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CFA Level II Economics Practice Questions

Official outline
CFA Institute 2026 Level II Topic Outlines (learning outcomes)
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6
Updated
Nov 3, 2026

  1. Question 1, easy

    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
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    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, easy

    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 explanationHide answer

    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, easy

    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%
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    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.

  4. Question 4, medium

    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 depreciates about 0.5% 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
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    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. Uses only the JPY rate as the expected move and ignores the USD rate. UIP depends on the ratio of both growth factors, 1.005/1.035, which gives about -2.9%.
    • B. Inverts the ratio, computing 1.035/1.005 - 1 of about +3.0%. That gives the wrong direction. The higher-yielding USD is expected to weaken, not strengthen.
    • C. Correct: 1.005/1.035 - 1 = -2.9%, so the high-yield USD is expected to weaken against JPY.
    • D. Uses only the USD interest rate as the expected move and ignores the offsetting JPY rate. UIP depends on the ratio of both growth factors, not on one rate alone.

  5. Question 5, hard

    A small economy fixes its exchange rate to a larger trading partner and has fully open capital markets. The central bank tries to stimulate demand by expanding the money supply. According to the Mundell-Fleming model, what is the likely result?

    • A.Domestic interest rates stay lower, output expands, and the central bank keeps the peg by selling domestic bonds
    • B.The currency depreciates freely, net exports rise, and output increases because the peg is automatically released
    • C.Capital outflows pressure the currency, so reserves must be sold, reversing the money supply increase and leaving output unchanged
    • D.The peg strengthens because lower rates attract capital, and output rises through higher investment
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    Correct answer: C. Capital outflows pressure the currency, so reserves must be sold, reversing the money supply increase and leaving output unchanged

    Lower domestic rates trigger outflows and downward pressure on the currency. To defend the peg the central bank sells foreign reserves and buys domestic currency, shrinking the money supply back. Monetary policy loses independence under fixed rates and high mobility.

    • A. The peg and open capital markets force the bank to follow the partner's rate, so lower rates cannot persist.
    • B. Under a peg, depreciation is resisted rather than allowed; that description fits floating rates.
    • C. Correct: defending the peg undoes the monetary expansion.
    • D. Lower rates cause capital to leave, not enter, so the pressure is toward depreciation.

  6. Question 6, easy

    An economy's labor force is projected to grow 0.6% per year and labor productivity is projected to grow 1.4% per year. Using the labor productivity approach, what is the projected growth rate of potential GDP?

    • A.2.0%
    • B.0.84%
    • C.0.8%
    • D.1.4%
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    Correct answer: A. 2.0%

    Potential GDP growth = growth in labor input + growth in labor productivity = 0.6% + 1.4% = 2.0%. Potential output grows with the quantity of labor employed and with output per unit of labor, and the two growth rates add.

    • A. Correct: 0.6% + 1.4% = 2.0%.
    • B. Multiplies the two growth rates (0.6 x 1.4).
    • C. Subtracts labor force growth from productivity growth (1.4 - 0.6).
    • D. Counts productivity growth alone and omits the labor force.

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