11. Behaviour of the Markets Flashcards
Higher risk requires…
higher return
What are government bond cash flows suitable to match?
Annuity business
What is the risk profile of a government bond
Secure & low risk
What 2 factors can impact the term of the government bonds issued. Give an example for each
Supply - in times of fiscal deficit, the government will issue more bonds
Demand - some bond durations are more marketable than others depending on asset-liability matching
Why are corporate bond yields higher than government bonds?
Risk premium
Name the 4 risks corporate bonds are exposed to over government bonds
- Default risk
- Inflation risk
- Marketability risk
- Liquidity risk
________ return is higher on a corporate bond than on a government bond
Expected
How can corporate bond holders eliminate both marketability & liquidity risk?
By matching exactly to maturity, meaning they won’t need to sell the bond
Are equities considered a real investment?
Yes - dividend growth is generally in-line with inflation
What risks are equities exposed to? (5)
- Default risk
- Marketability risk
- Liquidity risk
- Contagion risk
What’s contagion risk (aka systemic risk)?
Risk that difficulty in one equity will spill over into the wider financial system
Why are guarantees & investment options so much more capital intensive?
Regulators require capital to be held against them
On the supply-demand curve, which is the top line, which is the bottom line & what are the titles of the axes?
Top: Supply
Bottom: Demand
x: Quantity
y: Price level
Why is demand for various investment classes so price elastic?
There exists many very close substitutes
What is the main driver of demand for a particular investment class?
Investor expectation of risk vs return
How & why are interest-rates controlled?
Set by the central bank to achieve policy objectives
What 3 economic factors are controlled via interest-rates?
- Economic growth
- Inflation
- Exchange rate
How are interest rates used to influence economic growth?
Low interest rates stimulate spending which improves growth
How are interest rates used to influence inflation?
Consider supply-demand curve
Increasing interest rates brings supply down, driving down the general price level
How are interest rates used to influence the exchange rate?
If interest rates are low relative to other nations, demand from international investors will be lower
What is quantitative easing?
Printing money to buy assets as a way of driving interest rates down when the base rate is already near 0%
