Chapters 20 and 21: Economic and other influences on investment markets Flashcards

1
Q

Key factor affecting the supply of government bonds and hence the level of the government bond market

A

The size of the government’s fiscal deficit and how it decides to fund it.

If the government adopts a full funding policy by issuing bonds or bills, the extra supply of stocks at certain durations will cause downward pressure on the price of those bonds.

Alternatively, if the government decides to fund the deficit by printing money, this could have inflationary consequences, causing upward pressure on bond yields and downward pressure on the price of bonds.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Key economic factor affecting the demand for government bonds

A

Investors EXPECTATIONS of the level and riskiness of returns.

For government bonds, these will reflect investors expectations of:

  • future real short-term interest rates,
  • future inflation,
  • future uncertainty relating to inflation, the inflation risk premium
  • the exchange rate.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

How might an expected cut in future real short-term interest rates over the next couple of years affect bond yields and hence bond prices

A

Short-dated bond yields should fall as they are very similar to short-term interest rates.
This is because short-dated bonds and money market instruments are substitute goods.
Therefore the price of short-dated bonds should rise.

However, in the longer term a cut in future real short-term interest rates could be inflationary.
As a result, longer-dated bond yields may rise. Therefore the price of longer-dated bonds should fall.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

If sterling was expected to depreciate against the US dollar, how would this affect the relative levels of the US and UK bond markets?

A

If Sterling was expected to depreciate this would mean that any income and capital earned in US dollars would be worth more when converted back into sterling.

This would make US bonds relatively more attractive to UK investors, and UK bonds relatively less attractive to US investors.

However, you should also consider the underlying cause of the depreciation of sterling against the US dollar.
E.g. in the short term, the depreciation may have occurred in response to a cut in UK short-term interest rates.
In the longer term the depreciation may reflect the purchasing power parity path of the exchange rate, offsetting differences in US and UK inflation.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

3 Other factors affecting the demand for government bonds

A
  • Investors’ income which is mainly driven by the level of institutional cashflow
  • Investors’ preferences, as dictated by factors such as their liabilities, tax rules, risk appetite, fashion, education and the political climate
  • the price of alternative domestic and overseas investments
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What additional factors affect the SUPPLY of corporate bonds, relative to government bonds

A
  • the relative attractiveness of raising finance through corporate bond or equity issues, e.g. if the equity market is depressed, it may be easier to raise finance through corporate bond issues, increasing the supply and reducing the price.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What additional factors affect the DEMAND for corporate bonds, relative to government bonds

A

influenced by investors’ expectations of the extra yield that can be earned on corporate bonds relative to the extra risk involved.
If investors believe that the extra yield is greater than the additional marketability and security risks involved, then corporate bonds will seem relatively more attractive.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Key factors affecting the SUPPLY of equities

A

numbers of:

  • new listings
  • rights issues
  • demutualisations
  • share buy-backs
  • privatisations
  • nationalisations
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What influences the number of new listings? (equities)

A

the buoyancy of the economy.
They may be higher during times of higher economic growth, since there will be more startup companies and it will be easier to raise finance.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What influences the number of rights issues? (equities)

A

the buoyancy of the economy.

the relative attractiveness of raising finance through corporate bond or equity issues.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

Key economic factors affecting the DEMAND for equities

A

Investors’ expectations of the level and riskiness of returns.

Expectations of:

  • economic growth
  • real interest rates
  • inflation
  • the equity risk premium
  • the exchange rate
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

How might expectations of poor economic growth affect the equity market?

A

Dividend growth moves broadly in line with economic growth.
Therefore expectations of poor economic growth might cause the price of equities to fall.

Poor economic growth may also affect the perceived riskiness of equities, increasing the equity risk premium and hence the return that investors require to invest in equities.
This would reduce the price that investors are willing to pay for equities.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

How might expectations of low real interest rates affect the equity market?

A

Low real interest rates should stimulate economic activity, increasing companies’ profits, resulting in higher expected dividend growth causing equity prices to rise.

Also, the real rate of return required by investors may be lower, resulting in a higher present value of price of future dividends.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

How might expectations of inflation influence the equity market?

A

In general, equity prices should be relatively indifferent to inflation, since equities are a real investment.

However, high inflation is often accompanies by high interest rates, which may be seen as unfavourable for economic growth.

Alternatively, in times of high inflation, demand for equities may rise, as investors seek real investments to hedge against inflation risk.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

3 other factors affecting the demand for equities.

A
  • investors’ income, which is mainly driven by the level of institutional cashflow
  • investors’ preferences dictated by factors such as their liabilities, tax rules, risk appetite, education, fashion and the political climate
  • the price of alternative domestic and overseas investment.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

Key factors affecting the SUPPLY of property

A

Influenced by demand factors (since property is built to satisfy demand):

  • economic growth
  • level of real interest rates.

However, due to property development time lags, the supply of property tends to lag behind demand.
The supply of property is also influenced by:
- fixity of location
- statutory controls (e.g. planning permission)
- inflexibility of usage
- high trasaction costs.

17
Q

Demand for property can be split into (2)

A
  • OCCUPATIONAL demand (demand to own a property to live in)

- INVESTMENT demand (demand to own a property as an investment, to rent out to others)

18
Q

Economic factors affecting the OCCUPATIONAL DEMAND for property?

A

expectations of:

  • economic growth
  • real interest rates

as these stimulate economic growth and employment levels, and hence the number of businesses that need premises in which to operate.

19
Q

Economic factors affecting the INVESTMENT DEMAND for property?

A

expectations of:

  • economic growth
  • real interest rates
  • inflation
  • exchange rate
20
Q

How might expectations of INFLATION affect the property investment market?

A

in general, property prices should be relatively indifferent to inflation, since property is a real investment.

However, in times of high inflation, demand for property may rise, as investors seek real investments to hedge against inflation risk.
For properties that have infrequent rent reviews, inflation will erode the real value of the rental stream between rent reviews, reducing the price of the property.

21
Q

3 Other factors affecting the demand for property

A
  • investors’ income which is mainly driven by the level of institutional cashflow
  • investors’ preferences, as dictated by factors such as their liabilities, tax rules, risk appetite, fashion, education and the political climate
  • the price for alternative domestic and overseas investments