Macro Econmics

Question 1

4 ways in which a low BOE base rate may stimulate consumer spending? (4)

Answer 1

• savings interest rates are low
• which reduces incentive to save
• cheaper borrowing costs/mortgage costs
• gives more disposable income / encourages borrowing
• feel good factor

Question 2

Explain why low interest rates may fail to stimulate spending (8)

Answer 2

• those relying on savings income have less to spend
• debt interest may not reduce by the same amount
• banks less willing to lend due to lower margins
• debt may be repaid instead of spending
• other political or economic factors may outweigh
• lower consumer confidence
• there may be time lags due to fixes terms on savings and debts

Question 3

Explain why BOE may not raise interest rates even if inflation increases significantly and exceeds the target (4)

Answer 3

• may he seem as temporary
• future economic uncertainty
• risk to debtors
• exchange rate concerns and the effect on trade
• increasing interest rates may not impact on some types of inflation

Question 4

Definition of deflation (2)

Answer 4

• decrease in the general level of prices of goods and services

Question 5

Why might deflation be damaging to the economy? (8)

Answer 5

• it increases the real value of debt
• increases value of savings
• so investors hoard currency
• assuming prices will continue to fall
• reduces profits
• leads to decreased investment
• banks less likely to lend against falling asset prices

Question 6

Actions government / central bank can take to counteract deflation(4)

Answer 6

• reduces interest rates
• print money/ quantative easing/ increase money supply
• reduces taxes

Explaination:

• stimulates spending
• reduces borrowing costs
• encourageslending

Question 7

What is ‘carry trade’ (2)

Answer 7

• borrowing in a low interest rate currency

- and reinvesting in a high yielding currency

Question 8

What are the risks of carry trade? (3)

Answer 8

• exchange rate movements can easily erode interest rate profit
• the strategy can increase the volatility of the exchange rates involved
• with a ‘rush for the door’ mentality occurring when adverse movements occur

Question 9

Five factors that can affect the demand for a product (5)

Answer 9

• price
• the buyers income
• the demand for alternatives
• the demand for other goods used at the same time
• ease of purchasing
• whether the buyer likes the product

Question 10

Explain the price elasticity or demand (3)

Answer 10

• measurement of the extent to which demand responds to changes in price
• demand is said to elastic if a change (no matter how small) in price has a significant effect on demand
• demand is said to be inelastic if price changes have little or no effect on demand

Question 11

Actions and oil exploration / production company can take if oil prices drop and effect on company finances (4)

Answer 11

• reduces costs
• reduce production
• put on hold investment / exploration
• hedge against further falls

Question 12

Four economic factors which could lead to a depreciation in the value of the sterling (4)

Answer 12

• decreasing UK interest rates in comparison to other countries
• declining productivity
• higher relative inflation than other countries
• current account deficit
• capital account surplus
• money supply increasing faster than productivity

Question 13

Explain impact of rising interest rates in FI and Equities (4)

Answer 13

FI

• yields rise
• capital values fall

Equities

• debt costs rise / profitability reduces
• dividends/ share prices fall

Question 14

Why may a fund increase it’s exposure to equity and commodities in response to rising inflation (4)

Answer 14

• equities have higher profits
• higher share price
• demand for commodities increases
• resulting in higher prices

Question 15

3 Reasons why price of index linked gilt may fall even in inflation is rising and expected to continue to rise (3)

Answer 15

• if interest rates are increasing faster than inflation
• increases supply and demand
• inflation expectations are reducing
• difference in RPI

Question 16

What is meant by:

• current account
• capital account

(6)

Answer 16

Current account

• imports minus
• exports
• in goods and services
• plus receipts from overseas income generating assets

Capital account

• movement of all monies
• into
• and our of the country

Question 17

Four potential economic consequences of capital and current accounts being in deficit over the medium to long term (4)

Answer 17

• rising interest rates
• rising inflation rates
• economic growth falls
• currency devaluation
• capital leaving the UK
• unemployment rises

Question 18

Effect on bonds of

1) rising IR
2) rising inflation

Answer 18

Rising interest rates:

• capital values fall
• as the income the produce become unattractive in comparison to new issues

Rising inflation rates:

• Capital values tend to fall if the rate of inflation is deemed to be speeding up
• as fixed interest investments become less attractive in general

Question 19

Effect on equities of:

1) rising interest rates
2) rising inflation rates

Answer 19

Rising interest rates:

• companies have higher debt costs
• lower demand (as consumers struggle with higher mortgage costs)
• leads to lower profitability
• and smaller dividend payouts
• and falling share prices

Question 20

Effect on income of bonds of:

1) rising interest rates
2) rising inflation

Answer 20

Rising interest rates:

• Existing bonds become less attractive
• newer bonds tend to be issued at a higher rate
• interest yields increase as investors will not pay as much to buy

Rising inflation:

• purchasing power of the fixed income falls
• interest yields rise to compensate investors for the loss of real income