Chapter 6: Economic influences

Question 1

Central bank’s primary concern

Answer 1

Are primarily concerned with monetary policy. This involves setting interest rates to control inflation and may also involve implementing direct controls, e.g. setting minimum reserve ratios for banks

Question 2

The interests of the central bank

Answer 2

• monetary, interest rate and inflation policy
• banking regulation
• implementation of government borrowing
• performance and integrity of financial markets
• intervention in currency markets
• printing and minting of notes and coins
• taxation

Extent of involvement depends on division of power and responsibility between the central bank, the government and other regulatory bodies

Question 3

Quantitative Easing (QE)

Answer 3

Monetary policy tool used by central banks to increase the supply of money.

Usually involves direct increase in money supply or and a knock-on effect from the fractioning reserve system, increasing the money supply further, although it can involve only making changes to the fractional reserve system.

Question 4

Fractional reserve system

Answer 4

Refers to funds being received by banks and loaned on to other customers.

Question 5

Forward guidance

Answer 5

Enables central banks to indicate, in the absense of any unforeseen events, how the central bank believes monetary policy will change in the future - usually over the following 18-24 months

Question 6

What does forward guidance help the central bank do?

Answer 6

• Helps people see how the central bank sets interest rates and should reduce the uncertainty about the future path of monetary policy
• Controls short-term interest rates through setting the base rate
• Allows central bank to influence long term interest rates
• Allows central bank to influence inflation expectations

Question 7

Main investor classifications

Answer 7

• private individuals (‘households’)
• managers of short-term and long-term savings products (‘financial intermediaries’)
• corporates (‘businesses’)
• foreign investors

Question 8

Household considerations when making investment decisions

Answer 8

LACED SLUT

• Liabilities (generally real in nature)
• Attitude to risk
• Characteristics of available assets (investment and risk characteristics)
• Expertise (level of investment expertise)
• Diversification (NB)
• Stability of asset values
• Liquidity
• Uncertainty over future income and outgo
• Tax

Question 9

Financial intermediaries

Answer 9

Sell their own liabilities to raise funds that are used to purchase the liabilities of other corporations.

Channels resources between lenders (investors) and borrowers.

Question 10

Advatages financial intermediaries offer

Answer 10

• Pooling of resources of many small investors and therefore can lend considerable sums to large borrowers
• Significant diversification achieved by lending to many borrowers = can accept loans that individuals may regard as too risky
• Build expertise through the volumes of business they conduct
• Economies of scale = lower dealing, admin and management costs

Question 11

Disadvantages of financial intermediaries

Answer 11

• additional layer of cost to investor
• products offered by intermediaries may not meet exact requirements of the investor
• products offered by intermediaries may be inflexible
• investor loses an element of control over their investment choice

Question 12

Role of the investment bank in helping businesses achieve their fund raising objectives

Answer 12

• advise on price to be charged
• handle the marketing of the issue
• verify the quality of information supplied
• innovate security design and packaging

Question 13

Main forms of government policy

Answer 13

• Monetary policy
• Fiscal policy
• National debt management policy
• Exchange rate policy
• Prices and incomes policy

Question 14

Other forms of government policy

Answer 14

• Taxation
• Competition policy
• Labour policy
• Government incentives for investment

Question 15

Monetary policy

Answer 15

The control of some measures of the money supply and/or the level and structure of interest rates

Question 16

Fiscal policy

Answer 16

Decisions on the level and structure of taxation and government expenditure and hence, by implication, the public sector borrowing requirement (or debt repayment)

Question 17

National debt management policy

Answer 17

The manipulation of the outstanding stock of government debt instruments held by the domestic private sector, to influence the level and structure of interest rates or the availability of liquid reserve assets to the banking sector.

Question 18

Exchange rate policy

Answer 18

Directed towards achieving some target for the exchange rate of the domestic currency in terms of foreign currencies, perhaps with the objective of influencing the country’s international trading and investment patterns

Question 19

Prices and incomes policy

Answer 19

Aimed at influencing the rates of wage and price inflation.

Question 20

Taxation

Answer 20

Policy regarding taxation, its overall level and distribution between personal direct, indirect, corporate and other will affect demand for goods and services, including labour, because of the impact on prices.

Question 21

Competition policy

Answer 21

Competition policy will be a crucial element of the operating environment, especially for naturally oligopolistic industries, such as utilities.

Question 22

Labour policy

Answer 22

Labour policy will set the background for the flexibility of labour and the bargaining power of organised labour. The related domain of social policies will determine the cost of health services, welfare benefits and state pensions.

Question 23

Government incentives for investment

Answer 23

Incentives for investment will vary largely and will be important for suppliers of investment goods and to companies making investment decisions.

Government funded, or otherwise encouraged, investment infrastructure will help determine how easy it is for an organisation to put in place the physical requirements of its business within a territory.

Question 24

Major economic policy objectives

Answer 24

• unemployment
• inflation
• balance of payments
• economic growth

Question 25

Effects of interest rates

Answer 25

• personal sector expenditure
• business sector investment and economic growth prospects
• corporate profitability
• balance of payments

Question 26

Define monetary policy and its principal objectives

Answer 26

Monetary policy is the process by which the central bank controls the supply of money or the availability and price of money, i.e. interest rates.
Primary objectives:

• Growth and stability of the economy
• Price stability is a major objective
• Some monetary policies target inflation exclusively, while others have economic growth or employment as a secondary or additional objective.

Question 27

How do companies avoid tax (legally)?

Answer 27

• financing subsidiries in high-tax countries mainly with debt to reduce profits
• reducing profits in high tax areas through excessively high transfer pricing for intra-group transactions
• transferring profits through the use of hybrid instruments that arbitrage between tax regimes