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31 multiple-choice questions and 14 flashcards on Economics, about 8% of the CFA Level II bank. Every one carries a written rationale.
Economics is one of 10 chapters in CoStudy's CFA Level II bank, and it holds 31 of the bank's 401 multiple-choice questions — roughly 8% of the total. That proportion is not arbitrary: chapters follow the certifying body's published exam outline, and the number of questions in each is set by that domain's published weight, so the share of your practice time this chapter takes matches the share of the real exam it accounts for.
Studying by chapter is worth doing once you have a diagnostic score. A single overall percentage tells you whether you are close; it does not tell you which domain is dragging. Working a weak chapter in isolation, and re-testing it in isolation, is the fastest way to move a score that has stalled — and it is why the mock exams in CoStudy report by domain rather than as one number.
10 questions drawn from this chapter, with the full rationale shown — the controlling principle behind the right answer, and why each wrong option tempts and fails.
A junior analyst observes that the yield curve has inverted (2-year yield above 10-year yield) and tells a client that a recession is now certain within two quarters. Which of the following BEST characterizes the flaw in this statement?
Answer: C — An inverted curve is a probabilistic leading signal reflecting expectations, not a certain or precisely timed predictor of recession
A) This overcorrects — inversions have historically shown a meaningful, if imperfect, empirical association with subsequent recessions, so claiming 'no relationship' is false. B) This reverses the commonly cited causal story backwards; the standard view is that inversion reflects market expectations of future easing, not that recessions cause inversions — it restates the mechanism incorrectly rather than identifying the analyst's error. C) Correct — the analyst's error is treating a probabilistic, expectations-based signal with variable lead time as a certainty with a fixed near-term timeline; inversion correlates with elevated recession risk but is not a deterministic or precisely timed forecast. D) Both spreads are commonly cited in practice and research; asserting only one has any predictive value is an overstated, false distinction rather than the core flaw in the analyst's statement.
Spot USD/EUR is 1.0800. One-year USD rate is 5.0%; one-year EUR rate is 3.0%. Under covered interest parity, the one-year forward USD/EUR rate is approximately:
Answer: C — 1.1010 per calc approx
A) 1.2111 per calc approx — off-by-percent numeric trap. B) 0.9909 per calc approx — off-by-percent numeric trap. C) Correct — the computed value is 1.1010. D) 1.3212 per calc approx — off-by-percent numeric trap.
A sovereign with a debt-to-GDP ratio of 110% and a primary deficit of 2% of GDP must run a primary balance equal to (g − r) × debt/GDP to stabilize debt. With nominal growth g = 4% and effective interest rate r = 6%, the required primary balance is:
Answer: C — A surplus of 2.2% of GDP
A) Output gap positive pressure — related concept, not the definition. B) J-curve trade balance dynamic — related concept, not the definition. C) Correct — this identifies A surplus of 2.2% of GDP. D) Neutral real policy rate level — related concept, not the definition.
A regulator imposes a new financial-services rule that raises compliance costs disproportionately for small competitors. The likely effect, per regulatory-capture analysis, is:
Answer: A — Industry concentration may rise
A) Correct — this identifies Industry concentration may rise. B) Balassa-Samuelson effect impact — related concept, not the definition. C) USD depreciates by inflation gap — direction reversal. D) USD appreciates by inflation gap — direction reversal.
International CAPM extends domestic CAPM by:
Answer: B — Adding currency risk premium
A) Underfitting the sample data — related concept, not the definition. B) Correct — this identifies Adding currency risk premium. C) Sample selection bias effect — related concept, not the definition. D) Robust Newey-West correction — related concept, not the definition.
Under the Mundell-Fleming model, a small open economy with a floating exchange rate and high capital mobility implements expansionary fiscal policy (higher government spending). The MOST likely outcome is that:
Answer: C — Fiscal policy is largely offset because higher domestic interest rates attract capital inflows, appreciating the currency and crowding out net exports
A) Direction reversal — the currency appreciates, not depreciates, as capital inflows are drawn in by the higher rates the fiscal expansion produces. B) Direction reversal — appreciation crowds out net exports rather than boosting them; this states the opposite mechanism. C) Correct. D) Misconception — floating rates don't eliminate crowding out; under high capital mobility, floating-rate crowding-out via currency appreciation is precisely why fiscal policy is comparatively weak here, while monetary policy is the more effective tool.
A flattening of the yield curve following a series of policy rate hikes is MOST consistent with:
Answer: D — Expectations that policy will succeed in slowing growth or inflation, pulling down expected future short-term rates relative to current long rates
A) Uncovered interest rate parity concerns expected currency depreciation offsetting interest differentials, not yield curve shape. B) Covered interest rate parity is a no-arbitrage spot/forward relationship, unrelated to yield curve shape. C) The Marshall-Lerner condition concerns the trade balance response to depreciation, unrelated to the yield curve. D) Correct — a flattening curve after hikes typically reflects the market pricing in that tighter policy will succeed, lowering expected future short rates relative to current long rates.
A central bank following a Taylor-type rule observes inflation 1% above target and output 2% above potential. With equal weights of 0.5 on each gap, the prescribed policy rate adjustment above the neutral nominal rate is approximately:
Answer: A — 1.5% per calc approx
A) Correct — the computed value is 1.5%. B) 1.7% per calc approx — off-by-percent numeric trap. C) 1.4% per calc approx — off-by-percent numeric trap. D) 1.8% per calc approx — off-by-percent numeric trap.
Country A's inflation rate is expected to be 2% higher than Country B's over the next year. According to relative purchasing power parity, Country A's currency should be expected to:
Answer: A — Depreciate against Country B's currency by approximately the 2% inflation differential
A) Correct. B) Direction reversal — reverses which currency depreciates; the higher-inflation country's currency depreciates, not appreciates. C) Misconception — relative PPP specifically predicts exchange rate changes from inflation differentials; it is not confined to absolute price levels. D) Misconception — relative PPP describes a roughly proportional, not amplified, relationship; capital-flow amplification isn't part of the basic PPP relationship.
A small open economy operates under a fixed exchange rate regime with high capital mobility. The central bank pursues expansionary monetary policy (lowering domestic rates) to stimulate output. Under the Mundell-Fleming framework, the MOST likely outcome is that:
Answer: A — Capital outflows pressure the currency peg, forcing the central bank to sell foreign reserves to defend it, ultimately reversing the monetary expansion
A) Correct — under Mundell-Fleming with a fixed rate and high capital mobility, monetary policy is largely ineffective: lower domestic rates trigger capital outflows that pressure the peg, forcing reserve sales or a reversal of the easing. B) Domestic rates cannot durably diverge from world rates under high capital mobility and a credible peg; arbitrage forces convergence, so this describes the opposite of the actual mechanism. C) This describes the floating-rate, fiscal-policy-effective case, not the fixed-rate monetary case — a mix-up of which tool is effective under which regime. D) Under a fixed regime the exchange rate does not float to absorb the differential — that describes a floating-rate outcome; the peg is a commitment specifically to prevent this adjustment.
4 cards from the 14 in this chapter.
What is the Fisher relation?
(1+nominal) = (1+real)(1+expected inflation). Approximately: nominal ≈ real + expected inflation.
What is purchasing power parity (PPP)?
Exchange rates adjust so identical goods cost the same in different countries. Absolute PPP: spot = price ratio. Relative PPP: %ΔS ≈ inflation differential.
In a vignette: analyst hedges international portfolio currency 50%. Rationale?
Partial hedge — captures benefit when home currency strengthens, retains some FX exposure (and potential diversification). Cost lower than full hedge.
What is the difference between actual and potential GDP?
Potential: GDP at full employment, normal capacity. Actual: realized GDP. Output gap = actual − potential. Negative gap = slack; positive = inflationary pressure.
These are a sample. The full Economics chapter runs 45 items with per-chapter progress tracking, on the web and in the iOS app.
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