Economics - 1 - Free MCQ Practice Test with solutions, CFA Level 2

An analyst is forecasting the EUR/USD exchange rate using relative purchasing power parity. The current spot rate is 1.1200 USD per EUR. The expected annual inflation rate in the United States is 4.0% and in the Eurozone is 1.5%.

The expected spot rate one year from now is closest to:

A portfolio manager is studying international parity conditions. She notes that one theory requires that equivalent baskets of goods carry identical prices across countries when expressed in a common currency, implying the exchange rate equals the ratio of national price levels.

This description best corresponds to:

The current spot exchange rate is 1.3000 CAD per USD. The 1-year risk-free interest rate is 2.0% in Canada and 4.0% in the United States.

Using covered interest rate parity, the 1-year forward rate (CAD/USD) is closest to:

An economist argues that the expected rate of depreciation of a currency should equal the nominal interest rate differential between two countries, without the use of any forward contracts or hedging instruments to lock in exchange rates.

This economist is most likely referencing:

Empirical research spanning multiple decades consistently documents that high-interest-rate currencies tend to appreciate rather than depreciate, contrary to what a key theoretical parity condition predicts. This systematic deviation persists even after accounting for transaction costs and risk premia.

This documented phenomenon is most consistent with:

A country's international accounts for the year show the following: merchandise exports of USD 600 billion, merchandise imports of USD 500 billion, a services trade deficit of USD 30 billion, net investment income received of USD 10 billion, and net current transfer payments made of USD 5 billion.

The country's current account balance is closest to:

A balance of payments analyst is classifying the following international transactions recorded in a country's BOP accounts:

1. Debt relief granted by the domestic government to a low-income foreign nation
2. Royalty receipts earned by domestic firms from foreign licensees of patented technology
3. Equity stakes acquired by foreign corporations in domestic manufacturing facilities

Which transaction is most accurately classified under the financial account?

A small open economy maintains a fixed exchange rate and operates with perfect international capital mobility. The government enacts a large fiscal stimulus package, increasing public expenditure by 3% of GDP. The central bank simultaneously intervenes in foreign exchange markets to maintain the peg.

Under the Mundell-Fleming model, fiscal policy in this setting is most likely to:

In the Solow neoclassical growth model, an economist analyzes the long-run steady-state equilibrium of an economy where the savings rate, population growth rate, and depreciation rate are all held constant.

Which of the following best describes the long-run steady-state condition in this framework?

An international economist compares two countries - Country A (low income, low capital per worker) and Country B (high income, high capital per worker) - that share identical savings rates, population growth rates, and depreciation rates.

Which outcome is most consistent with the absolute convergence prediction of the Solow neoclassical growth model?

Country Z's government enacts legislation permanently increasing subsidies for university-based scientific research and strengthening intellectual property protection to encourage private R&D investment. An economist evaluating this policy applies endogenous growth theory.

The economist would most likely predict that this policy will:

An economist applies growth accounting to decompose output growth in an emerging market economy. The following data are provided:

• Real GDP growth: 4.0%
• Capital stock growth: 3.0%
• Labor force growth: 1.0%
• Capital's share of output (α): 0.35

The implied total factor productivity (TFP) growth rate is closest to:

An analyst studying a national telecommunications regulator observes that over a five-year period, the agency has consistently approved every request by incumbent operators for tariff increases, blocked new entrants citing technical grounds that industry experts dispute, and staffed its senior leadership almost exclusively with former executives from regulated firms.

This pattern is most consistent with:

An industry analyst is computing the Herfindahl-Hirschman Index (HHI) for a domestic automobile market. Three firms account for 100% of market sales with market shares of 50%, 30%, and 20%, respectively.

The HHI for this market is closest to:

A commercial real estate appraiser is assessing a manufacturing facility. The plant's physical condition is unchanged, its machinery remains technologically current, and it operates at full designed capacity. However, new environmental regulations have permanently restricted the production volume of the plant's primary output category by 40%, materially reducing the facility's income-generating potential.

The resulting decline in the plant's appraised value is best classified as:

An analyst at a sovereign wealth fund needs to project long-run bilateral exchange rate trends between two countries. The only reliable data available are each country's historical and projected Consumer Price Index (CPI) levels. Interest rate data are unavailable due to capital controls, and reliable forward markets do not exist in either currency.

Which exchange rate model is most appropriate given these constraints?

The central bank of a small open economy with a floating exchange rate and highly mobile international capital cuts its benchmark policy interest rate by 100 basis points. Prior to the cut, the country's interest rates were broadly in line with international levels.

Under the Mundell-Fleming model, the most likely immediate effect on the exchange rate and net exports is:

The current spot exchange rate is 0.7500 AUD per USD. The expected annual inflation rate in Australia is 3.0% and in the United States is 1.0%.

Using relative purchasing power parity, the expected AUD/USD spot rate in one year is closest to:

Country M has maintained a persistent current account deficit averaging 5% of GDP for six consecutive years. The country operates under a flexible exchange rate regime. An economist reviews the country's balance of payments accounts.

According to BOP accounting, this persistent current account deficit is most accurately described as necessarily accompanied by:

Country Y implements the following permanent policy measures: (1) a 30% government subsidy on all private-sector R&D expenditure; (2) mandatory five-year university education for all workers; and (3) a strengthened patent system extending intellectual property protection. An economist evaluates this package using endogenous growth theory.

The economist's most likely prediction is that these policies will:

The following data apply to EUR/USD:

• Spot rate: 1.1000 USD per EUR
• 1-year US risk-free interest rate: 3.0%
• 1-year Eurozone risk-free interest rate: 5.0%
• Quoted 1-year forward rate: 1.0700 USD per EUR

The CIP-implied 1-year forward rate is 1.0790 USD per EUR. An arbitrageur seeking to exploit the mispricing should most likely:

A government antitrust authority is reviewing a proposed merger in the domestic pharmaceutical distribution industry. Pre-merger data show that the industry's Herfindahl-Hirschman Index (HHI) is 1,800. Merger guidelines classify markets with HHI between 1,500 and 2,500 as moderately concentrated and those above 2,500 as highly concentrated.

The authority would most likely classify this market as:

An equity analyst is assessing the impact of an anticipated 10% depreciation of the domestic currency on a publicly listed manufacturer. The company generates 80% of its revenues from export markets (denominated in foreign currencies) and sources 30% of its raw material inputs from foreign suppliers (also foreign-currency-denominated). The remaining revenues and costs are domestic.

The most likely net effect on the company's operating margin is:

A growth economist is analyzing the Solow neoclassical model and is asked to identify the capital stock level that a policymaker should target in order to maximize the well-being of the current and all future generations, defined as the highest sustainable level of consumption per worker in the long-run steady state.

This capital stock level is best referred to as:

A macro hedge fund borrows Brazilian Real (BRL) at 2% annually and simultaneously invests in Australian Dollar (AUD) bonds yielding 13.5% annually, accepting full currency risk without any forward hedge. The fund's position implicitly assumes which of the following?

A development economist notes that several low-income Sub-Saharan African economies have maintained savings rates, population growth rates, and institutional quality broadly similar to high-income OECD nations for over 30 years yet have not converged to OECD income levels. This finding persists even after controlling for differences in human capital investment rates.

This observation provides the strongest challenge to which framework, and is most consistent with which alternative?

The following market data are observed:

• Spot rate: 0.9200 CHF per USD
• Annualized 6-month US risk-free rate: 2.0%
• Annualized 6-month Swiss risk-free rate: 0.0%

Using covered interest rate parity, the 6-month forward rate (CHF/USD) is closest to:

A regional electricity transmission company is the sole provider of power distribution infrastructure in its service area. Engineering studies confirm that average costs decline continuously across the entire relevant range of output, and independent analysts estimate that a second entrant would need to replicate fixed infrastructure investments exceeding USD 20 billion - an amount deemed prohibitive relative to market revenues.

This market structure is best described as:

Country P maintains a fixed exchange rate regime and has experienced a persistent current account deficit for four consecutive years, financed primarily by declining official foreign exchange reserves. The country's monetary authorities are committed to maintaining the peg. An IMF advisor is recommending a policy adjustment to restore external balance.

Under the Mundell-Fleming model, the policy response most likely to restore external balance without abandoning the exchange rate peg is:

An equity analyst covers a large multinational corporation that derives 60% of its revenues from subsidiaries operating in three foreign markets and reports earnings in its domestic currency. The analyst observes that the domestic central bank has raised its benchmark interest rate by 200 basis points above prevailing rates in the firm's major trading partner economies.

Based on interest rate parity, the analyst would most likely expect the domestic currency to: