20 Economic Factors & Financial Reporting Practice Questions & Answers

1. 1. A recession has begun and a client wants equity exposure in industries whose sales hold up relatively well when household spending falls. Which group of industries is generally considered defensive?

   • A.Luxury retailers, airlines and commercial construction firms
   • B.Electric utilities, packaged food makers and pharmaceutical firms✓ Answer
   • C.Automobile makers, homebuilders and heavy equipment firms
   • D.Semiconductor designers, steel producers and machine tool firms

   Defensive industries sell goods and services households keep buying regardless of income, so their revenues and dividends are less sensitive to the business cycle; utilities, consumer staples, pharmaceuticals and tobacco are the standard examples. The other three groups are cyclical: autos, housing, luxury goods, airlines, capital equipment and basic materials all depend on discretionary or capital spending that is deferred during a contraction.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023), Economic Factors and Business Information — Basic Economic Concepts: business cyclesReport a problem with this question

2. 2. An adviser is explaining to a client how a recession is conventionally defined in the economic data. Which description is correct?

   • A.Four consecutive quarters in which inflation exceeds wage growth
   • B.Two consecutive quarters of declining real gross domestic product✓ Answer
   • C.Two consecutive months of rising unemployment and falling retail sales
   • D.Six consecutive quarters of declining nominal gross domestic product

   The conventional rule of thumb is two consecutive quarters of decline in real gross domestic product, and the measure must be real because nominal GDP can keep rising on price increases alone while output shrinks. Six consecutive quarters of decline is the figure commonly cited for a depression, not a recession, and labor-market or inflation readings are symptoms rather than the definition.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023), Basic Economic Concepts — business cycles; Bureau of Economic Analysis, National Income and Product Accounts (real GDP)Report a problem with this question

3. 3. Which action is the tool the Federal Reserve uses most frequently and most flexibly to influence the money supply?

   • A.Changing the discount rate charged at the Federal Reserve's window
   • B.Setting the prime rate that commercial banks charge their best customers
   • C.Buying and selling Treasury securities through open market operations✓ Answer
   • D.Changing the reserve requirement applied to depository institutions

   Open market operations are conducted continuously and in any size the Federal Open Market Committee chooses, which makes them the most-used and most finely calibrated tool; buying securities adds reserves to the banking system and selling them drains reserves. The discount rate is used far less often, reserve requirements are the bluntest and least used tool, and the prime rate is set by commercial banks themselves rather than by the Fed.

   Source: Federal Reserve Act; Board of Governors of the Federal Reserve System, 'The Federal Reserve System: Purposes & Functions' — monetary policy toolsReport a problem with this question

4. 4. The Federal Reserve sells Treasury securities to primary dealers and raises the discount rate. All else equal, the most likely near-term result is:

   • A.Bank reserves fall, short-term interest rates fall and bond prices decline
   • B.Bank reserves rise, short-term interest rates fall and bond prices climb
   • C.Bank reserves fall, short-term interest rates rise and bond prices decline✓ Answer
   • D.Bank reserves rise, short-term interest rates rise and bond prices climb

   Selling securities takes cash out of the banking system and a higher discount rate makes borrowing at the window costlier, so both moves are tight-money actions that shrink reserves and push short-term rates up. Because bond prices move inversely to market interest rates, outstanding bond prices fall as those rates rise.

   Source: Board of Governors of the Federal Reserve System, 'The Federal Reserve System: Purposes & Functions' — open market operations and the discount windowReport a problem with this question

5. 5. Congress passes and the President signs legislation that cuts personal income tax rates and increases federal infrastructure spending. This action is best classified as:

   • A.Restrictive monetary policy, because it raises the demand for bank credit
   • B.Restrictive fiscal policy, because it enlarges the federal budget deficit
   • C.Expansionary monetary policy, because it increases the money in circulation
   • D.Expansionary fiscal policy, because it changes taxation and spending✓ Answer

   Fiscal policy is the taxing and spending authority exercised by Congress and the President, so any change in tax rates or government outlays is fiscal by definition, and cutting taxes while raising spending is expansionary because it puts more purchasing power into the economy. Monetary policy belongs to the Federal Reserve and works on reserves and interest rates, which is why attributing a tax bill to the Fed is the classic error here.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023), Basic Economic Concepts — monetary and fiscal policyReport a problem with this question

6. 6. The U.S. dollar weakens substantially against the euro. For a U.S. client, which outcome should the adviser expect?

   • A.U.S. exports become cheaper abroad and unhedged European holdings gain in dollars✓ Answer
   • B.U.S. imports become cheaper at home and unhedged European holdings gain in dollars
   • C.U.S. travel in Europe becomes cheaper and imported goods decline in price at home
   • D.U.S. exports become costlier abroad and unhedged European holdings lose in dollars

   A weaker dollar means each euro converts into more dollars, so U.S. goods priced in dollars look cheaper to European buyers and U.S. exporters become more competitive. The same conversion works in the client's favor on unhedged European securities, because euro-denominated values translate back into a larger number of dollars; imports and overseas travel become more expensive, not cheaper.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023), Basic Economic Concepts — global factors including currency valuation and exchange ratesReport a problem with this question

7. 7. A client is considering a bond fund that holds emerging-market sovereign debt denominated in the issuers' local currencies. Which statement about the fund's risks is accurate?

   • A.The fund carries both the issuer's default risk and currency risk that diversification cannot remove✓ Answer
   • B.The fund carries currency risk only, because sovereign issuers can always print money to repay
   • C.The fund carries default risk only, since currency moves are offset across many issuing countries
   • D.The fund carries neither risk, because sovereign debt is backed by a nation's power to tax

   Sovereign issuers can and do default or restructure, so credit risk is real even for a government, and when the bonds are denominated in a local currency the U.S. investor's return also depends on the exchange rate. Currency risk is a systematic exposure that holding more foreign issuers does not eliminate, and the ability to print money does not protect a bondholder whose repayment then arrives in a devalued currency.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023), Basic Economic Concepts — global factors: sovereign debt and currency valuationReport a problem with this question

8. 8. A client's bond portfolio earned a nominal return of 4% over the past year while the consumer price index rose 6% over the same period. The client's inflation-adjusted return for the year was approximately:

   • A.Positive 10%, because inflation adds to the nominal return earned
   • B.Positive 4%, because the coupon income was actually received in cash
   • C.Positive 2%, because inflation reduces only the bond's principal
   • D.Negative 2%, so the portfolio's purchasing power actually declined✓ Answer

   The real return is approximated by subtracting the inflation rate from the nominal return, so 4% minus 6% is about negative 2%. A positive nominal return can still be a real loss, which is precisely the purchasing-power risk that makes long-term fixed income vulnerable when inflation runs above the coupon.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023), Basic Economic Concepts — inflation/deflation (real versus nominal return)Report a problem with this question

9. 9. A retired client keeps nearly all of her assets in bank certificates of deposit and Treasury bills because she says she cannot afford to lose money. Over a 25-year retirement, the adviser's main concern about this portfolio should be:

   • A.Default risk, which is unusually high for federally insured deposit accounts
   • B.Business risk, which rises when an issuer's operating earnings become volatile
   • C.Purchasing-power risk, which erodes the real value of a fixed principal✓ Answer
   • D.Liquidity risk, which makes short-term instruments hard to sell at fair value

   Insured deposits and Treasury bills remove credit risk but leave the client fully exposed to inflation, because a fixed principal and a low nominal yield buy steadily less over a long retirement. That inflation or purchasing-power risk is systematic and is usually addressed with assets whose cash flows can grow, such as equities, real assets or Treasury inflation-protected securities.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023), Basic Economic Concepts — inflation/deflation and purchasing-power riskReport a problem with this question

10. 10. The Treasury yield curve is inverted. Among the following Treasury securities, which would be expected to offer the highest yield?

    • A.The three would yield the same, since one issuer backs them all
    • B.The 13-week Treasury bill, the shortest maturity on this list✓ Answer
    • C.The 30-year Treasury bond, the longest maturity on this list
    • D.The 10-year Treasury note, a common benchmark maturity here

    An inverted curve is by definition one on which short-term yields exceed long-term yields, so the shortest maturity listed carries the highest yield. The shape usually reflects an expectation that rates will fall, and historically an inversion has preceded recessions, but identical credit quality across Treasuries is exactly why maturity alone decides the answer.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023), Basic Economic Concepts — interest rates and yield curvesReport a problem with this question

11. 11. Over several weeks the yield spread between high-yield corporate bonds and comparable-maturity Treasury securities widens sharply. This most likely indicates that:

    • A.Investors fear more defaults and are demanding greater compensation for credit risk✓ Answer
    • B.Treasury yields have risen faster than corporate yields on stronger economic data
    • C.Investors expect fewer defaults and are accepting less compensation for credit risk
    • D.The Federal Reserve has lowered the reserve requirement for large commercial banks

    The credit spread is the extra yield investors require to hold a risky bond instead of a same-maturity Treasury, so a widening spread means that required compensation is rising. Spreads widen when investors expect more defaults and move toward safety, and they narrow when confidence returns, which is why spread direction is read as a gauge of risk appetite.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023), Basic Economic Concepts — interest rates and credit spreadsReport a problem with this question

12. 12. An adviser reviewing labor-market data notes that one series tends to confirm a turn in the economy only after that turn has already occurred. Which series is that lagging indicator?

    • A.The number of building permits issued for new private housing
    • B.The average weekly hours worked in manufacturing industries
    • C.The average weekly initial claims for unemployment insurance
    • D.The average number of weeks that a worker's unemployment lasts✓ Answer

    Average duration of unemployment lengthens only after a downturn is under way and keeps rising into the early recovery, which is why it is grouped with the lagging indicators along with the unemployment rate, the prime rate and the inventories-to-sales ratio. Initial claims, manufacturing hours and building permits all turn before the broad economy does and are classified as leading indicators.

    Source: The Conference Board, Composite Indexes of Leading, Coincident and Lagging Indicators (component lists); NASAA Series 65 Test Specifications, Basic Economic Concepts — economic indicatorsReport a problem with this question

13. 13. The United States runs a persistent trade deficit. Which statement about that condition is correct?

    • A.Imports exceed exports, which subtracts from gross domestic product✓ Answer
    • B.Exports exceed imports, which adds to gross domestic product and strengthens the dollar
    • C.Government spending exceeds tax receipts, which is the trade component of the accounts
    • D.Imports exceed exports, which adds to gross domestic product and strengthens the dollar

    Gross domestic product is measured as consumption plus investment plus government spending plus net exports, and net exports equal exports minus imports, so a trade deficit enters the calculation as a negative number. A persistent deficit also means more dollars are being supplied to foreign hands to buy foreign goods, which tends to weigh on the dollar; a shortfall of tax receipts against spending is the budget deficit, a fiscal measure rather than a trade measure.

    Source: Bureau of Economic Analysis, National Income and Product Accounts (GDP = C + I + G + net exports); NASAA Series 65 Test Specifications, Basic Economic Concepts — economic indicatorsReport a problem with this question

14. 14. Which statement correctly describes what a corporation's balance sheet presents?

    • A.A projection for a year, where forecast sales determine budgeted operating costs
    • B.A summary over a quarter, where revenues minus expenses equal reported net income
    • C.A snapshot on one date, where assets equal liabilities plus shareholders' equity✓ Answer
    • D.A record over a year, where cash inflows minus cash outflows equal the net change

    The balance sheet reports financial position as of a single date and must satisfy the accounting equation, assets equal liabilities plus shareholders' equity. Performance over a span of time belongs to the income statement, and the sources and uses of cash over that span belong to the statement of cash flows; none of the three required statements is a forecast.

    Source: SEC Regulation S-X, Article 5 (commercial and industrial companies); NASAA Series 65 Test Specifications, Financial Reporting — balance sheetReport a problem with this question

15. 15. A company reports current assets of $900,000, inventory of $300,000, current liabilities of $500,000 and long-term debt of $1,200,000. Its working capital is:

    • A.Negative $300,000, found by subtracting long-term debt from current assets
    • B.$1,400,000, found by adding current assets and current liabilities together
    • C.$100,000, found by removing inventory before subtracting current liabilities
    • D.$400,000, found by subtracting current liabilities from total current assets✓ Answer

    Working capital is defined as current assets minus current liabilities, so $900,000 minus $500,000 leaves $400,000 available to fund day-to-day operations. Inventory is removed only when computing the quick or acid-test ratio, and long-term debt is excluded entirely because it is not a current obligation.

    Source: SEC Regulation S-X, Rule 5-02 (classified balance sheet: current assets and current liabilities); NASAA Series 65 Test Specifications, Financial ReportingReport a problem with this question

16. 16. A corporation issues new long-term bonds and uses part of the proceeds to purchase a factory building. On the statement of cash flows, these two items appear respectively in:

    • A.Financing activities for the bond proceeds and operating activities for the factory
    • B.Operating activities for the bond proceeds and investing activities for the factory
    • C.Investing activities for the bond proceeds and financing activities for the factory
    • D.Financing activities for the bond proceeds and investing activities for the factory✓ Answer

    The statement of cash flows has three sections, and raising money by issuing debt or equity is a financing activity while buying or selling long-lived productive assets is an investing activity. Operating activities are limited to the cash effects of running the business, such as collections from customers and payments to suppliers and employees.

    Source: FASB ASC 230, Statement of Cash Flows (operating, investing and financing classifications)Report a problem with this question

17. 17. An independent auditor concludes that a company's financial statements present its financial position fairly, in all material respects, in conformity with generally accepted accounting principles. The auditor issues:

    • A.An unqualified opinion, the most favorable report an auditor can give✓ Answer
    • B.An adverse opinion, stating the statements are not fairly presented
    • C.A qualified opinion, noting one material exception to the statements
    • D.A disclaimer of opinion, because no conclusion could be reached at all

    An unqualified, or clean, opinion is the auditor's statement that the financials conform to generally accepted accounting principles without exception, and despite how the word sounds it is the best possible report. A qualified opinion flags a material exception or scope limitation, an adverse opinion says the statements are not fairly presented, and a disclaimer means the auditor could not form an opinion at all.

    Source: PCAOB Auditing Standard 3101 (unqualified opinion) and AS 3105 (departures from unqualified opinions)Report a problem with this question

18. 18. An adviser evaluating a private company for a client receives financial statements prepared by the company's own management with no accountant's report attached. The adviser should recognize that:

    • A.These statements are reviewed, which gives the same assurance as a full audit
    • B.These statements are compiled, so an accountant has tested the underlying records
    • C.These statements are unaudited and carry no independent verification of the figures✓ Answer
    • D.These statements are audited, since management must certify them under GAAP rules

    Only statements accompanied by an independent accountant's report carry outside assurance, so management-prepared figures with no report are unaudited and rest entirely on management's own representations. Review and compilation engagements provide less assurance than an audit rather than the same amount, which is why an adviser should weight audited statements more heavily when assessing a company for a client.

    Source: AICPA Statements on Standards for Accounting and Review Services (compilation and review engagements); NASAA Series 65 Test Specifications, Financial Reporting — audited versus unaudited statementsReport a problem with this question

19. 19. Which pairing of a public company's periodic reports to the SEC is correct?

    • A.The 10-K is the unaudited annual report and the 10-Q is an audited quarterly report
    • B.The 10-K is the audited annual report and the 10-Q is an unaudited quarterly report✓ Answer
    • C.The 8-K is the audited annual report and the 10-K is a quarterly report of events
    • D.The 10-Q is the audited annual report and the 8-K is an unaudited quarterly report

    The 10-K is the annual report filed with the SEC and its financial statements must be audited, while the 10-Q is the quarterly report and its interim statements may be, and normally are, unaudited. The 8-K is neither annual nor quarterly: it is the current report used to disclose specified material events, generally due within four business days of the triggering event.

    Source: Securities Exchange Act Rules 13a-1 (Form 10-K) and 13a-13 (Form 10-Q); Regulation S-X Rule 10-01(d); Rule 13a-11 and General Instruction B.1 to Form 8-KReport a problem with this question

20. 20. Under accrual accounting, how does a company record a large sale made on 60-day credit terms in the final week of its fiscal year?

    • A.Revenue is recorded only after the customer's check clears the company's bank
    • B.Revenue is recorded when the sale is earned, before any cash is collected✓ Answer
    • C.Revenue is recorded when the cash payment arrives, 60 days after the sale
    • D.Revenue is split evenly across the two years covered by the credit period

    Accrual accounting recognizes revenue when it is earned and expenses when they are incurred, regardless of when cash changes hands, so the sale belongs to the year in which the goods were delivered and an account receivable is set up. This is why reported net income can be strongly positive while operating cash flow is weak, and it is the reason an adviser reads the cash flow statement alongside the income statement.

    Source: FASB ASC 606, Revenue from Contracts with Customers; NASAA Series 65 Test Specifications, Financial Reporting — accounting fundamentals (cash versus accrual)Report a problem with this question

Practice questions written from the NASAA Series 65 Test Specifications and the Uniform Securities Act. Not affiliated with or endorsed by NASAA, FINRA or Prometric. Dollar thresholds, fee figures and contribution limits change; where one matters the question supplies it. Confirm current requirements with NASAA before testing. NASAA exam content outline →