Chapter 1 Economic factors Flashcards
Define Inflation, Deflation and Stagflation
Inflation - loss of purchasing power with rising prices and while rising associated with economic expansion Following expansion and peak growth can lead to contraction business cycle with higher unemployment and high inflation rates, (recession), which can lead to Fed (FRB -FOMC) constraining monetary policy (raising interest rates) prior to hitting trough.
Deflation - gain in purchasing power with decreasing prices - associated with lower corporate profit margins, higher unemployment and period of contraction or economic stagnation, under FED applies QE-easing monetary policy lowering interest rates.
Stagflation - An economic cycle characterized by slow growth and a high unemployment rate accompanied by inflation
What makes up CPI Core
Consumer price changes year over year as basket of goods, excluding food and energy prices
What is discount rate vs Fed Fund rate
Discount is rate banks must pay when borrowing from Federal Reserve
Fed Funds is rate banks charge each other for overnight loans < $1M- considered to be most volatile rate
What is the Broker call loan rate
Rate broker -dealer pays when borrowing on behalf of margin client
Prime Rate??
Rate paid by most creditworthy corporate customers when borrowing via unsecured loans
What are definitions of different lengths of maturity levels for fixed income instruments
Short term = bonds up to 3 yrs
Intermediate term = bonds from 4-10 years
Long term = bonds +10 yrs
Describe what happens with Normal, Flat and Inverted Yield curves relative to investor expectations and Fed reaction
Normal curve - investors expect greater returns longer periods out to cover risk of inflation which is reflective of stable economic conditions
Flat curve, which occurs at end of Fed tightening cycle that raises short term rates in line with intermediate and long, is when investors inflation expectations are so low that demands for higher yields on longer term bonds drop significantly
Inverted curve occurs when high inflation/interest rates cause yields to decline as maturity increases, since investors feel that interest rates have peaked and sell short term bonds to buy long term (trying to lock in interest rates in long term). WIth sale of short term bonds, prices of these drop which causes yields to rise and opposite for long term bonds
What are the factors that influence the different states of Credit Spreads
Yield or Credit spread shows bonds of the same maturity but different credit quality, whereas the yield curve shows bonds of the same credit quality over various maturities. When the spread is large between low and high rated bonds, this is a negative indicator for the economy
When the yield spread is small, meaning investors don’t demand higher yields for low vs high rated bonds and thereby expect equal ability to repay is positive.
Therefore narrowing of yield spread is good news, widening is not, (T note vs high yield risk premium )
Describe fixed vs floating rate currency system and impacts on exchange rate
Fixed rate currency have their values pegged to a commodity (gold) or another currency
Floating rate are determined by supply and demand
Exchange rates are based on supply and demand for the currency based on foreign reserves, perceived business investment attractiveness and and interest rates.
Contract balance of trade with balance of payments
Balance of trade tracks money in/out of economy for imports and exports; Based on value of dollar relative to foreign currencies can lead to more exports than imports - trade surplus or more imports than exports - trade deficit.
Balance of payments tracks invested money entering and leaving economy for/from other countries whereby there is surplus if more money is being invested by foreign sources than is going out to be invested in foreign countries, and if opposite then balance of payments deficit
ADR and how used, as compared to FOREX and Sovereign Debt
American Depository Receipt - allows US investors of foreign owned companies to invest in US dollars. However exposes investor to currency exchange risk as dividends are paid in local currency then converted into dollars which can be impacted by weak vs strong valuation to dollar
Can also trade directly in one 16 foreign currencies directly via FOREX
Soveriegn debt is government backed securities (US Treasuries, UK Gilts, German Bunds)
GDP vs GNP
GDP is quarterly change in valuation of all goods produced in US by local and foreign firms..is what is produced in America regardless of who is producing whereas GNP reflects how much American workers are producing wherever they are in the world
Name phases of business cycle and characteristics of each
Expansion - All indicators up except inventory levels and duration/unemployment down
Peak - highest period of growth between expansion and contraction
Contraction - All indicators down except inventory and unemployment, can be a depression (longer lasting) or recession
Trough - lowest point of economic deflation before expansion again
What are different categories of stock relative to how they react in different business cycles
Cyclical - Perform well during expansion, poorly during contraction (heavy equip, steel, autos, durable goods)
Defensive - Perform well during any period as non-cyclical (food, clothing, healthcare, RX, alcohol, tobacco)
Counter Cyclical - Perform well during contraction, poorly during expansion (job placement, career training)
Interest Rate Sensitive- React negatively to rising interest rates (high fixed dividend companies, real estate vs banks, insurance, broker dealers whose profits increase with rising interest rates)
In recession buy defensive stocks and expansion buy growth/cyclical stock
What can Federal Reserve do to impact business cycles
1) Change margin requirements for banks and broker dealers (up in inflation/expansion; down in recession/contraction)
2) Buy (expand/stimulate growth) Treasuries to increase price and reduce yields - QE-easing or loose credit/money supply
….and Sell (fight inflation-contraction) Treasuries to reduce price and increase yields/interest rates - QT-tight credit or money supply
3) Directly adjust Fed discount rate up (slow inflation) or down (stimulate economy) for member banks
What are financial reporting requirements of publicly traded companies
- 10Q: 3 quarterly
- 10K: 1 Annual
- 8K: IF significant event occurs
Construct an income statement, balance sheet and statement of cash flows - knowing components in what order
Income : Revenue - COGS (Gross Inc) - Op Ex (EBITDA)- Dep/Am = Op Inc; - Interest Exp = Pre Tax Inc - taxes = Net Income after tax
Cash Flow: +/- cash flow from operations; +/- cash flow from investing activities;
+/- cash flow from financing activities
Balance Sheet:
Assets (current, fixed, intangible) = Liabilities (current, long term) + Shareholder Equity/ Net Worth
or
Assets - Liabilities = Shareholders Equity
Requirements for cash vs accrual accounting methods
Small business and C-corp with gross reciepts under $5M
Formula for Financial ratios:
Current, Quick, Working Capital, Times Interest Earned, Inventory Turnover, Gross Profit/Operating/Net Margin, Dividend Payout, Debt, Debt to Equity, ROE, Earnings/Book Value Sales/Cash per share and associated P/E; P/B; P/S; P/C
Current: CA / CL
Quick: CA-Inventory/CL
Working Capital: CA - CL
Times Interest Earned: EBIT / Interest
Inventory Turnover: COGS / Average Inventory (FIFOvLIFO)
Gross Profit/Operating/Net Margin: GP/Rev; OpIn/Rev, NC/Rev
Dividend Payout: Dividend per share/Price
Debt: Total L / Total A
Debt to Equity: Total Liability / Shareholder Equity
ROE: Net Income / Stockholders Equity
EPS: Net Income/Outstanding Shares
Book Value to Share: Shareholder Equity/Share
Price to Sales: Market Price/ (Gross Revenue / Outstanding Shares)
Price to Cash: Market Price / (Operating Cash Flow /Outstanding Shares)
Calculation of EPS vs Diluted EPS given preferred stockholders
EPS = Earnings after paying preferred = earnings avail to common / outstanding shares
Diluted EPS = Earnings avail to common / total convertible shares outstanding (common+bond+ preferred+warrants)
Describe effects of FIFO and LIFO during inflationary and recessionary conditions
Inflation: With rising prices:
1) FIFO - COGS lower = increasing profit margin and higher taxes;
2) LIFO - COGS higher = decreasing profits and lower taxes
Recession: Opposite of above
Name formulas and use for:
Standard Deviation
Sharpe
Beta
Alpha
R2
CAPM
Standard Deviation = unit risk measure of volatility
Sharpe = (Rp - Rf)/ Std Dev p (measure of portfolio performance relative to risk adjusted return)
Beta = Market risk measure noted as -1..1 correlation or volatility to market
Alpha = (Rm*B)-Ri ; Investment performance against expected return adjusted for beta
R2 = degree to which movement can be explained by benchmark (<75-100)
CAPM (expected return) = Rf + (Rp-Rf)B or expected return of investment after adjusting for risk free and expected market returns
Describe 2 types of risk and specific risks under each
Systematic- (non diversifiable)
- Purchasing Power
-Reinvestment Risk
- Interest Rate
- Market Risk
- Exchange Rate
- Plus Call, Political, Prepayment,
UnSystematic- (diversifiable)
- Business
- Regulatory
- Credit/Default
- Liquidity
What is bond ladder and how used
Fixed income portfolio with different maturities spread evenly across short, med, long term to reduce interest rate risk
Name the primary leading, coincident and lagging indicators
Leading: S/P 500; Building Permits; #hrs worked by mfg; unemployment claims; consumer confidence; capital goods spending;
Coincident: Mfg and Trade Sales; Personal income; industrial production; non farm payroll (employment)
Lagging: Inventory levels; Unemployment duration/levels
Which of the following investments tends to benefit from inflation and economic uncertainty?
investment-grade corporate bonds
money market funds
common stock
precious metals
precious metals
common stock is the best asset class for inflation-adjusted returns, but inflation hurts common stock, too. When fear sets in, the price of gold tends to rise.
If interest rates are rising in the US much more than in other industrialized nations, which of the following would be expected to happen as a result?
the value of the US Dollar will decline relative to other currencies
bond prices in general will rise
the value of the US Dollar will rise relative to other currencies
the stock market is set for a rally
The value of the US Dollar will rise relative to other currencies
Rising interest rates increase the strength of our currency and push down the price of bonds.
When the Federal Reserve increases the federal funds rate, it typically increases interest rates throughout the economy, which tends to make the dollar stronger. The higher yields attract investment capital from investors abroad seeking higher returns on bonds and interest-rate products.
A substantial increase in the CPI is
negative for the bond market
negative for the stock market
irrelevant to stock market performance
negative for both the stock and bond markets
negative for both the stock and bond markets
stock is more resistant to inflation, but high inflation is bad news for both markets.
WHY?????review material!! page 33-34
If GDP has declined significantly the past several quarters, which of the following industries would you expect to have suffered the most and why?
pharmaceuticals
transportation
food
banking/financial services
transportation
if the economy isn’t moving that means that fewer products are being transported by trucks, trains, planes, etc. Chances are, people are still eating, turning on the heat or air conditioning, and taking their required medications, on the other hand.
What is SIPC and FDIC ?
SIPC covers broker-dealer failure/missing assets.
FDIC-insured means a bank CD cannot lose value and covers bank deposits up to $250K per account type
A stock that goes to zero is not covered by SIPC or FDIC.
What would the following signal to a technical analyst in a bull market condition
an inverted head-and-shoulders pattern
an uptrend showing lower highs and decreasing volume
a downtrend showing higher lows on increasing volume
an inverted head-and-shoulders pattern : a downtrend may be about to reverse
an uptrend showing lower highs and decreasing volume would suggest a bull trend is about to reverse
a bear downtrend showing higher lows on increasing volume - a downtrend may be about to reverse
What is the name for a balance sheet account that will be converted to cash in the short-term?
accounts receivable
accounts payable
fixed assets
current assets
current assets
“accounts receivable” would be one example of a “current asset,” along with inventory and cash equivalents. Therefore, the answer that works is the name of the category–current assets.
Which of the following debt securities would react the most to a change in interest rates?
20-year municipal bond
30-year Treasury bond
10-year corporate debenture
30-year zero coupon bond
30-year zero coupon bond
a zero coupon’s duration is equal to the term to maturity, because that is when all cash flows are received. Any “coupon bond” begins paying out cash flows within a few months, and continues to do so twice a year. Receiving part of this initial investment back on a regular schedule reduces the investor’s risk.
Which of the following statements concerning the strength of the US Dollar is accurate?
a strong dollar benefits an American investor holding an ADR
a strong dollar helps American exports
the dollar strengthens due to low interest rates relative to other nations
the dollar strengthens due to high interest rates in the US relative to other nations
the dollar strengthens due to high interest rates in the US relative to other nations
high interest rates in the US attract investments, which strengthens the dollar.
A weak dollar helps American exporters and Americans holding ADRs.
Core inflation does not include which of the following?
food
alcoholic beverages
apparel
housing
food
core inflation does not include volatile/seasonal items such as food and energy. It is usually called “all items less food and energy,” in fact.
Corporations set aside funds for repayment of principal on long-term bonds in
the sinking fund
the general account
the separate account
treasury stock
The sinking fund
they sink some money into a fund so they can repay the principal or maybe call the bonds.
Which of the following measures the weighted average of an investment’s likely returns?
expected return
present value
net present value
future value
expected return
remember the formula for expected return and then think of it in words rather than just numbers—it’s the possible returns times the chance of getting them.
A technical analyst notices that a stock has declined dramatically over the past 30 days but has begun to level off. If there is a high short interest, the analyst would most likely interpret this signal as
bullish
bearish
meaningless
bearish/neutral
bullish
technical analysts study charts, the advance/decline ratio, the 200-day moving average, and the level of short interest to try to determine what the other traders are giving away with their behavior.
The total number of shares sold short without being covered, of a particular stock, is called the short interest of that stock. The short interest is represented as a percentage. Thus, stocks with a high percentage (usually over 20%) of short interest are termed as high short interest stocks.
The short interest of stocks is tracked by the stock exchanges to understand market behavior and sentiments of investors around a specific stock. High short interest indicates overwhelmingly bearish sentiments around a particular company and its stock. but also if leveling off that investors will need to buy to cover position so will drive price back up…Bullish
Which of the following statements is/are true concerning the registration of investment advisers with offices in more than one state?
An investment adviser may only operate in one state, or it must register with the SEC
No State may enforce any law or regulation that would require an investment adviser to maintain a higher minimum net capital or to post any bond in addition to any that is required under the laws of the State in which it maintains its principal place of business
neither choice listed
both choices listed
No State may enforce any law or regulation that would require an investment adviser to maintain a higher minimum net capital or to post any bond in addition to any that is required under the laws of the State in which it maintains its principal place of business
advisers must comply with regulations in the state where they maintain their principal place of business.
The risk that an investment in an emerging market may be subject to volatility due to an immature governmental/regulatory system is referred to as
capital risk
political risk
governmental risk
market risk
political risk
Emerging markets present political, social, and natural event risk.
Unlike broader and well accepted definitions for related issues such as political risk, government risk has a more micro focus on specific risk issues or indicators that may be unique to a project, reform or investment such as regulatory issues or poor reputation of actors in question due to previous compliance failures which elevate the government risk profile for that specific matter
Which of the following items calculated from a corporation’s statement of financial condition measure(s) short-term liquidity?
Current Ratio
Quick Ratio
Net Working Capital
all of the choices given
all of the choices given (revist short term vs quick ratio)
current ratio and working capital are really six of one—half dozen of the other. For working capital we subtract current liabilities from current assets. For current ratio, we simply divide current assets by current liabilities.
Which of the following industries is probably LEAST affected by a rise in interest rates?
Mortgage Lending
Manufacturing
Utility
Software Design
Software Design (REVISIT ECONOMIC FACTORS)
Rationale
utilities and manufacturing companies are usually highly leveraged, so increased borrowing costs really hurt. As rates rise, consumers are less likely to take out a new mortgage or refinance.
Which of the following is an accurate statement of the effect rising interest rates have on the market for common stock?
Companies paying a relatively large and fixed dividend tend to see their stock prices drop.
Rising interest rates tend to depress the stock prices of companies whose capital structure is highly leveraged and those paying a high and relatively fixed dividend.
If the United States has a current balance of payments deficit, this is financed by
capital inflows from foreigners
a balance of trade or balance of payments deficit is when more $$ leaves US than comes in from foreigners or more imports than exports. Therefore, if foreigners are paying off loans to US banks, this would contribute to a balance of payments surplus for US or alternative, a balance of payment deficit would be financed by capital inflows from foreign investors
A company invoices a client $8,000 in March and receives a bill for $2,400 from a supplier. The company receives a payment of $1,000 on an invoice presented in late January and makes a payment of $250 on a bill received in February. If the company uses the accrual basis of accounting, what is their net income or net loss?
Net Income = $5,600
the accrual basis records the invoice and the bill, not the payments as they would have already been accrued and paid for
$8,000 - $2,400 = $5,600.
