Topic 1 - Economic Factors that can impact investment management Flashcards
What is economics?
Maximisation of economic output to direclty & indirectly increase the overall economic well-being of individuals within it.
Two forces that dominate the financial markets: Supply and demand which explains how resources are allocated.
An efficient market must find balance ‘equilabirium’ between supply and demand.
Theoretical Level:
Reallocation & reapportionment of limited resources subject to the continually competing stresses of supply & demand.
Production and consumption of goods, and how wealth (money or non-monetary resources) is used and transferred to make and obtain those goods.
Practical Level:
Interaction between people and markets to satisfy need for goods and to achieve objectives.
Limited resources can include:
- products
- goods
- services
- information
What is Microeconomics?
Understanding particular market & relationship between buyer & seller.
Involves individual units such as individuals, firms & industries.
E.g prices, supply and demand, consumer behaviour, and the way in which markets serve individual units’ needs.
What is Macroeconomics?
Understanding of how particular markets interact with one another on a local, national and global scale. Looks at ‘big picture’ aggregate economy. E.g national employment, GDP etc.
What is the law of demand?
If all remains equal, the higher price the less it is demanded.
The quantity of product that customers are prepared to buy at certain price. Known as the demand relationship.
The demand curve has a negative coefficient gradient - downward sloping so as price falls, precieved value increases and is wanted more..
What is the law of supply?
Amount of goods that producers willing to supply in return for a certain price. Known as the supply relationship.
The supply curve is the equal to and opposite of the demand curve, with a positive coefficient gradient - upward sloping so as price rises the organisation sees increased value and prepared to suppy more product at higher price.
Explain market equlibrium?
Market price is determined at intersection of the demand curve and supply curve.
Buyers and sellers in equal numbers. Price remains static until the number of buyers or sellers change and are no longer equal at which point the price changes and the curves meet again.
Known as market equlibrium.
GDP
Measure of economy output of an economy & indicator of performance.
GDP = All goods + All Services.
Shown as % change within most recent quarter or quarters % compared to previous year. Year on year most beneficial for GDP trend.
Downside is that it’s historical data and takes time to compile.
‘Gross’ in GDP refers to the measure being calculated before allowing for depreciation of a company’s plant, machinery and equipment, which can be significant.
A recession is defined as a fall in GDP in two successive quarters
Economy Activity
Using the simple method of the economy, what are the three measurements of economic activity?
In what ways does the simple model become more complicated as markets develop?
Individuals supply companies with land, labour and capital in exhcange for income.
Individuals use income to buy entire output produced by firms that use those resources which creates a circular flow of income that keeps economy running.
Measures of economic activity - Simple model:
- Total income paid by firms to individuals
- Individuals’ total expenditure on companies’ output
- Total output generated by companies
Gradually becomes more complex when:
- Individuals saving income
- Markets using savings to channel investment to firms or replace capital equipment for future production
- Government spending and taxation decisions
- International trade and globalisation
What is the Gross National Product?
Contribution made in calendar year to UK economy by UK individuals and firms based overseas.
GNP = GDP (Consuption + investment + government) + Net exports + net income earned by UK residents from overseas inveestments - net income earned by foreign residents from UK investments.
Income includes - Property income, wages, profits, interest and dividends.
Example of GNP and GDP
- UK firm produces cars in Poland
- UK firm sends £100m in profits back to shareholders in UK
UK Car Company produces cars in Poland, production counts towards Polish GDP. However, if UK firm sends £100m in profits back to shareholders in UK, this outflow of profit is added to UK GNP and subtracted from Polish GNP.
With globalisation and international trade increasing, GNP is becoming less relevant.
Define markets and financial markets?
What are the main functions of financial markets?
What are the benefits of an exchange when transacting financial instruments?
Markets = Place to buy/sell goods, services & information.
Financial Markets = Facilitates buying/selling of legal rights in money/money’s worth.
Stocks & Shares - Over exchange such as LSE or Over The Counter Medium such as FInancial Industry Regulation Authority (FNRA)
Main functions of financial markets:
- Raise capital for companies - Function performed by stock exchange
- Provide funds transformation by converting short-term savings into longer-term business investment.
- Bring buyers & sellers together to reduce search & transaction costs and facilitate objective price discovery between buyers and sellers - Function performed via stock & derivatives exchanges
- Transfer risk from risk-adverse to risk-seeking investors - Function performed through derivatives and insurance markets
- Provide borrowing & lending facilities to match surplus funds with investment opportunities - Function via banks & stock exchanges
Advantages of exchanges when transacting financial instruments:
- Increased regulation due to third party supervisor and therefore decreased central counterparty risk. Third party acts as broker to hold and release cash differences. So both party can be sure to fulfill transaction.
- Allows liquidity on both sides of transaction and prevent transaction freezing if buyer to not meet seller demand and vice versa.
Over The Counter Market
What is an Over The Counter Market?
What are the advantages and Disadvantages of an Over The Counter Market?
Alternative to an exchange for private individuals transact financial instruments directly in a more informal, unregulated process.
Advantages are:
- May be just as efficient as regulated market
- Cheaper transaction costs
- Quicker turnaround times
Disadvantage is increased counterparty risk by not having independent intermediary involved in the exchange.
What are the rules on Help to Buy ISAs?
What are the rules on the Lifetime ISAs?
Demand and price driven by those in position to buy.
Help to Buy ISA:
- Allows tax free savings each year
- Designed for first-time buyers to save for deposit towards first home.
- Allows people to save a certain amount tax-free each year.
- Avaialble up to November 2019 and have until 1 December 2030 to buy.
- Government top up £50 for every £200 the investor saves.
- Maximum bonus is £3,000 or £12,000 of savings.
- Each person has own allowance
Lifetime ISA:
Anyone under 40 can open lifetime ISA.
Savings of £4,000 each year and recieve 25% bonus on savings
Money can be saved into the Lifetime ISA until the saver is over 60, for use as retirement income, or it can be withdrawn to help buy a first home. Withdrawals for other purposes are subject to penalties and do not attract the government bonus.
What is the Bid, Offer and Spread?
What does the spread tell you about the broker and market conditions?
Why does the Bid, Offer and Spread affect Supply and Demand?
Spread = Difference between buying and selling price set by a broker
Spred covers costs, administration and profits
Offer has to be more than the bid + spread to make any gain
Example: Broker spread of 4 pips (£4 for every £1,000)
- Bid Price of GBP/USD = 1.4493
- Offer Price of GBP/USD = 1.4497
- Often quoted as 1.4493-97
- Broker spreads vary. Higher the spread the greater broker profit
- Spread widened in times of volatility to prevent mass selling because lack of broker liquidity to realise all orders. Or reduced to help move shares on.
Note: Tangible/Intagible peripheral costs not included in security price which affect supply and demand.
Example: Bid price is 100p and Offer price is 90p then spread/cost of 11.11%. Another company in same sector has spread/cost of 3%. Affets liquidity and so trades at higher price.
What are the costs in buying and selling a fund other than the bid/offer spread?
Operating costs
- Transaction costs
- Investment management fees
- Distribution & service fees - marketing, selling sahres, broker fees
- Legal and accountancy fees
Total Expense Ratio
Total annual fund operating expenses as a % of the fund’s simple-average net assets. Helps compare competing funds.
Buyer and seller costs
Seller needs to consider buyer costs which affects demand.
However selling costs - producing product at value means economies and diseconomies of scale become important.
Taxation - Stamp duty, CGT or income tax and determined by government.
