17.2 How Households Supply Financial Capital & 17.3 How to Accumulate Personal Wealth

What refers to the total rate of return, including capital gains and interest paid?

actual rate of return; The actual rate of return refers to the total rate of return, including capital gains and interest paid on an investment at the end of a period of time.

True or false? A contributing factor to the housing bubble in the early 2000s was a lack of credit risk assessment which hurt investors of mortgage-backed securities.

True; Lenders sold mortgages to financial companies who did not assess the credit risk associated with mortgage-backed securities. The result was a bust in housing prices that weakened bank and household finances.

True or false? Mutual funds are funds that buy a range of stocks or bonds from different companies, thus allowing an investor an easy way to diversify.

True; Mutual funds are funds that buy a range of stocks or bonds from different companies, thus allowing an investor an easy way to diversify. Each year, banks and other financial companies typically offer a wide range of mutual funds comprised of a range of stocks and bonds from a variety of different companies.

If one were to open a 5-year CD for $1000 that pays 2% interest, compounded annually, what is the value of that CD at the end of the 5 years? Do not round intermediately. Round the final answer to the nearest cent.

$1104.08; Compound interest is an interest rate calculation on the principal plus the accumulated interest. To find the future value of an investment that compounds annually, use the formula below: Future Value = Principal × (1+Interest Rate)^Time For the investment above, Future Value = $1,000 × (1+.02)^5 ≈ $1,104.08

A _____________ works like a credit card, except that purchases are immediately deducted from your checking account rather than billed separately through a credit card company.

debit card; A debit card is a card which works like a credit card, except that purchases are immediately deducted from your checking account rather than billed separately through a credit card company.

A bond has a _______________, which is the date at which the borrower will pay back the face value of the bond as well as its final interest payment.

maturity date; A bond has a maturity date, which is the date at which the borrower will pay back the face value of the bond as well as its final interest payment.

If stocks follow a random walk, then who is able to choose the stocks that will beat the average consistently?

none of the above; If stocks follow a random walk, then not even financial professionals will be able to choose those that will beat the average consistently. While some investment advisers are better than average in any given year, and some even succeed for a number of years in a row, the majority of financial investors do not outguess the market.

Which answer below is not one of the three components of a bond interest rate?

pays face value before maturity date; An investor who buys a bond expects to receive a rate of return. However, bonds vary in the rates of return that they offer, according to the riskiness of the borrower. We can divide a bond's interest rate into three components: compensation for delaying consumption, an adjustment for an inflationary rise in the overall level of prices, and a risk premium that takes the borrower's riskiness into account.

A financial intermediary is an institution that operates between a ________________ who deposits funds in a bank and a ________________ who receives a loan from that bank.

saver; borrower ; A financial intermediary is an institution that operates between a saver who deposits funds in a bank and a borrower who receives a loan from that bank. Banks are a financial intermediary because they stand between savers and borrowers. Savers place deposits with banks, and then receive interest payments and withdraw money. Borrowers receive loans from banks​​​​​​​ and repay the loans with interest.

A __________ typically pays some interest rate, but getting the money typically requires you to make a trip to the bank or an automatic teller machine (or you can access the funds electronically).

savings account; A savings account typically pays some interest rate, but getting the money typically requires you to make a trip to the bank or an automatic teller machine (or you can access the funds electronically).

Bob is nearing retirement and owns his own home. He is looking to invest some money to use for retirement. Which of the following investment opportunities would be the most risky for Bob?

stocks; Tradeoffs between risk and return must be considered in the context of where the investor is in life. For example, a person near retirement age, who already owns a house, may prefer reduced risk and certainty about retirement income. Stocks are risky in the short term, so if Bob is wanting to have a high return sooner rather than later, stocks are the most risky investment for him to make at this point in time.

Edward just bought a house for $750,000 by putting 15% as a down payment and borrowing the rest from the bank. What is the equity that Edward currently has in his home?

$112,500 ; Real estate equity is the market value of the house minus what is still owed to the bank. Edward put down 15% as the down payment. To determine, the amount that Edward owes to the bank, we must first calculate his down payment. $750,000×.15=$112,500 The value of the house is $750,000. After putting $112,500 down, Edward owes $637,500 to the bank. Therefore, his equity is $112,500.

What is the total amount collected from a $12,000 loan after three years with a simple interest rate of 5%?

$13800 ; Simple interest is an interest rate calculation only on the principal amount. To find the simple interest and total value on a loan, use the formulas below: Simple Interest = Principal × Rate × Time Total Value = Principal + Simple Interest For the example above, Simple Interest = ($12,000×.05×3) = $1800 Total Value = $12,000 + $1800 = $13,800

What is the total value collected from a $1500 loan after three years with a simple interest rate of 3%?

$1635 ; Simple interest is an interest rate calculation only on the principal amount. To find the simple interest and total value on a loan, use the formulas below: Simple Interest = Principal × Rate × Time Total Value = Principal + Simple Interest For the example above, Simple Interest = ($1500×.03×3) = $135 Total Value = $1500 + $135 = $1635

David just bought a house for $600,000 by putting 40% as a down payment and borrowing the rest from the bank. What is the equity that David has in his home?

$240,000 ; Real estate equity is the market value of the house minus what is still owed to the bank. To determine, the amount that David owes to the bank, we must first calculate his down payment. $600,000×.40=$240,000 The value of the house is $600,000. After putting $240,000 down, David owes $360,000 to the bank. Therefore, his equity is $240,000.

Freda bought a house for $150,000 in cash, but if she were to sell it now, it would sell for $250,000. What is the equity that Freda has in her home?

$250,000; Real estate equity is the market value of the house minus what is still owed to the bank. The value of Freda's house is $250,000. It does not matter what price she bought it for. She owes zero to the bank, so her equity is the whole $250,000

Marshall just bought a house for $156,000 by putting 20% as a down payment and borrowing the rest from the bank. What is the equity that Marshall has in his home?

$31200; Real estate equity is the market value of the house minus what is still owed to the bank. Marshall put down 20% as the down payment. To determine, the amount that Marshall owes to the bank, we must first calculate his down payment. $156,000×.20=$31,200 The value of the house is $156,000. After putting $31,200 down, Marshall owes $124,800 to the bank. Therefore, his equity is $31,200.

If one were to open a 5-year CD for $3,000 that pays 4% interest, compounded annually, what is the value of that CD at the end of the 5 years? Do not round intermediately. Round the final answer to the nearest cent.

$3649.96 ; Compound interest is an interest rate calculation on the principal plus the accumulated interest. To find the future value of an investment that compounds annually, use the formula below: Future Value = Principal × (1+Interest Rate)^Time For the investment above, Future Value = $3,000 × (1+.04)^5 ≈ $3,649.96

What is the total amount collected from a $3500 loan after two years with a simple interest rate of 7%?

$3990; Simple interest is an interest rate calculation only on the principal amount. To find the simple interest and total value on a loan, use the formulas below: Simple Interest=Principal×Rate×Time Total Value=Principal+Simple Interest For the example above, Simple Interest=($3500×.07×2)=$490 Total Value=$3500+$490=$3990

If one were to open a 10-year CD for $30,000 that pays 4% interest, compounded annually, what is the value of that CD at the end of the 10 years? Do not round intermediately. Round the final answer to the nearest cent.

$44407.33 ; Compound interest is an interest rate calculation on the principal plus the accumulated interest. To find the future value of an investment that compounds annually, use the formula below: Future Value=Principal×(1+Interest Rate)Time For the investment above, Future Value=$30,000×(1+0.04)10≈$44,407.33

What is the total value collected from a $5500 loan after three years with a simple interest rate of 3%?

$5995; Simple interest is an interest rate calculation only on the principal amount. To find the simple interest and total value on a loan, use the formulas below: Simple Interest = Principal × Rate × Time Total Value = Principal + Simple Interest For the example above, Simple Interest=($5500×.03×3)=$495 Total Value=$5500+$495=$5995

If one were to open a 4-year CD for $7,000 that pays 2% interest, compounded annually, what is the value of that CD at the end of the 4 years? Do not round intermediately. Round the final answer to the nearest cent.

$7,577.03 ; Compound interest is an interest rate calculation on the principal plus the accumulated interest. To find the future value of an investment that compounds annually, use the formula below: Future Value = Principal × (1+Interest Rate)^Time For the investment above, Future Value = $7,000 × (1+0.02)^4 ≈ $7,577.03

Stock prices rose pretty dramatically over which of the following time periods?

1980s to 2000; The trend in the stock market is generally up over time, but with some large dips along the way. Stock prices did not rise much in the 1970s but then started a steady climb in the 1980s, ultimately rising dramatically from the 1980s up to about 2000.

What is the current yield for a bond with a current price of $1,600, a face value of $1,500, and a coupon rate of 4%? Round your answer to the nearest tenth.

3.8% ; A bond's current yield is the annual rate of return the bond is expected to pay at the time of purchase. We know that: current bond yield = annual interest payment / current bond price × 100 To find current yield for this bond, we first calculate the annual interest payment: annual interest payment = (face value×interest rate) =($1,500×.04) = $60 Then, we can simply plug this value into the formula for current yield and solve: current bond yield = $60 / $1,600 × 100 = 3.8%

What is the current yield for a bond with a current price of $1,200, a face value of $1,600, and a coupon rate of 5%? Round your answer to the nearest tenth.

6.7% ; A bond's current yield is the annual rate of return the bond is expected to pay at the time of purchase. We know that: current bond yield = annual interest payment / current bond price × 100 To find current yield for this bond, we first calculate the annual interest payment: annual interest payment = (face value×interest rate) =($1,600×.05) = $80 Then, we can simply plug this value into the formula for current yield and solve: current bond yield = $80 / $1,200×100 = 6.7%

What is the current yield for a bond with a current price of $1,100, a face value of $1,000, and a coupon rate of 8%? Round your answer to the nearest tenth.

7.3%; A bond's current yield is the annual rate of return the bond is expected to pay at the time of purchase. We know that: current bond yield = annual interest payment / current bond price × 100 To find current yield for this bond, we first calculate the annual interest payment: annual interest payment = (face value×interest rate) =($1,000×.08) = $80 Then, we can simply plug this value into the formula for current yield and solve: current bond yield = $80 / $1,100 × 100 = 7.3%

What is the current yield for a bond with a current price of $1,600, a face value of $1,900, and a coupon rate of 7%? Round your answer to the nearest tenth.

8.313%; A bond's current yield is the annual rate of return the bond is expected to pay at the time of purchase. We know that: current bond yield = annual interest payment / current bond price × 100 To find current yield for this bond, we first calculate the annual interest payment: annual interest payment = (face value×interest rate) =($1,900×.07) = $133 Then, we can simply plug this value into the formula for current yield and solve: current bond yield=$133 / $1,600×100 = 8.3%

All of the following statements about mutual funds are true, except:

Diversification doesn't really offset much risk of individual stocks rising or falling.; Diversification can offset some of the risks of individual stocks rising or falling. Even investors who buy an indexed mutual fund designed to mimic some measure of the broad stock market, like the S&P 500, had better buckle their seatbelts against some ups and downs, like those the stock market experienced in the first decade of the 2000s.

Which stock index measures the stock market based on the stock prices of 30 large U.S. companies and representative industries?

Dow Jones Industrial Average; The Dow Jones Industrial Average is based on 30 large companies from a diverse set of representative industries, chosen by analysts at Dow Jones and Company. The index was started in 1896.

When mathematicians refer to "random walk with a trend", what does the "with a trend" refer to?

Stocks tend to gradually climb.; Because stock prices will shift in response to unpredictable future news, these prices will tend to follow what mathematicians call a "random walk with a trend." The "random walk" part means that, on any given day, stock prices are just as likely to rise as to fall. "With a trend" means that over time, the upward steps tend to be larger than the downward steps, so stocks do gradually climb.

Which of the following explains how the demand for housing impacted the housing bubble of the early 2000s?

The demand for housing increased, causing prices to rise, and more people borrowed money because of low interest rates.; The cumulative average annual growth rate in housing prices from 1981 to 2000 was 5.1%. The price of an average U.S. home then took off from 2003 to 2005, rising more than 10% per year. The sharp rise in housing prices was driven by a high level of demand for housing. Financial institutions encouraged people to borrow money because interest rates were so low, and banks loaned money with little to no down payment.

True or false? For young workers, just starting to make a reasonably profitable living, it may make sense to put most of their savings for retirement in mutual funds.

True; The high returns of stock market investments refer to a high average return that we can expect over a period of several years or decades. The high risk of such investments refers to the fact that in shorter time frames, from months to a few years, the rate of return may fluctuate a great deal. Thus, a person near retirement age, who already owns a house, may prefer reduced risk and certainty about retirement income. For young workers, just starting to make a reasonably profitable living, it may make sense to put most of their savings for retirement in mutual funds.

George is interested in investing his money in a high interest rate bond with little risk. Of the options below, which bond could provide George with a higher interest rate but low risk?

a bond from an established company that consistently earns profits; An established company will pay more interest on bonds than the U.S. Treasury. These bonds have lower rates of return than junk bonds, but that means they are also relatively safer. This type of bond would be a good fit for George's preferences.

Define risk.

a measurement of uncertainty of a project's or an investment's profitability; Risk measures the uncertainty of profitability of a project or an investment. There are several types of risk, including default risk and interest rate risk. Additionally, different types of investments carry different levels of risk, from low to high.

What is an index fund?

a mutual fund that seeks to mimic the stock market's overall performance; Mutual funds can focus in certain areas: one mutual fund might invest only in company stocks based in Indonesia, or only in bonds issued by large manufacturing companies, or only in biotechnology companies' stock. At the other end of the spectrum, a mutual fund might be quite broad. At the extreme, some mutual funds own a tiny share of every firm in the stock market, and thus the mutual fund's value will fluctuate with the overall stock market's average. We call a mutual fund that seeks only to mimic the market's overall performance an index fund.

A way to deposit savings at a bank is to use a _____________. With this, you agree to deposit a certain amount of money for a stated period of time. In exchange, the bank agrees to pay a higher interest rate than for a regular savings account.

certificate of deposit (CD); A way to deposit savings at a bank is to use a certificate of deposit (CD). With a CD, you agree to deposit a certain amount of money, often measured in thousands of dollars, in the account for a stated period of time, typically ranging from a few months to several years. In exchange, the bank agrees to pay a higher interest rate than for a regular savings account.

Bonds used to be paper documents with coupons that investors clipped and turned in to the bank to receive interest. What is the name of this bond interest rate?

coupon rate; A bond has a coupon rate or interest rate, which is usually semi-annual but can be paid at different times throughout the year. (Bonds used to be paper documents with coupons that investors clipped and turned in to the bank to receive interest.)

When it comes to investing, the principle of _______________ supports investing in a wide range of companies to reduce the level of risk.

diversification; Buying stocks or bonds issued by a single company is always somewhat risky. An individual firm may find itself buffeted by unfavorable supply and demand conditions or hurt by unlucky or unwise managerial decisions. Thus, a standard recommendation from financial investors is diversification, which means buying stocks or bonds from a wide range of companies. A saver who diversifies is following the old proverb: "Don't put all your eggs in one basket."