Chapter 19 Custom Exam
Which of the following bonds results in the highest real interest rate? A) A bond yields 8% when inflation is at 3% B) A bond yields 12% when inflation is at 8% C) A bond yields 10% when inflation is at 7% D) A bond yields 6% when inflation is at 4%
A) A bond yields 8% when inflation is at 3% The real interest rate, also referred to as the real rate of return, refers to a bond's yield after its been adjusted for inflation (yield minus inflation rate). The highest real interest rate is realized on a bond that yields 8% when the rate of inflation is 3%. This bond provides a real interest rate of 5% (8% - 3%).
A stock that typically performs in parallel to the changes in the economy is referred to as a: A) Cyclical stock B) Defensive stock C) Growth stock D) Value stock
A) Cyclical stock The performance of a cyclical stock normally runs parallel to changes in the economy. Examples of cyclical stocks include machine tool companies, construction firms, as well as transportation and energy companies.
During a deflationary period, interest rates: A) Decrease, causing bond prices to rise B) Increase, causing bond prices to fall C) Remain the same D) Are very unpredictable
A) Decrease, causing bond prices to rise A deflationary period is characterized by a sluggish economy where goods and services decline in value. Interest rates tend to trend downward, causing bond prices to rise.
During periods of deflation, the FRB will likely: A) Purchase securities in the open market B) Encourage a rise in interest rates C) Sell securities in the open market D) Issue new securities
A) Purchase securities in the open market In an effort to stimulate the economy, the FRB will attempt to move into a period of easy money. Easing money (making it available) may be accomplished by purchasing securities in the open market. On the other hand, selling securities, issuing new securities, or encouraging higher interest rates will have an opposite effect.
If the economy is experiencing rising inflation, this will generally lead to: A) A decrease in bond prices B) An increase in bond prices C) No change in bond prices D) Volatility in bond prices
A) A decrease in bond prices Rising inflation will usually lead to the FRB increasing short-term rates. This increase in rates will cause outstanding bond prices to decrease.
Which of the following is the likely result of persistent deflation? A) A decrease in interest rates B) A decrease in the level of inflation C) A decrease in bond prices D) An increase in the value of equities
A) A decrease in interest rates Deflation is considered a reduction in the general level of prices. Deflation leads to lower interest rates, which results in higher bond prices. Equities tend to perform well during periods of inflation, not deflation.
Which of the following choices is considered a leading economic indicator? A) Manufacturing new orders B) Industrial production C) Average duration of unemployment D) Commercial and industrial loans outstanding
A) Manufacturing new orders Manufacturing new orders is considered a leading economic indicator. Industrial production is considered a coincident indicator, while average duration of employment and commercial and industrial loans outstanding are lagging indicators.
During which phase of the business cycle will an investor experience a decrease in purchasing power? A) Peak B) Expansion C) Contraction D) Trough
A) Peak The peak is the high point of the business cycle, during which the demand for goods starts to overtake supply. During this phase, prices and inflation are increasing, which results in the decline of the consumer's purchasing power.
Which of the following is the rate that commercial banks charge their best corporate clients? A) Prime rate B) Discount rate C) Federal funds rate D) Call rate
A) Prime rate The prime rate is the rate commercial banks charge their best corporate clients. The discount rate is the rate that the Federal Reserve charges when lending to member banks. The federal funds rate is the rate charged for overnight loans between member banks. The call rate is what commercial banks charge on loans to broker-dealers for margin purposes.
During periods of easy money when interest rates are declining, yield curves tend to: A) Slope upward from the shorter to the longer maturities B) Slope downward from the shorter to the longer maturities C) Remain flat D) Slop downward from shorter to intermediate and then upward to longer maturities
A) Slope upward from the shorter to the longer maturities During periods of easy money when interest rates are declining, yields on shorter maturities will be less than yields on longer maturities. Yield curves tend to slope upward from the shorter to the longer maturities.
Which of the following items is considered a coincident economic indicator? A) The industrial production index B) The S&P index C) Housing starts D) Expenditures for capital goods
A) The industrial production index Economic indicators are classified as leading, coincident, or lagging. Leading indicators precede the change in the economy as a whole. Coincident indicators change with the economy as a whole and lagging indicators change after the economy as a whole. Industrial production comprises a large part of the economy and, therefore, changes at the same time as the whole economy. The other choices are examples of leading indicators.
Which of the following stocks would most likely be considered a defensive stock? A) An aerospace stock B) A utility stock C) An airline stock D) An automobile stock
B) A utility stock Utility, food, beer, candy, pharmaceutical, tobacco, and soft drink stocks would be considered defensive stocks. They offer the investor a greater amount of safety because in periods of recession and adverse economic conditions these companies are the last to be affected.
When watching for signs of inflation, which of the following is one of the most relevant statistics? A) S&P 500 B) CPI C) GDP D) Unemployment Figures
B) CPI The Consumer Price Index (CPI) measures the price of a basket of goods and services available in the U.S. When it is increasing, it is considered a sign of inflation, which is a general rise in the level of prices.
Cyclical stocks tend to be most influenced by: A) Regulatory changes B) Changes in economic trends C) Changes in the political climate D) Exchange rates
B) Changes in economic trends Cyclical stocks tend to follow changes in the economy. Examples of cyclical stocks include stocks of companies in basic industries (e.g., construction firms, machine tool companies, and transportation companies).
A significant decline in the general level of prices is referred to as: A) Inflation B) Deflation C) Disinflation D) Expansion
B) Deflation A significant decline in the general level of prices is referred to as deflation. On the other hand, inflation is an increase in the level of prices, while disinflation is a slowing down of the increase in the level of prices. Expansion is the phase of the business cycle during which inflation is a characteristic.
Which of the following is the rate that's charged when a member bank borrows from the Federal Reserve? A) Prime rate B) Discount rate C) Federal funds rate D) Call rate
B) Discount rate The discount rate is the rate that the Federal Reserve charges when its lends money to a member bank. The prime rate is the rate that commercial banks charge their best corporate clients. The federal funds rate is the rate charged for overnight loans between member banks. The call rate is what commercial banks charge on loans to broker-dealers for margin purposes.
The economic theory stating that government intervention in the marketplace is necessary for controlling economic growth is known as: A) Supply-side economics B) Monetary theory C) Keynesian theory D) The Dow Theory
C) Keynesian theory Keynesian economic theory looks at the demand side of the marketplace. It states that government intervention in the marketplace (by using such measures as expenditure programs) is necessary for controlling the economy. Supply-side economics states that the government should reduce marginal tax rates and the size of government to promote economic growth. Monetary theory looks to increase or decrease the money supply in order to control the economy. The Dow Theory, which is followed by some technical analysts, states that a major reversal in the market has occurred when both the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA) break their trends.
Historically, a decline in the Real GDP for two consecutive quarters is an indication that the economy is in a(n): A) Expansion B) Recovery C) Recession D) Depression
C) Recession Gross Domestic Product (GDP) is the total value of goods and services produced by the U.S. economy over a given period. It is one of the most significant measures of economic activity. Traditionally, economists considered a decline in Real GDP for two consecutive quarters to indicate a recession. Real GDP is the Gross Domestic Product adjusted for inflation.
When watching for signs of inflation, which of the following is one of the most relevant statistics? A) The Standard & Poor's 500 Index B) The balance of payments C) The Consumer Price Index D) The federal budget deficit
C) The Consumer Price Index The Consumer Price Index (CPI) measures the price of a basket of goods and services available in the U.S. When it is increasing, it is considered a sign of inflation, which is a general rise in the level of prices.
Who enacts fiscal policy? A) The Federal Reserve Board B) The Comptroller of the Currency C) The FDIC D) Congress
D) Congress Fiscal policy is enacted by Congress. Fiscal policy is the use of the government's power to tax and spend. Control of the economy by changing the levels of government spending and taxation can either put money into the economy, or take money out of the economy. Monetary policy is carried out by the Federal Reserve Board's use of its available options for increasing or decreasing the supply of money and credit in the economy.
Which of the following will occur if U.S. imports are increasing? A) The dollar will weaken. B) Yields will decrease. C) The money supply will increase. D) Gross Domestic Product will decrease.
D) Gross Domestic Product will decrease. When imports exceed exports, it means that more money is being spent than received. This typically leads to a decrease in the production of U.S. goods (i.e., a decrease in GDP). Monetary policy may then be implemented to use strategies designed to strengthen the dollar, increase yields, and decrease the money supply.
The Federal Reserve Board's Open Market Committee (FOMC) buys and sells which of the following securities most often to accomplish its aims? A) Agency bonds B) Treasury bonds C) Treasury notes D) Treasury bills
D) Treasury bills The Federal Reserve Board's Open Market Committee (FOMC) purchases and sells U.S. government securities in the open market to accomplish the Federal Reserve Board's aims of influencing the money supply. The securities most often used are Treasury bills.
A stock that generally trades at a price that's lower than its fundamentals would indicate is referred to as a: A) Cyclical stock B) Defensive stock C) Growth stock D) Value stock
D) Value stock A value stock relates to a company that investors feel is undervalued in relation to its fundamentals. The risk of these types of stocks is that many investors may not find them to be valuable.
Which FRB tools determines the amount of money that member banks must keep on deposit? A) Discount rate B) Reserve requirements C) Regulation T D) Open market operations
B) Reserve requirements The FRB sets the reserve requirements for member banks, which determine the amount of money that banks must keep on deposit. When banks have excess funds they tend to lend them to other banks that have deficits.
Money received by a corporation when it sells its stock above its par value is called: A) Excess capital B) Earned surplus C) Paid-in capital D) Stockholders' capital
C) Paid-in capital Money received by a corporation when it sells its stock above its par value is called capital surplus or paid-in capital. This is different from earned surplus (retained earnings), which is profits that have been retained by the company and have not been paid as dividends.
Which of the following choices is NOT a leading economic indicator? A) Building permits B) Consumer expectations C) Prime rate D) Stock prices
C) Prime rate The prime rate is the rate that banks charge their best credit customers and is considered a lagging (not leading) economic indicator. The other three choices are all considered leading economic indicators.
In the past 18 months, the CPI has been rising steadily. Under this circumstance, which of the following events is likely? A) Bond prices are falling. B) Bond prices are rising. C) Gold prices are falling. D) Deflation is accelerating.
A) Bond prices are falling. When the consumer price index (CPI) is steadily rising, the economy is operating under inflationary expectations. When inflation picks up, interestrates usually rise. When interest rates rise, prices fall. Gold and other precious metals would typically rise in value during inflationary times. Deflation (falling prices) is the opposite of inflation (rising prices).
The investments that tend to perform the WORST during periods of inflation are: A) Bonds B) Mutual funds C) ETFs D) Gold and silver
A) Bonds Bonds tend to perform the worst during periods of inflation since rising interest rates will result in falling bond prices and a decrease in the purchasing power of the interest payments. Mutual funds, ETFs, and gold and silver commodities tend to be good investments for a person seeking to offset inflation.
When interest rates are trending upward, the economy will normally be in which phase of the business cycle? A) Expansion B) Contraction C) Trough D) Peak
A) Expansion Increasing interest rates, along with increased costs and lower unemployment, are frequently associated with an expanding economy where there is an increasing demand for goods. As demand overtakes supply, prices begin to rise due to the scarcity of goods. This rise in prices is known as inflation. The Federal Reserve will look to raise interest rates in an attempt to curb demand and combat inflation.
What is the basic balance sheet equation? A) Total Assets = Total Liabilities + Stockholders' Equity B) Total Assets = Total Liabilities - Stockholders' Equity C) Total Assets + Total Liabilities = Stockholders' Equity D) Total Liabilities = Total Assets + Stockholders' Equity
A) Total Assets = Total Liabilities + Stockholders' Equity The balance sheet equation is: Total Assets = Total Liabilities + Stockholders' Equity.
An individual is considering making some changes in her portfolio due to expectations that the economy may be moving into a recessionary period. In what type of stocks should she consider investing? A) Cyclical stock B) Defensive stock C) Growth stock D) Value stock
B) Defensive stock Defensive stocks tend to react less to negative changes in the economy than other stocks These are stocks of companies that produce items of necessity (e.g., utilities, pharmaceuticals, food, and alcohol).
All of the following characteristics would be associated with a growth company, EXCEPT that it has a: A) High price/earnings ratio B) High dividend payout ratio C) High amount of research and development costs D) Wide trading range for the price of its stock
B) High dividend payout ratio Growth companies will normally retain most of their earnings to enable them to continue their growth. They would typically have low dividend payout ratios, high research and development expenses, and high price/earnings ratios, as well as a wide trading range for the stock.
Deflation will generally cause existing bond prices to: A) Remain the same B) Increase C) Decrease by a high percentage D) Decrease by a low percentage
B) Increase Deflation is an economic situation in which the prices of goods and services are declining. It is an unusual occurrence which results in the consumer price index (CPI) decreasing and the economy contracting. In order to stimulate the economy the FRB often lowers interest rates, which causes existing bond prices to rise. Long-term zero coupon bonds tend to perform best during periods of deflation.
If an investment's distribution increases by 3% while inflation has increased by 3%, what's the impact on the investment's purchasing power? A) It decreases. B) It stays the same. C) It increases. D) It increases by 3%.
B) It stays the same. When an investment's distribution increases by the same amount as inflation, the purchasing power remains the same. If inflation outpaces an investment's return, the purchasing power will decrease. If the rate of inflation is lower than an investment's return, the purchasing power will increase.
The Federal Reserve Board is attempting to talk down rates. This practice is referred to as: A) Utilizing open market operations B) Moral suasion C) Reducing the discount rate D) Increasing repurchase agreements
B) Moral suasion Talking rates up and talking rates down are methods by which the Federal Reserve tries to influence the market through its public statements. For example, if the FRB chairman believes that markets are overheated and uses the term irrational exuberance, the market will typically understand that the Federal Reserve may adopt a more restrictive policy. This practice is often referred to as moral suasion or jawboning.
If the FRB engages in repurchase agreements, which of the following statements is TRUE? A) The money supply has been decreased. B) The money supply has been increased. C)Short-term yields will likely increase. D) The FRB is initially selling securities.
B) The money supply has been increased. When the FRB conducts a repo, it is initially purchasing securities and the immediate result is an increase in money supply. This action tends to reduce short-term yields.
Which of the following actions by the Federal Reserve Board results in a decrease in the money supply? A) The purchase of securities in the open market B) The sale of securities in the open market C) A decrease in the discount rate D) A decrease in the reserve requirements
B) The sale of securities in the open market The sale of securities by the Federal Reserve Board in the open market results in the withdrawal of reserves from the banking system, thereby decreasing the money supply. All the other actions by the FRB result in an increase in the money supply.
Which of the following statements is TRUE if interest rates are lower in the U.S. than they are overseas? A) U.S. investors will invest in the United States. B) U.S. investors will invest overseas. C) The value of the dollar will strengthen. D) Foreign goods will become more attractive.
B) U.S. investors will invest overseas. If interest rates are lower in the U.S. than they are overseas, this will typically lead to U.S. investors investing overseas. This will decrease the demand for the dollar, which results in a weaker dollar and foreign goods being less attractive.
An increase in which of the following will likely result in the Federal Reserve Board implementing an easy money policy? A) Inflation B) Unemployment C) Consumer Price Index D) Personal income
B) Unemployment In an attempt to stimulate both spending and the economy, the FRB will likely pursue an easy money policy when unemployment is increasing. Implementing a tight money policy is more likely in periods of high inflation, represented by an increase in the CPI and personal incomes.
