Chapter 19 - Economic Factors

2 measures of economic activity

Gross National Product
Gross Domestic Product

Gross National Product

the total value of all goods and services that are produced by a national economy. For the U.S., it includes the goods and services being produced overseas by a U.S. company

Gross Domestic Product

the output of all the goods and services that are produced by labor and property located in the U.S., without regard to the origin of the producer
- includes a Toyota plant in Columbus

inflation

too much money chasing too few goods
persistent and appreciable rise in the general level of prices

what measures inflation?

the Consumer Price Index (CPI)

utility stock

highly leveraged; have significant reactions to changes in interest rates
natural gas, water, electricity
decline in prices of these securities when interest rates rise

equities to hedge against inflation

equity mutual funds, equity ETFs, variable annuities

Commodities as an Inflation Hedge

gold and silver

real interest rate

the rate of interest that a bond investor expects to receive after allowing for the decline in his purchasing power due to inflation
yield - inflation rate = real interest rate

deflation

a persistent and appreciable decline in the general level of prices.
May be caused by the supply of goods and services exceeding the demand for those items, resulting in producers lowering their prices to compete for the limited demand

4 phases of business cycle

expansion, peak, contraction, trough

when does a recession occur?

when Real GDP declines for 2 consecutive quarters

3 economic indicators

leading, coincident, lagging

leading economic indicators

Variables that predict, or lead to, a recession or recovery; examples include:
average weekly hours, manufacturing
average weekly initial claims for unempl. insurance
manufacturing new orders, consumer goods, and materials
ISM Index of New Orders
Manufact

Coincident Economic Indicators

Usually mirror the movements of the business cycle
employees on non-agricultural payrolls
personal income less transfer payments
the Index of Industrial Production
Manufacturing and Trade sales

Lagging Economic Indicators

average duration of unemployment
ratio of manufacturing and trade inventories to sales
change in labor cost per unit of output
the average prime rate charged by banks
commercial and industrial loans outstanding
ratio of consumer installment credit to pers

prime rate

what commercial banks charge their best corporate clients

discount rate

what the depository institutions are charged when they borrow from the Fed Reserve

Fed Funds Rate

what is charged on an overnight loan of reserves between member banks

Call rate

what commercial banks charge on collateralized loans to broker-dealers

from highest to lowest in terms of rates

prime rate
call rate
discount rate
fed funds rate

bond coverage ratio

EBIT/Interest Expense

do growth stocks have a high P/E ratio?

yes

do growth stocks have a high dividend payout ratio?

no

contrarian

someone who purchases value stocks

nano-cap

Below $50 Million

micro-cap

Between $50 Million and $300 Million

small-cap

Between $300 million and $2 billion

mid-cap

between $2 billion and $10 billion

large-cap

greater than $10 billion

Keynesian economics

states that government intervention in the economy is necessary for sustained economic growth and stability

who sets fiscal policy?

the President and Congress

primary focus of fiscal policy

economic growth and high employment

who controls monetary policy

the Fed

monetary policy

attempts to control the supply of money and credit in the economy
- primary focus to control inflation

easing money

increasing money supply and lowering rates

tightening money

reducing money supply and increasing rates

normal upward sloping yield curve

during periods of easy money
yields on short-term debt securities will be lower than those on long-term securities

inverted downward sloping

during periods of tight money
short-term interest rates will be higher than long-term rates

tools of the Fed

reserve requirements, discount rate, open market operations, margin requirements, moral suasion

if reserve requirements are lowered

the banks are able to extend more credit, which causes the money supply to increase and INTEREST RATES to fall

multiplier effect

the rate at which banks can create new money by re-lending deposits and, in turn, creating new deposits

discount rate

the rate charged by the for the loans that are made to its members

when the discount rate lowers,

the FRB is encouraging the borrowing from the FRB discount window, so money is injected into the system

fed funds rate

the short-term loans of excess reserves that banks lend to one another and the interest rate charged on these loans
MOST VOLATILE INTEREST RATE

what is the fed funds rate determined by

supply and demand

Federal Open Market Committee FMOC

oversees the FRB's buying and selling of U.S. government securities in the secondary market
- most frequently used tool of monetary control

when the Fed buys securities

it's injecting money into the banking system in order to stimulate investment and business activity
money is more available and interest rates tend to move downward
-easing of the money supply
-could lead to inflation

if the Fed sells securities

it's tightening the money supply
interest rates will rise
may curb inflation

repo

a contract entered into by the FRB to purchase government securities at a fixed price from dealers with the provisions for their resale back to the dealer at the same price plus a negotiated rate of interest
the FRB is lending money, and therefore increas

reverse repo

when the FRB sells securities to dealers with the intention of buying the securities back at a future date

margin requirements

the Securities Exchange Act of 1934 provides the FRB with the power to determine the amount of credit that may be extended to purchase securities
established under Reg. T
least effective method
by increasing requirements, FRB reduces the amount of money b

moral suasion

when the FRB attempts to influence bank lending policies through jawboning
the FRB exerts its influence through the public media or through the examiners who are sent to member banks

increasing bank reserve requirements

tightening

increasing discount rate

tightening

increasing margin requirements

tightening

selling government securities in the open market

tightening

spot rate

the current value of a currency

as demand for dollars increases,

the price of dollars increase. therefore, when U.S. interest rates are higher than foreign rates, it may lead to a stronger dollar.

U.S. exporters prefer

a weak dollar

U.S. importers prefer

a strong dollar