Use the following information for Questions 1 through 6.
Economist James Jones prepares economic forecasts for Global Bancorp, one of the world's largest
investment banks. The markets have been volatile with 1.3% inflation, and a change in the party in
power in Washington has many investors worried about the future. Jones has been tasked with
projecting what will happen in the year ahead.
Jones begins by looking at interest rates in the hopes of offering some help to Global's bond
department. He knows the yield curve is flat, but wants more insight on the future direction of interest
rates. Jones finds the Taylor rule useful for predicting the Federal Reserve's action, so he attempts
to calculate a short-term interest rate target based on the following data:
Current short-term rate target:
Target inflation rate:
Expected inflation rate:
Expected GDP growth, current year:
Long-term estimated GDP growth rate:
Jones also performs some analysis of the U.S. economy from an equity perspective. The stock
market has been going up, and sales and profit growth are on the increase. P/E ratios are very high,
but wage growth is very low.
While emerging markets are not Jones' area of expertise, he has also been asked to make a
recommendation regarding investment in Venvakia. In his research, Jones learns the following
Venvakia's population is rising at a 3.2% rate, while the rate of participation in the labor force is rising
at a 0.9% clip. Over the last year, GDP increased 4.5%. The world's GDP rose 3%. In an effort to
boost growth, the government funds high-quality colleges to improve the versatility of the Venvakian
Venvakia's government is uncommonly steady relative to that of other countries in its part of the
world. The country's tax rate is quite low, and there are very few deductions allowed for either
consumers or businesses. Spending on capital inputs is expected to fall 1.5% this year, though total
factor productivity is expected to rise 0.4%. The inflation rate is currently 1.3% and expected to stay
at that level this year. Consumer consumption is expected to rise 4.4% this year, and an expected
appreciation in Venvakian currency should boost buying power.
After collecting data on Venvakia, Jones submits his investment recommendation to Global's foreign
Question #1 of 6
Based on the shape of the yield curve, what is the most likely current blend of fiscal and monetary
Question #2 of 6
The target short-term interest rate using the Taylor rule is closest to:
Question #3 of 6
If Jones' inflation forecast is incorrect and inflation is 2.0%, which of the following are most
A) Interest rates will increase.
B) Bond prices will increase.
C) Stock prices will decline.
Question #4 of 6
Based on Jones' forecasts, what action should the bond portfolio managers take?
A) Increase duration.
B) Decrease duration.
C) Underweight cyclicals.
Question #5 of 6
Venvakia's long-term economic growth forecast is closest to:
Question #6 of 6
Should Global invest in Venvakian businesses?
A) No, because government policies are not likely to enhance growth.
B) Yes, because economic growth is likely to remain higher than the global average.
C) No, because economic growth is likely to fall below the global average.