Essentials of Investments, 11e (Bodie)
Chapter 21 Taxes, Inflation, and Investment Strategy
1) Which one of the following is an example of “global” consumption smoothing?
A) borrowing to buy a car
B) borrowing to buy a home
C) saving to send children to college
D) saving during your working years for retirement
2) Inflation has an adverse effect on your savings because:
I. It erodes the purchasing power of the dollars you have saved.
II. It increases the real rate of return on the dollars you save.
III. Unless sheltered, it increases the taxes owed on investment income.
A) I only
B) II and III only
C) I and III only
D) I, II, and III
3) If you want to tilt your savings toward later years, you might be well advised to purchase
which of the following types of readily available insurance?
A) Career failure insurance
B) Disability insurance
C) Unemployment insurance
D) Moral hazard insurance
4) Which one of the following represents local consumption smoothing?
I. Saving during your working years for retirement
II. Borrowing money to buy a car
III. Putting off a vacation for a year until you can afford it
A) I only
B) II and III only
C) I and II only
D) I, II, and III
5) In a private defined benefit pension plan the ________ bears the investment risk, and in a
private defined contribution plan the ________ bears the investment risk.
A) plan sponsor; employee
B) employee; plan sponsor
C) U.S. government; plan sponsor
D) plan sponsor; U.S. government
6) A decrease of 1% in both your tax exemption and your income tax rate would, on net,
________.
A) make you better off
B) make you worse off
C) make you neither better off nor worse off
D) make you either better or worse off depending on your age
7) Tax shelters ________.
A) postpone payment of tax liabilities
B) decrease investment risk
C) increase the pretax rate of return earned
D) benefit the government more than the investor
8) The tax effect of a traditional retirement plan is to ________ taxes.
A) evade
B) postpone
C) erase
D) avoid
9) The U.S. income tax code is generally ________.
A) regressive
B) progressive
C) flat
D) peaked
10) Contributions to a ________ are not tax deductible.
A) traditional retirement plan
B) Roth retirement plan
C) 401k plan
D) 403b plan
11) No taxes are paid on withdrawals made during retirement from a ________.
A) traditional retirement plan
B) Roth retirement plan
C) 401k
D) 403b plan
12) You earn 6% on your corporate bond portfolio this year, and you are in a 24% federal tax
bracket and an 9% state tax bracket. Your after-tax return is ________. (Assume that federal
taxes are not deductible against state taxes and vice versa).
A) 4.5%
B) 4.14%
C) 4.02%
D) 3.12%
13) You can tax-shelter only one-half of your retirement savings. You want to invest one-half of
your savings in bonds and one-half in stocks. How much of the bonds and how much of the
stocks should you allocate to the tax-sheltered investment?
A) Stock and bond investments should be equally invested in both tax-sheltered and non-
sheltered accounts.
B) You should place all the stocks in tax-sheltered accounts and all the bonds in non-sheltered
accounts.
C) You should place all the bonds in tax-sheltered accounts and all the stocks in non-sheltered
accounts.
D) It makes no difference how you allocate your stock and bond investments among tax
sheltered and non-sheltered accounts.
14) Social Security is ________.
A) a pension plan only
B) an insurance plan only
C) a combination of a pension and insurance plan
D) an involuntary intergenerational transfer
15) The Social Security system ________.
A) is financed in a regressive way
B) is regressive in the way it allocates benefits
C) is progressive in the way it is financed
D) is fully funded for the foreseeable future
16) The calculation of a standard annuity, using the PMY function of Excel or a financial
calculator, will produce an insufficient income because that approach fails to consider ________.
A) variable interest rates
B) retiree income needs
C) market volatility
D) inflation
17) The use of a Roth IRA versus a traditional IRA will allow you to ________.
A) retire with less money in your savings account
B) select more sophisticated investments
C) avoid relying as much upon social security
D) protect your spouse from a decline in income upon death
18) A person in poor health trying to buy supplemental health insurance is an example of
________.
A) moral hazard
B) adverse selection
C) a Texas hedge
D) actuarial error
19) A person in excellent health with a long life expectancy chooses a lifetime annuity. This is an
example of ________.
A) moral hazard
B) adverse selection
C) a Texas hedge
D) actuarial error
20) It would be costly to provide wage insurance because of the ________ problem.
A) moral hazard
B) adverse selection
C) Texas hedge
D) actuarial error
21) You earned 8% on your corporate bond portfolio this year, and you are in a 15% federal tax
bracket. If over your holding period inflation was 3%, your real after-tax rate of return was
________.
A) 6.8%
B) 3.69%
C) 4.91%
D) 4.25%
22) As you get older, you decide to reduce the risk level of your retirement portfolio because
your portfolio is nearing your minimum acceptable level. As the portfolio does better, you
reallocate funds into higher-risk categories. You are practicing a form of ________.
A) manipulating tax shelters
B) involuntary intergenerational transfers
C) excessive savings
D) dynamic hedging
23) Tilting your retirement savings plan toward your later years should only be done by investors
________.
A) who are sufficiently risk averse
B) who are more tolerant of risk
C) who are unsure if their income growth will keep up with inflation
D) who want to retire early
24) Employers commonly match at least some portion of employee contributions to:
I. 401k plans
II. 403b plans
III. Self-directed retirement plans
A) I only
B) I and II only
C) II only
D) I, II, and III
25) A saver who expects to have a higher tax rate after retirement would prefer a ________.
A) Roth retirement plan
B) traditional retirement plan
C) 401k plan
D) 403b plan
26) A retirement plan that offers a tax shelter will defer ________ taxes on contributions and
investment earnings.
A) income
B) sales
C) property
D) estate
27) The practice of trying to buy life insurance upon diagnosis of a terminal illness is an example
of ________.
A) estate planning
B) profit maximization
C) adverse selection
D) insurance fraud
28) Taxes are applied to the ________.
A) real value of sheltered investment income
B) nominal value of unsheltered investment income
C) nominal value of sheltered investment income
D) real value of unsheltered investment income
29) One feasible way to hedge labor income is to ________.
A) diversify your investment portfolio away from the industry in which you work
B) save for retirement only from investment income
C) change careers every 7 years
D) invest heavily in the stock options provided by your firm
30) Which one of the following is not likely to be subject to adverse selection?
A) Health insurance providers
B) Lifetime annuity providers
C) Life insurance providers
D) social security
31) An investor may deposit $2,000 into a traditional or Roth IRA. After 30 years, given a 9%
annual return and a 20% tax rate, how much more or less money will the investor have if all
investments are liquidated after 30 years?
A) Roth value is $5,307 higher
B) Roth value is $4,907 higher
C) traditional value is $4,907 higher
D) traditional value is $5,307 higher
32) An investor wants to retire when she has $3,000,000 in savings, after-taxes. Given a 20% tax
rate at retirement, how much money, per year, must she save in order to retire in 30 years, given
an 11% annual return? Assume she uses a traditional IRA and liquidates the entire portfolio at
retirement.
A) $12,827
B) $13,903
C) $15,074
D) $18,842
33) Contributions to a traditional retirement plan are ________, and contributions to a Roth
retirement plan are ________.
A) not tax deductible; not tax deductible
B) tax deductible; tax deductible
C) tax deductible; not tax deductible
D) not tax deductible; tax deductible
34) How many years of Social Security contributions count for determination of benefits?
A) 25
B) 35
C) 45
D) All yearly contributions count.
35) Under current rules most workers will have ________ of their salary deducted to pay for
Social Security retirement benefits and ________ toward Medicare.
A) 1.45%; 6.2%
B) 6.2%; 1.45%
C) 7.65%; 1.45%%
D) 15.3%; 4.9%
36) In 2018, the income cap on Social Security taxes was set at ________ with an exemption of
________.
A) $200,000; $10,000
B) $153,600; $7,600
C) $128,400; $0
D) $96,000; $10,000
37) In planning for retirement, an investor decides she will save $15,000 every year for 45 years.
At a 10% return on her investment, how much money will she have at the end of 45 years (to the
nearest hundred thousand dollars)?
A) $1,400,000
B) $2,800,000
C) $4,900,000
D) $10,800,000
38) A tax shelter that allows for tax-exempt saving for higher education is called a ________.
A) Roth savings plan
B) 403b
C) 401k
D) 529 plan
39) Withdrawals from a traditional retirement plan prior to age ________ are taxable and must
pay a ________ tax penalty.
A) 59½; 10%
B) 62; 5%
C) 65; 7½ %
D) 63½; 5%
40) In planning for retirement, an investor decides she will save $2,000 every year for 25 years.
At a 7% return on her investment, how much money will she have at the end of 25 years?
A) $119,015
B) $125,316
C) $126,498
D) $128,420
41) In planning for retirement, an investor decides she will save $17,000 every year for 38 years.
At an 8% return on her investment, how much money will she have at the end of 38 years (to
the nearest hundred thousand dollars)?
A) $3,700,000
B) $6,800,000
C) $7,900,000
D) $10,800,000