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International financial markets > International Financial Markets > Flashcards

International Financial Markets Flashcards

1
Q

State the six topics in Financial Markets?

A
  1. The Business Cycle
  2. Predicting the economy via use of leading indicators
  3. International monetary system and debt issues
  4. Derivatives and financial risk management
  5. Stock market pricing
  6. Smart investment behavior a la Buffet
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2
Q

What is Italy’s key problems?

A
  1. Productivity (has been at standstill since 2000)
  2. Public debt burden has stabilized a bit above 130% of GDP
  3. They suffer from a huge amount of bad debt in the banking sector.
  4. Their political parties have found it difficult to reform the economy and crackdown on curruption
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3
Q

What is a trade deficit?

A

When the trade balance is in deficit it means that they are importing more than exporting.

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4
Q

What are value stocks and what does value investment mean?

A
  • Value stocks are often classified as the 30% of the stocks trading at the lowest PE-ratio. (Deep value = 10%)
    (The companies behind the stocks are often mature business with subdued growth prospects.)

Value investing means to include these stocks (companies) in your portfolio.

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5
Q

State two well-known investment pitfalls.

A
  • Buy at the peak of the cycle

- Frequent Trading

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6
Q

Explain Graham’s 60/40 investment strategy and the ideas behind it.

A

Means to invest 60% of the portfolio in stocks and 40% in bond.
During good times an increase in stock prices will lead to a higher ratio in the portfolio than 60%. An investor following the strategy will have to trade some of his stocks to bonds. When the recession is coming the invester will through this method be less exposed to risk. And vice versa, when bond price most likely rise during recession due to the low interest rate // note: might be different in the next recession due to a historically low interest rate atm.

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7
Q

What’s the main issue with Turkey?

A

Over the past five years their growth have been keeping pace with China and India. But now the market is overheating:

  • They have a large trade deficit
  • They have a construction boom
  • The have a soaring debt
  • The inflation is above 15%
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8
Q

What does the term “value trap” refer to?

A

The value trap refers to a stock that looks cheap because of a low PE-ratio (like a value stock), but represents a non-performing company. Perhaps the company used to perform well, which is what initially made it look like a sound investment, but maybe due to lack of innovation, adaption to competition or “creative destruction”, etc. the company has stagnated.

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9
Q

What is the problem with the € ?

A

The common currency does not comprise anything in regard of productivity (and especially differences in productivity) between countries. Basically, it makes it impossible to adjust exchange rates in order to become more competitive and i.e. increase exports.
The problem is clear in the case of Italy, where productivity has been stagnated since 2000.

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10
Q

Explain the “visual” business cycle for both the short/medium-term and the long-term.

A

Y-axis = Real GDP, X-axis = Time. The short/medium-term curve moves as a cycle up and down. The long-term curve is a positive trend only moving upwards.

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11
Q

What is the problem with the € ?

A

The common currency does not comprise anything in regard of productivity among countries. Basically, it makes it impossible to adjust exchange rates in order to become more competitive and i.e. increase exports.
The problem is clear in the case of Italy, where productivity has been stagnated since 2000.

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12
Q

Explain the business cycle for both the short/medium-term and the long-term.

A

Y-axis = Real GDP, X-axis = Time. The short/medium-term curve moves as a cycle up and down. The long-term curve is a positive trend only moving upwards.

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13
Q

What does “Tapering” means?

A

Tapering is the gradual winding down of central bank activities used to improve the conditions for economic growth.

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14
Q

The US-stock market is at an all-time high atm. What is driving it?

A
  • Trump corporate tax-cuts (35% –> 21%)
  • TINA (there is no alternative, since interest rates, yields on bonds are still very low). This drives people to the stock market.
  • Animal spirit
  • Others, i.e. the great performance from Netflix, Apple, Google, Amazone, Facebook etc.
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15
Q

What is a key trigger for recession?

A

Aggregate demand falls as a result of less investment.

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16
Q

What is the Balance of Payments (BOP)?

A

The measure of all international economic transactions between the residents of a country and foreign residents.

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17
Q

The BOP is composed of three sub-account. Which?

A

The current account, the financial account and the capital account.

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18
Q

What does it mean if BOP < 0 (negative)?

A

If the BOP is positive then there is an inflow of money, if it is negative there is an outflow.

Negative: The country is earning less foreign currency than it needs for its imports etc. Hence, there is excess demand for for foreign currency.
Under a credible fixed exchange rate regime, the central bank will supply (sell) foreign currency worth the specific negative amount in the forex market. Thereby it will reduce its stock of foreign currency, but increase its stock of domestic currency.

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19
Q

What is the law of one price?

A

Identical products should have the same price in different markets, given there is no transaction costs.

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20
Q

What is the purchasing power parity (PPP)?

A

It describes the purchasing power of a currency.

If the law of one price is true, the PPP exchange rate could be found from any individual set of prices.

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21
Q

What is the relative purchasing power parity (RPPP)?

A

The relative change in price (the inflation) between two countries over a period of time determines the change in the exchange rate over that period.

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22
Q

What is the Fisher Effect?

A

The nominal interest rates are equal to the required real rate of return plus compensation for expected inflation.
i = r + pi

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23
Q

What is the international Fisher effect?

A

The spot exchange rate should change in an equal amount but in opposite direction to the difference in interest rates between two countries.

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24
Q

What are the primary foreign currency financial derivatives?

A
  • Foreign currency futures
  • Foreign currency options
  • Interest rate swaps
  • Cross currency interest rate swaps
25
Q

What was the key event in 2016 in relation to exchange rate?

A

Brexit. The Pound went down by more than 15%.

26
Q

What is seignorange?

A

How much does it cost to produce one-dollar bill. This bill can buy goods worth 1 dollar. The seignorance is the difference between what it cost to produce the one-dollar bill and what the one-dollar bill can buy.

27
Q

What are durable goods and what is the Durable Goods Report?

A

Durable goods are goods expected to last three years or more. These products tend to be quite pricey and are not usually purchased on a regular basis.

The advance report on durable goods contains four categories of data: shipments, new orders, unfilled orders, and inventories.

The monthly inventory postings in the M3 survey indicate the dollar value of goods stockpiled at factories and in sales branched, regardless of the stage of fabrication.

28
Q

Describe the Efficient Market Hypothesis (EMH)

A

The market is generally getting it right and is setting prices at levels consistent with economic fundamentals and rational expectations.

29
Q

Describe “Mr. Market”

A

The market is manic depressive governed by a fellow named Mr. Market who has servere emotional problems which leads to excessive volatility.
Basically Mr. Market describes behavioral finance.

30
Q

What is sound investment behavior?

A

There are two traps to avoid:

  1. Investing heavily at the peak and selling at the bottom with large discounts.
  2. Frequent trading in and out in response to contradictory news flows.
31
Q

What is the 60/40 investment strategy?

A

Invest 60 percent of the portfolio in a low cost equity fund and 40 percent in a low cost bond portfolio.

32
Q

What is value stocks?

A

Value stocks trade at the lowest price-to-book ratios, or lowest price-to-cash flow, or lowest price-to-earnings ratios.

33
Q

What is a value company?

A

Value companies are the cheapest ones in the market relative to earnings or book values.

34
Q

What are the key assumptions for Gordon’s growth model?

A
  • Fixed pay-out ratio
  • Constant growth rate of dividends and earnings
  • The required return has to be higher than the growth
  • Individuals are rational
  • Infinite time
35
Q

What is the profit share equation?

Remember we ignore raw material costs and interest payments

A

1 - (W/P)/(Y/L)

It is increasing sharply during recoveries and normally declining prior to recessions.

36
Q

State the most important economic (recession) indicators.

A
  • PMI
  • Ifo
  • Flattening yield curve
  • Declining durable goods orders and new orders relative to inventories
  • Declining profit margins (as a result of cost increases that exceeds productivity growth)
  • Overvalued asset prices
  • Overtime sharply reduced and hiring of new employees comes to a standstill
  • Consultants start getting fired.
  • Number of people seeking UI benefits is soaring.
37
Q

What is the relationship between bonds and interest rates?

A

Bonds and interest rates have an inverse relationship, meaning, when interest rates rises, bond prices fall and the other way around.

The logic is: when buying bonds the coupon-payments are the cash inflow one get until the maturity date. If alternatively the interest rate rises, this indicates one could get more “interests/coupons” depositing the money another place i.e. the price on the bond falls. Vice versa.

38
Q

What accounts make up the BoP

A
  • current
  • financial
  • capital
39
Q

Why is BoP always = 0 under a clean floating exchange rate?

A

in this case the central bank will not intervene and therefore the change in reserves will be = 0. If there should be a deficit on the BoP (e.g. due to a current account deficit), the exchange rate adjust until BoP = 0.

40
Q

What is the formula for total national GDP.

A

Y = C + G + I + X - Z

41
Q

X - Z + tr(net) + inc(net) = (S-I) + (NT-G), what does this mean?

A

It means that the current account is equal to the national public and private saving surplus (or deficit). It is derived from the GDP formula.

42
Q

What does income transfers refer to when calculated in the current account?

A
  • net interests
  • net dividends
  • net profits
  • worker’s remittances (net)
  • transfers (which includes: transfers to/from international institutions.
43
Q

Which indicators were able to predict the great recession? (in the US)

A
  • Profit share was declining
  • New building permits started declining already in 2006
  • The US house market peaked in mid 2006 and started declining there after
44
Q

Why are both the US and the EU more vulnerable towards a new recession than they were in both 2000 and 2008?

A
  • Interest rates back then were on app. 5% making it possible for CB to lower this in order improve the access to capital and thus stimulate the economy.
  • Now the US fed funds rate is 2-2,25% and the ECB rate is -0,4%
45
Q

What are the five PMI subindexes?

A
  • New orders
  • Production
  • Employment
  • Supplier deliveries
  • Inventories
46
Q

What does a “new orders minus inventories” index equal to zero tell us?

A

Anytime there is no difference between the inventories and new orders indexes, that is, when “new orders minus inventories” index is zero, the economic growth rate tends to contract. Historically, negative readings have been associated with economic recessions.

47
Q

Describe the Dual hypothesis testing problem:

A

General test of EMH is impossible as testing for efficiency requires an equilibrium model that takes different factors into account. However, for the model to work it would have to include all factors, which is not realistic

48
Q

Define beggar thy neighbour policies:

A

Beggar thy neighbour policies came about, originally, as a policy solution to domestic depression and high unemployment rates. The basic idea is to increase the demand for a nation’s exports, while reducing reliance on imports.

49
Q

How can a government in a fixed exchange rate regime ensure that BOP is near zero?

A
  • If surplus: sell domestic currency for foreign currencies or gold
  • If deficit: buy domestic currency with reserves of foreign currencies or gold
50
Q

How can government in a managed floats exchange rate regime ensure that BOP is near zero

A
  • They can seek to alter the market’s valuation of a specific exchange rate by influencing the motivations of market activity, rather than through direct intervention in the foreign exchange markets.
  • The primary action is thus to change the relative interest rate
51
Q

What is the Bretton Woods area and why did it collapse?

A

It is a dollar-based fixed exchange rate system which gave rise to a long period of economic recovery and growing openness towards international trade and capital mobility.

Researchers believe that rapid growth in the speed and volume of capital flows led to the failure of Bretton Woods

52
Q

What is the current level of the S&P 500 index and at what P/E is it trading?

A

The current level is 2670 and it is trading at a P/E on 22,4

53
Q

What caused the Japanese bubble in the 1980s and at what level was the Nikkei index trading?

A

the bubble was caused by extreme overvaluation of land, real estate and firms.
The Nikkei index was trading at a P/E on 60 at the peak. Three years after, the price of the index had decreased by 60% and it still hasn’t fully recovered.

54
Q

Define the Forward P/E

A

The forward P/E: the stock prices and expected earnings per share. Uncertain as the expected EPS has to be forecasted the next 12 months.
It is defines as: P0/E1=K/(R-g)

55
Q

Define the trailing P/E

A

The trailing P/E: stock prices and earnings per share over the last 12 months. The historical average is around 17.
It is defined as: P0/E0=K(1+g)/(R-g)

56
Q

How do we estimate the required real return

A

The required (real) return R can be thought of as the (nominal) risk free interest rate minus the expected rate of inflation plus a risk premium.

Thus: RRR= risk free interest rate – expected rate of inflation + risk premium

57
Q

State the leading indicators

A
  • PMI (Purchasing Managers’ Index)
  • IFO (indicator for Germany). Since Germany’s GDP accounts for 1/3 of the Euro Area’s GDP it is important for the entire Euro Area.
  • Durable Goods Report (US)
  • Consumer Sentiment
  • Yield curve spread
  • Credit Growth
  • Building permits in construction
  • Payroll report (US)
58
Q

How do you calculate the return on a stock?

A

3 steps:

  1. Calculate the dividend yield = D(0) / P(0)
    (P(0) is the price of the stock in the beginning of the year)
  2. Calculate the capital gain/loss = (P(1) - P(0))/P(0)
  3. The return on a stock = the dividend yield + the capital gain/loss

International financial markets (1 decks)

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