Module 42: Economics, Strategy, and Globalization
the economy because individuals and business save only
a portion of the increase in income. Therefore, the correct
answer is (a).
83. (a) The requirement is to identify the purpose of a tax
rebate. Answer (a) is correct because increasing the amount of
funds available to the consumer increases disposable income
that should stimulate economic activity. Consumers will spend
the additional funds and correspondingly expand the economy.
Answers (b), (c), and (d) are erroneous statements about the
effects of the rebate.
84. (c) The requirement is to identify the definition of
structural unemployment. Answer (c) is correct because
structural unemployment exists when aggregate demand is
sufficient to provide full employment, but the distribution of
the demand does not correspond precisely to the composition
of the labor force. This form of unemployment arises when
the required job skills or the geographic distribution of
jobs changes. Answer (a) is incorrect because frictional
unemployment results from imperfections in the labor market.
It occurs when both jobs and workers to fill them are available.
Answer (b) is incorrect because cyclical unemployment is
caused by contractions of the economy. Answer (d) is incorrect
because the full-employment unemployment rate is the sum of
frictional and structural unemployment.
85. (a) The requirement is to identify the nature of the
producer price index. Answer (a) is correct because the price
index measures the combined price of a selected group of
goods and services for a specified period in comparison with
the combined price of the same or similar goods for a base
period. The US government’s producer price index (PPI)
is an example. It measures the price of a basket of 3,200
commodities at the point of their first sale by producers.
Answer (b) is incorrect because the export price index
measures price changes for all products sold by domestic
producers to foreigners. Answer (c) is incorrect because the
import price index measures price changes of goods purchased
from other countries. Answer (d) is incorrect because the
consumer price index measures the price of a fixed market
basket of goods purchased by a typical urban consumer.
86. (a) The requirement is to identify the formula for
calculating a price index. Answer (a) is correct because the
2013 price index using 2008 as a reference period is the price
of the 2013 market basket in 2013 relative to the price of the
same basket of goods in 2008. The correct formula is
Price of market basket in a given year
× 100
Price of same market basket in base year
Answer (b) is incorrect because the 2008 market basket is
used. Answer (c) is incorrect because it uses two different
market baskets. Answer (d) is incorrect because it uses
the 2008 prices in the numerator and the denominator and
different market baskets.
87. (d) The requirement is to describe the discount rate. The
correct answer is (d) because the discount rate is the rate the
central bank charges commercial banks for loans. Answer (a)
is not correct because it describes the reserve requirement.
185
88. (c) The requirement is to identify which of the
statements is true about deflation. Answer (c) is correct
because deflation results in very low interest rates. They could
even turn negative. Answer (a) is incorrect because consumers
are not motivated to borrow money because they will be
paying back the debt with money that has greater purchasing
power. Answer (b) is incorrect because businesses are hesitant
to make investments because prices for capital goods are
declining. Answer (d) is incorrect because deflation typically
stalls the economy.
89. (a) The requirement is to identify the characteristics
of a deflationary economy. The correct answer is (a) because
businesses are hesitant to make investments when the prices
of assets are declining. Answer (b) is incorrect because
consumers are hesitant to make major purchases when prices
are declining. Answer (c) is incorrect because interest rates
are very low in periods of deflation. Answer (d) is incorrect
because when actual GDP exceeds potential GDP inflation will
exist.
90. (a) The requirement is to identify the factor that explains
the difference between real and nominal interest rates. Real
interest rates are in terms of goods; they are adjusted for
inflation. The difference between real and nominal rates is
the inflation premium. Thus, answer (a) is correct. Answers
(b) and (c) are incorrect because credit risk and default risk
explain the difference between the nominal rate and the rate a
particular borrower receives. Answer (d) is incorrect because
market risk explains the difference between the nominal rate
and the rate paid in a particular market.
91. (c) The requirement is to identify the statement that
is not true regarding international trade. Answer (c) is
correct because absolute advantage is the ability to produce
a product for less than other nations. Comparative advantage
is the ability of one nation to produce at a relatively lower
opportunity cost than another nation. Answers (a), (b), and (d)
are all incorrect because they are true.
92. (a) The requirement is to describe the effect of an
increase in the interest rate on a currency’s value. The correct
answer is (a) because if the interest rate is increased investors
will be able to get a larger return on investment in the
country. Therefore, demand for the currency will increase for
investment purposes, and the relative value of the currency will
increase.
93. (b) The requirement is to identify the group that would
most benefit from a tariff. The correct answer is (b) because
a tariff restricts the amount of imports of a specific good, and
the group most benefiting would be the domestic producers of
that good. Answers (a), (c), and (d) are incorrect because these
groups would not benefit from the tariff.
94. (a) The requirement is to identify the description of
comparative advantage. Answer (a) is correct because the
respective opportunity costs determine which country will
produce which product. Answer (b) is incorrect because profit
margins do not enter into the decision. Answer (c) is incorrect
because economic order quantity determines optimum
inventory levels. Answer (d) is incorrect because tariffs would
186 Module 42: Economics, Strategy, and Globalization
only come into play after each country produced its respective
products.
95. (c) The requirement is to identify the scenario that
would result in appreciation in the value of a country’s
currency. The correct answer is (c) because the lag in
imports in relation to exports means that there will be more
demand for the currency from other countries to pay for the
country’s exported goods. Answer (a) is incorrect because if
the country is importing goods this will increase demand for
other currencies and cause the country’s currency to decline
in relative value. Answer (b) is incorrect because a higher
rate of inflation depresses a country’s currency. Answer (d) is
incorrect because lower interest rates means there will be less
demand for the currency for investment.
96. (c) The requirement is to identify the effect of a decline
in the US dollar. The correct answer is (c) because US goods
will be cheaper in foreign countries and, therefore, US
exports will increase. Answer (a) is incorrect because foreign
currencies will appreciate if the dollar depreciates. Answer
(b) is incorrect because the US balance of payments should
improve due to the increase in exports. Answer (d) is incorrect
because US imports will decline because of the increase in
cost of foreign goods in dollars.
97. (c) The requirement is to describe how exchange rates
are determined. The correct answer is (c) because exchange
rates are determined in the same way price is determined for
other goods, based on demand and supply. Answers (a), (b),
and (d) are incorrect because while they can have a temporary
influence on exchange rates, supply and demand is the major
determining factor.
98. (b) The requirement is to determine the effect of
changes in exchange rates. Answer (b) is correct because
the dollar’s value has declined against the real and therefore
Brazilian goods become more expensive. Answer (a) is
incorrect because the Brazilian real has appreciated against the
dollar. Answer (c) is incorrect because the dollar will buy
less in Brazil. Answer (d) is incorrect because US exports
to Brazil should increase because they are less expensive in
Brazilian real.
99. (c) The requirement is to identify the most restrictive
barrier to an exporting country. The correct answer is (c)
because an embargo is a total ban on certain types of imports.
Answer (a) is incorrect because a tariff is merely a tax on
imports. Answer (b) is incorrect because quotas are merely
restrictions on the amounts of imports. Answer (d) is incorrect
because exchange controls are limits of the amount of foreign
exchange that can be transacted or exchange rates.
100. (d) The requirement is to identify the item that does not
describe a foreign exchange control. Answer (d) is correct
because requiring a market-driven (floating) exchange rate
involves no controls on the market. All others describe ways of
controlling foreign exchange.
101. (b) The requirement is to identify the item that describes
a dumping pricing policy. Answer (b) is correct because a
dumping pricing policy involves sales of goods by a company
of one country in another country at a price that is lower than
its cost or significantly lower than the price charged in the
company’s country.
102. (a) The requirement is to identify the item that describes
an appropriate response by importing country to export
subsidies. Answer (a) is correct because countervailing
subsidies is an appropriate response, as they serve to offset the
export subsidies.
103. (c) The requirement is to identify the item that describes
a pegged exchange rate. Answer (c) is correct because a
pegged exchange rate is one that is kept from deviating far
from a range or value by the central bank.
104. (a) The requirement is to calculate the forward premium
or discount on the euro. Answer (a) is correct because the
premium or discount is calculated as follows:
Forward rate – Months (or days) in
Premium Spot rate year
or = ×
Discount Spot rate Months (or days) in
forward period
$1.367 – $1.364 12
= ×
$1.364 3
= 0.88% premium
105. (a) The requirement is to identify the effect of negative
net exports. Answer (a) is correct because when a country has
negative net exports, it imports more than it exports. Therefore,
it results in a net flow of goods from firms in foreign countries
to the domestic country.
106. (d) The requirement is to identify the factor that is least
likely to affect a country’s currency foreign exchange rate.
Answer (d) is correct because the country’s tax rate is least
likely to affect the country’s currency exchange rate. Answers
(a), (b), and (c) are incorrect because they are all factors that
affect the value of the country’s currency.
107. (c) The requirement is to compute the foreign exchange
loss or gain. The correct answer is (c) because before the
decline in value, the receivable had a value of $18,000 (10,000
× $1.80), and after the decline in value, the receivable had a
value of $17,500 (10,000 × $1.75). Therefore, the loss is equal
to $500. Answers (a), (b), and (d) are incorrect because they
inaccurately calculate the loss.
108. (c) The requirement is to identify the appropriate
hedging strategy. The correct answer is (c) because by
selling euros in the futures market, the firm has locked in the
exchange rate today. Answer (a) is incorrect because lending
euros puts the company at greater risk for changes in value
of the euro. It would need to borrow euros to lock in the
exchange rate. Answer (b) is incorrect because it involves the
purchase of euros; the appropriate strategy would involve the
sale of euros. Answer (d) is incorrect because the purchase of
euros on the spot market would put the firm more at risk to
losses from decline in the value of the euro.
109. (b) The requirement is to identify hedging strategies
that are not appropriate for political risk. Political risk is
the risk related to actions by a foreign government, such as
 Module 42: Economics, Strategy, and Globalization
enacting legislation that prevents the repatriation of a foreign
subsidiary’s profits or seizing a firm’s assets. Answer (b)
is correct because purchasing or selling futures contracts
is designed to hedge transaction risks relating to foreign
exchange rates. Answer (a) is incorrect because a firm can
purchase insurance to mitigate political risk. Answer (c) is
incorrect because if the firm finances the investment with
local-country capital, it may not be forced to repay the loans
if assets are seized by the government. Answer (d) is incorrect
because by entering into joint ventures with local-country
firms, the firm can reduce the risk of seizure of the investment
by the government.
110. (c) The requirement is to describe how patents affect
markets. The correct answer is (c) because a patent prevents
another firm from coming into a market and selling the same
or a very similar product. Therefore, it is a barrier to entry into
the market. Answer (a) is incorrect because vertical integration
refers to expansion into another phase of producing the same
product. Answer (b) is incorrect because market concentration
refers to how many firms compete in the market. Answer (d) is
incorrect because collusion refers to firms acting collectively
to control the market.
111. (c) The requirement is to estimate the short-term and
long-term effects of an increase in demand in a perfectly
competitive market. Answer (c) is correct because in the short
term the price of the product will increase but in the long term
it will return to the equilibrium price for the market. Answers
(a), (b), and (d) are incorrect because the long-term price will
not likely increase.
112. (d) The requirement is to identify the ultimate purpose
of competitor analysis. Answer (d) is correct because the
ultimate purpose of competitor analysis is to understand and
predict the behavior of a major competitor. Answer (a) is not
a part of competitor analysis. Answers (b) and (c) are part of
competitor analysis but not the ultimate purpose.
113. (c) The requirement is to identify the item that
is not an important aspect of supply chain management.
Supply chain management is primarily designed to manage
the firm’s relationships with suppliers by sharing key
information all along the supply chain. The correct answer
is (c) because the area of customer relations is not a primary
focus of supply chain management. Answer (a) is incorrect
because information technology is used extensively to share
information electronically. Answer (b) is incorrect because
accurate forecasts are essential to effective supply chain
management. Answer (d) is incorrect because communication
is the basis for supply chain management.
114. (d) The requirement is to identify the type of
organization that would most likely engage in public relations-
type advertising. Firms that have monopolies are more likely
to engage in public relations-type advertising to forestall
additional regulation. Therefore, the correct answer is (d).
115. (b) The requirement is to identify target market analysis.
The correct answer is (b) because target market analysis
involves obtaining a thorough understanding of the market in
which the firm sells or plans to sell its product or services.
187
116. (c) The requirement is to identify an unlikely market
segmentation dimension for business customers. Answer (c)
is correct because lifestyle is a possible individual customer
market segmentation dimension for individuals, not
businesses. Answers (a), (b), and (d) are incorrect because
they all represent possible dimensions for business customer
segmentation.
117. (b) The requirement is to identify the percentage of
variance in quantity demanded explained by price. Answer (b)
is correct because the adjusted R squared (.72458) measures
the percent of the variance in the dependent variable explained
by the independent variable. Answer (a) is incorrect because it
is the Multiple R that is the coefficient of correlation. Answer
(c) is incorrect because it is the intercept that is used in the
equation to predict quantity. Answer (d) is incorrect because
it is the standard error that measures the standard deviation of
the estimate of quantity.
118. (a) The requirement is to calculate the predicted
quantity demanded. The correct answer is (a) because the
formula is
Quantity demanded = a + bx
= 56,400.50 + (7.00 x – 4,598.2)
= 24,213.
119. (d) The requirement is to identify the item that is
not one of the forces in Porter’s model for industry analysis.
The correct answer is (d) because consideration of general
economic conditions is not part of industry analysis. Answers
(a), (b), and (c) are incorrect because the five forces include
the threat of new entrants, the bargaining power of customers,
the bargaining power of suppliers, the threat of substitute
products or services, and the rivalry of the firms in the
market.
120. (a) The requirement is to identify the defining
characteristic of supply chain management. The correct answer
is (a) because a key aspect of supply chain management
is the sharing of key information from the point of sale to
the consumer back to the manufacturer, the manufacturer’s
suppliers, and the supplier’s suppliers. Answer (b) is incorrect
because it is the focus of process reengineering. Answer (c) is
incorrect because it is the focus of total quality management.
Answer (d) is incorrect because strategic alliances involve
joint ventures and partnerships.
121. (d) The requirement is to identify an unlikely strategy
for a firm in a purely competitive market. The correct answer
is (d) because in a purely competitive market firms compete
based on price, and developing a brand name is a product
differentiation strategy. Answers (a), (b), and (c) are all cost
leadership strategies and appropriate for a firm in a purely
competitive market.
122. (c) The requirement is to identify the purpose of a
response profile. The correct answer is (c) because a response
profile is a description of possible actions that may be taken by
a competitor in varying circumstances. Answers (a), (b), and
(d) all involve aspects of industry analysis.
188 Module 42: Economics, Strategy, and Globalization

123. (b) The requirement is to define the process of dividing workforce that is unemployed due to economic conditions.
all potential consumers into smaller groups of buyers with Answer (d) is incorrect because overall unemployment
distinct needs, characteristics, or behaviors. Answer (b) is includes the workforce that is unemployed for all reasons.
correct because this describes market segmentation. Answer
125. (a) The requirement is to identify the steps involved in
(a) is incorrect because strategic planning involves deciding
performing competitor analysis. Answer (a) is correct because
on the appropriate strategic initiatives for a period. Answer
competitor analysis is designed to predict the behavior of
(c) is incorrect because product positioning involves deciding
major competitors. Answers (b) and (c) are incorrect because
on a strategy for a particular product. Answer (d) is incorrect
they describe aspects of industry analysis. Answer (d) is
because objective setting involves establishing short-term
incorrect because it describes aspects of general environment
goals.
and industry analyses.
124. (c) The requirement is to identify the least important
126. (d) The requirement is to identify the item that is not a
measure of unemployment in predicting the future state of the
way in which companies in developed countries can generally
economy. Answer (c) is the correct answer because frictional
compete with companies in developing countries. Answer (d)
unemployment measures the temporary unemployment that
is correct because developing countries typically have low-cost
always exists as workers change jobs or new workers enter
resources. Answers (a), (b) and (c) are incorrect because they
the workforce. Answer (a) is incorrect because structural
all represent ways that a company in a developed country may
unemployment measures the workforce that is unemployed
compete with companies from developing countries.
due to a mismatch in job skills. Significant amounts of
structural unemployment can drag down the economy. Answer
(b) is incorrect because cyclical unemployment measures the
 Module 43: Financial Risk Management and Capital Budgeting 221

Multiple-Choice Questions (1–85)

Risk and Return 5. What is the expected return of the portfolio?

1. If an investment is expected to be held for a long period of a. 10.25%

time the preferred method of calculating the expected return is b. 9.86%
c. 12.5%
a. Arithmetic average. d. 11.35%
b. Median.
c. Geometric average. 6. If management decided to sell one of the investments,
d. Subjective estimate. which one should be selected?

2. Which of the following expresses the relationship between a. Investment A.

risk and return? b. Investment B.
c. Investment C.
a. Inverse relationship. d. Investment D.
b. Direct relationship.
c. Negative relationship. 7. A market analyst has estimated the equity beta of Modern
d. No relationship. Homes Inc. to be 1.4. This beta implies that the company’s
a. Systematic risk is lower than that of the market
portfolio.
Portfolio Returns and Risk b. Systematic risk is higher than that of the market
3. The expected return of a portfolio is measured by the portfolio.
c. Unsystematic risk is higher than that of the market
a. Variance. portfolio.
b. Weighted average. d. Total risk is higher than that of the market portfolio.
c. Standard deviation.
d. Beta. *8. A measure that describes the risk of an investment project
relative to other investments in general is the
4. Russell Inc. is evaluating four independent investment
proposals. The expected returns and standard deviations for a. Coefficient of variation.
each of these proposals are presented below. b. Beta coefficient.
c. Standard deviation.
d. Expected return.
Investment Expected Standard
proposal returns deviation **9. The expected rate of return for the stock of Cornhusker
I 16% 10% Enterprises is 20%, with a standard deviation of 15%. The
II 14% 10% expected rate of return for the stock of Mustang Associates is
III 20% 11% 10%, with a standard deviation of 9%. The riskier stock is
IV 22% 15%
a. Cornhusker because its return is higher.
Which one of the investment proposals has the least b. Cornhusker because its standard deviation is higher.
relative level of risk? c. Mustang because its standard deviation is higher.
d. Mustang because its coefficient of variation is higher.
a. Investment I.
b. Investment II. **10. A US company currently has domestic operations
c. Investment III. only. It is considering an equal-size investment in either
d. Investment IV. Canada or Britain. The data on expected rate of return and the
risk associated with each of these proposed investments are
Items 5 and 6 are based on the following: given below.
Natco has the following investment portfolio.
Proposed investment Mean Standard
Expected Investment Beta return deviation
return British Investment 22% 10%
Investment A 15% $100,000 1.2 Canadian Investment 28% 15%
Investment B 10% $300,000 −0.5
Investment C 8% $200,000 1.5 The mean return on the company’s current, domestic only,
Investment D 8% $100,000 −1.0 business is 20% with a standard deviation of 15%. Using
the above data and the correlation coefficients, the company
* CIA adapted
** CMA adapted