9. Macroeconomic Risk Flashcards

1
Q

Integration

A

Macroeconomic risk becomes more important, because markets become more integrated (more exposed to risk of other countries)

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2
Q

Global economy

A

Political risk (greater risks in global environment than found in US-based investments), exchange rate risk (changes prices of imports and exports)

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3
Q

Domestic macro economy:

A
  • Stock prices rise with earnings, which depend on macroeconomic state.
  • P/E ratios move within bounds, because of supply and demand.
    o Low P/E -> buy, high P/E -> short sell.
    o Exceeded bound in dotcom-bubble (normally 12-25).
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4
Q

Describe state of economy

A

GDP, industrial production, inflation, unemployment rate, consumer confidence.

Not that easy: benchmark is needed, some measures may point in opposite direction

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5
Q

Demand shock

A

Event that affects demand for goods and services in economy (government spending, lowering tax rates, more foreign demand)

  • Demand shock increase will lead to increase in Y, r (more demand for credit) and ᴨ (move in same direction).
  • More competition for capital (both government and enterprises).
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6
Q

Supply shock

A

Event that influences production capacity or production costs (lower imported oil prices, lower wages, better education)

  • If supply shock increases Y moves opposite direction to r and ᴨ.
  • Positive shock in oil prices (supply goes down).
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7
Q

Demand-side policy

A
  1. Fiscal policy

2. Monetary policy

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8
Q

Monetary policy

A

Manipulation of money supply to influence economy via interest rate policies.
EU didn’t do fiscal policy, because of long-run risk of inflation

o Open market operations
o Reserve requirements

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9
Q

Fiscal policy

A

Government’s spending and taxing actions by looking at budget deficit/surplus
(direct way to stimulate)

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10
Q

Fiscal policy

Deficit stimulates economy

A

o Increases demand for goods (via spending) more than it decreases demand (via taxes)

o Crowds out investments by firms (unfair competition -> survival based on non-market focus (government)

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11
Q

Monetary policy

Open market operations

A

Lending money to banks using bonds (cheaper for governments to get capital) as collateral to increase money supply (by ECB), demand goes up in short-term, inflation increases on long run.

  • Deflation is dangerous, because consumers will postpone investments (deflation stops economy)
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12
Q

Monetary policy

Reserve requirements

A
  • Banks need to hold certain reserve
  • Effect on economy: increase reserve requirements to slow down economy
  • Banks have less money to loan (10 times in 2007 in China)
  • Never used in Western world, because of liquidity
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13
Q

Fiscal policy

Deficit stimulates economy

A

o Increases demand for goods (via spending) more than it decreases demand (via taxes)

o Crowds out investments by firms (unfair competition -> survival based on non-market focus (government)

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14
Q

Fiscal policy

Drawback of deficit

A

large deficit -> pay interest, loss of trust in government (inability to pay back debt) -> not risk-free anymore

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15
Q

Fiscal policy

Unemployment definitions

A
  • U-3: standard unemployment rate
  • U-4: U-3 plus discouraged workers: want to work, have actively searched for job
    in past 12 months
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16
Q

What do we do about crisis?

A
  1. Increase government spending
  2. Offer banks opportunities to borrow against low rates
  3. Buy bonds/print money to lower interest rates -> last option
  4. Cut taxes, dangerous because government is already spending
17
Q

Economic calendar

A

Macroeconomic announcements are on fixed dates, more variation in stock market

Actual announcement is not very important, predictions attached to announcement determines how market responds to announcement

18
Q

Industry analysis

A

Returns are often strongly correlated within industries (assets bubbles are industry specific: insurance, railroads, technology), hard to perform different than industry-peers, but hard to define industry of diversified firm (codes get more specific with digit), economic performance can even vary across industries

19
Q

Business cycles

A

Hard to predict business cycle, cycle will not look perfectly (unpredictable)

We don’t know where economy is in business cycle, too many factors that describe state of economy

Difficult to predict peak and trough, booms and recessions vary in length, length between peaks and troughs varies

  • Cyclical industries
  • Defensive industries
20
Q

Cyclical industries

A

Above-average sensitivity to state of economy, high betas: producers of consumer durables (cars, PCs), technological

Invest during expansion

21
Q

Defensive industries

A

Little sensitivity to business cycle, low betas: utilities, pharmaceuticals, food

Invest during contraction

22
Q

Sensitivity to business cycle:

A
  1. Sensitivity of sales
  2. Operating leverage
  3. Financial leverage
23
Q

Sensitivity of sales

A

Reflected in betas of firms, items that aren’t sensitive to income levels (necessities) versus discretionary goods (cars, machine tools, steel)

24
Q

Operating leverage

A

Split between fixed and variable costs (high operating leverage -> more fixed assets), more sensitivity if larger part of costs is fixed (higher volatility), price doesn’t
depend on state of economy

25
Q

Financial leverage

A

Use of borrowing, interest is fixed cost that increases sensitivity of profits

26
Q

Sector rotation

A

Portfolio that is shifted to sectors that should outperform according to stage of business cycle: in peak inflation protection (commodities), in trough speculate on recovery (capital goods industries: PCs and cars)

27
Q

Economic indicators

A
  • Leading indicators: tend to rise and fall in advance of economy, forward looking (S&P500, consumer expectations)
  • Coincident indicators: move with business cycle (industrial production, sales)
  • Lagging indicators: change subsequent to market movements, can be measured afterwards (inflation, unemployment)