Unit 6
A recession is defined as a drop in GDP for: A) four consecutive quarters. B) two consecutive quarters. C) three consecutive quarters. D) six consecutive quarters.
B) two consecutive quarters. A recession is a drop in GDP for two consecutive quarters.
The research department of an investment advisory firm forecasts that the current business cycle should reach its peak within the next 2 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) Cyclical stocks C) Aggressive growth stocks D) Defensive stocks
D) Defensive stocks Explanation The concept of sector rotation involves moving assets from those sectors that are close to their peak and moving into those who will benefit from the next move in the business cycle. Defensive stocks such as those in the food, pharmaceuticals, and public utilities would most likely be suitable for investors who believe the cycle is near its peak. Defensive stocks are least likely to be affected by a reversal in the business cycle.
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
A) Fiscal policy The primary components of a government's fiscal policy are taxes and expenses.
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) Expansion to peak C) Contraction to trough D) Recovery to trough
B) 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.
In comparing the change in the GDP from one year to another, to arrive at an accurate figure, each year's GDP should be converted to which of the following? A) Dollars valued by exchange with foreign currencies B) Dollars in terms of gold bullion C) Constant dollars D) International dollars
C) Constant dollars The GDP must be adjusted for inflation to get an accurate comparison from one year to the next.
Which of the following is a coincident economic indicator? A) Agricultural employment B) Machine tool orders C) Stock market prices as measured by the S&P 500 D) Industrial production
D) Industrial production Explanation Industrial production is a coincident indicator. The stock indexes and manufacturing orders are leading indicators. Economists do not use agricultural employment as an indicator.
When a bank's reserve account is running low, it might choose to borrow from the Fed. When doing so, the bank will be charged A) the call loan rate. B) the federal funds rate. C) the prime rate. D) the discount rate.
D) the discount rate. Explanation When a bank borrows from the Federal Reserve, it does so at the discount rate. When borrowing from another bank, it is at the federal funds rate. The prime rate is charged by the banks to their stronger borrowers, and the call loan rate is what broker-dealers pay on stock market collateral pledged for margin accounts.
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) Expansion B) Contraction C) Trough D) Deflation
B) Contraction The contraction phase is characterized by business sales falling, unemployment increasing, and the gross domestic product (GDP) growth falling.
Which of these is a definition of inflation? A) An increase in the value of the dollar B) A decrease in the value of the monetary unit C) An increase in purchasing power D) A decrease in consumer demand
B) 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.
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 A's imports from 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 exports to Country B will decrease.
B) 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.
Which of the following statements about the federal government's fiscal policy are true? I. The federal government's fiscal policy is its policy for managing taxation, spending, and debts. II. The federal government's fiscal policy can have a great impact on the securities markets. III. The federal government finances its deficit spending by selling bonds. A) II and III B) I, II, and III C) I and II D) I and III
B) I, II, and III 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.
If the yield curve is positive (sloping upward), this means that long-term interest rates are A) expected to decline. B) higher than short-term rates. C) lower than short-term rates. D) the same as short-term rates.
B) higher than short-term rates. A yield curve shows the relationship between short-term and long-term interest rates. When the yield curve is positive, it slopes upward. This means that long-term interest rates are higher than short-term rates.
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) real estate B) common stock C) U.S. Treasury bonds D) commodities
C) U.S. Treasury bonds The combination of recession and deflation leads us to a security with the highest safety. The other 3 choices tend to rise with inflation and, therefore, are often thought of as inflation hedges. But, deflation is the opposite and you'd want to be in fixed investments because their purchasing power will increase.
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) Agricultural employment D) Industrial production
D) Industrial production Explanation Industrial production is a coincident indicator. The stock indexes and manufacturing orders are leading indicators. Economists do not use agricultural employment as an indicator.
Which school of economists encourages a government to spend money to move the economy into an expansionary phase? A) Classical B) Monetarist C) Supply side D) Keynesian
D) Keynesian Explanation Keynesians advocate government intervention in the workings of the economy through increased government spending, which in turn increases aggregate demand.
Gross domestic product (GDP) is increasing. Real interest rates are relatively high. Consumer sentiment is strong, as are auto and retail sales. Labor productivity is declining. What state of the business cycle is the economy likely experiencing? A) Expansion to peak B) Trough to recovery C) Peak to contraction D) Recovery to expansion
A) Expansion to peak When the economy is moving from expansion to peak, labor productivity starts to decline and interest rates are at a level where the Federal Reserve Board usually starts to contract or slow economic activity.
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 positive yield curve B) a normal yield curve C) a flat yield curve D) an inverted yield curve
C) a flat yield curve If you were to plot this curve, what would it look like? It would be a flat line because, regardless of the maturities, all of the yields are the same. In an inverted (or negative) yield curve, the short end of the curve has higher yields than the long end. A normal (or positive) yield curve slopes upwards, with lower yields at the short end and higher yields at the long end.
With respect to the fiscal policy of the United States, the annual budget request is submitted by the A) Federal Reserve Board B) Internal Revenue Service C) president D) Congress
C) president The president of the United States is responsible for submitting the country's annual budget request to Congress for their approval and ultimately sent back to the president for signature.
When the value of the U.S. dollar decreases, A) domestic manufactures will likely not be affected B) foreign manufacturers will likely export more to the United States C) domestic manufacturers will likely increase their imports D) domestic manufacturers will likely increase their exports
D) domestic manufacturers will likely increase their exports Explanation When the U.S. dollar decreases against other currencies, foreign goods become more expensive. On the other hand, domestically produced goods are cheaper for those buying with foreign currencies so we can expect the exporting of U.S. made goods to increase.
Which of the following is a component of U.S. fiscal policy? A) Money supply B) Discount rate C) Reserve requirements D) Taxes and budgeting
D) Taxes and budgeting Explanation U.S. fiscal policy is determined by the president and Congress through budgeting and taxation. The other choices are monetary policies employed by the Fed.
To stimulate a sluggish economy using fiscal policy measures, policymakers would A) reduce income taxes B) increase income taxes C) reduce the money supply D) increase the money supply
A) reduce income taxes Reducing income taxes is a fiscal policy tool intended to increase overall demand for goods and services. Think about it. If income taxes were reduced, you'd have more money in your pocket to spend. Adjusting the money supply is a monetary policy tool.
Which of the following statements describes the federal funds rate? A) Charge on loans to brokers on stock exchange collateral B) Rate charged on reserves traded among commercial banks for overnight use in amounts of $1 million or more C) Base rate on corporate loans at large U.S. money center commercial banks D) Charge on loans to depositary institutions by the New York FRB
B) Rate charged on reserves traded among commercial banks for overnight use in amounts of $1 million or more The federal funds rate represents the interest charged on reserves, traded among commercial banks for overnight use, in amounts of $1 million or more.
When investors tend to increase their investments in debt securities on the short end of the spectrum, it generally leads to A) an inverted yield curve B) short-term yields that exceed long-term yields C) a positive yield curve D) a flat yield curve
C) a positive yield curve Investors buying short-term debt rather than long-term debt will have the effect of driving the prices of short-term instruments up and, as a result, their yields down. This will produce a normal, or positive, yield. It is when the demand for bonds on the long end of the spectrum exceed demand for those in the near term that short-term yields exceed those of long-term yields. This creates an inverted or negative yield curve.
While listening to a commentator on cable TV, you hear the statement, "The flight to quality has ended." What would you expect the effect of this to be? A) Airline stocks are in for a beating. B) Pessimism is spreading. C) Yield spreads are narrowing. D) Yield spreads are widening.
C) Yield spreads are narrowing. The term yield spread refers to the difference in yield between very-high-quality debt instruments, such as U.S. government bonds, and those with lower ratings. The spread compensates for the additional risk. When investors perceive that the risk has lessened, they won't demand as much in return from the lower-rated instruments.
Proponents of the concept of inflation inertia believe that A) prices will rise rapidly and then begin to contract B) the rate of inflation will parallel the CPI C) prices will rise slowly and then begin to increase at a faster rate D) prices will remain the same for a protracted period of time
C) prices will rise slowly and then begin to increase at a faster rate The concept of inflation inertia is that prices will rise slowly during an initial period of inflation and then begin to "pick up steam" as a result of some economic shock.
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) Tobacco industry C) Pharmaceutical industry D) Automotive industry
D) Automotive industry Explanation 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) Manufacturers' new orders for consumer goods C) Nonagricultural employment D) Building permits (housing starts)
A) 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.
All of the following are tools that may be employed by the Federal Reserve in an effort to control the economy except A) the reserve requirements B) the prime rate C) the discount rate D) open market operations buying and selling Treasury securities
B) the prime rate The prime rate is set by money center commercial banks. All of the others are under the control of the Fed.
An investor using yield curve analysis would expect to view bonds of A) varying quality of similar maturities B) similar quality over varying maturities C) varying quality over a number of maturities D) a single issuer over varying maturities
D) a single issuer over varying maturities Explanation 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.
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) similar quality over varying maturities. C) varying quality over a number of maturities. D) a single issuer over varying maturities.
D) a single issuer over varying maturities. Explanation 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.
Increases in which of the following indicators are regarded as predictors of the level of business activity? A) Building permits B) Levels of inventories C) Corporate profits D) Personal incomes
A) 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.
A bond analyst notices that the yield spread between corporate bonds and government bonds is widening. This is typically predictive of A) increased concern over the national debt. B) an expanding economy. C) increasing interest rates. D) an economic slowdown.
D) an economic slowdown. Explanation 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.
A business reporter claims that we are suffering from inertial inflation. This means A) the economy is about to enter a deflationary period. B) the business cycle is heading toward a trough. C) prices are increasing at a steady rate. D) the current rate of inflation will remain at this level until economic shocks cause it to change.
D) the current rate of inflation will remain at this level until economic shocks cause it to change. Explanation 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.
In the investment industry, the term spread has many different meanings. When used in a discussion about bonds, which of the following would be most appropriate? A) Credit spread B) Debit spread C) Calendar spread D) Inverse spread
A) Credit spread A credit spread refers to the difference between yields of bonds with similar maturities but different ratings. For example, a bond analyst might compare the yield of a 10-year Treasury note with a AAA rated bond with 10 years to maturity. Wider spreads generally indicate a concern about the economy (investors are seeking the safety of the Treasury issue), while narrow spreads generally indicate economic optimism. Debit spread and calendar spread refer to options (as does credit spread, but our question asks about bonds). Bond prices and interest rates have an inverse relationship, but that isn't called an inverse spread.
A decrease in the value of the monetary unit is just a way of defining A) inflation B) deflation C) a decrease in consumer demand D) a likely decrease in exports
A) inflation What causes the value of the money unit (in the United States it is the dollar) to decrease? Inflation—it takes more dollars to pay for goods and services. This is usually caused by an increase in consumer demand. If the value of the currency declines, exports generally rise because domestically produced goods are less expensive to those using foreign currency.
To determine the amount of change in the GDP from one year to another, both years' GDP should be converted into A) the current dollar price of gold bullion. B) international depositary receipts. C) the exchange value of the dollar, as compared with major foreign currencies. D) constant dollars.
D) constant dollars. Explanation To compare GDP from one year to another, and thus to compare the amount of actual economic activity, economists use constant dollars to eliminate distortions caused by inflation.
