Q: Suppose a household earns $$\80$$,000$$ in wages, receives $$\$$5,000 in $$interest, and pays $$\15$$,000$ in taxes. What is the household's disposable income?

$$\70$$,000$$ $$\text{Disposable Income} = \text{Wages} + \text{Interest} - \text{Taxes} = 80,000 + 5,000 - 15,000 = 70,000$

Q: If the nominal interest rate is $$8\%$$ and the inflation rate is $$3\%$$, what is the real interest rate?

$$5\%$$ $$\text{Real Interest Rate} = \text{Nominal Interest Rate} - \text{Inflation Rate} = 8\% - 3\% = 5\%$$

Question 1

Which of the following best describes the difference between gross investment and net investment?

Accepted Answer

Gross investment is the total amount spent on new capital, while net investment is gross investment minus depreciation.

$$	ext{Net Investment} = 	ext{Gross Investment} - 	ext{Depreciation}$$

Question 2

Suppose a household earns $$\80$$,000$$ in wages, receives $$\$$5,000 in $$interest, and pays $$\15$$,000$ in taxes. What is the household's disposable income?

Accepted Answer

$$\70$$,000$$

$$	ext{Disposable Income} = 	ext{Wages} + 	ext{Interest} - 	ext{Taxes} = 80,000 + 5,000 - 15,000 = 70,000$

Question 3

Which of the following is NOT a characteristic of a bond?

Accepted Answer

It represents ownership in a corporation.

Question 4

If the nominal interest rate is $$8\%$$ and the inflation rate is $$3\%$$, what is the real interest rate?

Accepted Answer

$$5\%$$

$$	ext{Real Interest Rate} = 	ext{Nominal Interest Rate} - 	ext{Inflation Rate} = 8\% - 3\% = 5\%$$

Question 5

Which of the following best explains why the real interest rate is considered the opportunity cost of borrowing?

Accepted Answer

Because it reflects the true cost of funds after adjusting for inflation, representing the purchasing power forgone by lending or borrowing.

Question 6

A financial institution is considered insolvent when:

Accepted Answer

Its liabilities exceed its assets, resulting in negative net worth.

$$	ext{Net Worth} = 	ext{Assets} - 	ext{Liabilities}$$

Question 7

Which of the following is a direct effect of a government budget deficit in the loanable funds market?

Accepted Answer

It increases the demand for loanable funds, potentially raising the real interest rate and crowding out private investment.

Question 8

If the present value of $$\1$$,000$$ to be received in 3 years at an interest rate of 5$$\%$ is calculated, which formula should be used?

Accepted Answer

$$PV = \dfrac{FV}{(1 + r)^n}$$

$$PV = \dfrac{1,000}{(1 + 0.05)^3$}$$

Question 9

Which of the following is NOT a source of loanable funds?

Accepted Answer

Government purchases of goods and services.

Question 10

A movement along the demand curve for loanable funds (DLF) is caused by:

Accepted Answer

A change in the real interest rate.

Question 11

Which of the following would cause a rightward shift in the supply of loanable funds (SLF)?

Accepted Answer

An increase in disposable income, leading to higher household saving.

Question 12

If a financial asset's price increases, what happens to its interest rate, all else equal?

Accepted Answer

The interest rate decreases.

$$	ext{Interest Rate} = \dfrac{	ext{Coupon Payment}}{	ext{Price}}$$

Question 13

Which of the following best describes the crowding-out effect?

Accepted Answer

Government borrowing increases the real interest rate, reducing private investment.

Question 14

A mortgage-backed security is:

Accepted Answer

A financial asset that is backed by a bundle of home mortgages.

Question 15

If a country has a national saving of $$\500$ million and investment of $$\$$600$$ million, what is the amount of borrowing from the rest of the world?

Accepted Answer

$$\100$ million

$$	ext{Borrowing from Rest of World} = 	ext{Investment} - 	ext{National Saving} = 600 - 500 = 100$

Question 16

Which of the following is NOT considered a financial institution?

Accepted Answer

A manufacturing company.

Question 17

If a firm is considering a project with a net present value (NPV) of $$-\10$$,000$, what should it do according to the financial decision rule?

Accepted Answer

Reject the project, because a negative NPV means the project will decrease the firm's value.

Question 18

Which of the following is an example of capital gain?

Accepted Answer

Selling a stock for more than its purchase price.

Question 19

Which of the following would increase the demand for loanable funds (DLF)?

Accepted Answer

An increase in expected future profits by firms.

Question 20

If a financial institution has assets of $$\200$ million and liabilities of $$\$$180$$ million, what is its net worth?

Accepted Answer

$$\20$ million

$$	ext{Net Worth} = 	ext{Assets} - 	ext{Liabilities} = 200 - 180 = 20$

Ch. 7: Finance, Saving, and Investment

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