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Chapter 21 - Taxes, Inflation, and Investment Strategy
Chapter 21
Taxes, Inflation, and Investment Strategy

Multiple Choice Questions

1. Which one of the following is an example of glo!al cons"mption smoothing#
$. %orrowing to !"y a car
%. %orrowing to !"y a home
C. Saving to send children to college
&. Saving d"ring yo"r wor'ing years for retirement

2. Inflation has an adverse effect on yo"r savings !eca"se ((((((((((((.
I. it erodes the p"rchasing power of the dollars yo" have saved
II. it increases the real rate of ret"rn on the dollars yo" save
III. "nless sheltered, it increases the taxes owed on investment income
$. I only
%. II and III only
C. I and III only
&. I, II and III

). If yo" wish to tilt yo"r savings toward later years yo" might !e well advised to p"rchase
which of the following types of readily availa!le ins"rance#
$. Career fail"re ins"rance
%. &isa!ility ins"rance
C. *nemployment ins"rance
&. +oral ha,ard ins"rance

-. Which one of the following represents local cons"mption smoothing#
I. Saving d"ring yo"r wor'ing years for retirement
II. %orrowing money to !"y a car
III. ."tting off a vacation for a year "ntil yo" can afford it
$. I only
%. II and III only
C. I and II only
&. I, II and III

21-1
Chapter 21 - Taxes, Inflation, and Investment Strategy
/. In a private defined !enefit pension plan the ((((((((((( !ears the investment ris' and in
a private defined contri!"tion plan the (((((((((((( !ears the investment ris'.
$. plan sponsor0 employee
%. employee0 plan sponsor
C. *.S. government0 plan sponsor
&. plan sponsor0 *.S. government

1. $ decrease of 12 in !oth yo"r tax exemption and yo"r income tax rate wo"ld on net
(((((((((((((((.
$. ma'e yo" !etter off
%. ma'e yo" worse off
C. ma'e yo" neither !etter off or worse off
&. ma'e yo" either !etter or worse off depending on yo"r age

3. Tax shelters ((((((((((((((((((.
$. postpone payment of tax lia!ilities
%. decrease investment ris'
C. increase the pre-tax rate of ret"rn earned
&. !enefit the government more than the investor

4. The tax effect of a traditional I5$ is to ((((( taxes.
$. evade
%. postpone
C. erase
&. avoid

6. The *.S. income tax code is generally (((((.
$. regressive
%. progressive
C. flat
&. pea'ed

21-2
Chapter 21 - Taxes, Inflation, and Investment Strategy
17. Contri!"tions to a ((((((((((((( are not tax ded"cti!le.
$. traditional I5$
%. 5oth I5$
C. -71' plan
&. -7)! plan

11. 8o taxes are paid on withdrawals made d"ring retirement from a (((((((((.
$. traditional I5$
%. 5oth I5$
C. -71'
&. -7)! plan

12. 9o" earn 12 on yo"r corporate !ond portfolio this year and yo" are in a 2/2 federal tax
!rac'et and an 42 state tax !rac'et. 9o"r after tax ret"rn is (((((. :$ss"me that federal taxes
are not ded"cti!le against state taxes and vice versa;.
$. -./72
%. -.1-2
C. -.722
&. ).122

1). 9o" have the !roadest choice of investment alternatives for yo"r (((((((((((((.
$. traditional I5$
%. 5oth I5$
C. -71' plan
&. taxa!le savings acco"nt

21-)
Chapter 21 - Taxes, Inflation, and Investment Strategy
1-. 9o" can tax shelter only one-half of yo"r retirement savings. 9o" want to invest one-half
of yo"r savings in !onds and one-half in stoc's. <ow m"ch of the !onds and how m"ch of the
stoc's sho"ld yo" allocate to the tax sheltered investment#
$. Stoc' and !ond investments sho"ld !e e="ally invested in !oth tax sheltered and non-
sheltered acco"nts.
%. 9o" sho"ld place all the stoc's in tax sheltered acco"nts and all the !onds in non-sheltered
acco"nts.
C. 9o" sho"ld place all the !onds in tax sheltered acco"nts, and all the stoc's in non-sheltered
acco"nts.
&. It ma'es no difference how yo" allocate yo"r stoc' and !ond investments among tax
sheltered and non-sheltered acco"nts.

1/. Social Sec"rity is ((((((((((((.
$. a pension plan only
%. an ins"rance plan only
C. a com!ination of a pension and ins"rance plan
&. an invol"ntary intergenerational transfer

11. The Social Sec"rity system (((((((((((((((.
$. is financed in a regressive way
%. is regressive in the way it allocates !enefits
C. is progressive in the way it is financed
&. is f"lly f"nded for the foreseea!le f"t"re

13. $nn"ity income is positively correlated with (((((((((((.
I. longevity
II. d"ra!ility of marriage
III. expected length of yo"r !ase :Social Sec"rity; ann"ity
$. I only
%. I and II only
C. II and III only
&. I, II and III

21--
Chapter 21 - Taxes, Inflation, and Investment Strategy
14. The solvency of Social Sec"rity is threatened !y ((((((((((((((.
$. growing pop"lation longevity
%. a!ove replacement growth of the *.S. pop"lation
C. +edicare spending
&. the growth of competing defined contri!"tion plans

16. $ person in poor health trying to !"y s"pplemental health ins"rance is an example of
((((((((.
$. moral ha,ard
%. adverse selection
C. a Texas hedge
&. act"arial error

27. $ person in excellent health with a long life expectancy chooses a lifetime ann"ity. This is
an example of (((((((((.
$. moral ha,ard
%. adverse selection
C. a Texas hedge
&. act"arial error

21. It wo"ld !e costly to provide wage ins"rance !eca"se of the ((((((((((( pro!lem.
$. moral ha,ard
%. adverse selection
C. Texas hedge
&. act"arial error

22. 9o" earned 42 on yo"r corporate !ond portfolio this year and yo" are in a 1/2 federal
tax !rac'et. If over yo"r holding period inflation was )2 yo"r real after-tax rate of ret"rn was
(((((.
$. 1.472
%. ).162
C. -.612
&. -.2/2

21-/
Chapter 21 - Taxes, Inflation, and Investment Strategy
2). $s yo" get older yo" decide to red"ce the ris' level of yo"r retirement portfolio !eca"se
yo"r portfolio is nearing yo"r minim"m accepta!le level. $s the portfolio does !etter yo"
reallocate f"nds into higher ris' categories. 9o" are practicing a form of ((((((((((((.
$. manip"lating tax shelters
%. invol"ntary, intergenerational transfers
C. excessive savings
&. dynamic hedging

2-. Tilting yo"r retirement savings plan toward yo"r later years sho"ld only !e done !y
investors (((((((((((((.
$. who are s"fficiently ris' averse
%. who are more tolerant of ris'
C. who are "ns"re if their income growth will 'eep "p with inflation
&. who wish to retire early

2/. >mployers commonly match at least some portion of employee contri!"tions to
(((((((((((.
I. -71' plans
II.-7)! plans
III. Self directed I5$s
$. I only
%. I and II only
C. II only
&. I, II and III

21. $ saver who expects to have a higher tax rate after retirement wo"ld prefer a ((((((.
$. 5oth I5$
%. traditional I5$
C. -71' plan
&. -7)! plan

21-1
Chapter 21 - Taxes, Inflation, and Investment Strategy
23. $n I5$-style tax shelter will defer (((((((((((((( taxes on contri!"tions and
investment earnings.
$. income
%. sales
C. property
&. estate

24. $ st"dy !y Spiva' and ?otli'off :1641; showed that a marriage contract increases the
dollar val"e of lifetime savings !y as m"ch as (((((.
$. /2
%. 172
C. 2/2
&. /72

26. Taxes are applied to the (((((((((((((((((((((((.
$. real val"e of sheltered investment income
%. nominal val"e of "nsheltered investment income
C. nominal val"e of sheltered investment income
&. real val"e of "nsheltered investment income

)7. @ne way to hedge la!or income is to ((((((((((((((((((((.
$. diversify yo"r investment portfolio away from the ind"stry in which yo" wor'
%. save for retirement only from investment income
C. change careers every 3 years
&. invest heavily in the stoc' options provided !y yo"r firm

)1. Which one of the following is not li'ely to !e s"!Aect to adverse selection#
$. <ealth ins"rance providers
%. Bifetime ann"ity providers
C. Bife ins"rance providers
&. Social Sec"rity

21-3
Chapter 21 - Taxes, Inflation, and Investment Strategy
)2. The $verage Indexed +onthly Income is "sed to comp"te (((((((((((.
$. the cons"mer price index
%. yo"r Social Sec"rity retirement !enefits
C. yo"r maxim"m -71' contri!"tion
&. yo"r maxim"m I5$ contri!"tion

)). The Social Sec"rity .rimary Ins"rance $mo"nt form"la favors ((((((.
$. older wor'ers
%. high income wor'ers
C. yo"nger wor'ers
&. low income wor'ers

)-. Contri!"tions to a traditional I5$ are (((((((((( and contri!"tions to a 5oth I5$ are
((((((((((((.
$. not tax ded"cti!le0 not tax ded"ci!le
%. tax ded"cti!le0 tax ded"cti!le
C. tax ded"cti!le0 not tax ded"cti!le
&. not tax ded"cti!le0 tax ded"cti!le

)/. <ow many years of Social Sec"rity contri!"tions co"nt for determination of !enefits#
$. 2/
%. )/
C. -/
&. $ll yearly contri!"tions co"nt

)1. *nder c"rrent r"les most wor'ers will have (((((((( of their salary ded"cted to pay for
Social Sec"rity.
$. 1.-/
%. 1.22
C. 3.1/2
&. 1/.)2

21-4
Chapter 21 - Taxes, Inflation, and Investment Strategy
)3. In 2776, the income cap on social sec"rity taxes was set at ((((( with an exemption of
(((((.
$. C277,7770 C17,777
%. C1/),1770 C3,177
C. C171,4770 C7
&. C61,7770 C17,777

)4. If yo"r marginal tax rate is 1/2 yo"r capital gains tax rate on a stoc' yo" have held for 17
years wo"ld !e (((.
$. /2
%. 1/2
C. 272
&. 23./2

)6. Today most employees receive retirement !enefits in the form of ((((((((.
$. S>.s
%. defined !enefit plans
C. defined ann"ity plans
&. defined contri!"tion plans

-7. Withdrawals from a traditional I5$ prior to age ((( are taxa!le and m"st pay a ((( tax
penalty.
$. /6 D0 172
%. 120 /2
C. 1/0 3 D 2
&. 1) D0 /2

-1. In planning for retirement, an investor decides she will save C2,777 every year for 2/
years. $t a 32 ret"rn on her investment, how m"ch money will she have at the end of 2/
years#
$. C116,71/
%. C12/,)11
C. C121,-64
&. C124,-27

21-6
Chapter 21 - Taxes, Inflation, and Investment Strategy
-2. In planning for retirement, an investor decides she will save C11,777 every year for -7
years. $t an 112 ret"rn on her investment, how m"ch money will she have at the end of -7
years :to the nearest h"ndred tho"sand dollars;#
$. C1,-77,777
%. C2,477,777
C. C-,677,777
&. C1,-77,777

-). $n investor plans to retire at age 17, with a total savings of C1,777,777. If she is c"rrently
)/ years old, has no savings, and expects to earn 42 per year on her investments, how m"ch
money m"st she set aside every year#
$. C1/,/-1
%. C1),136
C. C11,462
&. C17,)2-

--. $n ins"rance company plans to sell ann"ities to investors. %ased on act"arial calc"lations,
an investor has a 1/ year life span and they want a C)7,777 per year ann"ity, paya!le at the
end of each year. If the ins"rance company "ses a -2 ass"med investment rate, how m"ch
sho"ld the ann"ity cost#
$. C261,624
%. C)12,2)1
C. C))),//2
&. C)/).642

-/. $ safe driver who drives faster as a res"lt of p"rchased collision car ins"rance wo"ld !e
an example of the ((((((((((( pro!lem.
$. moral ha,ard
%. adverse selection
C. Texas hedge
&. act"arial error

21-17
Chapter 21 - Taxes, Inflation, and Investment Strategy
-1. $ wor'er plans to retire in 27 years. <e needs C27,777 per year in retirement income in
todayEs dollars. If inflation is forecast at )./2 per year, what ann"al income sho"ld he plan to
receive in the first year of retirement in order to maintain the p"rchasing power on C27,777#
$. C)7,)/)
%. C)-,1/6
C. C)3,)64
&. C)6,361

-3. $n ins"rance company plans to sell ann"ities to investors. %ased on act"arial calc"lations,
an investor has a 27 year life span and they want a C/7,777 per year ann"ity, paya!le at the
end of each year. If the ins"rance company "ses a )2 ass"med investment rate, how m"ch
sho"ld the ann"ity cost#
$. C161,624
%. C3-),43-
C. C4)),//2
&. C6/).642

-4. $ wor'er plans to retire in )7 years. <e hopes to receive C1/,777 per year in retirement
income. If inflation is forecast at 2./2 per year, what ann"al income sho"ld he plan to receive
in the first year of retirement in order to maintain the p"rchasing power on C1/,777#
$. C1/,777
%. C31,1/6
C. C64,)64
&. C1)1,)-2

-6. $n investor m"st decide !etween p"tting C2,777 into a reg"lar I5$ or p"t C1,--7 into a
5oth I5$. If the investorEs tax rate is 242 now and in retirement, and she expects to earn 122
per year over the next 27 years, which will prod"ce more cash in the end#
$. The investment in the reg"lar I5$
%. The investment in the 5oth I5$
C. %oth investments will have the same f"t"re val"e after taxes
&. There is not information to determine which will prod"ce the most cash

21-11
Chapter 21 - Taxes, Inflation, and Investment Strategy
/7. $ reg"lar I5$ re="ires taxes !e paid at the time the money is removed from the plan.
What is the after-tax val"e of a C/,777 deposit into an I5$ today that generates an 42 ret"rn
for 27 years if the investor is taxed at the 242 level#
$. C11,336
%. C27,1)/
C. C21,14/
&. C2),)7/

/1. What is the val"e of a C2,/77 payment into an I5$, if the investment earns 122 per year
for 1/ years#
$. C12,13-
%. C1),14-
C. C1-,1/2
&. C1/,/2)

/2. The employees of a firm complain that they can not afford to contri!"te C4,777 per year to
a -71', !eca"se of the loss of C4,777 of ta'e home pay. In fact, how m"ch will the ta'e home
pay !e red"ced if all taxes com!ined total ))2#
$. C/,)17
%. C1,)-7
C. C3,1)3
&. C4,777

/). $n employee "ses his firmEs -71:'; plan. If he decides to contri!"te C11,777 per year and
pays an effective tax rate for all items at 242, what is the red"ction in her ta'e home pay each
year#
$. C),747
%. C-,217
C. C3,627
&. C11,777

21-12
Chapter 21 - Taxes, Inflation, and Investment Strategy
/-. $n investor has an effective tax rate on all items of )72 and he decides to p"t C4,777 into
a -71:';. The f"t"re val"e of the investment that res"lts from the deferral of taxes over )7
years at an 42 ret"rn e="als (((((((((((((.
$. C2,-77
%. C4,777
C. C17,-77
&. C2-,1/7

//. Withdrawals after retirement from a traditional I5$ are (((((((((( and withdrawals
after retirement from a 5oth I5$ are ((((((((((((.
$. taxa!le0 not taxa!le
%. not taxa!le0 taxa!le
C. tax ded"cti!le0 not tax ded"cti!le
&. not tax ded"cti!le0 tax ded"cti!le

/1. If yo" start saving for retirement only in yo"r later years and yo"r income growth from
that point is rapid then ((((((((((((((((((((((((.
$. a traditional I5$ is pro!a!ly a !etter choice than a 5oth I5$
%. a 5oth I5$ is pro!a!ly a !etter choice than a traditional I5$
C. a S>. is pro!a!ly a !etter choice than +edicare
&. a -71:'; is pro!a!ly a !etter choice than a -7):!;

/3. Which one of the following statements a!o"t -71:'; plans is not correct#
$. The employer will typically match some portion of an employeeEs contri!"tions to a
-71:';.
%. $ -71:'; plan is a defined contri!"tion plan.
C. $llowa!le contri!"tions to -71:'; plans are limited.
&. Withdrawals from -71:'; plans are not taxed "pon retirement.

21-1)
Chapter 21 - Taxes, Inflation, and Investment Strategy
/4. S"ppose yo" have maxed o"t yo"r allowa!le contri!"tions to yo"r tax sheltered retirement
plans and yo" still want to shelter income. The !est choice of investment for yo" to minimi,e
the tax !ill is to invest in (((((((((.
$. a !ond portfolio
%. stoc's with high dividend yields
C. a !lended stoc' and !ond portfolio containing ,ero co"pon !onds
&. stoc's with low or ,ero dividend yields

/6. $ !ond and a stoc' portfolio !oth provided "nreali,ed pretax ret"rn of 42 to a taxa!le
investor. If the stoc's paid no dividends we 'now that the ((((((((.
$. after-tax ret"rn of the stoc' portfolio was higher than the after-tax ret"rn of the !ond
portfolio
%. after-tax ret"rn of the !ond portfolio was higher than the after-tax ret"rn of the stoc'
portfolio
C. after-tax income of the stoc' portfolio was e="al to the after-tax income of the !ond
portfolio
&. after-tax income of the stoc' portfolio co"ld have !een higher or lower than the after-tax
income of the !ond portfolio depending on the marginal tax rate of the investor

17. Statistics show that life expectancy at age 1/ for males is a!o"t ((( years and for females
is a!o"t ((( years.
$. 1/0 16
%. 130 27
C. 140 22
&. 160 2-

11. C"rrently, the maxim"m com!ined taxa!le income of a retired ho"sehold that avoids
having to pay any taxes on a portion of their Social Sec"rity !enefit is ((((((.
$. C1/,777
%. C)2,777
C. C-/,777
&. C3/,777

21-1-
Chapter 21 - Taxes, Inflation, and Investment Strategy
12. $n investor can earn a 12 nominal rate of ret"rn !"t inflation is expected to !e )2. If the
individ"al invests C2,777 per year for 27 years the real f"t"re val"e of their investment is
((((((((. :$ll investments occ"r at year end;.
$. C3),/31
%. C11,))-
C. C/),2/1
&. C-4,3)2

1). $n individ"al wants to have C6/,777 per year to live on when they retire in )7 years. The
individ"al is planning on living for 27 years after retirement. If the investor can earn 12
d"ring her retirement years and 172 d"ring her wor'ing years, how m"ch sho"ld she !e
saving d"ring her wor'ing life# :<intF Treat all calc"lations as ann"ities.;
$. C6,432
%. C4,2)-
C. C3,674
&. C1,12-

1-. S"ppose yo" are a high tax !rac'et individ"al and yo" want to shelter yo"r investment
income. The !est choice of investment for yo" to minimi,e the tax !ill is to invest in
(((((((((.
$. a !ond portfolio
%. stoc's with high dividend yields
C. a m"nicipal !ond portfolio
&. stoc's with low or ,ero dividend yields

1/. 9o" want to minimi,e yo"r c"rrent tax !ill !y maximi,ing yo"r contri!"tions to yo"r
(((((((((((((.
$. taxa!le !ond portfolio
%. 5oth I5$
C. -71' or -7)! plan
&. taxa!le savings acco"nt

Sharon decides to p"t C/,777 into her I5$ at age of 2/. She will contin"e to invest the same
amo"nt for the next 1 years and then stop contri!"ting. $ss"me 172 ann"al ret"rn.

21-1/
Chapter 21 - Taxes, Inflation, and Investment Strategy
11. <ow m"ch money will Sharon have in her I5$ after 1 years#
$. C)7,777
%. C)/,/3/
C. C)4,/34
&. C-1,-/1

13. <ow m"ch money will Sharon have in her I5$ when she is ready to retire at age of 12#
$. C//-,4/1
%. C12),2-/
C. C3)4,/34
&. C41-,/23

$ non-profit organi,ation offers a /2 salary contri!"tion to GohnEs -7)! plan and matching
/2 when Gohn contri!"tes /2 of hisHher salary. Gohn ma'es C/1,777 a year.

14. What is the amo"nt of total contri!"tion to his -7)! if Gohn contri!"tes /2 of his own
money#
$. C/,177
%. C4,-77
C. C11,277
&. C12,/77

16. What is GohnEs effective salary red"ction if he is in the 2/2 tax !rac'et#
$. C2,177
%. C2,477
C. C/,177
&. C4,-77

21-11
Chapter 21 - Taxes, Inflation, and Investment Strategy
37. What is GohnEs total cost of his /2 contri!"tion#
$. C2,177 cost
%. C2,477 cost
C. C377 !enefit
&. C)/77 !enefit

31. The fact that the *.S. government provides deposit ins"rance to !an's creates a form of
((((((((((( which is at least partially offset !y re="iring !an's to hold more capital if they
are ris'ier.
$. moral ha,ard
%. adverse selection
C. ris' aversion
&. interest rate ris'

32. $n investor in the )-2 tax !rac'et wo"ld !e indifferent !etween a corporate !ond with a
!efore tax yield of 42 and a m"nicipal !ond with a yield of (((((((((.
$. ).612
%. 1.1/2
C. /.242
&. 17.322

3). $n investor who is in the )/2 federal tax !rac'et and the /2 state !rac'et !"ys a 1./2
yield corporate !ond. What is his after tax yield#
$. ).672
%. -.3/2
C. 1./72
&. 6.672

21-13
Chapter 21 - Taxes, Inflation, and Investment Strategy
Chapter 21 Taxes, Inflation, and Investment Strategy $nswer ?ey


Multiple Choice Questions

1. Which one of the following is an example of glo!al cons"mption smoothing#
$. %orrowing to !"y a car
%. %orrowing to !"y a home
C. Saving to send children to college
D Saving d"ring yo"r wor'ing years for retirement

Difficulty: Easy

2. Inflation has an adverse effect on yo"r savings !eca"se ((((((((((((.
I. it erodes the p"rchasing power of the dollars yo" have saved
II. it increases the real rate of ret"rn on the dollars yo" save
III. "nless sheltered, it increases the taxes owed on investment income
$. I only
%. II and III only
C I and III only
&. I, II and III

Difficulty: Medium

). If yo" wish to tilt yo"r savings toward later years yo" might !e well advised to p"rchase
which of the following types of readily availa!le ins"rance#
$. Career fail"re ins"rance
! &isa!ility ins"rance
C. *nemployment ins"rance
&. +oral ha,ard ins"rance

Difficulty: Easy

21-14
Chapter 21 - Taxes, Inflation, and Investment Strategy
-. Which one of the following represents local cons"mption smoothing#
I. Saving d"ring yo"r wor'ing years for retirement
II. %orrowing money to !"y a car
III. ."tting off a vacation for a year "ntil yo" can afford it
$. I only
! II and III only
C. I and II only
&. I, II and III

Difficulty: Medium

/. In a private defined !enefit pension plan the ((((((((((( !ears the investment ris' and in
a private defined contri!"tion plan the (((((((((((( !ears the investment ris'.
" plan sponsor0 employee
%. employee0 plan sponsor
C. *.S. government0 plan sponsor
&. plan sponsor0 *.S. government

Difficulty: Medium

1. $ decrease of 12 in !oth yo"r tax exemption and yo"r income tax rate wo"ld on net
(((((((((((((((.
" ma'e yo" !etter off
%. ma'e yo" worse off
C. ma'e yo" neither !etter off or worse off
&. ma'e yo" either !etter or worse off depending on yo"r age

Difficulty: Hard

3. Tax shelters ((((((((((((((((((.
" postpone payment of tax lia!ilities
%. decrease investment ris'
C. increase the pre-tax rate of ret"rn earned
&. !enefit the government more than the investor

Difficulty: Easy

21-16
Chapter 21 - Taxes, Inflation, and Investment Strategy
4. The tax effect of a traditional I5$ is to ((((( taxes.
$. evade
! postpone
C. erase
&. avoid

Difficulty: Easy

6. The *.S. income tax code is generally (((((.
$. regressive
! progressive
C. flat
&. pea'ed

Difficulty: Easy

17. Contri!"tions to a ((((((((((((( are not tax ded"cti!le.
$. traditional I5$
! 5oth I5$
C. -71' plan
&. -7)! plan

Difficulty: Easy

11. 8o taxes are paid on withdrawals made d"ring retirement from a (((((((((.
$. traditional I5$
! 5oth I5$
C. -71'
&. -7)! plan

Difficulty: Easy

21-27
Chapter 21 - Taxes, Inflation, and Investment Strategy
12. 9o" earn 12 on yo"r corporate !ond portfolio this year and yo" are in a 2/2 federal tax
!rac'et and an 42 state tax !rac'et. 9o"r after tax ret"rn is (((((. :$ss"me that federal taxes
are not ded"cti!le against state taxes and vice versa;.
$. -./72
%. -.1-2
C -.722
&. ).122
:12;:1 - 7.)); I -.722

Difficulty: Medium

1). 9o" have the !roadest choice of investment alternatives for yo"r (((((((((((((.
$. traditional I5$
%. 5oth I5$
C. -71' plan
D taxa!le savings acco"nt

Difficulty: Medium

1-. 9o" can tax shelter only one-half of yo"r retirement savings. 9o" want to invest one-half
of yo"r savings in !onds and one-half in stoc's. <ow m"ch of the !onds and how m"ch of the
stoc's sho"ld yo" allocate to the tax sheltered investment#
$. Stoc' and !ond investments sho"ld !e e="ally invested in !oth tax sheltered and non-
sheltered acco"nts.
%. 9o" sho"ld place all the stoc's in tax sheltered acco"nts and all the !onds in non-sheltered
acco"nts.
C 9o" sho"ld place all the !onds in tax sheltered acco"nts, and all the stoc's in non-
sheltered acco"nts.
&. It ma'es no difference how yo" allocate yo"r stoc' and !ond investments among tax
sheltered and non-sheltered acco"nts.

Difficulty: Hard

21-21
Chapter 21 - Taxes, Inflation, and Investment Strategy
1/. Social Sec"rity is ((((((((((((.
$. a pension plan only
%. an ins"rance plan only
C a com!ination of a pension and ins"rance plan
&. an invol"ntary intergenerational transfer

Difficulty: Easy

11. The Social Sec"rity system (((((((((((((((.
" is financed in a regressive way
%. is regressive in the way it allocates !enefits
C. is progressive in the way it is financed
&. is f"lly f"nded for the foreseea!le f"t"re

Difficulty: Hard

13. $nn"ity income is positively correlated with (((((((((((.
I. longevity
II. d"ra!ility of marriage
III. expected length of yo"r !ase :Social Sec"rity; ann"ity
$. I only
%. I and II only
C. II and III only
D I, II and III

Difficulty: Hard

14. The solvency of Social Sec"rity is threatened !y ((((((((((((((.
" growing pop"lation longevity
%. a!ove replacement growth of the *.S. pop"lation
C. +edicare spending
&. the growth of competing defined contri!"tion plans

Difficulty: Medium

21-22
Chapter 21 - Taxes, Inflation, and Investment Strategy
16. $ person in poor health trying to !"y s"pplemental health ins"rance is an example of
((((((((.
$. moral ha,ard
! adverse selection
C. a Texas hedge
&. act"arial error

Difficulty: Medium

27. $ person in excellent health with a long life expectancy chooses a lifetime ann"ity. This is
an example of (((((((((.
$. moral ha,ard
! adverse selection
C. a Texas hedge
&. act"arial error

Difficulty: Medium

21. It wo"ld !e costly to provide wage ins"rance !eca"se of the ((((((((((( pro!lem.
" moral ha,ard
%. adverse selection
C. Texas hedge
&. act"arial error

Difficulty: Medium

21-2)
Chapter 21 - Taxes, Inflation, and Investment Strategy
22. 9o" earned 42 on yo"r corporate !ond portfolio this year and yo" are in a 1/2 federal
tax !rac'et. If over yo"r holding period inflation was )2 yo"r real after-tax rate of ret"rn was
(((((.
$. 1.472
! ).162
C. -.612
&. -.2/2

Difficulty: Medium

2). $s yo" get older yo" decide to red"ce the ris' level of yo"r retirement portfolio !eca"se
yo"r portfolio is nearing yo"r minim"m accepta!le level. $s the portfolio does !etter yo"
reallocate f"nds into higher ris' categories. 9o" are practicing a form of ((((((((((((.
$. manip"lating tax shelters
%. invol"ntary, intergenerational transfers
C. excessive savings
D dynamic hedging

Difficulty: Medium

2-. Tilting yo"r retirement savings plan toward yo"r later years sho"ld only !e done !y
investors (((((((((((((.
$. who are s"fficiently ris' averse
! who are more tolerant of ris'
C. who are "ns"re if their income growth will 'eep "p with inflation
&. who wish to retire early

Difficulty: Medium

21-2-
Chapter 21 - Taxes, Inflation, and Investment Strategy
2/. >mployers commonly match at least some portion of employee contri!"tions to
(((((((((((.
I. -71' plans
II.-7)! plans
III. Self directed I5$s
$. I only
! I and II only
C. II only
&. I, II and III

Difficulty: Medium

21. $ saver who expects to have a higher tax rate after retirement wo"ld prefer a ((((((.
" 5oth I5$
%. traditional I5$
C. -71' plan
&. -7)! plan

Difficulty: Medium

23. $n I5$-style tax shelter will defer (((((((((((((( taxes on contri!"tions and
investment earnings.
" income
%. sales
C. property
&. estate

Difficulty: Easy

21-2/
Chapter 21 - Taxes, Inflation, and Investment Strategy
24. $ st"dy !y Spiva' and ?otli'off :1641; showed that a marriage contract increases the
dollar val"e of lifetime savings !y as m"ch as (((((.
$. /2
%. 172
C 2/2
&. /72

Difficulty: Easy

26. Taxes are applied to the (((((((((((((((((((((((.
$. real val"e of sheltered investment income
! nominal val"e of "nsheltered investment income
C. nominal val"e of sheltered investment income
&. real val"e of "nsheltered investment income

Difficulty: Medium

)7. @ne way to hedge la!or income is to ((((((((((((((((((((.
" diversify yo"r investment portfolio away from the ind"stry in which yo" wor'
%. save for retirement only from investment income
C. change careers every 3 years
&. invest heavily in the stoc' options provided !y yo"r firm

Difficulty: Medium

)1. Which one of the following is not li'ely to !e s"!Aect to adverse selection#
$. <ealth ins"rance providers
%. Bifetime ann"ity providers
C. Bife ins"rance providers
D Social Sec"rity

Difficulty: Medium

21-21
Chapter 21 - Taxes, Inflation, and Investment Strategy
)2. The $verage Indexed +onthly Income is "sed to comp"te (((((((((((.
$. the cons"mer price index
! yo"r Social Sec"rity retirement !enefits
C. yo"r maxim"m -71' contri!"tion
&. yo"r maxim"m I5$ contri!"tion

Difficulty: Easy

)). The Social Sec"rity .rimary Ins"rance $mo"nt form"la favors ((((((.
$. older wor'ers
%. high income wor'ers
C. yo"nger wor'ers
D low income wor'ers

Difficulty: Easy

)-. Contri!"tions to a traditional I5$ are (((((((((( and contri!"tions to a 5oth I5$ are
((((((((((((.
$. not tax ded"cti!le0 not tax ded"ci!le
%. tax ded"cti!le0 tax ded"cti!le
C tax ded"cti!le0 not tax ded"cti!le
&. not tax ded"cti!le0 tax ded"cti!le

Difficulty: Medium

)/. <ow many years of Social Sec"rity contri!"tions co"nt for determination of !enefits#
$. 2/
! )/
C. -/
&. $ll yearly contri!"tions co"nt

Difficulty: Easy

21-23
Chapter 21 - Taxes, Inflation, and Investment Strategy
)1. *nder c"rrent r"les most wor'ers will have (((((((( of their salary ded"cted to pay for
Social Sec"rity.
$. 1.-/
! 1.22
C. 3.1/2
&. 1/.)2

Difficulty: Medium

)3. In 2776, the income cap on social sec"rity taxes was set at ((((( with an exemption of
(((((.
$. C277,7770 C17,777
%. C1/),1770 C3,177
C C171,4770 C7
&. C61,7770 C17,777

Difficulty: Medium

)4. If yo"r marginal tax rate is 1/2 yo"r capital gains tax rate on a stoc' yo" have held for 17
years wo"ld !e (((.
" /2
%. 1/2
C. 272
&. 23./2

Difficulty: Medium

)6. Today most employees receive retirement !enefits in the form of ((((((((.
$. S>.s
%. defined !enefit plans
C. defined ann"ity plans
D defined contri!"tion plans

Difficulty: Easy

21-24
Chapter 21 - Taxes, Inflation, and Investment Strategy
-7. Withdrawals from a traditional I5$ prior to age ((( are taxa!le and m"st pay a ((( tax
penalty.
" /6 D0 172
%. 120 /2
C. 1/0 3 D 2
&. 1) D0 /2

Difficulty: Easy

-1. In planning for retirement, an investor decides she will save C2,777 every year for 2/
years. $t a 32 ret"rn on her investment, how m"ch money will she have at the end of 2/
years#
$. C116,71/
%. C12/,)11
C C121,-64
&. C124,-27

Difficulty: Medium

-2. In planning for retirement, an investor decides she will save C11,777 every year for -7
years. $t an 112 ret"rn on her investment, how m"ch money will she have at the end of -7
years :to the nearest h"ndred tho"sand dollars;#
$. C1,-77,777
%. C2,477,777
C. C-,677,777
D C1,-77,777

Difficulty: Medium

21-26
Chapter 21 - Taxes, Inflation, and Investment Strategy
-). $n investor plans to retire at age 17, with a total savings of C1,777,777. If she is c"rrently
)/ years old, has no savings, and expects to earn 42 per year on her investments, how m"ch
money m"st she set aside every year#
$. C1/,/-1
! C1),136
C. C11,462
&. C17,)2-

Difficulty: Medium

--. $n ins"rance company plans to sell ann"ities to investors. %ased on act"arial calc"lations,
an investor has a 1/ year life span and they want a C)7,777 per year ann"ity, paya!le at the
end of each year. If the ins"rance company "ses a -2 ass"med investment rate, how m"ch
sho"ld the ann"ity cost#
$. C261,624
%. C)12,2)1
C C))),//2
&. C)/).642

Difficulty: Medium

-/. $ safe driver who drives faster as a res"lt of p"rchased collision car ins"rance wo"ld !e
an example of the ((((((((((( pro!lem.
" moral ha,ard
%. adverse selection
C. Texas hedge
&. act"arial error

Difficulty: Easy

21-)7
Chapter 21 - Taxes, Inflation, and Investment Strategy
-1. $ wor'er plans to retire in 27 years. <e needs C27,777 per year in retirement income in
todayEs dollars. If inflation is forecast at )./2 per year, what ann"al income sho"ld he plan to
receive in the first year of retirement in order to maintain the p"rchasing power on C27,777#
$. C)7,)/)
%. C)-,1/6
C. C)3,)64
D C)6,361

Difficulty: Medium

-3. $n ins"rance company plans to sell ann"ities to investors. %ased on act"arial calc"lations,
an investor has a 27 year life span and they want a C/7,777 per year ann"ity, paya!le at the
end of each year. If the ins"rance company "ses a )2 ass"med investment rate, how m"ch
sho"ld the ann"ity cost#
$. C161,624
! C3-),43-
C. C4)),//2
&. C6/).642

Difficulty: Medium

21-)1
Chapter 21 - Taxes, Inflation, and Investment Strategy
-4. $ wor'er plans to retire in )7 years. <e hopes to receive C1/,777 per year in retirement
income. If inflation is forecast at 2./2 per year, what ann"al income sho"ld he plan to receive
in the first year of retirement in order to maintain the p"rchasing power on C1/,777#
$. C1/,777
%. C31,1/6
C. C64,)64
D C1)1,)-2

Difficulty: Medium

-6. $n investor m"st decide !etween p"tting C2,777 into a reg"lar I5$ or p"t C1,--7 into a
5oth I5$. If the investorEs tax rate is 242 now and in retirement, and she expects to earn 122
per year over the next 27 years, which will prod"ce more cash in the end#
$. The investment in the reg"lar I5$
%. The investment in the 5oth I5$
C %oth investments will have the same f"t"re val"e after taxes
&. There is not information to determine which will prod"ce the most cash

Difficulty: Hard

21-)2
Chapter 21 - Taxes, Inflation, and Investment Strategy
/7. $ reg"lar I5$ re="ires taxes !e paid at the time the money is removed from the plan.
What is the after-tax val"e of a C/,777 deposit into an I5$ today that generates an 42 ret"rn
for 27 years if the investor is taxed at the 242 level#
" C11,336
%. C27,1)/
C. C21,14/
&. C2),)7/

Difficulty: Medium

/1. What is the val"e of a C2,/77 payment into an I5$, if the investment earns 122 per year
for 1/ years#
$. C12,13-
! C1),14-
C. C1-,1/2
&. C1/,/2)

Difficulty: Medium

/2. The employees of a firm complain that they can not afford to contri!"te C4,777 per year to
a -71', !eca"se of the loss of C4,777 of ta'e home pay. In fact, how m"ch will the ta'e home
pay !e red"ced if all taxes com!ined total ))2#
" C/,)17
%. C1,)-7
C. C3,1)3
&. C4,777
Ta'e home pay red"ction I C4777 :1 - 7.)); I C/)17

Difficulty: Medium

21-))
Chapter 21 - Taxes, Inflation, and Investment Strategy
/). $n employee "ses his firmEs -71:'; plan. If he decides to contri!"te C11,777 per year and
pays an effective tax rate for all items at 242, what is the red"ction in her ta'e home pay each
year#
$. C),747
%. C-,217
C C3,627
&. C11,777
Ta'e home pay red"ction I C11777 :1 - 7.24; I C3627

Difficulty: Medium

/-. $n investor has an effective tax rate on all items of )72 and he decides to p"t C4,777 into
a -71:';. The f"t"re val"e of the investment that res"lts from the deferral of taxes over )7
years at an 42 ret"rn e="als (((((((((((((.
$. C2,-77
%. C4,777
C. C17,-77
D C2-,1/7
>xtra savings I C4777 x 7.)7 I C2-77
JK I :C2-77;:1 L .74;
)7
I C2-1/7

Difficulty: Hard

//. Withdrawals after retirement from a traditional I5$ are (((((((((( and withdrawals
after retirement from a 5oth I5$ are ((((((((((((.
" taxa!le0 not taxa!le
%. not taxa!le0 taxa!le
C. tax ded"cti!le0 not tax ded"cti!le
&. not tax ded"cti!le0 tax ded"cti!le

Difficulty: Medium

21-)-
Chapter 21 - Taxes, Inflation, and Investment Strategy
/1. If yo" start saving for retirement only in yo"r later years and yo"r income growth from
that point is rapid then ((((((((((((((((((((((((.
$. a traditional I5$ is pro!a!ly a !etter choice than a 5oth I5$
! a 5oth I5$ is pro!a!ly a !etter choice than a traditional I5$
C. a S>. is pro!a!ly a !etter choice than +edicare
&. a -71:'; is pro!a!ly a !etter choice than a -7):!;

Difficulty: Medium

/3. Which one of the following statements a!o"t -71:'; plans is not correct#
$. The employer will typically match some portion of an employeeEs contri!"tions to a
-71:';.
%. $ -71:'; plan is a defined contri!"tion plan.
C. $llowa!le contri!"tions to -71:'; plans are limited.
D Withdrawals from -71:'; plans are not taxed "pon retirement.

Difficulty: Medium

/4. S"ppose yo" have maxed o"t yo"r allowa!le contri!"tions to yo"r tax sheltered retirement
plans and yo" still want to shelter income. The !est choice of investment for yo" to minimi,e
the tax !ill is to invest in (((((((((.
$. a !ond portfolio
%. stoc's with high dividend yields
C. a !lended stoc' and !ond portfolio containing ,ero co"pon !onds
D stoc's with low or ,ero dividend yields

Difficulty: Medium

21-)/
Chapter 21 - Taxes, Inflation, and Investment Strategy
/6. $ !ond and a stoc' portfolio !oth provided "nreali,ed pretax ret"rn of 42 to a taxa!le
investor. If the stoc's paid no dividends we 'now that the ((((((((.
" after-tax ret"rn of the stoc' portfolio was higher than the after-tax ret"rn of the !ond
portfolio
%. after-tax ret"rn of the !ond portfolio was higher than the after-tax ret"rn of the stoc'
portfolio
C. after-tax income of the stoc' portfolio was e="al to the after-tax income of the !ond
portfolio
&. after-tax income of the stoc' portfolio co"ld have !een higher or lower than the after-tax
income of the !ond portfolio depending on the marginal tax rate of the investor

Difficulty: Medium

17. Statistics show that life expectancy at age 1/ for males is a!o"t ((( years and for females
is a!o"t ((( years.
$. 1/0 16
! 130 27
C. 140 22
&. 160 2-

Difficulty: Medium

11. C"rrently, the maxim"m com!ined taxa!le income of a retired ho"sehold that avoids
having to pay any taxes on a portion of their Social Sec"rity !enefit is ((((((.
$. C1/,777
! C)2,777
C. C-/,777
&. C3/,777

Difficulty: Medium

21-)1
Chapter 21 - Taxes, Inflation, and Investment Strategy
12. $n investor can earn a 12 nominal rate of ret"rn !"t inflation is expected to !e )2. If the
individ"al invests C2,777 per year for 27 years the real f"t"re val"e of their investment is
((((((((. :$ll investments occ"r at year end;.
$. C3),/31
%. C11,))-
C C/),2/1
&. C-4,3)2

Difficulty: Hard

1). $n individ"al wants to have C6/,777 per year to live on when they retire in )7 years. The
individ"al is planning on living for 27 years after retirement. If the investor can earn 12
d"ring her retirement years and 172 d"ring her wor'ing years, how m"ch sho"ld she !e
saving d"ring her wor'ing life# :<intF Treat all calc"lations as ann"ities.;
$. C6,432
%. C4,2)-
C. C3,674
D C1,12-

Difficulty: Hard

21-)3
Chapter 21 - Taxes, Inflation, and Investment Strategy
1-. S"ppose yo" are a high tax !rac'et individ"al and yo" want to shelter yo"r investment
income. The !est choice of investment for yo" to minimi,e the tax !ill is to invest in
(((((((((.
$. a !ond portfolio
%. stoc's with high dividend yields
C a m"nicipal !ond portfolio
&. stoc's with low or ,ero dividend yields

Difficulty: Medium

1/. 9o" want to minimi,e yo"r c"rrent tax !ill !y maximi,ing yo"r contri!"tions to yo"r
(((((((((((((.
$. taxa!le !ond portfolio
%. 5oth I5$
C -71' or -7)! plan
&. taxa!le savings acco"nt

Difficulty: Medium

Sharon decides to p"t C/,777 into her I5$ at age of 2/. She will contin"e to invest the same
amo"nt for the next 1 years and then stop contri!"ting. $ss"me 172 ann"al ret"rn.

11. <ow m"ch money will Sharon have in her I5$ after 1 years#
$. C)7,777
%. C)/,/3/
C C)4,/34
&. C-1,-/1

Difficulty: Medium

21-)4
Chapter 21 - Taxes, Inflation, and Investment Strategy
13. <ow m"ch money will Sharon have in her I5$ when she is ready to retire at age of 12#
$. C//-,4/1
%. C12),2-/
C. C3)4,/34
D C41-,/23
JK I C)4,/34 :1 L 7.1;
)2
I C41-,/23

Difficulty: Medium

$ non-profit organi,ation offers a /2 salary contri!"tion to GohnEs -7)! plan and matching
/2 when Gohn contri!"tes /2 of hisHher salary. Gohn ma'es C/1,777 a year.

14. What is the amo"nt of total contri!"tion to his -7)! if Gohn contri!"tes /2 of his own
money#
$. C/,177
! C4,-77
C. C11,277
&. C12,/77
C/1,777 x /2 L C/1,777 x 172 I C4,-77

Difficulty: Medium

16. What is GohnEs effective salary red"ction if he is in the 2/2 tax !rac'et#
" C2,177
%. C2,477
C. C/,177
&. C4,-77
C2477:1 - 7.2/; I C2,177

Difficulty: Medium

21-)6
Chapter 21 - Taxes, Inflation, and Investment Strategy
37. What is GohnEs total cost of his /2 contri!"tion#
$. C2,177 cost
%. C2,477 cost
C C377 !enefit
&. C)/77 !enefit
C/1777:7.7/ - 7.7/:1 - 7.2/;; I C377

Difficulty: Hard

31. The fact that the *.S. government provides deposit ins"rance to !an's creates a form of
((((((((((( which is at least partially offset !y re="iring !an's to hold more capital if they
are ris'ier.
" moral ha,ard
%. adverse selection
C. ris' aversion
&. interest rate ris'

Difficulty: Medium

32. $n investor in the )-2 tax !rac'et wo"ld !e indifferent !etween a corporate !ond with a
!efore tax yield of 42 and a m"nicipal !ond with a yield of (((((((((.
$. ).612
%. 1.1/2
C /.242
&. 17.322
:42;:1 - 7.)-; I /.242

Difficulty: Medium

21--7
Chapter 21 - Taxes, Inflation, and Investment Strategy
3). $n investor who is in the )/2 federal tax !rac'et and the /2 state !rac'et !"ys a 1./2
yield corporate !ond. What is his after tax yield#
" ).672
%. -.3/2
C. 1./72
&. 6.672
:1./2;:1 - 7.)/ - 7.7/; I ).62

Difficulty: Medium

21--1

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