Saturday, November 2, 2013

How much do you know about Financial Risk?





As I grew into my teenage years, I learned my first big lesson in family financing.  I learned that most people had no clue what the hell they were doing when it came to savings and investing.  That is still true today and is the reason why many people are taken advantage of by banks, insurance companies, and brokerage firms.
The first thing you should be concerned about when saving or investing money is the amount and kind of risk that you are taking.

1.      Let’s start with Mr. Smith, a 27 year old Home Heating and Cooling Specialist that wants to start an IRA for himself. He wants to take $1,000 per month from his pay for his investments. He also wants to take the $2,000 from his tax return every year and add it to his $1,200 per year savings.

2.      Mr. Smith wants to add his money into his IRA once a year. To safe guard his money throughout the year; he placed his money into an intermediary. What is an intermediary?
A.      A financial intermediary is a financial institution that connects surplus and deficit agents. The classic example of a financial intermediary is a bank that consolidates bank deposits and uses the funds to transform them into bank loans.
B.      A brokerage firm that is separate from banking.
C.      None of these
D.     Both of these
3.      Mr. Smith wants to make sure that his savings are insured in case of a banking collapse. He checks to see if they have;
A.      SPIC
B.      FDIC
C.      SIPC
D.      DFIC
4.      If Mr. Smith has the insurance above and he has $100,000 in the bank and the bank goes out of business, he will get back
A.      $200,000
B.      $75,000
C.      $100,000
D.     $99,000
5.      Mr. Smith moved his money after the first year, $3,200 to a well-known international brokerage firm located in New York that is in the top 5 firms in the world. He asked if they have insurance. What insurance is he asking that they have?  
A.      SPIC
B.      FDIC
C.      SIPC
D.     DFIC

6.      Mr. Smith checks the firm’s fee schedule to see if the fees are in line with what he wants to pay knowing that every brokerage firm sets different fee rates and schedules.  Fees will be different for;  
A.      Stock
B.      Bonds
C.      Mutual Funds
D.     All of these

7.      His broker told him that he will be safe if he bought into a "Retirement Date Funds" or "Target Fund." This fund;
A.      Makes investments in other mutual funds that buy individual stocks and bonds.  
B.      That matures on a given date
C.      That targets profitable companies
D.     None of these

8.      Some (one) of the fee(s) he found in a Target Fund can be;
A.      a 12-1b fee
B.      a sales load or commission for investing in the fund
C.      None of these
D.     Both of these

9.      Mr. Smith is opening a Traditional IRA. That means on a bond mutual fund, it is not a very intelligent thing to do to buy municipal bonds in that fund as you are already exempt with municipal bonds from taxation on the interest income!
True
False

10.  A Corporate Bond and a Mutual Fund is the same thing.
A.      Yes, they both mature
B.      No, only bonds mature
C.      Yes, they both give monthly interest
D.     Yes, they both give interest at the end of the year.

11.  A stock carries more market risk than bonds.
True
False
12.  An “AAA” bond carries more business risk than “A” bonds?
            True
            False
13.  More than likely, a “BB” bond gives higher interest than an “AAA” bond.
            True
            False
14.  A bond that matures in 4 years has less interest rate risk than a bond that matures in 10 years.
            True
            False
15.  A bond that matures in 4 years has less inflation risk than a bond that matures in 10 years.
            True
            True
16.  A bond that matures in 4 years has less market risk than stocks.
            True
            False
17.  Mr. Smith meets an insurance broker at his son’s football game. He says that he can give him an annuity investing his money in a junk bond fund that will give him $1,000 per month guaranteed for the rest of his life, if he gives Mr. Smith $300,000 today. Does this rate of return sound right?
A.      Yes because that rate comes to 4% per year.
B.      No because that rate comes to 4% per year.
C.      He can make more money than that.
D.     Take it and run!
18.  Would it be smart to put this annuity into Mr. Smith’s IRA?
Yes
No
19.  What type of product is this annuity?
A.      Banking
B.      Insurance
C.      Brokerage
D.     None of these
20.  Instead of buying an annuity, Mr. Smith can invest his money into several individual Junk Bonds over several years and achieve a higher return than the annuity. That is because the company overseeing the management of Mr. Smith’s annuity must pay expenses from his portfolio.
True
False 

21. The money in Mr. Smith's bank account carries no risk.
True
False

22. Mr. Smith's bank account carries inflation and interest rate risk.

True 
False



 Answers
1.      A
2.      A
3.      B
4.      C
5.      C
6.      D
7.      A
8.      D
9.      True
10.  B
11.  True
12.  False
13.  True
14.  True
15.  True
16.  True
17.  A
18.  No
19.  B
20.  True

      21. False
      22. True


If you got more than 9 wrong, you better read up on my financial blogs before committing money for long term savings and investment.



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