Exam Extras Flashcards
What can changing the short term interest rate effect?
SEDaTE
Spending, exchange rate, demand for money, currency/trade balance
Spending increases if lower interest rates (corporate and consumer)
Exchange rate falls - overseas investors earn less in deposits
Demand for money increases, so money supply increases so inflation
Currency/trade balance remains unchanged if globally all are reducing rates
If companies spend more, what can it lead to?
Increased employment
Growth, but time lag before between increased investments and this
What effect in consumer banks will lowering the short term interest rate have
Reduction in credit card (debt servicing) interest rates
Lower borrowing costs
Lower savings rate
Why might a lowering of interest rates not help increase consumer spending?
If confidence very low
What effects does a lower exchange rate have on companies?
Exports more competitive
Raw materials more expensive
Supply side inflation in imported goods
Increased competitiveness of domestically made goods
What other reasons would you reduce interest rates?
Pressure from government Decrease exchange rate Global tendencies Restore confidence in property market Increase inflation to the desired band
When thinking about effects of a change in interest rates on assets prices (demand/supply), what are the most important things
Growth (hence profits) Short term yield Long term yield Long term inflation Inflation uncertainty Exchange rate Borrowing costs
How is the short term yield on government bonds related to money market intstruments?
Money market instruments effected by short term interest rates. So yield goes the same way as short term interest rates
If interest rates decrease, what happens to yield hence price on government/corporate bonds
Increase in yield, decrease in price of short term bonds
If long term inflation expectations increase what happens to the yield on long term government bonds?
Yield decreases, but not as much as short term. So price increases, but not as much as short term, due to inflation risk
If exchange rate weakends, what happens to the price of government.corp bonds?
Increases, as o/s investors demand a lock in of interest????
What happens to the price of index linked government bonds with a decrease in interest rates?
More demands as long term inflation uncertainty, price increases
What extra effect on corporate bonds would a lowering of interest rates have over government bonds?
Growth increases, profitability increases, so default risk decreases, yield over government bonds decreases
How are equities affected by a change in interest rates?
Growth so profitablity increases, so equity level increases
dividend level increases, norminal and real
Uncertain inflation leads to demand for hedging that risk, so equity demand increases and level does, compared to bonds
Exchange rate decreases so exporters profits increase and importers decrease
How is property affected by a decrease in short term interest rates (think about mortgages)
Growth increase, employment increases, demand for commercial and industrial property increases
Cost of borrowing decrease, prices increase
Supply stays the same, demand increases, so price increases
Expected ifnlation increase, this is a hedge of inflation, so demand increases and prices
O/S demand increases so price increases
First approaches to managing enterprise risk (multi business unit company)
1) Determine overall risk appetite, divide amongst business units
2) Let the management teams of the business units manage their risks dependant on the allocated RA
3) No allowance for diversification
4) Allow for diversification by allowing allocated RA’s to be 130% of overall RA
Second approach to managing Enterprise risk
1) Set up group risk management function at enterprise level
2) Do similar risk assessments on all business units to combine into entity level risk assessment model
3) This shows where we have too much or too little risk
4) It is important to business planning and capital allocation cycles
Explain discounted covers (ART)
Provide full cover with no immediate need to finance the full undiscounted liability
Intergrated risk covers
Between insurers and reinsurers usually
Used to smooth results, avoid excess cover, lock into attractive terms
Securitisation
Transfer of insurance risk into the banking sector and capital markets
Insurance risk is uncorrelated with market risk so attractive to investors
Post loss funding
In exchange for a commitment fee, funding will be provided on the occurrence of a specified loss.
Funding will be on a loan on a pre-arranged terms or equity
Insurance derviatives
e.g. catastrophe or weather options
Swaps
Organisations of similar but negatively correlated risks can swap packages of risk so they have greater risk diversification
What internal ways can you manage risk?
Underwriting, fair price paid for the risk
Claims control, reduces fraud
Management control to reduce exposure to risk
Explain unregulated markets (why would we have them)?
Costs of regulated outweight the benfits
For example a market where only professionals operate
Explain voluntary codes of conduct and their weakness
They operate effictively in many circumstances
vulnerable to rogue traders and hence lack of public confidence
Explain self regulation
A system organised and operated by the market particiapnts without government intervention
Explain statutory regulation
The government sets out the rules and polices them for the market participants
Explain mixed regimes
These are a mixture of all the other regimes
regulations are developed by market-driven private institutions like the stock exchange, as well as governments
