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
