rate will he have to invest his money at?

18%
50%
.06%
None of the above

Correct Answer

A. 18%

Explanation

Jacob has $5,000 and wants to double it to $10,000 in four years. To determine the interest rate he needs, we can use the compound interest formula: A = P(1 + r/n)^(nt), where A is the final amount, P is the principal amount, r is the annual interest rate, n is the number of times the interest is compounded per year, and t is the number of years. In this case, P = $5,000, A = $10,000, and t = 4. By rearranging the formula and substituting the given values, we can solve for r. The only answer choice that matches the calculated interest rate is 18%.

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3.

A deferred compensation plan, such as a 401(k) _____

Is an arrangement between an employer and employee under which a portion of employee's pay is withheld and paid out a future date with earnings.
Allows an employee to make pre-tax contributions to an account that may be matched, in part, by the employer.
Pushes the tax liability to a future date when the money is withdrawn.
All of the above

Correct Answer

A. All of the above

Explanation

A deferred compensation plan, such as a 401(k), is an arrangement between an employer and employee where a portion of the employee's pay is withheld and paid out at a future date with earnings. This plan allows an employee to make pre-tax contributions to an account, which may be matched by the employer. Additionally, it pushes the tax liability to a future date when the money is withdrawn. Therefore, all of the above statements are true.

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4.

This type of savings vehicle requires a minimum amount to open, has a short term, and restricts the number of withdrawals you can make.

Passbook Savings
IRA
MMA
CD

Correct Answer

A. MMA

Explanation

A Money Market Account (MMA) is a type of savings vehicle that requires a minimum amount to open, has a short term, and restricts the number of withdrawals you can make. This type of account typically offers higher interest rates than a regular savings account and provides more flexibility than a Certificate of Deposit (CD) or an Individual Retirement Account (IRA). Therefore, MMA is the correct answer.

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5.

Which of the following is most liquid?

Certificate of deposit
Money market account
Savings account
All the above

Correct Answer

A. Savings account

Explanation

A savings account is the most liquid option among the given choices. Liquidity refers to the ease with which an asset can be converted into cash without causing significant price changes. A savings account allows individuals to deposit and withdraw money easily, without any penalties or restrictions. On the other hand, a certificate of deposit (CD) has a fixed term and early withdrawal may result in penalties. A money market account also has limitations on the number of transactions and may require a minimum balance. Therefore, a savings account provides the highest level of liquidity compared to the other options.

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6.

The strategy that maximizes your return with CD laddering involves the following:

Spreading money across several CDs that have different term or maturity dates
Placing all your money in the shortest-term CDs and when it matures, laddering up to longer-term ones.
Shopping the market for the best rates or highest rung rate across various financial institutions.
None of these strategies.

Correct Answer

A. Spreading money across several CDs that have different term or maturity dates

Explanation

The correct answer is spreading money across several CDs that have different term or maturity dates. This strategy allows for diversification and reduces the risk of having all the funds locked in one CD. By laddering the CDs, you can take advantage of higher interest rates as longer-term CDs usually offer higher returns. Additionally, shopping the market for the best rates ensures that you get the most favorable terms for your investments.

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7.

What is the relationship between the interest rate and liquidity of savings vehicles/

The interest rate is a product of liquidity.
Higher interest rates are offered in exchange for lower liquidity.
There is no correlation between these factors.
Higher interest rates are offered in exchange for higher liquidity.

Correct Answer

A. Higher interest rates are offered in exchange for lower liquidity.

Explanation

The relationship between the interest rate and liquidity of savings vehicles is that higher interest rates are offered in exchange for lower liquidity. This means that when savings vehicles have higher interest rates, they typically have less flexibility or accessibility for withdrawing funds. In other words, if someone wants a higher return on their savings, they may have to accept less immediate access to their money.

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8.

The strategy that maximizes your return with CD laddering involves the following:

Spreading money across several CDs that have different maturity dates.
Placing all your money in the shortest-term CD and when it matures, laddering up to longer-term ones.
Shopping the market for the best rates or highest rung rate across various financial institutions.
None of these strategies

Correct Answer

A. Spreading money across several CDs that have different maturity dates.

Explanation

The correct answer is spreading money across several CDs that have different maturity dates. This strategy, known as CD laddering, allows for diversification and flexibility. By investing in multiple CDs with varying maturity dates, you can ensure that you have access to a portion of your funds at regular intervals while still benefiting from higher interest rates on longer-term CDs. This strategy also allows you to take advantage of potential rate increases in the future by reinvesting the funds from maturing CDs into longer-term ones. Overall, CD laddering maximizes your return by balancing liquidity and higher interest rates.

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9.

Contributions to a deferred compensation plan, e.g., 401(k) plan, are made with after-tax dollars.

True
False

Correct Answer

A. False

Explanation

Contributions to a deferred compensation plan, such as a 401(k) plan, are not made with after-tax dollars. In fact, these contributions are typically made with pre-tax dollars, meaning that the money is deducted from an individual's salary before taxes are calculated. This allows individuals to reduce their taxable income and potentially lower their overall tax liability. Therefore, the correct answer is False.

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10.

What is the most significant distinction between a traditional IRA and a Roth IRA?

Both allow the investor to set aside pre-tax dollars.
Retirement-age withdrawals are taxed on a traditional IRA, but not on a Roth.
A Roth requires the investor to have earned income, but a traditional IRA does not.
There is no difference, other than the Roth name was added in honor of the deceased Senator who authored the legislation to create this account.

Correct Answer

A. Retirement-age withdrawals are taxed on a traditional IRA, but not on a Roth.

Explanation

The most significant distinction between a traditional IRA and a Roth IRA is that retirement-age withdrawals are taxed on a traditional IRA, but not on a Roth. This means that when an individual withdraws money from a traditional IRA during retirement, they will have to pay taxes on the amount withdrawn, whereas withdrawals from a Roth IRA are tax-free. This key difference impacts the overall tax implications and potential benefits of each type of account for retirement planning.

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11.

EE and I Bonds offer the following benefits:

Interest is exempt from local, state and federal taxes if used for qualifying educational expenses
Earn interest for up to 30 years
May be redeemed at any time after the initial 12-month holding period
All of the above

Correct Answer

A. All of the above

Explanation

EE and I Bonds offer the benefits of having interest that is exempt from local, state, and federal taxes if used for qualifying educational expenses. Additionally, they earn interest for up to 30 years and can be redeemed at any time after the initial 12-month holding period. Therefore, the correct answer is "all of the above."

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12.

Saving vehicles by definition are designed to minimize risk versus investment vehicles which tend to have greater earnings and risk potential.

True
False

Correct Answer

A. True

Explanation

Saving vehicles are designed to minimize risk, meaning they are intended to provide a safe and secure way to save money. On the other hand, investment vehicles, such as stocks or mutual funds, tend to have greater earnings potential but also come with higher risk. Therefore, the statement that saving vehicles are designed to minimize risk compared to investment vehicles is true.

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2013 Personal Finance Final: Savings Vehicles

The average stock market return spanning the 86 years from 1926-2012 has approximated 9%. According tp the Rule of 72, how often will an individual's investment double in that time?

Quiz Preview

Jacob has $5,000 that he has saved from doing odd jobs around the neighborhood. When he graduates from college in four years, he would like to have $10,000 to use as a down payment on a new car. If Jacob is going to realize his dream, what interest rate will he have to invest his money at?

A deferred compensation plan, such as a 401(k) _____

This type of savings vehicle requires a minimum amount to open, has a short term, and restricts the number of withdrawals you can make.

Which of the following is most liquid?

The strategy that maximizes your return with CD laddering involves the following:

What is the relationship between the interest rate and liquidity of savings vehicles/

The strategy that maximizes your return with CD laddering involves the following:

Contributions to a deferred compensation plan, e.g., 401(k) plan, are made with after-tax dollars.

What is the most significant distinction between a traditional IRA and a Roth IRA?

EE and I Bonds offer the following benefits:

Saving vehicles by definition are designed to minimize risk versus investment vehicles which tend to have greater earnings and risk potential.