Chapter 14- Economics And Analytics 15-20 Pages Flashcards
Economics
The study of supply and demand and how it affects the prices of goods
Business Cycles
Always start with Expansion when putting order of business cycle
- Expansions- Periods of increased business activity throughout the economy. Expansions end when a peak is hit
2, Peak
- Contractions- When business activity declines.
Short contractions= Recessions
Long contractions= depressions
Bottom of a contraction is a trough - Trough
US commerce department definition of contractions and depressions
Contraction- 6 month period or more of decline is real output of goods and services (GDP)
Depression- 6 quarter period or more, in which unemployment rates are greater than 15%
Expansion characteristics
Increased demand for goods and services
Increases in industrial production
Rising stock prices
Rising property value
Increase in GDP
Downturn characteristics
Rising number of bankruptcies and bond defaults
Higher consumer debt
Falling stock prices
Rising inventories
Decreasing GDP
Gross domestic product
Nations annual economic output of services and goods
Includes personal consumption, gov spend, gross private invest, foreign invest, net exports
Consumer price index
Measures rate of increase or decrease in broad range of consumer prices
Computed monthly
Uses constant dollar calculation to account for inflation
Allows economist to compare the actual purchasing power of the dollars rather than dollars themselves
Inflation
General increases in price
Mild inflation can stimulate growth, high inflation reduces buying power
Higher inflation drives up interest rates on fixed income, while decreases lower bond yield
Low inflation- drives up interest rates of fixed income securities, and bond prices down. Positive for business
Periods of high inflation are bad for business
Always some amount of inflation in a growing economy
Deflation
Occurs during severe recessions, when unemployment is rising
Stagflation
Combination of inflation and high unemployment (stagnation)
Leading indicators
Money Supply (M2) Building permits Average weekly claims for unemployment New orders for consumer goods Machine tool orders Changes in inventories of durable goods Changes in sensitive material prices Stock prices Changes in business and consumer borrowing
Positive change indicate growing economy
Negative forecast a recession
Coincident indicators
Vary directly and simultaneously with business cycle
Number of hours worked Employment levels Non agricultural employment Personal income Industrial production Manufacturing and trade sales GDP
Lagging indicators
Factors that change after the economy has begun a new trend but serve as confirmation
Corporate profits Average duration of unemployment Labor cost per unit of output Ratio of inventories to sales Commercial and industrial loans outstanding Credit to personal income
Keynesian Theory
Active government is vital to health of economy
Demand for goods drive employment and prices
Government should manipulate economy to drive it upwards
Gov reduces taxes to increase private sector spending
Monetarist theory
Milton Friedman is originator
Money supply is major determinant of price levels
Moderately increasing money supply leads to price stability, which allows business to plan and invest
Controlled by Federal Reserve Board
Supply Side Economics
Government should allow market forces to move freely
Laffer argues that as tax rates increase less people will be incentived to work
If taxes were 100%, no one would work
Three categories of money (M1, 2 and 3)
M1- Currency in circulation and checking accounts. Money used for ordinary purchases. Largest and most liquid
M2- adds time deposits (less than $100,000) that are fairly easy to convert. Includes savings accounts, money market funds…
M3- Adds time deposits over 100k and repurchase agreements past one day
Federal Reserve Board
12 regional fed banks and hundreds of banks nation wide
Controls monetary policy and implements policies including:
- acting as agent to US Treasury
- Regulating US money supply
- Setting reserve requirements
- supervising printing of money
- Clearing fund transfers
Three policy tools
- Open market ops (buy/sell gov securities)
- Changes in discount rate (bank loans)
- changes in reserve requirements
Open-market operations
Federal Open Market Committee meets to direct government open market operations
Buying securities- increases supply of money in banking system, which in turn increases bank reserves and loans issued by banks
Selling tightens or contracts the money supply
Less drastic compared to Reserve requirements, but more frequently used
Discount Rate
Discount Rate is the Rate in which the fed charges its members for short term loans
The charge between banks is called the federal funds rate
Fed funds rate fluctuates daily and is most volatile interest rate
Generally an overnight rate for funds exceeding $1MM
Higher rate usually indicates a shortage of funds to lend
Though interbank lending interest rates move more with policy change, long term bonds typically move more than short term under same conditions
Reserve requirement
Commercial banks must deposit a certain percentage of depositor money with Fed Reserve
All money deposited are known as federal funds
Increasing the reserve requirement, tightens the money available and increases interest rates
Most drastic mover of money supply
Fiscal policy
Government budget decisions
Includes:
Federal spending
Money raised through taxes and
Federal budget deficits or surpluses
Based on assumption gov can control l unemployment and inflation by adjusting demand (keynsian idea)
Inefficient due to politics in short term economic problems
Disintermediation
Flow of Money from low yielding savings accounts to a high yielding investment in the marketplace without bank acting as middleman
Occurs when money supply tightens
Balance of payments
Flow of money between US and international countries
Deficit occurs when higher interest rates can be found abroad because money flows to high interest rates
Largest component is balance of trade
Debits are imports and indicates spending abroad
Credits are exports and is foreign spending domestically
Value of dollar effect balance of payments
Technical analysis
Attempt to predict direction of prices on basis of historic price and trading volume patterns
Market trading volume
Substantial above normal movement indicates a pattern or trend
Significant jump in volume signals trend beginning
Market bredth
Number of advances and declines over the course of a day
Regardless of daily performance the market is bearish if there were more declines
Advance/decline line is graph that displays
3 common trend lines
- Consolidation- moves sideways neither up or down
- Reversal- change in movement usually indicated by a consolidation, saucer (reversal of downward trend) or inverted saucer. Could also be seen by a head and shoulders.
Inverted head and shoulders indicates bullish. Direction determined by opposite of the neck point - Support level- range of narrow trading
Resistance- top of the trading level
Breakout is when the market goes out of the range
Look for a breakout to start a trend
Overbough vs oversold
Overbought- number of increasing stocks declines relative to decreasing signifies correction
Oversold- number of falling stocks decreased relative to increasing stocks
Dow Theory
Three different types of changes
Primary trend- 1 year plus
Secondary trend- 3-12 weeks within a primary trend
Short term fluctuations- hours of days
In a primary bull market, there could be bearish secondary trends but each successive one would settle at a higher point.
Series of higher highs, and higher lows
Odd lot Theory
Belief that small investors invariably buy and sell at the wrong times
Therefore they get in when small investors trading in round lots get out
Short interest Theory
Shorts reflect mandatory demand and create a support level
High Short interest is bullish
Modern Portfolio theory h
Analyst predictions is of no value, develop a weighted portfolio to emphasize market trends
Random walk Theory
Direction of stock prices is unpredictable
Efficient market theory that all prices reflect current info
Market indexes
- Dow Jones Industrial Average- oldest and most widely quoted index, charts 30 stocks
- Dow Composite- 30 industrials, 20 transportation and 15 utilities
- Value Line index- 1700 NYSE and OTC stocks
- Wiltshire 5000 index- broadest market index, all NYSE and Nasdaq stocks
- S&P 500- 500 most widely held companies chosen with respect to market size, liquidity and industrial sector
Fundamental analysis
Study of business prospects of an individual company within context of the industry and the overall economy
Look for quality of management, historical earnings trends and examine the structure of a corporation and use of working capital
Defensive industries
Least affected by normal business cycles
Usually produce non durable consumer goods, pharmaceuticals or tobacco
Low risk, low return
Something that people can’t live without
Cyclical industries
Highly sensitive to business cycles and inflation trends
Produce durable goods such as heavy machinery, raw materials and automobiles
Growth industries
Growing faster than the economy as a whole due to technology enhancements, new products or changing consumer tastes
Most will retain their earnings
Special situation stocks
Stocks of a company with unusual profit potential resulting from nonrecurring circumstances
New management, discovery of natural resource on company property, patents pending etc
Financial statements (studied by fundamental analysts)
Provide info on profitability, financial strength and operating efficiency
Balance sheet- snapshot of financial position at a specific time. Does not provide analyst with determination of how Company is improving or deteriorating
Assets-liabilities=equity or net worth
Assets are listed in order of liquidity
Fixed assets are usually property, plant and equipment and are depreciated over time
Notes payable is balance due on equipment
Shareholders Equity= stockholders claim on company assets
Par value is an arbitrary figure that has no effect on market value
Retained earnings= profits not paid out in dividend shares
Capitalization
Combined sum of long term debt and equity accounts
Capital structure is the composition of the capitalization
Working capital
Current assets - current liabilities
Measure of liquidity and ability to pay near term expenses
Important because it highlights a company’s ability to pay the expenses associated with running the business
Depreciation effect on books
Reduces value of fixed assets on balance sheet and taxable income
Capital structure 4 elements
Long term debt
Capital stock
Capital in excesss of par
Retained earnings
Changes in capitalization are reflected in the balance sheet
Does not include short term debt
LIFO and FIFO: dealing with inventory
During inflationary period FIFO would boost profits while LIFO would present a more accurate picture
Inventory is understated in LIFO
Convertible securities effect on BS
Would have a net impact of 0 as liabilities would decrease and equity would increase in case of a bond being converted
Dividend effect on BS
Cash dividends- Reduce retained earnings and eventually reduce cash once paid
Stock dividends- does not affect anything on BS except possibly share price and share total
Spin offs
When a new company is created by the sale of all shares of a subsidiary company
Financial leverage
Company ability to use long term debt to increase its return on equity
Long term debt to equity ratio
Federal Reserve Board considers debt to equity ratios over 50% as high leverage
Total par value of share is
Not affected by a stock split rather the share price and total shares is only affected
Majority of private equity investments are made by
Institutional and accredited investors
Business development company
Help small companies grow and develop
Many are set up as closed end investment companies
FINRA warns that investments in these companies are usually highly illiquid
Nontraded BDCs are especially problematic in terms of suitability
Income statement (fundamental analysts
Summarizes quarterly, year to date or full year performance
Compares revenues with expenses
Operating income or EBIT includes non operating income
Taxable income
Also known as EBT
Interest on company debt does not reduce Operating income because it is not considered an operating expense
Net income after taxes
Common stock Dividends are paid from net income after preferred dividends are paid
Paid with after tax dollars
Earnings per share
Earnings available to common
/
Number of shares outstanding
Footnotes
Footnotes identify significant financial and management issues
Capitalization ratios
Debt to equity
Bond ratio (long term liabilities/ total cap)
Common stock ratio
Preferred stock ratio
Debt to equity over 50% is high
Leverage
Debt to equity is a common measure of leverage
Total capitalization is long term debt + equity
Liquidity Ratios
Working capital= CA-CL, though not a ratio is often used
Current ratio
Quick ratio (takes away unsold inventory from current assets)
Cash asset ratio= cash equivalents/ CL
Debt service Ratio
EBIT/ annual interest + principal
Asset coverage ratio
Book value of tangible and monetary assets
/
outstanding debt
Book value per share
Assets - liabilities - intangibles - par value of preferred stock
/
Share of common stock
Solvency if a company were to be liquidated
Valuation ratios
Earnings per share after dilution-
Can be complex with tax but attempts to count all shares that could be converted
Current yield
Dividend payout ratio- Annual dividend / EPS
Utilities have a high payout ratio
Price to earnings ratio- growth company’s typically have higher PtoE
Fiscal vs monetary policy
The government sets a fiscal policy while the Federal Reserve Board sets the monetary policy
Keynesian
Demand side economics
Stock market response to lower interest rates
Would create a bull market as it increase the money available and lowers interest rates
Increase in Fed Reserve requirements has what effect on total bank deposits
Decrease and multiplier effect
