Ch.2 Economics

Question 1

What 2 factors will Monetary policy attempt to influence?

Monetary policy is one of the key policy tools

Answer 1

real GDP (gross domestic product)

and the price level.

A country reduces its rate of monetary growth. Which of the following is the expected result for the country’s economy? lower the GDP growth

Question 2

In expansionary monetary policy, the Federal Reserve Board would do what 2 factors?

Answer 2

Purchase additional U.S. government securities

and lower the discount rate.

Question 3

If foreign currency goes up, then foreign liability will go ___.

Answer 3

If foreign currency goes up, then foreign liability will go up.

You can buy calls or buy futures/forward contract.

Use profit on derivative.

Question 4

If foreign currency goes down, assets go ____.

Answer 4

If foreign currency goes down, assets go down (A/R goes down) giving a loss. export greater than imports (net export). Buy put options or sell futures/forward contracts. Domestic currency goes up.

Question 5

What is Law of Diminishing Returns?

Answer 5

As I consume more goods/services, the less you value that good/service.

Question 6

Variations between business cycles (i.e. peak, expansion) is most likely attributable to which 2 factors?

Answer 6

Duration and intensity

Question 7

Macroeconomics
Supply curve is the ____ referred to as GDP
Demand curve is the ____ referred to as inflation/deflation

Answer 7

Supply = Quantity = GDP
Demand = Price Level = Inflation/deflation

Question 8

What is the GDP deflator?

Answer 8

GDP deflator = (nominal GDP / real GDP) x 100

Question 9

What is Personal Income (PI) ?

What does it include & exclude?

Answer 9

total income received by individuals/households

includes currently received, but not earned (soc. sec benefits)

excludes earned but not received (soc. sec contributions)

Question 10

How do you calculate the marginal propensity to consume/save?

Answer 10

difference or change in consumption/savings divided by change in income = marginal

Question 11

What is the multiplier effect?

Money supply, banks lending, spending, income

Answer 11

increase in money supply = 
banks being able to lend 
(which is contingent upon the banks' reserve requirement) = 
increase in spending = 
increases income

Question 12

What is a low multiplier effect?

Answer 12

higher reserve requirement = tighter the money supply

Question 13

What is a high multiplier effect?

Tip: what happens with the reserve requirement and money supply

Answer 13

lower reserve requirement = larger the money supply

Question 14

What is Monetary vs Fiscal policy?

Interest rates, money supply, tax, spending

Answer 14

Monetary policy is the management of
interest rates and the total supply of money in circulation
and is generally carried out by central banks, such as the U.S. Federal Reserve.
Influence GDP and price level.

Fiscal policy is a collective term for the taxing and spending actions of governments.

Question 15

What is Consumer Price Index (CPI)?

Answer 15

compares relative price changes over time

is a weighted price index

based on the prices of 364 consumer goods/services called “basket of goods”

same goods (i.e. basket) are used in order to compared year to year

Question 16

What are the two types of inflation?

Demand-?
Cost-?

Answer 16

Demand-pull is increase in price by increase in demand
(ex. low oil available, demand is going to pull price up)

Cost-push is increase in price by increase in cost
(ex. increase in minimum wage is going to drive cost up)

Question 17

To calculate the change, what do you divide by?

Answer 17

The base

Question 18

What is included in consumption expenditures?

Answer 18

consumer durable goods & nondurable goods

services

Question 19

Name 3 types of profit

Answer 19

revenue - explicit costs = accounting profit

accounting profit - implicit costs = economic profit
(it is the residual amount that goes to the owners of the firm)

Normal profit is the amount necessary for the firm to be willing to keep the resources deployed in the firm. The firm’s economic profit is equal to zero; that is, it is covering all its explicit costs and implicit costs (and the owners are making a return sufficient to cover the opportunity cost of the resources they are providing to the firm)

no nominal profit

Question 20

What are Usury laws?

What type of customers are excluded from the market?

Answer 20

were developed in order to provide protection for borrowers against unnecessarily high and unreasonable interest rates.

less creditworthy customers are excluded from the market

Question 21

Breakeven is also called ?

Answer 21

cost-volume-profit (CVP) analysis

Question 22

What are repatriation restrictions?

Answer 22

limit the parent’s ability to

receive cash from international subsidiaries

which is a prime consideration in its cash flow analysis.

Question 23

A company has several long-term floating-rate bonds outstanding. The company’s cash flows have stabilized, and the company is considering hedging interest rates.

Which of the following derivative instruments is recommended for this purpose?

Answer 23

Swap agreement

one party pays fixed interest and receives floating interest, while the other party receives fixed interest and pays floating interest

Question 24

When a firm finances each asset with a financial instrument of the same approximate maturity as the life of the asset, it is applying ________ .

Answer 24

a hedging approach

avoiding risks on interest rate changes which might cause problems in continuing financing of the asset in the future

Question 25

After adjusting for inflation, what percentage change occurred in expenditures for emergency rescue services?
Ten years ago, the expenditures were $72,800.
CPI for last yr is 168.5 as compared to 121.3 10 yrs ago.
Last year’s expenditures were $100,500.

Answer 25

= $72,800 ten yrs ago exp x (168.5 current / 121.3 base) = $101,128 current dollars
= $101,128 - $100,500 last yrs exp = $628 reduction

= $628 reduction divided by $101,128 current = 0.6% decrease

Question 26

When it comes to mitigating financial risk, regulators need to:

Answer 26

be MORE counter-cyclical in their approach to devising regulatory arrangements.

recognize capital as a “shock absorber” to DEFLATE bubbles before they burst and to then allow capital “drawdowns” during periods of market stress

with the understanding that capital will be replenished as market conditions improve

allow capital “drawdowns” to occur during periods of market stress

Question 27

Name 4 types of interest rate risk

Yield curve, repricing, options, basis

Interest rates, longer-duration assets, legal rights, interest margins)

Answer 27

Yield curve risk (arises from variations in interest rate moves along the yield curve)

Repricing risk (created by firms deliberately mismatching a portfolio by holding longer-duration assets when compared to liabilities in an attempt to enhance earnings)

Options risk (arises from legal rights to engage in a future transaction at a predetermined price)

Basis risk (Since loan rates tend to adjust upward more rapidly than deposit rates, there is a tendency for interest margins to increase spontaneously when rates are rising; however, as rates stabilize, the improvement may disappear as deposit rates catch up, and then interest margins would fall when rates began to decline.)

Question 28

Hedging is not a risk but rather a way to ?

Answer 28

mitigate risk

Question 29

If the dollar price of the euro rises, what will occur?

Answer 29

the dollar depreciates against the euro

Question 30

An increase in the federal debt may create inflationary pressures for which reason?

Answer 30

The economy’s money supply may increase.
an increase in the federal debt means more money is being utilized by the Federal Government relative to their inflows. For debt to increase, the Federal Government must be running a deficit by spending more than it brings in. This deficit spending infuses more money into the financial markets (i.e., increases the money supply) than would be present otherwise. An increase in money supply in the long run leads to inflationary pressures, causing prices to rise.

Question 31

Changes in per-unit labor costs is a leading or lagging indicator?

Answer 31

lagging economic indicator

Question 32

How does a change in net investment affect the level of income?

Answer 32

A decrease in net investment will cause a more than proportional decrease in the level of income.

Question 33

GDP deflator

Answer 33

The GDP deflator is a measure of price inflation. It is calculated by dividing the Nominal GDP by Real GDP and then multiplying by 100. (Based on the formula). Nominal GDP is the market value of goods and services produced in an economy, unadjusted for inflation.

Question 34

During deflation, what does company hold on to?

Answer 34

During deflation, a gain in purchasing power will be incurred by holding monetary assets such as cash. During inflation, a loss in purchasing power will be incurred by holding monetary assets such as cash.

Question 35

“Depression means idleness. And idleness means loss of skills, loss of self-esteem, dysfunctional family relationships, and increased criminal behavior.” This quote describes:

Answer 35

non-economic costs of unemployment.

Question 36

Keynesians theory supports expansionary fiscal policy

Answer 36

Keynesians believe consumer demand is the primary driving force in an economy. As a result, the theory supports expansionary fiscal policy; in other words, Keynesian economics says that the government should increase demand to boost growth.

Question 37

What is the natural rate of unemployment?

Answer 37

It is the rate of unemployment that accompanies an economy’s highest sustainable output.

Question 38

Regulators need to recognize capital as shock absorber to

Answer 38

deflate bubbles before they occur

and allow capital drawdowns during periods of market stress

regulators need to me MORE counter-cyclical in their approach toward devising regulatory arrangements, not less.

Question 39

control cycle approach to risk management

Answer 39

• Modeling the expected results using a set of initial assumptions using feedback loop
• Doing a profit test to determine if the product provides a contribution margin
• Measuring the actual results
• Determining, both in quantitative and qualitative terms, an understandable explanation of the differences between expected and actual results
• Determining what actions need to be taken with respect to the product, including possible adjustments to reserves
• Using the findings to strengthen the model and update the assumptions as needed with feedback from the process

Question 40

What would encourage a company to use short-term loans to retire its 10-year bonds that have five years until maturity?

Answer 40

Interest rates have declined over the last five years.

Question 41

Which hedging techniques defines hedging payables as borrowing funds in the local currency of the payables, and investing the funds until they are needed?

Answer 41

Money market hedge

Question 42

Keynesians believe consumer demand is the primary driving force in an economy. As a result, the theory supports what type of policy?

Answer 42

Expansionary fiscal policy. Keynesian economics says that the government should increase demand to boost growth.

Question 43

What is structural unemployment?

Answer 43

when changes in technology and competitiveness change the skills required to perform jobs and/or change the location of jobs.

For example, when the new minimum wage law reduces demand for low-skilled workers by businesses.

Question 44

Buying a wheat futures contract to protect against price fluctuation of wheat would be classified as a:

Answer 44

cash flow hedge

cash flow hedge is intended to protect against variability in cash flow that might result from future payments. A wheat futures contract would lock in the price of wheat that would be paid at some future date. Since the price is set, the cash flow is more certain.

Question 45

With elasticity of demand, the greater it is, the ____ the demand curve.

Answer 45

The greater it is, the flatter the demand curve.

A steep demand curve represents low elasticity.

Question 46

A type of risk unique to international investments held or considered by a domestic investor is ________ risk.

Answer 46

political

Individual countries may place constraints on resources and the use of such resources. These risks relate to doing business in those countries and are referred to as political risks. Political risks may include effects or prospects of terrorism.

Stand-alone risk is that risk related to a particular investment asset, domestic or foreign.

market risk relates to a portfolio of assets.

Question 47

What are the three main patterns created by the interest rate term structure?

Answer 47

Normal yield curve, flat yield curve, and inverted yield curve

Normal yield curve—this forms during normal market conditions.
Flat yield curve—this forms when the market is sending mixed messages to investors.
Inverted yield curve—this forms during extraordinary market conditions.

Question 48

When the Federal Reserve (the Fed) tightens its money policy, long-term interest rates will be _____ than short-term rates.

Answer 48

be lower than short-term rates.

Question 49

Risk is inherent in business. Which of the following is the type of risk that is influenced by product demand, sales, and input price variability and the amount of specific company operating leverage?

Answer 49

Business risk

Question 50

Financial risk management includes what 4 things?

Answer 50

1. assessing financial risk.
2. developing and implementing management strategies.
3. identifying UNcertainties in the financial market.
4. implementing internal priorities and policies.

Question 51

What is a yield curve?

Answer 51

A line that plots the interest rate,
at a set point in time,
with equal credit quality but
differing maturity dates

Question 52

If residents of a country export more than they import, and foreign investment inflows do not decrease, its currency is likely to ________.

Answer 52

depreciate

low exports and high imports will depreciate the currency. (The country does not have enough and has to purchase from overseas to cover the need.)

Question 53

Personal income (PI) =

Answer 53

National income (NI) 
− Social Security contributions 
− Corporate income tax 
− Undistributed corporate profits 
\+ Transfer payments

Question 54

What is true when it comes to the actual incidence of an indirect tax?

Answer 54

Sharing of the tax depends on the relative elasticities of the demand and supply curves. The greater burden is borne by the side that has a relatively inelastic curve.

Question 55

What would not improve firm risk management preferences?

Answer 55

Relying on government regulations