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CFA Level II 2020 COPY (552) > Economics > Flashcards

Economics Flashcards

1
Q

Sunset Clause

A

Requires Regulators to revisit the cost-benefit analysis based on actual outcomes before renewing laws

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2
Q

Technological Progress

A

An increase in growth rate of potential GDP in developed countries

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3
Q

Tools of Regulatory Intervention

A

Price Mechanism: Taxes or subsides

Restricting or requiring certain activities

Provision of public goods or financing of private projects

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4
Q

Regulatory Arbitrage

A

Companies shop for a country rather than changing their behavior (e.g. toxic waste dump)

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5
Q

Regulatory Capture Theory

A

Eventually the regulator will be influenced or controlled by the industry

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6
Q

Regulators

A

Statutes: laws made by legislative bodies

Admin Regulations: rules by governments

Judicial Law: findings of the court

SRO: can have conflicts of interest (e.g. FINRA)

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7
Q

Removing Trade Barriers

A
  1. Increased investments
  2. Country can focus on industries where it has an advantage
  3. Can export goods allowing for economies of scale
  4. Share of technology
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8
Q

Name the 3 Convergences

A

Club - only middle and rich nations will match poor countries need to make institutional changes

Absolute: A poorer country will match a richer one no matter what

Conditional: Poor will match rich only if they have same: Population growth, savings rate, and production function

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9
Q

Endogenous Theory

A
  1. Technology enhances labor and capital
  2. No steady stage: Increase in savings is a permanent increase to growth rate
  3. Need to innovate to grow
  4. Certain investments increase total TFP (Country benefits from R&D)
  5. No diminishing returns to knowledge capital
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10
Q

Neoclassical Theory

A
  1. Focused on estimating the steady growth rate which is based on TFP
  2. Economic growth is independent from population growth
  3. Labor productivity driven by new technology
  4. Sustainable growth: population growth, labors share of income, and technology
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11
Q

Classical Theory

A
  1. No permanent improvement from new technology
  2. Initial boom in growth than reverts back
  3. There is a subsistence real wage
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12
Q

Economic Labor

A
  1. Quantity of Labor: size of labor * average hours
  2. Labor Force Participation: Labor force / working age pop.
  3. Average hours decrease with wealth
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13
Q

Dutch Disease

A

Demand for a countries resources drives up currency

Note: Natural resources are essential for growth but ownership is not necessary

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14
Q

Cobb-Douglas Formula

A

Growth of TFP + (share of labor * growth of labor) + (share of capital * growth in capital)

*Constant returns to scale

*subject to diminishing returns

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15
Q

Why Potential GDP and Growth Matter

A
  1. Increase in GDP means income will rise, spend more
  2. Difference in actual and potential GDP is a sign for inflation (gov. policies could change)
  3. Increase GDP increases credit quality can pay off debt
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16
Q

Stock market and GDP

A

Potential GDP Growth = growth in equity

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17
Q

Preconditions for Growth

A
  1. Savings and investment
  2. Financial markets (returns/liquidity)
  3. Political stability and laws
  4. Investment in education and healthcare 5. Free trade
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18
Q

Foreign Exchange Expectation Relation

A

The forward rate is an unbiased predictor of the future spot rate.

Covered and uncovered interest rate parity holds

19
Q

Currency Crisis Warnings

A
  1. Deterioration in trade
  2. Dramatic decline in foreign exchange reserves
  3. Real rate substantially higher
  4. Increase in inflation
  5. Boom-bust cycle
  6. Bank reserves increase
  7. Growth of nominal private credit
20
Q

Dornbusch Overshooting Model

A

Prices are not flexible and do not immediately reflect changes

Restrictive policy:

  1. s/t appreciation of currency

Expansionary policy:

  1. Decrease in real rates
  2. Decrease in domestic currency
21
Q

Monetary and Fiscal Policy: Affects on Exchange Rates

Mundell-Flemming Model

A

Monetary/Fiscal Policy Capital Mobility
High Low

E / E Uncertain Decrease
E / R Decrease Uncertain
R / E Increase Uncertain
R/R Uncertain Increase

E = Expansion

R = Restrictive

22
Q

FX Carry Trade Risks

A
  1. Only profitable if uncovered interest rate parity holds
  2. Funding currency may appreciate
  3. Has negative skewness and excess kurtosis (fat fails)

Can limit risks by:

  1. Volatility filter (limit order)
  2. Valuation filter
23
Q

FX Carry Trade

A

Purpose: Invest in higher yielding currency by borrowing funds from the lower yielding one

Return = Interest earned - funding cost - currency depreciation

24
Q

Assessing Long-Run Values of Exchange Rates

A
  1. Macroeconomic Balance: Clues from current account
  2. External Sustainability: Clues from external debt relative to GDP
  3. Reduced Form: estimation of value based on macroeconomic variables
25
Q

Traylor Rule

A

Prescribed central bank policy rate

real policy rate + inflation + .5(inflation - target inflation) + .5(log of current level of output - log of the potential output)

26
Q

Current Account Influences

A
  1. Deficit leads to currency depreciation, increases supply, puts pressure on currency
  2. Surplus usually has financial account deficits
  3. Deficit leads to financial account surplus
27
Q

Balance of Payments

A

Purpose: Method used to track translations between countries

Formula: current + financial + official reserve = 0

Financial: flow of funds for debt/equity investments

Office reserve: monetary reserves

28
Q

RPPP - Relative Purchasing Power Parity

A

Purpose: High inflation leads to currency depreciation

Formula: real exchange rate = St [CPIb / CPIa]

Currency is: positively related to real interest rate

negatively related to risk premium

29
Q

PPP

A

Purpose: Goods have same price in all locations

Does not hold in the short-term

Formula: S(A/B) = CPI (A) / CPI (B)

30
Q

Uncovered Interest Rate Parity

A

Purpose: Currencies fluctuate based an interest rate in each country

Expected Spot = (1 + r quoted currency)^T x spot rate (1 + r base currency)

Note: not bound by arbitrage risk neutral

31
Q

Covered Interest Rate Parity Forward Rate

A

Purpose: Investing in any currency would yield the same. Means higher yield will depreciate

Forward: Spot * [1 + r quoted currency (n/360)] [1 + r base currency (n/360)]

Note: bound by arbitrage

32
Q

Fischer Relation

A

nominal = real + expected inflation

real = nominal - expected inflation

33
Q

International Fisher Relation

A

RnominalA - RnominalB = E(InflationA) - E(InflationB)

34
Q

Future Spot Currency

A

Spot = forward * (1 + r foreign) / (1 + r domestic)

35
Q

Forward Contract Price

A

FP = Spot0 (1 + Rf)^T

36
Q

Determine an Arbitrage Opportunity

A

(1 + r domestic) - [((1 + r foreign) * forward) / spot] = 0

If positive –> Borrow foreign If negative –> Borrow domestic

37
Q

Currency Implied Forward Rate

A

(1 + r domestic) * [(1 + r foreign ) * Spot]

38
Q

Mark to Market Forwards/Futures

A

Vt = (FPt - FP)(Contract size) / [1 + r (Days / 360)]

Note: r is the quoted currency

Use the bid/ask to EXIT the contract

39
Q

Forward Premium (discount)

A

Forward price - spot rate

40
Q

Bid-Ask Spread

A

Ask quote - bid quote

41
Q

Currency Exchange Details

A
  1. Bid: price to buy
  2. Offer (ask): Price to sell
  3. Spread: Difference between bid and ask

AKA: PIPS –> They are stated in the 10,000

  1. Bid = 1/ask Ask = 1/bid
42
Q

Currency Saying

A

Going up = bid (multiply)

Going down = ask (multiply)

Use the % from the top currency

Note: $1.55 per E1 means: 1.55 USD (quote) 1 E (base)

So USD is domestic, E is foreign

43
Q

Growth rate in potential GDP

A

l/t growth rate of labor force + l/t growth rate in labor productivity

Labor productivity already includes:

  1. Capital deepening
  2. Changes in total factor productivity
44
Q

Steady Growth Rate

A

growth rate of TFP / labor cost %+ labor force growth

CFA Level II 2020 COPY (552) (13 decks)

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