A study by Standard & Poor (S&P) in 2014 showed that only 25% of Filipino adults are financially literate. The global score is 31%, which means our country is below average and needs to improve.
Fortunately, the Philippine government is already working on several financial literacy programs to help address this. This news was announced last April 2016 by Undersecretary Gil Beltran during the 10th Financial Literacy Summit.
But what does it mean to be financially literate?
The US National Bureau of Economic Research (NBER) defines it as having an understanding of basic financial concepts such as interest, inflation, risk, and investments.
It also includes numeracy skills, or the ability to work with numbers. Particularly, having the ability to solve mathematical problems that involve the financial concepts mentioned above.
And that’s what we’ll try to do today.
Financial Literacy Test
Below are six multiple-choice questions. They’re from the US National Financial Capability Study, and among the many problems they use to measure financial literacy.
Note down your choice for each question, then check your answers in the key provided after. Add up your score and discover your level of financial literacy.
Suppose you have $100 in a savings account earning 2 percent interest a year. After five years, how much would you have?
a. More than $102
b. Exactly $102
c. Less than $102
d. I don’t know
Imagine that the interest rate on your savings account is 1 percent a year and inflation is 2 percent a year. After one year, would the money in the account buy more than it does today, exactly the same or less than today?
d. I don’t know
If interest rates rise, what will typically happen to bond prices? Rise, fall, stay the same, or is there no relationship?
c. Stay the same
d. No relationship
e. I don’t know
True or false: A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage but the total interest over the life of the loan will be less.
c. I don’t know
True or false: Buying a single company’s stock usually provides a safer return than a stock mutual fund.
c. I don’t know
Suppose you owe $1,000 on a loan and the interest rate you are charged is 20% per year compounded annually. If you didn’t pay anything off, at this interest rate, how many years would it take for the amount you owe to double?
a. Less than 2 years
b. 2 to 4 years
c. 5 to 9 years
d. 10 or more years
e. I don’t know
Financial Literacy Test Answer Key
QUESTION 1 ANSWER: a. More than $102
You’ll have more than $102 at the end of five years because your interest will compound over time. In other words, you earn interest on the money you save and on the interest your savings earned in prior years.
Here’s how the math works. A savings account with $100 and a 2 percent annual interest rate would earn $2 in interest for an ending balance of $102 by the end of the first year.
Applying the same 2 percent interest rate, the $102 would earn $2.04 in the second year for an ending balance of $104.04 at the end of that year. Continuing in this same pattern, the savings account would grow to $110.41 by the end of the fifth year.
QUESTION 2 ANSWER: c. Less
The reason you have less is inflation. Inflation is the rate at which the price of goods and services rises.
If the annual inflation rate is 2 percent but the savings account only earns 1 percent, the cost of goods and services has outpaced the buying power of the money in the savings account that year.
Put another way, your buying power has not kept up with inflation.
QUESTION 3 ANSWER: b. False
When interest rates rise, bond prices fall. And when interest rates fall, bond prices rise.
This is because as interest rates go up, newer bonds come to market paying higher interest yields than older bonds already in the hands of investors, making the older bonds worth less.
QUESTION 4 ANSWER: a. True
Assuming the same interest rate for both loans, you will pay less in interest over the life of a 15-year loan than you would with a 30-year loan because you repay the principal at a faster rate.
This also explains why the monthly payment for a 15-year loan is higher. Let’s say you get a 30-year mortgage at 6 percent on a $150,000 home. You will pay $899 a month in principal and interest charges. Over 30 years, you will pay $173,757 in interest alone.
But a 15-year mortgage at the same rate will cost you less. You will pay $1,266 each month but only $77,841 in total interest—nearly $100,000 less.
QUESTION 5 ANSWER: b. False
In general, investing in a stock mutual fund is less risky than investing in a single stock because mutual funds offer a way to diversify.
Diversification means spreading your risk by spreading your investments. With a single stock, all your eggs are in one basket.
If the price falls when you sell, you lose money. With a mutual fund that invests in the stocks of dozens (or even hundreds) of companies, you lower the chances that a price decline for any single stock will impact your return.
Diversification generally may result in a more consistent performance in different market conditions.
QUESTION 6 ANSWER: b. 2 to 4 years
Ignoring interest compounding, borrowing at 20 percent per year would lead to doubling in five years; someone who knew about interest on interest might have selected a number less than five.
Someone who knows the “Rule of 72” heuristic would know that it would be about 3.6 years, which makes the correct answer “2 to 4 years.”
In finance, the Rule of 72 is a method for estimating an investment’s doubling time. The rule number (i.e., 72) is divided by the interest percentage per period to obtain the approximate number of periods (usually years) required for doubling.
What’s your score?
5 to 6 correct answers:
You’re above average. Congratulations and keep up the good work. I’m proud of you.
3 to 4 correct answers:
Your financial literacy is on the average level. Stay on track and continue learning.
0 to 2 correct answers:
You need to give more effort in learning, so you can eventually increase your financial literacy. It’s never too late to start learning!
So how did you do? Please share your score in the comments section. Thank you.
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