60 QUESTIONS AND CORRECT DETAILED ANSWERS WITH
RATIONALES (VERIFIED ANSWERS) |ALREADY GRADED A+.
QUESTION
Richard wants to have an annual retirement income of $100,000 (payable at the
beginning of each year) protected against 3% inflation. Assuming a 7% after-tax rate of
return and a retirement period of 30 years, how much money does Richard need in
order to meet his goal? Explain how you need to input this on the calculator and why.
CORRECT ANS: Step One - Set the calculator to BEGIN. Step Two - Calculate the
inflation adjusted rate of return (One plus the Rate of Return divided by One plus the
interest rate, minus one, multiplied by 100 = the inflation adjusted rate of return) Put
this number in the I/YR. Step Three - 100,000 goes in as a PMT. Step Four - 30 goes in as
N. Step Five - Press PV. Richard needs $1,822,042.88 in today's dollars to meet his needs.
Expert Rationale
This problem requires calculating the present value of an inflation-adjusted annuity due.
The BEGIN mode is used because the payments are made at the beginning of each year,
which is typical for retirement income needs. The inflation-adjusted rate of return (also
known as the real rate of return) must be calculated to account for the eroding effect of
inflation on purchasing power. The formula [(1 + nominal return) / (1 + inflation rate)] -
1 provides the real rate. This real rate is then used as the discount rate in the present
value calculation. The PV of $1,822,042.88 represents the lump sum needed today to
fund 30 years of inflation-protected payments of $100,000 at the beginning of each
year.
DIF: Cognitive Level: Apply (Application) TOP: Retirement Needs Analysis MSC: N/A
QUESTION
How do you calculate the inflation-adjusted rate of return?
CORRECT ANS: 1 plus the Rate of Return, Divided by 1 plus the interest rate, minus one,
multiplied by 100.
Expert Rationale
The inflation-adjusted rate of return, also known as the real rate of return, is calculated
by dividing the nominal rate (1 + investment return) by the inflation factor (1 + inflation
,rate), subtracting one, and then multiplying by 100 to express it as a percentage. This
formula strips out the effects of inflation, providing a rate that reflects the true growth
of purchasing power. This calculation is fundamental when determining how much
capital is needed to fund a stream of income that is protected against inflation.
DIF: Cognitive Level: Understand (Comprehension) TOP: Time Value of Money MSC: N/A
QUESTION
Tom has been promised a stream of $40,000 annual payments at the end of each year
for 25 years. The present value of these payments discounted at a rate of 5% is which
one of the following amounts?
CORRECT ANS: Step One - The problem says END in it so you have to set your
calculator to the END mode. Step two - Enter the $40,000 as a PMT. Step Three - Enter
25 as the N. Step Four - Enter 5 as the I/YR. Step Six - Hit PV. $563,758.
Expert Rationale
This is a standard present value of an ordinary annuity problem. The END mode is
appropriate because the payments occur at the end of each period. Using a financial
calculator, the present value of a 25-year, $40,000 annuity discounted at 5% is $563,758.
This represents the lump sum amount that, if invested today at a 5% return, would be
sufficient to fund the 25 annual payments of $40,000.
DIF: Cognitive Level: Apply (Application) TOP: Time Value of Money MSC: N/A
QUESTION
Nick wants to maintain the purchasing power of $75,000 (in today's dollars) in
retirement. If inflation continues to average 3.5%, approximately what amount will Nick
need in 20 years to equal the purchasing power of $75,000 today? (Round your answer.)
CORRECT ANS: If you know the Rule of 72, and you divide 3.5 into 72, you arrive at the
number 20, which is the number of years it will take for a sum to double. With a
calculator, you can solve for the future value of $75,000 over 20 years at 3.5%.
Keystrokes: 20 N, 3.5 I/YR, 75,000 PV, FV = $149,234; rounded = $150,000.
Expert Rationale
The Rule of 72 is a quick approximation method to estimate how long an investment will
, take to double at a given rate of return (72 / rate = years to double). Conversely, it can
be used to estimate the future value of a sum given an inflation rate. At 3.5% inflation,
purchasing power halves approximately every 20 years. Thus, $75,000 today would need
to grow to approximately $150,000 in 20 years to maintain its purchasing power. The
financial calculator provides the precise future value of $149,234, which rounds to
$150,000.
DIF: Cognitive Level: Apply (Application) TOP: Inflation and Purchasing Power MSC: N/A
QUESTION
What is the second step in the retirement planning process?
CORRECT ANS: The second step in the retirement planning process is to gather client
data, including goals and expectations.
Expert Rationale
The retirement planning process is structured to ensure a comprehensive approach to
client engagement. The first step is establishing the client-counselor relationship,
including defining the scope of services and disclosing compensation. The second step
is the critical data-gathering phase, where the planner collects financial information,
identifies client goals, and assesses expectations. This data forms the foundation for
developing a tailored retirement plan.
DIF: Cognitive Level: Remember (Knowledge) TOP: Retirement Planning Process MSC:
N/A
QUESTION
What is the first step in the retirement planning process?
CORRECT ANS: The first step is to establish and define the client-counselor relationship
which includes disclosing the counselor's compensation arrangement.
Expert Rationale
The initial step in the retirement planning process is foundational. The client-counselor
relationship must be clearly defined, and the advisor's compensation structure must be
transparently disclosed to the client. This establishes trust and ensures the client
understands the nature of the advisory relationship, including any potential conflicts of