Explanations for Week 6 Quiz

Question 1
A rise in interest rates will cause the value of your U. S. Treasury note to Go Up Go Down Remain unchanged EXPLANATION: If yesterday you bought Treasury note A for $1,000 that paid 10% annually and today anybody could buy for $1,000 Treasury note B that paid 11% annually, do you think that anybody would pay you $1,000 for your note? No, they would be willing to pay you something less.

Question 2
If the government is offering to sell you a one-year note with a face value of $10,000 for $9,500, then the discount rate is: 0% 2.5% 5% 5.26% 6% EXPLANATION: The government is offering you the opportunity to buy their note today for $9,500 in exchange for their promise to pay you $10,000 one year from today. The discount is the percentage that you as the seller of cash need in order to be persuaded to buy the note. If you accept the offer you will have paid $9,500 in order to receive $10,000 in one year. Thus you make $500 for your one-year investment of $9,500. Your rate of return is $500/$9500= 5.26%. It is also the discount rate.

Question 3
If you purchase a bond at a treasury auction are you a buyer or a seller of cash? Buyer

Explanations for Week 6 Quiz

Seller EXPLANATION: You sold your cash for the promise of a future return.

Question 4
Which of the following is an example of trending data? Property taxes Mortgage Life insurance Schoolteachers pay EXPLANATION: Property taxes generally go up with the rising trend of property values. Mortgages and life insurance premiums remain constant for extended periods. Schoolteachers pay ( at least in the United States) typically has a trending component.(for example, an annual cost of living adjustment, a longevity component (that adjusts separate from the Cola Adjustment and a mastery component (educational degree achieved). While an argument could be made for schoolteachers pay and property taxes, property taxes is a better example so long as a new bond measure has not been passed.

Question 5
If company employees have had a pay freeze for 3 years while inflation was 3%, how much of a pay raise would they need to be restored to their former purchasing power? 6% 8.7% 9% 9.3% 9.6% EXPLANATION: Assume the employees pay is $1,000. What they used to buy for $1,000 now costs $1,000 x 1.03 x 1.03 x 1.03 = $1092.60. The raise needed is 1092.6/1000 =9.26%

Question 6
Chained CPI is
1. Higher than regular CPI

Explanations for Week 6 Quiz

2. Lower than regular CPI 3. Intended to account for substitution of consumers 4. Designed to account for product improvements

1 only 1 and 3 2 and 4 2 and 4 1 and 2 EXPLANATION: This question comes primarily from the reading although it is alluded to in the second lecture. It has also been roundly discussed in the financial and political press this year. Chained CPI is a likely successor to the CPI as the means to adjust Social Security and therefore save money. A chained CPI takes into account the fact that as prices rise consumers make substitutions. For example when the price of beef rises, people eat more chicken. The chained CPI is therefore consistently lower than regular CPI

Question 7
Which series best represents the increasing cost of food over time?

Series 1

Explanations for Week 6 Quiz

Series 2 Series 3 Series 4 EXPLANATION: This series of graphs was intended to make you apply the concepts of the various model possibilities from data in a visual context. The cost of food increases at a fairly constant rate in the long run. Thus it is trending data. It follows the formula FV =PV X (1 + rate of return)Y where y is the number of years. This creates a line-like series that has an everincreasing slope. Series 1 is such a line

Question 8
Which series best represents placing money in a bank savings account getting 3.4% annual interest?

Series 1 Series 2 Series 3 Series 4 Having money in a savings account follows the same pattern as before. Again Series 1 is the correct line

Explanations for Week 6 Quiz

Question 9
Which series best represents paying down a 30-year mortgage?

Series 1 Series 2 Series 3 Series 4 EXPLANATION: Paying off a mortgage is a step function, i.e. a cost that goes along at one level for an extended period and then changes. Series 4 is a representation of a step function that stays the same for 30 years and then goes to zero. (Note: Due to a data entry error in Coursera, Series 1 was incorrectly marked as the correct answer. However, Series 4 is the correct answer.)

Explanations for Week 6 Quiz

Question 10
Which series best represents regularly saving money and placing it under your mattress?

Series 1 Series 2 Series 3 Series 4 EXPLANATION: Saving money and placing it under you mattress would follow the function of the sum of the deposits. Unfortunately this question only refers to the regularity of the deposits and not a constancy of the amount. If the amount is constant you get the graphical form of Y = M * X + B where B is the starting amount and M is the contribution. This is the classic straight line with a slope M. (Series 2) If a person were to interpret the contribution as an increasing amount the line would look more like Series 1.

Explanations for Week 6 Quiz

Question 11
Which series best represents the increasing cost of food over time, discounted by inflation?

Series 1 Series 2 Series 3 Series 4 EXPLANATION: This is certainly a more advanced question. If something like food rises at the rate of inflation and you wanted to discount it by the rate of inflation this would be the formula for each time along a timeline: PVn =CF X (1+ INF)n./ (1+INF)n PV is the present Value, CF is the current cost of Food, and INF is the rate of inflation. Thus the graphical form is that of series 4 -- a horizontal straight line, or a constant amount.

Explanations for Week 6 Quiz

Question 12
Which series best represents paying down a 30-year mortgage discounted by inflation?

Series 1 Series 2 Series 3 Series 4 EXPLANATION: This question is poorly worded for the concept. Intended rightfully it would be better stated as Which series best represents the discounted value of the payments on a 30 year mortgage? The form of this equation would be PVpmt1 =MP/(1+INF)n This would create the line as shown in Series 3.