Interest Cost of Money Test - MoneyPower

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1 Interest Cost of Money Test - MoneyPower Multiple Choice Identify the choice that best completes the statement or answers the question. 1. To determine the time value of depositing $100 in a savings account, a person needs to know the interest rate and a. her total income. b. the rate of inflation. c. whether the account is FDIC protected. d. whether the bank offers overdraft protection. 2. A person is convinced that a lending institution is charging too much interest for a loan. This person should be aware that a. there are state usury laws. b. lending institutions all have their rates of interest set by the SEC c. interest rates depend entirely on the borrower s ability to pay back the loan. d. the Federal Trade Commission has laws against intimidating borrowers. 3. What should a person do when he believes he is charged too high a rate of interest for a loan by a lending institution? a. Accept the loan but pay it off early. b. Ask the lending institution to lower its rates. c. Notify the lending institution about state usury laws. d. Notify the local Better Business Bureau. 4. The time value of money refers to the concept that money: a. Received today is worth more than the same amount of money received in the future. b. Changes in value along with interest rates c. Money will double in value over seven years d. Is the foundation for developing a financial plan 5. If a person has $1,000 in a savings account and earns $20 a year in interest on that account, the rate of return on the money is close to a. 5% c. 10% b. 2% d. 20% 6. Interest earned on interest is known as: a. Simple interest c. Compounded interest b. True interest d. Variable interest 7. The annual percentage rate (APR) is: a. The true cost of credit that must be disclosed on a loan agreement b. Always expressed in dollars c. Required by the Securities Exchange Commission d. Required by the Comptroller of the Currency 8. Which type of financial institution usually pays the highest rate of interest on savings account balances? a. Savings and loan associations b. Commercial banks c. Credit unions d. Investment firm money market accounts

2 9. Which of the following is the federal law that requires the cost of credit be disclosed to consumers in bold print on loan agreement? a. Fair Credit Reporting Act c. Truth in Lending Act b. Equal Credit Opportunity Act d. Fair Debt Collection Practices Act 10. The amount a lender charges to borrow money is called the: a. Principal c. Loan balance b. Annual Percentage Rate (APR) d. Finance charge 11. The Rule of 72 is an easy way to: a. Approximate your savings balance each year b. Calculate how fast your savings will double in value at given interest rates c. Calculate how much tax you will owe on the interest earned d. Calculate the length of time it takes to pay off a credit balance 12. Money received today is worth more than the same amount of money received sometime in the future is: a. The Rule of 72 c. Not true b. The time value of money d. Investing 13. Lamar believes that interest rates are going to fall in the near future and remain low for a considerable period of time. She should invest in: a. Nothing, she should put her money under her mattress b. A variable rate certificate of deposit c. A long-term, fixed rate certificate of deposit d. A short-term, fixed rate certificate of deposit 14. The information that a lender must disclose to consumers applying for a cash loan is: a. The formula for compounded interest b. The annual percentage rate (APR), and/or the finance charge c. Full dollar amount being paid back on the loan over its life d. The tax obligations 15. Who benefits the most from inflation? a. Long-term fixed rate borrowers c. Persons on fixed incomes b. Lenders d. The government 16. Why might rising interest rates depress stock prices: a. Stock investors are lured away from c. Rising interest rates usually means the interest-paying investments to stocks economy has less b. Rising interest rates can result in lower d. Rising interest rates can result in higher business profits business profits 17. The cost to use someone else s money for a period of time is called the: a. Interest rate expressed as a percentage b. Opportunity cost c. Minimum payment d. Inflation rate 18. Which investment would you choose today if you believe interest rates will go up? a. Long-term bonds c. Short-term savings instruments b. Variable-rate loans d. Stocks

3 Interest Cost of Money Test - MoneyPower Answer Section MULTIPLE CHOICE 1. ANS: B The time value of money is a way of looking at how much a saving or investment is worth at the end of a period of time when it is compared to the rate of inflation during that period and the person s earning power. For example, it may not seem as though depositing $100 a month in a retirement account when someone is 23 makes a whole lot of sense; why not wait until age 40 when it will probably be a lot easier to deposit $250 or $300 a month in the account. However, because of the miracle of compounding interest, that $100 will be worth a lot more when the person is older than the money that is deposited at age 40. However, the other factor to consider in making deposits to a regular savings account is the rate of interest as compared to the rate of inflation. If the annual rate of inflation is 03% and the interest earned on money is 01%, the deposit is actually going to have less purchasing power at the end of the year than it did at the start. 2. ANS: A Charging excessive interest rates on loans is known as usury and that practice is prohibited by law. 3. ANS: C Charging excessive interest rates on loans is known as usury and that practice is prohibited by law. The first thing the person should do is inform the institution that he is aware of the law and will not pay the exorbitant rates. 4. ANS: A The time value of money refers to the declining value of a fixed sum of money over time due to inflation. Accordingly, a sum of money received today has more value than the same sum received in the future. If you receive $100 today, you can put it to work immediately through savings or investing immediately. The $100 will have the opportunity to grow over a longer period of time than $100 received in the future. 5. ANS: B Though interest is calculated on a daily basis, the closest Annual Percentage Rate earned is 2% ($20 is 2% of $1000).

4 6. ANS: C Compound interest enables the saver to earn interest on the interest that was earned earlier. 7. ANS: A The annual percentage rate (APR) is the true cost of credit because it takes into account all the costs of borrowing. The federal Truth in Lending Act requires that every consumer loan agreement disclose the APR in large, bold print 8. ANS: C Credit unions usually pay the highest rates of interest because they have lower risks and costs of operation. They are not-for-profit organizations, and their members have something in common, such as their employer, geographic area, or religious affiliation. Credit unions also offer fewer services than a commercial bank. 9. ANS: C The Truth in Lending Act requires that the finance charge and annual percentage rate be disclosed to the consumer in advance and specifies how the annual percentage rate must be calculated. 10. ANS: D The finance charge is the amount charged by the lender for any kind of credit. Finance charge = principal x stated interest rate x time (in years). The finance charge is used to calculate the annual percentage rate (APR). 11. ANS: B The Rule of 72 is a formula to approximate the time it will take for a given amount of money to double at a given compound interest rate. The formula is 72 divided by the interest rate earned. In a little over seven years, $100 will double at a compound annual rate of 10 percent (72/10 = 7.2 years). 12. ANS: B The time value of money is the concept that money received today is worth more than the same amount of money received in the future. If you receive $100 today, you can put it to work immediately through savings or investing immediately.

5 13. ANS: C By investing now in a long-term, fixed rate certificate of deposit, she will lock in the higher current rate over a long period of time. If she waited until later to invest and interest rates had fallen, the certificate of deposit would have a lower interest rate. This is an example of interest rate risk. 14. ANS: B The Consumer Credit Protection Act of 1968, known as the Truth in Lending Act, stipulates that consumers be told annual percentage rate (APR), the finance charge, and any special loan terms for mortgages, cash loans, vehicle loans, etc. 15. ANS: A Inflation reduces the purchasing power of money, so every dollar you spend in the future has less value than it has now. Since the payments on long-term fixed rate loans, like 30-year mortgages remain the same for the term of the loan, future payments will take place with dollars that have less purchasing power. Inflation also raises long-term interest rates, so if you are already locked into a fixed rate loan. your interest rate looks more and more favorable. 16. ANS: B Rising interest rates might depress stock prices if investors move their money from stocks to the fixed rate instruments with higher interest rates. This movement reduces the demand for stocks, causing their prices to go down. 17. ANS: A Consumers usually pay a price for the goods and services they buy. The cost to buy the right to use someone else's money for a period of time is called the interest rate. 18. ANS: C By investing money in short-term savings instruments, your money will be available to invest in a higher interest instrument in the near future.