Chapter 5 Environmental Influences Flashcards
Describe forward guidance
It is a tool used by some central banks enabling them to indicate how it believes monetary policy will change in the future - usually over the following 18 to 24 months
It is designed to help people see how the central bank sets interest rates and to reduce the uncertainty about the future path of monetary policy
It allows the central bank to influence
+Long term interest rates
+Inflation expectations
It is not a guarantee. The central bank can depart from its guidance either as a consequence of some unforeseen economic event or if the economic outlook changes
List the four main classes of investor
+Private individuals
+managers of short term and long term mass savings products (intermediaries)
+corporate
+foreign investors
List four features that vary between the different categories of investor and also the investors within each category
Time horizons eg whether they want investment returns over short term or long term
appetite for risk ie extent to which averse to or tolerant of risk
taxation postion - reflects boh tax rules that applly to particular types of investor and individual investor’s own circumstances, eg how weathy or otherwise
Liability profiles (NTCC) and other features and circumstances
State four possible advantages offered by financial intermediaries compared to direct investment
+Pool resources and thereby enable small investors to gain access to investments which they could otherwise not do so by themselves
+diversification
+expertise
+lower dealing, administration and management costs
State possible disadvantages of financial intermediaries compared to direct investment
+Additional layer of costs to the investor
+products offered might not meet the exact requirements of investor
+products offered may be inflexible
+investor loses element of control over investment choice
Describe
The aims of businesses when issuing securities
the role of investment banks in the issue of securities
Aims of business when issuing securities
Issue securities to raise money to finance investment in real assets.
+Aim to
Get the best possible price for securities
+market issues at lowest possible cost
+issue securities that best meet their own requirements with regarding to the term, pattern and flexibility of funding
Role of investment banks in the issue of securities
+Advise issuing firms on prices they can charge
+handle marketing security issue to the public
+Check and certify quality of information offered
+innovate security design and packaging to stimulate demand
List the 5 main forms of government policy
- Monetary policy- the control of some measure of money supply and the structure of interest rates
- Fiscal policy- decision on the level and structure of taxation and government expenditure and hence public sector borrowing (fiscal deficit).
- National debt management policy- The manipulation of outstanding stock of government debt held by the domestic private sector. ‘
- Exchange rate policy- directed towards achieving some target exchange rate for domestic currency in terms of foreign currency, with the objective of influencing international trading patterns. This could influence the competitiveness of a location for internationally traded goods.
- Price and income policy- Aimed at influencing the rate of wages and price inflation, directly by imposing maximum increases. This sometimes results in distortions between private and public wages.
List seven areas in which a central bank may be interested
+Banking regulation
+Implementation of government borrowing
+taxation
+performance and integrity of financial markets
+intervention in currency markets
+monetary interest rate and inflation policy
+Printing and minting of notes and coins
Describe the role of the central banks in monetary policy and control
Prilmarily concerned with monetary policy and control
Adjustment of banking sector liquidity
control of money supply growth and short term interest rates
Achieved through
Open market operations - buying and selling bills to influence level of liquidity within banking sector and short term interest rates
setting reserve rations
Setting discount rate and interest rate ceilings for bank deposits
issuing directives regarding types of lending under taken by banks
Describe quantitative easing
It is a monetary policy tool to increase money supply
It involves an increase in money supply and an increase from the fractional reserve system
Usually, central bank will credit its account with money, then buy financial assets
typically the assets bought are government bonds, mortgage backed debt or corporate bonds in open market operations
Central banks using QE may give forward guidance to the market regarding the anticipated levels of QE that they intend to conduct in the short to medium term
State the four major economic objectives
Low unemployment - so as not to have economic resources lying idle that could e used to produce goods and services
Low and stable inflation - so as to avoid costs associated with inflation both anticipated and unanticipated
high and stable economic growth - as growth leads to more goods and services and hence higher standard of living
Sustainable balance of payments position that doesn’t constrain achievement of other objectives. Stable exchange rate often viewed as desirable to encourage international trade
Describe the main problem associated with tax policy in an environment where trade is truly global and where there is liberalisation of capital flows, and outline the three main ways that the problem manifests itself.
The main problem with tax policy
Cross border investors and international companies will seek to maximise profits net of tax, and therefore seek more profits to countries with low tax rates. This produces a competitive pressure for countries to lower their tax rates
How the problem manifests itself
Subsidiaries in high tax countries are heavily leveraged, meaning that the profits after interest are very low
Intra- group transfer pricing rates are set, which are inconsistent with market rates, leaving the profits in high tax countries significantly lower
Hyrbrid instruments are used, that lead to tax deduction on country and a tax liability in another to transfer taxable profits
Describe the effects of higher interest rate on the
Personal sector
business sector
Effects of higher interest rates on personal sector
+Consumer’s expenditure reduced due to
Increase in mortgage interest payments, which reduce disposable income
+higher rates on credit facilities
+higher rates of interest on savings
Effects of higher interest rates on the business sector
+Investment reduced due to increased cost of capital and reduced growth and profit prospects
+Currency corporate profitability reduced particularly if much floating rate corporate borrowing
Describe the effect of higher interest rates on the :
(1) Exchange rate and the capital account of the balance of payments
(2) current account of the balance of payments
Effect of higher interest rates on change rate and capital account
Increase in interest rates attracts “hot money”, leading to increase in domestic currency’s exchange rate
if it is believed that domestic activity likely to be depressed, then may be reduced inward flows of direct capital investment
Effect of higher interest rates on current account
If exchange rate rises, then likely to be reduced exports and higher imports, leading to a reduction in net exports
