Principles of Investment Flashcards

Questions and Answers

How much interest will Michael earn on his CD in the first year, based on the real interest rate?

$200

Which is an example of a high-risk investment?

Real estate

Government bonds

Stock in a start-up company (correct)

Savings account

What is the relationship between risk and return?

A higher risk often means a higher return.

Which of these investments may be long-term? Check all that apply.

Mutual funds Signup and view all the answers

Why is it risky to invest in a commodity?

The commodity's price might drop significantly very quickly. Signup and view all the answers

What does the information about Gale's investments demonstrate?

If she had purchased only the stock and had not diversified her investments, she would have lost money. Signup and view all the answers

What does the information about Alex's investments demonstrate?

He most likely would have benefited by diversifying. Signup and view all the answers

When investors purchase a commodity, what do they believe?

The commodity's price will go up after purchase. Signup and view all the answers

In what way does a 401(k) differ from an individual retirement account (IRA)?

A 401(k) is created through an individual's employer. Signup and view all the answers

How is a savings account most useful?

For using money in the near future but not right away. Signup and view all the answers

What might convince an investor to buy stock or mutual funds?

Belief that a company has just reached its peak popularity or news that a company is about to release a promising product. Signup and view all the answers

What is the definition of risk?

Possibility of losing money on an investment. Signup and view all the answers

Which type of investment would be an example of an investment at point B?

A stock Signup and view all the answers

Which statements apply to a certificate of deposit (CD)? Check all that apply.

It can be purchased from a banking institution. Signup and view all the answers

Which investment is best for someone who is likely to need cash soon?

Savings account Signup and view all the answers

Taxes are often owed on:

Investment returns Signup and view all the answers

Which statement is true of the relationship between risk and return?

The greater the risk, the greater the potential return. Signup and view all the answers

Which statement best describes how inflation affects the value of investments over time?

It decreases the value of money. Signup and view all the answers

The nominal interest rate could best be described as the ______ rate.

stated Signup and view all the answers

An investment with a stable and predictable history will most likely have:

Low risk Signup and view all the answers

What occurs over time as a result of inflation? Check all that apply.

Interest becomes worth less money. Signup and view all the answers

______ policy involves government changes to spending or taxation to affect the economy.

fiscal Signup and view all the answers

The graph shows the effect of inflation. Approximately how much of the initial investment's value would be lost after 15 years at 3% inflation?

40% Signup and view all the answers

Why should investors know the difference between nominal and real interest rates?

To recognize the effects of inflation. Signup and view all the answers

If the nominal interest rate is 4.00% and the rate of inflation is 2.25%, what is the real interest rate?

1.75% Signup and view all the answers

If an investor has a $5,000 pretax return, the state tax rate is 4.5%, and the federal tax rate is 22.0%, what is the real investment value?

$3,675 Signup and view all the answers

If the Federal Reserve decreased the money supply, what would the effects be? Check all that apply.

Decreased investing Signup and view all the answers

Changes in monetary policy have the greatest effect on:

Demand for investments. Signup and view all the answers

What investment practices is Cody following?

Diversifying investments. Signup and view all the answers

Which investment shortcoming has Cody failed to avoid?

Focusing on sunk costs. Signup and view all the answers

What step should Cody take to improve his investment portfolio?

Sell the failing stock. Signup and view all the answers

What should investors consider when planning for their retirement? Check all that apply.

The tax laws and breaks related to different retirement plans Signup and view all the answers

What are some characteristics of short-term investments? Check all that apply.

They usually last for less than a year. Signup and view all the answers

Long-term investments tie up money for:

More than one year. Signup and view all the answers

What investment options should Angela consider?

CDs. Signup and view all the answers

What statements are true regarding an individual retirement account?

People can contribute to the account until retirement age. Contributions to the account are limited each year. Contributions can be deducted from federal taxes. Signup and view all the answers

Which investor is making a common error?

An employee of a popular software company who invests in many similar companies. Signup and view all the answers

Which of these are considered both short- and long-term investments? Check all that apply.

Stocks Signup and view all the answers

People who make money investing in the stock market must pay taxes on profits.

True. Signup and view all the answers

Who regulates markets where investments are traded?

The federal government. Signup and view all the answers

Which is a commodity someone might invest in?

Natural resources. Signup and view all the answers

Which investment option would best meet William's needs?

A commodity. Signup and view all the answers

Which statements are true regarding an individual retirement account? Check all that apply.

Contributions can be deducted from federal taxes. Signup and view all the answers

Analyzing the likelihood of the economy changing is part of understanding the risks of an investment.

Risks. Signup and view all the answers

Which are common mistakes people make when investing? Check all that apply.

They hold onto investments longer than they should to recoup losses. Signup and view all the answers

Which investment advice would Gale most likely give to Alex?

Spread your investments in several different areas. Signup and view all the answers

Study Notes

Investment Basics

Certificate of Deposit (CD): Michael's $20,000 investment at a 3% interest for five years yields $600 nominal interest in the first year, adjusted for 2% inflation for a real interest of $200.
Interest Types: Nominal interest is the stated rate (3%), while real interest accounts for inflation (1%).

Risk and Return

High-Risk Investments: Investments like start-up stock exemplify higher risk with potential high returns.
Risk-Return Relationship: Typically, higher risk investments promise higher returns.
Risk Evaluation: Understand that unpredictable investments are riskier.

Investment Timeframe

Long-Term Investments: Examples include mutual funds, bonds, retirement funds, and commodities.
Short-Term Investments: Generally last less than a year, including CDs and savings accounts.

Diversification and Economic Conditions

Portfolio Diversification: Gale's investment strategy highlights the necessity of diversification to prevent losses. Alex would have benefited from this strategy.
Impact of Economic Growth: During growth, investors tend to take more risks; a decrease in money supply leads to increased interest rates, decreased borrowing, and investment.

Taxes and Investment Returns

Investment Returns Taxation: Returns on investments are subject to taxation at both state and federal levels.
Real Investment Value Calculation: Factors in taxes on profits, affecting net returns significantly. E.g., Amber's profit reduces to $7,000 after tax deductions.

Inflation Effects

Inflation Impact: Inflation erodes the purchasing power of returns over time, with a loss of about 40% of an investment's value after 15 years at 3% inflation.
Inflation vs. Interest Rates: The nominal interest rate does not reflect real returns without considering inflation.

Investment Strategies

Selecting the Right Investment: For low-risk tolerance, options like CDs are ideal. High-risk investments might include commodities or tech start-ups.
Common Investor Mistakes: Avoid concentrating investments in a single type or holding onto losses hoping for a return.

Retirement Planning

Retirement Investment Considerations: Ideal retirement age, contribution limits, and tax implications play crucial roles in retirement strategy.
401(k) Differences: A 401(k) is employer-sponsored, distinct from an IRA which individuals can manage independently.

Individual Retirement Accounts (IRAs)

IRA Characteristics: Contributions can continue until retirement age, have yearly limits, and may offer federal tax deductions.
Investment Profit Realities: Profits from stock market investments incur tax obligations.

Market Regulation and Commodities

Market Oversight: The federal government regulates trading markets, ensuring compliance and protection for investors.
Investment in Commodities: Natural resources are typical examples of commodities that can be invested in, but they come with price volatility risks.

Investment outcomes and Financial Literacy

Investment Evaluation: Consider factors like inflation rates, historical performance, and potential taxes when making investment decisions.
Financial Literacy is Key: Understanding potential market changes and personal risk tolerance aids in making informed investment choices.

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Description

Test your knowledge on the principles of investment with these flashcards. This quiz covers key concepts such as Certificates of Deposit, interest rates, and real interest calculations. Perfect for anyone looking to deepen their understanding of investment fundamentals.