Answer Question 1.

Time-period bias is related to analysis that represents a relationship that might have held true during a specific p
Analyses that look at a very limited time periods or exclude certain time periods without economic justification c
in this case, extending the data series might not make the analysis more robust because of the potential for inclu
Regime changes are changes in policy, environment or technology that elicit a change in the behavior of data be
For example the development of computer technology over the last 25 years may make very distant data less re
The analyst must also consider the possibility that the productivity measures from more distant time periods ma
employed matrics. Thus there is an economic justification for excluding the older data

Answer Question 2.
By relying on the most recent 6 years of y-o-y growth, Brown might be falling into the STATUS QUO TRAP. Projec
future is not an objective estimate of future consumption.
Brown's reference to the recent news story about frenzied shoppers may be indicative of the CONFIRMING EVID
are nor necessarily indicative of the national trend. Local conditions and/or sales promotions may have affected
that are not necessarily indicative of the wider population.
Brown's reference to the Cabbage Patch doll craze of the 1980s might indicate the RECALLABILITY TRAP. The Cab
sales, particularly around the holiday season. The memory of the robust sales surrounding that period may be un
products available this year.
By failing to qualify his projections, Brown may be falling into the OVERCONFIDENCE TRAP.

To mitigate the bias introduced by these potential psychological traps, Brown should analyze objective factors th
* growth in disposable income
* employment
* stock market returns (the so called "wealth effect")
* consumer credit trends
* consumer confidence surveys

Answer Question 3.
Country B's economy is heavily dependent upon exports and vulnerable to a global reecession. If the demand fo
cut imports significantly while exports would be likely to decline disproportionately due to their commodity natu
imports would lead to a deterioration of the current account balance, which, in turn, would cause the currency o
Country A. The economy of Country A is much less dependent on exports and less vulnerable to a global recessio

Answer Question 4.
The model would predict a low GDP based upon the low GDP and low inflation in the recession. It would be unab
The model does not predict the inflation rate; it predicts GDP.
The coefficients of both exogenous variables are positive. Thus the effects of GDP and inflation in the model wou

Answer Question 5.
The investor would seek to invest in short-maturity bonds so that he could minimize the loss in market values (a
market values of long duration more than those of short duration bonds) and also reinvest at higher yields next y

Answer Question 6.
ST government bonds would provide a refuge from inflation and recession. Wimble's economic forecast call for i
over the coming year. The short maturity of the bonds would enable Wimble to reinvest funds at the higher yield
would protect capital from erosion of principal value.
On the other end, the P/E ratios of equities tend to fall during periods of high inflation and slowing economic con
Also, commercial real estate would be a good hedge against inflation, but would be vulnerable to default risk in

Answer Question 7.
A rise in inflation negatively affects P/E ratios and leads to equity underperformance. The modest increase in eco
would be positive for equities. On balance, it might be advisable to decrease the allocation to equities because o
Real estate, in contrast, tends to appreciate with the rate of inflation. The increase in GDP and modest ST interes
estate market. Given the similar rates of return between equities and real estate, the investor would likely decre
to equities and increase his allocation to real estate.

The investor is advised also to reallocate a portion of the portfolio from LT bonds, especially Treasury bonds, to c
the real rate of return on the fixed coupon bonds and increase the rate of return on the TIPS. Increasing the cash
a portion of the portfolio at the higher short-term interest rates in the next year

Answer Question 8.
Bonds actually perform well during periods of falling inflation or deflation, because interest rates are declining.
This holds true as long as credit risk does not increase. Equities do poorly in periods of declining infllation due to
declining economic growth and asset prices. Deflation also reduces the value of investments financed with debt,
because leverage magnifies losses. Deflation is negative for cash, because the return on holding cash declines to

Answer Question 9.
Her conclusion may increase and not be warranted. In an economic expansion, the budget deficit will decline na
and disboursements to the unemployed decrease. The changes she is observing may be independent of the gove
We have to remember that only government-directed changes in fiscal policy influence the growth of the econo
Changes in the deficit that occur naturally over the course of the business cycle are not stimulative or restrictive
e held true during a specific period of time, but will not likely hold in the future.
thout economic justification can be suspect. However,
ause of the potential for including outdated regimes.
ge in the behavior of data before or after the time of implementation.
make very distant data less relevant for estimating future productivity.
more distant time periods may have changed relative to more recently

he STATUS QUO TRAP. Projecting the most recent trend into the

tive of the CONFIRMING EVIDENCE TRAP. The events at the local mall
omotions may have affected the behavior of consumers in his area

RECALLABILITY TRAP. The Cabbage Patch doll was a toy that generated significant
unding that period may be unduly influencing his opinion in light of the new

d analyze objective factors that affect consumer spending:

reecession. If the demand for imports is inelastic, Country B would be unable to

due to their commodity nature. The disproportionately decline of exports versus
n, would cause the currency of Country B to deteriorate relative to the currency of
ulnerable to a global recession.

he recession. It would be unable to predict an inflection point in the economic cycle.

nd inflation in the model would be additive and not offset each other.

e the loss in market values (as increasing interest rates would affect the
einvest at higher yields next year.

's economic forecast call for inflation to increase and the economy to slow
nvest funds at the higher yields one year from now. The government guarantee
tion and slowing economic conditions.
vulnerable to default risk in a slowing economy.

e. The modest increase in economic growth and the stable ST interest rates
ocation to equities because of the large rise in inflation.
in GDP and modest ST interest rates would lead to an expansion of the real
he investor would likely decrease his allocation

specially Treasury bonds, to cash and TIPS. The rising inflation rate will decrease
n the TIPS. Increasing the cash allocation would also unable the investor to invest

interest rates are declining.

s of declining infllation due to the
estments financed with debt, such as real estate,
n on holding cash declines to zero.

budget deficit will decline naturally, because tax receipts

ay be independent of the government's fiscal policy.
ence the growth of the economy.
not stimulative or restrictive.