CFA Economics for Investment Analysis 1 — Questions and Answers
Question 1: In the CFA curriculum, which phase of the business cycle is characterized by rising GDP, declining unemployment, and increasing inflation?
- Trough
- Contraction
- Expansion (Correct answer)
- Peak
Correct answer: Expansion
During an expansion, economic output (GDP) rises, unemployment falls, and inflation tends to increase as demand outpaces supply.
Question 2: The Fisher Effect describes the relationship between nominal interest rates, real interest rates, and inflation as:
- Nominal rate = Real rate + Expected inflation (Correct answer)
- Real rate = Nominal rate + Expected inflation
- Nominal rate = Real rate × Expected inflation
- Real rate = Nominal rate × (1 – Tax rate)
Correct answer: Nominal rate = Real rate + Expected inflation
The Fisher Effect: nominal interest rate ≈ real interest rate + expected inflation rate; lenders demand compensation for both the time value of money and expected purchasing power erosion.
Question 3: Monetary policy transmission to the real economy occurs PRIMARILY through which channel?
- Government fiscal expenditure programs
- Changes in short-term interest rates that affect borrowing costs, asset prices, and exchange rates (Correct answer)
- Tariff and trade policy adjustments by the central bank
- Direct central bank loans to private businesses
Correct answer: Changes in short-term interest rates that affect borrowing costs, asset prices, and exchange rates
Central banks adjust short-term interest rates, which then transmit to borrowing costs, investment decisions, asset prices, currency values, and ultimately aggregate demand and inflation.
Question 4: Which of the following BEST describes stagflation?
- High growth combined with low inflation
- High unemployment combined with high inflation and stagnant growth (Correct answer)
- Low unemployment with rapidly rising wages
- Deflation during a period of strong economic growth
Correct answer: High unemployment combined with high inflation and stagnant growth
Stagflation is the combination of high inflation, high unemployment, and weak economic growth — a situation that is difficult to address because standard policy tools involve trade-offs.
Question 5: Purchasing Power Parity (PPP) theory suggests that, in the long run, exchange rates will adjust so that:
- All countries have identical interest rates
- The price of a basket of goods is the same in all countries when expressed in a common currency (Correct answer)
- Trade balances must equal zero for all trading partners
- Inflation rates converge to zero globally
Correct answer: The price of a basket of goods is the same in all countries when expressed in a common currency
PPP holds that exchange rates should equalize the purchasing power of currencies by adjusting to offset inflation differentials between countries.
Question 6: Which of the following is considered a leading economic indicator?
- Unemployment rate
- Industrial production
- Average weekly hours worked in manufacturing (Correct answer)
- Consumer Price Index (CPI)
Correct answer: Average weekly hours worked in manufacturing
Average weekly hours worked in manufacturing is a leading indicator because firms adjust hours before hiring or laying off workers, signaling future employment and output trends.
