Reading 23: Capital Market Expectations－LOS l between, linkages, interest, exchange, interpret

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CFA Institute Area 6: Economics
Session 6: Economic Concepts for Asset Valuation in Portfolio Management
Reading 23: Capital Market Expectations
LOS l: Identify and interpret macroeconomic and interest and exchange rate linkages between economies.

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Which of the following would indicate that a country is less affected by global events? The country is:

A) small and has a diversified economy.

B) large and has a diversified economy.

C) small and has an undiversified economy.

D) large and has an undiversified economy.

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Answer and Explanation

Larger countries with diverse economies are less affected by events in other countries. Small countries with undiversified economies are more susceptible to global events.

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Which of the following statements regarding global economies is most accurate?

A) Neither emerging nor developed country economies are perfectly integrated.

B) Both emerging and developed country economies are perfectly integrated.

C) Emerging economies are perfectly integrated but not developed countries.

D) Developed economies are perfectly integrated but not emerging countries.

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Answer and Explanation

Emerging market economies are noted for the fact that they are segmented (i.e., not integrated). Even among developed countries, economies are not perfectly integrated. For example, the Federal Reserve in the U.S. and the European Central Bank will respond to local effects in their economies, thus creating differences in U.S. and European economic growth.

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Which of the following would be consistent with Country A having higher interest rates than Country B?

A) Country A has a tighter monetary policy and a slower growing economy.

B) Country A has a looser monetary policy and a faster growing economy.

C) Country A has a tighter monetary policy and a faster growing economy.

D) Country A has a looser monetary policy and a slower growing economy.

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Answer and Explanation

Countries with a tighter monetary policy and stronger economic growth will see higher currency values. In fact, in the early 1980s, the U.S. had high real and nominal interest rates due to a tight monetary policy, robust economy, and an increasing budget deficit. This resulted in a higher value for the dollar.

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An analyst believes that a recession is likely to develop that will affect many of the world economies. She believes that Country As GDP should be forecast using current and lagged economic data for it as well as from other countries that may influence Country A. What type of country is Country A and what type of forecasting model should be used? Country A is most likely a:

A) large country and its GDP should be forecast using an econometric approach.

B) large country and its GDP should be forecast using a checklist approach.

C) small country and its GDP should be forecast using a checklist approach.

D) small country and its GDP should be forecast using an econometric approach.

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Answer and Explanation

Small countries with undiversified economies are more susceptible to global events. Larger countries with diverse economies are less affected by events in other countries. An econometric approach can be very complex, involving several data items of various time periods lags to predict the future. They can be used to accurately model real world conditions.