2 1 CFA l1 economics questions and answers pdf

CFA LEVEL – ECONOMICS © 2019 AnalystPrep.com All rights reserved By AnalystPrep.com By AnalystPrep.com The Canadian dollar and the Euro share a common feature with most other major currencies in that: A They can be exchanged for a fixed quantity of gold B Their values relative to the UK pound and the US dollar float within tightly controlled bounds C These currencies have value only because of our shared willingness to accept them The correct answer is C Modern currencies are almost all fiat currencies with values relative to other currencies determined by demand and supply There are some exceptions, especially in the case of small economies, where the local currency has a fixed exchange rate with, for example, the US dollar At various points, major currencies were tied to precious metals such as gold, which has the benefit of limiting the central bank’s ability to create inflation by the expansion of the money supply CFA Level 1, Volume 2, Study Session 5, Reading 18 – Monetary and Fiscal Policy, LOS 18b: Describe functions and definitions of money All else being equal, estimate the change in price levels if the money supply increases by 11% A Price levels will decrease by 11% B Price levels will increase by 11% C Price levels will increase at a faster pace (more than 11%) The correct answer is B Quantity Equation of Exchange is: Money supply × Velocity = Price level × Real output (MV=PY) The Equationof Exchange addresses the relationship between money and price level, and between money and nominal GDP If all other variables are constant, then an 11% increase in money supply will increase price levels by 11% © 2019 AnalystPrep.com All rights reserved CFA Level 1, Volume 2, Study Session 5, Reading 18 – Monetary and Fiscal Policy, LOS 18d: describe theories of the demand for and supply of money Suppose that the exchange rate between the Canadian dollar and the Brazilian real is BRL/CAD = 3.27 If the interest rate in Canada is 2.5 percent and the interest rate in Brazil is 8.0 percent, the exchange rate you should expect one year from today is closest to: A BRL/CAD 3.45 B BRL/CAD 3.10 C BRL/CAD 3.53 The correct answer is A To understand the Fisher relationship that links interest rates and forward exchange rates, recognize that an investment in the Canadian dollar should convert to the same number of Brazilian reais (the plural of real), as one would obtain by converting the dollar to reaisand investing it in Brazil That is × 1.025 F = 3.27 × 1.08, where F is the future exchange rate between the Canadian dollar and the real Solving for the future rate, F = 3.27 × (1.08/1.025) = BRL 3.45/CAD CFA Level 1, Volume 2, Study Session 5, Reading 20 – Currency Exchange Rates, LOS 20f: Explain the arbitrage relationship between spot rates, forward rates, and interest rates The effect of imposing additional emissions control requirements on electricity producers can be best characterized as a: A Leftward shift in the electricity supply curve B Leftward movement along the electricity supply curve C Rightward shift of the electricity demand curve The correct answer is A This is most easily understood by recognizing that for any given quantity of electricity production, producers must now receive sufficient extra income to recover the additional cost of the emission control equipment Therefore, this is a leftward movement of the supply curve © 2019 AnalystPrep.com All rights reserved CFA Level 1, Volume 2, Study Session 4, Reading 16 – Aggregate Output, Prices, and Economic Growth, LOS 16h: Explain causes of movements along and shifts in aggregate demand and supply curves Calculate the growth in potential GDP if the growth in technology, labor and capital is 2%, 3%, and 4% respectively Assume that national income allocated to labor compensation is 55% A 5.55% B 5.45% C 5.85% The correct answer is B The growth rate of an economy depends on the rate at which technological advances, labor forces, physical and human capital, and natural resources grow Therefore, these forces can be summarized to the GDP equation as follows: Growth in potential GDP = Growth in technology + WL(growth in labor) + WC(growth in capital), where WL and WC are the relative shares of capital and labor in national income Growth in potential GDP= 2% + (0.55 × 3%) + (0.45 × 4%) = 5.45% CFA Level 1, Volume 2, Study Session 4, Reading 16 – Aggregate Output, Prices, and Economic Growth, LOS 16m:Describe sources, measurement, and sustainability of economic growth For an inferior good, if the price of the good falls in comparison to a normal good, the: A Income effect will reinforce the substitution effect leading to a larger increase in demand B Income effect will offset the substitution effect leading to a smaller increase in demand C Income effect will reinforce the substitution effect leading to a larger decrease in demand © 2019 AnalystPrep.com All rights reserved The correct answer is B The income effect will be negative, and it will be in the opposite direction to the substitution effect Therefore, a reduction in price will, as in the case of a normal good, cause substitution towards the now cheaper good but this effect will be weakened by the income effect, which in the case of an inferior good, is negative CFA Level 1, Volume 2, Study Session 4, Reading 14 – Topics in Demand and Supply Analysis, LOS 14b: Compare substitution and income effects Suppose that for a manufacturer their total costsare currently greater than their total revenue In the short run, the manufacturer should: A Shut down B Shut down if fixed cost is greater than marginal revenue C Shut down if marginal cost is greater than marginal revenue The correct answer is C In the short run, if marginal revenue is greater than marginal cost, any revenue that is left over after paying the variable costs can be used to pay for some portion of the fixed costs This is a better outcome than shutting down and not recovering any of the fixed costs CFA Level 1, Volume 2, Study Session 4, Reading 14 – Topics in Demand and Supply Analysis, LOS 14e: Determine and describe breakeven and shutdown points of production Calculate the 4-firm Herfindahl-Hirschman Index of Tech Inc., Sun Systems, LiteC.org, and Git firms with market shares of 32%, 20%, 31%, and 17% respectively A 1.0000 B 0.2674 C 0.5171 © 2019 AnalystPrep.com All rights reserved The correct answer is B The Herfindahl-HirschmanIndex (HHI) is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them 4-firm HHI = 0.322+0.202+0.312+0.172 = 0.2674 CFA Level 1, Volume 2, Study Session 4, Reading 15– The Firm and Market Structures, LOS 15g:Describe the use and limitations of concentration measures in identifying market structure Suppose the GDP deflator for Brazil was 120.0 in 2012 and 211.5 in 2017 This indicates an inflation rate of: A 9.8% B 15.3% C 12.0% The correct answer is C (211.5/120.0)1/5 -1 = 0.12, or 12.0 percent CFA Level 1, Volume 2, Study Session 4, Reading 16 – Aggregate Output, Prices, and Economic Growth, LOS 16c: Compare nominal and real GDP and calculate and interpret the GDP deflator 10 An economy is operating at full employment when the government eliminates sales taxes This will most likely result in: A Cost-push inflation B Supply-push inflation C Demand-pull inflation © 2019 AnalystPrep.com All rights reserved The correct answer is C Eliminating the sales tax, all else equal, will increase consumption spending This is a rightward shift in aggregate demand and if the economy is already at or near full employment, demandpull inflation is the most likely consequence CFA Level 1, Volume 2, Study Session 4, Reading 17 – Understanding Business Cycles, LOS 17h: distinguish between cost-push and demand-pull inflation 11 If the economy is at or near full employment, a sudden and unanticipated reduction in the availability of a key resource such as electricity is most likely to: A Shift aggregate supply to the left resulting in higher GDP B Shift aggregate supply to the left resulting in higher prices C Shift aggregate demand to the left causing a higher price level The correct answer is B A sudden and unanticipated reduction in the availability of a key resource is most likely to shift aggregate supply to the left resulting in higher prices The famous example of this was the oil price shock from actions by OPEC which resulted in stagflation Output shrank while the inflation rate rose CFA Level 1, Volume 2, Study Session 4, Reading 16 – Aggregate Output, Prices, and Economic Growth, LOS 16j: Distinguish between the following types of macroeconomic equilibria: longrun full employment, short-run recessionary gap, short-run inflationary gap, and short-run stagflation 12 Weaknesses of the CPI as a tool to measure the rate of inflation include: A Overrepresentation of the purchases made by farmers and other rural residents B Failure to account for changes over time in the nature or quality of goods included C Over sensitivity to changes in gasoline prices © 2019 AnalystPrep.com All rights reserved The correct answer is B The CPI is a weighted basket of purchases by urban consumers, in which the weights represent budget shares If the items are weighted by budget share, then changes in the price of gasoline or any other component will be reasonably represented in the index CFA Level 1, Volume 2, Study Session 4, Reading 17 – Understanding Business Cycles, LOS 17i: Interpret a set of economic indicators and describe their uses and limitations 13 In November of 2008, Zimbabwe had an estimated monthly inflation rate of 79.6 billion percent If nominal annual GDP increased by 1,000 percent, then: A Real GDP also increased B Real GDP declined C The change in real GDP cannot be estimated without knowing the change in wages The correct answer is B This was a hyperinflation during which workers were typically paid more frequently than once per day, and the value of the Zimbabwe dollar plummeted The change in nominal GDP would have to exceed the rate of inflation to represent an increase in real GDP CFA Level 1, Volume 2, Study Session 4, Reading 17 – Understanding Business Cycles, LOS 17e: Explain inflation, disinflation, and deflation 14 Which of the following best describes a market structure with only one buyer? A Monopoly B Monopolistically competitive market C Monopsony © 2019 AnalystPrep.com All rights reserved The correct answer is C A monopsony has only one buyer whereas a monopoly has one seller but many buyers A monopolistically competitive market has many buyers and fairly many sellers CFA Level 1, Volume 1, Study Session 3, Reading 16 – Aggregate Output, Prices, And Economic Growth, LOS 16d: compare GDP, national income, personal income, and personal disposable income 15 For the years 1981, 1982 and 1983, the year to year changes in the Canadian CPI were 10.0, 12.5 and 10.9 percent, respectively For 1984 and 1985, although prices continued to rise, the year to year changes declined to 5.8 and 4.3 percent, respectively The 1984 and 1985 changes most likely indicate a period of: A Disinflation B Deflation C Stagflation The correct answer is A Disinflation is a reduction in the rate of inflation It occurs when the rate at which the prices are risingis diminishing Deflation is a decrease in the price level Stagflation is an economic phenomenon marked by slow economic growth and rising prices CFA Level 1, Volume 1, Study Session 3, Reading 17 – Understanding Business Cycles, LOS 17e: Explain inflation, hyperinflation, disinflation, and deflation © 2019 AnalystPrep.com All rights reserved 16 A small island nation has the following economic characteristics: Account (in billions dollars) Government expenditures Current account balance Consumption Investment Capital depreciation allowance Exports Imports 100 350 10 10 The GDP of this country (in billions dollars) is closest to: A 456 B 449 C 447 The correct answer is A GDP = C+I+G+(X-M) = [Consumption + Investment + Government expenditures + Net exports] = 350 + 10 + 100 + (6-10) = 456 CFA Level 1, Volume 2, Study Session 4, Reading 16 – Aggregate Output, Prices, and Economic Growth, LOS 16a: Calculate and explain gross domestic product (GDP) using expenditure and income approaches 17 Consider the following table for a country’s nominal GDP and corresponding GDP deflators Year 1995 2000 2005 2010 2015 Nominal GDP 290 310 360 342 375 © 2019 AnalystPrep.com All rights reserved GDP deflator 85 90 100 115 118 73 Debora Eaton is analyzing money supply and demand in the nation of Nigeria Based on her preliminary findings, Eaton has determined that the interest rate where there will be no excess money balances is 6.5% Holding all else constant, if bonds offer an interest rate of 6.2%: A Bond prices will increase B Bond supply will increase C Individuals will decrease their money holdings The correct answer is B If bonds offer a rate below the equilibrium rate of interest - in this case, below 6.5% - there would be an excess demand for money with individuals seeking to increase their money holdings as corporations and individuals sell their bonds The higher selling activity will increase the supply of bonds In doing so, the prices of bonds will fall and the interest rate offered will increase until it reaches its equilibrium CFA Level 1, Volume 2, Study Session 5, Reading 18 – Monetary and Fiscal Policy, LOS 18d: describe theories of the demand for and supply of money 74 If the income effect dominates the substitution effect, the impact of higher interest rates on the level of savings is most likely: A Neutral B Positive C Negative The correct answer is C If the income effect dominates the savings effect, higher interest rates will suggest less savings are required to attain a given sum of money for the future, resulting in individuals substituting present consumption for future consumption In this event, it is possible to observe higher interest rates resulting in lower savings CFA Level 1, Volume 2, Study Session 4, Reading 14 – Topics in Demand and Supply Analysis, LOS 14b: compare substitution and income effects © 2019 AnalystPrep.com All rights reserved 75 Recordia is a German seller of smart music players Recordia’s monthly supply of music players is given by the equation: Qssp = - 50.5 + 28.5Psp – 4.5W where Qssp is the number of smart music players sold, Psp is the price of players sold in euros, and W is the wage rate in euros paid by smart music player sellers to laborers The per unit price of a smart music player is €225 and wage is €13.50 There are currently five sellers producing smart music players identical to Recordia Based on the data provided, the slope of the aggregate market supply curve is closest to: A 0.007 B 50.500 C 142.500 The correct answer is A The slope of the supply curve is the coefficient on Qsp in the inverse supply function The inverse supply function is calculated below Holding W constant at 13.50 and inserting it in the supply function provided, the value of Psp needs to be determined Qssp = 5[- 50.5 + 28.5Psp – 4.5(13.5)] = - 556.25 + 142.5Psp Inverting the supply function, Psp = 3.904 + 0.007 Qssp CFA Level 1, Volume 2, Study Session 4, Reading 16 – Aggregate Output, Prices, and Economic Growth, LOS 16g: explain the aggregate supply curve in the short run and long run 76 A decrease in the price of a good is followed by a decrease in consumption if: A The good is normal B The income effect dominates the substitution effect and the good is inferior C Positive income effect dominates the substitution effect and the good is Giffen © 2019 AnalystPrep.com All rights reserved The correct answer is B A decrease in the price of a good will result in the consumer reducing its purchases if the good is inferior and the income effect dominates the substitution effect Although a decrease in price will cause a consumer to buy more, the effect is mitigated due to the income effect; the consumer will want to purchase less of that good as income rises In the case of Giffen goods, a decrease in price will decrease consumption if the decrease in price is strong enough, as well as negative, to overpower the substitution effect CFA Level 1, Volume 2, Study Session 4, Reading 14 – Topics in Demand and Supply Analysis, LOS 14b: compare substitution and income effects 77 The table below summarizes financial data for ABC Inc., which was incorporated on January 1, 2017 Total revenue ($) 38,560 Total economic costs ($) 25,315 Accounting profit 15,000 Cost of equity capital (%) 12% The level of accounting profit needed to cover the opportunity costs of capital is closest to: A $1,755 B $13,245 C $25,315 The correct answer is A The level of accounting profit needed to cover the opportunity costs of capital is defined as normal profit Economic profit = Total revenue – Total economic costs = $38,560 – $25,315 = $13,245 Accounting profit = Economic profit + Normal profit Normal profit = Accounting profit – Economic profit = $15,000 – $13,245 = $1,755 © 2019 AnalystPrep.com All rights reserved CFA Level 1, Volume 2, Study Session 4, Reading 15 – The Firm and Market Structures, LOS 15a: Describe characteristics of perfect competition, monopolistic competition, oligopoly, and pure monopoly 78 A fiscal policy may not be able to stabilize aggregate demand completely because: I Relevant data often appears well before a policy decision needs to be made II There is uncertainty on where the economy will be heading independent of policy changes III Private sector behavior may change as discretionary fiscal adjustments are announced A I, II and III B I and III C Only I The correct answer is A The fiscal policy may not be able to stabilize aggregate demand completely, as a policymaker may not have complete information on how the economy functions For instance, it may take several months for a policymaker to realize an economy is slowing because data may appear with a considerable lag Secondly, there is uncertainty of where the economy will be heading independent of policy changes Thirdly, when fiscal adjustments are announced, private sector behavior may change, leading to rises in consumption or investment, both of which will reinforce the effects of a rise in government expenditure CFA Level 1, Volume 2, Study Session 5, Reading 18 – Monetary and Fiscal Policy, LOS 18s: determine whether a fiscal policy is expansionary or contractionary © 2019 AnalystPrep.com All rights reserved 79 The table below illustrates economic data concerning Giyata (local currency, GT), a developing country in Africa (in million GT) Domestic business investment in capital goods 45.7 Domestic business investment in inventories 23.6 Exports 12.2 Domestic business investment in owner-occupied property Government spending on final goods and services 21.0 28.8 Transfer payments 8.9 Imports 10.5 Net tax revenue collections 14.2 The GDP for Giyata, based on the expenditure approach, is closest to (in GT millions): A 99.8 B 122.9 C 143.9 The correct answer is A All figures are in GT millions GDP = Consumer spending on final goods and services + Gross domestic private investment + Government spending on final goods and services + (Exports – Imports) GDP = 45 + 23.6 + 28.8 + (12.2 – 10.5) = 99.8 Gross domestic private investment includes business investment in capital goods and inventory investment Transfer payments are not included in government spending on final goods and services because they are a monetary transfer by the government of tax revenue back to individuals with no corresponding receipt of goods and services © 2019 AnalystPrep.com All rights reserved CFA Level 1, Volume 2, Study Session 4, Reading 16 – Aggregate Output, Prices, and Economic Growth, LOS 16a: calculate and explain gross domestic product (GDP) using expenditure and income approaches 80 In an effort to boost economic growth, the ratio of government spending to tax collection revenue in Belarus has exceeded 1.0 for the past two years This trend is expected to continue for the foreseeable future For the aggregate income to equal aggregate expenditure, the: A Country should run a trade surplus B Country should increase foreign borrowings C Private sector should increase domestic investment The correct answer is B When a country runs a fiscal deficit, G – T > 0, the private sector must save more than it invests S – I > 0, the country should run a trade deficit (X – M < 0) with a corresponding inflow of foreign saving, or both CFA Level 1, Volume 2, Study Session 5, Reading 18 – Monetary and Fiscal Policy, LOS 18s: explain the implementation of fiscal policy and difficulties of implementation 81 In the year 2013, the quantity of money on hand in a country, in local currency units, amounted to 450 million During the year, the average number of times the local currency changed hands was equal to 58 The country’s GDP, in real terms, amounted to 300 million If money neutrality holds and all else is held constant, an increase in the supply of money by 2% will most likely: A Decrease velocity to 56.86 B Increase price level to 88.74 C Increase real output to $306 million © 2019 AnalystPrep.com All rights reserved The correct answer is B Based on the quantity theory of money, if money neutrality holds, then an increase in the money supply (M) will not affect Y, real output, or the speed with which money changes hands, V However, it would cause the aggregate price level to rise To determine the level to which price level rises, the following equation is used: M×V=P×Y P (before increase in money supply) = (450,000,000 × 58)/300,000,000 = 87.00 P (after increase in money supply) = 87 × 1.02 = 88.74 CFA Level 1, Volume 2, Study Session 5, Reading 19 – International Trade and Capital Flows, LOS 19d: Explain the Ricardian and Heckscher–Ohlin models of trade and the source(s) of comparative advantage in each model 82 Which of the following fiscal stances will be most effective in boosting aggregate demand? A Expanding the supply of money B Exploration of natural resources C Enhanced public spending on social goods The correct answer is C An expansionary fiscal policy helps in boosting aggregate demand An expansionary policy can include enhanced (new) public spending on schools, social goods, hospitals and infrastructure CFA Level 1, Volume 2, Study Session 5, Reading 19 – International Trade and Capital Flows, LOS 19n: An expansionary fiscal policy helps in boosting aggregate demand An expansionary policy can include enhanced (new) public spending on schools, social goods, hospitals and infrastructure © 2019 AnalystPrep.com All rights reserved 83 Currently, the USD/GBP spot rate is 1.6736, while the three month forward rate is 1.6745 Which of the following is the best interpretation of the forward discount/premium? A The interest rates in Great Britain are higher than those in United States B The real value of the USD/GBP spot rate will appreciate in the next 90 days C The interest rates in the United States are higher than those in Great Britain The correct answer is C The GBP is selling at a forward premium of 0.009 (1.6745 – 1.6736) A forward premium indicates that interest rates in the foreign currency (the United States, which uses dollars) are higher than those in the base currency (Great Britain, which uses the pound) CFA Level 1, Volume 2, Study Session 5, Reading 20 – Currency Exchange Rates, LOS 20a: define an exchange rate and distinguish between nominal and real exchange rates and spot and forward exchange rates 84 The Moroccan government authorities have launched a program whereby they intend to enhance spending on public infrastructure as well as develop schools and hospitals To offset the effects of the fiscal policy, the country’s central bank is reducing money supply What are the implications of the two policies on Morocco’s economy? A Interest rates will be reduced B Reduction in private sector demand C Growth in private and public sectors The correct answer is B An easy fiscal policy will lead to a rise in aggregate output If this policy is accompanied by a tight monetary policy, interest rates will rise and have a negative effect on private sector demand While the public sector may expand due to increased government spending, the private sector will shrink due to a fall in demand CFA Level 1, Volume 2, Study Session 5, Reading 18 - Monetary and Fiscal Policy - LOS 18s: determine whether a fiscal policy is expansionary or contractionary © 2019 AnalystPrep.com All rights reserved 85 If the market demand for a product always responds positively to an increase in price resulting in a positively sloped demand curve, the product is most likely classified as: A Giffen B Normal C Inferior The correct answer is A In the case of Giffen goods, the magnitude of the income effect is larger and negative such that it overpowers the substitution effect This will result in a positively sloped demand curve and will imply that consumers will buy more (less) of the product when price increases (decreases) In the case of normal goods, the market demand’s response to price changes is always inverse; a decrease in price will increase quantity demanded producing a negatively sloped demand curve In the case of inferior, non-Giffen goods, an increase in income will cause the consumer to buy less of the good Demand curves are negatively sloped for inferior goods in general CFA Level 1, Volume 2, Study Session 5, Reading 20 – Currency Exchange Rates, LOS 20h: calculate and interpret the forward rate consistent with the spot rate and the interest rate in each currency 86 Holding wages and labor constant, what will be the impact on the aggregate supply curve of Canada if the government decides to increase corporate income taxes and decrease the maximum labor hours per day? A Decrease in the aggregate supply B Increase in the aggregate supply C Both decisions have different impacts on aggregate supply The correct answer is A An increase in taxes will increase the input prices Thus, producers will produce less output A decrease in labor hours (holding wages and labor constant) will decrease productivity, decreasing aggregate supply © 2019 AnalystPrep.com All rights reserved CFA Level 1, Volume 2, Study Session 4, Reading 16 – Aggregate Output, Prices, and Economic Growth, LOS 16l: Analyze the effect of combined changes in aggregate supply and demand on the economy 87 Primary objectives of fiscal policy are typically to: A Ensure stable prices and low-interest rates B Control inflation and unemployment C Manage the economy through the government's ability to influence GDP The correct answer is C Because government expenditures are a significant part of aggregate demand, the government can directly alter GDP It can also adjust taxes and other policies to influence aggregate demand and aggregate supply Monetary policy is better suited to addressing price stability and interest rates CFA Level 1, Volume 2, Study Session 5, Reading 18 – Monetary and Fiscal Policy, LOS 18o: describe roles and objectives of fiscal policy 88 Which of the following measures would most likely be necessary for a country with a ''high capital per labor'' to increase the growth in its GDP? A Increased growth in technology B Increased capital C Increased labor supply The correct answer is A In developed countries where capital per labor is high, an economy will experience diminishing marginal productivity For these countries, economists argue that growth in GDP can only be achieved by growth in technology CFA Level 1, Volume 2, Study Session 4, Reading 16 – Aggregate Output, Prices, and Economic Growth, LOS 16o: distinguish between input growth and growth of total factor productivity as components of economic growth © 2019 AnalystPrep.com All rights reserved 89 All else being equal, a larger money supply most likely: A Raises market interest rates B Has no effect on market interest rates C Lowers market interest rates The correct answer is C All else being equal, a larger money supply lowers market interest rates Conversely, a tighter money supply tends to raise market interest rates The current level of liquid money (supply) coordinates with the total demand for liquid money (demand) to help determine interest rates CFA Level 1, Volume 2, Study Session 5, Reading 18 – Monetary and Fiscal Policy, LOS 18k: explain the relationships between monetary policy and economic growth, inflation, interest, and exchange rates 90 What is the most likely effect of a contractionary monetary policy at the same time as an expansionary fiscal policy? A Aggregate demand increases, while interest rates increase B Inconclusive effect on aggregate demand, and interest rates increase C Inconclusive effect on aggregate demand, and interest rates decrease The correct answer is B Interest rates will increase due to the contractionary monetary policy Government spending will increase aggregate demand, but interest rates will have an opposite effect Therefore, the effect on aggregate demand is inconclusive and depends on the elasticity of demand for interest rate sensitive purchases CFA Level 1, Volume 2, Study Session 5, Reading 18 – Monetary and Fiscal Policy, LOS 18t: explain the interaction of monetary and fiscal policy © 2019 AnalystPrep.com All rights reserved 91 Which of the following measures of price index excludes energy and food items from the basket for calculation purposes? A Core inflation B Headline inflation C Wholesale price index The correct answer is A Core inflation refers to the price index that excludes energy and food items from the basket for calculation purposes because food and energy prices are deemed too volatile CFA Level 1, Volume 2, Study Session 4, Reading 17 – Understanding Business Cycles, LOS 17i: Interpret a set of economic indicators and describe their uses and limitations 92 In which of the following exchange rate strategies can a country make an explicit commitment to exchange its domestic currency for a specified foreign currency at a fixed rate? A Currency board arrangement B Monetary union C Target zone The correct answer is A In a currency board arrangement, a country makes an explicit commitment to exchange its domestic currency for a specified foreign currency at a fixed rate CFA Level 1, Volume 2, Study Session 5, Reading 20 – Currency Exchange Rates, LOS20i: describe exchange rate regimes © 2019 AnalystPrep.com All rights reserved 93 An investor is interested in earning risk-free profit on 100 United Arab Emirates Dirham (DUB) He finds out that the DUB/CAD exchange rate is 0.4, and the futures exchange rate DUB/CAD one year from today is 0.45 Given that the risk-free interest rate in Canada is 5%, and the risk-free rate in the United Arab Emirates is only 2%, the amount of risk-free profit earned in terms of DUB is closest to: A 18.125 B 16.125 C 12.5 The correct answer is B 100 DUB invested = 100/0.4 = 250 CAD invested Interest earned = 250 CAD×5% = 12.5 CAD Thus, the total amount = 250 CAD + 12.5 CAD = 262.5 CAD 262.5 CAD converts into (250×0.45) = 118.125 DUB in the future Interests earned in Dubai would be 2%×100 DUB = DUB Therefore, profit = 118.125 DUB - 100 DUB - DUB = 16.125 DUB CFA Level 1, Volume 2, Study Session 5, Reading 20 – Currency Exchange Rates, LOS 20f: Explain the arbitrage relationship between spot rates, forward rates, and interest rates 94 Russia can produce, at maximum capacity, 30 million litres of beer and million liters of vodka, while Ukraine can produce 35 million liters of beer and 21 million liters of vodka Which of the following statements is/are accurate? I Ukraine has an absolute advantage in the production of both products II Ukraine has a comparative advantage in the production of beer III Ukraine has a comparative advantage in the production of vodka A I & II only B I & III only C II & III only © 2019 AnalystPrep.com All rights reserved The correct answer is B Absolute advantage goes to the more productive country In this case, Ukraine has the absolute advantage in producing both products Comparative advantage goes to the low opportunity cost producer The opportunity cost of beer in Ukraine and Russia is respectively 21/35 and 6/30 Since the opportunity cost of Russia is lower (6/30 < 21/35), it has a comparative advantage in the production of beer The opportunity cost of vodka in Ukraine and Russia is respectively 35/21 and 30/6 Therefore, Ukraine has a comparative advantage in the production of vodka CFA Level 1, Volume 2, Study Session 5, Reading 19 – International Trade and Capital Flow, LOS 19c: Distinguish between comparative advantage and absolute advantage 95 The CPIs of India and Pakistan are 132 and 121, respectively If the nominal exchange rate is 1.32 PKR/INR, then the real exchange rate for India is closest to: A 1.78 B 1.44 C 1.12 The correct answer is B Real exchange rate = Nominal exchange rate × (Domestic inflation/Foreign inflation) = 1.32× (132/121) = 1.44 We could also arrive at the same conclusion using the following formula: Real exchange rate = Nominal exchange rate × (Foreign inflation/Domestic inflation) = (1/1.32) × (121/132) = 0.6944 1/0.6944 = 1.44 Note: The numerators and denominators (PKR and INR) have to cancel each other out in all circumstances CFA Level 1, Volume 2, Study Session 5, Reading 20 – Currency Exchange Rates, LOS 20a: Define an exchange rate and distinguish between nominal and real exchange rates and spot and forward exchange rates © 2019 AnalystPrep.com All rights reserved 96 Which of the following is least likely to be used as a pricing strategy in a monopoly? A Single price strategy B Interdependent pricing C Discriminating pricing strategy The correct answer is B Single price and discriminating pricing strategies are used by firms in a monopoly form of market structure Interdependent prices are a characteristic of the kinked demand curve in an oligopoly CFA Level 1, Volume 2, Study Session 4, Reading 15 – The Firm and Market Structures, LOS 15a: describe characteristics of perfect competition, monopolistic competition, oligopoly, and pure monopoly 97 If the money supply curve shifts to the left, interest rates will most likely: A Increase B Decrease C Remain unaffected in the short-run The correct answer is A A leftward shift in the money supply curve will create excess demand for money, and households and firms will sell securities, which will increase interest rates CFA Level 1, Volume 2, Study Session 5, Reading 18 – Monetary and Fiscal Policy, LOS 18a: compare monetary and fiscal policy © 2019 AnalystPrep.com All rights reserved ... JPY/CHF = 12 0 . 3 21 1 CAD/JPY = 1/ 99.00 01 = 0. 010 1 01 © 20 19 AnalystPrep.com All rights reserved GBP/CAD = 0.5556 1. 5903 × 0.8833 × 12 0 . 3 21 1 × 0. 010 1 01 × 0.5556 = 0.948558 CFA Level 1, Volume 2, Study... closest to: A 2. 011 1 B 3. 024 8 C 4.8 524 The correct answer is B HHI = 0. 522 + 0 .1 52 + 0 .1 32 + 0. 12 2 + 0.0 82 = 0.3306 Equivalent number of firms = 1/ HHI = 1/ 0.3306 = 3. 024 8 CFA Level 1, Volume 2, Study... CAD/USD = 0.88 31 USD/CAD = 1/ 0.88 31 = 1. 1 324 EUR EUR USD ∗ USD = = 1 .23 41 ∗ 1. 1 324 = 1. 3975 CAD CAD 1. 3975 × $760,000 = $1, 0 62, 10 0 CFA Level 1, Volume 2, Study Session 5, Reading 20 – Currency