Section 1 Part 3

*Q: Those industries that are LEAST affected by normal business cycles are:* A. Defensive Industries B. Cyclical Industries C. Special Situation D. Growth Industries

*Answer* A. Defensive Industries *Explanation* Defensive Industries are least affected by normal business cycles. Companies in defensive industries produce nondurable consumer goods, such as good, pharmaceuticals, & tobacco or supply essential services such as those supplied by utility companies. Public consumption of such goods remains fairly steady throughout the business cycle. Reference: 1.3.2 in the License Exam Manual

*Q: The countrys annual economic output of all the goods & services produced within the nation, is known as:* A. Gross Domestic Product B. Expansion C. Indicators D. Balance of Payments

*Answer* A. Gross domestic product *Explanation* A nations annual economic output, all of the goods & services produced within that nation, is its gross domestic product (GDP). U.S. GDP includes personal consumption, govt spending, gross private investment, foreign investment & net exports. Reference: 1.3.3 in the License Exam Manual

*Q: Match the following statement to the BEST expression: Govt should allow market forces to determine prices of all goods & that the federal govt should reduce govt spending as well as taxes:* A. Supply-side Economic Theory B. Keynesian Theory C. Socialsm D. Monetarist Theory

*Answer* A. Supply-side Economic Theory *Explanation* Supply-side economics holds that govts should allow market forces to determine prices of all goods. Supply-side adherents judge that the federal govt should decrease govt spending & taxes. In this way, sellers of goods will price them at a rate that allows them to meet market demand & still sell them profitably. Reference: 1.3.2 in the License Exam Manual

*Q: Money available to lend to corporations & consumers is impacted most in the United States by the policies of which of the following?* A. the Federal Open Market Committee (FOMC) B. The National Securities Clearing Corporation (NSCC) C. The Securities & Exchange Commission (SEC) D. The Internal Revenue Service (IRS)

*Answer* A. The Federal Open Market Committee (FOMC) *Explanation* The Federal Open Market Committee (FOMC) meets regularly to direct the Federal Reserve Board to either buy or sell Treasury securities in the open market. Purchases add money to the economy, making the money available to lend more plentiful, & sales take money out of the economy, making money available to lend less plentiful. Reference: 1.3.1 in the License Exam Manual

*Q: Economists refer to longer, more severe contractions in the economy as:* A. depressions B. recessions C. depletions D. declines

*Answer* A. depressions *Explanation* Economists call mild, short-term contractions recessions, while longer, more severe contractions are called depressions. Reference: 1.3.2 in the License Exam Manual

*Q: To stimulate the economy during a recession by expanding the availability of credit, the FRB would do any of the following EXCEPT:* A. raise the federal funds rate B. lower the discount rate C. buy U.S. govt securities in open-market operations D. lower the reserve requirement

*Answer* A. raise the federal funds rate *Explanation* To stimulate the economy by expanding the availability of credit (more money available, which lowers interest rates), the FRB can buy U.S. govt securities in open-market operations, lower the discount rate, & lower the reserve requirement. The federal funds rate is not set by the FRB. Reference: 1.3.1 in the License Exam Manual

*Q: If the U.S. dollar is relatively strong against the Japanese yen, is can be assumed that:* A. the U.S. dollar will buy more goods produced in Japan, while the Japanese yen buys fewer goods produced in the United States B. the U.S. dollar will buy fewer goods produced in Japan, while the Japanese yen buys more goods produced in the United States C. the U.S. dollar will buy more goods produced in Japan & the Japanese yen will also buy more goods produced in the United States D. the U.S. dollar will buy fewer goods produced in Japan & the Japanese yen will also buy fewer goods produced in the United States

*Answer* A. the U.S. dollar will buy more goods produced in Japan, while the Japanese yen buys fewer goods produced in the United States *Explanation* The strength of one country's currency against another impacts trade in between the two. The stronger currency (in this case the U.S. dollar) will buy more foreign goods, & the weaker currency (in this case the Japanese Yen) will buy fewer goods produced in other countries. Reference: 1.3.3 in the License Exam Manual

*Q: The flow of money between the United States & other countries is known as:* A. the balance of payments B. the balance of trade C. the payment reserves D. the surplus

*Answer* A. the balance of payments *Explanation* The balance of payments represent the flow of money between the United States & other countries. Reference: 1.3.3 in the License Exam Manual

*Q: The largest component of the U.S. balance of payments is:* A. the balance of trade B. exports C. imports D. foreign currency

*Answer* A. the balance of trade *Explanation* U.S. imports & exports are the components used to calculate the balance of trade. The balance of trade is the measure of those 2 components against each other-- the net being either more money coming into or going out of the U.S. economy. That measure, the balance of trade, is the largest component of the U.S. balance of payments. Reference: 1.3.3 in the License Exam Manual

*Q: The business cycle includes all of the following classifications EXCEPT:* A. waves B. expansion C. peak D. trough

*Answer* A. waves *Explanation* Throughout modern history, periods of economic expansion have been followed by periods of contraction in a pattern referred to as the "business cycle" or "economic cycle". Business cycles go thru 4 stages: 1. expansion 2. peak 3. contraction 4. trough Reference: 1.3.2 in the License Exam Manual

*Q: Which of the following BEST fits the description of a "growth" stock?* A. Preferred shares in companies that back stated dividends with investments in pharmaceutical companies B. Common shares in companies that retain earnings & pay little or no dividends C. Common shares in companies that pay a high dividend on rapid growth experience D. Common or preferred shares in companies, which experience growth in unusual, non-recurring profitable circumstances

*Answer* B. Common shares in companies that retain earnings & pay little or no dividends *Explanation* Most every industry passes through phases; 1. Introduction 2. Growth 3. Maturity 4. Decline An industry is in its growth phase if it is growing faster than the economy as a whole due to e.g. technological changes, new products, or changing consumer tastes. Because growth companies retain nearly all of their earnings to finance business expansion, growth stocks pay little or no dividends. Reference: 1.3.2 in the License Exam Manual

*Q: Which of the following BEST fits the description of a "growth" stock?* A. Common shares in companies that pay a high dividend on rapid growth experience B. Common shares in companies that retain earnings & pays little or no dividends C. Preferred shares in companies that back stated dividends with investments in pharmaceutical companies D. Common or preferred shares in companies, which experience growth in unusual, non-recurring profitable circumstances

*Answer* B. Common shares in companies that retain earnings & pay little or not dividends *Explanation* Most every industry passes through phases; 1. Introduction 2. Growth 3. Maturity 4. Decline An industry is in its growth phase if it is growing faster than the economy as a whole due to e.g. technological changes, new products, or changing consumer tastes. Because growth companies retain nearly all their earnings to finance business expansion, *growth stocks pay little or no dividends.* Reference: 1.3.2 in the License Exam Manual

*Q: Which segment of the business cycle would one expect to find rising interest rates & higher wages?* A. Trough B. Expansion C. Contraction D. Recession

*Answer* B. Expansion *Explanation* Expansions in the business cycle are characterized by increasing consumer demand for goods & services & increasing industrial production. One would expect these increases to lead to rising interest rates as demands for loans for purchases increases & higher wages for workers as production increases. Reference: 1.3.2 in the License Exam Manual

*Q: The country's annual economic output of all the goods & services produced within the nation, is known as:* A. Balance of Payments B. Gross Domestic Product C. Expansion D. Indicatprs

*Answer* B. Gross Domestic Product *Explanation* A nations annual economic output, all of the goods & services products within that nation, is its gross domestic product (GDP). U.S. GDP includes personal consumption, govt spending, gross private investment, foreign investment, & net exports. Reference: 1.3.3 in the License Exam Manual

*Q: A member of the Federal Reserve System wanting to increase its reserves could do so by borrowing money from:* *I the Federal Reserve Board (FRB) at the discount rate* *II the Federal Reserve Board (FRB) at the federal funds rate* *III another FRB member bank at the discount rate* *IV another FRB member bank at the federal funds rate* A. I & III B. I & IV C. II & III D. II & IV

*Answer* B. I & IV *Explanation* A Federal Reserve Board member bank can increase its reserves by borrowing from the Federal Reserve Bank directly, or it can borrow from another FRB member bank. When borrow from the FRB directly, a bank will pay the *discount* rate. When borrowing from another member bank, a bank will pay the *federal funds* rate. Reference: 1.3.1 in the License Exam Manual

*Q: Federal Reserve member banks needing to borrow money can borrow from:* *I the Federal Reserve Bank at the federal funds rate* *II the Federal Reserve Bank at the discount rate* *III other member banks at the federal funds rate* *IV other member banks at the discount rate* A. II & IV B. II & III C. I & IV D. I & III

*Answer* B. II & III *Explanation* Federal Reserve member banks needing to borrow have 2 resources: 1. the Federal Reserve Bank itself(which will lend to them((Federal Reserve Member Banks)) at the discount rate) 2.Other Member Banks(who will lend to one another(Federal Reserve member bank to Federal Reserve member bank) at the federal funds rate

*Q: The prime rate is set by:* A. the Federal Open Market Committee B. individual banks C. the Federal Reserve Board D. the Securities & Exchange Commission

*Answer* B. Individual Banks *Explanation* The *Prime Rate* is the interest rate that large U.S. money center commercial banks charge their most creditworthy corporate borrowers for unsecured loans. Each bank sets its own prime rate. Reference: 1.3.1 in the License Exam Manual

*Q: If large money center commercial banks begin to lower their prime rates, which of the following is most likely to occur?* A. smaller banks will need to offset the lower prime rate by increasing the broker call loan rate B. Smaller banks will lower lending rates for creditworthy corporate customers as well C. Smaller banks will need to increase their lending rates for credit worthy corporate customers D. Smaller banks will follow by lowering the discount rate

*Answer* B. Smaller banks will lower lending rates for credit worthy customers as well *Explanation* When large money center commercial bank lower the prime rat, the rate charged to their most creditworthy corporate customers, smaller banks will generally follow in order to stay competitive. The discount rate is set by the FRB (Federal Reserve Board) - not by banks, & if the broker call loan rate banks charge is impacted, it would also be lowered (not increased). Reference: 1.3.1 in the License Exam Manual

*Q: A strong U.S. dollar leads to more:* A. U.S. exports & a balance of payments surplus B. U.S. imports & a balance of payments deficit C. U.S. imports & a balance of payments surplus D. U.S. exports & a balance of payments deficit

*Answer* B. U.S. importants & a balance of payments surplus *Explanation* When the dollar is strong, it is more affordable for U.S. consumers to buy more foreign goods, so U.S. imports increase. As more imported goods flow in, more money flows out, deficit. Reference: 1.3.3 in the License Exam Manual

*Q: The U.S. balance of payments deficit would decrease in all the following scenarios EXCEPT:* A. a decrease in imports of foreign goods into the United States B. a decrease in purchases of U.S. securities by foreign investors C. an increase in exports of domestic goods from the United States D. a decrease in dividend payments by U.S. companies to foreign investors

*Answer* B. a decrease in purchases of U.S. securities by foreign investors *Explanation* A deficit in the balance of payments occurs when more money is flowing out of the country than in to the country. When foreign investors decrease their purchases of U.S. securities, the flow of money coming into the United States decreases, this adds to the deficit rather than decreasing it. Reference: 1.3.3 in the License Exam Manual

*Q: Deflation occurs during:* A. a depression, coinciding the economic expansion in the business cycle B. a recession, coinciding with an economic contraction C. a depression, coinciding with an economic trough in the business cycle D. a recession, coinciding with economic peaks

*Answer* B. a recession, coinciding with an economic contraction *Explanation* Deflationary periods in the economy are most associated with severe recessions. Recessions occur during periods of economic contraction in the business cycle. Reference: 1.3.2 in the License Exam Manual

*Q: When the Federal Reserve Board wants to expand (loosen) the money supply, it will:* A. buy corporate securities from banks in the open market B. buy Treasury securities from banks in the open market C. sell corporate securities to banks in the open market D. sell Treasury securities to banks in the open market

*Answer* B. buy Treasury securities from banks in the open market *Explanation* When the Federal Reserve Board wants to expand (loosen) the money supply, it will buy Treasury securities from banks in the open market. The securities come out of the economy, & the money goes into the economy. Reference: 1.3.1 in the License Exam Manual

*Q: When the Federal Reserve Board wants to expand (loosen) the money supply, it will:* A.buy corporate securities from banks in the open markets B. buy Treasury securities from banks in the open market C. sell corporate securities to banks in the open market D. sell Treasury securities to banks in the open marker

*Answer* B. buy Treasury securities from banks in the open market *Explanation* When the Federal Reserve Board wants to expand (loosen) the money supply, it will buy Treasury securities from banks in the open market. The securities come out of the economy, & the money goes into the economy. Reference: 1.3.1 in the License Exam Manual

*Q: To expand the overall economy, the Federal Reserve Board, acting as agent for the U.S. Treasury dept. will:* A. sell securities via open-market operations , pushing interest rates up B. buy securities via open-market operations, pushing interest rates down C. buy securities via open-market operations, pushing interest rates up D. sell securities via open-market operations, pushing interest rates down

*Answer* B. buy securities via open-market operations, pushing interest rates down *Explanation* To expand the overall economy, we want to push interest rates down by increasing the money supply. Lower interest rates make borrowing & spending easier for consumers. To increase the money supply, the FRB will buy securities via open-market operations, taking securities out of the banking system & putting money into the banking system. Reference: 1.3.1 in the License Exam Manual

*Q: Downturns in the business cycle or economic contractions are characterized by all of the following EXCEPT:* A. rising numbers of bankruptcies B. falling inventories C. higher consumer debt D. rising numbers of bond defaults

*Answer* B. falling inventories *Explanation* When the economy is contracting, inventories tend to rise (not fall) due to a decreasing demand for goods. Reference: 1.3.2 in the License Exam Manual

*Q: The Federal Reserve Board (FRB) might impact the money supply by using all of the following EXCEPT:* A. reserve requirements for member banks B. prime rate C. buying or selling securities in open market D. discount rate

*Answer* B. prime rate *Explanation* The prime rate is set by money center banks, not the FRB. The remaining 3 answer choices are the tools available to the FRB to be used to impact the money supply. Reference: 1.3.1 in the License Exam Manual

*Q: Economic growth has slowed to a halt with little consumer demand, but prices for goods & services are still rising. This is known as economic:* A. stagnation B. stagflation C. contraction D. deflation

*Answer* B. stagflation *Explanation* When prices for goods & services are rising (inflation) during times when the economy isnt growing (stagnation), the economy is known to be in a period of stagflation. Reference: 1.3.2 in the License Exam Manual

*Q: Implementing monetary policy & thereby undertaking the responsibility to maintain the stability of the U.S. financial system is:* A. the Securities & Exchange Commission (SEC) B. the Federal Open Market Committee (FOMC) C. the New York Stock Exchange (NYSE) D. the Internal Revenue Service (IRS)

*Answer* B. the Federal Open Market Committee (FOMC) *Explanation* A special committee within the Federal Reserve Bank of the United States is the Federal Open Market Committee (FOMC). This committee sets monetary policy. Reference: 1.3.1 in the License Exam Manual

*Q: Reports of rising inventories generally occur during which period of the business cycle?* A. Recovery B. Expansion C. Contraction D. Peak

*Answer* C. Contraction *Explanation* 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 & goods are less likely to remain in inventory. Reference: 1.3.2 in the License Exam Manual

*Q: A bank is likely to do which of the following when the Federal Reserve Board (FRB) eases the money supply?* *I Lower its prime rate* *II Raise its prime rate* *III Lower its broker call loan rate* *IV Raise its broker call loan rate* A. II & IV B. I & IV C. I & III D. II & III

*Answer* C. I & III *Explanation* The prime rate & the broker call loan rate are set by banks for loans to corporate customers & broker-dealers, respectively. If the FRB eases the money supply (makes more money available to lend), banks can charge less for loans & will lower their lending rates. Reference: 1.3.1 in the License Exam Manual

*Q: The cost of doing business is closely linked to the cost of money, which is known as:* A. demand B. supply C. interest D. M1

*Answer* C. Interest *Explanation* The cost of doing business is closely linked to the cost of money; the cost of money is called *interest*. In large measure, the supply & demand of money determines the rate of interest that must be paid to borrow it. Reference: 1.3.1 in the License Exam Manual

*Q: Match the following statement to the BEST term: Govt Intervention in the economy is a significant force in creating prosperity by engaging in activities that affect aggregate demand:* A. Socialism B. Balance of Payments C. Keynesian Theory D. Monetarist Theory

*Answer* C. Keynesian Theory *Explanation* According to the late economist, John Maynard Keynes, a govt's fiscal policies determine the country's economic health. Fiscal policy involves adjusting the level of taxation & govt spending. In this way the govt intervenes in the economy & is a major force in creating prosperity by engaging in activities that affect aggregate demand. Reference: 1.3.2 in the License Exam Manual

*Q: Which of the following can encourage economic growth because gradually increasing prices tend to stimulate business investment?* A. Deflation B. High Inflation C. Mild Inflation D. Stagnation

*Answer* C. Mild Inflation *Explanation* Inflation is a general increase in prices. Mild inflation encourages economic growth because gradually increasing prices stimulate business investment. High inflation reduces a dollars buying power, which hurts the economy. Reference: 1.3.2 in the License Exam Manual

*Q: Which of the following refers to prolonged periods of slow or little economic growth, unusually accompanied by high unemployment?* A. Stagflation B. Deflation C. Stagnation D. Trough

*Answer* C. Stagnation *Explanation* Economic "stagnation" refers to prolonged periods of slow or little economic growth, unusually accompanied by high unemployment. Reference: 1.3.2 in the License Exam Manual

*Q: Recent reports indicate that the gross domestic product (GDP) has been declining steadily over the past 2 quarters. This would suggest:* A. an economic expansion B. a depression C. a recession D. an inflationary period

*Answer* C. a recession *Explanation* A recession is defined as 6 consecutive months (2 quarters) or more of economic decline. By contrast, a depression is 6 consecutive quarters of economic decline(18 months). Reference: 1.3.2 in the License Exam Manual

*Q: To expand the overall economy, the Federal Reserve Board, acting as agent for the U.S. Treasury department, will:* A. sell securities via open-market operations, pushing interest rates up B. sell securities via open-market operations, pushing interest rates down C. buy securities via open-market operations, pushing interest rates down D. buy securities via open-market operations, pushing interest rates up

*Answer* C. buy securities via open-market operations, pushing interest rates down *Explanation* To expand the overall economy, we want to push interest rates down by increasing the money supply. Lower interest rates make borrowing & spending easier for consumers. To increase the money supply, the FRB will buy securities via open-market operations, taking securities out of the banking system & putting money into the banking system. Reference: 1.3.1 in the License Exam Manual

*Q: Which of the following points to a general decline in prices occuring during severe recessions & the unemployment rate is rising?* A. stagflation B. stagnation C. deflation D. contractions

*Answer* C. deflation *Explanation* Deflation is a general decline in prices. Deflation usually occurs during severe recessions when unemployment is on the rise. Reference: 1.3.2 in the License Exam Manual

*Q: When the Federal Open Market Committee (FOMC) directs that Treasury securities be purchased in the open market, this:* A. decreases the money supply B. is intended to hinder contraction of the money supply C. increases the supply of money D. stabilizes the money supply

*Answer* C. increases the supply of money *Explanation* When the Federal Open Market Committee (FOMC) directs that Treasury securities be purchased in the open market, this increases the supply of money. Treasury securities are coming out of the economy & therefore, money is going in- the money supply increases. Reference: 1.3.1 in the License Exam Manual

*Q: A customer of a FINRA member firm buys securities on margin. The customer is expected to pay a rate of interest on the margin loan based on which of the following?* A. the federal funds rate B. the prime rate C. the broker call loan rate D. the discount rate

*Answer* C. the broker call loan rate *Explanation* The broker call loan rate is the interest rate banks charge broker-dealers on money they borrow to lend to margin account customers. Margin accounts permit customers to purchase eligible securities without paying in full. Typically, an investor is required to deposit only 50% of the purchase price of eligible common stock with the balance being borrowed. The amount borrowed, as with any loan, is subject to interest payments. Reference: 1.3.1 in the License Exam Manual

*Q: When the Federal Reserve Board (FRB) utilizes the tools available to it, it is influencing:* A. fiscal policies B. the amount of money raised thru taxes C. the money supply D. the federal budget

*Answer* C. the money supply *Explanation* Through the use of open-market operations, affecting changes in the discount rate, & setting reserve requirements, the FRB is influencing the money supply. The money supply is the capital available for lending institutions to lend & thus consumers to borrow & spend. Reference: 1.3.1 in the License Exam Manual

*Q: According to the U.S. Commerce Department, the economy is in a depression when a decline in real output of goods & services lasts* A. 9 months or more (3 quarters) B. beyond 12 months (4 quarters) C. 6 months or more (2 quarters) D. 18 months or more (6 quarters)

*Answer* D. 18 months or more (6 quarters) *Explanations* The U.S. Commerce Department defines a depression as a decline in real output of goods & services lasting 18 months or more (6 quarters) Reference: 1.3.2 in the License Exam Manual

*Q: Of the statements listed, which best characterizes the potential impact of factors occurring outside our domestic economy & markets?* A. Factors outside the United States can impact our securities & trade markets, but the effects are always short term & thus impact our domestic economy very little B. Factors outside the United States have little impact on our securities & trade markets, & thus our domestic economy C. Factors outside the United States never have immediate impact on our securities & trade markets, but over time can impact our domestic economy D. Factors outside the United States can have immediate & prolonged impact on our securities & trade markets, & thus our domestic economy

*Answer* D. Factors outside the United States can have immediate & prolonged impact on our securities & trade markets, & thus our domestic economy *Explanation* While not all factors outside of the United States will impact our domestic economy & markets, some can & will immediately. In these instances, the effects can be prolonged & thus the impact to our overall domestic economy is also felt. Reference: 1.3.3 in the License Exam Manual

*Q: Exports from the United States would likely increase if:* *I the Japanese yen strengthened against the dollar* *II the U.S. dollar strengthened against the Euro* *III the U.S. dollar weakened against the British pound* *IV the Swiss franc weakened against the Dollar* A. II & III B. I & IV C. II & IV D. I & III

*Answer* D. I & III *Explanation* U.S. exports should increase when foreigners have greater purchasing power. That occurs when their currency is stronger than the dollar. Reference: 1.3.3 in the License Exam Manual

*Q: Certain actions taken by the FRB would likely have the effect of causing interest rates to increase. Which would these be?* *I The FOMC buying securities* *II Raising the reserve requirements* *III Raising the discount rate* *IV Raising the prime rate* A. I & IV B. I & III C. II & IV D. II & III

*Answer* D. II & III *Explanation* Raising reserve requirements, having more member deposits being held on reserve at the Fed, would lessen the money to lend. Raising the discount rate, charging member banks more for loans, would also lessen the money available to lend. With less money available to lend, interest rates would go up. Reference: 1.3.1 in the License Exam Manual

*Q: According to economists which of the following is the correct characterization of the money supply?* A. M1 includes all of M2 and M3 (M1 = M2 + M3) B. M2 equals M1 plus M3 (M2 = M1 + M3) C. M1 plus M2 equals M3 (M1 + M2 = M3) D. M3 includes all of M1 and M2 (M3 = M1 + M2)

*Answer* D. M3 includes all of M1 and M2 (M1 + M2 = M3) *Explanation* M3 includes all of M1 & M2, plus time deposits of more than $100,000 & repurchase agreements with terms longer than 1 day. In this light, M3 is that measure of the money supply that is the most inclusive. Reference: 1.3.1 in the License Exam Manual

*Q: If large money center commercial banks begin to lower their prime rates, which of the following is most likely to occur?* A. Smaller banks will follow by lowering the discount rate B. Smaller banks will need to increase their lending rates for creditworthy corporate customers C. Smaller banks will need to offset the lower prime rate by increasing the broker call loan rate D. Smaller banks ill lower lending rates for creditworthy corporate customers as well

*Answer* D. Smaller banks will lower lending rates for creditworthy corporate customers as well *Explanation* When large money center commercial bank lower the prime rate, the rate charged to their most creditworthy corporate customers, smaller banks will generally follow in order to stay competitive. The discount rate is set by the FRB (not banks), & if the broker call loan rate banks charge is impacted, it would also be lowered (not increased). Reference: 1.3.1 in the License Exam Manual

*Q: Which of the following organizations engaging in open-market operations acts as agent for the U.S. Treasury Department?* A. The Securities & Exchange Commission (SEC) B. The Securities Investors Protection Corporation (SIPC) C. The Federal Reserve Board (FRB) D. The Federal Reserve Board (FRB)

*Answer* D. The Federal Reserve Board (FRB) *Explanation* Acting as an agent for the U.S. Treasury Department & under the direction of the Federal Open Market Committee (FOMC), the Federal Reserve Board (FRB) engages in open-market operations buying & selling Treasury securities: T-Bills, Notes & Bonds

*Q: The Federal Reserve Board (FRB) does all of the following EXCEPT:* A. regulate & impact the money supply B. determine monetary policy C. supervise the printing of currency D. enact fiscal policy

*Answer* D. enact fiscal policy *Explanation* The FRB determines monetary policy (not fiscal) & takes actions to implement its policies, including but not limited to regulating the U.S. money supply & supervising the printing of currency. Reference: 1.3.1 in the License Exam Manual

*Q: Downturns in the business cycle or economic contractions are characterized by all of the following EXCEPT:* A. rising numbers of bond defaults B. higher consumer debt C. rising numbers of bankruptcies D. falling inventories

*Answer* D. falling inventories *Explanation* When the economy is contracting, inventories tend to rise (not fall) due to a decreasing demand for goods. Reference: 1.3.2 in the License Exam Manual

*Q: Deflationary periods are characterized by all of the following EXCEPT:* A. coinciding with recessions B. a decline in prices C. rising unemployment D. increased consumer demand

*Answer* D. increased consumer demand *Explanation* Periods of deflation tend to occur during recessions. Consumer demand decreases, leading to declining prices. When demand decreases, so does production, which leads to rising unemployment. Reference: 1.3.2 in the License Exam Manual

*Q: Rising employment due to an increase in demand for goods & services would be associated with periods of:* A. stagflation B. stagnation C. deflation D. inflation

*Answer* D. inflation *Explanation* During inflationary periods, prices are rising due to a rising remand for goods & services. This will have the effect of creating more employment. Conversely, when the economy slows down, employment generally falls & claims for unemployment benefits will rise. Reference: 1.3.2 in the License Exam Manual

*Q: When the money supply in the economy decreases, * A. interest rates go up, hence borrowing & spending for consumers is easier B. interest rates go down, hence borrowing & spending for consumers is more difficult C. interest rates go down, hence borrowing & spending for consumers is easier D. interest rates go up, hence borrowing & spending for consumers is more difficult

*Answer* D. interest rates go up, hence borrowing & spending for consumers is more difficult *Explanation* Decreases in the money supply means less money is available to lend. This pushes interest rates up, hence borrowing & spending for consumers is more difficult. Reference: 1.3.1 in the License Exam Manual

*Q: Tools available to the Federal Reserve Board (FRB) include:* A. setting the discount rate, enacting tax laws, & setting the Fed funds rate B. open-market operations, setting the discount rate, & enacting tax laws C. setting the Fed funds rate, setting the prime rate, & setting the discount rate D. open-market operations, setting the discount rate, & setting reserve requirements

*Answer* D. open-market operations, setting the discount rate, & setting reserve requirements *Explanation* While engaging in monetary policy to impact the money supply, the FRB has 3 tools: 1. open-market operations 2. setting the discount rate 3. setting reserve requirements Tax laws are fiscal policy & neither the prime rate not the Fed funds rate is set by the FRB. Reference: 1.3.1 in the License Exam Manual

*Q: The Federal Reserve Board (FRB) might impact the money supply by using all of the following EXCEPT:* A. buying or selling securities in open market B. discount rate C. reserve requirements for member banks D. prime rate

*Answer* D. prime rate *Explanation* The prime rate is set by money center banks, not the FRB. The 3 remaining answer choices are the tools available to be used to impact the money supply which are: 1. reserve requirements for member banks 2. discount rate 3. buying or selling securities in the open market Reference: 1.3.1 in the License Exam Manual

*Q: To tighten its monetary policy, making it more difficult for consumers to borrow money, the Federal Reserve Board can:* A. lower the discount rate B. lower the federal funds rate C. raise the federal funds rate D. raise the discount rate

*Answer* D. raise the discount rate *Explanation* Wanting to tighten its monetary policy, which would make it harder for consumers to borrow money, the Federal Reserve Board can raise the discount rate--the rate it charges its member banks for short-term loans. This lessens the availability of money its member banks have to lend to consumers. The federal funds rate isnt a rate charged by the FRB, but instead by large commercial banks to one another. Reference: 1.3.1 in the License Exam Manual

*Q: When the Federal Reserve Boar wants to contract (tighten) the money supply, it will:* A. buy corporate securities from banks in the open market B. buy Treasury securities from banks in the open market C. sell corporate securities to banks in the open market D. sell Treasury securities to banks in the open market

*Answer* D. sell Treasury securities to banks in the open market *Explanation* When the Federal Reserve Board wants to contract (tighten) the money supply, it will sell Treasury securities to banks in the open market. The securities go into the economy & the money comes out of the economy. Reference: 1.3.1 in the License Exam Manual

*Q: To contract the overall economy, the Federal Reserve Board, acting as agent for the U.S. Treasury department, will:* A. buy securities via open-market operations, pushing interest rates up B. buy securities via open-market operations, pushing interest rates down C. sell securities via open-market operations, pushing interest rates down D. sell securities via open-market operations, pushing interest rates up

*Answer* D. sell securities via open-market operations, pushing interest rates up *Explanation* To contract the overall economy, we want to push interest rates up by decreasing the money supply. Higher interest rates make borrowing & spending more difficult for consumers. To decrease the money supply, the FRB will sell securities via open-market operations, putting securities into the banking system & taking money out of the banking system. Reference: 1.3.1 in the License Exam Manual

*Q: The economy is showing that employment is low, there is little consumer demand, & loans for expansion & retooling are way down, showing a lack of business activity. Yet prices for consumer goods are still rising. Economists would call this a period of:* A. deflation B. inflation C. stagnation D. stagflation

*Answer* D. stagflation *Explanation* Inflation is characterized by a rise in prices for goods & services. Stagnation is characterized by high unemployment & lack of growth & business activity. When these occur simultaneously, economists refer to these times as periods of stagflation. Reference: 1.3.2 in the License Exam Manual

*Q: Tools available to the Federal Reserve Board (FRB) include:* A. open-market operations, setting the discount rate, & enacting tax laws B. setting the discount rate, enacting tax laws, & setting the Fed funds rate C. setting the Fed funds rate, setting the prime rate, & setting the discount rate D. open-market operations, setting the discount rate, & setting reserve requirements

*Answer* While engaging in monetary policy to impact the money supply, the FRB has 3 tools: 1. open-market operations 2. setting the discount rate 3. setting reserve requirements Tax laws are fiscal policy & neither the prime rate nor the Fed funds rate is set by the FRB. Reference: 1.3.1 in the License Exam Manual

*Q: All currency held by the public, including coins, checking accts plus time deposits of less than $100,000, & money market mutual funds, is what economists define as:* A. M2 B. the money supply C. M1 D. M3

*Answer* A. M2 *Explanation* M2 Equals all of M1 (currency held by the public including coins & checking accts) + time deposits less than $100,000 & money market mutual funds Reference: 1.3.1 in the License Exam Manual