Unit 7.1 Basic Economics (Series 65)

Which of the following statements accurately describes a tight money policy? I. A tight money policy is typically implemented when there is a threat of excessive inflation. II. A tight money policy decreases the supply of money. III. A tight money policy increases a bank's ability to make loans. A) I and II. B) I and III. C) II and III. D) I, II and III.

Answer: A A tight money policy occurs when the Federal Reserve Board decreases the supply of money and credit because of threatening inflation. Decreasing the supply of money and credit decreases the ability of banks to make loans. Reference: 7.1.1.3 in the License Exam Manual.

Which school of economists encourages a government to spend money to move the economy into an expansionary phase? A) Keynesian. B) Classical. C) Supply side. D) Monetarist.

Answer: A Keynesians advocate government intervention in the workings of the economy through increased government spending, which in turn increases aggregate demand. Reference: 7.1.1.2 in the License Exam Manual.

The economy has gone through three consecutive quarters of economic decline with no immediate end in sight, and therefore could be said to be: A) in a Recession. B) in a Depression. C) in a Recovery. D) Lagging.

Answer: A 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. Reference: 7.1.2.1.1 in the License Exam Manual.

Final approval of the annual operating budget for the United States is given by the: A) Congress. B) Cabinet. C) Conference of Governors. D) President.

Answer: A The United States Congress is responsible for voting approval of the budget submitted by the President. Reference: 7.1 in the License Exam Manual.

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) Commodities. C) Real estate. D) Common stock.

Answer: A The combination of recession and deflation leads us to a security with the highest safety. The other three 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. Reference: 7.1.2.3.1 in the License Exam Manual.

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) fundamental analysis B) bottom-up analysis C) top-down analysis D) sector analysis

Answer: B 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. Reference: 7.1.2.5 in the License Exam Manual.

Keynesian economists generally believe that: A) business should be free to operate with minimal government interference. B) governments drive national economies through taxation and government spending activities. C) the Federal Reserve Board (FRB) management of the money supply should be the major influence on the domestic (U.S.) economy. D) reducing the size of the government generally stimulates a nation's economy.

Answer: B Keynesian economics, so named for the noted British economist John Maynard Keynes, maintains that governments should manage the economy by adjusting levels of taxation and government spending. Monetarist economics maintains that the economy operates best when the Federal Reserve manages the money supply, not when the government stimulates economic activity through fiscal programs. Supply side economics states that reducing government and its claims on taxpayers' income is the best way to keep a nation's economy healthy. Free-market economists believe that government interference in business should be minimal in order for the invisible hand of the market to allocate goods and services in the most efficient manner. Reference: 7.1.1.1 in the License Exam Manual.

To stimulate a sluggish economy using fiscal policy measures, policymakers would: A) reduce the money supply. B) reduce income taxes. C) increase income taxes. D) increase the money supply.

Answer: B Reducing income taxes is a fiscal policy tool intended to increase overall demand for goods and services. Adjusting the money supply is a monetary policy tool. Reference: 7.1 in the License Exam Manual.

Sector rotation would most likely be employed by an investment adviser using which of the following investment styles? A) Strategic. B) Tactical. C) Buy and hold. D) Contrarian.

Answer: B Sector rotation is the practice of moving portfolio assets from those industries that have reached their peak in the current economic cycle to those that are now on the upswing. Buy and hold, as the name implies, does not involve constant trading and strategic is a passive technique as well. Contrarian investors go opposite the trend which is not the case here. Reference: 7.1.2.1.2 in the License Exam Manual.

The economic theory that says economic growth results from lower tax rates and lower government spending is: A) demand-side theory. B) supply-side theory. C) monetary theory. D) Keynesian theory.

Answer: B Supply-side economics is the theory of Arthur Laffer, who believed that heavy taxing and government intervention have a negative effect on the economy. Reference: 7.1.1.2 in the License Exam Manual.

The four stages of a business cycle would not include: A) peak. B) stagnation. C) trough. D) expansion.

Answer: B The four stages of a business cycle are trough, expansion, peak, and contraction. Reference: 7.1.2.1 in the License Exam Manual.

Which of the following is a component of U.S. fiscal policy? A) Reserve requirements. B) Taxes and budgeting. C) Discount rate. D) Money supply.

Answer: B U.S. fiscal policy is determined by the president and Congress through budgeting and taxation. The other three choices are monetary policies employed by the Fed. Reference: 7.1 in the License Exam Manual.

A recession is defined as a drop in GDP for: A) four consecutive quarters. B) six consecutive quarters. C) two consecutive quarters. D) three consecutive quarters.

Answer: C A recession is a drop in GDP for two consecutive quarters. Reference: 7.1.2.1 in the License Exam Manual.

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) gold B) real estate C) US Treasury securities D) common stock

Answer: C It is times like this that the flight to safety has investors commit their funds to US 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. Reference: 7.1.2.3.1 in the License Exam Manual.

Which of the following statements reflects the monetarist economic position? A) The total amount of money in the economy is the result of the level of interest rates. B) 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. C) The amount of money in the economy determines the overall price level over time, therefore the Federal Reserve should control the growth in the amount of money in the economy in a gradual and predictable way. D) 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.

Answer: C Monetarists believe that the economy and inflation are best controlled through the management of the money supply rather than through fiscal policy stimulation. Reference: 7.1.1.3 in the License Exam Manual.

Which of the following statements about the Consumer Price Index (CPI) is NOT true? A) The CPI is computed monthly. B) The CPI measures the rate of increase or decrease in a broad range of prices, such as food, housing, medical care, and clothing. C) The CPI measures the increase or decrease in the level of consumer prices with respect to the level of wholesale prices on which consumer prices depend. D) The CPI measures the increase in the general price level of a basket of consumer goods.

Answer: C The CPI does not measure the increase or decrease in the level of consumer prices with respect to the level of wholesales prices. The CPI only measures retail prices; not whether wholesale prices are passed through to the consumer. Reference: 7.1.2.2 in the License Exam Manual.

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) efficient frontier. B) top-down. C) bottom-up. D) capital asset pricing model.

Answer: C The bottom-up method of stock selection goes from micro to macro-that is, identify the specific company and then work up through the overall economy. It is the opposite of top-down. Reference: 7.1.2.5 in the License Exam Manual.

Proponents of the concept of inflation inertia believe that: A) prices will remain the same for a protracted period of time. 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 rise rapidly and then begin to contract.

Answer: C The concept of inflation inertia is that prices will rise slowly during an initial period of inflation and then begin to "pick up steam". Reference: 7.1.2.2 in the License Exam Manual.

Which of the following statements about the federal government's fiscal policy is 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) I and III. B) II and III. C) I, II and III. D) I and II.

Answer: C 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. Reference: 7.1 in the License Exam Manual.

During the past two quarters, the GDP declined by 3%, unemployment rose by .7%, and the Consumer Price Index fell off by 1.3%; this economic condition is called: A) depression. B) stagflation. C) recession. D) inflation.

Answer: C Two consecutive quarters of economic decline is termed a recession. Reference: 7.1.2.1.1 in the License Exam Manual.

Which of these is a definition of inflation? A) an increase in purchasing power. B) a decrease in consumer demand. C) a decrease in the value of the monetary unit. D) an increase in the value of the dollar.

Answer: C 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. Reference: 7.1.2.2 in the License Exam Manual

he 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? I. A high rate of inflation. II. A low rate of inflation. III. A high rate of unemployment. IV. A low rate of unemployment. A) I and III. B) I and IV. C) II and IV. D) II and III.

Answer: D 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. Reference: 7.1.2.1 in the License Exam Manual.

Expansions in the business cycle are characterized by: A) higher consumer debt, rising inventories. B) increase in want ads in newspapers, decrease in nonfarm jobs. C) increasing college enrollments and enlistment in military service. D) increasing consumer demand for goods and services, increasing industrial production, and rising stock markets and property values.

Answer: D 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. Reference: 7.1.2.1.1 in the License Exam Manual.

In a deflationary period, interest rates will more than likely: A) increase. B) remain the same. C) fluctuate violently. D) decrease.

Answer: D In a deflationary period, generally defined as a period where the CPI is declining, interest rates will usually decline. Because the real rate of return is the nominal return less the CPI, the lower the CPI, the lower the nominal return needs to be to offer the same overall return on investment. Reference: 7.1.2.2.1 in the License Exam Manual.

Which of the following CORRECTLY defines the Consumer Price Index (CPI)? A) The average cost of goods and services (market basket) in domestic currency, compared to the cost of those same goods and services in another country. B) The average increase in the general price level over a defined period of time. C) The wholesale cost of goods and services purchased by manufacturers, compared to those same goods and services purchased during a base period. D) The average cost of goods and services (market basket) purchased by consumers, compared to those same goods and services purchased during a base period.

Answer: D The Consumer Price Index (CPI) is the average cost of goods and services (market basket) purchased by consumers as compared to those same goods and services purchased during a base period. The CPI compares price inflation in one country and does not reflect the relative price changes of goods and services in one country with those of another. CPI measures retail prices not wholesale costs. Reference: 7.1.2.2 in the License Exam Manual.

With respect to the fiscal policy of the United States, the annual budget request is submitted by the A) Congress B) Federal Reserve Board C) Internal Revenue Service D) President

Answer: D The President of the United States is responsible for submitting the country's annual budget request to the Congress for their approval and ultimately sent back to the POTUS for signature. Reference: 7.1 in the License Exam Manual.

The Consumer Price Index (CPI) is released: A) weekly. B) quarterly. C) semiannually. D) monthly

Answer: D The U.S. Bureau of Labor Statistics releases the CPI monthly. Reference: 7.1.2.2 in the License Exam Manual.

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) gold. B) commercial real estate. C) common stock. D) U.S. treasury bonds.

Answer: D 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. Reference: 7.1.2.3 in the License Exam Manual.

What generally happens to outstanding fixed-income securities when the rate of inflation slows? A) Yields go up. B) Coupon rates go up. C) Short-term securities are affected the most. D) Prices go up.

Answer: D 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. Reference: 7.1.2.2.1 in the License Exam Manual.