IAR Economic & Financial Concepts 3 — Questions and Answers
Question 1: When a central bank engages in quantitative easing (QE), it primarily:
- Raises short-term interest rates to reduce inflation
- Purchases longer-term securities to inject money into the economy (Correct answer)
- Issues government bonds to finance deficit spending
- Reduces the money supply by selling assets to commercial banks
Correct answer: Purchases longer-term securities to inject money into the economy
QE involves a central bank buying longer-term financial assets from commercial banks to increase money supply and stimulate lending and investment.
Question 2: A bond trading at a price ABOVE its par value is said to be trading at a:
- Discount
- Yield spread
- Premium (Correct answer)
- Par
Correct answer: Premium
When a bond's market price exceeds its face (par) value, the bond is trading at a premium, which typically means its coupon rate is above current market yields.
Question 3: In portfolio theory, the 'efficient frontier' represents:
- The maximum possible return achievable without any risk
- The set of portfolios offering the highest expected return for each level of risk (Correct answer)
- Government regulations limiting investment in high-risk assets
- The boundary between acceptable and unacceptable investment losses
Correct answer: The set of portfolios offering the highest expected return for each level of risk
The efficient frontier, from Modern Portfolio Theory, plots portfolios that maximize return for a given level of risk, or minimize risk for a given return.
Question 4: The price-to-earnings (P/E) ratio is calculated as:
- Net income divided by total assets
- Market price per share divided by earnings per share (Correct answer)
- Dividends per share divided by earnings per share
- Total revenue divided by outstanding shares
Correct answer: Market price per share divided by earnings per share
The P/E ratio divides the current market price per share by earnings per share, indicating how much investors pay per dollar of earnings.
Question 5: Which economic concept describes the additional output gained from employing one more unit of a production input, holding all other inputs constant?
- Economies of scale
- Marginal product (Correct answer)
- Opportunity cost
- Total factor productivity
Correct answer: Marginal product
Marginal product measures the change in total output resulting from adding one additional unit of a single input while keeping all other inputs fixed.
Question 6: Which of the following best describes 'fiscal policy'?
- Central bank decisions regarding interest rates and money supply
- Government decisions on taxation and public spending to influence the economy (Correct answer)
- International trade agreements affecting import/export tariffs
- Regulatory frameworks governing financial institution solvency
Correct answer: Government decisions on taxation and public spending to influence the economy
Fiscal policy refers to the use of government spending and taxation decisions to influence macroeconomic conditions such as growth, employment, and inflation.
Question 7: When evaluating fixed-income securities, 'duration' primarily measures:
- The number of years until a bond matures
- A bond's sensitivity to changes in interest rates (Correct answer)
- The creditworthiness rating assigned by a rating agency
- The total return earned if held to maturity
Correct answer: A bond's sensitivity to changes in interest rates
Duration measures a bond's price sensitivity to interest rate changes; higher duration means greater price volatility when rates move.
IAR Economic & Financial Concepts 3
When a central bank engages in quantitative easing (QE), it primarily: