Financial Literacy Practice Exam - 2 of 2

How might a savings account be impacted by inflation over time if interest rates are lower than inflation rates?

• The purchasing power of the savings decreases over time

• The account earns more interest than the inflation rate

• The savings balance remains unaffected

• The bank adjusts rates to match inflation automatically

Why is it beneficial to start saving for retirement early?

• To avoid penalties for late contributions

• To maximize compound interest growth over time

• To minimize taxes on investment returns

• To achieve higher annual contribution limits

If you had $10,000 to invest, which would be the best option for long-term growth, and why?

• A savings account for stability and no risk

• Stocks for higher returns despite potential risk

• A certificate of deposit for fixed returns

• Real estate for immediate liquidity

Why might someone prefer a Roth IRA over a traditional IRA for retirement savings?

• Roth IRA contributions are tax-deductible

• Roth IRA withdrawals are tax-free in retirement

• Roth IRA accounts require no minimum contributions

• Roth IRA funds can only be invested in stocks

How can diversifying investments reduce risk?

• By concentrating funds in high-performing stocks

• By spreading funds across different asset types

• By investing only in low-risk bonds

• By focusing on a single, stable market

What is the advantage of 'pay yourself first' when creating a budget?

• It ensures savings are prioritized before expenses

• It allows for more discretionary spending

• It eliminates the need for a detailed financial plan

• It focuses only on short-term financial goals

How does compound interest benefit long-term investments?

• It reduces the risk of market fluctuations

• It generates returns on both principal and prior interest

• It provides immediate access to funds when needed

• It minimizes taxes on investment earnings

If a certificate of deposit (CD) offers a higher interest rate than a savings account, what trade-off does the investor make?

• Higher liquidity in exchange for lower returns

• Lower risk in exchange for higher interest

• Less liquidity for higher, fixed interest

• More fees for additional flexibility

What is the relationship between risk and return in investing?

• Higher risk usually means higher potential returns

• Lower risk always results in higher returns

• Risk and return are unrelated in investment strategies

• High returns are guaranteed with low-risk options

Why might inflation erode the value of savings?

• Inflation increases interest rates on savings accounts

• Prices rise faster than interest earned on savings

• Inflation reduces the total balance of savings

• Banks charge higher fees during inflation