NASAA Series 65 — All Questions

During the contraction phase of the business cycle, which of the following typically occurs?

• a.Gross domestic product rises for at least two consecutive quarters
• b.Unemployment rises while corporate profits tend to decline✓
• c.Central banks typically raise rates to cool demand
• d.Consumer spending accelerates and profits expand

A contraction is marked by falling output, rising unemployment, weakening demand and declining corporate profits. Two consecutive quarters of rising GDP describe an expansion, not a contraction, and accelerating consumer spending with expanding profits is the expansion pattern. Central banks generally cut rates during downturns to stimulate activity; raising them to cool demand is typical of the late-expansion or peak phase.

An economist states that the money supply and general price level tend to move together over time. This view is most closely associated with which school of thought?

• a.Monetarist economics✓
• b.Keynesian economics
• c.Supply-side economics
• d.Behavioral economics

Monetarists, led by Milton Friedman, argue that changes in the money supply are the primary driver of inflation and nominal output. Keynesians emphasize aggregate demand and fiscal policy. Supply-siders focus on tax and regulatory incentives to production.

Which government body sets U.S. monetary policy by adjusting the federal funds target and open market operations?

• a.The Federal Open Market Committee of the Federal Reserve✓
• b.The Council of Economic Advisers within the Executive Office of the President
• c.The Securities and Exchange Commission, through its regulation of securities markets
• d.The U.S. Treasury Department, through its management of federal debt issuance

Monetary policy is conducted by the Federal Reserve, and specifically the Federal Open Market Committee (FOMC), which sets the federal funds target and directs open market operations. The Council of Economic Advisers only advises the President and sets no rates. The Treasury manages federal debt and, with Congress, conducts fiscal policy such as taxing and spending. The SEC regulates securities markets, not the money supply.

An investor expects $10,000 in 5 years and wants its present value at a 6% annual discount rate. Which statement is correct?

• a.A higher discount rate would raise the present value
• b.The present value equals $10,000 multiplied by 1.06 raised to the fifth power
• c.The present value is greater than $10,000
• d.The present value equals $10,000 divided by 1.06 raised to the fifth power✓

Present value discounts a future amount back to today by dividing by (1 + rate) raised to the number of periods. Because money has time value, the present value is less than the future $10,000. A higher discount rate lowers, not raises, present value.

A portfolio has an expected return of 9% and a standard deviation of 12%. What does the standard deviation measure?

• a.The portfolio's sensitivity to movements in the overall market relative to a benchmark index
• b.The excess of the portfolio's 9% expected return over the return on Treasury bills
• c.The strength of the linear relationship between the portfolio's returns and those of a benchmark
• d.The dispersion or variability of the portfolio's returns around its mean✓

Standard deviation is a statistical measure of total volatility, showing how widely returns are dispersed around their average. Sensitivity to the overall market is measured by beta, not standard deviation. The excess of expected return over the risk-free rate is a risk premium, a measure of reward rather than risk. The strength of co-movement with a benchmark is correlation, a separate statistic.

Two assets have a correlation coefficient of -1.0. What is the diversification implication?

• a.The assets are unrelated and move independently, offering moderate diversification
• b.The assets move perfectly together, so combining them provides no diversification benefit
• c.The assets move exactly opposite, offering maximum diversification benefit✓
• d.The assets move exactly opposite, so the portfolio's expected return must be zero

A correlation of -1.0 means two assets move in exactly opposite directions, so losses in one can be offset by gains in the other, giving the greatest diversification benefit. Independent movement describes a correlation near zero and gives only moderate benefit. A correlation of +1.0 describes assets moving in lockstep and gives no diversification. Opposite movement does not force the expected return to zero, since each asset keeps its own expected return.

A stock's beta is 1.5. If the market rises 10%, what does beta suggest about the stock's expected move?

• a.The stock is uncorrelated with the market
• b.The stock would be expected to rise about 6.7%
• c.The stock would be expected to fall about 15%
• d.The stock would be expected to rise about 15%✓

Beta measures systematic risk relative to the market; a beta of 1.5 means the stock is expected to move 1.5 times as much as the market. A 10% market gain implies an expected 15% gain. Beta above 1.0 indicates greater volatility than the market.

Which of the following is a leading economic indicator?

• a.The unemployment rate
• b.The average duration of unemployment
• c.Corporate profits reported for the prior quarter
• d.New building permits issued for housing✓

Leading indicators, such as new building permits and stock prices, tend to change before the broader economy does. The unemployment rate and average duration of unemployment are lagging indicators. Prior-quarter corporate profits reflect activity that has already occurred.

A company's current ratio is calculated as which of the following?

• a.Net income divided by total shareholders' equity
• b.Current assets divided by current liabilities✓
• c.Earnings before interest and taxes divided by interest expense
• d.Total liabilities divided by total assets

The current ratio measures short-term liquidity by dividing current assets by current liabilities. Net income over equity is return on equity, and total liabilities over assets is a leverage ratio. EBIT over interest expense is the interest coverage ratio.

An investor earns a 12% nominal return in a year when inflation is 4%. Using the approximate method, the real return is closest to which of the following?

• a.12%
• b.16%
• c.3%
• d.8%✓

The approximate real return is the nominal return minus the inflation rate, or 12% minus 4%, which is about 8%. The nominal 12% ignores the loss of purchasing power. Adding the two rates to get 16% reverses the adjustment. Dividing the nominal return by the inflation rate to get 3% is not a real-return calculation. Real return adjusts nominal gains for lost purchasing power, which is why it matters when judging whether an investment truly grows wealth.

Which measure best captures the total percentage gain from an investment, including both price change and reinvested income?

• a.Nominal yield
• b.Total return✓
• c.Current yield
• d.Coupon rate

Total return combines price appreciation and income (such as dividends or interest), giving the complete measure of performance. Current yield reflects only annual income relative to price. Coupon rate and nominal yield reflect only a bond's stated interest, not price changes.

The Consumer Price Index (CPI) is primarily used to measure which of the following?

• a.The inflation-adjusted value of all final goods and services produced within the country
• b.Changes in the price level of a basket of consumer goods and services✓
• c.The share of the labor force without work that is actively seeking employment
• d.Changes in the prices that producers receive for their output at the wholesale level

The CPI tracks the average change over time in prices paid by consumers for a representative basket of goods and services, and is a common inflation gauge. The inflation-adjusted value of total output is real GDP. The share of the labor force without work is the unemployment rate. Producer price changes at the wholesale level are measured by the Producer Price Index, a neighboring but different gauge.

Under the time value of money, which factor increases the future value of a single deposit?

• a.A shorter investment horizon with fewer compounding periods
• b.A higher interest rate compounded over more periods✓
• c.A lower interest rate over the same period
• d.Regular withdrawals of interest during the investment period

Future value grows with higher interest rates and more compounding periods, because each period's interest earns further interest. A shorter horizon means fewer periods of growth, and a lower interest rate means slower growth, so both reduce future value. Withdrawals remove money that would otherwise keep compounding, so they also reduce the future value of the deposit.

A yield curve that slopes downward, with short-term rates higher than long-term rates, is described as which of the following?

• a.A flat yield curve
• b.A normal yield curve
• c.A humped yield curve
• d.An inverted yield curve✓

An inverted yield curve occurs when short-term interest rates exceed long-term rates and is often watched as a potential recession signal. A normal curve slopes upward. A flat curve shows little difference between short and long maturities.

Which statement about the Sharpe ratio is correct?

• a.It divides the portfolio's total return by its standard deviation, without subtracting the risk-free rate
• b.It measures excess return earned per unit of systematic risk, using the portfolio's beta
• c.A lower ratio indicates better risk-adjusted performance when comparing two portfolios
• d.It measures return earned per unit of total risk, using standard deviation✓

The Sharpe ratio divides a portfolio's excess return over the risk-free rate by its standard deviation, measuring reward per unit of total risk. The risk-free rate is subtracted, so a ratio built on total return alone is wrong. Using beta as the risk measure describes the Treynor ratio. A higher Sharpe ratio, not a lower one, indicates better risk-adjusted performance.

An analyst using fundamental analysis of a common stock would most likely focus on which of the following?

• a.Chart patterns and trading volume trends used to forecast short-term price direction
• b.The company's earnings, revenues, and competitive position✓
• c.Support and resistance price levels plotted alongside momentum indicators
• d.The stock's 200-day moving average relative to its current market price

Fundamental analysis evaluates a company's financial statements, earnings, revenues, management, and industry position to estimate intrinsic value. Chart patterns, volume trends, support and resistance levels, and moving averages are tools of technical analysis, which studies price and volume history instead.

Fiscal policy, as distinct from monetary policy, is carried out through which of the following?

• a.Government decisions on taxation and public spending made by Congress and the President✓
• b.The SEC's registration of newly issued securities
• c.Federal Reserve open market operations and reserve requirements
• d.Commercial banks setting their prime lending rates

Fiscal policy is the use of federal taxing and spending decisions by Congress and the President to influence the economy. Monetary policy, by contrast, is the Federal Reserve's domain, using tools like open market operations and reserve requirements. The prime rate is set by banks, and the SEC oversees securities registration; the trap is mistaking the Fed's monetary tools for fiscal policy.

Demand-pull inflation is best described as rising prices caused by:

• a.Rising wages and raw-material costs that squeeze profit margins and force producers to raise prices
• b.Falling consumer confidence and reduced spending
• c.A weaker currency that makes imported goods and inputs more expensive for domestic buyers
• d.Aggregate demand outpacing the economy's productive capacity✓

Demand-pull inflation occurs when total demand exceeds what the economy can produce, pulling prices upward. Cost-push inflation, by contrast, stems from rising wages and raw-material costs, and a weaker currency raises prices through higher import costs rather than through excess demand. Falling confidence and spending would be disinflationary, not inflationary.

Using the Rule of 72, approximately how long will it take an investment earning 8% compounded annually to double in value?

• a.About 6 years
• b.About 9 years✓
• c.About 12 years
• d.About 8 years

The Rule of 72 estimates doubling time by dividing 72 by the annual rate: 72 divided by 8 equals 9 years. The trap answers come from subtracting the rate (8 years) or misdividing (72 divided by 12, or 72 divided by 6). It is a quick approximation for compound growth.

Using the constant-growth dividend discount model, a stock expected to pay a $2 dividend next year, growing 4% annually, with a required return of 9%, has an estimated value closest to:

• a.$22.22
• b.$50.00
• c.$20.00
• d.$40.00✓

The constant-growth (Gordon) dividend discount model values a stock as next year's dividend divided by the required return minus the growth rate: $2 divided by (0.09 minus 0.04) equals $2 divided by 0.05, or $40. The $22.22 trap comes from forgetting to subtract growth ($2 divided by 0.09), and $50 from dividing by the growth rate alone.

A company's stock trades at $60 and reported earnings of $3 per share. Its price-to-earnings (P/E) ratio is:

• a.5
• b.0.05
• c.180
• d.20✓

The price-to-earnings ratio equals share price divided by earnings per share: $60 divided by $3 equals 20. The 0.05 trap inverts the ratio (earnings divided by price), and 180 comes from multiplying instead of dividing. A P/E of 20 means investors pay $20 for each $1 of annual earnings.

Gross domestic product (GDP) measures which of the following?

• a.The total income earned by a country's residents and firms at home and abroad, including net income from overseas investments
• b.The weighted average change in the prices of a fixed basket of consumer goods and services purchased by households
• c.The total market value of all final goods and services produced within a country during a period✓
• d.The total value of all intermediate and final goods and services produced in a country, counting each stage of production separately

GDP measures the market value of all final goods and services produced within a country's borders over a period, the broadest gauge of national output. Income earned by residents abroad belongs to gross national income rather than GDP, the change in a basket of consumer prices is the Consumer Price Index, and counting intermediate goods as well as final ones would double count the same output.

Which of the following is generally classified as a coincident economic indicator?

• a.Industrial production and personal income✓
• b.The average duration of unemployment
• c.New orders for consumer goods and materials
• d.Building permits for new private housing

Coincident indicators move in step with the overall economy; industrial production and personal income are classic examples. New orders and building permits are leading indicators that turn before the economy, and the average duration of unemployment is a lagging indicator. The trap is confusing leading indicators with coincident ones.

Real gross domestic product differs from nominal GDP in that real GDP:

• a.Measures only the output of the government sector
• b.Is adjusted for inflation, expressing output in constant dollars✓
• c.Includes the value of intermediate goods double-counted at each stage of production
• d.Is always larger than nominal GDP during periods of rising prices

Real GDP adjusts nominal output for inflation using a price deflator, stating production in constant-dollar terms so growth is not overstated by rising prices. During inflation, nominal GDP exceeds real GDP, so the claim that real is larger is the trap. GDP measures total final output, not only government.

A recession is conventionally identified by:

• a.A sustained rise in real GDP over a full year
• b.Any month in which stock prices fall
• c.A single quarter of rising unemployment
• d.Two consecutive quarters of declining real GDP✓

The common shorthand for a recession is two consecutive quarters of falling real GDP, reflecting a broad contraction in output. A one-month stock decline or a single quarter of higher unemployment is not the standard definition. A year of rising GDP describes an expansion.

Stagflation describes the unusual combination of:

• a.Rising output and falling unemployment accompanied by accelerating inflation as demand outstrips capacity
• b.Stagnant growth and high unemployment occurring together with rising prices✓
• c.Falling prices together with weak growth and rising unemployment, as consumers postpone purchases
• d.Rapid growth and low unemployment together with falling prices, as in a productivity-driven boom

Stagflation pairs stagnation (weak growth and high unemployment) with inflation at the same time, as seen in the 1970s. It challenges the usual inverse trade-off between unemployment and inflation captured by the Phillips curve. Strong output with accelerating prices is an overheating economy, weak growth with falling prices is deflationary recession, and rapid growth with falling prices and low unemployment is the opposite of stagflation.

The discount rate set by the Federal Reserve is the interest rate at which:

• a.Corporations borrow short-term from investors by issuing commercial paper, usually at a discount to face value
• b.The Fed lends short-term funds to member banks through the discount window✓
• c.The Treasury sells new bills and notes to primary dealers at its regularly scheduled auctions
• d.Banks lend reserve balances to one another overnight, a rate the FOMC targets and influences through open market operations

The discount rate is what the Fed charges banks that borrow at its discount window. The overnight interbank lending rate is the federal funds rate, which the FOMC targets rather than sets directly, and that is the trap in the last option. Commercial paper rates and Treasury auction yields are determined in the market and are unrelated to the discount rate.

If the Federal Reserve lowers the reserve requirement, the most likely effect is to:

• a.Increase the money supply by allowing banks to lend a larger share of deposits✓
• b.Have no effect on the amount banks can lend
• c.Force banks to hold more cash against their deposits, which in turn pushes market interest rates sharply lower
• d.Reduce the money supply and raise interest rates

A lower reserve requirement frees a larger share of deposits for lending, expanding the money supply and tending to lower interest rates. This is an expansionary monetary tool. Raising the requirement would do the opposite by forcing banks to hold more.

During the expansion phase of the business cycle, which of the following typically occurs?

• a.Increasing GDP, rising consumer spending, and growing corporate profits✓
• b.Falling industrial production and a sharp rise in business inventories as sales slow across most sectors
• c.Rising unemployment and falling consumer spending as businesses cut production and delay investment
• d.Declining GDP for two consecutive quarters, shrinking payrolls and falling consumer demand

An expansion features rising GDP, employment, consumer spending, and corporate profits as demand strengthens. Falling production with unsold inventories, rising unemployment with cutbacks in investment, and two straight quarters of declining GDP with shrinking payrolls all describe a contraction or recession, not an expansion.

An economist who argues the government should increase spending during a downturn to boost aggregate demand is applying which school of thought?

• a.Keynesian economics✓
• b.Supply-side economics
• c.Monetarist economics
• d.Classical laissez-faire economics

Keynesians emphasize aggregate demand and active fiscal policy, favoring government spending and tax changes to smooth the business cycle. Monetarists focus on the money supply, supply-siders on production incentives, and classical economists on minimal intervention.

Supply-side economics primarily emphasizes:

• a.Government spending and deficit financing to raise aggregate demand and close the output gap
• b.Central bank management of interest rates and bank reserves to stabilize prices and employment
• c.Lowering taxes and reducing regulation to encourage production and investment✓
• d.Steady growth in the money supply at a fixed rate each year, regardless of the business cycle

Supply-side economics focuses on incentives to produce, chiefly cutting marginal tax rates and easing regulation to spur output and investment. Deficit spending to lift aggregate demand is the Keynesian approach, central bank management of interest rates and reserves is monetary policy, and a fixed annual growth rate for the money supply is the monetarist rule.

The prime rate is best described as:

• a.The rate on overnight loans of reserve balances between banks, which the FOMC sets as a target
• b.The rate the Federal Reserve charges depository institutions that borrow from its discount window
• c.The yield on three-month Treasury bills, determined at the Treasury's weekly auctions of new bills
• d.The interest rate commercial banks charge their most creditworthy corporate customers✓

The prime rate is what banks charge their most creditworthy customers and serves as a benchmark for many consumer and business loans. It is set by the banks, not the Fed, although it tends to move with the federal funds target. The federal funds rate is the overnight interbank rate, the discount rate is what the Fed charges banks at its discount window, and the T-bill yield is set by market demand at auction.

A company reports current assets of $300,000, inventory of $100,000, and current liabilities of $100,000. Its quick (acid-test) ratio is:

• a.3.0
• b.0.5
• c.2.0✓
• d.1.0

The quick ratio equals (current assets minus inventory) divided by current liabilities: ($300,000 minus $100,000) divided by $100,000 equals 2.0. It excludes inventory as a less-liquid asset. Including inventory gives the current ratio of 3.0, which is the trap.

Using current assets of $300,000 and current liabilities of $100,000, a company's working capital is:

• a.$400,000
• b.$3.00
• c.$200,000✓
• d.$30,000

Working capital equals current assets minus current liabilities: $300,000 minus $100,000 equals $200,000. It measures the short-term liquidity cushion available to fund operations. Adding the two figures ($400,000) is the trap.

A firm has total debt of $6 million and total shareholders' equity of $3 million. Its debt-to-equity ratio is:

• a.0.5
• b.2.0✓
• c.9.0
• d.3.0

Debt-to-equity equals total debt divided by equity: $6 million divided by $3 million equals 2.0. A higher ratio signals greater leverage and financial risk. Inverting the fraction gives the 0.5 trap.

A corporation earns net income of $10 million, pays $1 million in preferred dividends, and has 3 million common shares outstanding. Earnings per share (EPS) is:

• a.$2.70
• b.$9.00
• c.$3.33
• d.$3.00✓

EPS equals net income minus preferred dividends, divided by common shares: ($10 million minus $1 million) divided by 3 million equals $3.00. Forgetting to subtract preferred dividends yields the $3.33 trap. Preferred claims come before common.

A company reports net income of $2 million on shareholders' equity of $20 million. Its return on equity (ROE) is:

• a.10%✓
• b.20%
• c.5%
• d.2%

Return on equity equals net income divided by shareholders' equity: $2 million divided by $20 million equals 10%. ROE gauges how efficiently a firm turns equity capital into profit. It is a core profitability ratio in fundamental analysis.

A company earns $5.00 per share and pays a $1.50 annual dividend. Its dividend payout ratio is:

• a.150%
• b.30%✓
• c.3.3%
• d.50%

The payout ratio equals dividend per share divided by EPS: $1.50 divided by $5.00 equals 30%. The remaining 70% is the retention ratio reinvested in the business. Inverting the fraction gives distractor traps.

A firm has common shareholders' equity of $40 million and 2 million common shares outstanding. Its book value per share is:

• a.$0.05
• b.$20.00✓
• c.$80.00
• d.$2.00

Book value per share equals common equity divided by common shares: $40 million divided by 2 million equals $20.00. It is an accounting measure of net worth per share, not a market price. Multiplying instead of dividing gives the $80 trap.

A company has earnings before interest and taxes (EBIT) of $8 million and interest expense of $2 million. Its interest coverage ratio is:

• a.4 times✓
• b.0.25 times
• c.16 times
• d.2 times

The interest coverage ratio equals EBIT divided by interest expense: $8 million divided by $2 million equals 4 times. A higher ratio indicates a greater ability to service debt from operating earnings. Inverting the ratio gives the 0.25 trap.

A savings instrument pays a stated (nominal) annual rate of 6% compounded quarterly. Its effective annual yield is:

• a.Exactly 6%, because quarterly compounding changes only when interest is credited, not the annual yield
• b.Less than 6%, because each quarterly credit of 1.5% is smaller than the stated annual rate
• c.Greater than 6%, because interest is earned on interest more than once a year✓
• d.Equal to 1.5%, because the effective yield is measured over a single quarterly compounding period

More frequent compounding raises the effective annual yield above the stated nominal rate; 6% compounded quarterly equals about 6.14% effective, using (1 plus 0.06 divided by 4) raised to the fourth power minus 1. Only annual compounding leaves the two equal. The 1.5% is only the rate for one quarter, and four quarterly credits that each earn interest on prior interest cannot total less than the stated 6%.

Using the Rule of 72, an investment earning 6% compounded annually will take approximately how long to double?

• a.8 years
• b.6 years
• c.18 years
• d.12 years✓

The Rule of 72 estimates doubling time by dividing 72 by the annual rate: 72 divided by 6 equals 12 years. It is a quick approximation for compound growth. Subtracting or misdividing produces the trap answers.

What is the approximate present value of $5,000 to be received in 3 years, discounted at 8% annually?

• a.About $4,600
• b.About $3,969✓
• c.About $5,000
• d.About $6,299

Present value equals the future amount divided by (1 plus the rate) raised to the number of periods: $5,000 divided by 1.08 cubed equals about $3,969. Discounting reduces the amount below $5,000; compounding forward to about $6,299 is the trap.

An analyst who studies the advance/decline line and moving-average crossovers to forecast price direction is engaged in:

• a.Discounted cash flow valuation of the firm
• b.Credit analysis of the issuer's balance sheet
• c.Technical analysis of market and price data✓
• d.Fundamental analysis of earnings quality

Advance/decline lines, moving averages, and chart patterns are technical-analysis tools that study price and volume history to predict direction. Fundamental and credit analysis instead examine a company's financials and intrinsic value.

Two assets have a correlation coefficient of +0.3. This indicates:

• a.A strong positive relationship, so the assets nearly always move together and offer little diversification
• b.A weak negative relationship, so the assets tend to move in opposite directions and offset each other's losses
• c.No relationship at all, so the assets' returns are completely independent
• d.A weak positive relationship, so combining them still provides meaningful diversification✓

A correlation of +0.3 is a weak positive relationship: the assets tend to move in the same direction, but only loosely. Because it is well below +1.0, blending them still lowers portfolio risk. A strong positive relationship would be near +1.0, which is where diversification disappears. A negative relationship would require a coefficient below zero, and a coefficient of zero, not +0.3, means no linear relationship.

A weakening U.S. dollar relative to foreign currencies generally:

• a.Helps U.S. importers by lowering the cost of foreign goods
• b.Guarantees lower domestic inflation over the coming year
• c.Helps U.S. exporters by making their goods cheaper abroad✓
• d.Has no effect on international trade flows

A weaker dollar makes U.S. exports cheaper and more competitive abroad, helping exporters, while making imports more expensive. This is a currency-risk consideration for international investing. It does not guarantee lower inflation and typically raises import prices.

Rising consumer prices that are driven by higher raw-material and wage costs rather than by stronger buyer demand are best described as:

• a.Deflation, in which the general level of prices actually falls from period to period
• b.Disinflation, in which the rate of price increases slows while prices still rise
• c.Cost-push inflation, in which higher input and labor costs are passed along in prices✓
• d.Demand-pull inflation, in which total spending outruns the economy's productive capacity

Cost-push inflation originates on the supply side: energy, materials, or wage costs rise, producers' margins compress, and they raise selling prices. Demand-pull inflation originates on the demand side, when spending exceeds what the economy can produce. Disinflation is a slowing of the inflation rate, and deflation is an outright decline in the price level. Knowing which force is at work matters because cost-push inflation can coexist with weak growth, which limits how aggressively a central bank can ease.

When the Federal Open Market Committee buys U.S. government securities from banks in the open market, the most direct effect is that:

• a.Bank reserves and the money supply expand, putting downward pressure on short-term rates✓
• b.Bank reserves contract and short-term interest rates are pushed sharply higher
• c.The federal budget deficit is reduced because the Treasury retires outstanding public debt
• d.Commercial banks are required to hold a larger percentage of their deposits in reserve

Open market operations are the Federal Reserve's primary monetary tool. When the Fed buys securities it pays the selling banks by crediting their reserve accounts, so reserves and the money supply grow and the cost of overnight money tends to fall. Selling securities drains reserves and pushes rates up. Retiring public debt is a Treasury (fiscal) function, and reserve requirements are a separate tool set by the Fed, not a consequence of a purchase.

The federal funds rate is best defined as the interest rate at which:

• a.Banks lend excess reserve balances to one another on an overnight basis✓
• b.Banks charge their most creditworthy corporate customers for short-term loans
• c.The U.S. Treasury borrows for terms of one year or less through bill auctions
• d.The Federal Reserve lends directly to member banks through the discount window

The fed funds rate is the market rate on overnight interbank loans of reserve balances, and the FOMC steers it toward a target range. The discount rate is charged by the Fed itself when it lends at the discount window. The prime rate is what banks charge their best commercial customers. Treasury bill yields are set by auction in the government securities market.

An economy's annual inflation rate falls from 5% to 2% over two years while the price level continues to rise. This is best described as:

• a.Disinflation, a slowing in the rate at which prices increase✓
• b.Hyperinflation, an accelerating collapse in the value of money
• c.Deflation, a sustained decline in the general price level
• d.Stagflation, high inflation combined with stagnant output

Disinflation means inflation is decelerating: prices are still going up, just more slowly. Deflation requires the price level itself to fall, which would be a negative inflation rate. Stagflation pairs high inflation with weak growth and high unemployment. Hyperinflation is extreme, accelerating inflation. Candidates lose points by treating any decline in the inflation rate as deflation.