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1 Personal Finance Practice Final Exam Name: ________________________________________________ • You have 2.5 hours for the exam. • Write your answers in the space provided. • The exam is divided into 3 parts. In Part I, there are multiple choice questions. In Part II, there are short-answer questions. In Part III, there are long questions asking for multiple calculations. • Please read ALL of the information provided in the questions. • You are allowed 2 pages (one sided, regular size) of notes. Otherwise this is a closed-book exam. Accessing extra information, for example via your iPhone or iPad, or asking classmates is considered cheating. • Some scrap pages are provided at the end of the exam. The scrap pages will not be graded. • Good luck!
2 Section I. Multiple Choice Please circle the correct answer for each of the following questions. Note that there is only one correct answer for each question. Each question is worth 2 points. 1. Which of the following statements is true about the balance of a single deposit in an interest earning savings account? (Only one is true.) A) The balance will not grow exponentially because multiple deposits are required to achieve exponential growth. B) The balance will grow exponentially, but only if the interest rate increases so that the dollar amount of interest earned increases. C) The balance will grow exponentially, but only if the interest rate is high enough. D) If the balance doubles after 15 years, it will more than triple after 30 years because of compound interest. 2. Which of the following about Perkins loans is false ? (Only one is false) A) No interest accrues on the loan while a student is in school, and repayment does not begin immediately after a student graduates, but following a grace period after graduation. B) The effect of subsidized interest and the grace period is that the implicit interest rate on the loan decreases below the stated APR. C) If a Perkins loan did not have a grace period, but no interest accrued and no payments were due while the student is in school, the implicit rate on the loan would be equal to the stated APR. D) If interest on a Perkins loan did accrue while the student is in school and throughout the grace period, but no payments were required while the student is in school or through the 9-month the grace period, the implicit interest rate on the loan would be equal to the stated APR.
3 3. Which of the following is true of the amortization of an installment loan with monthly payments? (Only one is true.) A) The monthly payment increases over time. B) The principal portion of the monthly payment decreases over time. C) The interest portion of the monthly payment increases over time. D) The interest portion of the monthly payment decreases over time. 4. Which of the following statements about mortgage refinancing is true ? (Only one is true.) A) Refinancing is always a bad idea because of the large closing costs. B) If the interest rate has dropped by at least 0.25%, refinancing is always a good deal because the lower future monthly payments will make up for all other costs. C) With all other things being equal, refinancing a mortgage is more likely to be a good deal if the borrower still has many years left on the mortgage and plans to stay in the home for a long time after refinancing. D) Refinancing is only a good deal if the borrower did not take any mortgage points on the original mortgage but takes at least two points during the refinance. 5. Which of the following statements is true ? (Only one is true.) A) It’s only a good idea to buy a stock if you believe you will be able to sell it to somebody else at a higher price at a later date. B) Generally, a stock issued by a company is safer than a bond because stockowners may achieve very high returns if the company performs well, while bondholders’ returns are limited by the coupon rate of the bond. C) Mutual funds provide superior diversification benefits than index funds because, in the U.S., index funds are legally required to only invest in the stocks of the largest 100 companies. D) Some studies find that mutual fund managers are not able to outperform the market regularly after considering transaction costs. This evidence that supports the efficient market hypothesis.
4 6. Which of the following statements about Social Security is true ? (Only one is true) A) Social Security is necessarily a bad deal because the return implied by Social Security is usually lower than the historical return on stocks. B) Collecting Social Security early is never a good idea because the drop in annual benefits from collecting early outweighs the ability to collect a few extra years’ worth of benefits. C) With all else being equal, Social Security benefits retirees with above-average life expectancies more than retirees with average life expectancies. D) Social Security is the best asset for retirees because it is not subject to financial risk, longevity risk, inflation risk, or any other risk. 7. Which of the following statements is false? (Only one is false) A) A retiree may die before using all of his or her retirement funds. This is an example of longevity risk . B) Because stock prices fluctuate often, an investor may be forced to sell his or her stock at a price lower than that at which it was purchased. This is an example of financial risk . C) Corporations below investment grade have a higher risk of defaulting on their debt obligations than investment grade corporations. An investor that buys the bond of such a company may not receive the contractual payments promised by the bond in the event of such a default. This is an example of default risk . D) If the cost of living increases faster than expected, a retiree may be unable to purchase as much as he or she planned during retirement. This is an example of inflation risk .
5 8. Which of the following statements is false ? (Only one is false.) A) For a given change in interest rates, duration provides a better approximation for the change in a bond’s price for a long-term bond than for a short-term bond. B) The duration of a bond may be equal to its maturity. C) For a given change in interest rates, the new price of a bond estimated using duration will always underestimate the actual new price of the bond (calculated by taking the present value of the cash flows). D) The price of a longer-term bond is more sensitive to interest rate changes. 9. Which of the following statements is true ? (Only one is true.) A) An investor may reduce the standard deviation of the returns on his or her portfolio by buying several shares of the same company’s stock. B) An investor may completely eliminate financial risk in a U.S. stock portfolio by diversifying across a sufficient number of stocks. C) Risk diversification is only effective if two assets are positively correlated (i.e. have a correlation coefficient of greater than zero). D) If two asset classes are uncorrelated, the standard deviation of returns on a portfolio weighted equally between these two assets will be less than it would be if the two assets were perfectly, positively correlated. 10. Which of the following statements is false ? (Only one is false.) A) With all else equal, an immediate life annuity is less expensive than a deferred life annuity because of the time value of money. B) A life annuity can be purchased to insure against longevity risk. C) A variable annuity indexed to the performance of the stock market is subject to financial risk, but a fixed annuity is not. D) The implied return received on a fixed life annuity depends on how long the annuitant (the purchaser of the annuity) lives.
6 Section II. Short Answer Please write your answers to the following questions in the spaces provided. Please show your work if you wish to receive partial credit. Each question is worth 3 points. 11. A worker is saving for a down payment on a house. If the down payment will be $40,000 and she can earn 5% interest on her savings, how much must she set aside today to make the down payment in 10 years? Answer: ______________ 12. Max borrows $400 for two weeks from a local payday lender. His fee for borrowing the $400 for two weeks is $56, which is due in two weeks along with the original $400. What is the APR on this payday loan? Answer: ______________
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