NASAA Series 66 — All Questions

During a period of rising inflation, the Federal Reserve is MOST likely to:

• a.Raise interest rates to slow economic activity✓
• b.Take no action at all
• c.Cut interest rates to stimulate spending
• d.Guarantee bond prices

To combat rising inflation, the Federal Reserve typically tightens monetary policy by raising interest rates, which cools borrowing and spending. Higher rates tend to pressure bond and equity prices. This is a core macroeconomic relationship advisers must understand.

Gross domestic product (GDP) declining for two consecutive quarters is a common informal indicator of:

• a.A bull market
• b.Hyperinflation
• c.An economic expansion
• d.A recession✓

Two consecutive quarters of declining real GDP is a widely used informal signal of a recession, reflecting contracting economic output. Recessions typically bring rising unemployment and weaker corporate earnings. Advisers consider the business cycle when positioning portfolios.

The real rate of return is best described as:

• a.The return guaranteed by the government
• b.The nominal return before any adjustment
• c.The dividend yield only
• d.The nominal return adjusted for inflation✓

The real rate of return is the nominal return reduced by the inflation rate, reflecting the true increase in purchasing power. It matters because inflation erodes the value of investment gains. Advisers use it to set realistic long-term expectations.

A leading economic indicator is one that:

• a.Tends to change before the overall economy changes, helping to forecast direction✓
• b.Moves at the same time as the economy
• c.Has no predictive value
• d.Confirms trends after they have occurred

Leading indicators, such as building permits or stock prices, tend to shift ahead of the broader economy, offering forecasting value. Coincident indicators move with the economy, and lagging indicators confirm trends after the fact. Analysts use leading indicators to anticipate turning points.

If the yield curve is inverted, meaning short-term rates exceed long-term rates, this is often interpreted as:

• a.A potential signal of an approaching economic slowdown or recession✓
• b.Evidence of falling inflation only
• c.A guarantee of strong future growth
• d.Proof that bond prices cannot change

An inverted yield curve, where short-term yields exceed long-term yields, has historically been viewed as a possible warning of an economic slowdown or recession. It reflects expectations of future rate cuts amid weakening growth. Advisers monitor the curve as one of several signals, not a certainty.

The four phases of the business cycle, in order, are:

• a.Growth, maturity, decline, and renewal, as measured primarily by aggregate corporate earnings reports
• b.Inflation, deflation, stagflation, and recovery, repeating over a fixed and predictable number of years
• c.Expansion, peak, contraction, and trough✓
• d.Bull market, bear market, correction, and rally, driven mainly by shifts in overall investor sentiment

The business cycle moves through expansion (growth), a peak, contraction (recession), and a trough before the next expansion begins. Recognizing the phase helps advisers position portfolios, since different sectors lead at different points. The cycle's timing and length are irregular, not fixed.

Fiscal policy refers to the use of:

• a.Bank reserve requirements set to control how much money financial institutions are permitted to lend out
• b.Interest-rate targets and open-market operations that are controlled by the nation's central bank committee
• c.Currency-exchange interventions used to keep the nation's currency stable relative to foreign currencies
• d.Government spending and taxation to influence the economy✓

Fiscal policy is the use of government spending and taxation decisions — made by Congress and the President — to influence economic activity. It is distinct from monetary policy, which the Federal Reserve conducts through interest rates and the money supply. The two often work together to manage the economy.

Which of the following is a tool of the Federal Reserve's monetary policy?

• a.Open-market operations — buying and selling government securities✓
• b.Setting the federal income tax rates that apply to individuals and corporations for the coming fiscal year
• c.Deciding the level of federal government spending on national infrastructure and defense programs each year
• d.Establishing tariffs on imported foreign goods in order to protect domestic industries from competition

Open-market operations — the buying and selling of government securities — are the Fed's primary monetary-policy tool, alongside the discount rate and reserve requirements. Buying securities adds reserves and eases policy; selling drains reserves and tightens it. Taxes, spending, and tariffs are fiscal or trade matters, not monetary tools.

To stimulate a weak economy, the Federal Reserve would MOST likely:

• a.Sell government securities in the open market in order to withdraw reserves from the banking system
• b.Raise the reserve requirement so that banks are forced to hold more funds and can lend out much less
• c.Buy government securities in the open market, adding reserves and lowering rates✓
• d.Increase the discount rate charged to member banks so that borrowing directly from the Fed becomes considerably more expensive

To ease policy and stimulate growth, the Fed buys government securities in the open market, which injects reserves into the banking system, lowers interest rates, and expands the money supply. Selling securities, raising the reserve requirement, or raising the discount rate would all tighten policy instead. Easing supports borrowing and spending.

The discount rate is the interest rate:

• a.The Federal Reserve charges member banks that borrow from it✓
• b.The U.S. Treasury pays on newly auctioned short-term Treasury bills sold to investors at the auction
• c.That banks charge their most creditworthy corporate customers for short-term business borrowing needs
• d.That commercial banks charge one another for overnight loans of their excess reserve balances at the Fed

The discount rate is the interest rate the Federal Reserve charges member banks that borrow directly from it through the discount window. Lowering it encourages bank borrowing and eases credit; raising it does the opposite. It is separate from the federal funds rate, which is a bank-to-bank rate.

The federal funds rate is the rate at which:

• a.The Federal Reserve lends directly to commercial banks through its discount window lending facility
• b.Banks lend money to their most creditworthy corporate and commercial customers for their operations
• c.The federal government borrows money by issuing long-term Treasury bonds to investors in the market
• d.Banks lend reserves to one another overnight✓

The federal funds rate is the interest rate banks charge one another for overnight loans of reserves held at the Fed. It is a key barometer of monetary policy and heavily influenced by open-market operations. It differs from the discount rate (a bank-to-Fed rate) and the prime rate (a bank-to-customer rate).

If the Federal Reserve lowers the reserve requirement, the MOST likely effect is that:

• a.Long-term Treasury bond prices will fall sharply at the same time that their yields also decline steadily
• b.Banks will have less money available to lend out to borrowers, which tends to slow overall economic growth
• c.Banks can lend more, expanding the money supply✓
• d.The federal government's annual budget deficit will immediately shrink as its tax revenue collections rise

Lowering the reserve requirement frees up a larger portion of deposits for lending, expanding banks' lending capacity and the money supply — an easing (expansionary) action. Raising the reserve requirement does the reverse. Reserve requirements are one of the Fed's three main monetary-policy tools.

The Consumer Price Index (CPI) is used primarily to measure:

• a.The unemployment rate among the workers who are actively seeking full-time paid employment
• b.The total dollar output of all final goods and services produced within the nation's geographic borders in a year
• c.Inflation, by tracking the average change in the prices of a basket of consumer goods✓
• d.The overall performance of the stock market's largest and most widely held publicly traded companies

The Consumer Price Index measures inflation by tracking the average change over time in the prices paid by consumers for a representative basket of goods and services. A rising CPI signals inflation; a falling one signals deflation. It is widely used to adjust wages, benefits, and TIPS principal.

A fundamental analyst evaluating a stock would focus primarily on:

• a.Investor sentiment surveys and the relative-strength index measured over the past several trading weeks
• b.Chart patterns, trading volume, and moving averages used to predict short-term movements in the share price
• c.The historical sequence of the stock's daily high, low, and closing prices as plotted on a price graph
• d.The company's earnings, financial statements, and industry conditions✓

Fundamental analysis evaluates a company's intrinsic value using its earnings, financial statements, management, and industry and economic conditions to judge whether the stock is under- or overvalued. It contrasts with technical analysis, which studies price and volume patterns. Fundamental analysts ask what a company is worth.

A technical analyst primarily relies on:

• a.Estimates of the company's future earnings growth and an assessment of the quality of its management team
• b.Macroeconomic forecasts of gross domestic product, the inflation rate, and the direction of interest rates
• c.A detailed review of the issuer's balance sheet, income statement, and statement of cash flows each quarter
• d.Historical price and trading-volume patterns to forecast future movements✓

Technical analysis studies historical market data — chiefly price and volume patterns, trends, and chart formations — to forecast future price movements, rather than assessing a company's underlying value. It assumes that price action reflects all information and that trends tend to persist. It contrasts with fundamental analysis.

The fundamental balance-sheet equation states that a company's total assets equal:

• a.Its net income for the period plus the total dividends it paid out to its shareholders during that period
• b.Its total annual revenue minus all of the operating and non-operating expenses it incurred during the year
• c.The current market value of all of its outstanding common and preferred shares added together
• d.Its liabilities plus shareholders' equity✓

The balance-sheet identity is Assets = Liabilities + Shareholders' Equity, meaning everything a company owns is financed either by debt or by owners' equity. Rearranged, equity equals assets minus liabilities. This equation underlies fundamental analysis of a firm's financial position.

A company's working capital is calculated as:

• a.Net income for the year divided by the total number of common shares outstanding during that year
• b.Current assets minus current liabilities✓
• c.Annual sales revenue minus the cost of the goods that the company actually sold during the period
• d.Total assets minus total liabilities, which instead represents the shareholders' overall equity stake

Working capital equals current assets minus current liabilities and measures a firm's short-term liquidity — its ability to cover obligations due within a year. Positive working capital suggests adequate liquidity. It differs from total net worth (assets minus all liabilities) and from earnings measures.

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

• a.The average duration of unemployment, which historically tends to peak only after a recession has already ended
• b.The average number of weekly hours worked in manufacturing, which tends to shift before the broader economy
• c.Nonfarm payroll employment, which moves in step with the overall economy✓
• d.The number of new building permits that are issued for residential housing construction projects each month

Coincident indicators, such as nonfarm payroll employment, industrial production, and personal income, move in step with the overall economy and confirm the current phase of the business cycle. Leading indicators (like building permits) change before the economy, and lagging indicators (like unemployment duration) change after it.

The average duration of unemployment is considered a lagging indicator because it:

• a.Changes several months before the broader economy shifts direction, thereby helping analysts to forecast it
• b.Has been shown over time to have no meaningful statistical relationship to the business cycle whatsoever
• c.Tends to change after the economy has already turned✓
• d.Moves at exactly the same time as overall economic output rises and falls from one quarter to the next

A lagging indicator changes after the overall economy has already shifted direction, confirming a trend rather than predicting it. The average duration of unemployment typically keeps rising for a time even after a recession ends. Lagging indicators help verify that a turn in the cycle has genuinely occurred.

Stagflation describes an economic condition characterized by:

• a.Falling prices across the whole economy accompanied by strong and steadily rising levels of employment
• b.A booming stock market that keeps climbing even as underlying corporate earnings decline quite sharply
• c.Rapid economic growth combined with very low unemployment and remarkably stable consumer prices throughout
• d.Stagnant growth and high unemployment together with rising inflation✓

Stagflation is the unusual combination of stagnant economic growth, high unemployment, and rising inflation occurring at the same time — as seen in the 1970s. It is difficult for policymakers because tools that fight inflation can worsen unemployment and vice versa. The term blends 'stagnation' and 'inflation.'

The prime rate is BEST described as:

• a.The rate at which banks lend their excess reserves to one another on an overnight basis at the Fed
• b.The rate banks charge their most creditworthy corporate customers✓
• c.The rate the Federal Reserve charges commercial banks that borrow funds at its discount window facility
• d.The guaranteed yield that is paid on newly issued short-term United States Treasury bills at auction

The prime rate is the interest rate commercial banks charge their most creditworthy (lowest-risk) corporate customers, and it serves as a benchmark for many consumer and business loans. It typically moves with the federal funds rate. It is distinct from the discount rate and the fed funds rate.

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

• a.Makes imports cheaper for U.S. buyers but U.S. exports more expensive abroad✓
• b.Makes U.S. exports cheaper for foreign buyers abroad, thereby boosting sales for domestic exporting firms
• c.Automatically drives up the rate of domestic inflation because the prices of imported goods rise quickly
• d.Has no measurable effect at all on the prices of goods and services that are imported or exported

A stronger dollar buys more foreign currency, so imports become cheaper for U.S. buyers, while U.S. goods become more expensive for foreign buyers, which can hurt exporters. A weaker dollar has the opposite effect. Currency movements thus affect trade balances and multinational company earnings.

Gross domestic product (GDP) measures the total value of:

• a.The money supply circulating throughout the nation's banking and broader financial system during the year
• b.A country's exports minus its imports, which instead represents its overall balance of trade with the world
• c.All financial assets, including stocks and bonds, that are owned by a nation's households and its businesses
• d.All final goods and services produced within a country in a period✓

GDP is the total market value of all final goods and services produced within a country's borders during a specific period, and it is the broadest measure of economic output. Real GDP is adjusted for inflation. Two consecutive quarters of declining real GDP are a common informal marker of recession.

Keynesian economic theory generally holds that:

• a.Government spending can stimulate demand and help pull an economy out of a recession✓
• b.Government should never intervene at all, allowing free markets to correct any downturn entirely on their own
• c.Reducing taxes on producers and suppliers is the only truly effective way to stimulate a weak economy
• d.The growth of the money supply is the single most important factor determining economic output and prices

Keynesian economics emphasizes aggregate demand and holds that active government intervention — especially deficit spending during downturns — can stimulate demand and help lift an economy out of recession. It contrasts with monetarism, which stresses money-supply control, and with pure laissez-faire views. It supports countercyclical fiscal policy.

Monetarist economists, such as those following Milton Friedman, emphasize that:

• a.Trade tariffs and strict import restrictions are the single best means of ensuring lasting domestic prosperity
• b.Higher income tax rates imposed on the wealthy will automatically produce faster long-term economic growth
• c.Controlling the growth of the money supply is the key to managing inflation and output✓
• d.Aggressive increases in government deficit spending are consistently the most reliable and effective tool for quickly ending any recession

Monetarists, led by Milton Friedman, argue that the money supply is the primary driver of economic activity and inflation, and that steady, controlled money-supply growth is the key to stability. This view contrasts with the Keynesian emphasis on fiscal spending. Monetarism heavily influenced central-bank policy.