Portfolio Management - The Business Cycle

The entire financial industry rests on the fundamental concept of the market economy, which means you should be armed with some basic economic theory when you walk into the testing room.

Phases of the Business Cycle
The first concept you need to know is the business cycle, the series of fluctuations in the level of economic activity. The timing and degree of these fluctuations are notoriously unpredictable; however, there is a pattern that seems to recur with these gyrations. A hypothetical business cycle is comprised of the following phases:

  • Peak: Economic activity is growing rapidly and production facilities are operating at full capacity.

  • Contraction (Recession, Depression): Economic growth slows or the economy actually shrinks; sales decline and unemployment rises. This phase follows the peak. There are also different classifications of contractions:
    • A recession is a contraction in which gross domestic production(explained below) declines for two consecutive quarters.
    • A depression is a prolonged, severe recession.

  • Trough: Economic activity is at its lowest point in the cycle.

  • Recovery: Sales, employment levels and other measures of economic activity rebound and eventually reach a new peak. This phase follows the trough.

Phases of the Business Cycle




Exam Tips and Tricks
Memorize the order of the phases of the Business Cycle. You may have a question asking you to put them in order. Recognize that this is a repetitive cycle, so the correct sequence may begin with any phase.

Keynesian Theory
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