Economic environment

Question 1

What happens to profits, unemployment, interest rates and inflation during a recovery?

Answer 1

• Profits increase
• Unemployment decreases
• Inflation and interest rates remain low

Question 2

What happens to profits, unemployment, interest rates and inflation during a boom?

Answer 2

• Profits increase
• Unemployment at its lowest
• Inflation and interest rates increase

Question 3

What happens to profits, unemployment, interest rates and inflation during a slowdown?

Answer 3

• Profits decrease
• Unemployment increases
• Inflation and interest rates remain high

Question 4

What happens to profits, unemployment, interest rates and inflation during a recession?

Answer 4

• Profits at their lowest
• Unemployment at its highest
• Inflation and interest rates falling

Question 5

What impact will a recovery have on the three main asset classes?

Answer 5

• Cash returns will be low, but real value maintained through low inflation
• FI returns will increase, as the fixed coupons become more attractive in a low interest rate environment.
• Equity returns will increase as profits begin to rise.

Question 6

What impact will a boom have on the three main asset classes?

Answer 6

• Cash returns will increase in nominal terms, but will be dampened in real terms.
• FI returns will decrease, as the coupons look less generous when interest rates rise.
• Equity returns will increase as profits are high.

Question 7

State the four stages of the economic cycle in order.

Answer 7

• Recession
• Recovery
• Boom
• Contraction

Question 8

Why might the Bank of England not raise interest rates when inflation increases significantly above target?

Answer 8

• Deemed to be temporary
• Ensure economic stability
• Risk to debtors
• Exchange rate concerns & effect on trade
• Increasing interest rates may not impact on certain types of inflation

Question 9

What are the consequences of globalisation on investments?

Answer 9

• Increased interconnectivity of trade.
• Increased correlation of equity markets.
• Market risk harder to diversify
• International exposure through domestic listed companies.
• Increased volatility risk.
• Greater sensitivity to political policy/events.
• Markets increasingly efficient.
• Increased competition for investment capital.

Question 10

What is the difference between M0 and M4 measures of money supply?

Answer 10

• M4 includes
• Bank/building society deposits
• Of UK residents