RIA Economic & Financial 2 — Questions and Answers

Question 1: Which economic indicator is considered a leading indicator of future economic activity?

Unemployment rate
GDP growth rate
Building permits issued (Correct answer)
Consumer Price Index

Correct answer: Building permits issued

Building permits are a leading indicator because they signal future construction activity before it occurs.

Leading indicators change before the economy as a whole changes. Building permits predict future construction spending and employment. Unemployment rate and GDP are lagging/coincident indicators that reflect what has already happened.

Question 2: The yield curve inverts when:

Short-term rates exceed long-term rates (Correct answer)
Long-term rates exceed short-term rates
All rates are equal
The Fed raises the discount rate

Correct answer: Short-term rates exceed long-term rates

An inverted yield curve occurs when short-term interest rates are higher than long-term rates, often signaling recession.

Normally, long-term bonds yield more than short-term bonds to compensate for time risk. When the yield curve inverts (short-term > long-term), it typically signals that investors expect future economic slowdown or recession, as they seek safety in long-term bonds, driving their prices up and yields down.

Question 3: What does a P/E ratio measure?

Price relative to earnings (Correct answer)
Profit relative to equity
Price relative to book value
Profit relative to expenses

Correct answer: Price relative to earnings

The Price-to-Earnings ratio measures how much investors pay for each dollar of earnings.

The P/E ratio is calculated by dividing the stock price by earnings per share (EPS). A high P/E may indicate investors expect high growth; a low P/E may indicate undervaluation or low growth expectations. It's one of the most widely used valuation metrics.

Question 4: Stagflation is characterized by:

High growth and low inflation
Low growth and low inflation
High inflation and high unemployment (Correct answer)
Low unemployment and high growth

Correct answer: High inflation and high unemployment

Stagflation combines stagnant economic growth with high inflation and unemployment.

Stagflation is an unusual economic condition where slow growth, high unemployment, and high inflation occur simultaneously. It challenges traditional economic policy because measures to combat inflation (raising rates) can worsen unemployment, and vice versa. The 1970s oil crisis is a classic example.

Question 5: Which type of risk cannot be eliminated through diversification?

Unsystematic risk
Company-specific risk
Systematic risk (Correct answer)
Credit risk

Correct answer: Systematic risk

Systematic risk (market risk) affects the entire market and cannot be diversified away.

Systematic risk includes factors like interest rate changes, recessions, and geopolitical events that affect all securities. Unlike unsystematic (idiosyncratic) risk, which can be reduced through diversification, systematic risk remains regardless of how many securities are held in a portfolio.

Question 6: The Federal Reserve's primary tool for implementing monetary policy is:

Fiscal spending
Tax policy
Open market operations (Correct answer)
Trade tariffs

Correct answer: Open market operations

The Fed conducts open market operations—buying and selling Treasury securities—to influence money supply and interest rates.

Open market operations allow the Fed to expand or contract the money supply. When the Fed buys securities, it injects money into the banking system (expansionary). When it sells securities, it removes money (contractionary). This directly influences the federal funds rate and overall economic conditions.

RIA Economic & Financial 2

Which economic indicator is considered a leading indicator of future economic activity?