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Securities and Investments > Chapter 2: Economic Environment > Flashcards

Chapter 2: Economic Environment Flashcards

1
Q

State controlled economies

A

State decides what is produced and how it’s distributed. Also known as planned economy (production is planned) or command economy.

Advantage is low levels of inequality and unemployment.

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2
Q

Market economies

A

Forces of supply and demand determine how resources are allocated.

Businesses produce goods and services to meet the demand from consumers. The interaction of demand from consumers and supply from businesses in the market will determine the market-clearing price. This is the price that reflects the balance between what consumers will willingly pay for goods and services and what suppliers will accept for them. Oversupply = low price and opposite for undersupply.

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3
Q

Mixed economies

A

Combines market economy with state control. In mixed economies governments will provide a welfare system to support the unemployed, the infirm and the elderly, in tandem with the market-driven aspects of the economy.

Governments raise finance by:
- collecting taxes
- raising money through borrowing

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4
Q

Open economies

A

Economic relationships between outside countries. Few barriers to trade or controls over foreign exchange.

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5
Q

Protectionism

A

When a country prevents other countries from trading freely with it in order to preserve its domestic market.

World trade organisation (WTO) exists to promote the growth of free trade between economies.

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6
Q

Macroeconomic objectives

A
  1. Full employment
  2. Economic growth
  3. Low inflation
  4. Balance of payments equilibrium
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7
Q

Stages of economic cycle

A

Begins with the PEAK which drops to the CONTRACTION. Hits a TROUGH at the bottom. Rises with is EXPANSION and then PEAKS again.

Peak - GDP at highest point

Contraction - GDP declines as economic activity slows

Trough - GDP at lowest point

Expansion - economic activity picks up and GDP begins growing again

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8
Q

Fiscal policy

A

An action by the government to spend money, or to collect money in taxes, with the purpose of influencing the condition of the economy.

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9
Q

Tools to influence the level of spending in economy

A
  1. The budget - the government budget is a statement of public income and expenditure over a period of one year. There will be a balanced budget where income equals expenditure. A deficit budget where expenditure exceeds income or a surplus budget where income exceeds expenditure. With a budget deficit the government must borrow to make up the difference. This is known as public sector borrowing requirement (PSBR).
  2. Taxation - gov can influence the level of spending in the economy. If gov reduce tax and keep its own spending constant it would mean that firms and households would have more disposable income.
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10
Q

Implications of fiscal policy for business

A
  1. Planning
  2. Costs
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11
Q

Monetary policy

A

The regulation of the economy through control of the monetary system by operating on such variables as the money supply, the level of interest rates and the conditions for the availability of credit.

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12
Q

Monetary policy: money supply

A

The government can target the stock of money as an economic tool. They may decide to impose a ‘credit squeeze’ and restrict credit lending to control levels of spending and reduce inflation. They may also impose reserve requirements on banks.

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13
Q

Monetary policy: interest rates

A

An increase in interest rates is thought to discourage spending in the economy and thereby reduce the level of aggregate spending.

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14
Q

The role of central banks

A
  1. Act as banker to banking system by accepting deposits from and lending to commercial banks
  2. Act as bank to government
  3. Manage national debt
  4. Regulate domestic banking system
  5. Set official short term rate of interest
  6. Control money supply
  7. Issue notes and coins
  8. Hold nations gold and foreign currency reserves
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15
Q

Bank of England (BoE)

A

UK central bank.

Two core purposes:
1. Monetary stability
2. Financial stability

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16
Q

Monetary stability

A

Interest rate decisions are taken by the Monetary Policy Committee (MPC). Made up of 9 members.

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17
Q

MPC

A

Focus is to ensure that inflation is kept within a government set range, set each year by the chancellor of the exchequer, to support the governments economic objectives, including those for growth and employment. The MPC does this by setting the base rate which is otherwise known as the ‘official bank rate’.

18
Q

Quantitative easing (QE)

A

Inject cash directly into the economy to stimulate demand and return inflation to target.

Involves the central bank creating money, which it then used to buy assets such as government bonds and high quality debt from private companies, resulting in more money in the wider economy.

The central bank buys assets from private sector institutions and credits the sellers bank account so the seller has more money in their account, while the central bank holds assets as part of its reserves. The objective is to move money out in the wider economy.

19
Q

QE: injecting money into economy

A
  1. Seller of bonds ends up with more money and may spend it, which will help boost growth
  2. They may buy others assets instead and in doing so boosts prices and provide liquidity to other sectors of the economy - spend more
  3. Buying assets means higher asset prices and lower yields which brings down cost of borrowing for businesses and households - spend more
20
Q

Financial stability

A

Central banks preserve financial stability which maintains 3 vital functions:

  1. Provides the main mechanism for paying for goods, services and financial assets
  2. Intermediates between savers and borrowers, and channels savings into investments via debt and equity instruments
  3. Insures against and disperses risk
21
Q

Financial policy committee (FPC)

A

Tasked with monitoring the stability and resilience of the UK financial system and using it powers to tackle those risks. It also gives direction and recommendations to PRA and FCA.

It has two key policy levers:
1. Recommendation - ‘comply or explain’
2. Directions - to PRA and FCA

22
Q

Federal reserve (Fed)

A

Comprises 12 regional federal reserve banks, each do which monitors the activities of and provides liquidity to the banks in the region.

Governed by a seven strong board appointed by the president of the US. 5 presidents of the 12 Feds makes up the Federal open market market committee (FOMC). Chairman (appointed by president) takes responsibility for the committees decisions which are directed towards its statutory duty of promoting price stability and sustainable economic growth.

23
Q

European Central Bank (ECB)

A

Based in Frankfurt. Principally responsible for setting monetary policy for the entire Eurozone, with the objective of maintaining internal price stability.

Sets policy through its president and council.

The single supervisory mechanism (SSM) is a new framework for banking supervision. Main aims:
1. Ensure safety and soundness of European banking system
2. Increase financial integration and stability in Europe

24
Q

What is inflation:

A

The persistent increase in the general level of prices.

This is due to excess demand in the economy, scarcity of resources and key workers, or rapidly increasing government spending. Most governments seek to control inflation at 2-3%.

25
Q

High inflation problems:

A
  1. Businesses have to continually update prices
  2. Employees find their real value of their salaries eroded.
  3. Those on fixed levels of income will suffer as prices rise
  4. Exports become less competitive
26
Q

High inflation pros:

A
  1. Rising house prices can contribute to a ‘feel good’ factor
  2. Borrowers benefit because the value of borrowers debt falls in real terms
  3. Inflation also erodes the real value of a country’s national debt and can benefit an economy in difficult times.
27
Q

What is Deflation:

A

General fall in prices. Creates a vicious cycle of reduced spending and a reluctance to borrow as the real burden of debt in an environment of falling prices increases. Leads to depression.

28
Q

Measuring inflation

A

Done by the Office of national statistics (ONS) in the UK. They publish three main measures of inflation:
1. Consumer price index (CPI)
2. Occupiers housing costs (CPIH)
3. Retail price index (RPI)

ONS calculates inflation by collecting price data on a ‘typical shopping basket’ of 700 items from month to month.

To calculate changes in price , ONS sets a base year for the total cost of the shopping basket which is then converted into an index of 100: CPI and CPIH base year is 2015.

29
Q

Gross domestic product (GDP)

A

An economy comprises two distinct groups: individuals and firms. Individuals supply firms with the productive resources of the economy in exchange for an income. In turn, these individuals use this income to buy the entire output produced by firms employing these resources. This gives rise to what is known as the circular flow of income.

GDP is the most commonly used measure of a country’s output. It measures economic activity on an expenditure basis and is typically calculated as below:

Consumer spending + government spending + investments + exports - imports = GDP

30
Q

Economic growth

A

Comes from:
- growth and productivity of labour force
- rate at which an economy efficiently channels its domestic savings and capital attracted from overseas into new and innovative technology and replaces obsolescent capital equipment
- the extent to which an economy’s infrastructure is maintained and developed to cope with growing transport, communication and energy needs

In a mature economy the labour force grows at about 1% per annum

31
Q

Economic cycle

A

Starts with RECOVERY, rises up which is known as ACCELERATION and then hits a BOOM. There is then a decline which is DECELERATION and it ends in a RECESSION.

32
Q

What is balance of payments

A

A summary of all the transactions between the UK and the rest of the world. If the UK imports more than it exports, there is a balance of payments deficit. The UK exports more than it imports there is a balance of payments surplus.

The main components of the balance of payments are:
1. The trade balance
2. The current account
3. Capital amount

33
Q

Balance of payments: The trade balance

A

Comprises a visible trade balance - the difference between the value of imported and exported goods such as those arising from the trade of raw materials and manufactured goods; and an invisible trade balance - the difference between the value of imported and exported services, arising from banking and tourism.

34
Q

Balance of payments: Current account

A

Used to calculate the total value of goods and services that flow into and out of a country. Comprises the trade balance figures for the visibles and invisibles. The results of the current account provide details of the balance a country has with the rest of the world.

35
Q

Balance of payments: Capital account

A

Records international capital transactions related to investment in business, real estate, bonds and stocks.

36
Q

For balance of payments to balance…

A

The current account must equal the capital account, plus or minus a balancing item - used to rectify the many errors in compiling the balance of payments - plus or minus any change in central bank foreign currency reserves.

37
Q

Government debt

A

What the government owes

38
Q

Budget deficit

A

The shortfall between what the government receives in tax receipts and what it spends. The most widely quoted is the Public Sector Net Cash Requirement (PSNCR) which is the difference each year between government expenditure and government income.

39
Q

Exchange rates

A

The price of one currency in terms of another and is quoted in pairs of currencies.

40
Q

The two extremes of the exchange rate regime:

A
  1. Fixed rate system - exchange rate is pegged to a particular currency. To ensure rate stays fixed the central bank will intervene in the currency market to offset the natural forces of demand and supply by spending its foreign currency reserves or buying foreign currency.
  2. Floating rate system
41
Q

Exchange rate regimes

A
  1. Target zone - exchange rate is managed within a band. Means the rate can fluctuate.
  2. Crawling peg - similar to target zone but with upper and lower bands gradually widening. Used as a strategy for moving away from a fixed rate system
  3. Managed float - also known as dirty float. Exchange rate is largely a floating rate with central bank sometimes altering direction of the rate

Securities and Investments (11 decks)

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