Chapter 10 - Economics and Monetary Policy

Question 1

A normal yield curve depicts that
A) short-term yields are higher than long-term yields
B) long term bonds have a higher yield compared to short term bonds
C) there is no apparent relationship between short and long-term yields
D) short and long term yields are very close to each other

Answer 1

Correct Answer:
B) long term bonds have a higher yield compared to short term bonds

Answer Explanation
A normal yield curve is one in which longer maturity bonds have a higher yield compared to shorter-term bonds because of the risks associated with the longer investment horizon.

Textbook Reference
Please see textbook section 10.2.2

Question 2

Nonagricultural employment is what kind of economic indicator?
A) Coterminous
B) Lagging
C) Leading
D) Coincident

Answer 2

Correct Answer:
D)

Answer Explanation
Nonagricultural employment is a coincident indicator while average duration of unemployment is a lagging indicator as it must be calculated after an individual has successfully found a new job.

Textbook Reference
Please see textbook section 10.1.4.3

Question 3

Which of the following is a common metric provided by research analysts?
A) Earnings per share (EPS) estimates
B) Manufacturing sales data
C) Money supply figures
D) Short interest data

Answer 3

Correct Answer:
A) EPS

Answer Explanation
Research analysts typically provide data about companies they follow, sometimes in the form of estimates, such as EPS estimates. Money supply and short interest data are tracked and reported by the US government and SROs (FINRA) respectively.

Textbook Reference
Please see textbook section 10.2.6.1

Question 4

All of the following are considered coincident economic indicators EXCEPT
A) GDP
B) personal income
C) the unemployment rate
D) retail Sales

Answer 4

Correct Answer:
C) The unemployment rate

Answer Explanation
Coincident indicators are economic factors that vary directly and simultaneously with the business cycle. Examples of coincident indicators are:
* GDP
* nonagricultural employment
* personal income
* consumer spending
* inventory/sales ratio
* retail sales
* industrial production
* manufacturing sales

The rate of unemployment is a lagging indicator because it changes after the economy has begun a particular trend.

Textbook Reference
Please see textbook section 10.1.4.3

Question 5

Which of these events is most likely to accompany a decline in personal income?
A) A decrease in the GDP
B) An increase in industrial production
C) A decline in inventories
D) An increase in retail sales

Answer 5

Answer Explanation
Personal income is a coincident economic indicator that is likely to occur at the same time as a decrease in the GDP. Increases in industrial production and retail sales and declining inventories indicate improving economic conditions.

Textbook Reference
Please see textbook section 10.1.2

Question 6

During a period of economic growth, consumers generally experience

I. Increasing bond prices
II. Decreasing bond prices
III. Lower bond yields
IV. Higher bond yields
A) II and III
B) I and IV
C) II and IV
D) I and III

Answer 6

correct Answer:
C) II and IV

Answer Explanation
In an expansionary economy, interest rates are generally rising, so bond prices are falling.

Textbook Reference
Please see textbook section 10.2.1

Question 7

The interest paid by investors in a margin account is based upon the
A) Federal funds rate
B) Broker call rate
C) Prime rate
D) LIBOR rate

Answer 7

Correct Answer:
B) Broker call rate

Answer Explanation
This rate of interest is the broker call rate. It is determined independently by commercial banks.

Textbook Reference
Please see textbook section 10.3.3.5

Question 8

A country is running a trade surplus, which will likely result in
A) appreciation of that country’s currency.
B) depreciation of that country’s currency.
C) a downgrade in the credit rating of the country.
D) a reduction in its ability to cover its immediate expenses.

Answer 8

Correct Answer:
A) appreciation of that country’s currency

Answer Explanation
When a country is running a trade surplus (exports exceed imports), the country’s currency will strengthen relative to other country’s currency. The opposite will occur with a trade deficit.

Textbook Reference
Please see textbook section 10.4.1

Question 9

Recently, the federal funds rate has been rising. This could indicate any of the following EXCEPT
A) Rates for short-term loans are increasing
B) The Fed is buying securities in open market operations.
C) Overnight loan rates between banks are more expensive
D) The Federal Reserve is tightening credit

Answer 9

Correct Answer:
B) The Fed is buying securities in open market operations

Answer Explanation
The federal funds rate is charged by banks when funds are loaned overnight to meet reserve requirements. If the fed funds rate is rising, it indicates that the Federal Reserve is tightening credit by raising interest rates (selling securities). Therefore, banks will have to pay higher rates for overnight loans to meet reserve requirements. The general level of short term interest rates will also rise.

Textbook Reference
Please see textbook section 10.3.3.3

Question 10

What term do economists use to describe a downturn in the economy that is characterized by both rising unemployment and rising prices?
A) Inflation
B) Depression
C) Stagflation
D) Recession

Answer 10

Correct answer;
C) Stagflation

Answer Explanation
Stagflation is characterized by rising unemployment and increasing prices.

Textbook Reference
See textbook section 10.1.3

Question 11

Rank the following interest rates in order from lowest to highest:

I. Prime Rate
II. Broker’s Call Rate
III. Fed Funds Rate
IV. Discount Rate
A) I, II, III, IV
B) IV, III, II, I
C) II, III, IV, I
D) III, IV, II, I

Answer 11

Correct Answer:
D)

Answer Explanation
Generally, the Fed Funds Rate (overnight lending rate between banks) is the lowest. Fed funds is followed by the discount rate (from the Fed), broker’s call rate (to a broker dealer) and the prime rate (to a credit worthy customer).

Textbook Reference
Please see textbook section 10.3.3.5

Question 12

The velocity of money is best characterized as the
A) average number of individuals who handle the same unit if currency over a specified time period.
B) rate of turnover of US currency between financial institutions.
C) average speed at which the US Treasury Department creates a new roll of currency for the financial system.
D) number of times that a unit of currency is used to purchase a goods or services within a specified time period.

Answer 12

Correct answer:
D)

Answer Explanation
The velocity of money measures the frequency a unit of currency such as the dollar or euro) is used to purchase goods and services during a certain time period. When velocity is low, consumers may be spending less and saving more.

Textbook Reference
Please see textbook section 10.1.1

Question 13

Which of the following is the formula for the price-to-earnings (P/E) ratio?
A) Current assets ÷ current liabilities
B) Earnings ÷ outstanding shares
C) Market price ÷ earnings per share
D) Earnings per share ÷ market price

Answer 13

Correct Answer:
C) Market Price / EPS

Answer Explanation
P/E ratio is the common stock’s current market price ÷ earnings per share. The current ratio is current assets ÷ current liabilities. The other choices are distractors.

Textbook Reference
Please see textbook section 10.2.6.1

Question 14

Purchasing power parity is useful in economics in that it enables
A) the analysis of the strength of a country’s currency when purchasing goods.
B) bond yields of different countries to be compared to a benchmark.
C) margin account customers to determine the value of securities they may purchase using the credit in their accounts.
D) yield curves in international markets to be accurately compared.

Answer 14

Correct Answer:
A) the analysis of the strength of a country’s currency when purchasing goods.

Answer Explanation
Purchasing power parity is a theory that measures prices in different places using the same good or service, to analyze the real purchasing power between different currencies.

Textbook Reference
Please see textbook section 10.4.2

Question 15

All of the following are likely to accompany a decline in interest rates EXCEPT
A) increase in inventory build up by manufacturers
B) increased business investing in expansions
C) increased demand for the dollar by foreign investors
D) increased consumer spending on goods and services

Answer 15

C

Answer Explanation
When interest rates decline, consumers and businesses are likely to spend more money. The demand for the dollar, however, is likely to decrease. Foreign investors want to in vest their funds in the U.S. when interest rates are higher, which drives the demand for the U.S. dollar higher.

Textbook Reference
Please see textbook section 10.4.3

Question 16

The demand for credit will typically slow in which phase of the economy?
A) Peak
B) Trough
C) Expansion
D) Contraction

Answer 16

D

Answer Explanation
A reduced demand for borrowing is consistent with slowing economic activity, or a contraction in the economic cycle. Consumer use less credit when they have less confidence in economic performance.

Textbook Reference
Please see textbook section 10.1.3

Question 17

A stock split makes earnings per share:
A) Increase
B) Indeterminable
C) Remain the same
D) Decrease
Answer Explanation
A stock split has a dilutive effect on EPS, because the same earnings are divided among a greater number of shares. A reverse split increases EPS because the earnings are divided among fewer shares.

Textbook Reference
Please see textbook section 10.2.6.1

Answer 17

D

A stock split makes earnings per share:
A) Increase
B) Indeterminable
C) Remain the same
D) Decrease
Answer Explanation
A stock split has a dilutive effect on EPS, because the same earnings are divided among a greater number of shares. A reverse split increases EPS because the earnings are divided among fewer shares.

Textbook Reference
Please see textbook section 10.2.6.1

Question 18

Which two of the following statements are TRUE?

I. Yield spreads widen when the economy is weakening
II. Yield spreads widen when the economy is strengthening
III. Yield spreads narrow when the economy is weakening
IV. Yield spreads narrow when the economy is strengthening
A) II and IV
B) II and III
C) I and III
D) I and IV

Answer 18

D

Answer Explanation
In general, yield spreads increase during periods of recession and decrease during periods of expansion.

Textbook Reference
Please see textbook section 10.2.4

Question 19

Unemployment is an example of an economic indicator that is
A) Defensive
B) Procyclic
C) Acylic
D) Countercyclic

Answer 19

D

Answer Explanation
Countercyclic indicators move in the opposite direction of the general economy. The unemployment rate is countercyclic because it rises when the economy is declining.

Textbook Reference
Please see textbook section 10.2.5.1

Question 20

The policy that relies heavily on the use of interest rates to stabilize the economy is
A) Fiscal policy
B) Public finance policy
C) Keynesian economics
D) Monetary policy

Answer 20

Correct Answer:
D

Answer Explanation
Monetary policy is based on the relationship between interest rates, or the price at which money can be borrowed, and the total supply of money. Fiscal policy utilizes government spending and taxation.

Textbook Reference
Please see textbook section 10.3.3

Question 21

Earnings per share estimates are developed and released by
A) Research analysts
B) Investment banking analysts
C) Sales and trading
D) The issuer’s chief financial officer

Answer 21

A

Answer Explanation
EPS estimates produced and released by independent research analysts who follow a selected list of companies, frequently in the same sector. They are NOT produced internally by the issuer. To avoid unauthorized dissemination of inside information, the research department must be separate from other broker-dealer departments including investment banking and sales/trading.

Textbook Reference
Please see textbook section 10.2.6

Question 22

If the U.S. trade deficit is decreasing, which two of the following are also likely to occur?

I. U.S. bond prices will rise
II. U.S. bond prices will fall
III. the value of the dollar has weakened against foreign currency
IV. The value of the dollar has strengthened against foreign currency
A) I and IV
B) II and IV
C) I and III
D) II and III

Answer 22

Correct Answer:
c) I and III

Answer Explanation
If the trade deficit is growing smaller, foreign buyers are buying more U.S. goods. This is because foreign currency has strengthened against the dollar. The value of the dollar against foreign currency and interest rates move in the same direction. So if the dollar is weakening, interest rates are falling, and bond prices are rising.

Textbook Reference
Please see textbook section 10.4.1

Question 23

Which of the following is not a measure that is used to evaluate and compare stocks?
A) Free cash flow yield
B) Dividend yield
C) Volatility market index
D) Price-earnings-growth ratio

Answer 23

C

Answer Explanation
The volatility market index (VIX), also called the fear index, measures the volatility of S&P 500 Index options. The other three measures are used to evaluate and compare stocks.

Textbook Reference
Please see textbook section 10.2.6.1

Question 24

During times of decreasing economic activity, which two of the following are most likely to occur?

I. Increased demand for borrowing
II. Decreased demand for borrowing
III. Upward pressure on interest rates
IV. Downward pressure on interest rates
A) II and III
B) I and III
C) II and IV
D) I and IV

Answer 24

C

Answer Explanation
When the economy shows signs of weakness and consumer confidence begins to fall, people’s demand for borrowing falls. This lack of demand causes the Fed to take action to push interest rates downward.

Textbook Reference
Please see textbook section 10.3.3

Question 25

What is the correct sequence of the following interest rates from high to low?
A) Prime rate, Broker’s call rate, Discount rate, Federal funds rate
B) Discount rate, Prime rate, Broker’s call rate, Federal Funds rate
C) Discount rate, Broker’s call rate, Prime rate, Federal funds rate
D) Federal funds rate, Discount rate, Broker’s call rate, Prime rate

Answer 25

A

Answer Explanation
The correct order of these interest rates, from high to low is:
Prime rate, Broker’s call rate, Discount rate, Federal funds rate.

Textbook Reference
Please see textbook section 10.3.3.5

Question 26

Which two of the following are the general objectives of economic policy?

I. Zero inflation
II. Low inflation
III. High growth
IV. Steady growth
A) I and IV
B) II and III
C) I and III
D) II and IV

Answer 26

D

Answer Explanation
The general consensus by economists is that low inflation and steady economic growth are desirable economic performance.

Textbook Reference
Please see textbook section 10.3.3.1

Question 27

Manufacturing sales is what kind of economic indicator?
A) Lagging
B) Coincident
C) Leading
D) Coterminous

Answer 27

B

Answer Explanation
Manufacturing sales is a coincident indicator. Coincident indicators provide a snapshot of the economy’s current level of health.

Textbook Reference
Please see textbook section 10.1.4.3

Question 28

Spreads are widening between bonds of different quality ratings. Which two of the following is true?

I. The economy is strengthening
II. The economy is slowing down
III. The market is forecasting greater risk of default on low grade bonds
IV. Low grade bonds are projected to have less risk of default.
A) I and IV
B) I and III
C) II and IV
D) II and III

Answer 28

D

Answer Explanation
In general, yield spreads increase during periods of recession and decrease during periods of expansion. When the spread is wide between bonds of different quality ratings, investors can conclude that the market is factoring more risk of default on the lower grade bonds, which implies that the economy is slowing down. The increased spread indicates that the market is predicting a greater risk of default.

Textbook Reference
Please see textbook section 10.2.4

Question 29

In order to lower the budget deficit or enable a larger budgetary surplus, fiscal policy would recommend

I. higher taxation
II. lower taxation
III. reduced government spending
IV. increased government spending
A) II and IV
B) I and III
C) I and IV
D) II and III

Answer 29

B

Answer Explanation
The two main instruments of fiscal policy are government spending and taxation. An increase in taxation and/or a decrease in government spending will have the effect of reducing a budget deficit or increasing a budget surplus.

Textbook Reference
Please see textbook section 10.3.2

Question 30

Which of the following interest rates is established by the Federal Reserve Board?
A) Money Market rate
B) Discount rate
C) Fed Funds rate
D) Prime rate

Answer 30

B

Answer Explanation
The discount rate is set by the Fed, and is the rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank’s lending facility–the discount window. The Fed influences the Fed Funds Rate, but does not actually set the rate - it is set by the market. The prime rate is set by banks.

Textbook Reference
Please see textbook section 10.3.3.3

Question 31

What trend occurs when the value of real goods, such as a barrel of oil, rises against most of the world’s currencies?
A) Inflation
B) Deflation
C) Devaluation
D) Depreciation

Answer 31

A

Answer Explanation
One way to measure the value of currencies is against real goods such as real estate, commodities or precious metals. When real goods rise in value against currencies, the trend is called inflation. In the U.S. inflation is measured by the Consumer Price Index (CPI)

Textbook Reference
Please see textbook section 10.1.3

Question 32

The measure of inflation experienced by manufacturers is the:
A) Volatility Market Index
B) Consumer Price Index
C) Constant Dollar Index
D) Producer Price Index

Answer 32

D

Answer Explanation
PPI measures inflation for producers of products, such as manufacturers. CPI measures inflation on consumer goods. The Volatility Market Index (VIX), also called the fear index, measures the volatility of S&P 500 Index options.

Textbook Reference
Please see textbook section 10.1.1.2

Question 33

Which two of the following are likely to occur after an increase in taxation?

I. spending by the public will increase
II. spending by the public will decrease
III. production will increase
IV. production will decrease
A) I and III
B) II and IV
C) I and IV
D) II and III

Answer 33

B

Answer Explanation
An increase in taxes reduces disposable income. Therefore consumers spend less. As demand is reduced production will also decrease.

Textbook Reference
Please see textbook section 10.3.2

Question 34

Monetary policy in the US is controlled by (the)
A) Congress
B) Federal Reserve Board
C) SEC
D) FINRA

Answer 34

B

Answer Explanation
Monetary policy is controlled by the FRB. Fiscal policy is controlled by Congress.

Textbook Reference
Please see textbook section 10.3.3

Question 35

If the Fed determines that the current economic growth rate is too slow it is most likely to do which of the following
A) Increase the reserve requirement
B) Decrease the discount rate
C) Sell U.S. Treasury securities
D) Decrease the federal funds rate

Answer 35

B

Answer Explanation
When economic growth is slow, the fed will attempt to stimulate the economy with an easy money policy. A decrease in the discount rate will make more funds available for lending, thus easing the money supply. An increase in the reserve requirement or the sale of U.S. Treasuries will tighten the money supply. The federal funds rate is not controlled by the Fed.

Textbook Reference
Please see textbook section 10.3.3

Question 36

Which of the following statements are true regarding the yield curve?

I. A normal yield curve reflects higher yields for bonds with longer maturities
II. A flat yield curve generally indicates a time of economic transition
III. An inverted yield curve may be a predictor of an upcoming recession
A) I and II only
B) I and III only
C) I, II and III
D) II and III only

Answer 36

C

Answer Explanation
Normal yield curves are the most common, and reflect longer maturity bonds with a higher yield than shorter-term bonds, due to the risks associated with holding a bond for a longer period of time. A flat or humped yield curve shows very little difference between short and long term rates, and typically is linked with a time of economic transition. An inverted yield curve reflects shorter-term yields that are higher than the longer-term yields, which can be a sign of upcoming recession.

Textbook Reference
Please see textbook section 10.2.2

Question 37

The Fed uses repurchase agreements to

I. ease credit
II. tighten credit
III. add money to the system
IV. remove money from the system.
A) II and IV
B) I and III
C) II and III
D) I and IV

Answer 37

Correct Answer:
B

Answer Explanation
In repurchase agreements, the Fed first buys and then sells securities to primary dealer, thus adding money to the system. This activity eases credit. Note that the perspective of repurchase agreements is from the viewpoint of the counterparty, not the Fed.

Textbook Reference
Please see textbook section 10.3.3

Question 38

The U.S. deficit has been steadily increasing. Which of the following are likely?

I. U.S demand for foreign products is increasing
II. U.S. Demand for foreign products is decreasing
III. The Fed may purchase foreign currency to stabilize the value of the dollar
IV. The Fed may sell foreign currency to stabilize the value of the dollar.
A) I and IV
B) II and IV
C) II and III
D) I and III

Answer 38

D

Answer Explanation
The deficit typically increases when demand for foreign products rises. This results when the value of the dollar is strong against foreign currency. To counteract the strong U.S. dollar the FED may actually attempt to weaken its value by purchasing foreign currency (selling dollars). This is also accomplished when the FED injects more money into the economy (purchasing securities) or by lowering interest rates. These actions help make our goods less expensive to foreign customers.

Textbook Reference
Please see textbook section 10.4.3

Question 39

The purpose of a government action called an economic stabilizer is to
A) avoid high rates of inflation.
B) keep stock prices high during a market downturn.
C) support housing prices.
D) increase gross domestic product (GDP) during a recession.

Answer 39

Correct Answer:
D

Answer Explanation
During a recession, governments often takes steps to increase GDP, such as cutting taxes or introducing new spending programs. These are called economic stabilizers.

Textbook Reference
Please see textbook section 10.1.2

Question 40

U.S. Treasury Securities are purchased by the Federal Reserve Board. The result of this transaction is that

I. Money supply will increase
II. Money supply will decrease
III. Interest rates will rise
IV. Interest rates will fall
A) II and IV
B) I and IV
C) II and III
D) I and III

Answer 40

B

Answer Explanation
When the Federal Open Markets Committee (FOMC) purchases U.S. Treasury securities, the money supply increases. Because of an increase in the supply of money, interest rates will decline.

Textbook Reference
Please see textbook section 10.3.3.2

Question 41

All of the following are examples of lagging economic indicators EXCEPT
A) The prime rate
B) Labor cost per unit of output
C) Unemployment rates
D) The money supply

Answer 41

D

Answer Explanation
Lagging economic factors change after the economy has already begun to follow a particular pattern or trend. Examples of lagging indicators include:
* Interest rates, particularly the prime rate, which is a key bank lending rate that is often used as a reference rate of interest for credit cards and other loan rates
* unemployment rates
* corporate profits
* labor cost per unit of output
The money supply is a leading economic indicator - it changes before the economy begins to follow a particular pattern.

Textbook Reference
Please see textbook section 10.1.4.2

Question 42

In analysis of business cycles, which of the following statements is NOT true?
A) A bullish market trend in the stock market often begins before the general economy shows clear signs of recovery.
B) Economic fluctuations are often measured using the growth rate of real gross domestic product
C) Most fluctuations in economic activity follow a predictable pattern
D) Economic stabilization is attempted using fiscal policy and monetary policy

Answer 42

C

Answer Explanation
Business cycles are generally considered to be random and unpredictable. While it is true that the sequence of the cycles is generally the same, the factors and impacts differ substantially.

Textbook Reference
Please see textbook section 10.1.3

Question 43

The short-term effect of the Federal Reserve’s Open Market Committee is to
A) check inflation
B) stop a recession
C) make credit more or less available
D) do all of the above

Answer 43

C

Answer Explanation
The Fed buys and sells securities in the marketplace to increase or decrease the money supply, making credit more or less available. When the Fed buys securities it is putting money into circulation, increasing the money supply and making credit more available. When the Fed sells securities it is taking money out of circulation, decreasing the money supply and making credit less available. Long term, these actions may check inflation or stop a recession.

Textbook Reference
See textbook section 10.3.3.2

Question 44

All of the following economic trends typically have a positive impact on the value of the dollar EXCEPT
A) an increase in Gross Domestic Product
B) an increase in the balance of payments
C) an increase in building permits
D) an increase in business inventories

Answer 44

D

Answer Explanation
An increase in business inventories indicates that consumers are purchasing less, and is likely to have a negative impact on the value of the dollar.

Textbook Reference
Please see textbook section 10.4.3

Question 45

When the Federal Reserve announces a decrease in interest rates
A) businesses will be less likely to expand
B) the economy is likely to exhibit slower growth
C) bond prices are likely to decrease
D) investors are likely to move their funds from the bond market to the equity market

Answer 45

D

Answer Explanation
A decrease in interest rates will cause interest income on newly issued bonds to fall, making bonds less attractive as an investment versus equities. This will typically cause a movement from the bond market to the equity market. Businesses are likely to invest in expansion when the cost of money is low, which generally drives economic growth. Also, the general purpose of the Fed’s reducing interest rates is to spur economic growth.

Textbook Reference
Please see textbook section 10.2.1

Question 46

An investor considering making a bond purchase in a deflationary environment may be more attracted to a(n)
A) STRIP, which eliminates reinvestment rate risk
B) outstanding issue of debt
C) treasury bill
D) new issuance of debt by a top rated corporation

Answer 46

B

Answer Explanation
In a deflationary environment, investors may be more attracted to outstanding debt, which will likely carry higher interest rates than newly issued debt, given that interest rates are likely lower in the current economic landscape.

Textbook Reference
Please see textbook section 10.2.5.2

Question 47

On the balance sheet, shareholder’s equity is sometimes referred to as
A) Net worth
B) Net basis
C) Net debt
D) Net income

Answer 47

a

Answer Explanation
Shareholder’s equity is sometimes referred to as net worth.

Textbook Reference
Please see textbook section 10.2.6.2

Question 48

All of the following economic indicators are considered coincident indicators EXCEPT
A) GDP
B) industrial production
C) Housing starts
D) personal income

Answer 48

c

Answer Explanation
While personal income, industrial production and GDP change at approximately the same time as the whole economy, housing starts are considered a leading indicator. Sustained declines in housing starts slow the economy, while increases in housing activity trigger economic growth.

Textbook Reference
Please see textbook section 10.1.4.3

Question 49

Economic indicators are pointing toward inflationary times. Which of the following would be likely?
A) Demand for credit is falling
B) Fixed income securities will fall in price
C) Interest rates are falling
D) The CPI is decreasing

Answer 49

b

Answer Explanation
In inflationary times, investors demand a higher yield from their investments as interest rates are rising. Fixed income securities will fall in value to provide the higher yield. The Consumer Price Index (CPI), demand for credit and business investments are increasing during inflationary times.

Textbook Reference
Please see textbook section 10.2.1

Question 50

Which of the following statements describe the impacts of shifts in the yield curve?

I. If the yield curve flattens, the yield spread between long- and short-term interest rates narrows
II. If the yield curve flattens, the yield spread between long- and short-term interest rates increases
III. If the yield curve steepens in a positively sloping direction, long-term rates will be higher than short-term rates.
IV. If the yield curve steepens in a positively sloping direction, long-term rates will be lower than short term rates.
A) I and IV
B) I and III
C) II and III
D) II and IV

Answer 50

B

Answer Explanation
If the yield curve flattens, then the yield spread between long- and short-term interest rates narrows, and the price of long-term bonds relative to short-term bonds will decrease. If the yield curve steepens, long-term rates will be higher than short term rates. This is known as a normal yield curve.

Textbook Reference
Please see textbook section 10.2.4

Question 51

An increase in corporate inventories is

I. A leading indicator
II. A lagging indicator
III.A sign of economic growth
IV. A sign of economic decline
A) I and IV
B) II and IV
C) II and III
D) I and III

Answer 51

a

Answer Explanation
A change in corporate inventories is a leading indicator because it generally predicts an economic trend. An increase in inventories is a signal of economic decline because sales are slowing, which will result in less manufacturing.

Textbook Reference
Please see textbook section 10.1.4.1

Question 52

Devaluation of the dollar will lead to which of the following?

I. An increase in the balance of trade
II. A decrease in the balance of trade
III. An increase in exports
IV. A decrease in exports
A) II and III
B) I and III
C) I and IV
D) II and IV

Answer 52

B

Answer Explanation
When the dollar declines relative to other currencies, other currencies are stronger and will buy more U.S. goods. This causes exports to increase which results in a increase in the balance of trade (defined as exports – imports).

Textbook Reference
Please see textbook section 10.4.2

Question 53

The common stock of a staple food company is most likely classified as a(n)
A) Cyclical stock
B) Income stock
C) Blue chip stock
D) Defensive stock

Answer 53

D

Answer Explanation
Staple food companies and other consumer goods that have constant demand regardless of the state of the economy are examples of defensive stocks. The demand for these items remains consistent regardless of variations in the economic cycle.

Textbook Reference
Please see textbook section 10.2.5.1

Question 54

Which of the following companies’ stock might perform best during a recession?
A) Home builder
B) Utility
C) Cruise lines
D) manufacturing

Answer 54

B

Answer Explanation
Defensive stocks, such as those of utilities, may be expected to perform best during a recession.

Textbook Reference
Please see textbook section 10.2.5.1

Question 55

The most volatile interest rate is the
A) Brokers’ call rate
B) Federal funds rate
C) Discount rate
D) Prime lending rate

Answer 55

B

Answer Explanation
The federal funds rate is the most volatile interest rate, which changes on a daily basis

Textbook Reference
Please see textbook section 10.3.3.3

Question 56

During a period of expanding inflation, it might be anticipated that the Fed will
A) loosen the money supply by lowering interest rates.
B) leave the money supply unchanged and take no immediate action on interest rates.
C) engage in an easy money policy.
D) tighten the money supply by increasing interest rates.

Answer 56

D

Answer Explanation
During an inflationary period, the FED will aim to tighten the money supply by increasing interest rates. They will aim to decrease interest rates during a deflationary period.

Textbook Reference
Please see textbook section 10.3.3.2

Question 57

An “easy” monetary policy is one where the FRB
A) Buys securities to increase the money supply.
B) Increases the discount rate.
C) Increases reserve requirements.
D) Sells securities to reduce the money supply.

Answer 57

A

Answer Explanation
“Easy” money occurs when the FRB is buying securities to increase the money supply and spur economic growth.

Textbook Reference
Please see textbook section 10.3.3.2

Question 58

Spreads are narrowing between bonds of different quality ratings. Which two of the following is true?

I. The economy is strengthening
II. The economy is slowing down
III. The market is forecasting greater risk of default on low grade bonds
IV. Low grade bonds are projected to have less risk of default.
A) II and IV
B) I and IV
C) I and III
D) II and III

Answer 58

B

Answer Explanation
In general, yield spreads increase during periods of recession and decrease during periods of expansion. When the spread is wide between bonds of different quality ratings, investors can conclude that the market is factoring more risk of default on the lower grade bonds, which implies that the economy is slowing down. The increased spread indicates that the market is predicting a greater risk of default.

Textbook Reference
Please see textbook section 10.2.4

Question 59

Which of the following are likely to occur when the Fed buys securities from primary dealers?

I. Banks will be inclined to lend less
II. Banks will be inclined to lend more
III. There will be downward pressure on the fed funds rate
IV. There will be upward pressure on the fed funds rate
A) II and IV
B) I and IV
C) II and III
D) I and III

Answer 59

C

Answer Explanation
When the Fed buys securities, it injects funds into the banking system, giving banks more to lend and putting downward pressure on the fed funds rate. When the Fed sells securities, money comes out of circulation, so the opposite occurs.

Textbook Reference
Please see textbook section 10.3.3.2

Question 60

Interest rates are likely to rise if

I. The demand for money increases
II. The supply for money increases
III. The demand for money decreases
IV. The supply for money decreases
A) I and IV
B) II and IV
C) I and III
D) II and III

Answer 60

A

Answer Explanation
If the supply of money is tight interest rates will increase. This happens when the demand for money has increased.

Textbook Reference
Please see textbook section 10.4.3

Question 61

An increase in the value of the dollar against a foreign currency will
A) Strengthen demand for U.S. goods from U.S. trading partners
B) Typically result when interest rates in the U.S. are falling
C) Result from the Federal Reserve buying dollars and selling foreign currency
D) Decrease demand for assets denominated in dollars

Answer 61

C

Answer Explanation
The dollar will strengthen against foreign currency if the Federal Reserve buys dollars and sells the foreign currency. The dollar increases in value against foreign currency when interest rates are rising. A strong dollar results in an increased demand for assets denominated in dollars, and strengthens demand for foreign goods. Import activity increases.

Textbook Reference
Please see textbook section 10.4.2

Question 62

The beginning of an inflationary period is characterized by
A) Low interest rates and an undersupply of money.
B) High interest rates and an oversupply of money.
C) High interest rates and an undersupply of money.
D) Low interest rates and an oversupply of money.

Answer 62

D

Answer Explanation
Inflation begins with low interest rates and an oversupply of money. Once inflation reaches a peak, these conditions will tend to reverse.

Textbook Reference

Question 63

The conventional sequence of the business cycle is
A) Trough, expansion, contraction, peak.
B) Peak, trough, expansion, contraction.
C) Expansion, peak, contraction, trough.
D) Expansion, contraction, peak, trough.

Answer 63

C

Answer Explanation
The correct sequence is expansion, peak, contraction, trough.

Textbook Reference
Please see textbook section 10.1.3

Question 64

Yield spread is often viewed as a measurement of which of the following?
A) The risk premium for investing in a particular bond
B) The likelihood of default between different securities
C) The credit quality of an issuer
D) The correlation of a bond’s performance to the economic cycle

Answer 64

A

Answer Explanation
The yield spread is an indication of the risk premium for investing in one bond over another, or against a common benchmark. It is a key metric that bond investors use to analyze the cost of a particular investment.

Textbook Reference
Please see textbook section 10.2.3

Question 65

A bond issued by a well-known and highly rated municipal issue
A) Will likely experience a widening spread relative to the U.S. Treasury 10 year bond when the economy is growing
B) Will trade at a relatively low spread relative to the U.S. Treasury 10 year bond
C) Will trade at a relatively wide spread relative to the U.S. Treasury 10 year bond
D) Will likely experience yield compression relative to the U.S. Treasury 10 year bond when the economy is weakening

Answer 65

B

Answer Explanation
Generally speaking, the higher the risk of a bond, the higher its yield spread. A bond issued by a large well-known, and financially strong municipality will typically trade at a relatively low spread in relation to U.S. Treasuries. Spreads widen in weakening economies and narrow when the economy is strong.

Textbook Reference
Please see textbook section 10.2.4