CFA Economics for Investment Analysis 2 — Questions and Answers
Question 1: The J-curve effect describes how a country's trade balance initially worsens after a currency depreciation because:
- Imports become cheaper immediately, increasing import volumes
- Import and export volumes adjust slowly while prices change immediately, causing the trade deficit to temporarily widen (Correct answer)
- Trading partners retaliate with tariffs, reducing exports further
- Domestic inflation immediately erodes the competitive advantage
Correct answer: Import and export volumes adjust slowly while prices change immediately, causing the trade deficit to temporarily widen
After depreciation, import prices rise and export prices fall immediately, but trade volumes adjust slowly; the short-term effect is a wider trade deficit before volumes respond to improve the balance.
Question 2: In the context of CFA economics, an expansionary fiscal policy is MOST likely to lead to which of the following in the short run?
- Higher government spending or lower taxes leading to increased aggregate demand and GDP (Correct answer)
- Reduced money supply causing deflation
- Appreciation of the domestic currency due to higher interest rates
- Decreased consumer spending due to Ricardian equivalence in all cases
Correct answer: Higher government spending or lower taxes leading to increased aggregate demand and GDP
Expansionary fiscal policy (increased spending or tax cuts) directly boosts aggregate demand, leading to higher short-run GDP and potentially higher employment.
Question 3: The concept of 'crowding out' in economics refers to:
- Government deficits reducing private investment by driving up interest rates (Correct answer)
- Central bank bond purchases eliminating private sector bond markets
- High corporate taxes reducing business formation
- Excessive imports crowding out domestically produced goods
Correct answer: Government deficits reducing private investment by driving up interest rates
Crowding out occurs when government borrowing increases interest rates, raising the cost of capital and reducing private sector investment spending.
Question 4: Which of the following central bank tools directly controls the money supply by influencing bank reserves?
- Discount rate changes
- Open market operations (buying/selling government securities)
- Reserve requirement changes
- Both B and C (Correct answer)
Correct answer: Both B and C
Open market operations directly affect bank reserves by injecting or withdrawing cash, while changing reserve requirements alters how much of those reserves banks must hold vs. lend out.
Question 5: Covered interest rate parity (CIP) states that the forward exchange rate between two currencies is determined by:
- Relative inflation rates between the two countries
- The differential in interest rates between the two countries (Correct answer)
- Relative purchasing power in each country
- Central bank intervention in the foreign exchange market
Correct answer: The differential in interest rates between the two countries
CIP requires the forward exchange rate to reflect the interest rate differential between two countries; otherwise, risk-free arbitrage profits would be available.
Question 6: Which economic concept explains why some countries specialize in producing certain goods even if they are absolutely less efficient than their trading partners?
- Absolute advantage
- Comparative advantage (Correct answer)
- Economies of scale
- Factor endowment theory
Correct answer: Comparative advantage
Comparative advantage shows that countries benefit from specializing in goods where they have the lowest opportunity cost, even if a trading partner is better at producing everything.
CFA Economics for Investment Analysis 2
The J-curve effect describes how a country's trade balance initially worsens after a currency depreciation because: