Question #1 of 6
A) Restrictive Expansive
The key piece of data here is the fact that the yield curve is flat. When fiscal policy is expansive
but monetary policy is restrictive, the yield curve is more or less flat.
Question #2 of 6
To calculate the target interest rate, use the following equation. Target rate = neutral rate + 0.5 ×
(expected GDP - GDP trend) + 0.5 × (expected inflation - target inflation). Target rate = 3.57% +
0.5 × (3.84% - 3.27%) + 0.5 × (0.6% - 2.0%) = 3.15%.
Question #3 of 6
A) Interest rates will increase.
Inflation has been 1.3% and Jones is forecasting 0.6%. If Jones is wrong and inflation rises to
2%, the central bank will need to increase short-term rates, which is often associated with a
general increase in interest rates and a decline in bond prices. The link to stock prices is much
less certain, so that is not as good an answer.
Question #4 of 6
A) Increase duration.
Jones projects a target short-term interest rate of 3.15% (see Question 2), lower than the current
rate. To take advantage of the likely rate reduction, bond managers should increase duration.
With a higher duration the bonds will appreciate more in price when rates fall. This assumes
Jones is right. A mix of high stock valuations, a rising market, strong sales and profit growth, and
modest growth in labor costs suggests the economy is in the early expansion phase, historically
a good time to invest in (i.e., over-weight) cyclicals, but not very relevant to a bond manager.
Question #5 of 6
The components of a long-term growth forecast are population growth, labor market participation,
capital input spending, and total factor productivity. The Cobb-Douglas formula is a more refined
way to use similar inputs, but it requires elasticities (weights) for labor and capital. Those are not
provided in the question, so a cruder model is to use the simple sum of those four inputs: 3.0%
(= 3.2 + 0.9 - 1.5 + 0.4).
Question #6 of 6
B) Yes, because economic growth is likely to remain higher than the global average.
Economic growth is higher than the global average. The political system is stable and the
Venvakian government imposes modest taxation while investing in the education of the
workforce. In addition, the currency is expected to appreciate, boosting the return for a foreign