Economics Practice Question

On the Series 65 exam, you should expect to see at least three or four questions concerning economic indicators. Like this one:

Which of the following is/are generally associated with the economic phase known as "expansion"
A. falling CPI
B. falling interest rates
C. falling unemployment
D. all choices listed

EXPLANATION: during an expansion, everybody’s working, so unemployment is falling, decreasing, dropping, or whatever the exam wants to call it. The CPI and interest rates tend to rise during an expansion. In other words, stockholders tend to do better in an expansion while bond holders tend to do worse . . . and during a contraction, bondholders tend to do better, since falling interest rates raise the market price of their bonds, and since their fixed income stream has greater purchasing power if the CPI begins to drop (deflation).

ANSWER: C

Economic Indicators

Once again the economy is in the news this morning. New claims for unemployment are expected to rise, as is the number of people who remain on unemployment. That's the bad news. The good news includes the fact that inflation--measured by the CPI--is virtually nonexistent. Also, inventories are low, meaning factories will have to ramp up production soon. And, building permits are expected to rise about 3.5%. As you know, building permits and new claims for unemployment are leading indicators. CPI and unemployment/employment rates are coincident indicators. And, inventory is a lagging indicator.

In the article referenced below, you will see brief mention of both fiscal and monetary policy, even though those terms are not used. You'll see that "the Fed" sees no reason to change the discount or fed funds rate. You'll also see that fiscal policy, in the form of a tax credit, can help increase demand for housing.

I invite you to read the brief article at the link below. See how the "test world" matches up with the "real world" at:
http://news.yahoo.com/s/ap/20090917/ap_on_bi_ge/us_economy

Economic Indicators

If you're studying for the Series 65 or 66 exam right now, you picked a pretty good time. Every day the economy is in the news, it seems, and the news typically uses some of the same terminology you'll see on the test: new unemployment claims, unemployment rate, consumer confidence, corporate profits, GDP, recession, economic stimulus, etc. Try to relate what you're hearing, seeing, and reading in the news with what you're studying for your exam. When the media begins to chatter about new unemployment claims dropping, remember that this is a leading indicator, and it's good news. Recently, it was reported that while new claims for unemployment were dropping, the unemployment rate rose slightly. That's the difference between a leading indicator and a coincident indicator. The number of new unemployment claims was changing before it was being reflected in the number of people who remain on unemployment. GDP, a coincident indicator, has been shrinking, but since the rate of shrinkage has slowed lately, some economists point to this as "good news." The stock market, a leading indicator, has been rising since March, and many people pin their hopes of a recovery on that signal. If it seems that nobody really knows where the economy is headed over the next year or so, there is good reason for that--nobody does. But that doesn't stop anyone from reading the economic indicators and using the numbers to make predictions about the economy. Your job is to know which indicators are leading, coincident, and lagging, and to know their significance. Expect two or three questions on economic indicators on the Series 65 or 66 exam.

Economic Indicators

The Series 65 will almost certainly ask 2 or 3 questions about economic indicators. You'll need to memorize which are leading, which are coincident, and which are considered lagging indicators. And, you'll need to recognize the significance of rising claims for unemployment insurance, increased or decreased inventories, etc. Remember that a leading indicator shows up before it plays out in the economy, including: # of new claims for unemployment insurance, # of manufacturing workers, and the stock market. Coincident indicators indicate where the economy is right about now, including: GDP, CPI, personal income, unemployment rate, manufacturing and trade sales. Lagging indicators point backwards, including: inventory, duration of unemployment, and corporate profits.

This morning I see headlines that the number of initial claims for unemployment insurance dropped last week. Of course, millions of people will probably interpret that as good news and rush off to throw their hard-earned cash into "the market," but if you read more closely, you see that this so-called "good news" must be taken with a grain of salt. First, the number fell from 636,000 to 623,000, which is a lot of unemployed people and about twice as high as what we'd see in a healthy economy. Second, although the leading indicator--initial claims for unemployment--improved, the coincident indicator--unemployment rate--worsened. How bad is the unemployment rate? About 9%, with economists expecting it to hit 10% soon. There are approximately 6.78 million people receiving unemployment benefits now, which is the largest number ever recorded since they started keeping track in 1967, and is the 17th week in a row that we've set a record!

Hmm, what else does this economy have going for it?

The only "good news" I've seen lately is that consumer confidence is rising and that durable goods (washers & dryers, refrigerators, etc.) orders are rising. I would sure hate to miss out on the next bull market for stocks, but something tells me that party won't even get started until this time next year. Of course, as Warren and Charlie said in Omaha a few weeks ago, the economy will almost certainly be miserable for all of 2009 and most of 2010 . . . but that doesn't mean they can predict where the stock market will be over the next year or so. They don't try to time the market or play the "top-down" game of looking at economic indicators and "determining" which companies will benefit from economic trends. They just buy good companies and hold them as long as possible.

Do some web research on economic indicators. www.investopedia.com is a good site for that.

Economic Indicators

Bond yields would be expected to rise due to a drop in which of the following indicators?
A. prime rate
B. unemployment claims
C. GDP
D. building permits

EXPLANATION: remember that bond yields rise as economic activity increases. So, a drop in GDP is associated with falling yields, as is a drop in building permits. If the prime rate is dropping, we would assume other interest rates are dropping. But, when unemployment claims are dropping, that means people are going back to work, which is the only indicator that might point toward an increase in economic activity.

ANSWER: B