Chapter 4 Personal Finance Practice Test

A personal budget is a plan for spending and saving that outlines one's income and expenses. It helps manage finances effectively by providing a clear picture of financial inflows and outflows.

Saving money is essential for building financial security and preparing for future expenses. It provides a safety net for emergencies and helps avoid high-interest debts.

Fixed expenses remain constant over time and are predictable. Monthly rent payments are a common example of fixed expenses.

Variable expenses change from month to month based on consumption and usage. Utility bills are a clear example, as they often fluctuate with the level of usage.

A credit score is a numerical representation of an individual's creditworthiness. It is used by lenders to assess the risk involved in lending money.

APR stands for Annual Percentage Rate, which represents the annual cost of borrowing money including interest and fees. This helps borrowers understand the true cost of a loan.

The future value of a compound interest investment depends on the principal, the duration of the investment, and how often interest is compounded. The color of the bank is irrelevant to the calculation.

Diversification spreads investments across various assets, reducing the impact of any single asset's poor performance. This minimizes overall risk while still providing opportunities for returns.

Inflation is defined as a general rise in prices over time, which erodes the purchasing power of money. It affects consumer spending and economic stability at large.

A high credit score indicates a strong history of managing debt responsibly. This can lead to lower interest rates and better loan approval prospects, reducing overall borrowing costs.

A personal budget should reflect current financial conditions, including any changes in income or expenses. Regular updates ensure that spending habits and savings goals remain relevant and achievable.

Emergency savings act as a financial reserve for unexpected events such as medical emergencies or sudden job loss. Having a dedicated emergency fund helps prevent reliance on high-interest debt during crises.

Taking on excessive debt increases interest payments and can strain monthly finances. This high debt load reduces flexibility and may lead to long-term financial difficulties.

Paying more than the minimum reduces the principal balance faster, which in turn lessens the total interest accrued over time. This strategy results in quicker repayment and lower overall debt costs.

A personal budget tracks income and expenditures, offering insight into spending habits. It is an essential tool for managing finances and planning for future expenses.

The total interest earned in a compound interest account is heavily influenced by the principal amount invested. Increasing the initial deposit boosts the base amount upon which interest is calculated, leading to greater overall returns.

More frequent compounding means that interest is calculated and added to the principal more often, which accelerates growth over time. This results in a higher accumulated amount compared to less frequent compounding.

In investing, higher risk is generally associated with the possibility of higher returns, though it also increases the chance of losses. Investors must balance their risk tolerance with the potential rewards when making decisions.

Interest rates directly affect the cost of borrowing, which in turn impacts the total interest paid over the duration of a mortgage. Even a small change in the rate can lead to a significant difference in overall loan cost.

When evaluating an investment with variable returns, it is crucial to consider the risk associated with fluctuating returns. Assessing this risk helps determine whether the potential higher gains justify the increased uncertainty.