Today I'm trying to do some work with the Canadian Financial Capability Survey. This survey contains a test of financial literacy/knowledge, which I have reproduced below the fold:
Objective (assessment) measure of financial knowledge (OA) - Source: 2008 Canadian Financial Capability Survey
OA_Q01 If the inflation rate is 5% and the interest rate you get on your savings is 3%, will your savings have at least as much buying power in a year’s time?
1. Yes.
2. No.
OA_Q02 A credit report is…?
1. A list of your financial assets and liabilities.
2. A monthly credit card statement.
3. A loan and bill payment history.
4. A credit line with a financial institution.
OA_Q03 Who insures your stocks in the stock market?
1. The National Deposit Insurance Corporation.
2. The Securities and Exchange Commission.
3. The Bank of Canada.
4. No one.
OA_Q04 True or false: By using unit pricing at the grocery store, you can easily compare the cost of any brand and any package size.
1. True.
2. False.
OA_Q05 If each of the following persons had the same amount of take home pay, who would need the greatest amount of life insurance?
1. A young single woman with two young children.
2. A young single woman without children.
3. An elderly retired man, with a wife who is also retired.
4. A young married man without children.
OA_Q06 If you had a savings account at a bank, which of the following statements would be correct concerning the interest that you would earn on this account?
1. Sales tax may be charged on the interest that you earn.
2. You cannot earn interest until you pass your 18th birthday.
3. Earnings from savings account interest may not be taxed.
4. Income tax may be charged on the interest if your income is high enough.
OA_Q07 Inflation can cause difficulty in many ways. Which group would have the greatest problem during periods of high inflation that lasts several years?
1. Young working couples with no children.
2. Young working couples with children.
3. Older, working couples saving for retirement.
4. Older people living on fixed retirement income.
OA_Q08 Lindsay has saved $12,000 for her university expenses by working parttime. Her plan is to start university next year and she needs all of the money she saved. Which of the following is the safest place for her university money?
1. Corporate bonds.
2. Mutual funds.
3. A bank savings account.
4. Locked in a safe at home.
5. Stocks.
OA_Q09 Which of the following types of investment would best protect the purchasing power of a family’s savings in the event of a sudden increase in inflation?
1. A twenty-five year corporate bond.
2. A house financed with a fixed-rate mortgage.
3. A 10-year bond issued by a corporation.
4. A certificate of deposit at a bank.
OA_Q10 Under which of the following circumstances would it be financially beneficial to borrow money to buy something now and repay it with future income?
1. When something goes on sale.
2. When the interest on the loan is greater than the interest obtained from a savings account.
3. When buying something on credit allows someone to get a much better paying job.
4. It is always more beneficial to borrow money to buy something now and repay it with future income.
OA_Q11 Which of the following statements is not correct about most ATM (Automated Teller Machine) cards?
1. You can get cash anywhere in the world with no fee.
2. You must have a bank account to have an ATM card.
3. You can generally get cash 24 hours-a-day.
4. You can generally obtain information concerning your bank balance at an ATM machine.
OA_Q12 Which of the following can hurt your credit rating?
1. Making late payments on loans and debts.
2. Staying in one job too long.
3. Living in the same location too long.
4. Using your credit card frequently for purchases.
OA_Q13 What can affect the amount of interest that you would pay on a loan?
1. Your credit rating.
2. How much you borrow.
3. How long you take to repay the loan.
4. All of the above.
OA_Q14 Which of the following will help lower the cost of a house?
1. Paying off the mortgage over a long period of time.
2. Agreeing to pay the current rate of interest on the mortgage for as many years as possible.
3. Making a larger down payment at the time of purchase.
4. Making a smaller down payment at the time of purchase.
I have all of the respondents' answers to all 14 of these questions. I want to use these answers to these questions to come up with a measure of each respondent's level of financial literacy. Unfortunately the codebook doesn't tell me which of the answers are correct, and which of the answers are incorrect.
This is what I think the right answers supposed to be:
Q1 (2), Q2 (3), Q3 (4), Q4 (1), Q5 (1), Q6 either (3) or (4) because of TFSAs, Q7 (4), Q8 (3), Q9 (2), Q10 (3), Q11 (1), Q12 (1), Q13 (4), Q14 (3).
However I can see that there are arguments that can be made for other answers, e.g. for Q14 (2) might be correct in some circumstances, and sometimes (1) might be the right answer to Q10.
Do you agree/disagree with these responses?
Worthwhile Canadian Initiative 
I agree with all of your suppositions except Q6, where I think that the intended answer is (4) and that TFSAs are not meant to be considered – they are implicitly a special case of “savings account”.
I agree that there is some ambiguity on Q6, Q10 and Q14, but unfortunately this is almost inevitable with the multiple choice format. Although these specific ambiguities could have been avoided with different question phrasing, someone is bound to come up with an ingenious interpretation that you hadn’t thought of.
I answered Q6 as 4, because I read the “may not” in 3 as “is not allowed to”.
For Q10 I answered both 1 and 3. Maybe 3 is the best answer, and it’s the one I would have chosen, but 1 is right too.
For Q14 I think all the answers are wrong, because I interpret “lower the cost” as “lower the Present Value of the cost”. But I’m being picky and ornery. 3 is the best answer, and the one I would have chosen.
In general, I think it’s a good set of questions.
One I would like to add is: “Do you pay no interest on your credit card balance as long as you make the minimum monthly payment?” I have heard some people think you don’t.
Question 10 could be better phrased: who is this “someone” who gets a better-paying job when I go into debt?
And in reality taking on debt to purchase something at a (sufficiently deep) discount could well prove less emptily speculative — in purely financial terms — than, say, even the most shrewdly-calculated investment in higher education.
Basically though, I agree with your answers Frances.
I’d be curious what portion of the population answered something other than (4) for question (3). Technically (4) could be wrong, since you could buy a put option on your stock holdings to “insure” them against a loss. “None of the above” would have been a better answer, but(4) is unambiguously less wrong than the other 3 answers.
Two comments:
Q4: By using unit pricing at the grocery store, you can easily compare the cost of any brand and any package size.
This assumes that the products are equal in quality. That is nitpicky, but something that might trip me up, especially when you use the word “easily”.
Q10: There are two possible answers, as far as I can tell, but both of them would require more information about the relative cost of borrowing and the relative financial advantage of buying the item – those being the sale and the better job answers. I think an interesting point about this is that rules of thumb are useful, but numbers matter too.
For the record, I answered
Q6: 3 or 4
Q10: 1 or 3
Q14: I had no idea what answer they wanted and wondering what the right concept of “cost” was.
I also answered Q4: 2 because I was being pedantic.
(Read the question.
“By using unit pricing at the grocery store, you can easily compare the cost of any brand and any package size.”
The cost of any brand and any package size is given by its PRICE, not its unit pricing.
The question is not asking us which is a better buy or value, or which we should buy.)
Q11: Don’t most credit cards work in ATM machines? Should they count as “ATM cards”? Do they always require a bank account?
Now that I think about it, Q5 leaves wiggle room as well.
– Children have fathers. Fathers have obligations to provide for their dependent children and nearly all do. If the single mother dies, the kids have a father for financial support.
– The elderly wife could be entirely dependent on her husband for financial support. We don’t know how much of the pension benefits, assets, etc. pass to her in the event of his death. Now, the question of “how much life insurance” does not make clear whether this is incremental insurance to be bought after retirement (i.e. very expensive) or the value of an existing policy that he has paid into for decades (i.e. savings.)
But I think you have be to determined to construct alternative answers like this one…
“OA_Q09 Which of the following types of investment would best protect the purchasing power of a family’s savings in the event of a sudden increase in inflation?”
1. A twenty-five year corporate bond.
2. A house financed with a fixed-rate mortgage.
3. A 10-year bond issued by a corporation.
4. A certificate of deposit at a bank.
Your answer to question QA_Q09 is #2, but answer #2 is a bit deceiving. The house is the investment, the fixed rate mortgage is the financing arrangement. Would the answer still be #2 if the answer were just “A house”?
Case Shiller’s 10 city price index for housing in the US only goes back to 1987 (though I would think that any large mortgage company has more extensive records). In any case, here is a comparison of housing prices and the general price level:
http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=line&graph_id=&category_id=&recession_bars=On&width=630&height=378&bgcolor=%23b3cde7&graph_bgcolor=%23ffffff&txtcolor=%23000000&ts=8&preserve_ratio=true&fo=ve&id=SPCS10RSA,CPIAUCSL&transformation=pc1,pc1&scale=Left,Left&range=Custom,Custom&cosd=1987-01-01,1987-01-01&coed=2012-12-01,2013-01-01&line_color=%230000ff,%23ff0000&link_values=,&mark_type=NONE,NONE&mw=4,4&line_style=Solid,Solid&lw=1,1&vintage_date=2013-03-01,2013-03-01&revision_date=2013-03-01,2013-03-01&mma=0,0&nd=,&ost=,&oet=,&fml=a,a&fq=Monthly,Monthly&fam=avg,avg&fgst=lin,lin
Not only is a house “as an investment” less liquid than say corporate bonds or CD’s, but also, it is subject to manias and depressions.
Working my way through prep for the CISSP exam (6 hours, 250 questions, no set breaks) adds tremendous clarity! Don’t look for the right answer, just pick the best answer. You only are there to answer the question, not rewrite it. Don’t drag in outside information.
So… I agree with most of your answers, Frances, except:
Q06:4 … If you were to consider TFSAs, it would have said so. This is a financial literacy survey, not a financial planner test.
Q10:1 … This is the better answer, as it is much more “financial literacy” relevant. It’s the “use the credit card for something on sale” model.
Overall, though, I like it. The scenario structure is going to make it more appropriate for financial literacy than a straight memory/knowledge test.
@Frank: I think 2 would still be the right answer if there were no mortgage. It is the only item that will rise with inflation. Liquidity isn’t a problem in keeping up with inflation. All the others have a locked in nominal value at maturity, which provides some certainty at the expense of growth potential. In a high inflation environment, it’s very unlikely that housing would be so overvalued as to take a nominal loss.
Investing is about probabilities, and there’s a very high probability that the house will be a better investment than fixed-interest investments in a high inflation environment.
Regardless of value as an investment, the house (as a home rather than an investment) provides certainty in your cash flow, since the payments will remain constant no matter what inflation does
Inflation, inflation, inflation! Did I mention inflation!
Seriously, there are other bad things that can happen to good economies. Was this written in 1981?
Neil,
“Liquidity isn’t a problem in keeping up with inflation.” But it can be a problem to realize the purchasing power of savings. Suppose someone sold you a security that offered 6% + the prevailing inflation rate, but you and your family had to hold onto it for 50 years. In buying it, have you protected your family’s purchasing power if you are over 50 years old with adult children?”
“Investing is about probabilities, and there’s a very high probability that the house will be a better investment than fixed-interest investments in a high inflation environment.” The question did not mention a high inflation rate environment. It mentioned a sudden increase in the rate of inflation.
“All the others have a locked in nominal value at maturity.” Not exactly. The certificate of deposit has a locked in nominal value at maturity. The corporate bonds (assuming they are not Z tranche) make regular interest payments that can be re-invested.
I agree with all your answers. I am unsure of 8 and 10. Theoretically, a safe could be a better option, depending on which country you were in and how high crime was. Answer 1 for 10 could also be true, but it would have to be a big sale.
Well! Perhaps these questions are more interesting than I had supposed; I appear to differ with an accredited professor of economics over Q14.
Suppose that I am about to buy a house and I have a choice of mortgaging at rate R with downpayment D + X or with downpayment D and investing X in a mortgage (or mortgage pool) of the same maturity at the same rate R. Am I indifferent between these alternatives?
No! One obvious reason is that I must pay interest R with after-tax dollars (for other readers, this is Canada) whereas I am liable for tax on the interest R that I earn.
But there is another reason, perhaps more subtle: there is a substantial basis risk between my asset and my liability. Suppose that interest rates rise, house prices fall, and I am obliged to liquidate my portfolio before maturity. My asset is a negotiable security, and will have realized a loss. But although my lender will benefit when I terminate my mortgage, I will not be paid for this; on the contrary, I will probably have to pay a penalty!
Thanks for all of the feedback, will reply in a few hours.
Bob, I only have the working age married or common law respondents on my computer right now. There’s around 6,500 of them, and a lot answered don’t know to question #3. Here are the answers of the people who figured they knew:
Insures your stocks in the stock market | Percent
—————————————-+———————————–
The National Deposit Insurance Corporat | 8.29
The Securities and Exchange Commission | 23.65
The Bank of Canada | 18.42
No one | 49.64
—————————————-+———————————–
So about 1/2 of people got that question right.
Nick, excellent points about questions 10 and 14.
Simon – I just think of trying to compare paper towels with unit pricing – the unit price is per sheet, but each brand has different size sheets. Similar problems arise with cleaners when some are more concentrated than others. So, yes, unit pricing helps, but sometimes price comparisons are still difficult.
The correct answer for Q8 is #4. Sure the $12,000 is insured but it can take anywhere from a few months to many months to recover deposited funds in a bank failure. There is no guarantee that the money will be available to her when her education starts. She should buy a money order payable to herself or travelers cheques to eliminate theft worries from the safe.
Among survey respondents (the subsample on my computer) the most common answer to Q10 is 1, with 36.9% of respondents. 34.99% picked the “when buying something on credit allows someone to get a better job” option.
tab OA_Q10
Financially beneficial to borrow money | Freq. Percent Cum.
—————————————-+———————————–
When something goes on sale | 1,759 36.90 36.90
Interest on the loan is greater than th | 798 16.74 53.64
When buying something on credit | 1,668 34.99 88.63
It is always more beneficial to borrow | 542 11.37 100.00
—————————————-+———————————–
Total | 4,767 100.00
My first response is that this is not a well-written set of questions. My answers would be (with comments as necessary):
Q1: 2
Q2: 3 (A credit report is generally more than this—or less than this—however)
Q3: 4
Q4: 1 (Assuming the question means: “Any brand and any package size of essentially the same product.” That is, we are comparing the price per unit weight of laundry detergent Brand A in Package Size X to laundry detergent Brand B, Size Y. I think that’s a reasonable assumption, but not everyone will read the question that way.)
Q5: 1 (This is what I think the test-writers are looking for, but there’s an implicit assumption about the assets held by the people in the question, isn’t there?)
Q6: 3 or 4 may be right depending on the specific institutional arrangements of the country. I’d bet the test writers were looking for 4.
Q7: They’re looking for 4, but I could make a case for 3, possibly 2, and (by stretching) for 1. This is a really bad question.
Q8: 4 is literally the correct answer, isn’t it? Especially given the rate of bank failures (even with deposit insurance?
Q9: 2 would be my guess as to the suggested correct answer.
Q10: I don’t think any of those answers is correct. I wouldn’t even hazard a guess. I understand picking 3, but, even then, it depends on the interest rate on the loan, doesn’t it?
Q11: 1. Finally, an easy one.
Q12: 1 is obvious. But as I understand how credit scoring works, 4 could also hurt your credit rating, even if you pay off the balances every month.
Q13: 4. Another easy one.
Q14: This is another question for which I see no correct answer. Or, rather, the “correct” answer depends on how one defines the “cost of a house.”
Sorry about the extremely long comment.
Q8: 4 is literally the correct answer, isn’t it? Especially given the rate of bank failures (even with deposit insurance?
Not in Canada. The last bank failures of in this country were in 1985. The last one before that was in 1923. Canadian banks did not fail in the First Depression nor in the Second (current one). For which we all give thanks.
Curmudgeon’s answer is wrong as postal money orders per se are limited to $1200 in Canada, and bank drafts/traveller’s cheques and all other forms of bank paper do not hold their value in a bank failure. The Northland/Canadian Commercial Bank failures were painful because they showed that bank drafts were not guaranteed funds, or rather the guarantee of the bank’s credit and estate could be insufficient.
What is up with all the inflation questions?
Question 5 is also a bit weird. Are single mothers really a big market for individual life insurance policies?
I agree with the consensus on all of the other questions.
Question 10 (from personal experience, sigh): when the foundation of your house needs repair.
Q3 is actually ambiguous, re SIPC.
Question 5 isn’t weird, Alex, it’s ordinary Life Insurance Needs Assessment, the kind of question I saw on my licensing exam. The single mother has the most dependants of all the options and the dependants who will live the longest. Therefore she has the greatest need for income replacement if she dies.
Determinant, I understood that and figured it was the “correct” answer, it’s just a weird one because as far as I know it is ignore by real life.
Alex “What is up with all the inflation questions?”
Two theories (1) The questions were either drafted by someone who remembers the 70s, or based on questions drafted at some point by someone who remembers the 70s
(2) it’s actually not that easy to think of measures of financial literacy that don’t require a calculator or calculations (I like Nick’s credit card example); understanding of inflation is an easy thing to test
Determinant, I understood that and figured it was the “correct” answer, it’s just a weird one because as far as I know it is ignore by real life.
She would only need term life insurance, not whole life, so the premium would be very reasonable. T10 would be fine. The market for term life insurance has a large component of young families and especially new homeowners, as they are reading financial material and trying to get life insurance for the mortgage. Her youth is also an advantage as it means a lower price.
Possibly related: why financial literacy fails.
Nick, yup, that pretty much summarizes my views on the subject.
question 4: this could be a language thing, me, a physicist, living for 7 years in the US.
question 11: I definitely can get money a lot more without a fee, but no balance information.
Balance information is not shared across the brands, and not until recently across german states, but I get fee free cash across not only the nation, but the continent.
Getting your emotions / habits under control is more important, but the financial mechanics should be taught more , too.
I would be interested in your results.
Something similar, seemingly a horror story, for my place:
http://www.handelsblatt.com/politik/oekonomie/nachrichten/oekonomische-bildung-deutsche-haben-von-wirtschaft-keine-ahnung/7911402.html
“…we don’t think about our spending. We spend on impulse. Or we spend — usually subconsciously — to keep up with our friends, our family, and our neighbors. We spend to make ourselves feel better when we’re down and blue. We spend to show off. We spend on things we think we want instead of the things we actually use and do. We spend because spending is a habit.”
All those intertemporal work-consumption optimization problems I had to slog through and it turns out the hippies were right all along?
Bummer.
It’s tough to locate knowledgeable people on this subject, but you sound like you know what you’re talking about! Thanks
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