Economics & Monetary Policy Flashcards
This deck focuses on important terms and concepts relating to economics and monetary policy including the business cycle, balance of trade, and the role of the Federal Reserve.
Environment in which longer-term bonds have higher yields than short-term securities
Normal yield curve
Graphically depicts the yield relationship between long- and short-term bonds
Yield curve
A short-term economic contraction
Recession
The four phases of the economic cycle
Expansion, peak, contraction and trough
Longer term, severe economic contraction
Depression
A nation’s annual output of all goods and services
Gross Domestic Product (GDP)
Measures the general rate of increase or decrease in prices paid for certain standard goods
Consumer Price Index (CPI)
General increase in the level of prices
Inflation
The three types of economic indicators
Leading, lagging and coincident
Type of indicator that predicts a trend in the economy
Leading
Leading, lagging or coincident indicator? The money supply
Leading
Leading, lagging or coincident indicator? Employment levels
Coincident
Leading, lagging or coincident indicator? Corporate profits
Lagging
Leading, lagging or coincident indicator? Industrial production
Coincident
Leading, lagging or coincident indicator? Average duration of unemployment
Lagging
Leading, lagging or coincident indicator? New orders for consumer goods
Leading
Leading, lagging or coincident indicator? Stock prices
Leading
Leading, lagging or coincident indicator? Personal income
Coincident
Leading, lagging or coincident indicator? GDP
Lagging
Leading, lagging or coincident indicator? Manufacturing and trade sales
Coincident
Leading, lagging or coincident indicator? Ratio of inventories to sales
Lagging
Economist who theorized that aggregate demand controls employment and prices
John Maynard Keynes
The originator of monetarist theory
Milton Friedman
Three tools used by monetarist theory to regulate the economy
Reserve requirement, discount rate, federal open market operations
Two critical fiscal policy tools used to impact economic performance
Level of taxation and government spending
Economic theory that promotes strong government involvement in economic policy
Keynesian economics
Acts as agent of the US Treasury as the nation’s central bank
Federal Reserve Board
Regulates the U.S. money supply
Federal Reserve Board
Conducts the U.S. government’s open-market operations
Federal Open Market Committee (FOMC)
Impact on the money supply of FOMC purchase of securities
Increases
Impact on interest rates of FOMC purchase of securities
Decreases
Interest rate charged between banks for loans of excess reserves
Federal funds rate
Minimum amount of customer deposits that commercial banks must deposit with the Federal Reserve
Reserve requirement
The Interest rate charged by the Fed to member banks for short-term loans
Discount rate
Economic policy that centers on federal spending, taxation and federal budgets
Fiscal policy
Impact of tight monetary policy on interest rates
Interest rates rise
Impact of a weak dollar on U.S. exports
Exports will rise
Impact of a weak dollar on U.S. imports
Imports will fall
Impact on balance of payments when U.S. exports exceed U.S. imports
Surplus in the balance of payments
Impact on balance of trade when foreign interest rates are higher than U.S. interest rates
increase in the balance of trade
Defensive, Cyclical or Growth Industry? Food
Defensive
Defensive, Cyclical or Growth Industry? Utilities
Defensive
Defensive, Cyclical or Growth Industry? Steel
Cyclical
Defensive, Cyclical or Growth Industry? Automobile
Cyclical
Defensive, Cyclical or Growth Industry? Technology
Growth
Basic balance sheet equation
Assets - Liabilities = Net Worth
Financial statement that summarizes revenues and expenses
Income statement
Characterized by falling stock markets, rising inventories, declining GDP
Contraction
Characterized by low unemployment , increased business activities
Expansion
assets
The component of a company’s balance sheet that reflects everything a company owns.
balance of trade
The difference between a country’s exports and imports. Debit items include money flowing out of a country, including imported goods, foreign aid, and domestic spending abroad. Credit items include exported goods and foreign spending in the domestic country.
balance sheet
One of a company’s financial statements, which provides a snapshot of the company’s assets and liabilities at a given point in time.
bear market
A prolonged period of declining stock prices, typically caused by fear of a slowdown in the economy.
broker call rate
The rate that a broker-dealer pays a bank when a broker-dealer borrows money so that a customer can purchase securities on margin.
bull market
A prolonged period of increasing stock prices, typically caused by the expectation of an expanding economy.
business cycle
The recurring pattern and fluctuation in economic activity ranging over several months to a number of years. The four phases of the cycle are: expansion, peak, contraction, and trough.
central bank
A country’s banking institution, such as the Federal Reserve Board in the US, which is tasked with controlling the nation’s money supply.
classical economics
Sometimes referred to as laissez-faire economics, an economic theory that believes that a free market economy with no government interference would achieve full employment and the best results.
coincident indicators
An economic measure that is used to confirm current trends and changes in the economy.
Consumer Price Index (CPI)
Measures inflation by measuring the change in the average price of consumer goods and services from one period to the next.
contraction
One of the four stages of the business cycle, characterized by a slowdown in the pace of economic activity.
contractionary fiscal policy
A government policy in which a government’s tax revenues outweigh its spending. The goal of this policy is to slow down economic growth.
cyclical stock
Shares of a company that mirror the larger economic environment. They tend to increase in value when the company is growing and decline in value in a recessionary environment. Examples include companies that produce high-ticket consumer items, such as cars and large appliances.
defensive stock
Shares of a company that are resistant to downturns in the economy. Sometimes referred to as recession-proof stocks, these include companies that produce consumer staples, such as food retailers and cosmetics and alcohol companies.
depression
A sustained, long-term downturn in economic activity, typically characterized by a 10% drop in GDP or at least six consecutive quarters of negative GDP growth.
discount rate
A tool of the Federal Reserve Board, this is the interest rate the Fed charges banks over short-term loans. To ease the money supply, the Fed would lower the rate, allowing banks to borrow at a cheaper rate. To tighten the money supply, the Fed would raise the rate, making it more expen-sive for banks to borrow money from the Fed.
ease the money supply
A situation in which the Federal Reserve Board wants to drive down interest rates, by increasing the money supply. To do this, the Fed would purchase government securities from primary dealers or lower the discount rate and/or reserve requirement. This action will generally spur economic growth.
economic indicators
Measures that help evaluate the health of the economy, including its past, current, or future performance.
economic policy
Refers to government intervention to impact economic performance, generally to stimulate an economy out of recession or to constrain excessive growth and prevent inflation.
economy
Encompasses all wealth and resources of a specific area or country, especially as these relate to production and consumption of goods and services.
exchange rate
Specifies how much one currency is worth in terms of another.
expansion
One of the four stages of the business cycle, characterized by increased economic activity.
expansionary fiscal policy
A government policy in which government spending exceeds tax revenue. The goal of this policy is to spur economic growth at the cost of increasing the budget deficit.
expenses
The total costs incurred by a business to generate its sales. This includes variable costs, which are the costs directly associated with producing the goods that generate sales as well as the fixed costs of the business.
export
A product or service that is sold to a trading partner in another country.
federal funds rate
The interest rate that banks charge each other for overnight loans. This rate is heavily influenced by the open market operations of the Federal Reserve Board. However, it is not actually set by the Fed. Instead, it is determined by supply and demand in the market.
Federal Open Market Committee (FOMC)
The arm of the Federal Reserve Board that conducts open market operations, therefore controlling the amount of money in circulation.
fiscal policy
The use of government spending and taxation to influence the economy.
flat yield curve
A rare type of yield curve in which short-term and long-term yields are equal to one another.
gross domestic product (GDP)
The total market value of all goods and services produced within a country.
gross national product (GNP
The total market value of all goods and services produced by the residents of a country, even if they are living abroad.
income statement
One of a company’s financial statements, which shows the revenue, expenses, and net income of a business over a period of time.
import
A product or service that is purchased from a trading partner in another country.
inflation
A rise in the prices of goods and services in an economy over a period of time, which is measured by the Consumer Price Index.
inverted yield curve
A type of yield curve in which the yields on short-term bonds are higher than the yields on long-term bonds. This is often a sign of an upcoming recession.
lagging indicators
An economic measure that is used to confirm past trends and changes in the economy.
Keynesian economics
An economic theory that believes that government intervention in the form of government spending and taxes can help ensure a strong economy.
liabilities
The component of a company’s balance sheet that reflects everything a company owes.
leading indicators
An economic measure that is used to predict future trends and changes in the economy.
monetary policy
Set by the Federal Reserve Board, it is the amount of money in circulation, which helps to control inflation and economic growth.
monetarism
An economic theory that believes that controlling the money supply of a country can help control inflation and economic growth and therefore ensure a strong economy.
narrowing yield spread
When the rates of return between bonds with different quality ratings decrease, forecasting a smaller risk of default on lower-grade bonds.
neutral fiscal policy
A government policy in which government spending equals tax revenue in order to maintain a balanced budget.
net income
The profits earned by a company after all of its expenses, including fixed and variable costs, interest expenses, and taxes, have been paid.
normal yield curve
The most common type of yield curve in which longer maturity bonds have a higher yield compared to shorter-term bonds. Higher rates for longer maturities compensate investors for the default risk associated with longer-term bonds.
open market operations
The primary tool of the Federal Reserve Board’s monetary policy, which is the buying and selling of government securities with primary dealers (banks). To ease the money supply, the Fed would buy securities as this would add cash to the banking system. To tighten the money supply, the Fed would sell securities as this would remove cash from the banking system.
peak
One of the four stages of the business cycle, in which an expansion reaches its highest point and marks the beginning of an economic downturn.
primary dealers
Banks that are required to buy and sell government securities with the Federal Reserve Board in order to aid in open market transactions and allow the Fed to implement monetary policy.
prime rate
The interest rate that banks charge their most credit-worthy customers, typically large institutional clients.
real economic growth
The change in gross domestic product (GDP) from one period to another, adjusted for inflation.
recession
A prolonged period of contraction defined as a decline in GDP for at least two consecutive quarters.
reserve requirement
A tool of the Federal Reserve Board requiring banks to keep a certain percent-age of deposits on hand that are not to be lent out to customers. To ease the money supply, the Fed would lower this requirement, allowing banks to give out more loans. To tighten the money supply, the Fed would raise this requirement, forcing banks to keep more money on reserve and therefore allowing them to give out fewer loans.
retained earnings
The portion of a company’s net income that is not paid out to shareholders and is instead reinvested in the business.
revenue
The sales of a company’s products and services that are generated by a business.
shareholder’s equity
The component of a company’s balance sheet that reflects the difference between a company’s assets and its liabilities.
stagflation
A period of slow economic growth accompanied by high unemployment and rising prices.
tighten the money supply
A situation in which the Federal Reserve Board wants to increase interest rates, by decreasing the money supply. To do this the Fed would sell government securities to primary dealers or raise the discount rate and/or reserve requirement. This action will help curb inflation and prevent the economy from overheating.
trade deficit
Occurs when a country has more imports than exports.
trade surplus
Occurs when a country has more exports than imports.
trough
One of the four stages of the business cycle, in which a contraction reaches its lowest point and begins to turn into an expansion.
unemployment rate
An economic measure that details the percentage of individuals in the labor force who are without work.
widening yield spread
When the rates of returns between bonds with different quality ratings increase, forecasting a greater risk of default on lower-grade bonds.
yield curve
A graph that plots the relationship between interest rates and time until maturity, which provides an idea of future interest rate expectations and predicts changes in economic output and growth.
yield spread
The difference in the quoted rates of return between two types of bonds. Yield spread provides an indication of the increased return for investing in one type of bond over another.
What is it called when short-term rates match long-term rates on the yield curve?
Flat Yield Curve
What is it called when short-term rates exceed long-term rates?
Inverted Yield Curve
What is the relationship between maturity and yield?
Longer Maturity = Higher Yield
Investors demand higher yields for locking up their money for longer periods of time. Exactly how much yield is required is what determines the shape of the yield curve.
The difference between the value of a country’s exports and imports is known as the:
balance of trade
The balance of trade is the difference between the value of a country’s exports and the value of its imports.
What is most likely cause a nation’s currency to depreciate?
an extreme increase in the nation’s inflation rate
High domestic inflation will cause the currency to depreciate because the demand for the nation’s output will fall as prices increases.
According to the law of demand, as price rises the demand for a good decreases. Thus, rising domestic prices implies that foreign demand for the nation’s output will fall. Falling demand for goods implies falling demand for domestic currency; this decrease in demand causes the “price” or exchange rate of the nation to fall or depreciate.
If the value of a nation’s exports exceeds imports, then the nation is running a ________.
balance of trade surplus
The balance of trade is the difference between the value of a country’s exports and the value of its imports. Whenever this difference is positive, the balance of trade is said to be in surplus.
Define:
shareholders equity
Reflects the difference between a company’s assets and liabilities and can be calculated as:
Total Assets - Total Liabilities = Shareholders Equity
What is a rights offering?
Rights offering is a capital raise where existing shareholders are given the right to purchase additional shares, proportionate to their current holdings in order to avoid dilution.
What are the risks a stock owner faces?
- Market Risk - the risk that the performance of an individual security will be impacted by the performance of the overall market
- Business Risk - the risk that the the performance of an investment is negatively impacted by company’ management and other company specific factors
What are the broad categories usually used to describe a particular segment or industry?
- Growth - Stocks that reinvest most of their earnings to their business in order to grow the value over time
- Income - Stocks that regularly pay income in the form of dividends
- Defensive - Stocks that are resistant to changes in the business cycle
- Cyclical - Stocks that mirror the performance of the conomy
Assets, liabilities, and shareholders’ equity are reported on a company’s
balance sheet
An investor’s stock position has appreciated, but they have not yet sold the shares. The investor has
Unrealized capital gains
What type of risk cannot be avoid through diversification?
systematic risk
Define:
Which section of a company’s balance sheet reflects everything owed by the company?
liabilities
During which stage of the business cycle would it be advisable for an investor to purchase defensive stocks?
Recession
Define:
Which part of the balance sheet reflects a company’s net worth?
Shareholder’s equity
