CMA Interest Rates & Economic Factors 2 — Questions and Answers
Question 1: Which Federal Reserve tool most directly influences short-term interest rates in the US?
- Open market operations
- Discount rate adjustments
- Reserve requirement changes
- Federal funds rate target (Correct answer)
Correct answer: Federal funds rate target
The federal funds rate target set by the FOMC is the primary benchmark that directly steers short-term borrowing costs throughout the economy.
Question 2: When the yield curve inverts, what does it signal about the economy?
- Strong economic growth ahead
- Potential recession in 6–18 months (Correct answer)
- Inflation is under control
- Housing demand will rise sharply
Correct answer: Potential recession in 6–18 months
An inverted yield curve, where short-term yields exceed long-term yields, has historically been a reliable predictor of economic recession within roughly 6–18 months.
Question 3: A borrower is choosing between a 5/1 ARM at 5.5% and a 30-year fixed at 6.25%. If rates are expected to rise significantly after 5 years, which is the better long-term choice?
- 5/1 ARM, because initial savings outweigh future risk
- 30-year fixed, because it locks in today's rate before increases (Correct answer)
- 5/1 ARM, because ARMs always adjust downward
- 30-year fixed, but only if the borrower plans to refinance
Correct answer: 30-year fixed, because it locks in today's rate before increases
When rates are expected to rise significantly after the fixed period, a 30-year fixed mortgage protects the borrower from future payment shock.
Question 4: Which economic indicator is most closely watched as a leading predictor of mortgage application volume?
- GDP growth rate
- Consumer Price Index (CPI)
- 10-year Treasury yield (Correct answer)
- Unemployment claims
Correct answer: 10-year Treasury yield
The 10-year Treasury yield is the benchmark most directly tied to 30-year fixed mortgage rates, making it the primary leading indicator for mortgage volume.
Question 5: What is the relationship between inflation expectations and long-term mortgage rates?
- Higher inflation expectations push long-term rates down
- Higher inflation expectations push long-term rates up (Correct answer)
- Inflation expectations have no effect on mortgage rates
- Lower inflation expectations push long-term rates up
Correct answer: Higher inflation expectations push long-term rates up
Lenders demand higher nominal interest rates when inflation expectations rise to preserve the real return on their loan investment.
Question 6: A mortgage has a periodic cap of 2% on a 3/1 ARM. If the index rises 4% at the first adjustment, what is the maximum rate increase?
- 4%
- 2% (Correct answer)
- 1%
- 3%
Correct answer: 2%
The periodic cap limits how much the rate can change at any single adjustment interval, regardless of how much the underlying index moves.
Question 7: Which of the following best describes the 'spread' on a mortgage rate?
- The difference between the borrower's rate and the prime rate
- The margin added above the benchmark index to determine the mortgage rate (Correct answer)
- The gap between fixed and adjustable rate offerings
- The lender's origination fee expressed as a percentage
Correct answer: The margin added above the benchmark index to determine the mortgage rate
The spread (or margin) is the fixed percentage added above the index rate to compensate the lender for credit risk, servicing costs, and profit.
CMA Interest Rates & Economic Factors 2
Which Federal Reserve tool most directly influences short-term interest rates in the US?