CFA CFA Level 1 Question of the Week – Economics

Question of the Week – Economics

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    • exam_whiz
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      Larry Anderson, economist with RTG Financial Inc., is discussing effects of inflation with his colleague, Christopher. Discussing the impacts of unanticipated increase in inflation, Larry says, “Unanticipated increases in inflation create losses for fixed-rate borrowers.” 

       The two then went on to discuss the impacts of high anticipated inflation. Christopher states, “High anticipated inflation reduces the level and growth rate of GDP by increasing real after-tax returns on investment, increasing transaction costs, and decreasing productive activity.” 
       Are the statements made by Larry and Christopher correct?
      • Larry is correct but Christopher is not
      • Christopher is correct but Larry is not
      • Both of them are incorrect
    • hairyfairy
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      I think I’m right…… The second one confuses me but I’m going with the conviction that I think Larry is right.

    • farlo001
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      I vote neither are correct. Inflation would be good for borrowers as the value of the original amt borrowed would be less in terms of real dollars. Also, Christopher states that “High anticipated inflation reduces the level and growth rate of GDP by increasing real after-tax returns on investment”. A high rate of inflation would decrease real after-tax returns.

    • jmsatchwell
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      I agree with farlo, inflation will aid fixed rate borrowers due to their interest rate being lock in at a particular point. Think of it as the borrower paying back the lender with devalued dollars. For part two inflation will again result in a payment of devalued dollars for after-tax ROI thus the percent return for ROI must increase in order to combat the weaker currency. 

    • hairyfairy
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      D’oh! Got my concepts mixed around. I was thinking that unexpected inflation will increase rates which is advantageous to fixed-rate borrowers, but don’t know how that translated in my muddled mind to ‘Larry is right’.

      damn.

    • LeChiffre
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      @hairyfairy I made the same mistake you did. Chris is clearly wrong and switching one word around in Larry’s statement would make him correct, however he is wrong too.

    • Maverick
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      I very nearly read this as a rates rise and not inflation, but then re-read it… Obviously a rate rise would mess with borrowers as repayments on a floating interest rate would rise, but obviously inflation, as stated helps borrowers by devaluing their payments.

    • shannondaily
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      Woo! I got it right. 🙂 

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