AER Financial Literacy Exam Practice Quiz

A budget is a financial plan that outlines expected income and expenditures over a specific period. It helps individuals manage their money and plan for future expenses.

Simple interest is calculated only on the original principal amount, not on any accumulated interest. This method results in a linear growth of interest over time.

A savings account allows you to earn interest on your deposits while keeping your money accessible. It is a safe method for managing short-term funds and emergency savings.

Inflation is characterized by a general increase in the prices of goods and services over time, which erodes the purchasing power of money. Understanding inflation is important for managing personal finances.

The interest rate is the percentage charged on borrowed money or earned on investments. It represents the cost of borrowing or the reward for saving and investing money.

Compound interest takes into account the interest earned on both the original amount and any previously accumulated interest. This leads to exponential growth over time, contrasting simple interest which is linear.

Reinvesting interest leads to a higher principal for subsequent interest calculations, which is the essence of compound interest. This contrasts with simple interest, where earned interest is not reinvested.

Diversification reduces risk by spreading investments across various asset classes and sectors. This strategy helps to mitigate the impact of poor performance in any single investment.

Opportunity cost is the benefit that is foregone by choosing one option over the next best alternative. It is a key concept in decision-making, highlighting potential losses when one option is selected over another.

As inflation rises, the general price level of goods and services increases, reducing the purchasing power of money. This means that the same amount of money buys fewer goods and services over time.

Liquidity refers to how quickly and easily an asset can be converted into cash without significantly affecting its price. Highly liquid assets, such as cash or marketable securities, can be quickly accessed when needed.

Risk diversification involves spreading investments across various assets to reduce the impact of any one asset's poor performance. This strategy helps mitigate overall risk in a portfolio.

Interest rates are influenced by factors such as credit history, loan term, and prevailing market rates. Personal hobbies do not affect the determination of an interest rate.

The principal is the initial amount of money that is either invested or borrowed. Interest is calculated based on this original sum, making it a fundamental concept in finance.

Banks earn profits by charging a higher interest rate on loans than what they pay on deposits. This difference, known as the net interest margin, is a primary source of revenue for banks.

Using the compound interest formula A = P(1 + r)^n, where P = $1,000, r = 0.05, and n = 3, the calculated amount is roughly $1,158. Compound interest causes the investment to grow exponentially over time.

Making regular, equal payments into an investment account is characteristic of an annuity. In an annuity, these payments grow over time due to compound interest.

While nominal returns may appear high during periods of inflation, the real value, or purchasing power, of those returns declines. High inflation erodes the long-term benefits of investments.

Increased market volatility means that asset prices can fluctuate significantly over short periods. This heightened uncertainty translates into higher investment risk.

Return on Equity (ROE) measures how effectively a company uses shareholder investments to generate profits, making it a strong indicator of profitability. It allows investors to directly compare the performance of different companies.