Exam II - Chapter 20 Flashcards
What is a “bottoms-up” approach to selecting securities?
Does not use
- Perceived economic cycles
- Industry specific information
What classifies a “top-down” analysis?
- Money managers take a “big picture” perspective of the global economy
- Potential investments are funneled into smaller and smaller groups
What are the 5 components of the top down analysis funnel?
- All possible companies in which to invest
- Global economic analysis
- Industry Analysis
- Company Analysis
- Selected Investments
What is the definition of GDP?
GDP is the market value of goods and services produced over a time period.
What is GDP an indicator of?
GDP is an indicator, or measure, of the standard of living for people in a country.
On what basis is GDP usually reported?
Nominal basis
What type of GDP do economists prefer to focus on?
- Many economists prefer to focus on real GDP
- Real GDP is nominal GDP adjusted for inflation.
What is the advantage of using real GDP?
Using Real GDP makes it easier to compare standard of living across time periods.
Why is real GDP useful for investors?
Real GDP is a better growth measure than nominal GDP when using expected growth rates for investments on a country wide level.
What is the relationship between GDP and market values?
- Significantly correlated.
- Countries with the highest GDP also have the highest equity market valuations.
- The correlation value is .97—almost perfectly positive.
Most economists rely on a group of _____ economic indicators for accurate forecasts of future economic conditions.
leading economic indicators
10 Examples of leading economic indicators:
- Manufacturing Hours
- Unemployment claims
- Manufacturing orders
- Supplier deliveries
- Nondefense capital goods orders
- Private Housing Permits
- Stock Prices, S&P 500
- M2 money growth
- Index of consumer expectations
- Interest rate spread, 10 yr treasury less federal funds rate
4 Examples of coincident indicators:
- Employees on nonagricultural payroll
- Personal income less transfer payments
- Industrial production
- Manufacturing and trade sales
7 Examples of lagging indicators:
- Average duration of unemployment
- Trade inventories to sales ratio
- Index of labor cost per unit of output
- Prime rate charged by banks
- Loans outstanding
- Ratio of consumer credit outstanding to personal income
- Change in consumer price index
Does the stock market normally reflect current economic conditons?
The stock market is typically looking about six months ahead, making it difficult to invest ahead of the market.
Economists divide the nonmilitary working-age population into what three groups?
- Employed
- Unemployed (Seeking Employment)
- Unemployed (Not Seeking Employment)
The labor force is defined as:
All nonmilitary working-age people who are employed or unemployed (but seeking employment).
The unemployment rate is:
The percentage of the labor force that is unemployed but seeking employment.
The labor force participation rate equals:
The labor force divided by the nonmilitary working-age population.
The Consumer Price Index (CPI) is widely used to:
Measure inflation
The CPI uses the _____________ to measure inflation.
Average price of a fixed basket of goods and services.
How is inflation calculated from CPI?
Inflation rate = (Current CPI / Previous CPI) / Previous CPI
Major parts of the CPI basket include:
- Housing
- Transportation
- Food
- Beverages
Smaller parts of the CPI basket include:
- Medical care
- Recreation
- Education
- Apparel
Some economists focus on ____ CPI which excludes:
Core CPI
- Food
- Energy
There is a pronounced ______ relationship between inflation and Real GDP.
Inverse
Meaning high inflation hurts real economic growth.
Why might an inverse relationship exist between inflation and real GDP?
- Driven by the fact that high inflation leads to higher interest rates.
- Lenders will demand a higher interest rate to compensate for their loss in purchasing power.
- High interest rates tend to reduce the demand for loans—which, in turn, reduces economic growth.
A common rule of thumb on Wall Street is that:
- The inflation rate plus the market price-to-earnings (P/E) ratio should less than 20.
- Indication that inflation can affect stock prices
What are the two primary tools of the government used to stimulate economic policy?
- Monetary Policy
- Fiscal Policy
The money supply is important for the economy because it represents:
- The “gas” for the economic “engine.”
- Giving the economy more gas (i.e., more money) makes it go faster.
- Giving it too much money, however, can result in overheating (i.e., high inflation).
What should the goal be of responsible policy makers?
The goal should be to keep the money supply growing at the pace to keep the economy moving forward at the desired rate.
There is a _______ relationship between money supply growth and stock prices.
Positive
What is M1 money supply?
-Currency
-Checking deposits.
(More Focused)
What is M2 money supply?
M1 + -Time deposits -Savings accounts - Money markets (Broader)
A central bank is a:
“banker’s bank”—provides loans and holds deposits (for banks).
The Fed regulates many _______ and also monitors and changes the ________.
- U.S. banks
- Money supply
What are the 4 goals of the fed?
- Keep inflation in check
- Generate full employment
- Moderate the business cycle
- Help achieve long-term economic growth
The fed has control over what 2 interest rates that help it to regulate the money supply?
- Discount rate
- Fed funds rate
What is the discount rate?
The interest rate the Fed charges its member banks on loans.
What is the fed funds rate?
The short-term rate at which banks lend to each other, generally changes with the discount rate.
Changes in the fed funds rate can impact longer-term rates such as:
Mortgage rates
All else equal, reducing the _______ should stimulate demand for loans, which, in turn, spurs economic growth.
Discount rate
To impact the money supply through the financial markets, the Fed conducts:
Open market operations.
To spur economic growth the Fed:
- Buys Treasury bonds in the open market.
- Buying bonds puts money into the financial system
- The Fed pays dollars to the bond sellers.
To put the brakes on the economy the Fed:
- Sells Treasury bonds in the open market.
- Selling bonds takes money out of the financial system.
- The Fed received dollars from the bond buyers.
Monetary Policy is generally:
“Money supply policy”
Fiscal Policy is generally:
“Tax rates and spending policy”
Fiscally if the government wanted to spur investment:
- It could reduce (or even eliminate) taxes on capital gains.
- Or, the federal tax code could allow for a faster depreciation of capital spending by businesses—which would also spur investment.
A “hot button” issue in recent years has been the fact that the federal government’s:
- Expenditures exceed tax revenues—the resulting shortfall is called the budget deficit.
- Over time, these budget deficits grow and increase the national debt, because excess spending must be paid for with borrowings.
What are the classifications of sectors?
- Cyclical
- Sensitive
- Defensive
