Economic Flashcards
Which of the following describes the hedging approach to financing?
A. Maturity dates of financing instruments are staggered so that they mature in a steady, predictable fashion when it is expected that funds will be needed.
B. The firm takes out insurance to protect itself against uneven cash flows.
C. Each asset is offset with a financing instrument of the same approximate maturity or duration.
D. Each asset is offset with either a put or a call.
C. Each asset is offset with a financing instrument of the same approximate maturity or duration.
Under the hedging approach the length of the financing term is matched to the maturity or duration of assets financed. Long-term debt is used to finance long-term assets and short-term debt is used to finance short-term assets.
Thus, each asset is offset with a financing instrument of the same approximate maturity.
Globalization is a process by which nations of the world become integrated through global networks of communication. Its current success is tied to a number of socioeconomic effects, with one of the key effects being:
A. an understanding that the success of the emerging economies is more than simply the cost advantage they have due to having relatively low-cost labor.
B. the relatively large labor force in emerging markets and declining birth rates that have historically been associated with dynamic positive economic change.
C. an undervalued currency in emerging economies that would stimulate exports and strong investment in infrastructure.
D. the fact that innovation blowbacks as the low-priced, high-quality products developed for the emerging economics now will be effectively marketed and sold in the developed world.
B. the relatively large labor force in emerging markets and declining birth rates that have historically been associated with dynamic positive economic change.
Socioeconomic effects are the social and economic experiences and realities that help mold one’s personality, attitudes, and lifestyle. Declining birth rates reduce the dependency ratio, and the large labor force tends to keep wages low as economic activity expands. Most of the world’s currently developed economies were in this phase of the demographic cycle when they began their economic expansion.
An individual had been working for a firm that supplies parts to the automotive industry. In which of the following circumstances would be said that the individual was structurally unemployed?
A. “I was laid off because there is a recession in the auto industry.”
B. “I was laid off due to the model changeover at the auto plant.”
C. “I was laid off because my firm installed robotic technology that allowed them to reduce production costs.”
D. “I was laid off because my company closed my plant.”
C. “I was laid off because my firm installed robotic technology that allowed them to reduce production costs.”
Structural unemployment is defined as unemployment due to workers not having the skills demanded by employers, and workers who cannot easily move to the location where jobs are available. In this case, it would not be feasible for the worker to work as fast and as long as the robotic technology.
In relation to the role of capital in mitigating financial risk, it has been strongly suggested that in the new regulatory environment, regulators treat capital:
A. as a necessary component of risk margin reserves that should be held to deal with black swan events.
B. as being inadequate on a prima facie basis and require that regulators mandate significantly higher levels of capital that would be fixed in nature to convince investors that the institutions could absorb risk.
C. as being inadequate and thus causing regulators to need to monitor and regulate compensation packages so that the incentive structure does not distort the proper evaluation of risk and cause management not to make appropriate contributions to capital.
D. as a shock absorber and allow firms to draw down capital during periods of market stress that would be expected to be replenished when market conditions improve.
D. as a shock absorber and allow firms to draw down capital during periods of market stress that would be expected to be replenished when market conditions improve.
Regulators are looking to be more proactive in dealing with potential bubbles in financial markets and, as a result, are looking at primary capital to serve as a “shock absorber” as early warning signs that a bubble might occur.
Regulators are concerned about the need to increase capital requirements for any market participant where remuneration and incentives focus excessively on short-term results. However, that is not the focus of this question. Risk margin capital is designed to be available in the event of high uncertainty or the occurrence of “black swan” events.
All other things being equal, movement along a supply curve occurs if:
A. the number of sellers increases or decreases.
B. the price of resources needed in the production of the product is expected to increase.
C. technology in the production of the product improves.
D. the price for the product increases or decreases.
D. the price for the product increases or decreases.
Movement along the supply curve occurs when the price for the product increases or decreases if all other factors remain constant. The supply curve shifts (a change in demand) when there are changes in other supply determinants such as technology, the prices of resources, the expectation of future prices, the number of sellers, and in taxes and other government restriction or subsidies.
As per FASB ASC 815, if an entity engages in a hedge against the exposure to the variable cash flow of a forecasted transaction, the entity would:
A. recognize the gain or loss as earnings in the period of loss together with the offsetting loss or gain on the hedged item attributable to the risk being hedged, in order to reflect in earnings the extent to which the hedge is not effective in achieving offsetting changes in fair value.
B. report the gain or loss in other comprehensive income as part of a cumulative translation adjustment.
C. recognize the gain or loss in earnings during the period of change.
D. recognize the effective portion of the derivative’s gain or loss initially as a component of other comprehensive income, and subsequently reclassify it into earnings when the forecasted transaction affects earnings.
D. recognize the effective portion of the derivative’s gain or loss initially as a component of other comprehensive income, and subsequently reclassify it into earnings when the forecasted transaction affects earnings.
FASB ASC 815 specifically indicates that for a derivative designated as hedging the exposure to variable cash flow of a forecasted transaction (i.e., a cash flow hedge), the effective portion of the derivative’s gain or loss is initially reported as a component of other comprehensive income and is subsequently reclassified into earnings when the forecasted transaction affects earnings. Any ineffective portion of the gain or loss is reported in earnings immediately.
If the hedge is designated as a hedging exposure to changes in fair value of a recognized asset or liability (i.e., a fair value hedge), the gain of loss is recognized as earnings in the period of change together with an offsetting loss or gain on the hedged item attributable to the risk being hedged. The effect is to reflect in earnings the extent to which the hedge is not effective in achieving offsetting changes in fair value.
If the derivative is designated as hedging the foreign currency exposure of the firm’s net investment in foreign operations, the gain or loss is reported in other income as part of the cumulative translation adjustment.
Bank reserves would be decreased by:
A. an increase in Federal Reserve float.
B. a sale of government securities by the Federal Reserve.
C. a loan to member banks by the Federal Reserve.
D. a purchase of gold by the Federal Reserve.
B. a sale of government securities by the Federal Reserve
The reserve level is affected by the Federal Reserve’s open market operations. When the Federal Reserve sells a security to a household or firm, it receives the buyer’s check drawn against its own deposits in a commercial bank. The Federal Reserve presents the check to the commercial bank for payment. On payment of the check, the commercial bank’s reserves are reduced.
Supply chain metrics are created to measure the performance of the supply chain. If a firm developed metrics to measure things such as fill rates and on-time delivery, we would assume that they are trying to measure:
A. manufacturing flexibility.
B. supplier relationships.
C. customer service.
D. the flexibility the firm has to respond to environmental changes.
C. customer service.
One key element of customer service management is to provide customers with real-time information as to product availability and delivery and customer satisfaction could be measured by metrics such as fill-rates and on-time delivery.
Division A currently makes a widget. The following is information related to the production of the widgets:
Production capacity 100,000 units per year
Current sales level 80,000 units per year
Selling price to outside customers $20 per unit
Variable costs per unit $12 per unit
Total fixed costs $600,000
Division B wishes to purchase 15,000 widgets from Division A for $16 per unit. Division A has the capacity to handle all of Division B’s needs without changing either fixed or variable costs nor losing any sales to outside customers. Division B currently purchases widgets from the outside for $18 per unit. If Division A accepted the $16 internal price and Division B purchases the widgets from Division A, the company as a whole will be:
A. $30,000 better off each period.
B. $90,000 better off each period.
C. $30,000 worse off each period.
D. $60,000 worse off each period.
B. $90,000 better off each period.
Division A will have an addition
Contribution Margin of $4 per widget
sold internally ($4 x 15,000) $60,000
Division B will have an addition
saving in variable cost of $2 per widget
Purchased internally ($2 x 15,000) 30,000
Savings to Company if purchased Division B
purchases the widget from Division A $90,000
When there is equilibrium in a monopolistically competitive industry, a firm:
A.
will operate efficiently at minimum average total cost.
B.
will not engage in advertising to promote product differentiation.
C.
will operate inefficiently with price greater than marginal revenue.
D.
will be able to make economic profits in the long run.
C. will operate inefficiently with price greater than marginal revenue
Given free entry and exit in a monopolistically competitive industry, firms only earn normal profits in the long-run. However, since the firm faces a downward-sloping demand curve with MR
The Bytax Company and the Tytax Company are both members of the same multinational corporation (MNC). The Bytax Company has a home-country 50% tax rate and the Tytax Company has a home-country 20% income tax rate. The Bytax Company desires to purchase a component part from the Tytax Company. An acceptable range for the transfer price has been established to be between $300 and $600 per unit. The following statement is true regarding the optimal transfer price:
A. The Bytax Company as well as the MNC will maximize earnings by setting the transfer price at $300 per unit.
B. The Bytax Company as well as the MNC will maximize earning by setting the transfer price at $600 per unit.
C. The Tytax Company as well as the MNC will maximize earnings by setting the transfer price at $300 per unit.
D. The Tytax Company as well as the MNC will maximize earning by setting the transfer price at $600 per unit.
D. The Tytax Company as well as the MNC will maximize earning by setting the transfer price at $600 per unit.
The Bytax Company (purchasing subsidiary) will maximize earnings by having the transfer price set at the lowest possible price. The Tytax Company (selling subsidiary) will maximize earning by having the transfer price set at the highest possible price. The multinational corporation (MNC) will benefit by having the higher income shifted to the Company with the lowest home-country tax rate; therefore, the Tytax Company as well as the MNC will maximize earning by setting the transfer price at $600 per unit since the Tytax Company has the lower home-country tax rate of 20%.
Which of the following variables is not one of the variables traditionally found in national income calculations?
A. Disposable income
B. Gross domestic product
C. Net domestic product
D. Real per capita gross domestic product
D. Real per capita gross domestic product
Real per capita gross domestic product is gross domestic product for a particular year adjusted for inflation compared to a base year using a price index. This adjusted number is then divided by population to derive real per capita GDP (gross domestic product). This measure is often used as an estimate of changes in well-being in a society over time, but it is not one of the variables one would traditionally see in national income calculations.
Which of the following scenarios would encourage a company to use short-term loans to retire its 10-year bonds that have five years until maturity?
A. The company expects interest rates to increase over the next five years.
B. Interest rates have increased over the last five years.
C. Interest rates have declined over the last five years.
D. The company is experiencing cash flow problems.
C. Interest rates have declined over the last five years.
If interest rates have declined, refunding with short-term debt may be appropriate. The bonds pay a higher interest rate than the new short-term debt. Assuming that rates continue to fall, the short-term debt can itself be refunded with debt having a still lower interest charge. The obvious risk is that interest rates may rise, thereby compelling the company to choose between paying off the debt or refunding it at higher rates.
Debt-servicing problems of less developed countries that primarily sell raw materials to the United States would be eased by:
A. a recession in the United States with declines in interest rates.
B. an expanding United States economy with stable money supply growth.
C. an expansion of the lending authority of the World Bank.
D. a significant increase in the level of U.S. tariffs.
B. an expanding United States economy with stable money supply growth.
An expanding United States economy with stable money supply growth would maintain a steady demand for raw materials of less developed countries. The moneys earned from the sale of raw materials will aid in servicing the debt of less developed nations.
The U.S. inflation rate is expected to be 5% per annum while the Italian lira is expected to depreciate against the U.S. dollar by 10% during the same period. During the next year, an Italian firm importing from its U.S. parent can expect its lira cost for these imports to:
A. decrease by about 5%.
B. increase by about 5%.
C. increase by about 15%.
D. decrease by about 15%.
C. increase by about 15%.
Taking the two events in order, if the inflation in the United States is expected to be 5%, then according to the purchasing power parity theorem of exchange rates, the exchange rate between the United States and Italy will increase by 5% (1 lira will increase in worth by 5% more dollars). On top of this expected inflation, is a 10% depreciation of the lira against the dollar, which will drive up the exchange rate another 10%, on top of the 5% inflation change.
Mathematically we have:
$1.00 x 1.05 = $1.05 $1.05 x 1.10 = $1.155
Therefore, the price of imported goods to Italy will rise from $1.00 to $1.1550, an overall increase of about 15%.
The Federal Financial Institutions Examination Council (FFIEC) has suggested that regulated institutions should engage in scenario planning and undertake stress tests to determine the impact of a series of possible changes in market interest rates. If the institution did a test for basis risk, they would be dealing with:
A. instantaneous and significant changes in the levels of interest rates.
B. changes in the relationship between key market interest rates.
C. changes in the shape and slope of the yield curve.
D. substantial changes in interest rates over time.
B. changes in the relationship between key market interest rates.
The FFIEC has suggested that institutions undertake stress tests for a variety of types of interest rate risks. Testing for basis risk would involve testing for the impact of the changes in relationships between key market interest rates.
Other tests would include tests for instantaneous rate shocks that deal with instantaneous and significant changes in the level of interest rates;
prolonged rate shocks that deal with substantial changes in rates over a longer period of time; and yield curve risk that deals with the impact of a changing shape of the yield curve.
Regulators understand that not all financial institutions will be required to develop the full range of scenarios; however, tests of interest rate shocks of significant magnitude should be run by all institutions, regardless of the institution’s size or complexity.
Consider a world consisting of only two countries, Canada and Italy. Inflation in Canada in one year was 5%, and in Italy 10%. Which one of the following statements about the Canadian exchange rate (rounded) during that year will be true?
A.
The Canadian dollar will appreciate by 5%.
B.
The Canadian dollar will depreciate by 5%.
C.
The Canadian dollar will depreciate by 15%.
D.
The Canadian dollar will appreciate by 15%.
A. The Canadian dollar will appreciate by 5%.
The factors which affect exchange rates are changes in tastes (demand for each other’s goods), changes in relative income, changes in relative prices (determined by respective inflation rates), speculation, and changes in real interest rates. In this case, there is a change in relative prices, as the two countries have differing inflation rates. If inflation is higher in Italy, Canadian goods will become relatively cheaper and Italian demand for Canadian goods will rise. This increases demand for the Canadian dollar and supply of the Italian lira, causing the Canadian dollar to appreciate and the Italian lira to depreciate. The difference in inflation rates is 5% (Italy’s 10% minus Canada’s 5%), so the Canadian dollar appreciates by 5%.
Which of the following formulas should be used to calculate the economic rate of return on common stock?
A. (Dividends + Change in price) ÷ Beginning price
B. (Net income - Preferred dividend) ÷ Common shares outstanding
C. Market price per share ÷ Earnings per share
D. Dividends per share ÷ Market price per share
A. (Dividends + Change in price) ÷ Beginning price
The economic rate of return is a percentage measure of the total return received by the investor. This is determined by the following formula:
[Dividends received + (Ending price - Beginning price)] ÷ Beginning price
A company obtained a short-term bank loan of $250,000 at an annual interest rate of 6%. As a condition of the loan, the company is required to maintain a compensating balance of $50,000 in its checking account. The company’s checking account earns interest at an annual rate of 2%. Ordinarily, the company maintains a balance of $25,000 in its checking account for transaction purposes. What is the effective interest rate of the loan?
A. 6.00%
C. 6.44%
C. 6.66%
D. 7.11%
C. 6.44%
If a firm borrows $250,000 but is required to maintain $50,000 as a minimum compensating balance, then the firm only has use of $200,000, but is paying 6% interest on the entire $250,000. To determine the effective interest rate, the interest in dollars ($250,000 × 6%, or $15,000) should be divided by the amount of the loan available to the borrower, the effective loan amount, which is only $200,000. However, there are two issues that further complicate this problem. This company ordinarily maintains a $25,000 balance in its checking account. Therefore, the company will only be out $25,000 ($50,000 - $25,000). This means the effective loan amount is $225,000 ($250,000 - $25,000), not $250,000. Also, the company earns checking account interest which partially offsets the loan interest. The applicable amount on which to determine interest is only the part that pertains to this borrowing, the additional $25,000. The interest on this is $500 (2% × $25,000). The effective interest dollar amount for this borrowing is $14,500 ($15,000 - $500). The effective interest rate is now calculated as:
$14,500 ÷ $225,000 = .0644, or 6.44% effective interest
Which of the following is not an example of price discrimination?
A.
A department store charges $10 for an item while the same good sells for $7.75 at a discount store.
B.
An airline charges $175 for 14-day advance purchase ticket round trip between New York and Chicago and charges $400 for a ticket on the same route, purchased two days before the flight.
C.
A restaurant gives seniors a 15% discount if the order their food before 5:30 p.m.
D.
A grocery store provides discount coupons to everyone.
A. A department store charges $10 for an item while the same good sells for $7.75 at a discount store.
Price discrimination requires that consumers can be separated according to elasticity of demand, the firm must be able to prevent resale of the product, and there no cost difference for the product that would explain the different price.
Coupons represent what one might at least call quasi-price discrimination. It is a form of what is known as “third-degree price discrimination.”
The use of coupons is similar in some respects to the “senior discount” in that it is designed to attract the low-end customer who is more price-conscious and is likely to have a more flexible time schedule.
Coupons are available to all (most generally to anyone who subscribes to a newspaper). However, given the opportunity cost of their time, most middle-to-upper income individuals do not avail themselves of an opportunity to “clip the coupons.” Thus, it is the individuals from the lower-income households who, on the average, get the benefit of the coupons.
Department store vs. discount store:
The operative issue here relates to “when those price differences are not justified by cost differences.” The business model of the discount store is to be a low cost (relative to the department store) provider of merchandise. One of the key differences in cost drivers between the two types of stores is the “level of service” that is provided.
The department store charges higher prices due to their higher cost structure. This is independent of the basic “cost of the merchandise” itself which may, or may not, be the same for the two types of stores depending on the various firms’ bargaining power with suppliers.
The primary sources of funds for sovereign wealth funds would be:
A. the export earnings that are driven by government policies designed to have a strong currency.
B. the Central Bank in an attempt to sterilize the inflationary impact of the inflow of foreign exchange reserves on the money supply of the country.
C. earnings from commodity-based exports and trade surpluses driven by the export of manufactured goods.
D. foreign direct investment attracted by donor governments that hope to gain political leverage by making such investments.
C. earnings from commodity-based exports and trade surpluses driven by the export of manufactured goods.
The primary sources of funds for sovereign wealth funds are export earnings from commodity (energy)-based exports and the trade surplus generated by the export of manufactured goods. The trade surplus is often tied to the country having a weak currency that causes a country’s goods and services to be priced lower in terms of a foreign currency.
Additionally, increases in commodity prices have shifted the terms-of-trade in favor of nations exporting goods from extractive- and commodity-based industries.
