Influences on Markets

Question 1

State the quantity theory of money

Answer 1

M × V = P × Q

Question 2

Explain what everything stands for the the Quantity theory of money formula

Answer 2

M = the amount of money in an economy
V = the velocity of money – the number of times money circulates the economy over a specified period
P = the average price level of goods, services and assets
Q = the volume of goods, services and assets produced/ Transacted

Question 3

According to the quantity supply of money - what would a doubling of the money supply accomplish

Answer 3

It would not necessarily make people better off unless an increase in the volume of goods, services and assets produced accompanied it. A doubling of the money supply would likely lead to a doubling of prices - as there is the same amount to buy. Increases in prices pushing inflation levels up

Question 4

Define a fiat currency

Answer 4

Means currency without an intrinsic value, only valuable because people believe in it.

Question 5

Why did the US dollar become a fiat currency in 1971

Answer 5

The US economy was good at the time of the convertibility agreement after WW2 so it was agreed the dollar could be converted into gold. But then US currency had a lot of power so it retracted the convertibility - since 1971 now most currencies do not have any intrinsic value

Question 6

Define broad money

Answer 6

Broad money (M3) is defined by the OECD as currency, deposits with an agreed maturity of up to two years, deposits redeemable at notice of up to three months and repurchase agreements, money market fund shares/units and debt securities up to two years. Most inclusive method of measuring the amount of money in the economy

Question 7

What is the current political economy

Answer 7

Most developed countries are capitalist rather than centrally planned communist countries. Capitalist economies aim to give more economic freedom to their people. This enables people to take more risk, by giving them greater access to markets and to speculate on these markets, which may result in a better allocation of capital to profitable projects

Question 8

What of QE or QT is happening now

Answer 8

The fed currently up until now has been engaging in QT mostly and there is alot of speculation about when this will stop.

Question 9

What is the most significant trend/monetary policy of the last decade

Answer 9

Undoubtedly the most significant policy of the recent past has been Quantitative Easing (QE). The media contain various shallow narratives on QE giving an erroneous impression of its impact. At its heart this is a form of monetary policy in which a central bank purchases securities to achieve the desired outcome

Question 10

In QE environment what does the central bank do

Answer 10

The central bank prints new money.
It uses the money to purchase assets – mainly bonds and corporate bonds but also equities (purchases may be made indirectly by buying ETFs of the relevant assets).
This causes asset prices to rise in each of these markets – and bond yields to fall.

Question 11

What are the ripple effects of the central banks actions in a QE environment

Answer 11

Bond investors who sold bonds will want to hold other assets in their place so they buy corporate bonds /other assets - pushing these prices up
Corporate bond investors who sold to the bond investors will typically want to hold other assets so will buy other asset ex: equity
Speculators will likely purchase bonds, corporate bond and other assets in anticipation of the increased demand for these assets and the price increases
Corporates will likely want to take advantage of the low corporate bond yields and issue more bonds. This will partially offset the price rises in the corporate bond market. In some cases, the proceeds of the bond sale may be used to buy back their shares; this will further exacerbate the price increases in the equity markets.

Question 12

What is the impact of QE on Asset Prices

Answer 12

Assets price inflation
Central bank purchases will push up (bond) prices in those (bond ) markets
Asset prices increase in other markets too as (bond) sellers will look to buy toher assets to replace them, etc etc this continues recursively
Speculation further adds to inflation of prices

Question 13

What is the impact of QE on Wealth and economic inequity

Answer 13

Asset owners have wealth increases
No assets no gains - will be worse off having no participation
Increase in inequality

Question 14

What is the impact of QE on hedge funds

Answer 14

Inflation will make it harder to see what stocks are overvalued/ undervalued - the stock price of companies with weak fundamentals could increase for a sustained period of time
Investors will grow in numbers as more people have money to invest in assets
Investors become more wealthy

Question 15

What is the impact of QE on economic growth

Answer 15

Increases due to the wealth effect
People with wealth gains have higher purchasing power - spend more so economic activity is creased
Should mean increased employment
Most impact will be in areas with higher concentration fo asset owners
Those without assets will gain from the creation fo jobs- Money trickles down
Not massive growth

Question 16

What is the impact of QE on interest rates

Answer 16

It lowers the interest rates on savings and loans. And that stimulates spending in the economy.
Increasing the supply of money lowers interest rates further and provides liquidity to the banking system
On most fundamental level it is because interest rate is price for money

Question 17

What is the impact of QE on Price inflation

Answer 17

Retail inflation rates stay low - Less wealthy people will not see any significant gains from QE
Ratil price inflation may turn to deflation as relatively less well off are worse off - demand for normal baket of goods falls
Ex: House prices going up so need to save and dont spend as much on groceries

Question 18

What is the impact of QE on wages

Answer 18

Nominal wages see small gains
Most of the increase in employment is likely to be in the service industry to service those with greater levels of wealth. These jobs are often poorly paid.
Real wage increases small due to low inflation but increased asset prices mean purchasing power of these real wages is lower

Question 19

What is the impact of QE on bank lending

Answer 19

Banks have more cash from selling bonds to central banks - cna lend more
They will only lend to those that can repay (those with greater level of assets)
Low interest rates have a detrimental impact of banks lending margins, dampens overall willingness to lend

Question 20

What are the risks arising from QE

Answer 20

Likely lead to significant bubbles in asset markets
Low interest rates mean that future equity earnings will be discounted using very low interest rates.
As these move towards zero, theoretical equity prices move to infinity. - overvalued
QE is also likely to impact corporate finance decisions, meaning otherwise poor projects will get finance as they show profitability using the low interest rates,
Idea of TINA – ‘There Is No Alternative’ . The idea was that the investor needed to invest, and the least overvalued alternative was equities.

Question 21

What are the principal aims of regulation?

Answer 21

Correct market inefficiencies and to promote efficient and orderly markets.
Protect consumers of financial products.
Maintain confidence in the financial system.
Help reduce financial crime.

Question 22

What are the direct and indirect costs to regulation

Answer 22

Direct costs arise in administering the regulation; indirect costs arise from changes in behaviour, both of consumers and regulated firms, to react to the regulations.

Question 23

What is the need for regulation very prominent in the financial sector?

Answer 23

The need for regulation of financial markets is seen to be greater than the need for regulation of most other markets primarily because of the importance of confidence in the financial system and the damage that would be done by a systemic financial collapse.

Question 24

Explain Efficient Market hypothesis

Answer 24

The EMH states that an asset’s prices fully reflect some(or all) available information. Hence, stocks always trade at their fair value so it is impossible to consistently pick individual stocks that will ‘beat the market’. States that outperformance of the market is only possible by taking greater (systematic) risk, which roughly is the equivalent to saying that CAPM Holds. This is a consensus investment analysis approach not based on any judgement or instinct - purely mathematical.

Question 25

What is the SML?

Answer 25

The Security Market Line (SML) plots the expected rate of return on an individual security as a function of systematic (non-diversifiable) risk based on the theory known as the Capital Asset Pricing Model.

Question 26

What is the SML formula

Answer 26

E[rp]=rf+beta x (rm-rf)

E[rp] is the return on a portfolio of stocks
rf is the risk-free rate of return (however defined); and
rm is the market return, or the return on the market.

Question 27

What are some trading characteristics that make money

Answer 27

Letting winning trades run.
Not getting caught up in a market/media frenzy.
Increased exposure to a winning trade.
Respecting stops when the trend reversed.

Question 28

Explain technical analysis

Answer 28

Technical analysis is a method for forecasting the direction of prices through the study of past market data, primarily price and volume. it helps to identify trends, tendencies, and trading opportunities but it cannot predict the future

Question 29

What is currently going on with QT

Answer 29

A pretty key monetary policy at the moment is QT. U.S. Federal Reserve is currently engaging in Quantitative tightening trying to shrink it’s balance sheet due to stop this movement by the middle of next year.

Question 30

What is QT

Answer 30

At its heart this is a form of monetary policy in which a central bank Sells securities in particular sells bonds or lets them mature to achieve the desired outcome. Their aim is generally to shrink their balance sheet and reduce the money supply in the economy

Question 31

Explain the central banks actions in QT and breifly the response to that

Answer 31

The central bank sells their assets to reduce its money reserves - this in turn is removing liquidity/money from financial markets.
In response to this asset markets prices start to go down. The bond investors who buy back the bonds from the central banks do so by selling their other assets pushing the prices to fall more.
Overall assets prices fall, bond prices fall but bond yields increase.

Question 32

What are some ripple effects of QT

Answer 32

Bond investors who bought bonds will sell their other assets as prices fall - pushing these prices down
Corporate bond investors who bought back want to sell their other assets ex: equity. So QT does the opposite raising cost of borriwng for corporations so funds by selling equities.
Speculators will likely not purchase bonds, corporate bond and other assets in anticipation of a decrease demand for these assets and the consequence price decreases and although bond yields rise as do interest rates. They may also sell assets.
Corporates will likely want to take advantage of the low corporate bond prices to buy back their corporate bonds. This will partially offset the price decreases in the equity market. In some cases, they may issue more shares to be bought to also try to boost equity prices.
Overall, QT will likely lead to lower asset prices.

Question 33

What does QE impact in terms of corporate finance

Answer 33

Quantitative easing to push money into areas such as corporate bonds, thereby lowering corporations’ borrowing costs and, it hoped, sparking the productive use of capital.

Question 34

What impact with QT have in terms of asset price?

Answer 34

Asset prices deflation
Central bank eliminating its assets will push bond prices in the markets
Asset prices decrease in other markets also as bond investors will look to sell other assets when they are buying back bonds, this continues recursively for many market players exacerbating the price decrease
Speculation adds to the deflation fo prices too

Question 35

What impact with QT have in terms of wealth?

Answer 35

Asset owners have wealth decreases
No assets: gains - will be better off having no participation
Those less well off hopefully benefit from less inflated prices

Question 36

What impact with QT have in terms of Hedge funds?

Answer 36

Deflation of prices will make it harder to see what stocks are overvalued/ undervalued - the stock price of companies with great fundamentals could decrease for a sustained period of time
Investors will deplete as people have less liquidity to invest in assets
There is a lull in investor gains - gains fall

Question 37

What impact with QT have in terms of economic growth?

Answer 37

Slows economic growth as there is les smoney to be spent
Hope is that People with less wealth have higher purchasing power - demand for goods and service decreases with cost of borrowing increasing so deflation occurs.
Not massive growth and may just ba transitionaly before asset prices revert to the mean levels in time

Question 38

What impact with QT have in terms of bank lending?

Answer 38

Higher interest rates have a good impact of banks lending margins, increasing overall willingness to lend
They may lend to people they previously wouldn’t have because of favourable margins
Less demand for borrowing as costs are high

Question 39

What impact with QT have in terms of wages?

Answer 39

Decreased asset prices mean purchasing power of these real wages is higher

Question 40

What impact with QT have in terms of price inflation?

Answer 40

interest rate hikes are known as the central bank’s one major tool to lower inflation, which it does by raising the cost of borrowing money to curb the demand for goods and services

Question 41

What impact with QT have in terms of interest rates?

Answer 41

Interest rates increase on savings and loans meaning short term less spending in the economy
Decreasing the supply of money highers interest further and means lack of liquidity in the banking system
Interest is the price of money- money is in low supply so it costs more

Question 42

What are the risks of QT

Answer 42

Potential to destabilize financial markets- panic due to lack of liquidity
QT likely puts upward pressure on interest rates, there is significant uncertainty about the magnitude of these effects
High-interest rates mean that future equity earnings will be discounted using very High-interest rates.
QE is also likely to impact corporate finance decisions, meaning good projects may not get finance as they don’t show profitability using the high interest rates, even though they might show profitability under normal interest rates.