2 - The macro-economic evironment and its impact on asset classes

Question 1

How has the ability of governments to create a boom ahead of an election been curtailed?

Answer 1

By granting central banks independance from the government.

Question 2

Why do financial bubbles occur?

Answer 2

When investors lose sight of fundamental values and buy shares on the expectation prices will continue to rise - known as the greater fool theory

Question 3

What are the consequences of an ageing population?

Answer 3

Working households increase savings to fund a longer retirement:
Demand for services grow, with people spending less of manufactured goods
Services sector accounts for the largest percentage of GDP, resulting in a further decline in manufacturing
Governments become concerned with inflation so ensure values of savings are not wiped out by inflation

Question 4

How is a country capacity for technological change measured?

Answer 4

By the proportion of nati
onal output devoted to research and development, simply put as its ability to incorporate technological international advances inot economic production

Question 5

What are the effects of globalisation on investors?

Answer 5

Can take advantage by investing in foreign markets or shares of international companies with large overseas operations
It puts low skilled, labour intensive industries in the developed world at risk from competition from the developing world.

Question 6

What political factors need to be considered when investing globally?

Answer 6

Significant changes in tax, spending policies in sectors could reduce thier profitability
War or military conflicts
Terrorist attacks could undermine confidence
Leadership of governments could impact policies and therefore growth.

Question 7

What are the four main phases of the business cycle of an economy?

Answer 7

Recovery, followed by an acceleration of growth
Boom
Slowdown
Recession

Question 8

What are the indications within GDP of economic activity?

Answer 8

GDP falls compared to previous quarter - contracting economy
GDP falls in two successive quarters - recession
GDP rises quarter to quarter - expanding

Question 9

What is the PSNCR?

Answer 9

Pulbic sector net cash requirement - difference between the governments expenditure and its revenues

Question 10

What does the PSNCR indicate?

Answer 10

The extent to which the public sector needs to borrow from other sources to finance the difference between expenditure and receipts

Question 11

How is the PSCNR impacted by economic activity?

Answer 11

If in recession, tax revenues are weak and spending on unemployment will grow, so PSCNR will grow
In expansion, tax reveues rise and unemployment falls therefore reducing the deficit.

Question 12

How are interest rates impacted by the economy?

Answer 12

Slow down - interest rates reduce to encourage borrowing and stimulate cosumer demand

Expansion and boom - interest rates may increase to slow down the economy and reduce inflationary pressure

Question 13

What is the impact on fixed interest securities in a booming economy?

Answer 13

Yields need to be higher due to rising inflation and interest rates to compete with other investments, therefore the values fall.

If a downturn they become more attractive due to falling interest rates and therefore become more valuable.

Question 14

How are equities impacted by upturns and downturns of the economy?

Answer 14

Prices pick up as a country moves out of recession, interest rates remain low and the environment for companies improves
Tend to falter during a boom as interest rates are raised to curb expansion
Fall as economy slows down due to higher interest rates and declining earnings

Question 15

What has been the aim of the MPC since 2003?

Answer 15

Meet government target of 2% inflation based on the CPI (consumer price index)

Question 16

What are the commonly quoted measures for money supply and what do they mean?

Answer 16

M0 (narrow money) - notes and coins, banks operational deposits, reflects the economic cycle, is an indicator of consumer spending

growth in M0 indicates buoyant spending, contraction suggests more caution in spending

M4 - notes, coins, bank accounts, including deposits created by banks through lending and deposits of those wanting to save.

Growth indicates increased demand for loans
Rapid growth in money circulating is interpreted and a build up on inflationary pressures

Question 17

How does the government influence the amount of money in circulation?

Answer 17

By selling and buying treasury bills and government stock on the open market

Selling securities reduces the money supply by removing it from the economy, will lead to higher short tern interest rates

Buying securities and paying for them creates money and releases it into the economy leading to lower interest rates.

Question 18

How does the CPI differ to the CPIH and how is the CPIH superior?

Answer 18

The CPIH measures the cost of housing within the cosumer goods and services index and therefore is considered the most comprehensive measure of inflation

Question 19

Describe disinflation?

Answer 19

Decrease in rate of inflation, price of goods and services are still rising but at a slower rate.

Question 20

What is deflation?

Answer 20

Prices decline and over all inflation rate becomes negative. The supply of goods rises faster than the supply of money, purchasing power increases and the general price of goods falls.

People are reluctant to buy expensive items such as cars and houses and they know it will become cheaper in the future.

Manufacturers will reduce output as prices fall, as it becomes more difficult to cover manufacturing costs.

Question 21

How is inflation important to fixed interest securities?

Answer 21

Investors receive the same income whether prices rise or fall, therefore purchasing power will fall by the rate of inflation. A reduction in the rate of inflation will result in the investor being better off.

Any inflation over the term of the security will result in the real value of capital being eroded.

Changes in the value - rise if expectation of falling inflation, decline if inflation speeding up

Question 22

Why do equities generally benefit from low interest rates?

Answer 22

Company profits are usually higher and could lead to an increase in dividend.
Future dividend streams are more vaulable

Question 23

How do imports and exports impact the foreign exchange market?

Answer 23

Imports create a domestic demand for foreign currency to pay for the imports and therefor reduces the supply in the exchange market

Exports create a demand for sterling by foreign buyers and the increases the supply in the foreign market

Question 24

Describe the meaning of the term ‘real exchange rate’

Answer 24

The exchange rate of a country adjusted to take into account their rate of inflation.

Question 25

How is the real exchange rate an indicator of a country’s competitiveness?

Answer 25

If rises, domestic goods become more expensive relative to foreign goods therefore demand reduces, If falls domestic goods become cheaper and demand increases

Question 26

Which firms would benefit from a rise in the pound and which would benefit from a reduction?

Answer 26

Rise - those that rely on imports of raw materials or components

Fall - those that export to other countries

Question 27

What are the two offsetting components of the balance of payments?

Answer 27

Current account - imports and exports of goods and services

Capital account - foreign investments in the UK and Uk investments abroad as well as loans

Question 28

What are the four parts of the balance of payments current account

Answer 28

Visible trade
products ranging from commodities to manufacturing

Invisible trade
Services - tourism, transport, banking
Investment Income - Earning on investments held overseas and those held by foreigners in the UK
Transfer payments - overseas aid and payments to and from EU institutions