Series 65 Unit 6 Exam: Key Economics Terms & Definitions

All of the following are tools that may be employed by the Federal Reserve in an effort to control the economy except

A. open market operations buying and selling Treasury securities.

B. the reserve requirements.

C. the prime rate.

D. the discount rate.

The primate rate

A fixed-income investor notices that the short, intermediate, and long ends of the yield curve reflect a similar return. This would be typical of

A. a flat yield curve.

B. an inverted yield curve.

C. a normal yield curve.

D. a positive yield curve.

A flat yield curve

A recession is defined as a drop in GDP for

A. four consecutive quarters.

B. three consecutive quarters.

C. six consecutive quarters.

D. two consecutive quarters.

2 consecutive quarters

An investor using yield curve analysis would expect to view bonds of

A. similar quality over varying maturities.

B. varying quality over a number of maturities.

C. varying quality of similar maturities.

D. a single issuer over varying maturities.

A single issuer over varying maturities

Proponents of the concept of inflation inertia believe that

A. prices will rise slowly and then begin to increase at a faster rate.

B. the rate of inflation will parallel the Consumer Price Index.

C. prices will remain the same for a protracted period of time.

D. prices will rise rapidly and then begin to contract.

Prices will rise slowly and then begin to increase at a faster rate

Some prominent stock market pundits are predicting that the economy will slide into a recession in the near future. Furthermore, they are expecting moderate deflation during the same period. If this were to happen, your clients would probably enjoy the greatest overall return from investing in

A. U.S. Treasury bonds.

B. common stock.

C. real estate.

D. commodities.

U.S. Treasury bonds

When investors tend to increase their investments in debt securities on the short end of the spectrum, it generally leads to

A. short-term yields that exceed long-term yields.

B. a flat yield curve.

C. a positive yield curve.

D. an inverted yield curve.

A positive yield curve

When the value of the U.S. dollar decreases,

A. foreign manufacturers will likely export more to the United States.

B. domestic manufacturers will likely increase their exports.

C. domestic manufactures will likely not be affected.

D. domestic manufacturers will likely increase their imports.

Domestic manufacturers will likely increase their exports

A decrease in the value of the monetary unit is just a way of defining

A. a likely decrease in exports.

B. a decrease in consumer demand.

C. inflation.

D. deflation.

Inflation

The research department of an investment advisory firm forecasts that the current business cycle should reach its peak within the next two months. Under such circumstances, which of the following portfolio adjustments would be most suitable for the firm's customers who actively invest in common stocks?

A. Corporate bonds

B. Aggressive growth stocks

C. Cyclical stocks

D. Defensive stocks

Defensive stocks

To stimulate a sluggish economy using fiscal policy measures, policymakers would

A. reduce the money supply.

B. increase the money supply.

C. increase income taxes.

D. reduce income taxes.

Reduce income taxes

With respect to the fiscal policy of the United States, the annual budget request is submitted by the

A. Internal Revenue Service.

B. Congress.

C. president.

D. Federal Reserve Board.

President

Which of the statements below best describes why a normal yield curve is positively sloped?

A. Stocks generally have lower yields than bonds, although their total returns may be higher.

B. Short-term bonds generally fluctuate in price more than long-term bonds.

C. Investors demand higher interest when lending their money for longer periods.

D. Investors logically demand higher returns from government securities than they do from corporate securities.

Investors demand higher interest when lending their money for longer periods

When the yield curve is positively sloped (and thus normal), long-term bonds carry higher interest rates than short-term bonds of the same quality.

A free trade agreement is entered into between Country A and Country B. As time goes on, the value of Country A's currency decreases while that of Country B increases. The effect of this will likely be that

A. Country B's imports from Country A will increase.

B. the free trade agreement will be abrogated.

C. Country A's exports to Country B will decrease.

D. Country A's imports from Country B will increase.

Country B's imports from Country A will increase

As a country's currency decreases in value, its exports become less expensive, so they will rise. On the other hand, with a weaker currency, the country's citizens will have less buying power, and this will cause imports to decrease.

A bond analyst notices that the yield spread between corporate bonds and government bonds is widening. This is typically predictive of

A. an economic slowdown.

B. an expanding economy.

C. increasing interest rates.

D. increased concern over the national debt.

An economic slowdown

A widening yield spread shows that the difference in yield between corporate bonds and U.S. Treasury bonds is increasing. This is usually caused by a flight to quality, the pattern of investors moving their investments to the safety of Treasury securities. This is commonly felt to be a prediction of a future recession or economic slowdown. During a slowdown, interest rates generally decline.

The final step in the approval process of the annual operating budget for the United States is

A. a majority vote of the cabinet.

B. the signature of the Speaker of the House.

C. the signature of the president.

D. the signature of the secretary of the Treasury.

The signature of the president

The president submits a proposed budget to Congress. Once Congress comes up with an approved version, it is sent to the president. Once signed by the president, we have an approved budget.

The business cycle has expanded, peaked, and contracted. The current economic activity could best be described as a trough. Which of the following would most likely be found in the trough?

1. A high rate of inflation

2. A low rate of inflation

3. A high rate of unemployment

4. A low rate of unemployment

A low rate of inflation and a high rate of unemployment

A trough is the latter stage of a recession. Unemployment is higher than normal, and with a lesser demand for goods and services, the inflation rate is low.

If an economist were to describe defensive issues, he would probably not include companies that produce

A. clothing.

B. building materials.

C. tobacco products.

D. food products.

Building materials

Defensive issues are issues that are defensive against a downturn in the economy. Building materials are usually susceptible to downturns when the economy is bad.

Which term refers to the taxation, expenditures, and debt management of the federal government?

A. Fiscal policy

B. Monetary policy

C. Open-market operations

D. Revenue code procedures

Fiscal policy

The primary components of a government's fiscal policy are taxes and expenses.

If the dollar weakens, which of the following statements is true?

A. U.S. exports will fall.

B. A rise in U.S. interest rates might strengthen the dollar.

C. Foreign securities denominated in their domestic currency decrease in value to the U.S. investor.

D. The dollar buys more foreign currency.

A rise in U.S. interest rates might strengthen the dollar

If U.S. interest rates rise, foreign investors would invest in U.S. dollar-denominated securities, thereby increasing the demand for dollars and causing the dollar to strengthen.

Which of the following would lead to a debit to our foreign account balance?

A. Foreign governments repaying loans to U.S. banks

B. Residents of other countries buying apartments here

C. U.S. residents taking vacations abroad

D. An increase in exports

U.S. residents taking vacations abroad

When our foreign account balance is debited, that creates a negative action. It is like a charge on your credit card—your account is debited. On the other hand, a credit to your card account is money coming to you. Our foreign-accounts balance will be debited whenever our money goes out rather than coming in. When U.S. residents take vacations abroad, our money is being spent on hotels, restaurants, and other items in foreign countries. The other choices represent a credit to our foreign account balance. When exports increase, more foreign money comes in. When foreigners buy property here, we get their money, and when loans are repaid here, once again, foreign money comes into the United States.

The Conference Board releases information about the economy on a monthly basis. Included are a number of different indicators. Economic indicators can be leading, lagging, or coincidental, which indicates the timing of their changes relative to how the economy as a whole changes. Which of the following is a lagging economic indicator?

A. Manufacturers' new orders for consumer goods

B. Prime interest rate

C. Nonagricultural employment

D. Building permits (housing starts)

Prime interest rate

The prime interest rate is a lagging indicator. Nonagricultural employment is a coincident indicator. The other two choices are leading indicators.

Which of the following is most likely to be regarded as a defensive stock?

A. A stock selling at an extremely high PE ratio

B. A food company stock

C. A stock with a strong cash position and little debt

D. An aerospace stock

A food company stock

A defensive stock maintains future earnings that are likely to withstand an economic downturn. Typical examples are stocks of those firms that supply basic consumer necessities such as foodstuffs. A stock selling at an extremely high PE ratio is indicative of a speculative company or one that can decline in value rapidly.

During an economic downturn, one would expect to see

A. a rising CPI.

B. bond prices fall.

C. manufacturers' inventories to decline.

D. higher unemployment.

Higher unemployment

When the economy enters the contraction portion of the business cycle, employers cut costs by letting employees go, thus increasing the number of unemployed persons. With less money in the economy, the CPI will generally remain level or even decline. Manufacturing sales will slow, so their inventories will rise as it takes longer to move product, and we can expect a reduction in interest rates, which will cause bond prices to rise.

The economy has gone through three consecutive quarters of economic decline with no immediate end in sight; therefore, it could be said to be

A. in a recovery.

B. in a recession.

C. in a depression.

D. lagging.

In a recession

Recession is defined as two or more consecutive quarters of economic decline. It would have to be at least six quarters to be considered a depression.

Which of the following industries would be least cyclical?

A. Heavy equipment

B. Leisure products

C. Supermarket chain

D. Automobile manufacturing

Supermarket chain

Industrial activity usually follows business cycles, which have more impact on some industries than others. The food industry is one for which the demand is not generally based on economic conditions.

In the secondary market, U.S. Treasury bond prices are most influenced by

A. the Treasury Department.

B. the primary dealers.

C. the inflation rate.

D. the prime rate.

The inflation rate

There are two major influences on the price of bonds in the secondary market. One of those is the amount of credit risk (chances that the issuer won't be able to pay the interest and/or principal). That is not considered a risk with U.S. Treasury securities. The other, and generally stronger, influence is the inflation rate. Inflation eats away at the fixed income and principal of bonds. To compensate, the bonds must offer a higher return. That is either in the form of a new bond carrying a higher coupon rate or, as this question refers to, trading in the secondary market at a lower price. Remember the inverse relationship between interest rates and bond prices. Interest rates follow the inflation rate, so when inflation rises, so must the yield on bonds. The yield on outstanding bonds increases as the market price decreases.

Among the responsibilities of the Federal Reserve (the Fed) is influencing the supply of money and credit in the economy. When performing this function, adjusting which of the following is not a tool at its disposal?

A. The activities of the Federal Open Market Committee

B. The discount rate

C. The prime rate

D. The reserve requirements

The prime rate

The prime rate is set by the banks. All of the others are under the control of the Fed.

When analyzing the business cycle, you would expect which phase to occur before reaching the trough?

A. Peak

B. Recovery

C. Contraction

D. Expansion

Contraction

Before reaching the bottom (the trough), the business cycle is in the contraction phase.

If a country's current account shows a trade deficit, it is most likely that

A. imports are greater than exports.

B. tax payments are greater than tax receipts.

C. net exports are greater than zero.

D. short-term flows are greater than long-term flows.

Imports are greater than exports

A trade deficit occurs when imports are greater than exports.

The contraction phase of the business cycle is least likely accompanied by

A. decreasing inflation pressure.

B. low or negative economic growth.

C. decreasing business and consumer expenditures.

D. decreasing unemployment.

Decreasing unemployment

An economic contraction is likely to feature increasing unemployment (i.e., decreasing employment), along with declining economic output and decreasing inflationary pressure. Watch out for the double negatives.

Which of the following statements best describes what will happen when the value of the American dollar rises in relation to foreign currencies?

A. Shares of foreign stock will be worth more in terms of American dollars.

B. Foreign goods and services will become more expensive for Americans.

C. The risk of stagflation will increase.

D. Foreign goods and services will become less expensive for Americans.

Foreign goods and services will become less expensive for Americans

When the value of the dollar rises, it will buy more foreign money, making foreign goods and services less expensive for Americans. Because foreign securities are valued in foreign currencies, shares of foreign stock will be worth fewer American dollars when the value of the dollar increases.

Which of the following statements reflects the monetarist economic position?

A. The amount of money in the economy determines the overall price level over time; therefore, the Federal Reserve should control the growth of the amount of money in the economy in a gradual and predictable way.

B. The amount of money in the economy is not significant because economic activity reflects the value of real goods and services; therefore, the Federal Reserve should not attempt to manage the money supply.

C. The total amount of money in the economy is the result of the level of interest rates.

D. The best way to control the money supply is to raise taxes, which will reduce the amount of money in the economy and lower prices.

The amount of money in the economy determines the overall price level over time; therefore, the Federal Reserve should control the growth of the amount of money in the economy in a gradual and predictable way

Monetarists believe that the economy and inflation are best controlled through the management of the money supply rather than through fiscal policy stimulation.

Expansions in the business cycle are characterized by

A. an increase in want ads in newspapers and a decrease in nonfarm jobs.

B. increasing college enrollments and enlistment in military service.

C. higher consumer debt and rising inventories.

D. increasing consumer demand for goods and services, increasing industrial production, and rising stock markets and property values.

Increasing consumer demand for goods and services, increasing industrial production, and rising stock markets and property values

Expansions in the business cycle are characterized by increasing consumer demand for goods and services, increasing industrial production, and rising stock markets and property values. Simply stated, business activity is expanding.

A bond analyst reports that there is currently an inverted yield curve. That would mean

A. the closer the bond is to its maturity date, the higher the yield.

B. the closer the bond is to its maturity date, the lower the yield.

C. the further the bond is from its maturity date, the higher the yield.

D. bonds with intermediate maturities have the highest yields.

The closer the bond is to its maturity date, the higher the yield

An inverted yield curve shows near-term maturities with higher yields than those of long-term maturities. Sometimes called a negative yield curve, it is usually an indication that interest rates are near a peak and the trend should soon reverse.

An upward-sloping yield curve represents all of the following except

A. increased risk of default over time.

B. foreign interest rate differentials.

C. inflation expectations.

D. time value of money.

Foreign interest rate differentials

Foreign interest rate differentials are not reflected in an upward-sloping yield curve. Interest rate differentials between countries reflect differences in domestic monetary and fiscal conditions. The time value of money is reflected in the upward-sloping yield curve. Longer-term rates require higher rates to compensate for loss of current buying power and liquidity. Longer-term funds bear a higher risk of default than do shorter-term funds and, as a result, command higher rates. Increasing inflation expectations cause the yield curve to slope upward to compensate lenders for the loss of future buying power. This is an example of how you get a question correct by process of elimination.

Which of the following statements regarding the economics of fixed-income securities are true?

1. Short-term interest rates are more volatile than long-term rates.

2. Long-term interest rates are more volatile than short-term rates.

3. Short-term bond prices react more than long-term bond prices given a change in interest rates.

4. Long-term bond prices react more than short-term bond prices given a change in interest rates.

Short-term interest rates are more volatile than long-term rates and long-term bond prices react more than short-term bond prices given a change in interest rates

There are two separate issues in this question: the volatility of rates and the volatility of bond prices. Short-term rates are more volatile than long-term rates and move more quickly than long-term rates. Often the most volatile interest rate is the federal funds rate, which is an overnight rate of interest. Given a change in rates, long-term bond prices move more than short-term bond prices because of the compounding effect over a much longer period.

If the value of the U.S. dollar were to increase with respect to other currencies, it would do which of these?

1. Make U.S. exports, like heavy equipment, more competitive in foreign markets

2. Make U.S. exports, like heavy equipment, less competitive in foreign markets

3. Make foreign imports into the United States, such as cars, less competitive in U.S. markets

4. Make foreign imports into the United States, such as cars, more competitive in U.S. markets

Make U.S. exports, like heavy equipment, less competitive in foreign markets and make foreign imports into the United States, such as cars, more competitive in U.S. markets

When the value of the U.S. dollar rises in relation to other currencies, exported products become more expensive in those foreign markets and are less competitive. On the other hand, imported products become less expensive in U.S. markets and are more competitive.

A frequently used metric by analysts is the yield, or credit, spread. Common methods of computing this would be comparing which of these?

1. Bonds of similar quality and similar maturities

2. Bonds of similar quality and different maturities

3. Bonds of different quality and different maturities

4. Bonds of different quality and similar maturities

Bonds of similar quality and different maturities & bonds of different quality and similar maturities

The term spread always signifies a difference. Therefore, the correct choices have to reflect some kind of difference. One way is when the quality (rating) of the bonds is the same but the length to maturity is different. A very common example of this is the U.S. 2-year Treasury note plotted against the 10-year Treasury note. The other method is to take bonds of different quality (ratings) having the same maturities. An example might be comparing two bonds with a 20-year maturity: one has a AAA rating and the other a BBB rating.

If disposable personal income has fallen steadily over the past year, which of the following is most likely going to be affected?

A. Firms that produce nondurable consumer goods

B. Pharmaceutical industry

C. Tobacco industry

D. Automotive industry

Automotive industry

The automobile industry is cyclical and, of the choices, the most likely to be affected by a change in the business cycle as indicated by declining personal income. The tobacco industry and producers of nondurable consumer goods (e.g., toilet paper and basic clothing) are considered defensive industries: those where the demand is relatively constant, regardless of economic conditions. The defensive industry relies on government spending and is affected by conditions not related to our personal incomes. Even when your income falls, you still need to buy your medications, tobacco products (if you are a smoker), and nondurable consumer goods like food and clothing.

The Conference Board releases information about the economy on a monthly basis. Included are a number of different indicators. Economic indicators can be leading, lagging, or coincidental, which indicates the timing of their changes relative to how the economy as a whole changes. Which of the following is a lagging economic indicator?

A. Average prime rate

B. Building permits (housing starts)

C. Nonagricultural employment

D. Manufacturers' new orders for consumer goods

Average prime rate

Both the S&P 500 and housing permits are leading economic indicators, as is the measure of hours worked because it reflects changes in the average workweek during the current period. The average prime rate is a lagging indicator because, in an economic downturn, the longer rates stay low, the quicker the recovery should be.

Which of these is a definition of inflation?

A. A decrease in consumer demand

B. An increase in the value of the dollar

C. An increase in purchasing power

D. A decrease in the value of the monetary unit

A decrease in the value of the monetary unit

We tend to think solely in terms of our dollar, but inflation can occur worldwide and leads to a decrease in the purchasing power (or value) of the monetary unit in use in any particular jurisdiction. Inflation is commonly caused by increased consumer demand, not a decrease.

Which school of economists encourages a government to spend money to move the economy into an expansionary phase?

A. Classical

B. Supply side

C. Monetarist

D. Keynesian

Keynesian

Keynesians advocate government intervention in the workings of the economy through increased government spending, which in turn increases aggregate demand.

Which of the following statements about the federal government's fiscal policy are true?

1. The federal government's fiscal policy is its policy for managing taxation, spending, and debts.

2. The federal government's fiscal policy can have a great impact on the securities markets.

3. The federal government finances its deficit spending by selling bonds.

The federal government's fiscal policy is its policy for managing taxation, spending, and debts; the federal government's fiscal policy can have a great impact on the securities markets; & the federal government finances its deficit spending by selling bonds

The federal government's fiscal policy establishes the government's taxation, spending, and debt practices. Fiscal policy can affect the securities markets because it can be used to regulate prices, employment, and economic growth. If fiscal policy includes deficit spending, the government sells bonds to make up the deficit.

A bond analyst is plotting a yield curve and notices that short-term maturities have higher yields than intermediate and long-term maturities. This is an example of

A. an algorithmic yield curve.

B. a normal yield curve.

C. a positive yield curve.

D. an inverted yield curve.

An inverted yield curve

An inverted, or negative, yield curve is one that results when debt with short-term maturities has higher yields than those with maturities that are longer. A positive, or normal, yield curve results when the yields increase as maturities do.

Generally, an inverted yield curve is caused by

A. investors buying long-term bonds and selling short-term bonds.

B. rising interest rates.

C. declining interest rates.

D. investors buying short-term bonds and selling long-term bonds.

Investors buying long-term bonds and selling short-term bonds

First of all, what is an inverted yield curve? That is what we get when the yields on short-term debt are higher than the yields on long-term debt. Next, what happens to make the yield of a bond go up? When the price of the bond falls, the yield rises. Conversely, when the price of a bond rises, the yield falls. Finally, what causes the price of a security, any security, to go up or go down? Supply and demand in the marketplace. That is, when there are more buyers than sellers, that demand pushes the price up. Likewise, if there are more sellers than buyers, the price will go down. That's the basic economics of supply and demand.

When investor demand is for long-term bonds, the price of those bonds will rise, causing the yields to fall. And, when investors are selling short-term bonds, that selling pressure causes the price to drop and the yields to increase. That is what has happened in this question: more demand for the long-term, resulting in higher prices and lower yields, and more supply for the short-term, resulting in lower prices and higher yields.

While reviewing nationwide industrial production figures, an analyst notices that inventories have been rising. From that information, one would gather that the economy is most likely in which phase of the business cycle?

A. Expansion

B. Recovery

C. Contraction

D. Peak

Contraction

Downturns in the business cycle (a contraction) tend to be characterized by rising inventories due to a lack of consumer demand. During expansion or recovery, demand is high and goods are less likely to remain in inventory.

A common measurement used to evaluate attitudes regarding future economic conditions is the difference in yields between U.S. Treasury bonds and corporate bonds. This is known as

A. a business cycle.

B. a yield curve.

C. a yield spread.

D. the Consumer Price Index.

A yield spread

Many analysts compare the difference between yields on bonds with the same maturity but different quality (rating) to get a sense of the market sentiment. A common example of that is comparing the difference between the yield on a U.S. Treasury bond and a highly rated corporate bond. When investor sentiment is positive, the extra safety of the Treasury security is not considered as valuable, so the spread is narrow. When there is "gloom and doom" ahead, investors flock to the safety of the Treasury, causing the spread to widen. This spread is found by comparing the yield curves, but that doesn't answer the specific question, which is dealing with the difference, and a difference in this industry is called a spread.

Stock market indices have a variety of uses. Which of the following is least accurate regarding the use of stock market indices?

A. They help in portfolio performance measurement.

B. They are a lagging indicator of an economy's corporate performance.

C. They act as a market barometer.

D. They act as the basis of ETFs.

They are a lagging indicator of an economy's corporate performance

The stock market and market indices are leading indicators of the economy's corporate and financial performance.

Ana is a bond analyst who notices a wider credit spread between Treasury bonds and AAA corporate debt. From this, she would be most likely to infer

A. the economy is weakening.

B. interest rates on Treasury bonds are increasing.

C. corporate earnings are reaching record highs.

D. corporate bond prices are increasing.

The economy is weakening

The reason the spread gets wider is that investors are getting out of corporate bonds and getting into Treasuries. Why would they do that? Because, as the industry says, "It is an escape to quality." When there are economic clouds on the horizon, like a recession, you would much rather have your money invested in U.S. Treasuries because you know they will pay off. Higher corporate yields come from lower market prices.

An investor purchasing gold bullion is most likely looking for an investment that is

A. exchange traded.

B. countercyclical.

C. cyclical.

D. income producing.

Countercyclical

Countercyclical assets are those whose prices tend to move in the opposite direction of the overall economy. Historically, the price of precious metals, especially gold (and stock in gold-mining companies), moves up when the economy enters the contraction phase and moves in the reverse direction during expansion. Cyclical stocks follow the cycle. There is no "gold bullion exchange." It is a dealer market with bullion dealers all over the world setting their own spreads. A bar of gold does not provide income.

If the Consumer Price Index (CPI) is down but consumer demand is up, the economy is likely in which stage of the business cycle?

A. Contraction to trough

B. Peak to contraction

C. Recovery to trough

D. Recovery to expansion

Recovery to expansion

As prices trend downward and consumer demand increases, the economy is moving from recovery to expansion. As demand continues to increase, assuming supply remains constant, upward pressure will be put on prices through the expansion to the peak.

If a customer purchases a food company stock and a utility stock, the customer's portfolio is

A. cyclical.

B. defensive.

C. diversified.

D. balanced.

Defensive

Food company stocks and utilities are defensive investments. Defensive investments are those that tend to hold up well in economic downturns

Economists have determined that the economy is slowing down. Orders for durable goods have been declining and unemployment, while not a reason for concern, has been steadily increasing over the past year. Given the information provided, what phase of the business cycle is the economy currently experiencing?

A. Contraction

B. Deflation

C. Expansion

D. Trough

Contraction

The contraction phase is characterized by business sales falling, unemployment increasing, and the gross domestic product (GDP) growth falling.

Interest rates are declining. An analyst would be most likely to state that the business cycle is in which stage?

A. Expansion

B. Peak

C. Contraction

D. Trough

Contraction

It is during periods of economic contraction that interest rates tend to decline. They tend to rise during expansions.

Which of the following is a coincident economic indicator?

A. Machine tool orders

B. Stock market prices as measured by the S&P 500

C. Industrial production

D. Agricultural employment

Industrial production

Industrial production is a coincident indicator. The stock indexes and manufacturing orders are leading indicators. Economists do not use agricultural employment as an indicator.

During an economic recession, which of the following items will most likely increase?

A. Consumer confidence and profits

B. Inflation

C. Interest rates

D. Bond prices

Bond prices

During a recessionary period, inflation and interest rates generally decline. This causes bond prices to increase because they are inversely related to the change in interest rates. Consumer confidence and profits are declining at this point in the economic cycle.

A business reporter claims that we are suffering from inertial inflation. This means

A. the current rate of inflation will remain at this level until economic shocks cause it to change.

B. the economy is about to enter a deflationary period.

C. prices are increasing at a steady rate.

D. the business cycle is heading toward a trough.

The current rate of inflation will remain at this level until economic shocks cause it to change

Inertial inflation means that there is not expected to be a change in the inflation rate until some kind of economic event shakes things up and causes the rate to move up or down.

A securities analyst's stock selection method is to begin by looking for superior companies, regardless of their industry sector or the condition of the overall economy. In so doing, this analyst is using

A. the optimal portfolio approach.

B. the business cycle approach.

C. the top-down approach.

D. the bottom-up approach.

The bottom-up approach

This is the basic approach of bottom-up analysis. Rather than focusing the attention on the overall market (the macro view of the economy) or the sectors that are likely to outperform, this approach seeks to identify—usually based on the company's fundamentals—the most attractive individual stocks.

A free trade agreement is entered into between Country A and Country B. As time goes on, the value of Country A's currency increases while that of Country B's decreases. The effect of this will likely be that

A. Country A's exports to Country B will increase.

B. Country B's imports from Country A will increase.

C. the free trade agreement will be abrogated.

D. Country A's imports from Country B will increase.

Country A's imports from Country B will increase

As a country's currency increases in value, its exports become more expensive, so they will fall. On the other hand, with a stronger currency, the country's citizens will have a greater buying power, and this will cause imports to increase.

What generally happens to outstanding fixed-income securities when the rate of inflation slows?

A. Coupon rates go up.

B. Short-term securities are affected the most.

C. Prices go up.

D. Yields go up.

Prices go up

When the rate of inflation slows and is expected to remain stable, coupons on new issue bonds will often decline to offer lower yields. The prices of outstanding bonds will go up to adjust to the lower yields on bonds of similar quality.

If the value of the U.S. dollar increases against other currencies, which of the following are true?

1. U.S. exports are more competitive in foreign countries.

2. U.S. exports are less competitive in foreign countries.

3. Foreign imports into the United States are more competitive in U.S. markets.

4. Foreign imports into the United States are less competitive in U.S. markets.

U.S. exports are less competitive in foreign countries and foreign imports into the United States are more competitive in U.S. markets

If the value of the U.S. dollar increases against other currencies, then U.S. exports cost more for foreign markets to purchase. This also makes foreign imports less expensive for U.S. consumers.

If the U.S. dollar is devalued relative to other world currencies, which of the following will occur with respect to the prices of goods?

1. U.S. exports will be more price competitive overseas.

2. U.S. exports will be less price competitive overseas.

3. Foreign imported goods will be more price competitive with ours.

4. Foreign imported goods will be less price competitive with ours.

U.S. exports will be more price competitive overseas and foreign imported goods will be less price competitive with ours

If the dollar goes down in relation to foreign currencies, then foreigners can buy more U.S. goods with the same amount of their currency, making U.S. goods more competitive in foreign markets. This same movement in the dollar means it takes more dollars to buy the same amount of foreign goods in domestic markets, making foreign goods less competitive with U.S. goods.

If the Consumer Price Index (CPI) is up and consumer demand is also up, the economy is likely in which stage of the business cycle?

A. Peak to contraction

B. Contraction to trough

C. Expansion to peak

D. Recovery to trough

Expansion to peak

As prices trend higher and consumer demand increases, the economy is moving from expansion to a peak. As demand continues to increase, assuming supply remains constant, upward pressure will be put on prices through the expansion to the peak.

A significant increase in the importing of goods into the United States would likely have what effect on the strength of the U.S. dollar?

A. No effect

B. Fluctuation both ways

C. Strengthen

D. Weaken

Weaken

Currency rates tend to ebb and flow as the balance of payments shift from positive to negative. A significant increase in imports represents a large outflow of U.S. dollars, which results in a negative trade balance. As this builds, the value of the dollar falls against those currencies that have a positive trade balance.

All the pundits are predicting bad times ahead—not only a recession but a period where prices actually fall (deflation). If they are right, the best place for your client would probably be

A. real estate.

B. U.S. Treasury securities.

C. gold.

D. common stock.

U.S. Treasury securities

It is times like this that the flight to safety has investors commit their funds to U.S. government securities. Gold (and other commodities) tends to increase in price during inflationary, not deflationary, periods. Both real estate and equities tend to rise when things are good, not during recessions.

Under the concept of inertial inflation,

A. prices tend to increase at a steady rate until the system receives an economic shock.

B. inflation and deflation alternate at regular intervals.

C. prices tend to remain the same until the system receives an economic shock.

D. core inflation is a better measure of the actual inflation rate than the CPI.

Prices tend to increase at a steady rate until the system receives an economic shock

Inertial inflation is an economic condition where the rate of price increases reaches a stable equilibrium and stays there until a shock to the system occurs, at which time, the rate of inflation changes. It is true that most economists view the core inflation rate as a more accurate measure of true inflation than the CPI, but that has nothing to do with inertial inflation.

The economic theory that says economic growth results from lower tax rates and reduced government regulation is

A. monetary theory.

B. supply-side theory.

C. demand-side theory.

D. Keynesian theory.

Supply-side theory

Supply-side economics is the theory of Arthur Laffer, who believed that heavy taxing and government intervention have a negative effect on the economy.

A research analyst studying the performance of ABC Industries compares that with reports from other analysts reviewing other companies in other industries. This is known as

A. sector analysis.

B. bottom-up analysis.

C. fundamental analysis.

D. top-down analysis.

Bottom-up analysis

Bottom-up analysis starts by attempting to find superior performing companies, regardless of the industry. Those analysts believe that these companies will provide attractive returns even if they are in an industry sector that is in a negative position in the economic cycle.

Your client calls you after reading a story in the business section of his local newspaper. It seems that the article focused on changes to the core CPI, and the client wants to know how that is different from the normal CPI. You should explain that it is

A. the total of the leading indicators, excluding stock prices.

B. the Consumer Price Index, excluding housing and automobiles.

C. the figure used to determine annual increases, if any, to Social Security benefits.

D. the Consumer Price Index, excluding energy and food prices.

The Consumer Price Index, excluding energy and food prices

Because of their high volatility, economists exclude energy and food prices from core inflation figures. Social Security adjustments (and many others as well) are based upon the CPI itself, not the core.

The primary function of the Federal Reserve System (the Fed) is to

A. issue bonds to the general public.

B. manage the revenues and expenditures of the federal government.

C. carry out monetary policy.

D. implement fiscal policy.

Carry out monetary policy

The Federal Reserve controls the money supply, enabling it to significantly affect interest rates. The Fed will follow a loose, or easy, monetary policy when it wants to increase the money supply to expand the levels of income and employment. In times of inflation, when it wants to constrict the money supply, the Fed will follow a tight monetary policy. The U.S. Treasury issues bonds to the general public to finance the budget deficits of the federal government.

An economic indicator that has turning points that tend to occur after the turning points in the business cycle is classified as

A. a coincident indicator.

B. a lagging indicator.

C. a leading indicator.

D. a trailing indicator.

A lagging indicator

Lagging indicators have turning points that occur after business cycle turning points. That is why they are called lagging indicators. Leading indicators are ahead of the cycle and coincident indicators parallel the cycle.

All of the following are leading indicators for economic growth except

A. average weekly initial claims for state unemployment compensation.

B. orders for durable goods.

C. stock prices as measured by the S&P 500 index.

D. average prime rate.

Average prime rate

The average prime rate is a lagging indicator. The duration of unemployment is also a lagging indicator, but the number of initial unemployment claims is a leading indicator. The S&P 500 index and orders for durable goods are leading economic indicators.

An investor regularly reads financial blogs on the internet, and they are filled with articles suggesting that the economy is headed for a slump. Some are even saying that there will be price deflation. If these projections are accurate, the best place for the investor to place funds would probably be

A. commercial real estate.

B. gold.

C. U.S. Treasury bonds.

D. common stock.

U.S. Treasury bonds

When the economy is headed downward, safety is the imperative, and nothing is as safe (at least for exam purposes) as U.S. Treasuries. Gold and most other commodities are a hedge against inflation, not deflation. In down times, real estate—both residential and commercial—usually underperforms.

The Conference Board, a nongovernmental nonprofit organization, regularly publishes a list of economic indicators. Which of the following would be included in their list of leading indicators?

A. Average weekly initial claims for unemployment insurance

B. Average duration of unemployment

C. Average prime rate

D. Manufacturing and trade sales (in constant dollars)

Average weekly initial claims for unemployment insurance

Of these, the only one that is included in the list of leading indicators is the average weekly initial claims for unemployment insurance. Manufacturing and trade sales is a coincident indicator, and average duration of unemployment and average prime rate are lagging indicators.

Yield curve analysis plays an important role as a benchmarking and forecasting tool for the future direction of interest rates. In most cases, this analysis involves examining bonds of

A. varying quality of similar maturities.

B. a single issuer over varying maturities.

C. similar quality over varying maturities.

D. varying quality over a number of maturities.

A single issuer over varying maturities

The most common yield curves are drawn using U.S. Treasury securities. The curve is plotted using maturities ranging from the short-term T-bills to the long bonds. There are other curves drawn with bonds from other sectors, such as corporate bonds, to show the yield spread, but that is going beyond the scope of this question.

Which of the following best describes the economic phase in which unemployment increases and businesses operate at their lowest capacity levels?

A. Trough

B. Peak

C. Contraction

D. Expansion

Trough

A trough in a business cycle occurs at the end of a contraction phase when businesses are operating at their lowest capacity levels.

Increases in which of the following indicators are regarded as predictors of the level of business activity?

A. Building permits

B. Corporate profits

C. Levels of inventories

D. Personal incomes

Building permits

Increases in building permits are indicative of increased future business activity and therefore are considered a leading economic indicator. Increases in personal income reflect current, not future, activity and are therefore considered a coincident indicator. Increases in inventories indicate that goods are not being sold in anticipated quantities, so they function as a disincentive to manufacturing. Buildup in inventories is a lagging economic indicator. Corporate profits are not included in the Conference Board's list of economic indicators.

An analyst uses a stock selection method that involves analyzing a specific corporation, followed by evaluating where it fits in its industry and then viewing the overall economy. The term that best describes this method is

A. capital asset pricing model.

B. efficient frontier.

C. top-down.

D. bottom-up.

Bottom-up

The bottom-up method of stock selection goes from micro to macro—that is, identifying the specific company and then working up through the overall economy. It is the opposite of top-down.