Chapter 3 - The Macro-Economic Environment & its Impact On Asset Classes Flashcards
Impact of politics generally - due to what central banks use of interest rates to influence what and control what is limited?, passes responsibility to who and policies can affect (3) and what can also affect the economy (international)
Electoral cycle - what generated before election and what happens after and why is it curtailed now?
Most important effects in inflation come from (2), in financial crisis gov use what to support economies and fiscal deficits lead to
Who are interest rates set by? (Think R01)
Due to ultra-low interest rates, central banks use of rates to influence money supply and control inflation is limited. Passes more responsibility onto Gov and their policies can affect interest rates and currencies, business and competition and economic cycles and inflation. International relations and political developments also affect the economy.
Electoral cycle - boom generated before election then economy cooled down in first stage of parliament. Boom curtailed now due to many central banks granted independence.
Most important effects on inflation have come from Gov taxing and spending. In times of financial crisis, Gov can use monetary and fiscal policy to support economies which leads to fiscal deficits and would’ve previously lead to fears of impending inflation.
Interest rates set by Monetary Policy Committee (MPC)
Speculative fashions - Greater fool theory - when investors lose sight of what and buy assets because?
Financial bubbles happen when investors overestimate and underestimate what? Bubbles swells as investors buy because?
Crashes occur when investors do what and why
Speculative episodes - happen when what allows investors to do what (liquidity and repercussions)
Loose monetary policies can lead to?, super bull markets, how are these caused (reviving economy by and its affect and acceleration and collapse)
Greater fool theory - when investors lose sight of fundamental values and buy shares or other assts because expect that prices will continue to rise.
Financial bubbles happen when investors overestimate potential returns and underestimate competitive pressures. Bubble swells as more and more investors buy equities because they have risen rather than because they offer value.
Crashes occur when investors sells shares because they think prices will continue to fall or forced to sell due to regs or losses.
Speculative episodes happen when excess liquidity allows investors to magnify the financial repercussions of real changes e.g. technology breakthroughs generating bubbles or political unrest generating crashes.
Loose monetary policies can lead to booms as central banks try to stave off recessions. Investors have noticed a super bull market for past 6 decades that generally lasts ten years. Possible cause that due to attempting to revive the economy in early part of decade, rates are cut too far and liquidity rushes into speculative investments. This accelerates at end of decade before collapsing and rates therefore being cut aggressively again.
Socio-economic issues - increased longevity also leads to and why and consequences;
- services and manufacturing demand, its affect on service sector and man and inflation
Technological change
- created new what and offers investors what
- what is key to economic performance (incorporation) and what does it hinge on (workforce)
- what is an important vehicle for what (inv and transfer)
- setting up a business and economic development
- technology and competitiveness
Increased longevity does not only lead to more retirees but also higher average wealth holdings as people fund a longer retirement which has following consequences;
- As become richer, demand for services grow and less spent on manufactured goods.
- Contributed to fact that services sector (banking, insurance and business service) now largest proportion of GDP while manufacturing declines.
- Ageing of population important reason for Gov combatting inflation and elderly concerned about it wiping away their savings.
Technological change
- has created new sectors and industries that offer investors potential for high growth but also risky.
- key to economic performance is ability to incorporate international advances in technology. Hinges on overall education and skill of workforce.
- inward investment is important vehicle for technological transfer between countries.
- Ease or difficulty setting up a business can have an effect on economic development.
- successful incorporation of new technology has lead to businesses gaining competitive advantage over rivals.
World economics and globalisation - developing countries can be assist who by developed world and its effect on emerging market and western competition, international trade means emerging… (sell and standards)
Effects of globalisation - investors take adv via (investing 2) and disadvantage to who and where
When investing what needs to be considered (2) and includes;
- taxation and spending and their affect
- war
- terrorist
- Gov changes
Developing countries can be assisted with capital and technology from developed world which enhances growth of emerging markets and depresses industries in the west in competition. International trade creates opportunity for emerging economies to sell across the globe which raises their quality to global standards.
Effects of globalisation are;
- investors can take advantage of g through investing in foreign markets or by investing in shares of multinational companies.
- Puts disadvantage on low skilled, labour intensive industries in developed world that competing with developing countries.
When investing, political stability and viability needs to be considered;
- changes to taxation or spending policies as they can reduce activities in sectors and therefore reduce profitability.
- war or conflicts can disrupt activities.
- terrorist attacks can undermine confidence and cause sharp drop in eco.
- Gov can change and policies can interfere with investment growth.
Economic and Financial cycles - business cycles last for how long and can have what?, measured from…, four main phases?
Expansion
- growth, sales and profits
- prices and inflation do what, economy does what and what are increased and why.
- when does boom occur
Slowdown
- output growth, inflation and affect on interest, sales drop why and unemployment and business
Recession
- how does this happen (slowdown), output growth is and profits, what are falling, reaches trough and potentially what which means what
Recovery
- moves out of and spending, output growth and profits, inflation and interest rates
Business cycles last around ten years and can have short term fluctuations. Measured from one peak or trough to another. Cycle can be divided into four main phases;
- recovery followed by expansion, boom, slowdown/contraction and recession.
Expansion
- above average growth and record sales and profits
- as prices and inflation rises, economy overheats and interest rates increased to dampen demand and stop expansion
- boom occurs when growing at fastest rate during cycle
Slowdown
- output growth slows but inflation remains high so central bank reluctant to cut interest rates.
- sales drop as consumers become more cautious and spend less.
- unemployment rises and some firms go out of business.
Recession
- if slowdown becomes severe enough results in a recession.
- output growth sluggish and profits are weak
- inflation and interest rates falling
- eventually reaches trough and can go into depression whereby high levels of business failure and unemployment.
Recovery
- moves out of recession and people start to spend more
- output growth accelerates and profits rise while inflation and interest rates remain low.
Economic and financial cycles - what is most closely watched indicator of economic activity and;
- when it falls compared to what, economy is what?
- in recession if?
- expanding
- peak
What is vital to GDP (spending on what and how financed).
Public sector net cash requirement (PSNCR) - what is it, indicates what (borrowing to finance what) and public finances dependant on what;
- if recession, tax revenues are what and spending on what is higher and its affect on PSNCR
Interest rates and economic activity
- if slowing down, % are what to do what (borrow, demand and recession
- if expansion or boom, % are what and why
Most closely watched indicator of economic activity is GDP;
- When GDP falls compared to previous sector, economy said to be contracting.
- After two successive quarters of declining GDP, recession
- if rising compared to previous quarter, expanding.
- peak is where GDP is highest.
Vital to GDP is Gov spending on current and capital expenditure and is financed by taxation.
PSNCR - difference between Gov’s expenditure and revenue. Indicates extent that Gov needs to borrow in order to finance difference between expenditure and receipts. Public finances dependant on economic activity;
- if recession, tax revenues weak and spending on unemployment higher, PSNCR likely to grow and vice versa.
Interest rates rise and fall in line with Eco activity;
- if slowing down, % reduced to encourage borrowing to stimulate demand and stop risk of recession.
- if expansion or boom, increased to slow down economy in order to reduce inflation.
Business Cycles and Investments
FIS - booming and its affect on interest rates and inflation and yields
- recession and recovery and affect on FIS prices and why
Equities - moving out recession and affect on prices and why (% rates and business environment)
- falter when and why (% rate increase and why) but offer chance for?
- fall when? Due to higher what and declining what
- long term, what is more of an influence on prices than what?
FIS - if booming, inflation and % rates are higher therefore yields need to be higher to compete therefore price will fall. If inflation or % fall, income from FIS becomes more attractive. In recession and early stages of recovery, prices of FIS should increase due to falling % rates.
Equities - Generally rise and fall with the economy but speed of changes is varied;
- prices begin to pick up as move out of recession where interest rates remain low and environment for companies improve.
- Falter during boom as % rates raised to slow economy but should offer chances for enhanced profitability.
- Generally fall when eco contracts due to higher % rates and declining corp earnings.
- Over long term, corp profitability tend to have more influence on prices of equities than interest rates.
Fiscal & Monetary policy -
Fiscal - what is it
- in recession Gov does what in order to?
- in boom, Gov does what?
- increase in what has more impact than what and why
- affect on individual (investment decisions) and company (dividend and capital)
Monetary - what is it/does it do, what has most effect in the ST
- Financial Repression - what is it (% and inflation) and effect on deficit
- what is inflation target
- increases in % mean what to monetary policy
- same with decrease
Fiscal - use of Gov spending and taxation to influence level of demand and eco activity;
- in recession or low activity, gov may increase spending or cut taxation to stimulate demand in the economy.
- in a boom, gov may reduce spending or increase taxation.
- increase in Gov spending has more impact than a decrease in income tax of same amount as it will be spend on domestic services and goods.
- Individual - different tax treatment of types of asset will influence investment decisions.
- Company - tax treatment of earnings will affect div policy and choice of raising capital through debt or equities.
Monetary - attempts to stabilise the economy by controlling interest rates and supply of money. In short term, changes in % have most effect.
- Financial Repression - interest rates are below rate of inflation and effectively becomes tax on savers. But for Gov, means negative real interest rates + inflation therefore reducing deficit.
- MPC’s aim to meet Gov’s inflation target which is 2% based on CPI.
- increases % rate = eases monetary policy
- decreases % rate = tightens monetary policy
Money Supply - amount of money in circulation provides info on… (growth, economy and consumer demand), banking lending increasing rate gives who indication of what, how to reduce demand.
M0 Narrow Money
- includes? (Physical and deposits)
- reflects what and little effect on?
- indicator of what
M4 Broad Money;
- includes (as above)
- includes deposits created by who through? + what else (lending and savings)
- acts as indicator of what
- increase in demand for what shows faster what?
- what is rapid growth of money in circulation interpreted as?
General paragraph on how inflation works - money increase, volume of good and service, value. Demand and prices and reducing money supply
The amount of money in circulation in the economy provides information on the growth of the cash base in the economy, which provides an indicator of strength of consumer demand.
Rate at which bank lending is increasing gives MPC indication of demand for credit at that interest rate. Increase in % rates should reduce demand.
Measures of money supply - M0 Narrow Money;
- includes notes and coins in circulation plus banks operational deposits
- reflects but does not cause changes in economic cycle - little effect on national output or inflation
- indicator of consumer spending and retail sales (i.e. growth in M0 indicates consumer spending buoyant and vice versa).
M4 broad money;
- includes notes and coins as above
- includes deposits created by banks through lending activities and savings deposits from public
- acts as indicator of economy
- increased demand for loans shows faster growth of M4
- rapid growth in money circulation is interpreted as inflationary pressures.
If quantity of money increased without increase in volume of goods and services, value of each unit of money will fall. This causes excess is demand and force prices up causing inflation. By reducing money supply, money increase in value and therefore reduce prices.
Money Supply - how can BoE influence volume of money in circulation (selling and purchasing what?) and works;
- selling securities affect on money supply and how. Leads to higher what?
- use what to change interest rates
Quantitative tightening - what is it
Inflation - what do RPI and CPI measure
Disinflation - what is it and when does it occur
Deflation - occurs when (prices and inflation rate), happens due to (supply of goods and money supply), manufacturers react how which leads to what (profits and employment)
BoE can influence volume of money in circulation by selling and purchasing treasury bills and Gov stock. Works as follows;
- selling securities reduces money supply by removing money from circulation and taking away excess purchasing power. This leads to higher short term %. Vice versa.
- Use repo market to change interest rate.
Quantitive tightening - drain money from financial system through selling assets in the market.
RPI & CPI - measures costs of goods and services purchased from month to month. RPI only used to measure inflation for index-linked gilts.
Disinflation - decrease in rate of inflation. Occurs during recession.
Deflation - opposite of inflation and occurs as prices decline over time and inflation rate becomes negative. Happens when supply of goods rises faster than supply of money, then the purchasing power of money increases and general prices will fall. If prices continue to fall, manufacturers will reduce output due to cost of production and therefore lead to reduction in profits and could create unemployment.
Effects of inflation on investments
- Cash - inflation falls then % rates? And why, real rate of return, deposits rate of return, current inflation effect, capital
- FIS - income and better if inflation is?, capital and inflation seen to be diminishing and speeding up effect on price
Equities - why are they good against inflation?, rising profits lead to (2) and real returns
Cash - If inflation reducing, % rates fall as do not need high rate to keep up with inflation.
- Need to consider real rate of return.
- deposits generally have provided real return but at low rates
- rate of inflation currently higher therefore negative real return.
- capital initially invested eroded away
FIS - receive fixed income despite prices so reduction in rate of inflation is better
- capital at maturity eroded
- price rises if expectations for inflation diminish and rise if deemed to be speeding up.
Equities - Good hedge against inflation as companies will increase profits in line with inflation.
- rising profits leads to greater div + value of share.
- equities have consistently grown in real terms.
Interest rates - doing what with % in short term is main tool to control (3), falling % signal what for economy and why, what does this case (goods) and recommendations.
Equities and % - benefit from what and why
Raising and lowering of short term % is main tool to control inflation, stimulate spending and encourage/dis savings;
- falling interest rates signal that economy will expand in medium term as borrowing cheaper.
- due to this, demand for goods rises and more to spend due to cheaper credit.
- can be important when recommending investments for client.
Equities - generally benefit from low % as profits are higher due to reduced cost of borrowing + higher demand.
Money Supply - Exchange rates - adjusted to take into account what, countries competitiveness and exchange rate falling causes demand to?, developed countries use what exchange rate and ER determined how and based onwhat
Value of currency determined by… (eco and current account) - surplus and deficit
Currency too strong causes;
- exports price and effect on competitiveness and profits
- manufacturers
Two factors that lead to strong and rising currency
Major factor affecting exchange rates
- adjusted to take into account differences in inflation rates
- good indicator of countries competitiveness - if exchange rate falls, demand for goods goes up as cheaper to buy and vice versa.
- developed countries use floating exchange rates whereby ER determined by foreign exchange markets and based on supply and demand for currencies.
Value of currency is determined by health of economy and balance of current account;
- surplus on current account (export more than import) then buyer must acquire the currency to pay for those goods.
- deficit means need to sell currency in order to acquire foreign goods.
If currency becomes too strong may be an issue;
- makes exports more expensive, weakening competitive position as exporters profits are reduced.
- manufacturers products become too expensive to compete with other countries
Foreign investment can affect currency value. Countries that run current account surplus (sell more goods and services to other countries than they buy) + keep inflation low usually causes strong and rising currency value. Flows of capital seen as major factor affecting exchange rates.
Balance of payments - what is it (transactions and measured)
- receipt and payments - represents sterling… or any transaction that requires?
BoP consists of two components?
Current account - consists of what (2) and divided into (what are they, simple);
- trade in goods, trade in services, investment income and transfer payments
What is CA balance (net + receipts), deficit in current account means… and a persistent deficits puts pressure on what and therefore encourages (price)
It is the record of the country’s trade transaction with the rest of the world, measured in receipts and payments.
- receipt - represents sterling flowing into the UK or any transaction that requires foreign exchange of currency.
- payments - represent sterling flowing out of the UK, or a transaction that requires the conversion of Sterling into some other currency.
Balance of payments consists of two components - current and capital account.
Current account - consists of transactions in goods (visible, e.g. raw materials, machinery etc) and services (invisible, e.g. tourism, financial etc). Divides into four parts;
- trade in goods - exports and imports of goods
- trade in services - as above but services
- Investment income - comprises of earnings on investments held by Brits overseas (credit the balance) and earnings of investments held by foreigners in Britain (debt the balance of payments).
- Transfer payments - items such as overseas aid or payments to/from EU inst.
Current account balance is the net balance of trade in goods and services + net receipts coming into UK from overseas. A deficit in current account means that more g/s have been imported into the UK than have been sold and vice versa. Persistent deficit puts pressure on currency, which encourages devaluation to increase price competitiveness of exports and decrease imports.
Balance of payments - Capital Account - records movement of what, works as follows (sale and purchase of assets and foreign currency) and when is there a surplus)
If deficit on current account what happens and via (net and loans). If net deficit on both what must country do
Records all movement of money into and out of the country for investment (real assets or financial assets). Works as follows;
- Sales of assets earn foreign currencies, while purchases use up foreign currencies.
- UK capital account has surplus if overseas investors invest more in the country than UK investors do overseas.
Any deficit on current account balance must be made up by capital account via net investments into the country or loans from abroad. If net deficit on from both accounts, country must use official reserves to finance it.
