Exam Focus Flashcards

Question

What does the Quantity theory of money tell us

Answer 1

Primary research areas for the branch of economics referred to as monetary economics is the quantity theory of money According to the Quantity Theory of Money, if the money supply doubled, it would not necessarily make people better off unless an increase in the volume of goods, services and assets accompanied it. - likely lead to a doubling of prices and still the same amount of stuff to buy. This will bring rising inflation level (as the buying capacity of one unit of currency decreases.); inflation is a measure of the rate of rising prices of goods and services in an economy.

Answer 2

QE is At its heart this is a form of monetary policy in which a central bank purchases securities to achieve the desired outcome of boosting the money supply and liquidity in the market. QT A pretty key monetary policy at the moment is QT. At its heart this is a form of monetary policy in which a central bank sells securities in particular sells bonds or lets them mature to achieve the desired outcome - reducing liquidity int he market

Answer 3

The current climate in the US market and globally is for a period of QT to happen. The Federal Reserve’s balance-sheet has been shrinking since July and will continue this trend until the middle of 2023 In Europe there has also been an expectation of QT for months. The Bank of England held its first gilt auction on November 1st but the ECB is yet to let go of a bond - It is expected that the key principles of quantitative tightening are laid out for the ECB this month. In general, QT is in response to QE which pumped alot of liquidity into system. There is too much hence reducing a little has no massive impact. Less of an extreme impact that QE. However as further liquidity removal occurs, could effect on multiple markets.

Answer 4

Assets price inflation Central bank purchases will push up (bond) prices in those (bond ) markets Asset prices increase in other markets too as (bond) sellers will look to buy toher assets to replace them, etc etc this continues recursively Speculation further adds to inflation of prices

Answer 5

Asset owners have wealth increases No assets no gains - will be worse off having no participation Increase in inequality

Answer 6

Inflation will make it harder to see what stocks are overvalued/ undervalued - the stock price of companies with weak fundamentals could increase for a sustained period of time Investors will grow in numbers as more people have money to invest in assets Investors become more wealthy

Answer 7

Increases due to the wealth effect People with wealth gains have higher purchasing power - spend more so economic activity is creased Should mean increased employment Most impact will be in areas with higher concentration fo asset owners Those without assets will gain from the creation fo jobs- Money trickles down Not massive growth

Answer 8

It lowers the interest rates on savings and loans. And that stimulates spending in the economy. Increasing the supply of money lowers interest rates further and provides liquidity to the banking system On most fundamental level it is because interest rate is price for money

Answer 9

Retail inflation rates stay low - Less wealthy people will not see any significant gains from QE Ratil price inflation may turn to deflation as relatively less well off are worse off - demand for normal baket of goods falls Ex: House prices going up so need to save and dont spend as much on groceries

Answer 10

Banks have more cash from selling bonds to central banks - cna lend more They will only lend to those that can repay (those with greater level of assets) Low interest rates have a detrimental impact of banks lending margins, dampens overall willingness to lend

Answer 11

Likely lead to significant bubbles in asset markets Low interest rates mean that future equity earnings will be discounted using very low interest rates. As these move towards zero, theoretical equity prices move to infinity. - overvalued QE is also likely to impact corporate finance decisions, meaning otherwise poor projects will get finance as they show profitability using the low interest rates, Idea of TINA – ‘There Is No Alternative’ . The idea was that the investor needed to invest, and the least overvalued alternative was equities.

Answer 12

Quantitative easing to push money into areas such as corporate bonds, thereby lowering corporations’ borrowing costs and, it hoped, sparking the productive use of capital.

Answer 13

Asset prices deflation Central bank eliminating its assets will push bond prices in the markets Asset prices decrease in other markets also as bond investors will look to sell other assets when they are buying back bonds, this continues recursively for many market players exacerbating the price decrease Speculation adds to the deflation fo prices too

Answer 14

Asset owners have wealth decreases No assets: gains - will be better off having no participation Those less well off hopefully benefit from less inflated prices

Answer 15

Deflation of prices will make it harder to see what stocks are overvalued/ undervalued - the stock price of companies with great fundamentals could decrease for a sustained period of time Investors will deplete as people have less liquidity to invest in assets There is a lull in investor gains - gains fall

Answer 16

Slows economic growth as there is les smoney to be spent Hope is that People with less wealth have higher purchasing power - demand for goods and service decreases with cost of borrowing increasing so deflation occurs. Not massive growth and may just ba transitionaly before asset prices revert to the mean levels in time

Answer 17

Higher interest rates have a good impact of banks lending margins, increasing overall willingness to lend They may lend to people they previously wouldn’t have because of favourable margins Less demand for borrowing as costs are high

Answer 18

Decreased asset prices mean purchasing power of these real wages is higher

Answer 19

interest rate hikes are known as the central bank's one major tool to lower inflation, which it does by raising the cost of borrowing money to curb the demand for goods and services

Answer 20

Interest rates increase on savings and loans meaning short term less spending in the economy Decreasing the supply of money highers interest further and means lack of liquidity in the banking system Interest is the price of money- money is in low supply so it costs more

Answer 21

Potential to destabilize financial markets- panic due to lack of liquidity QT likely puts upward pressure on interest rates, there is significant uncertainty about the magnitude of these effects High-interest rates mean that future equity earnings will be discounted using very High-interest rates. QE is also likely to impact corporate finance decisions, meaning good projects may not get finance as they don’t show profitability using the high interest rates, even though they might show profitability under normal interest rates.

Answer 22

Low yields on bonds reduce the scope for gaining from compound interest to provide generous future pensions. Interest rates are lower than normal -overvaluing a pensions likely future benefit payments (aka future liabilities) Stock price of companies with weak fundamentals could increase for a sustained period of time. Pension fund may grow in size and as more people/corporations have money to invest in their future Overall QE environment can destabalise pension plan finances. With falling interest there tends to be a shortfall in pension value especially plans relying on bonds to fund regular pay-outs in the future. To cover this, funds have had to invest even more. Interest rates being lower than normal

Answer 23

Alot of pension funds rely on Bonds pretty heavily- panic as central bank sells Need a plan. Deflation of prices will make it harder to see what stocks are overvalued/ undervalued - the stock price of companies with great fundamentals could decrease for a sustained period of time. Investors will deplete as people have less liquidity to invest. There is a lull in pension gains - fund value may stop growing. Higher yields on bonds potentially increase the scope for gaining from compound interest to provide generous future pensions

Answer 24

The main requirements for a framework to assess comparative advantage in investment psychology are that it is based on an adequately powerful narrative and that it is practical. In order for an individual to use any comparative psychological advantage that they have created for themselves, the individual needs not just to create a better understanding of the market but also to create a better understanding of the behaviour of others.

Answer 25

Bretton Woods QE QT Media Fiscal influences and Politics

Answer 26

Method for forecasting the direction of prices through the study of past market data, primarily price and volume. Contrasts the fundamental analysis, which attempts to forecast market prices using financial and economic data. Technical analysis helps identify trends, tendencies and trading opportunities using a variety of techniques but it cannot predict the future. Technical analysis of trends is built on the view that all relevant information impacting the market price is reflected in its price history.

Answer 27

Need deep narrative Investigate whether any of the technical analyses methods work in a particular market by looking at previous price action over various time periods and frequencies. Also examine why certain methods do not work Apply curiosity- being comfortable to combine techniques and examine for patterns. A self aware investor will recognise purpose for investing. Technical factors are quite unpredictable over long periods of time. Technical analysis is only really key for a short term investor or day trader. Once the investor has explored different ways to use technical analysis in a particular market, they could determine how these would work with or without modification. or if the methods nearly work - why don’t they fully. Can then be used for market timing and trading but only in the context of a deep overall narrative

Answer 28

Exchanges are a central marketplace where securities can be bought and sold that are regulated, executed trade information is published at regular intervals for all market participants to see. The regulation on exchanges in very absolute to ensure trading is conducted in an appropriate manner, there are alot of rule around price, execution, settlement and provision of information. The US stock exchange is the most highly respected in the world and alot fo companies want to be listed on it but they must fulfil certain conditions.

Answer 29

Over the counter are deals agreed directly between buyer and seller, typically a bank and a client ex: swaps are typically OTC. OTC markets unlike an exchange do not have trades published OTC can offer different negotiation to agree transactions an dcustomised products but the investors may have higher risk such as coutnerparty default, non transparent, lack of information etc. In OTC markets each party is exposed to the credit risk of their counterpart to the trader but this risk is generally mitigated through collateralisation.

Answer 30

Depends on the purpose and type of trading/ investment But for some securities regulators do encourage market participants to transact deals on exchanges or to centrally clear transactions to improve transparency and reduce counterparty risks.

Answer 31

The ISDA Master Agreement is an internationally agreed legal document published by the International Swaps and Derivatives Association outlining certain terms for derivative trades. This is essential as trading is a global affair so to have one key gold standard across the board allows for standardisation. A big part of ISDAs activity is ensuring the enforceability of the netting provisions in the Master agreement as this stipulation is of massive importance.

Answer 32

Netting allows long and short exposure transacted between the same counterparties to be offset in the event of default, so that only the net exposure is considered as a claim against the defaulter. The Netting idea comes from a frequent occurrence where lots of payments are arising due to lots of contracts between two parties. It is more simple and easier for each party to work out what they owe and the party owing the most can balance up in one payment.

Answer 33

ISDAs work in netting has seen laws being passed in many countries that give legal certainty in those jurisdictions for netting in the event of default. When parties enter into individual Transactions a Confirmation will be prepared which details in advance the terms of that specific trade with reference to the Master Agreement. All the trades are then covered by the terms of the (netting) Agreement. All Transactions depend upon each other under the agreement. Therefore a default under one Transaction counts as a default under all Transactions. This fact is a key protection against unfair behaviours such as clients making some payments (profitable ones) and refusing to pay the unprofitable ones.

Answer 34

Netting opinions The other area where ISDA have been very active is obtaining legal opinions on the validity and scope of netting and updating those opinions when new products like credit derivatives are added under existing agreements. ISDAs netting opinions cover a lot of countries in the world and there is an established case history now from actual case defaults involving derivatives to draw on. The latest version of the ISDA Master agreement is 2002. Overall the practicalities of derivatives trading are massively improved with the agreement in place.

Answer 35

In a cash or spot market, purchasers take immediate possession of goods at the point of sale. Stock exchanges are considered cash markets because shares are exchanged for cash at the point of sale.

Answer 36

This can be contrasted with derivatives markets, where investors purchase the right to take possession at some future date.

Answer 37

Very often the usefulness of the type of market depends ont he purpose of your investment, how long you intend to hold it, and when you want to own/ be exposed to the asset. here are some general thoughts: Derivatives more accessible to smaller investors Hedging risk - currency hedging More liqudity Trading with lower costs in most cases - watch rollover costs Leveraged investment Tax

Answer 38

Very often the cash markets can require alot of capital to invest directly into assets so smaller investors find derivatives markets more accessible because of minimum contract sizes. An example of how to gain exposure to assets in derivatives markets is using financial spread betting.

Answer 39

Derivatives markets are often used for hedging risk, inparticular currency ehdging programmes. Overseas investors will want to generate returns int heir local currency rather than take on any unintended currency exposure giving more volatile returns. Currency forwards allow unintended currency exposures to be hedged.

Answer 40

Another advantage of the derivative versus cash market is there tends to be more liquidity as more people buy and sell derivatives. An example of thiis would be comparing the corporate bond market to a Credit default swap. This is the case for most asset classes and they can also be traded with lower costs in the majority of cases.

Answer 41

Generally however int he derivatives market there could be high rollover costs if contracts are quite short. If an investors wants to invest long term into an asset it may be astute to consider investing in the underlying assets itself to save on renewal of contracts fees and benefit form capital gains.

Answer 42

Leveraged investment is using borrowed money to increase return on an investment. If the return on the total value invested (your own cash plus borrowed funds) is higher than the interest you pay on the borrowed funds, you can make greater profit. In the derivatives market you can have exposure without entry into financing agreements and hence lower your costs.

Answer 43

Taxation when you invest in derivatives tracking assets as opposed to the assets themselves. Direct investment : tax on income and capital gains. Many derivatives, There may be commissions or fees to be paid ex: spread betting incurred betting duty paid by the spread betting company but gains are generally tax free. However, when you invest into the underlying assets it means losses can be offset against future profits where in spread betting for example typically cannot happen. It is something to be aware of and means that alot of discipline and deep understanding of the derivatives markets is needed to prevent big losses.

Answer 44

Synthetic positions are something traders often use to take a position without laying out the capital to actually buy or sell an asset.

Answer 45

Playing the yield curve. In practice when a bank receives deposits it keeps the regulatory amount and lends out the rest. Profitability is limited by the size of the funds it has to lend. A larger balance sheet means more loans. A bank typically lends for relatively long terms, at a fixed rate which funds itself short term with a floating rate in the form of deposits. These floating rates are typically lower than the fixed rate which gives them a healthy profit. Banks could create synthetic lending. Derivatives enable banks to create further leverage beyond what is suggested which some banks may take advantage of. This is because things like interest rate swaps create similar cash flows to normal bank lending.

Answer 46

The Psyche is a word to refer to the full human mind in its widest sense. It can be translated to mean Mind or soul. The simple tripartite model of the Psyche has three parts namely:Nous Logos and Pyr.

Answer 47

Nous is your perspective in life and probably the most important part of the psyche. It includes your thought or imagination for reality, intuition, reflection and narrative development. It’s the mental picture of the world the individual is using and often formulates our narratives.

Answer 48

Logos is logic or rational thinking. The function of logos is to condition the mental picture created by Nous. Logos is logic everyone understands, it’s not necessarily personal to you.

Answer 49

Pyr - Means fire in the belly and refers to the mind's impulse and drive. It is the energy used in and by the psyche.

Answer 50

These three parts of the mind can work together but can also limit each other. Engaging each part of the mind requires contrasting things, for example Nous requires openness and vulnerability , Logos needs stability and Pyr needs passion. To apply all three parts well, individuals need a healthy ego and to be comfortable with applying Nous. Working in investment markets it is essential to create a methodology to evaluate rationalisations regarding investments from a psychological perspective. Firstly one must be aware of how their mind works. Building up this method by assessing the narrative to determine the use of Nous and Ego. It's also helpful to assess any analysis to determine the degree to which Logos was used. The level of Pyr also needs to be considered.

Answer 51

An individual sees the world partly the way the world is and partly the way they are. The Ego is the individual self and is something that's constructed over time. It can be thought of as a filter through which an individual sees the world. A healthy ego - person sees the world as it really is and constructively tries to engage with the world. An unhealthy ego means a person uses degrees of self-deception to justify their actions to make themselves feel better about the world - Every individual has an ego that influences their mind, it’s just the extent to which we can identify ego defence mechanisms and be open to change An individual’s Ego can defend them from realities that they don’t like and only the individual can open their eyes to these realities using what’s called ego defence mechanisms.

Answer 52

It’s important to highlight that often in ordinary conversation we refer to someone having a big ego or small ego. If an individual has a ‘big ego’, our meaning is they have higher self-regard , and a greater sense of self. If this is true then they are more liable to ego-defence mechanisms being activated to protect their high self-regard. But it is possible to have a high self-regard and a healthy ego. So it is more appropriate to label an unhealthy or healthy ego.

Answer 53

When an individual makes a judgement based partly on the way they are and partly on the way the world is, this is referred to as a rationalisation. The more emotional or the higher our expectations of a certain scenario the greater the likelihood and severity of any rationalisations that we make in response. In investing this is particularly prominent often there are high amounts of money at stake. The quality of rationalisation would also be influenced by the degree of Nous and Pyr (effort) applied. - can be positive or negative

Answer 54

Evaluating rationalisations we should assess the narrative to determine the use of Nouns and Ego and secondly, we should set the analysis to determine the degree to which Logos was used. Pyr also needs consideration . Ego defence mechanisms are a type of rationalisation caused by high emotion and high expectations of something that didn't happen. It’s like a protective bubble to stop the hard reality we are about to face crashing down on us. It’s a key skill to practise enduring truth - we do this by engaging Nous.

Answer 55

Having a psychologically sound way of investing-its high pressure position. nNeed a Disciplined, well defined and practised approach. Exercise patience and humility when investing. Always create their own unique, realistic narrative that is deep. It looks for cause and effects and they are constantly trying to improve their narrative They can question existing narratives in a progressive manner They understand the implication of opposing theories like the Efficient Market hypothesis. They dig deeper into any media narratives they come across. One of the hardest things to do as an investor is either do nothing or stick to your stops on potential losses. It is key for investors if they are not in a psychologically good way to step away from trading. Stick to stop loss Astute investor will have the ability to persist and start over

Answer 56

Modern derivatives markets began in Chicago in the mid 1800s. To arrive contract began to be used between farmers and purchasers when transacting grain. This was to reduce the risks faced by both parties whereby the price was agreed in advance for delivery to arrive at a specified date. The risks for farmers and purchasers was the price as when harvest was greater than expected prices would be lower and vice versa. Contract reduced their risks, but there was a new addition of counterparty risk. This defined the idea of derivatives markets. Financial derivatives have caught on in the 1970s and have been growing exponentially since then. Chicago is the biggest derivative exchange location globally with the Chicago Mercantile Exchange and the Chicago Board Options Exchange.

Answer 57

Asset transitions More liquid - lower trading costs Currency hedging programmes Leveraged investments Long/Short portfolios Non linear/ options based strategies

Answer 58

Structured investment products are collective investment vehicles offering investors a target return profile typically linked to a combination of standard indices and often with variable leverage or protection features. Ex: Equity linked return but minimum guaranteed payment of 90% initial investment after a period of time.

Answer 59

Principal protection though often there are hidden costs not advertised Can obtain a tailored investment return More tax efficient in some cases than underlying asset Typically have lower volatility than the underlying asset but with scope to participate in rising equity markets.

Answer 60

Counterparty or credit risk - the possibility of a loss resulting from a borrower's failure to repay a loan or meet contractual obligations. Low liquidity Complex underlying structure with opaque pricing - embedded fees are high.

Answer 61

A contract for differences (CFD) is a financial contract that pays the differences in the settlement price between the open and closing trades and is priced based on the prices of other assets and derivatives. Spread betting involves this action of speculating on the direction of a financial market without actually owning the underlying security.

Answer 62

Can gain exposure to assets in derivative markets even with smaller amounts of capital. Tax merits to these methods. Spread betting is classified usually as gambling and taxed accordingly meaning gains are often tax-free. If you were to directly invest into the underlying asset you would have to pay tax on any income and capital gains. Costs of buying and selling tend to be less. This is because the bid/offer spread in financial spread betting and CfDS is often narrower than in underlying cash markets.

Answer 63

Investing directly into assets does somewhat protect against losses as they can be offset against future profits, unlike losses on spread betting and CfDs which cannot. This is why it’s considered “gambling” and is often subject to restriction. It requires a lot of discipline to engage in to prevent significant losses. Additional costs to rollover any positions in spread betting and CfDs as contracts periodically expire. Costs of this nature add up as expected holding time increases - something to consider if you are looking to take a more long term position.

Answer 64

To remain competitive To keep your job? Survival

Answer 65

Monitoring any trading algorithms in place is really important to asses the quality of the algorithms in place. This could be done in multiple different way including tracking quantitative data like how often the trade makes money, but also what narrative the algorithm is assuming. Is it current? Is it kept up to date, how will it be altered etc/. These are all factors to consider.

Exam Focus Flashcards

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