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CFA Level II Economics Practice Questions

  1. Question 1

    The spot exchange rate is 1.2500 USD per EUR. The one-year interest rate is 4% in USD and 2% in EUR, and covered interest parity holds. A treasurer needs the one-year forward rate quoted as USD per EUR. What is it?

    • A. 1.2260
    • B. 1.2745
    • C. 1.2750
    • D. 1.3000
    Show answer and explanation

    Correct answer: B. 1.2745

    Covered interest parity: F = S x (1 + i_price)/(1 + i_base) = 1.2500 x 1.04/1.02 = 1.2745 USD per EUR. The currency with the lower interest rate (EUR) trades at a forward premium.

    • A. Inverts the ratio (1.02/1.04), which would put the lower-yielding EUR at a forward discount.
    • B. Correct: 1.2500 x 1.04/1.02 = 1.2745.
    • C. Adds the two-point rate difference to the spot as a simple percentage (1.25 x 1.02), ignoring the proper ratio of growth factors.
    • D. Multiplies spot by the USD growth factor only (1.25 x 1.04), ignoring the EUR rate.

  2. Question 2

    A country's output grew 4.0% last year. Capital input grew 5.0% and labor input grew 1.0%. The capital share of income is 0.35 and the labor share is 0.65. Using a Cobb-Douglas growth accounting equation, what was total factor productivity growth?

    • A. 0.40%
    • B. 2.25%
    • C. 1.60%
    • D. -2.00%
    Show answer and explanation

    Correct answer: C. 1.60%

    Growth accounting: g_TFP = g_Y - a g_K - (1-a) g_L = 4.0 - 0.35(5.0) - 0.65(1.0) = 4.0 - 1.75 - 0.65 = 1.60%. TFP growth is the Solow residual: the part of output growth not explained by weighted growth in capital and labor inputs.

    • A. Swaps the weights (0.65 on capital, 0.35 on labor), giving 4.0 - 3.25 - 0.35 = 0.40%.
    • B. Omits the labor contribution: 4.0 - 1.75 = 2.25%.
    • C. Correct: 4.0 - 1.75 - 0.65 = 1.60%.
    • D. Subtracts the unweighted input growth rates: 4.0 - 5.0 - 1.0 = -2.0%.

  3. Question 3

    A country's private saving is 20% of GDP and private investment is 23% of GDP. The government runs a budget deficit of 2% of GDP. Using the saving-investment identity, what is the current account balance as a percent of GDP?

    • A. -1%
    • B. -5%
    • C. -3%
    • D. +5%
    Show answer and explanation

    Correct answer: B. -5%

    Current account = (private saving - investment) + (taxes - government spending) = (20 - 23) + (-2) = -5% of GDP. A deficit must be financed by net capital inflows.

    • A. Treats the government deficit as an addition to saving: -3 + 2 = -1.
    • B. Correct: -3% from the private balance plus -2% from the fiscal balance.
    • C. Ignores the government deficit and uses only the private saving-investment gap.
    • D. Gets the sign wrong; saving below investment signals a deficit.

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  5. Question 4

    The JPY/USD spot rate is quoted as JPY per USD. One-year interest rates are 0.5% in JPY and 3.5% in USD. Assuming uncovered interest parity holds, what change in the USD does the market expect over the year?

    • A. USD appreciates about 2.9% against JPY
    • B. USD appreciates about 3.0% against JPY
    • C. USD depreciates about 2.9% against JPY
    • D. USD depreciates about 3.5% against JPY
    Show answer and explanation

    Correct answer: C. USD depreciates about 2.9% against JPY

    Under UIP the expected change in JPY/USD = 1.005/1.035 - 1 = -2.9%. The higher-yielding USD is expected to depreciate by roughly the interest differential, leaving expected returns equal.

    • A. Gets the sign backwards; the higher-yielding currency is expected to depreciate under UIP.
    • B. Gets the sign backwards and also uses the simple difference rather than the ratio of growth factors.
    • C. Correct: 1.005/1.035 - 1 = -2.9%, so the high-yield USD is expected to weaken.
    • D. Uses only the USD rate and ignores the offsetting JPY rate.

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