Module 1 Practice Test Flashcards
Which of the following are the three categories on a company’s cash flow statement?
A) operating activities, purchase activities, taxes
B) profit inflow, debt outflow, taxes
C) profitable activities, deficit activities, taxes
D) operating activities, investing activities, taxes
E) operating activities, investing activities, financing activities
E) Those are the three main figures by which net cash flow is calculated.
Which of the following statements BEST describes the difference between current and longterm
liabilities?
A) Current liabilities are debts that need to be paid immediately, whereas long-term liabilities do
not.
B) Current liabilities are those which will cost less in debt interest than long-term liabilities.
C) Current liabilities are debts that are settled sooner than long-term debts.
D) Current liabilities are debts on tangible assets, whereas long-term liabilities are debts on
intangible assets.
E) Current liabilities are debts on current assets, whereas long-term liabilities are debts on fixed
and intangible assets.
C) Current liabilities include accounts payable: unpaid bills to suppliers for
materials as well as wages and taxes that must be paid in the coming year. Long-term liabilities
are debts that are not due for at least a year.
Which are the two major fields of accounting? A) managerial and forensic B) financial and managerial C) bookkeeping and advisory D) corporate and individual E) public and private
B) The two fields of accounting can be classified according to the users they serve;
it is convenient and accurate to classify users as those outside the company and those inside the
company.
Which of the following statements is TRUE?
A) As common practice, a sales representative for a firm receives information from the firm’s
financial accounting system.
B) As common practice, a sales representative for a firm receives information from the firm’s
managerial accounting system.
C) As common practice, a sales representative for a firm receives information from both the
firm’s managerial accounting system and its financial accounting system.
D) As common practice, a sales representative for a firm receives information from the firm’s
revenue accounting system.
E) As common practice, a sales representative for a firm does not receive any information from
the firm’s accounting system.
B) The managerial accounting system is concerned with internal users.
Which of the following describes assets such as land, building, and equipment? A) liquid assets B) fixed assets C) intangible assets D) current assets E) limited assets
B) Fixed assets are tangible things of value.
Which of the following terms refers to the amount of money that owners would receive if they
sold all of a company’s assets and paid all of its liabilities?
A) asset
B) owners’ equity
C) inventory
D) liability
E) credit
B) Owners’ equity or stockholders equity is that value that represents the financial
stake in a company by the owners. Using the accounting equation A=L+OE => OE=A-L
Which of the following terms refers to the examination of a company’s accounting system to
determine whether its financial reports fairly represent its operations?
A) company-wide analysis
B) forensic accounting
C) portfolio analysis
D) audit
E) preliminary investigation
D) An audit is an examination by an external party to ensure that a company’s
financial reports are faithful and accurate.
Big Al’s Cheese is a cheese shop. In January, Al’s Cheese finds some excellent cheese called
Gouda from Holland. They buy $500 worth on credit, taking delivery in January, to pay Gouda
in 60 days (i.e. they will pay the supplier in March). In February they start to sell the cheese, and
deliver 60% of the cheese to their favorite customers for a 200% markup in February. The
customers pay immediately in cash. What is the Revenue, Income and Cash flow for Al’s
Cheese in February?
Revenue - Income - Cash flow
a) 900 - 400 - 900
b) 0 - 900 - 0
c) 900 - 600 - 400
d) 900 - 600 - 900
D) Cost of Goods Sold = 60% x $500 = $300 (only 60% of the cheese is sold, $200 remains to be
sold next month)
Revenue = $300 + ($300 x 200%) = $900 (the cost is marked up by 2 times (200%))
Cash flow = $900 (revenue is received immediately, costs to be paid in March)
Income = Revenues minus costs = $900 - $300 = $600
What is the point at which the supply curve and the demand curve intersect on a graph? A) equilibrium price B) decision point C) surplus price D) perfect price E) parity point
A) The equilibrium price is determined by the shape of the supply curve and the
demand curve when plotted by amount available and price. The equilibrium price is set at the
point at which the supply curve and the demand curve intersect.
What does a planned economy rely on a centralized government to do?
A) support free enterprise in every way possible
B) allocate all or most factors of production
C) encourage citizens to buy shares of stock in small companies
D) keep its control activities to a minimum
E) direct workers to start their own small businesses.
B) A centralized government controls all or most of the factors of production.
Which of the following terms refers to the percentage of its deposits a bank must hold, in
cash or on deposit, with a Federal Reserve bank?
A) discount rate
B) key rate
C) prime rate
D) federal insurance premium
E) reserve requirement
E) This is controlled by the Fed.
Assume that 10% reserve requirement has been imposed on banks. A client of Wells Fargo
discovers a $50 bill that has been lost for 100 years and therefore was not included in the money
supply statistics. He deposits the $50 in a checking account, which the bank relends to a new
client (minus the reserve requirement) in cash. What is the effect on the M-1 money supply?
a) There is no change in the M-1 Money supply
b) The M-1 Money supply increases by $50
c) The M-1 Money supply increases by $95
d) The M-1 Money supply increases by $100
C) M-1 increases by $50 (bank balance) + ($50*.9) (cash in hands of borrower) = $95
A jeweler assesses the value of a flawless white diamond as considerably more than that of a
rhinestone. Which function of money does this illustrate?
A) foundation of banking
B) medium of exchange
C) store of value
D) measure of worth
E) stabilization of value
D) Money lets us measure the value of goods and services.
Which of the following statements BEST describes why a decrease in reserve requirements
often results in an increase in the money supply?
A) A decrease in reserve requirements gives banks more money to better determine their interest
rates.
B) A decrease in reserve requirements gives banks more money to pay off their debts.
C) A decrease in reserve requirements gives banks more money to lend out.
D) A decrease in reserve requirements gives banks more money to offer in dividend payments to
their clients.
E) A decrease in reserve requirements gives banks more money to reward their employees for
meritorious financial ventures.
C) A decrease in the reserve requirement “frees up” extra money that can be
distributed in the form of loans, for example.
Which of the following is NOT part of the M-1 supply?
A) currency at hand
B) currency amount of written checks
C) currency available through a debit card
D) currency in checking accounts
E) currency value of time deposits
E) M-1 includes only the most liquid forms of money: cash, checks, and checking
accounts.
When thinking about exchange rates, a cheap dollar relative to the Euro is best for
a) US tourists visiting Euro zone countries
b) US exporters selling into the Euro Zone
c) European companies seeking to sell imports into the USA
d) Japanese tourists visiting Europe
B) a given number of euros buys more in dollars, so the Europeans are encouraged to
buy more US products.
Who is the Governor of the Bank of England
a) Mario Draghi
b) Mark Carney
c) Silvio Berlusconi
d) Jacob Lew
B
A person seeking to plan their retirement will be able to save the lowest proportion of their income and meet income replacement goals if they
a) begin saving at 35 and retire at 62
b) begin saving at 25 and retire at 62
c) begin saving at 35 and retire at 65
d) begin saving at 25 and retire at 65
D) Most years saving and least years retired will lead to the lowest required savings
rate.
A person invests $100 for 3 years at the prevailing interest rate of 15%. The future value of the investment is closest to….
a) $68
b) $100
c) $145
d) $152
D) 100 with simple interest (no compounding) will give $145. With compounding it must be slightly higher, but cannot be lower. Therefore $152 must be the correct answer.
The following are all sources of cash in the Capsim finance screen except
a) Paying dividends
b) Selling unwanted production capacity
c) Issuing Long Term Debt
d) Issuing Stock
A) Dividends are cash out of the company.
Growth Revised to 4.6%, Brightening the Outlook
New York Times / ASSOCIATED PRESS
SEPT. 26, 2014
WASHINGTON — The bounce-back in the United States’ economy last quarter from a dismal winter was even faster than previously thought, a sign that growth will most likely remain solid for the rest of the year. The economy as measured by gross domestic product grew at a 4.6 percent annual rate in the April-June quarter, the Commerce Department said on Friday. It was the fastest pace in more than two years and was higher than the government’s previous estimate of 4.2 percent. The upward revision reflected stronger-than-expected business investment and exports last quarter. The healthy second-quarter growth was a sharp rebound from the January-March quarter, when the economy shrank at a 2.1- percent rate during a brutal winter that idled factories and kept consumers at home.
GDP is defined as
a) Gross national product divided by national population
b) The total value of all goods and services produced within a given period by a national
economy through domestic and international factors of production
c) The total value of all goods and services produced within a given period by a national
economy through domestic factors of production
d) The total value of all goods and services produced within a given period by a national
economy through international factors of production
C
Growth Revised to 4.6%, Brightening the Outlook
New York Times / ASSOCIATED PRESS
SEPT. 26, 2014
WASHINGTON — The bounce-back in the United States’ economy last quarter from a dismal winter was even faster than previously thought, a sign that growth will most likely remain solid for the rest of the year. The economy as measured by gross domestic product grew at a 4.6 percent annual rate in the April-June quarter, the Commerce Department said on Friday. It was the fastest pace in more than two years and was higher than the government’s previous estimate of 4.2 percent. The upward revision reflected stronger-than-expected business investment and exports last quarter. The healthy second-quarter growth was a sharp rebound from the January-March quarter, when the economy shrank at a 2.1- percent rate during a brutal winter that idled factories and kept consumers at home.
All of the following statements are true with regard to the above article except
a) The commerce department initially underestimated the rate of GDP growth in April-June
b) The shrinkage of the economy in January-March is thought to be due to bad weather
c) The upward revision of last quarter GDP was partly due to exports
d) The annual growth rate of 4.6% in the April-June quarter equates to a year on year
economic growth of 19.7% when compounding is taken into account
D) The quarterly growth has already been annualized – “gross domestic product grew at a 4.6 percent annual rate in the April-June quarter”.
Sam’s Pizza pays $800 fixed rent per month and each pizza costs $3 in ingredients and
hourly paid labor. Pizzas sell for $5 per pizza - what is the break even number of pizzas for
Sam’s pizza?
a) 400 pizzas
b) 267 pizzas
c) 667 pizzas
d) 500 pizzas
A) CM per unit = price minus variable cost per unit = $5-$3 = $2
Profit = volume x CMPU – fixed_cost => Volume_BE = fixed_cost/CMPU = 800/2 = 400 u
Sam’ Pizza pays $800 fixed rent per month and each pizza costs $3 in ingredients and hourly
paid labor. Pizzas sell for $5 per pizza. If Sam’s sells 500 pizzas, what is the total contribution
margin and what is the profit (ignore taxes)?
Contribution margin - Profit
a) $1000 - $0
b) $1500 - $700
c) $1000 - $200
d) $1500 - $500
C) Total_CM = $2 x 500 = $1000
Profit = volume x CMPU – fixed_cost = Total_CM – fixed_cost = $1000 – 800 = $200
Kim has investments in stocks, and wants to calculate her total return. What should she do?
A) Divide the yearly dollar amount of dividend income by the investment’s current market value.
B) Compare the dividend against current yields from other investments.
C) Subtract the cost of the stock from what she sold it for.
D) Divide the current dividend payment plus capital g
D) Total return is the sum of current dividend plus capital gain, divided by the
original investment. It is expressed as a percentage.
What is the formula for measuring a firm’s working capital?
A) current assets = working capital /current liabilities
B) working capital = current assets - current liabilities
C) current liabilities = current assets + working capital
D) working capital = current assets x current liabilities
E) current liabilities = current assets / working capital
B) Subtracting current liabilities from current assets lets you know how much
money a firm has to work with.
Financial Statement and ratio analysis: Use the following information on Peters Incorporated
Average stockholders' equity $10,000 Net income $ 1,500 Average total assets $15,000 Net sales $30,000 Current assets $10,000 Total liabilities $5,000 Current liabilities $2,000
What is the Return on equity for Peters? A) 2 B) 15% C) 5% D) 5
B) RoE = net income/equity = 1500/10000 = 15%
Financial Statement and ratio analysis: Use the following information on Peters Incorporated
Average stockholders' equity $10,000 Net income $ 1,500 Average total assets $15,000 Net sales $30,000 Current assets $10,000 Total liabilities $5,000 Current liabilities $2,000
What is the Asset Turnover for Peters? A) 2 B) 15% C) 5% D) 5
A) Asset Turnover = Sales/assets = 30000/15000 = 2
Which of the following is considered by many to be the BEST single indicator of the U.S. equities market? A) NASDAQ Composite B) Russell 2000 C) Dow Jones Industrial Average D) Standard & Poor's 500 E) New York Stock Exchange
D) The S&P 500 considers more companies than the Dow Jones, and so is
regarded as a better indicator.
What is the term for buying several different kinds of investments rather than just one? A) spreading B) shorting C) margin buying D) diversification E) management
D) The risk of loss is reduced by spreading the investment across asset classes and,
within those classes, different stocks and bonds.
Which of the following statements is true about common stocks as investments?
A) Stocks are among the riskiest of all investments.
B) Stocks are most suitable for investors who seek security.
C) Stocks will never become worth less than their purchase price.
D) Stock prices reflect only government action.
A) Stocks are a volatile and risky investment, and crashes can lead to sizable
losses.
Which of the following correctly describes a defined contribution (DC) pension scheme?
a) The pension is a guaranteed income which is paid unless the employer goes broke
b) The employee’s dollar ownership in the scheme is difficult to calculate due to actuarial
issues
c) The pension is entirely dependent on the money contributed by the employee, which is
repaid in retirement without loss or gain
d) The pension is entirely dependent on the money contributed by the employee and/or
employer, and the investment choices made by the employee to increase that money
D) The DC scheme allows the employee to choose the investments and benefit from
the returns, however the pension is not guaranteed. Options a and b describe a defined benefit
(DB) scheme.
Which of the following is an example of a psychological bias known to be a problem for investors a) profit affection b) bandwagon effect c) program trading d) dark pool effect
B
Jose is a recent college graduate who has been hired for an entry-level professional position in the accounting department of a large corporation. Which of the following terms BEST describes Jose's capacity as an accountant? A) public accountant B) private accountant C) forensic accountant D) advisory accountant E) management accountant
B) Most private accountants are also management accountants,
but not all.
A company’s owners established a company on January 1, investing $10,000 total into the
stockholders equity of the company. The company then made net income of $3,500 in the first
year. No dividends were paid. Its total liabilities stand at $7,000 on December 31 of the first
year. What is the value of the total assets of this company?
A) $500
B) $6,500
C) $13,500
D) $20,500
E) $27,500
D) SE = 10+3.5 (all profits retained as part of equity as no dividends were paid);
A = L+SE = 7 +13.5 =20.5
Who is the President of the European Central Bank?
a) Mario Draghi
b) Angela Merkel
c) Silvio Berlusconi
d) Jacob Lew
A
Which of the following statements is TRUE?
A) As common practice, a union representative for the workers at a firm receives information
from the firm’s financial accounting system.
B) As common practice, a union representative for the workers at a firm receives information
from the firm’s managerial accounting system.
C) As common practice, a union representative for the workers at a firm receives information
from both the firm’s managerial accounting system and its financial accounting system.
D) As common practice, a union representative for the workers at a firm receives information
from the firm’s forensic accounting system.
E) As common practice, a union representative for the workers at a firm does not receive any
information from the firm’s accounting system.
A) The financial accounting system is concerned with external users, such as
unions. “A firm’s financial accounting system is concerned with
external information users: consumer groups, unions…”
Which of the following refers to the financial statement detailing a firm's assets, liabilities, and owners' equity? A) income statement B) statement of cash flows C) balance sheet D) expense report E) annual budget
C) A balance sheet uses the accounting equation to show the current value of a
company
Which of the following terms refers to any economic resource that is expected to benefit a firm or individual who owns it? A) asset B) liability C) equity D) account E) deposit
A
Which of the following terms refers to the comprehensive system for collecting, analyzing, and communicating financial information? A) bookkeeping B) accounting C) controlling D) auditing E) budgeting
B
According to the standard rule of thumb of asset allocation, as investors near retirement they
should have
A) An increasing proportion of their investments in stocks
B) A decreasing proportion of their portfolio in stocks
C) A constant dollar amount of their portfolio in stocks
D) A constant percentage of their portfolio in stocks
B) Investors should consider investing about their age as a percentage in bonds, so as
age increases common stock proportion decreases
A customer has a bond fund which returns 1% before fees, and the fees/charges for the fund
are 1.5% of the investment per year. In 2009, the customer invests $10,000 in the fund. After
three years, the customer’s funds would be closest to:-
a) $9550
b) $9700
c) $9850
d) $10,150
C) 0.5% or about $50 lost per year
A person will receive $132 in 2 years while the prevailing interest rate is 15%. What is the present value of the payment? a) $100 b) $115 c) $132 d) $175
A) PV = FV/(1+r)^t = 132/1.15^2 = $100
Which of the following agencies guarantees the safety of all of its members' bank accounts? A) Internal Revenue Service B) Federal Open Market Committee C) Federal Reserve Bank D) Federal Deposit Insurance Corporation E) Federal Exchange Commission
D
Which of the following is a use of cash on the Capsim finance screen?
a) Promo budget
b) Selling unwanted plant and equipment
c) Retiring Long term Debt
d) Issuing Stock
C) Promo budget is not on the finance screen. Sales of equipment and issuance of
stock are both sources of cash
What is the price at which the quantity of goods demanded and the quantity of goods supplied are equal? A) the going rate B) the margin rate C) the market price D) the optimum price E) the cost price
C
Which economic system emphasizes the private ownership of most factors of production? A) Socialism B) Communism C) Capitalism D) Marxism E) Federalism
C
In terms of GDP, how does the US Economy compare?
a) The US economy is larger than all of the other economies combined and constitutes 80%
of World GDP
b) The US economy is the largest in the world, and is 80% larger than its nearest competitor
c) The US economy was the largest in the world but is now 2nd with 80% of the size of
China
d) The US economy is about half the size of the Chinese economy
B
Andrews Cheese is a cheese shop. In January, Andrews Cheese finds some excellent cheese
called Camembert. They buy $800 worth, taking delivery and paying in cash in January. In
February they start to sell the cheese, and deliver half of the cheese to their favorite customers
for a 50% markup (earning revenue of $600) in February. The customers must pay in 30 days
(so they will pay Andrews Cheese in March). What is the Revenue, Income and Cash flow for
Andrews Cheese in February?
Revenue / Income /Cash flow
a) 0 / -200 / 0
b) 600 / 400 / -800
c) 600 / 200 / 0
d) 600 / 200 / -200
C) Cost = half x 800 = 400
revenue = 400+(400*.5) = 600
income = 600-400 = 200
cash flow = there is none
Which of the following BEST describes what are called the “open-market operations” of the
Federal Reserve System?
A) the development of new financial opportunities for banks
B) the minting of new money to disperse into the money market
C) the control of interest rates among banks
D) the maintenance of a well-functioning lending system among banks
E) the buying and selling of securities
E) This allows the Fed to ensure an active market.
When thinking about exchange rates, an expensive dollar relative to the Euro is best for
a) European tourists visiting the USA
b) US exporters selling into the Euro Zone
c) Euro zone companies seeking to sell imports into the USA
d) Japanese tourists visiting the United States
C– a given number of dollars buys more in euros
David is saving $25 a week toward getting a new truck. Which function of money does this illustrate? A) stabilization of value B) foundation of banking C) medium of exchange D) store of value E) measure of worth
D) In the form of currency, money can be used for future purchases and thus
“stores” value.
Mick’s Pizza pays $1200 fixed rent per month and each pizza costs $2 in ingredients and
hourly paid labor. Pizzas sell for $5 per pizza - what is the break even number of pizzas for
Mick’s pizza?
a) 400 pizzas
b) 267 pizzas
c) 667 pizzas
d) 500 pizzas
A
Mick’s Pizza pays $1200 fixed rent per month and each pizza costs $2 in ingredients and hourly paid labor. If Mick’s sells 500 pizzas, what is the total contribution margin and what is the profit (ignore taxes)? Contribution margin / Profit a) $1200 / $0 b) $1500 / $700 c) $1000 / $200 d) $1500 / $300
D
Use the following information on Peters Incorporated to answer the next question: Average stockholders' equity $10,000 Net income $ 1,500 Average total assets $15,000 Net sales $30,000 Current assets $10,000 Total liabilities $5,000 Current liabilities $2,000
What is the Net profit margin for Peters?
a) 2
b) 15%
c) 5%
d) 5
C) Net profit margin = net income/sales = 1500/30000 = 5%
Use the following information on Peters Incorporated to answer the next question: Average stockholders' equity $10,000 Net income $ 1,500 Average total assets $15,000 Net sales $30,000 Current assets $10,000 Total liabilities $5,000 Current liabilities $2,000
What is the Current ratio for Peters?
a) 2
b) 15%
c) 5%
d) 5
D) Current ratio = Current assets/current liabilities
Which of the following statements is NOT true about dividend payments?
A) Many companies distribute between 30 and 70 percent of their profits to shareholders.
B) Some firms, especially fast-growing companies, do not pay dividends.
C) Many fast-growing companies use cash earnings for expanding the company so that future
earnings can grow even faster.
D) During unprofitable years, companies are still required by law to pay dividends to their
stockholders.
E) Dividend payments are made to stockholders on a per-share basis.
D) Companies are not compelled by law to pay dividends; stockholders receive
dividends only if the company makes money.
Twenty-six-year-old Lisa Lamont became an investor one day after a friend explained that
there was a much better way to make her money work for her than by letting it sit in a savings
account earning a very low rate of interest. Lisa decided to withdraw $10,000 from her savings
account and invest it in stocks. She wanted to invest it in such a way as to minimize her risk.
Which one of the following strategies makes the MOST sense for a new investor like Lisa?
A) Invest all $10,000 in a small fast-growing computer company.
B) Invest $5,000 in a gold mining company and $5,000 in a silver mine.
C) Invest the $10,000 in four different home builders.
D) Invest $10,000 in ten different oil companies.
E) Invest $10,000 in a large-cap mutual fund.
E) As a person investing in stocks for the first time, the possibility of losing money
can be scary. For peace of mind, the safest way to go is to choose maximum diversification. A
large-cap mutual fund offers this diversification, and large-cap companies offer potential capital
gains with less risk than small-cap companies.
What is the term for the proportion of funds invested in each of several investment alternatives or asset classes? A) spreading B) shorting C) margin buying D) asset allocation E) diversification
D) For example, you may decide to allocate $10,000 to common stocks, $5,000 to
a money market mutual fund, and $2,500 to a U.S. Treasury bond fund.
“I am a chemist with the nation’s largest chemical company. We have secretly developed a
cure for three of the world’s most serious epidemics. Before this news breaks out, I’m going to
buy as many shares of stock in my company as I can get my hands on. Then I’ll sit back and
watch the stock price head for the sky.” What is the person making this statement about to
engage in?
A) selling shares of stock
B) insider trading
C) blue-sky trading
D) open-market operations
E) investment banking
B) Insider trading is an illegal activity that occurs when individuals use special
knowledge about a firm for profit or gain.
Tonio has some stocks and is carefully watching the stock market. Which of the following
should he pay attention to in order to find out the performance of the largest companies?
A) Standard & Poor’s 500
B) the NYSE index
C) Dow Jones Industrial Average (Dow 30)
D) Moody’s Stock List
E) the NASDAQ
C) The Dow includes only 30 of the thousands of companies on the market, but
these companies are the largest and most important
A company holding a large proportion of cash will most likely have which of the following
characteristics
a) It will have little money available for investment
b) It will have a higher asset turnover than a similar company with no cash
c) The cash will tend to increase the company’s return on assets
d) The cash will tend to decrease the company’s return on assets
D. Cash has low returns compared to operating assets, as shown by the example of
Google.
Which of the following is an example of a psychological bias known to be a problem for investors a) profit affection b) market fluctuation effect c) loss aversion d) lack of liquidity
C
Read the following information about sub prime loans and then answer the next question:
Subprime loans have higher interest rates than conventional loans. Subprime loans are designed for borrowers with low credit scores who would not qualify for conventional loans. The borrower pays a higher rate
to compensate the lender for the greater risk of a default. Subprime loans typically have adjustable rates, meaning that the interest rate can change over the life of the loan. Borrowers who take out adjustable subprime loans
usually try to keep the rate as low as possible at the start of the loan, even when doing so would lead to higher payments over the entire life of the loan. After a large number of people defaulted on their subprime loans, research revealed that the majority of people who took out subprime loans could have qualified for conventional loans.
The statements above most strongly suggest that if all subprime loan borrowers had taken out
the loan that was most appropriate for their needs, then what would have been the outcome?
A) None of them would have taken out an adjustable loan.
B) None of them would have taken out a subprime loan.
C) Most of them would have paid less in interest.
D) Most of them would have taken out a conventional loan to cover any expenses not covered by
a subprime loan.
E) Most of them would have paid money at the start of the loan in order to get a reduced interest
rate over the life of the loan.
C) Subprime loans cost more than conventional loans, but most people who took
out subprime loans could have gotten conventional loans. So if everyone had gotten the most
appropriate loan, most of the people who took out subprime loans would have gotten lower rates
and therefore paid less in interest, Choice C. Choices A and B go too far. There might have been
some people who were better off with these loans. Choices D and E are possible events, but
there’s no evidence that either would have happened most of the time
The key intuition is that a subprime loan is a bad idea for two main reasons – firstly, it is aimed
at people with poor credit, who intrinsically have less chance of being able to genuinely “afford”
a house. Secondly, the high costs of subprime further push marginal borrowers into default.
Therefore, only if you know something positive about your own circumstances that is not known
to the lender (i.e. that they will quickly improve, answering point 1 above), should you take on
the loan, and then only for a short time, to refi when your circumstances do improve
Read the following information about sub prime loans and then answer the next question:
Subprime loans have higher interest rates than conventional loans. Subprime loans are designed for borrowers with low credit scores who would not qualify for conventional loans. The borrower pays a higher rate
to compensate the lender for the greater risk of a default. Subprime loans typically have adjustable rates, meaning that the interest rate can change over the life of the loan. Borrowers who take out adjustable subprime loans
usually try to keep the rate as low as possible at the start of the loan, even when doing so would lead to higher payments over the entire life of the loan. After a large number of people defaulted on their subprime loans, research revealed that the majority of people who took out subprime loans could have qualified for conventional loans.
Taking out a subprime loan to buy a house is MOST likely to be a reasonable financial
decision when which of the following is TRUE?
A) Qualifying for a conventional loan is impossible.
B) Owning a home is an important life goal for the borrower.
C) Adjustable rates are likely to be higher than fixed rates.
D) The borrower reasonably expects to have greater financial means in the near future.
E) The previous owner of the house took out a subprime loan.
D) Can a subprime loan ever be a good idea? Sure. If you need a subprime loan
because you can’t qualify for a conventional one, then you’re probably a high-risk buyer. But if
you’re about to come into more money in the near future, Choice D, then it might be worth
getting a bad rate now if you reasonably think you’ll be able to afford it later. Choice A: Not
being able to get a regular loan doesn’t mean that a subprime loan is a good idea. Maybe you
really can’t afford it. Choice B: Wanting a house desperately isn’t a reason to take out a highinterest
loan. Choices C and E tell us nothing about the buyer and his or her ability to pay.
The key intuition is that a subprime loan is a bad idea for two main reasons – firstly, it is aimed
at people with poor credit, who intrinsically have less chance of being able to genuinely “afford”
a house. Secondly, the high costs of subprime further push marginal borrowers into default.
Therefore, only if you know something positive about your own circumstances that is not known
to the lender (i.e. that they will quickly improve, answering point 1 above), should you take on
the loan, and then only for a short time, to refi when your circumstances do improve
All of the following are true about GDP except
a) GDP considers only domestic factors of production
b) GDP is a good measure of aggregate output
c) GDP and GNP will usually only differ by less than 1%
d) GDP is dependent on the volume of common stocks traded on a nation’s stock exchanges
D
