2nd video: Topics in Macroeconomics applied to asset management II

Question 1

Explain what is emerging country risk index (CRI)
6 components?

Answer 1

Country risk index (CRI): has 6 components and 18 indicators. Each country is ranked relative to others for each indicator (1-best 29-worst)

is a measure that assesses the potential risks and uncertainties associated with investing or doing business in a particular country. It provides investors, businesses, and policymakers with a quantitative or qualitative evaluation of the overall risk level associated with a specific country. Emerging markets are economies that are in the process of rapid industrialization and experiencing significant growth. These markets often present unique challenges and opportunities, and assessing the risk environment is crucial for making informed investment or business decisions.

Each country is ranked relative to others for each indicator from 1 (best) to 29 (worst);The lower the overall CRI rank, the better the economic fundamentals

Economic environment
-Ex: CPI inflation rate
Public finance
-Ex: Debt to GDP ratio
Private finance
-Ex: Loans to GDP or Loans to deposits
External financing
-Ex: Total external debt or current account
External strength
-Ex: FX(foreign exchange) reserve to imports or openness (whether is an open economy. or the ratio of trade to the size of economy)
Governance score
-Ex: Voice and accountability, rule of law, government effectiveness, control of corruption

Question 2

What is Consumer Price Index (CPI) 3.4
What is CPI inflation rate?

Answer 2

Consumer Price Index (CPI): The CPI is a statistical estimate constructed using the prices of a sample set of goods and services that represent the spending habits of a typical urban consumer. It covers a broad range of items, including food, clothing, rent, healthcare, entertainment, and more.

The CPI inflation rate is expressed as a percentage and reflects the percentage change in the CPI from one period to another.
Inflation rate = ((Current CPI - Base CPI)/Base CPI) x 100

A positive inflation rate indicates an increase in the general price level over time, while a negative rate suggests deflation (a decrease in prices). The inflation rate provides insights into the overall rate of price changes in the economy.

Uses: Central banks, policymakers, businesses, and individuals use the CPI inflation rate to make informed decisions about monetary policy, budgeting, wage adjustments, and investment strategies. It helps measure the purchasing power of a currency and assess the impact of inflation on consumers.

Question 3

What is current account? (Just form me to know)

Answer 3

The current account is a component of a country’s balance of payments, tracking the flow of goods, services, income, and transfers with the rest of the world. It includes the balance of trade in goods and services, income from foreign investments, and unilateral transfers. A surplus in the current account indicates that a country is exporting more value than it is importing, while a deficit suggests the opposite. The current account, along with the capital and financial accounts, provides a comprehensive view of a country’s economic interactions and external financial position.

Question 4

What is EMBI- Emerging Markets Bond Index? (3.8)

Answer 4

EMBI spread refers to the spread or difference in yields between bonds in emerging markets and U.S. Treasuries.

The EMBI spread is a measure of the risk premium investors demand for holding emerging market bonds compared to the relatively lower-risk U.S. Treasuries. The spread is calculated as the difference in yields between the average yield of the bonds in the EMBI and the yield of comparable U.S. Treasuries.

A widening EMBI spread indicates increased perceived risk in emerging market bonds, reflecting concerns about economic conditions, political stability, or other factors affecting the creditworthiness of these countries. Conversely, a narrowing spread may signal improved confidence in emerging market bonds.

Question 5

Total debt = ? 3.10
Explain components, it is important to know the differences

Answer 5

Total debt = public debt + private debt

Public debt = Central government debt + local government debt
Private debt = household debt + non-financial corporate debt

-Household debt represents the total amount of money that individuals and families owe to creditors. It includes various forms of debt such as mortgages, credit card debt, car loans, and student loans.

-Non-Financial Corporate Debt:
Definition: Non-financial corporate debt refers to the total debt incurred by companies that are not primarily engaged in financial services. These companies produce goods or provide non-financial services.
Examples: Manufacturing companies, technology firms, retail businesses, and other entities that are involved in producing goods or delivering services unrelated to finance.
Purpose: Non-financial corporations may borrow to fund capital expenditures, expand operations, invest in research and development, or manage day-to-day operational expenses.

-Central Government Debt:
Often used for macroeconomic purposes, such as managing the overall money supply, controlling inflation, and stabilizing the national economy.
May include borrowing for large-scale national projects and addressing national economic challenges.

-Local Government Debt:
Primarily used for financing local projects and services that fall under the jurisdiction of the specific local government.
Examples include building local infrastructure, providing public services, and addressing regional needs.

!!! What matters is not debt level, but significant changes in levels

Question 6

BIS? Bank for International Settlements 3.10

Answer 6

The Bank for International Settlements (BIS) is an international financial institution that serves as a bank for central banks. It was established in 1930 and is headquartered in Basel, Switzerland. The BIS operates with the primary goal of promoting international monetary and financial stability.

Question 7

Credit gap formula? What does credit gap entails? 3.11What are 3 advantages of it? (I guess compared to the basic credit numbers)

Answer 7

Credit gap = credit / GDP

The credit gap represents the variance between the current level of credit in the economy and the level of credit that would support healthy economic growth without contributing to excessive risk or financial instability.

Central banks, financial regulators, and policymakers often monitor the credit gap as part of their efforts to assess financial stability. A rapidly widening credit gap might indicate excessive risk-taking or the formation of asset bubbles, which could pose risks to the stability of the financial system.

1. It is normalised by the size of the economy
2. Credit is not influenced by the cyclical pattern of credit demand
3. A ratio of levels is smoother than differences in levels

Question 8

What matters in not debt level, but significant___ 3.13

Answer 8

changes in levels

Question 9

Public vs private credit?3.14-15

Answer 9

Private credit refers to loans and financial obligations held by individuals, businesses, and non-government entities, typically encompassing mortgages, consumer loans, and corporate debt. Public credit, on the other hand, represents borrowing by government entities, including national, state, and local governments. This includes government bonds, treasury bills, and other forms of public debt used to finance government spending and investments. Both types are crucial in economic analysis, impacting overall financial stability, economic growth, and monetary policy.

Question 10

Public debt risk 3 measurements? .17

Answer 10

1. Debt affordability
   -Measuring the actual cost of the debt
2. Debt finance ability
   -Assessing the funding capacity of the private sector
3. Debt reversibility
   -Anticipating the ability to reduce debt through economic growth

Question 11

sovereign risk analysis? 3.20

Answer 11

the term “sovereign” refers to national governments or the government of a particular country. Sovereign risk analysis is an evaluation of the creditworthiness and potential risks associated with a sovereign government’s ability to meet its financial obligations, particularly regarding its debt. This analysis assesses various factors, including the economic, political, and institutional conditions of a country, to gauge the likelihood of the government defaulting on its debt payments or facing other financial challenges.

Question 12

What is a central bank? (mandatory knowledge)

Answer 12

A central bank is a financial institution responsible for managing a country’s money supply, implementing monetary policy, and overseeing the banking system. Central banks play a crucial role in the stability and functioning of the economy. Key functions of central banks include:

Central banks formulate and implement monetary policy to achieve specific economic objectives, such as price stability, full employment, and economic growth. They use tools like interest rates and open market operations to influence the money supply.
Central banks have the sole authority to issue and regulate the national currency. Central banks often act as the government’s banker.Central banks provide banking services to commercial banks and regulate their activities. They may act as lenders of last resort, offering financial support to banks facing liquidity problems. Central banks manage a country’s foreign exchange reserves.

Question 13

The Taylor rule? 3.22 Is the same as central banks’ interest rate policy. Our focus is on PAM Taylor Rule. How is it different from classical Taylor rule?

Answer 13

The Taylor Rule is a classical approach for modelling Central Banks’ policy interest rates as a function of macroeconomic fundamentals (inflation, output gap/GDP growth, exchange rate, etc). It is a normative devise that indicates at what level interest rates should be set according to the level of macroeconomic fundamentals. Taylor Rule can be used as a predictive device in order to anticipate Central Banks; interest rate movements in real-time.

Our approach differs from the “classical” Taylor Rule as we account for a possibly changing Central Bank’s responsiveness to macroeconomic fundamentals (nonlinear!!!) depending on the state of the economy (contraction, crisis, strong expansion…)

To achieve this, we use a semi-parametric specification (PAM Taylor Rule)

Question 14

Two types of interest rates? (knowledge-gap)

Answer 14

There are two primary types of interest rates:

-Borrowing (Lending) Interest Rate (or Cost of Borrowing):
When individuals, businesses, or governments borrow money, they typically pay interest on the borrowed amount. This interest rate represents the cost of borrowing and is applied to the principal amount. For example, if you borrow $1,000 at an annual interest rate of 5%, you would owe $50 in interest for the year.
-Deposit (Investment) Interest Rate (or Return on Investment):
On the other side, when individuals or entities deposit money in a bank or invest in financial instruments, they may earn interest on their deposits or investments. This interest rate represents the return on investment and is the compensation for allowing the bank or institution to use the deposited funds. For instance, if you deposit $1,000 in a savings account with an annual interest rate of 3%, you would earn $30 in interest for the year.

Question 15

!!!!He was talking about 3.24 graph on the right as possible exam question (example). Standardised score, which is (predicted value - consensus ) / standard deviation. So, if it is above 1, we have significant signal for rate hike. Meaning that the current monetary policy is too loose. If it is below -1, we have a significant signal for a rate cut, which means that monetary policy/central bank is not loosening the rates quickly enough.

Thus, we have a signal for a rate cut in eurozone next year (and UK)

Question 16

Purchasing Power Parity (PPP) is?3.31

Answer 16

Purchasing Power Parity (PPP) is an economic theory and a method used to compare the relative value of currencies, suggesting that exchange rates should adjust to equalise the prices of a basket of goods and services in different countries.

The concept is based on the idea that in the absence of transportation costs and other barriers to trade, identical goods should sell for the same price when expressed in a common currency.

PPP holds over the long run! But has significant deviations over time

Question 17

The Law of One Price?

Answer 17

The Law of One Price is an economic principle that suggests that identical goods or assets (tradable goods!) should sell for the same price when expressed in a common currency and traded in efficient markets with no transportation costs or other barriers to trade. In other words, the law posits that in the absence of factors preventing arbitrage, the price of a homogeneous good should be uniform across different locations.

For tradable goods, like our MacBooks

If in us MacBook is 1000 dollars, and in Germany its 1000 euros, so exchange rate should be 1:1!!!!!!!!!

Question 18

What are two long-run exchange rate determinants? explain both .34

Answer 18

productivity & net foreign assets
\he didn’t focus much on explaining each, but should know the ideas in a sentence each at least

Productivity is a measure of efficiency and output per unit of input. In the context of exchange rates, a country with higher productivity is often viewed as more competitive in the global market. Higher productivity can lead to lower production costs, making the country’s goods and services more attractive to foreign buyers.

Net foreign assets represent the difference between a country’s external assets and liabilities. A positive NFA indicates that a country owns more assets abroad than it owes to foreign entities. A negative NFA suggests the opposite.
Impact on Exchange Rates: A country with a positive NFA may be perceived as financially sound and less reliant on external borrowing. This can instill confidence in the country’s currency and contribute to its appreciation. Conversely, a negative NFA may raise concerns about a country’s external indebtedness and lead to depreciation.

Question 19

Long-run equilibrium exchange rates (LTEs)?3.35

Seems quite an important topic, many slides for this

Answer 19

Are theoretical rates at which a currency would stabilize over time, reflecting economic fundamentals without short-term fluctuations. Based on: 1) relative prices (CPI), 2) relative productivities (relative productivity between countries is gauged by comparing the ratio of Consumer Price Index (CPI) to Producer Price Index (PPI)), 3) net foreign assets (Net foreign assets represent a nation’s total holdings of foreign assets minus its total foreign liabilities. They reflect the country’s external wealth, including foreign investments, property, and currency reserves, subtracting what it owes to foreign entities. Positive net foreign assets indicate a creditor nation, while negative signify a debtor status.)

Question 20

Positive vs negative credit gap?

Answer 20

A positive credit gap occurs when the level of credit (public or private) exceeds its long-term trend, suggesting potential overborrowing and increased risk of financial instability or a credit bubble. Conversely, a negative credit gap indicates credit levels below the long-term trend, reflecting underborrowing or deleveraging, which might suggest cautious lending practices, reduced investment, or economic sluggishness. Both positive and negative gaps are critical for assessing economic health and guiding monetary and fiscal policy decisions.

Question 21

Revise how to calculate exchange rates. Interpret if it is undervalued/overvalued and should we short or long that currency!!!

Answer 21

Try with random numbers or rewatch the end of 2nd video and compare your answers