Economic Analysis

Question 1

Gross Domestic Product is production:

A. within U.S. borders as measured in inflated dollars
B. outside of U.S. borders as measured in inflated dollars
C. within U.S. borders as measured in constant dollars
D. outside of U.S. borders as measured in constant dollars

Answer 1

The best answer is C.

Gross Domestic Product is the sum of all goods and services produced in this country. To make GDP comparisons valid, GDP is measured in constant dollars, using a GDP deflator.

Question 2

Gross Domestic Product (GDP) consists of all of the following EXCEPT:

A. Consumer spending
B. U.S. Government spending
C. Foreign Government spending
D. Fixed investment

Answer 2

The best answer is C.

Gross domestic product is the entire output of the U.S. economy. It includes individual consumption, government spending, and fixed investment. Since it measures output within the United States only, foreign spending and investment is excluded.

Question 3

If a country is importing more, then that country’s:

A. GDP is increasing
B. GDP is decreasing
C. Inflation rate is increasing
D. Inflation rate is decreasing

Answer 3

The best answer is B.

GDP is Gross Domestic Product – the sum of all goods and services produced within a country. If a country exports more, it is producing more within that country and GDP increases. If a country imports more, it is producing less within that country and GDP decreases.

Question 4

If a country is exporting more, then the country’s:

A. GDP is increasing
B. GDP is decreasing
C. Inflation rate is increasing
D. Inflation rate is decreasing

Answer 4

The best answer is A.

GDP is Gross Domestic Product – the sum of all goods and services produced within a country. If a country exports more, it is producing more within that country and GDP increases. If a country imports more, it is producing less within that country and GDP decreases.

Question 5

During the normal sequence of the economic cycle, after a period of recession, the economy will move to a period of:

A. depression
B. recovery
C. expansion
D. prosperity

Answer 5

The best answer is B.

The normal sequence of the economic cycle is a period of expansion, followed by an economic peak (prosperity), followed by a decline in economic activity (recession), followed by an economic recovery leading to further expansion, etc.

Question 6

During which phase of the economic cycle would one most likely find monetary “inflation” starting to occur?

A. Expansion
B. Prosperity
C. Recession
D. Recovery

Answer 6

The best answer is A.

During the expansion phase of an economic cycle is when inflation begins to build. As output expands and there are fewer unemployed workers, pressure is put on employers for wage increases. As output expands, increased demand for goods and services also causes prices to rise. Thus, inflation tends to accelerate.

Question 7

If Gross Domestic Product has declined for 3 successive quarters, the economy is said to be in a:

A. recession
B. correction
C. depression
D. contraction

Answer 7

The best answer is A.

2 consecutive quarters of GDP decline means that the economy has entered into a recession. If GDP declines for 6 consecutive quarters, then the economy has entered into a depression.

Economic contraction is a broader term that simply denotes a decline in GDP. The length of the contraction will determine if the decline is characterized as a recession or depression.

Finally, the term correction is used when stock market indicators decline, with the market entering correction territory when it drops by 10%.

Question 8

Fiscal policy encompasses all of the following EXCEPT:

A. government spending
B. social security payment levels
C. tax policy
D. monetary policy

Answer 8

The best answer is D.

Fiscal policy is set through Government Actions (approved by Congress) that influence economic activity. Fiscal policy encompasses the tax code, government transfer payment levels, and government spending. Monetary policy is controlled by the Federal Reserve Board.

Question 9

Monetary policy is conducted through all of the following methods EXCEPT:

A. setting margin requirements
B. setting tax rates
C. conducting open market operations
D. setting reserve requirements

Answer 9

The best answer is B.

Changes in tax rates are made with approval of Congress - this is a tool of fiscal policy. Monetary policy actions that can be taken by the Fed include changing the discount rate; open market operations; changing reserve requirements; and changing margin requirements.

These can be memorized as “DORM.”

D is Discount rate;

O is Open Market Operations;

R is Reserve Requirements; and

M is Margin on securities.

Question 10

Keynesian Economic Theory postulates that production and economic growth are stimulated by:

A. Lower government spending and decreased government borrowing
B. Higher government spending and decreased government borrowing
C. Lower government spending and increased government borrowing
D. Higher government spending and increased government borrowing

Answer 10

The best answer is D.

Keynesian Economic Theory states that economic growth is controlled by government spending and transfer payments (e.g., Social Security). This theory gained adherents in the 1930s during the Great Depression. With the private economy shattered at that time, the only way out was to have the government employ workers in large projects. This increased Government spending; and helped to stimulate economic activity as earnings were placed in individual pockets. To pay for this, the Government had to borrow more money.

Question 11

Monetarist Theory states that the economy is stimulated by:

A. the actions of the Federal Reserve
B. increased Government spending
C. tax rate reductions
D. decreased Government spending

Answer 11

The best answer is A.

Monetarists claim that the actions of the Federal Reserve Board to tighten or loosen credit are the driving force behind economic cycles.

Question 12

Supply Side Theory states that the economy is stimulated by:

A. the actions of the Federal Reserve
B. increased Government spending
C. tax rate reductions
D. Government incentives to consumers

Answer 12

The best answer is C.

Supply Side Theory states that economic growth is controlled by individual initiative. If individuals are given the incentive to produce, they will, and the economy will grow. To give this incentive, the theory holds that government spending, and the tax collections necessary to support that government spending, should be reduced. This leaves the individual with an economic incentive to produce, since less of his or her income is being taxed.

Question 13

Under Supply Side Theory, which of the following will stimulate the economy?

A. Tax rate increases and increased government spending
B. Tax rate increases and decreased government spending
C. Tax rate reductions and increased government spending
D. Tax rate reductions and decreased government spending

Answer 13

The best answer is D.

Supply Side Theory states that economic growth is controlled by individual initiative. If individuals are given the incentive to produce, they will, and the economy will grow. To give this incentive, the theory holds that government spending, and the tax collections necessary to support that government spending, should be reduced. This leaves the individual with an economic incentive to produce, since less of his or her income is being taxed.

Question 14

Supply Side Theory states that:

A. increased government spending will stimulate the economy
B. tax rate reductions and lower government spending will stimulate the economy
C. the actions of the Federal Reserve are the driving force behind the economy
D. tax rate increases will stimulate the economy

Answer 14

The best answer is B.

Supply Side Theory states that economic growth is controlled by individual initiative. If individuals are given the incentive to produce, they will, and the economy will grow. To give this incentive, the theory holds that government spending, and the tax collections necessary to support that government spending, should be reduced. This leaves the individual with an economic incentive to produce, since less of his or her income is being taxed.

Question 15

What is subtracted to find the real interest rate?

A. The inflation rate
B. The deflation rate
C. The discount rate
D. The prime rate

Answer 15

The best answer is A.

The “real interest rate” is the nominal yield to maturity (YTM) of that security minus the inflation rate. So, if a 30-year T-Bond is yielding 3.50%, and the inflation rate is 1%, then the “real” interest rate on that security is 2.50%. It is the yield that is being earned, once inflation is stripped out of the equation.

Question 16

During extended periods of high inflation, it can be expected that common stock price movements, as measured by the NYSE Composite Index, will show a:

A. positive correlation
B. negative correlation
C. lower volatility level
D. greater volatility level

Answer 16

The best answer is B.

A rising inflation rate is a “lose-lose” situation for both the stock and long term bond markets.

During extended periods of high inflation, interest rates rise, bond prices fall, and stock prices fall because corporate earnings deteriorate (corporations have a hard time increasing prices as their costs rise).

In such time periods, because both stocks and long bonds are “losers,” investors “flee to safety” - in the form of short term money market instruments (that are paying relatively high rates of interest in such periods).

Question 17

In a period of inflation, which of the following corporate actions is likely to occur?

A. Issuers are more likely to sell preferred stock
B. Issuers are more likely to call in outstanding bond issues
C. Issuers are less likely to sell fixed income securities
D. Issuers are less likely to add call features to any bonds issued

Answer 17

The best answer is C.

In inflationary periods, interest rates rise. As interest rates rise, issuers are less likely to sell fixed income securities or preferred stock- it costs them more to finance. If issues are sold, issuers are likely to sell callable issues. Callable issues are generally sold in periods of high interest rates, so the issuer can call in the securities if interest rates fall subsequently. Issuers would not call in bonds in a rising interest rate environment since it would cost them more to refinance the debt.

Question 18

The rate of inflation as measured by the Consumer Price Index has been rising rapidly over the last months. Ignoring other factors, the effect will be to:

A. lower bond market values and raise stock market values
B. raise bond market values and lower stock market values
C. raise bond market values and raise stock market values
D. lower bond market values and lower stock market values

Answer 18

The best answer is D.

A rising inflation rate is a “lose-lose” situation for both the stock and long term bond markets. If the inflation rate rises, then interest rates are likely to rise, with short term rates rising more than long term rates (the yield curve “flattens” as the Fed tightens credit to tame inflation, with short term rates rising more than long term rates). If interest rates rise, then long term bond prices will fall fastest, and long bondholders will have large losses on their positions.

Furthermore, during periods of inflation, corporate earnings tend to fall, because companies are not able to keep raising prices at the same pace as their costs rise. This lowered earnings outlook depresses stock prices.

Thus, both stock and long bond prices tend to fall in inflationary periods. Instead, during these periods of high inflation, investors “flee to safety” - they abandon the stock and long term bond markets, and put money in short term money market instruments, which offer safety and relatively high interest rates during inflationary periods; and they also put money into real estate and other “hard” assets that tend to keep pace with inflation.

Question 19

In a period of deflation, all of the following statements about fixed income securities are true EXCEPT:

A. holders receive payments on fixed income securities that buy more in real terms
B. holders are likely to realize capital appreciation on fixed income securities that are not close to maturity
C. issuers are less likely to sell fixed income securities because interest rates will rise
D. issuers are likely to sell non-callable issues

Answer 19

The best answer is C.
In a deflationary period, prices fall. Therefore, money buys “more” in real terms. As deflation occurs, interest rates will drop, causing long term debt prices to rise. Because interest rates will be lower, issuers are more likely to sell fixed income securities - it costs them less to finance.

Issuers are likely to sell non-callable issues because interest rates are low, and there is no need to call in such issues when the financing rates are so favorable. Callable issues are generally sold in periods of high interest rates, so the issuer can call in the securities if interest rates fall subsequently.

Question 20

In a period of deflation, which statement about fixed income securities is FALSE?

A. Issuers are more likely to sell fixed income securities
B. Issuers are likely to sell non-callable issues
C. Holders are likely to realize capital appreciation on fixed income securities that are not close to maturity
D. Holders receive payments on fixed income securities that buy less in real terms

Answer 20

The best answer is D.

In a deflationary period, prices fall. Therefore, money buys “more” in real terms.

As deflation occurs, interest rates will drop, causing long term debt prices to rise. Because interest rates will be lower, issuers are more likely to sell fixed income securities - it costs them less to finance.

Issuers are likely to sell non-callable issues because interest rates are low, and there is no need to call in such issues when the financing rates are so favorable. Callable issues are generally sold in periods of high interest rates, so the issuer can call in the securities if interest rates fall subsequently.

Question 21

In a deflationary period, which security would be most negatively affected?

A. Long-term bond
B. Intermediate-term bond
C. Common stock
D. Preferred stock

Answer 21

The best answer is C.

In a deflationary period, interest rates will fall, raising the prices of fixed income securities. Thus, fixed income securities are defensive securities in times of deflation. Remember that preferred stock, which pays a fixed dividend rate, is a fixed income security.

In contrast, common stock price movements will depend on the state of the economy at the time deflation occurs, and thus would not be defensive during deflationary periods.

Question 22

In a deflationary period, which statement is TRUE?

A. Equity securities are a defensive investment
B. Interest rates will likely rise
C. Fixed income securities are a defensive investment
D. Fixed income security prices will fall

Answer 22

The best answer is C.

In a deflationary period, interest rates will fall, raising the prices of fixed income securities. Thus, fixed income securities are defensive securities in times of deflation. Equity securities’ price movements will depend on the state of the economy at the time deflation occurs, and thus would not be defensive during deflationary periods.

Question 23

Inflation has been running at the annualized rate of 6%. You have just received a distribution from a mutual fund investment that has increased by 4%. The purchasing power relating to this investment has:

A. increased
B. decreased
C. stayed the same
D. become more variable

Answer 23

The best answer is B.

If inflation is running at 6%; and that individual’s income has risen by 4%; then that individual’s purchasing power has decreased by 2%. The individual is earning 4% more, but it costs 6% more to live, so that individual’s economic status has deteriorated by 2%.

Question 24

The Federal Reserve will lend funds at the discount rate to:

A. savings and loans
B. commercial banks
C. investment banks
D. insurance companies

Answer 24

The best answer is B.

Only commercial banks are members of the Federal Reserve System. Member banks can borrow reserves from the Fed at the discount rate.

Question 25

This speed with which deposits clear from bank to bank is known as which of the following?

A. Discount Rate Expediter
B. Federal Funds Rate Accelerator
C. Money Multiplier
D. Money Velocity

Answer 25

The best answer is D.

Federal Reserve actions can directly influence the discount rate, which can be raised or lowered by the Federal Reserve. The discount rate is the rate charged to member banks to borrow reserves from the Fed.

The Federal Reserve directly influences the Federal Funds rate by its daily open market operations. To raise the Federal Funds rate (overnight loan rate for reserves bank to bank), the Fed will engage in reverse repos (matched sales) with bank dealers. To lower the Federal Funds rate, the Fed will engage in repurchase agreements with bank dealers.

The Fed can directly influence the money multiplier by changing reserve requirements of member banks. The multiplier effect is the expansion of a country’s money supply that results from banks being able to lend. The larger the percentage reserve requirement, the lower the money multiplier (since banks must keep a larger portion of deposits on reserve, and so, can loan out less). nds available at any moment in time.)

Question 26

The use of which tool of the Federal Reserve has the smallest impact on money supply levels?

A. Open market operations
B. Discount rate
C. Reserve requirements
D. Margin on securities

Answer 26

The best answer is D.

Monetary policy tools of the Fed include setting reserve requirements, open market operations, setting the discount rate, and setting margin rates on securities. Changing margin rates on securities has the smallest impact on money supply levels, since the securities market is not that large relative to the government bond and credit markets.

Question 27

The Federal Reserve open market trading activities affect all of the following EXCEPT:

A. M 1 levels
B. GDP growth
C. Treasury’s accounts
D. National debt levels

Answer 27

The best answer is D.

Open market operations do not affect the national debt. The issuance and redemption of government securities by the Treasury determines the national debt level. Open market operations affect monetary levels such as M1 (currency in circulation and demand deposits); affect the business cycle; and affect the Treasury’s accounts, since FRB funding for its trading activities is provided through the Treasury.

Question 28

Open market operations of the Federal Reserve Board cause direct changes in:

A. M1 levels
B. velocity of money
C. dollar exchange rate
D. short term interest rates

Answer 28

The best answer is A.

Open market operations of the Federal Reserve Board are used to inject monetary reserves into banks via repurchase agreements or to drain monetary reserves from banks via reverse-repurchase agreements. Thus, open market operations cause direct changes in money supply levels. (M1 is the money supply measure that includes all currency in circulation and demand deposits).

As the money supply expands or contracts, this influences interest rate levels in the economy, which can also influence the dollar exchange rate (the higher the level of interest rates, the higher the dollar).

The velocity of money is not affected by open market operations. Velocity is affected mainly by bank clearing times for deposits.

Question 29

All of the following statements are true about Federal Reserve open market trading activities EXCEPT open market operations affect:

A. the National Debt
B. M 1 levels
C. the Treasury’s accounts
D. the business cycle

Answer 29

The best answer is A.

Open market operations do not affect the national debt. The issuance and redemption of government securities by the Treasury determines the national debt level. Open market operations affect monetary levels such as M1 (currency in circulation and demand deposits); affect the business cycle; and affect the Treasury’s accounts, since FRB funding for its trading activities is provided through the Treasury.

Question 30

Open market operations of the Federal Reserve designed to slow down the economy will:

A. inject monetary reserves via reverse repurchase agreements
B. inject monetary reserves via repurchase agreements
C. drain monetary reserves via repurchase agreements
D. drain monetary reserves via reverse repurchase agreements

Answer 30

The best answer is D.

Open market operations of the Federal Reserve Board are used to inject monetary reserves into banks via repurchase agreements or to drain monetary reserves from banks via reverse-repurchase agreements.

In a repurchase agreement, the Fed buys government securities from the bank-dealer, giving the bank cash that can be lent out.

In a reverse repurchase agreement, the Fed sells government securities to the bank-dealer, draining the bank of cash that can be lent out.

Question 31

Open market operations of the Federal Reserve designed to stimulate the economy will:

A. inject monetary reserves via reverse repurchase agreements
B. inject monetary reserves via repurchase agreements
C. drain monetary reserves via repurchase agreements
D. drain monetary reserves via reverse repurchase agreements

Answer 31

The best answer is B.

Open market operations of the Federal Reserve Board are used to inject monetary reserves into banks via repurchase agreements or to drain monetary reserves from banks via reverse-repurchase agreements.

In a repurchase agreement, the Fed buys government securities from the bank-dealer, giving the bank cash that can be lent out.

In a reverse repurchase agreement, the Fed sells government securities to the bank-dealer, draining the bank of cash that can be lent out.

Question 32

If the FOMC directs the Federal Reserve trading desk to loosen credit, which of the following will happen?

A. The trading desk will engage in repurchase agreements with banks and cash reserves will be injected into the banking system
B. The trading desk will engage in reverse repurchase agreements with banks and cash reserves will be injected into the banking system
C. The trading desk will engage in repurchase agreements with banks and cash reserves will be drained from the banking system
D. The trading desk will engage in reverse repurchase agreements with banks and cash reserves will be drained from the banking system

Answer 32

The best answer is A.

To lower interest rates, the Federal Open Market Committee (FOMC) would direct a expansion of the money supply. In a repurchase agreement, the Fed buys government securities from the bank dealers, with an agreement to sell them back (usually the next day). For that day, the bank is injected with cash that can be lent out and credit is loosened, lowering interest rates.

In contrast, in a reverse repurchase agreement, the Fed sells government securities to the bank dealers, with an agreement to buy them back (usually the next day). For that day, the bank is drained of cash and credit is tightened, raising interest rates.

Question 33

All of the following actions taken by the Fed would increase interest rates EXCEPT:

A. reverse repurchase agreements
B. buying securities from government dealers
C. draining reserves from the money supply
D. raising the discount rate

Answer 33

The best answer is B.

To increase interest rates, the Federal Open Market Committee must direct a tightening of the money supply.

Sales of securities by the Fed drains cash from the dealers, and tightens available credit.

Reverse repos by the Fed do the same thing. In a reverse repo the Fed sells government securities to the bank dealers, with an agreement to buy them back (usually the next day). For that day, the bank is drained of cash and credit is tightened.

By raising the discount rate, increases in the other market rates are likely to occur as well, tightening credit.

If the Fed buys securities from government dealers, it is giving the dealers cash that they can lend. This loosens credit and lowers interest rates.

Question 34

Monetary aggregates have increased over the last month. Which statement is TRUE?

A. The Federal Funds rate is likely to increase
B. Loans made by banks are likely to increase
C. The prime rate is likely to increase
D. Reserve requirements are likely to increase

Answer 34

The best answer is B.

If monetary aggregates increase (such as M1), then deposits in banks have increased and the banks can loan out most of these funds (they only have to retain the reserve requirement). If there is more credit available, then interest rates are likely to fall.

Question 35

To counter rapidly rising inflation rates, the Federal Reserve would:

A. decrease reserve requirements
B. decrease the discount rate
C. sell securities in open market operations
D. sell bonds to the public

Answer 35

The best answer is C.

To counter rising inflation, the Fed must decrease money supply levels and slow down economic activity. To do this, the Fed could tighten reserve requirements; increase the discount rate; or engage in “reverse repurchase” agreements with government dealers (mainly large commercial banks).

In a reverse repurchase, the Fed sells Government securities to the dealers with an agreement to buy them back at a later date. This drains cash from the dealers and tightens credit.

The Fed does not sell bonds directly to the public.

Question 36

The Federal Reserve might consider an easing of credit if all of the following decline EXCEPT:

A. real Gross Domestic Product
B. stock prices
C. Consumer Price Index
D. unemployment levels

Answer 36

The best answer is D.

Declining unemployment means that the economy is chugging along nicely and does not need the stimulus of credit easing.

Falling GDP indicates that economic output is contracting and that credit stimulus may be needed.

Stock prices fall in response to either higher interest rates or other bad economic news - the Fed may attempt to correct the situation by easing credit.

If the Consumer Price Index is falling, then prices are falling and deflation becomes a risk. The Fed will then inject funds into the economy to loosen credit, stimulating lending, which stimulates purchases, which expands the econom

Question 37

To counter a recession, the Federal Reserve would:

A. increase reserve requirements
B. increase the discount rate
C. buy securities in open market operations
D. sell bonds to the public

Answer 37

The best answer is C.

To counter a recession, the Fed must increase money supply levels and stimulate economic activity. To do this, the Fed could lower reserve requirements; lower the discount rate; or engage in “repurchase” agreements with government dealers (mainly large commercial banks).

In a repurchase agreement, the Fed buys Government securities from the bank dealers. This injects cash into the money supply and thus loosens credit. The Fed does not sell bonds directly to the public.

Question 38

During a period of economic slowdown, the Federal Reserve would increase:

A. reserve requirements
B. Treasury securities purchases in the secondary market
C. the discount rate
D. the margin requirement

Answer 38

The best answer is B.

To loosen credit and stimulate the economy, the Fed, via open market operations, buys Treasury securities from the primary dealers (mainly the large commercial banks), giving them cash that can be lent out. This lowers interest rates and makes it easier for businesses and individuals to borrow, increasing spending and economic growth.

Increasing reserve requirements held at banks reduces the amount that banks can lend out, And tightens credit. Increasing the discount rate (the rate at which member banks can borrow from the Fed) tightens credit. Increasing margin requirements on securities would also tighten credit.

Question 39

What can the Federal Reserve do to stimulate the economy?

A. Buy Treasury securities from banks
B. Sell Treasury securities to banks
C. Increase the reserve requirement
D. Increase the margin requirement

Answer 39

The best answer is A.

If the Federal Reserve buys Treasury securities from banks, it is giving the banks cash to lend out. This will reduce interest rates, making borrowing more attractive and will stimulate growth.

If the Federal Reserve sells Treasury securities to the banks, this drains cash out of the banks, which gives banks less money to lend, increasing interest rates and restraining growth.

An increase in the reserve requirement makes banks keep a larger portion of each deposit in reserve, reducing the amount they can lend.

An increase in the margin requirement will reduce the amount that can be borrowed when securities are used as collateral.

Question 40

The term “dovish” monetary policy means that:

A. the Federal Reserve is loosening credit by lowering interest rates
B. the Federal Reserve is tightening credit by raising interest rates
C. Congress is stimulating economic growth by increasing government spending
D. Congress is curbing economic growth by decreasing government spending

Answer 40

The best answer is A.

If the Fed is worried about increasing unemployment and an economy that not growing, it needs to increase the available money supply and increase the level of loans being made. To do this, it would lower interest rates. This is commonly known as the Fed taking a “dovish” tone - which comes from Federal Reserve leaders taking a looser monetary policy, keeping rates low to fuel growth.

In contrast, when the Fed is taking a “hawkish tone,” it is increasing rates, reducing money supply levels, to reduce inflation and slow down economic growth.

Both terms come from the Fed needing to be an “inflation hawk” - on the watch for inflation, where it will take action to raise interest rates if inflation grows rapidly. On the other hand, when there is little inflation, the Fed can be an “inflation dove.”

Question 41

The interest rate charged from the banks to broker-dealers on loans where securities are collateral is the:

A. Discount Rate
B. Federal Funds Rate
C. Broker Loan Rate
D. Prime Rate

Answer 41

The best answer is C.

The lowest rate is the Federal Funds Rate. This is the rate on overnight loans of reserves from bank to bank.

The next highest rate is the Discount Rate. This is the rate that the Federal Reserve charges member banks for borrowing reserves from the Fed, and is typically set at 50 basis points above the Fed Funds rate.

The next highest rate is the Broker Loan Rate. This is the rate that brokerage firms can borrow from banks using securities as collateral.

The highest rate is the Prime Rate. This is the rate for unsecured borrowing from banks by the best corporate customers.

Question 42

Which statement is TRUE?

A. The Discount Rate is higher than the Prime Rate
B. The Fed Funds Rate is higher than the Call Loan Rate
C. The Fed Funds Rate is higher than the Discount Rate
D. The Prime Rate is higher than the Fed Funds Rate

Answer 42

The best answer is D.

The lowest rate is the Federal Funds Rate. This is the rate on overnight loans of reserves from bank to bank.

The next highest rate is the Discount Rate. This is the rate that the Federal Reserve charges member banks for borrowing reserves from the Fed, and is typically set at 50 basis points above the Fed Funds rate.

The next highest rate is the Broker Loan Rate. This is the rate that brokerage firms can borrow from banks using securities as collateral.

The highest rate is the Prime Rate. This is the rate for unsecured borrowing from banks by the best corporate customers.

Question 43

The “effective” Federal Funds Rate is the:

A. daily average rate of all commercial banks
B. daily average rate of member banks of the Reserve System
C. weekly average rate of all commercial banks
D. weekly average rate of member banks of the reserve system

Answer 43

The best answer is B.

The “effective” Federal Funds Rate is the daily average rate for overnight loans of reserves from member bank to member bank within the Reserve system.

Question 44

If the Federal Reserve Board tightens credit via open market operations, which of the following will also increase?

A. Treasury Bill Discount Rate
B. Checking Account Rates
C. Passbook Savings Rate
D. Lending levels at financial institutions

Answer 44

The best answer is A.

If the Federal Reserve tightens credit via open market operations (to do this, it would use reverse repurchase agreements), then the Fed Funds rate would increase. Since the Discount Rate is set by the Federal Reserve at 50 basis points over the Fed Funds rate, this rate increases as well. The effect of increased rates then ripples through all of the other money rates including T-Bill rates.

If interest rates rise, lending levels should fall. Rates on passbook savings and checking accounts will likely be unaffected since banks set these rates fairly low and don’t change them often.

Question 45

If the federal reserve tightens credit via open market operations, which of the following interest rates will likely NOT increase?

A. Fed Funds Rate
B. Discount Rate
C. Broker Loan Rate
D. Credit Card Interest Rates

Answer 45

The best answer is D.

If the Federal Reserve tightens credit via open market operations (to do this, it would use reverse repurchase agreements), then the Fed Funds rate would increase. Since the Discount Rate is set by the Federal Reserve at 50 basis points over the Fed Funds rate, this rate increases as well. The effect of increased rates then ripples through all of the other money rates. Since the bank’s cost of borrowing has increased, it increases rates at which it will lend monies to customers (e.g., the Broker Loan Rate and Prime Rate), so that the bank can maintain its profit margins.

Consumer rates, such as passbook savings rates and credit card interest rates are fairly constant. Banks do not adjust these rates because consumers are not as sensitive to interest rate changes and are uncomfortable with rapidly changing market rates. These are large profit centers for banks because passbook savings rates are kept artificially low, while credit card interest rates are kept artificially high, relative to the banks’ cost of funds.

Question 46

All of the following are components of M-1 EXCEPT:

A. Currency in Circulation
B. Demand Deposits
C. Super NOW Accounts
D. Certificates of Deposit and Time Deposits

Answer 46

The best answer is D.

M-1 consists of currency in circulation and demand deposits. A Super NOW Account is a Super Negotiable Order of Withdrawal account. This is a type of checking account (so it is a demand deposit, because it is payable on demand) that pays interest. Time Deposits are included in M-2, which is a broader measure of the money supply.

CDs are included in M-3, which is an even broader measure than M-2. (Note that the Federal Reserve no longer computes M-3, but it may still be tested.)

Question 47

The narrowest monetary measure is:

A. M 1
B. M 2
C. M 3
D. L

Answer 47

The best answer is A.
The measures of the money supply are:

M-1 includes currency in circulation and demand deposits.
M-2 includes M-1 plus time deposits of $100,000 or less.
M-3 includes M-2 plus time deposits over $100,000.
L is M-3 plus savings bonds and money market
instruments, and is the broadest money supply measure.

(Note that the Federal Reserve no longer computes M-3 or L, but these may still be tested.)

Question 48

The components of M-2 include all of the following EXCEPT:

A. Jumbo CDs
B. Time Deposits
C. Demand Deposits
D. Currency in Circulation

Answer 48

The best answer is A.

M-2 is a broader money definition than M-1. M-1 consists of currency in circulation and demand deposits. M-2 consists of M-1 plus time deposits.

Certificates of Deposit over $100,000 are “negotiable” CDs, also known as Jumbo CDs. These are included in an even broader money definition, M-3, which is M-2 plus Jumbo CDs (certificates of deposit over $100,000).

L is M-3 plus savings bonds and money market instruments, and is the broadest money supply measure.

(Note that the Federal Reserve no longer computes M-3 or L, but these may still be tested.)

Question 49

Which of the following is NOT a component of M-2 ?

A. Currency in Circulation
B. Demand Deposits
C. Certificates of Deposit over $100,000
D. Time Deposits

Answer 49

The best answer is C.

M-2 is a broader money definition than M-1. M-1 consists of currency in circulation and demand deposits. M-2 consists of M-1 plus time deposits.

Certificates of Deposit over $100,000 are “negotiable” CDs. These are included in an even broader money definition, M-3, which is M-2 plus certificates of deposit over $100,000.

L is M-3 plus savings bonds and money market instruments, and is the broadest money supply measure.

(Note that the Federal Reserve no longer computes M-3 or L, but these may still be tested.)

Question 50

A change in each of the following is a leading economic indicator EXCEPT:

A. Money supply level as measured by M-2
B. Stock prices as measured by Standard and Poor’s 500 index
C. Durable goods orders
D. Reported corporate profits

Answer 50

The best answer is D.

Reported corporate profits is a lagging economic indicator - it shows how the company collected and spent its money in the preceding quarter.

The money supply level as measured by M-2 is a leading economic indicator, as is stock prices as measured by the Standard and Poor’s 500 index, and the amount of durable goods orders. Increasing money supply levels lead to increased spending; increased stock prices make people feel richer, so they are likely to spend more in the future; and increases in durable goods orders will require future production levels to be increased to fill those orders.

Question 51

Which of the following is NOT included in the leading economic indicators?

A. Standard and Poor’s 500 Index
B. Supplier Delivery Delays
C. Consumer Price Index
D. Initial Unemployment Claims

Answer 51

The best answer is C.

Leading economic indicators include stock prices (as stock prices rise, people feel richer and spend more), supplier delivery delays (as capacity tightens, delays increase), and initial unemployment claims (high levels indicate future production cutbacks).

The consumer price index is not a future indicator. It is one of the lagging indicators, but is not used much. CPI can be used as a lagging indicator because when there is a recession, prices are lowered, and this gets reflected in CPI after economic output has declined; and when there is a rapid economic expansion, prices are increased, and this is reflected in CPI after the growth in output occurs.

Question 52

All of the following are considered to be coincident economic indicators EXCEPT:

A. Stock market prices
B. Personal income levels
C. Index of industrial production
D. Gross Domestic Product

Answer 52

The best answer is A.

Stock market prices (as measured by the Standard and Poor’s 500 Index) are a leading indicator, since as stock prices rise, people spend more.

Personal income, the index of industrial production, and the level of Gross Domestic Product show current levels of economic output and are all considered coincident indicators.

Question 53

An economic indicator that has a turning point that tends to occur after the turning point in the business cycle is known as a:

A. leading economic indicator
B. lagging economic indicator
C. coincident economic indicator
D. concomitant economic indicator

Answer 53

The best answer is B.

An economic indicator that tends to move after movement occurs in the economy is known as a lagging economic indicator. Classic lagging indicators are the unemployment rate and reported corporate profits. Both of these move after a change in economic output.

Question 54

A review of major newspapers across the United States reveals that “help wanted” advertisement lineage has been increasing. This is a:

A. leading indicator showing that economic activity is going to increase
B. a coincident indicator showing that economic activity is currently a high levels
C. a lagging indicator showing that economic activity has peaked and is declining
D. a combination leading/ coincident/lagging indicator

Answer 54

The best answer is A.

The amount of “help wanted” advertising shows the current demand for labor. If the number of advertisements is increasing, this would show that employers plan future production. If it is decreasing, it shows that future production will be slowing. Thus it is a leading indicator, though is not included as one of the 10 leading economic indicators reported monthly.
The employment indicators that are reported by the Bureau of Labor Statistics are: levels of employment, which are a coincident indicator, initial unemployment claims which are a leading indicator; and duration of employment which is a lagging indicator.

Help wanted ad lineage is an indicator published by the Conference Board, in its “Help Wanted Advertising Index.” (The Conference Board is an economic forecasting firm, that is mainly known for its consumer “Confidence Index.”) The Help Wanted Advertising Index measures ad volumes in 51 leading newspapers in nine regions across the United States.

Question 55

Which statement is TRUE regarding the “help wanted” advertising index?

A. If the number of advertisements is increasing, the economy is growing
B. If the number of advertisements is increasing, the economy is signaling deflation
C. The index is a a coincident economic indicator
D. The index is a lagging economic indicator

Answer 55

The best answer is A.

The amount of “help wanted” advertising shows the current demand for labor. If the number of advertisements is increasing, this would show that employers plan future production and the economy is doing well which could eventually lead to inflationary wage pressures. If it is decreasing, it shows that future production will be slowing. Thus it is a leading indicator, though is not included as one of the 10 leading economic indicators reported monthly.

Question 56

An increasing Consumer Confidence Index indicates that:

A. consumers are confident in the overall economy and future spending is likely to increase
B. consumers are not confident in the current overall economy but future spending is likely to fall
C. consumers are likely to curtail spending on credit
D. consumers plan on saving more money

Answer 56

The best answer is A.

An increasing index indicates that consumers are “confident,” and thus are likely to spend money(not save more) - resulting in increased future output. Confident consumers would also be more likely to incur debt. Conversely, if the index is falling, then consumer confidence is low and future spending will be reduced.

Question 57

Decreasing inventory levels are an indication of all of the following EXCEPT:

A. consumer demand is increasing
B. economic expansion is occurring
C. consumer demand is high
D. economic conditions are deteriorating

Answer 57

The best answer is D.

If inventories are decreasing, this is a sign that demand is increasing (inventory levels are low because people are buying), and therefore, economic conditions are good.

Question 58

Increasing inventory levels are an indication that:

A. consumer demand is increasing
B. economic conditions are deteriorating
C. economic expansion is occurring
D. central bank intervention is occurrin

Answer 58

The best answer is B.

If inventories are increasing, this is a sign that demand is falling off, and therefore, economic conditions are deteriorating.

Question 59

If factory inventory levels are increasing, which statement is TRUE?

A. Economic conditions are improving and consumer demand is increasing
B. Economic conditions are improving and consumer demand is decreasing
C. Economic conditions are deteriorating and consumer demand is increasing
D. Economic conditions are deteriorating and consumer demand is decreasing

Answer 59

The best answer is D.

If inventory levels are increasing, this is a sign that demand is falling off (more inventory is still on the shelves, not being sold), and therefore, economic conditions are deteriorating.