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Section 1 - Economic Environment Flashcards

1
Q

What are the Impact of Politics on an economy

A
  • Interest rates and currencies, quantitative easing
  • Governments may use economic policy to create favourable economic conditions prior to voting (electoral cycle)
  • Inflation: worldwide move to make central banks more independent
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2
Q

Impact of International Relations

A
  • Economies and markets are more globally integrated and interdependent
  • Events such as 9/11 and the euro crisis of 2010/11 have an effect on global markets

International relations touch our lives daily as global markets, the World Wide Web, and foreign travel stimulate a flood of people, products, and ideas across national borders.

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3
Q

Speculative Fashions

A
  • Greater Fool Theory: investors lose sight of fundamental values and buy shares or other assets simply because they expect prices will continue to rise.

The more people use housing as a form of speculative investment, the greater the risk of surges and collapses in value. He lost millions in a series of speculative investments

Speculative investing is the purchase of high-risk assets based on price fluctuations and “hunches” over solid fundamentals. It’s often compared to gambling. Modern examples include crypto, GameStop stock, and angels/VCs investing in unproven startups

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4
Q

Socio-Economic Issues

A
  • People are living longer and birth rates are declining, leading to ageing population with fewer workers and more people in retirement with higher average wealth holdings.
  • This leads to increased demand for services and reduced demand for manufactured goods
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5
Q

Technological Change

A
  • Systematic application of science & technology required alongside investment in R&D
  • Key is ability to incorporate international advances into economic production

Technological change refers to the idea of improving existing technologies and developing new ones to improve the existing products and to create new products in the market. This whole process helps in creating new markets and new market structures, and destroying obsolete markets

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6
Q

World Economies & Globalisation

A
  • Global economy allows consumers to buy goods from anywhere in the world
  • Developing countries also assisted with capital & technology from developed world
  • Political factors - investors should consider political & economic stability / viability of a country
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7
Q

Four Phases of the Business Cycle

A

Recovery/Expansion

Boom

Slowdown/Contraction

Recession

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8
Q

Recovery/Expansion

A

GDP risen compared to last quarter

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9
Q

Boom

A

When economy growing at its fastest

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10
Q

Slowdown/Contraction

A

GDP fallen compared to last quarter

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11
Q

Recession

A

Two successive quarters of declining GDP

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12
Q

What does GDP estimate?

A
  • GDP estimates total value of income/production from economic activity

Gross domestic product (GDP) estimates as the main measure of UK economic growth based on the value of goods and services produced during a given period

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13
Q

What is market value?

A

value of final output at current prices inclusive of indirect taxes eg VAT

Example of market value

To calculate the market value of a company, you would take the total shares outstanding and multiply the figure by the current price per share. For example, if ABC Limited has 50,000 shares in circulation on the market, and each share is priced at $25, its market value would be $1.25 million (50,000 x $25

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14
Q

What is Final output

A
  • Final output is defined as the product or service that is bought by the end user
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15
Q

What does GDP measure?

A
  • GDP measures total market value of all domestically produced final goods and services
  • Usually during a calendar year

GDP measures the monetary value of final goods and services—that is, those that are bought by the final user—produced in a country in a given period of time (say a quarter or a year). It counts all of the output generated within the borders of a country.

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16
Q

What is Gross national product

A

GNP measures the monetary value of all the finished goods and services produced by the country’s factors of production irrespective of their location.

Gross national product is one metric for measuring a nation’s economic output. Gross national product is the value of all products and services produced by the citizens of a country both domestically, and internationally minus income earned by foreign residents. For instance, if a country had production facilities in a neighboring country and its home country, gross national product would account for both of these production outputs

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17
Q
  • Public sector net cash requirement (PSNCR)
A

o Difference between Government’s expenditure & revenue (normally a deficit)

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18
Q
  • Interest rates tend to fall and rise with economic activity
A

True

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19
Q

How is the price of Fixed Interest effected during the
(Business Cycles and Investment)

A
  • Attractive when inflation and interest rates are low and falling
  • Price of fixed interest falls when economy is booming
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20
Q

Equities:
(Business Cycles and Investment)

A
  • Generally, price of equities rise and fall with economy
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21
Q

Fiscal and Monetary policy

A
  • Government’s macroeconomic policy aimed at smoothing economic cycles - carried out through fiscal & monetary policy
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22
Q

What is Fiscal Policy

A

Use of government spending and taxation to influence economic activity (eg cut taxes to stimulate demand)

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23
Q

What is Monetary Policy

A

Attempt to stabilise economy through interest rates and money supply
* The Monetary Policy Committee (MPC) of the Bank of England responsible for setting interest rates (inflation target is 2%)
* Reducing interest rates eases monetary policy: Inflation prospects should reduce, leading to rising asset prices which increase willingness to borrow, spend and businesses to invest
* Increasing interest rates tightens monetary policy: leads to falling asset prices, reduces willingness to borrow, spend and invest

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24
Q

Money Supply

A
  • Quantity of money available within economy
  • Bank of England influences volume of money through buying/selling Treasury bills and government stock
  • In 2009-2011 the Bank of England created £375 billion through quantitative easing ‘Creating money’ to buy gilts and corporate bonds to increase UK money supply (to bring liquidity to financial markets and increase banks’ lending capacity)
  • Extra money works its way through system resulting in higher spending and growth or a reduction in recession
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25
Q

MO - Narrow Money

A

The narrow money supply only contains the most liquid financial assets. These funds must be accessible on-demand, which limits the category to physical notes and coins and funds held in the most accessible deposit accounts.

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26
Q

M4 - Broad Money

A

Notes & coins in circulation plus all instant access and time deposits

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27
Q

Inflation

A
  • Rising prices reduces real value of future interest & dividend payments
  • RPI historically used but now CPIH - measures average change from month to month of prices of UK consumer goods and services.
  • CPIH is more comprehensive than CPI as includes owner occupiers’ housing costs (OOH) and
    council tax – otherwise CPIH is exactly the same as CPI.
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28
Q

Disinflation

A
  • Decrease in rate of inflation (prices still rising but at a slowing rate)
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29
Q

Deflation

A
  • Prices declining over time and inflation becomes negative
  • Consumers defer purchases and manufacturers reduce output
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30
Q

Stagflation

A
  • Combination of ‘stagnant growth’ and ‘inflation’
    persistent high inflation combined with high unemployment and stagnant demand in a country’s economy.
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31
Q

Effects of Inflation on Cash Deposits and how do bank interest rates react

A

Variable rates tend to rise and fall in line with inflation
‘Real’ interest rate takes account of inflation

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32
Q

Effects of Inflation on Fixed Interests

A

Inflation particularly significant
Income is fixed whether prices rise or fall
Index-linked gilts offer long term inflation protection

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33
Q

Effects of Inflation on Equities

A

Seen as good hedge against inflation
Efficient companies increase profits at least in line with inflation Leading to increased dividends and share price

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34
Q

How do changes in Interest Rates affect cash, fixed interest and Equities?

A
  • Cash -returns fluctuate broadly in line with interest rates
  • Fixed Interest - inverse relationship
  • Equities - generally benefit from low interest rates
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35
Q

Exchange Rates

A
  • Foreign exchange market allows currency used by one country to be bought and paid for with another currency
  • Exchange rate is the price at which two currencies trade on foreign exchange market
  • Real exchange rate is adjusted to take account of inflation (good indicator of competitiveness)
  • Current account surplus - country exports more than it imports
  • Strong currency - beneficial effects, but if too strong then causes problems (e.g. exports too expensive)
  • Effect on foreign investments: higher overseas interest rates make overseas investments attractive
  • Effect on domestic shares: increasing value of £ increases profitability of exports
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36
Q

What is made up in the Current Account

A

Made up of transactions in goods (visible trade) and services (invisible trade) - imports and exports

A country’s current account balance = net balance of trade in both goods and services PLUS net receipts from income generating assets flowing into the UK from overseas

Deficit means more goods and services have been imported into the UK than have been sold overseas

Persistent deficit puts pressure on country’s currency

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37
Q

Capital Account

A

Records all movement of money into and out of the country for investment

Real assets such as land and buildings or financial assets such as shares, bonds and loans

Capital account surplus when overseas investors invest more money in the country than UK investors invest overseas

If there is a net deficit on the combined current and capital accounts - official reserves of foreign currencies owned by Bank of England will be used to finance it

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38
Q

Visible Trade

A

Transactions in goods (e.g. oil, agricultural products)

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39
Q

Invisible Trade

A

Transactions in services (e.g. transport, travel, tourism)

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40
Q

Role of Financial Investment in Economy

A
  • Well-functioning financial institutions and markets (e.g. stock exchange) play central role in moving funds from where they are to where they are best used
  • Primary markets: Governments, companies & other organisations issue new securities
  • Secondary markets: Investors buy/sell securities in issue
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41
Q

Delete

A

Delete

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42
Q

What are the 3 types of unemployment?

A
  • Types of unemployment:
    o Frictional
    o Structural
    o Cyclical
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43
Q

Describe a Competition and Monopoly Market

A

In a monopolistic market, there is only one firm that dictates the price and supply levels of goods and services, and that firm has total market control. In contrast to a monopolistic market, a perfectly competitive market is composed of many firms, where no one firm has market control.

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44
Q
  • Competition has advantages:
A

o Producers have to operate efficiently and meet customers’ needs
o Producers have an incentive to innovate and find lower cost methods of supply
o Producers have to keep down costs per unit produced
o Consumers receive better value through lower prices

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45
Q

Main Characteristics of a Monopoly

A
  • One producer
  • No clear substitute for the product or service
  • High entry barriers
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46
Q

What is the definition of a recession?

A
  • Two successive quarters of declining GPD means the economy is in recession
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47
Q

What does ‘visible trade’ include?

A
  • Visible trade includes imports and exports of goods such as oil, raw materials, machinery, white goods and clothing
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48
Q

What does ‘easing monetary policy’ mean?

A
  • Reduction of short-term interest rates
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49
Q

What is a combination of ‘stagnant growth’ and ‘inflation’ known as?

A
  • Stagflation
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50
Q

Name the three types of unemployment.

A
  • Frictional
  • Structural
  • Cyclical
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51
Q

Inverse Relation Between Interest Rates and Bond Prices

A

Bonds have an inverse relationship to interest rates. When the cost of borrowing money rises (when interest rates rise), bond prices usually fall, and vice-versa

Most bonds pay a fixed interest rate that becomes more attractive if interest rates fall, driving up demand and the price of the bond.

Conversely, if interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in its price.

Zero-coupon bonds provide a clear example of how this mechanism works in practice.

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52
Q

What is the Labour market

A

The labor market, also known as the job market, refers to the supply of and demand for labor, in which employees provide the supply and employers provide the demand. It is a major component of any economy and is intricately linked to markets for capital, goods, and services.

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53
Q

What Is a Zero-Coupon Bond?

A

A zero-coupon bond, also known as an accrual bond, is a debt security that does not pay interest but instead trades at a deep discount, rendering a profit at maturity, when the bond is redeemed for its full face value

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54
Q

What is used to measure inflation?

A

The most well-known indicator of inflation is the Consumer Price Index (CPI), which measures the percentage change in the price of a basket of goods and services consumed by households.

What does the UK use to measure inflation?
The Consumer Prices Index (CPI) is the main measure of inflation. It is produced in line with international standards and is the measure used for the Bank of England’s 2% inflation target

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55
Q

What are exports

A

The export definition in economics is any goods or services produced domestically but sold abroad. When a country exports goods or services, it engages in international trade. This is when countries or domestic firms purchase and sell goods to foreign firms and countries.

56
Q

What is an import

A

Is when the UK buys a product or service from another country

Imports can be finished products, like cars, TV sets, computers, or sneakers, or they can be raw materials, such as zinc, oil, wood, or grains. They can also be services, like financial services, travel services, and insurance.

57
Q

GDP vs. GNP

A

Gross domestic product (GDP) is the value of the finished domestic goods and services produced within a nation’s borders. On the other hand, gross national product (GNP) is the value of all finished goods and services produced by a country’s citizens, both domestically and abroad

58
Q

What happens to a company who has loans if interest rates rise?

A
  • Interest payments increase
  • Profits will reduce
  • Dividends reduce / cease
  • Further finance may be required
  • Possibility of the share price falling
59
Q

How could a company reduce its losses?

A
  • Reduce dividends
  • Raise share capital / hold a rights issue
  • Renegotiate any finance
60
Q

4 Stages of the business cycle

A
  • Recession - Share prices begin to recover
  • Recovery - Share prices rise strongly
  • Boom - Share prices begin to falter
  • Slowdown - Share price falls
61
Q

The differences between cyclical and non cyclical stock

A
  • Cyclical stocks are correlated to the economy will often perform well when the economy is doing well and badly when the economy is doing badly
  • Non cyclical stocks are not correlated to the economy and perform steadily regardless of the economic position
62
Q

What are the causes of inflation?

A
  • Rising costs of raw materials
  • Increasing cost of labour
  • Increased demand
  • Lack of capacity
  • Growth / money supply
  • Rising demand
  • Fuelled by expanding money supply
  • War or shortages / decreasing supply
  • Currency devaluation
  • High wage demands and general increasing costs
  • Investor sentiment leading to investment bubbles.
63
Q

The effects of inflation

A
  • Interest rates rise
  • Loss of purchasing power as goods and services become more expensive.
64
Q

What would happen if Sterling were to rise in value against the Dollar?

A
  • Exports to the UK would become cheaper with a likely increase in demand for companies goods
  • Profitability is likely to increase, share values are likely to go up for companies who export and thus will help to offset the currency conversion costs.
65
Q

What is Price Elasticity of Demand measure?

A
  • Price elasticity of demand measures the extent to which demand responds to a given change in prices.
66
Q

Implications of elastic demand for the profitability of goods.

A

When a good has elastic demand, a small price decrease would lead to a large increase in demand, assuming an adequate supply for the product and a reasonable profit margin. Then profitability should increase substantially with a small price decrease or should decrease substantially with a small price increase.

67
Q

Describe the characteristics of a good with elastic demand.

A

Goods with elastic demand are usually frequently bought goods with many substitutes in competitive markets where consumers are price sensitive.

68
Q

What is deflation in terms of the Retail Price Index?

A

When the annual Retail Prices Index falls below 0%

69
Q

What is the effect of deflation on demand and peoples spending habits?

A
  • Demand for goods and services will fall as individuals / business will defer spending
    in the expectation that prices will be lower in the future
70
Q

What are the Factors that affect level of supply:

A

o Price
o Costs of making and distribution
o Supply of alternatives
o Unexpected events that make supply easy or more difficult

71
Q

What is The state of balance between supply and demand

A

equilibrium

72
Q

The difference between what the Government receives (taxes) and what it spends (public services) in a given year is referred to as the?

A

Net cash requirement (NCR). This is fiscal policy governed by the UK elected government.

73
Q

A high NCR may give rise to concerns about?

A

Inflation as the Government is spending large sums of money and injecting cash into the economy – as it loosens or tightens fiscal policy.

74
Q

If the UK government receives more than it spends and makes debt repayment, what is this called?

A

PSNDR (public sector net debt repayment).

75
Q

What is Inflation?

A

Inflation is a general increase in prices and fall in the purchasing value of money

76
Q

What are the issues surrounding Deflation?

A

people are not spending and not consuming: no consumption (relative to output), means recession and lower GDP, lower next taxes and lower standards of living.

77
Q

What can central banks do to combat Deflation?

A
  • Reduce interest rates: in order to stimulate consumer demand / business investment
  • Engage in a strategy of Quantitative Easing (ie. “QE”, see further): so increasing the money supply in order to stimulate bank lending to individuals and businesses
  • Increase government spending
  • Reduce taxes
78
Q

What are the potential causes of Inflation?

A
  • A rising cost of raw materials for businesses
  • Increasing cost of labour via wages
  • Increased consumer demand in the wider economy
  • A lack of capacity in business / industry
  • Growth in the money supply
79
Q

How can Inflation can be perceived in both negative and positive ways?

A
  • A reduction in the purchasing power of money held on deposit (negative for savers),
  • Increasing asset prices such as property (positive for property owners)
80
Q

What is The best known measure of inflation in the UK

A

Retail Price Index (RPI).

81
Q

What does RPI represent?

A

It represents the average price of a basket of goods purchased by a typical household (+mortgage interest) and the current RPI series uses a base of January 1987.

82
Q

Who is responsible for keeping UK inflation within +/- 1% of the 2% target

A

The Monetary Policy Committee (MPC) of the Bank of England

83
Q

When did CPI take over from RPI

A

The CPI took over from the RPI as the official measure of UK inflation in 2003 and many pension funds and others changed over in April 2011

84
Q

What is the key measure of Consumer Prices is Europe?

A

the Harmonised Index of Consumer Prices (HICP) is the key inflation measure. The UK CPI is effectively the same as the HICP.

85
Q

The Bank of England (and any other international central bank) can use interest rates to control inflation in the economy by:

A
  • Increasing interest rates so making borrowing more expensive
  • Increasing interest rates so providing higher interest on savings and cash deposits
  • Both consumers and companies will have less disposable income and profits to invest, and
  • Both consumers and companies will spend and invest less – thus, demand should fall
86
Q

Why might the Bank of England wish to keep Interest rates low

A

a lower cost of debt makes it easier to service that debt.

87
Q

How does the government benefit from low interest rates

A
  • A lower cost to public borrowing thus making more money available for public services,
  • In addition, low interest rates mean that (high) gilt values are maintained (QE implications)
88
Q

How do companies benefit from low interest rates

A
  • May be encouraged to borrow money to invest,
  • Low interest rates may lower the value of UK Sterling meaning that exports will be cheaper
89
Q

How do consumers / individuals benefit from low interest rates

A
  • May be encouraged to borrow money to invest,
  • May stimulate the housing market (encourages people to take out mortgages),
  • The so-called “Wealth Effect”: encourages people to spend more money,
  • Encourages business start-ups and investment
90
Q

What may happen if unemployment levels are too high or too low

A

If unemployment is too high it may indicate a fall in production and a fall in tax receipts; conversely, if unemployment is too low it may result in increased labour cost and increased inflation:

91
Q

What is frictional unemployment

A

Frictional unemployment is caused by changes in the economy that lead to qualified jobseekers temporally unmatched with job openings

92
Q

What is Structural unemployment

A

Structural unemployment caused by structural changes to the economy such as declines in particular industries and skills no longer being in demand.

93
Q

What is Cyclical unemployment

A

Cyclical unemployment caused by changes in the overall level of economic activity and often associated with the business cycle.

94
Q

How do Rising interest rates and high inflation have an inverse relationship with bond prices?

A

Bond Prices fall (cost of purchase decreases) and increase the running yield on bond’s which have fixed coupons, to correlate with increasing interest rates

They have an inverse relationship to interest rates, meaning that when interest rates rise, bond prices generally fall and when interest rates fall, bond prices generally rise.

95
Q

How can Bond yields be an indicator of of market expectations of future inflation and interest rates

A

Bond yields can be a useful indicator of market expectations of future inflation and interest rates when you look at yield curves in future and compare the trend in movement of the 10 year bond price; many use it as an indicator of future market sentiment.

96
Q

Why is the FTSE used as an indicator of current economic activity

A

The theory is that the price of an index signals future economic expectations and that is why the FTSE is often used as a bell-weather of current economic activity (and is quoted daily). Although, 70%+ of earnings of FTSE 100 companies is derived from outside the UK and there is less and less resemblance to the UK economy.

97
Q

What does the UK Current account indicate

A

This indicates the UK trade position: subtracting imports (M) from exports (X).

It is split into visible (real tangible goods) and invisibles (services like financial services) and if the UK imports more goods than it exports, it is in deficit with the rest of the world.

98
Q

What happens if the UK Current account has a long-term annual deficit

A

A fall in the value of its currency may be needed to make imports more expensive and exports cheaper to balance the trade. When we buy imports from abroad we need foreign currency to pay for them. When foreign countries buy our exports they need our currency to pay for them.

99
Q

What happens when a country’s goods are in demand?

A

When a country’s goods are in demand, a demand is also created for their currency to buy these goods. When there is a strong demand for a currency it tends to appreciate in value. Unfortunately, this makes the goods in this country now more expensive and inflation starts going up. If no growth follows then stagnation could follow.

100
Q

Why is measuring economic activity important?

A

Measuring economic activity is important for a country to measure changes in living standards and to assist the central government in its economic planning.

101
Q

What does GDP measure?

A

GDP is the value of economic activity generated by factors of production from within the country’s domain. GDP represents the total MARKET VALUE of all FINAL goods and services. The growth of an economy’s GDP is used as a measure of its economic growth.
GDP is the output of the UK of those firms (British and Foreign) based in the UK.

102
Q

What is the purpose of the Bank of England setting interest rates?

A

The Bank of England set interest rates in the UK. One of the purposes is to help adjust the money supply to stimulate growth. If the bank believes inflation caused by too much money in the economy will be a problem, it is likely to increase interest rates. The effect of this will be to encourage people to save due to the higher rates of return achievable on savings and discourage them from borrowing because financing costs have also increased.

103
Q

What is Liquidity trap

A

during the last financial crisis 2008, the bank had reduced interest rates to record levels, and could not, with any expectation of a significant result, reduce them further. Despite this, the increase in consumption and particularly investment had not occurred as expected.

In economics terms this is known as a “Liquidity Trap” because, with UK interest rates at historically low levels and approaching zero, they cannot fall any further.

104
Q

how can quantitative easing supplement the government dropping interest rates?

A

As a supplement to dropping interest rates, the bank also set out on a large programme of quantitative easing (QE) to directly increase the amount of money in the economy through the purchase of mainly government but also corporate bonds from the financial institutions (gilt purchases by the BoE saw gilts yields fall from 3.63% to 2.92% in one particular week, demonstrating the increased demand/price).

105
Q

What is the role of the BofE

A
  • To act as “lender of last resort”, ie. in terms of Royal Bank of Scotland and the Financial Crisis of 2009
  • To control the UK’s money supply to act as banker to the government and other banks
  • To act as a supervisor of other banks and major financial institutions
106
Q

What is the governments fiscal policy?

A

The government’s fiscal policy is based on government spending and taxation and can run in deficit, surplus or as a balanced figure between income (tax) and outgoings (public services).
If the government spends more than it receives in tax, it runs a budget deficit.

The effect of a budget deficit is to increase the money supply within the economy, drive aggregate demand and is referred to as an expansionary policy.

107
Q

What happens if the amount of money in an economy grows faster than the amount of goods on which it can be spent?

A

the price of those goods will increase. This is called Inflation

108
Q

What can the MPC do if they feel inflation is excessive?

A

Monetary Policy Committee of the Bank of England will advise the Bank to control inflation by raising interest rates. Typically this will discourage consumer borrowing and thereby reduce spending, forcing prices lower. It is therefore necessary to keep a measure of the money in the economy:

109
Q

What is M0

A

Narrow money

Notes and coins in circulation +

Operational deposits held by banks with the Bank of England

This is the NARROWEST measure of money because it includes the fewest forms of money. The Bank of England discontinued measuring M0 in 2006.

110
Q

What is M4

A

Broad money

Notes and coins in circulation plus

Instant access and timed deposits of UK residents with UK banks and building societies

M4 was introduced in 1987 and has become the measure that the government has shown the greater interest in over recent years. If you really want to know the detail, the Bank defines M4 as:
Sterling notes and coins in circulation +

Sterling deposits with UK-resident banks and building societies +

Sterling holdings of certificates of deposit, commercial paper and debt securities of up to and including five years’ original maturity issued by UK-resident banks and building societies; and
Claims on UK-resident banks and building societies arising from sale and repurchase agreements in sterling
M4 is now the only measure of money supply published by the Bank of England.

111
Q

What is a fixed exchange rate?

A

A “fixed exchange rate” is where a country’s currency is fixed (called “pegged”) against another country’s currency so that it moves in line / within a pre-defined range. This will be set by the country’s government or central bank.

112
Q

What is a floating exchange rate?

A

A “floating exchange rate” is where a country’s exchange rate is not fixed and varies according to market supply and demand.

113
Q

Economic factors that can cause a country’s currency to fall in value (using the UK as an example) are:

A
  • A fall in UK interest rates when compared to other countries
  • Falling productivity or GDP is growing faster than the amount of money in circulation in the economy
  • The government / Bank of England increases the money supply at a faster rate than productivity in the UK economy
  • Higher UK inflation (rising prices) when compared to other countries
  • A UK current account deficit or negative balance of payments with other countries (ie. importing more than exporting)
  • A UK capital account surplus
114
Q

What happens if UK Sterling falls in value relative to another country’s currency?

A

this means that “more UK pounds would be needed to buy the same imports priced in another currency”. This makes these imports more expensive for people holding UK Sterling and would most likely cause a rise in UK inflation.

115
Q

What is classed as a cyclical share?

A

A company is said to be a “cyclical share” when its profits (and losses!) and ultimately, its share price, moves in line (is positively correlated) with the economic cycle. Examples would be luxury goods manufacturers, house-building companies and entertainment sector businesses (both would suffer falling demand in a recession and rising demand in boom times).

116
Q

What is classed as a non-cyclical share?

A

Likewise, a “non-cyclical share” is negatively correlated with the economic cycle. Examples would be utility companies and basic food manufacturers (people still need water and bread in both recessions and economic booms

117
Q

Describe an economic Boom?

A

Boom occurs when national output is rising strongly.
In boom conditions, output and employment are both expanding:
Strong and rising level of aggregate demand, driven by consumption
Rising employment and real wages.
High demand for imports
Government tax revenues rise
Company profits and investment increase
Danger of inflation if the economy overheats
Share prices begin to top-out and plateau.

118
Q

Describe an economic slow down

A

A slowdown occurs when the rate of growth decelerates - but national output is still rising.
Share prices fall.

119
Q

Describe an economic recession?

A

A recession means a fall in the level of real national output when the rate of economic growth is negative in (at least) two successive quarters; national output declines, leading to a contraction in employment, incomes and profits (position of UK economy 2009-12):
Declining aggregate demand for output Rising unemployment
Fall in imports
Decrease in tax receipts and increase in benefit payments Increased government borrowing
Share prices begin to improve.

120
Q

Describe an economic recovery

A

A recovery occurs when real national output picks up from the trough reached at the low point of the recession.
Share prices rise strongly.

121
Q

When was the Bank of England granted independence in creating monetary policy for the UK (interest rate decisions)

A

1998

122
Q

What happens of the Bank prints money and buys securities

A

money supply will go up (M4).

123
Q

In terms of the money supply, What happens if the Bank sells securities and receives cash

A

the money supply will fall

124
Q

What is securitisation?

A

Securitization is the process in which certain types of assets are pooled so that they can be repackaged into interest-bearing securities. The interest and principal payments from the assets are passed through to the purchasers of the securities.

125
Q

Calculate the dividend yield

A

12p/980p = 1.22%

126
Q

Calculate price earnings ratio

A

980p/47p = 20.85

127
Q

calculate price book ratio

A
  • £310m fixed assets + £160m current assets = £470m total assets
  • £50m preference shares = £50m
  • £50m long-term liabilities and £120m current liabilities = £170m
  • £470m total assets - £50m preference shares - £170m total liabilities = £250m net asset value of the company
  • £250m / 100m shares = 250p NAV per share
  • 980p share price / 250p NAV per share = 3.92
128
Q

Calculate Gearing ratio

A
  • Debt to equity ratio = £50m / £25m = 2.00. There are other ways this could be calculated.
129
Q

Outline FOUR differences between OEICs and unit trusts

A

OEIC
Fund is a company
Issues shares
Open-ended
Single price - initial charge separate
Can issue different classes of shares, with differing charging structures or in different currencies
Charges paid from fund
Independent depositary protects shareholders’ assets
Managed by an Authorised Corporate Director

Unit Trust
Fund is a trust
Issues units
Open-ended
Dual price -Bid/offer spread, including initial charge
Only difference between units is whether they are ‘distribution’ or ‘accumulation’.
Charges included in managers’ fees
Trustee oversees fund on unit holders’ behalf
Fund Manager

130
Q

Quantitative easing (QE) is the process by which central banks inject cash into economies by buying vast amounts of government debt and other assets. This both increases the money supply, and also lowers bonds yields to reduce borrowing costs for corporates and individuals: what happens when central banks stop buying bonds and instead actually start selling down their assets?

State the consequences of quantitative tightening

https://www.tutor2u.net/economics/reference/quantitative-tightening-and-the-possible-impact-on-uk-commercial-banks

A

Quantitative tightening (QT) refers to a monetary policy strategy implemented by central banks to reduce the money supply and withdraw liquidity from the financial system. It typically involves the central bank selling government bonds or other financial assets it holds in order to reduce the amount of money in circulation.

When a period of quantitative tightening occurs in the UK, it can have several effects on commercial banks. Here are some key ways in which commercial banks in the UK may be affected:

Liquidity reduction: Quantitative tightening reduces the liquidity available in the financial system as the central bank sells its assets. This can lead to a decrease in the amount of funds that commercial banks have available for lending and conducting their day-to-day operations. As a result, banks may face challenges in meeting their funding needs and may need to seek alternative sources of liquidity.

Increased borrowing costs: With reduced liquidity, the demand for funds may exceed the available supply, leading to an increase in borrowing costs. Commercial banks may find it more expensive to obtain funding from other banks or the money markets, which can impact their profitability and ability to offer competitive lending rates to businesses and individuals.

Impact on interest rates: The reduction in the money supply resulting from quantitative tightening can also have an impact on interest rates in the economy. As the central bank sells bonds and reduces liquidity, it puts upward pressure on interest rates. Higher interest rates can affect commercial banks in multiple ways. They may face increased borrowing costs for their own financing needs, and they may also see a decline in demand for loans from businesses and consumers who are deterred by higher borrowing costs.

Asset prices and balance sheet effects: Quantitative tightening can have implications for asset prices. When the central bank sells its assets, it puts downward pressure on prices, particularly for bonds. This can lead to potential losses for commercial banks that hold these assets on their balance sheets. Banks may experience a decline in the value of their bond holdings, which can impact their capital positions and overall financial stability.

Exchange rate impact: If the UK experiences quantitative tightening while other countries maintain loose monetary policies, it can lead to an appreciation of the domestic currency. A stronger currency can have both positive and negative effects on commercial banks. On the positive side, it can lower the cost of imported goods and services. However, it can also make exports more expensive and reduce the competitiveness of UK businesses operating in international markets.

Overall, a period of quantitative tightening in the UK can have significant effects on commercial banks. It can reduce liquidity, increase borrowing costs, impact interest rates, affect asset prices and balance sheets, and potentially influence exchange rates. Commercial banks must closely monitor these developments and adjust their strategies and operations accordingly to navigate the changing economic conditions.

131
Q

The following data is extracted from the latest accounts of LTA plc.

The company has 100 million shares in issue and the annual dividend per share is 60p which represents a dividend yield of 5%.

a) Identify the two components of shareholders’ funds

A
  • Share capital
  • share premium capital account
132
Q

The following data is extracted from the latest accounts of LTA plc.

The company has 100 million shares in issue and the annual dividend per share is 60p which represents a dividend yield of 5%.

b) Calculate, showing all your workings, the return on equity (ROE

A
  • £75m - £24m - £4m = £47m
  • £47m / £760m = 6.18%
133
Q

The following data is extracted from the latest accounts of LTA plc.

The company has 100 million shares in issue and the annual dividend per share is 60p which represents a dividend yield of 5%.

c) Calculate, showing all your workings, the return on capital employed (ROCE)

A
  • £75m /
  • (£760m + £650m) = 5.31%
134
Q

d) Explain why ROE and ROCE are used to evaluate a share’s returns

A
  • Both ratios are measures of efficiency of profit generation.
  • ROE is better for comparing different investments/assets but is affected heavily by differences in company capital structure (i.e. the degree to which a company is funded by debt and/or equity) and is therefore not as suitable as ROCE when comparing companies.
135
Q

The following data is extracted from the latest accounts of LTA plc.

The company has 100 million shares in issue and the annual dividend per share is 60p which represents a dividend yield of 5%.

e) Calculate the interest cover

A
  • £75m / £24m = 3.125
136
Q

f) State, giving your reasons, whether the company should be concerned with the level of interest cover (3.125)

A
  • Not a concern about this level of interest cover
  • Can afford to repay interest on loans 3 x over; profits would have to fall significantly.
137
Q

g) You have read that LTA plc is a cyclical share; explain the meaning of a ‘cyclical share’ and why LTA plc might fall into that category, stating how this will affect the company’s profits and share price (5)

A
  • A Cyclical share is where the share price is positively correlated with by ups & downs in the economic cycle.
  • Typically, companies that sell discretionary items, sell more in a booming economy but sell less in a slowing economy.
  • When the economy is slow, this results in less purchases, less demand from consumers who have had their real cost of debt increase through tighter monetary policy, which has resulted in less output, and fewer job – more slack in the economy.
  • Profits and share price will therefore rise and fall in-line with the economic cycle – thus in a slowing economy the profits will fall, so the dividend may be cut, which means that the share price could fall.

Remember, it specifically asked you to describe the share price.

AF Flash Cards (3 decks)

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