Unit C - Business and Finance News Knowledge Flashcards
(216 cards)
Outline stock markets.
Companies exist by selling products and/or services. After an initial investment, their sales revenue pays for all the raw materials, staff, offices or factories, ideally leaving enough profits to reward the owners for their initial time, ideas, leadership and upfront cash.
If a company is successful it grows – and then often needs extra money beyond the basic revenues and costs calculation to fund that expansion. This might be to buy more premises or equipment, to invest in research and development of new products and services, or to employ extra staff.
Company directors can raise this money in two different ways. They can do what you might do if you wanted to buy a car or house – arrange an overdraft and/or loan with a bank. This is known as debt financing. Or they can decide to list the company on the stock market, selling ‘stock’ in the business to public and institutional investors. This is known as equity financing.
The stock market, therefore, exists to allow companies to raise money with equity financing by selling shares. A person or organisation who buys a share of a company’s stock becomes a shareholder. This means they (along with other shareholders) are the company’s owners and are entitled to a proportion of its assets – the buildings, offices, factories, raw materials, products and any related trademarks the company owns. Shareholders are also entitled to a share of the company’s profits, distributed via dividend payments. At times when revenues are falling or new investment is needed, profits can be retained by a company to meet debt repayments or in a bid to create higher potential growth.
Companies listed on the stock market are known as PLCs – Public Limited Companies. This means that ordinary shareholders have limited liability: they can lose no more than the cash they have invested. The stock market itself operates as a stock exchange.
The London Stock Exchange (LSE) is one of the oldest and largest stock markets. It serves two customers: companies who want to raise money by offering their stock onto the market through initial public offerings (IPOs) or new issues of shares; and investors eager to own stock in that listed company.
Shares are first issued in the primary market, and are then traded in the secondary market. The vast majority of the LSE’s business takes place in this market of ‘second hand’ stock. Not every company can join the stock market. The LSE has certain criteria that must be met, such as a minimum amount of money to be raised (market capitalisation), a minimum proportion of the company to be in share ownership, and a minimum period that it has been trading as a successful company.
For companies that do not meet these criteria, they can go to the Alternative Investment Market (AIM), which is another stock market that works on the same basic principles but has less strict entry rules.
Using these basic principles, stock markets exist in almost all developed, and in most developing, countries across the world. The largest is in the USA, known as the New York Stock Exchange (NYSE). Other important stock exchanges include the Frankfurt Stock Exchange, the Tokyo Stock Exchange and the Shanghai Stock Exchange.
Stock exchanges are measured by a range of price indices covering different sectors and industries. Each stock market index is calculated from the prices of selected stocks, which therefore measures the value of that section of the stock market. Examples include the Dow Jones Industrial Index and the FTSE-100.
The rise and fall of share prices therefore becomes an important indicator of the strengths and weaknesses of either certain sectors of the economy or, at times, the whole economy. This can be within a single nation, but because large companies are often international and therefore listed on multiple stock exchanges, these rises and falls can quickly cross borders to affect continents and the whole world.
Positive or upward price trends are referred to as bull markets, and this can result in what is called a stock market bubble. Negative or downward price trends are referred to as bear markets, and this can result in what is called a stock market crash. History has seen that bubbles – when shares can be priced above the real worth of stock – often lead to crashes.
Outline commodity markets.
A ‘commodity’ in the global finance world refers to raw materials or other primary products that are bought and sold internationally in bulk.
There are nearly 100 recognised commodity material and products including:
- Seeds, grains and other agricultural products.
- Cattle and other livestock and meat products.
- Oil, coal and other energy products.
- Gold, silver and other precious metals.
- Steel, lead and other industrial metals.
- Diamonds and other minerals and materials.
These materials and products are traded in commodity markets which are officially priced and regulated via commodities exchanges. There are scores of physical and virtual commodities exchanges in countries across the world, and their changing price indices are another indicator of the strengths of various economies and economic sectors. Like the stock market, commodity markets can rise and fall sharply, and these changes quickly cross borders and create problems or benefits for the general public. Examples include the rising costs of fuel on petrol station forecourts (because of oil prices in commodity markets), and the cost of bread in shops (because of wheat prices).
Outline currency markets.
They trade in denominations of money.
Known as the foreign exchange market (often abbreviated to ‘forex’ or ‘FX’), this takes place in financial centres based in all but the least developed countries around the world.
On every weekday, the FX market organises trading between a wide range of different types of buyers and sellers, based on major interbank trading platforms. The rises and falls in the demands of different currencies results in the FX market determining the relative values of different currencies.
This assists international trade and investment activity with fast, regulated currency conversion, a necessity for imports and exports between countries. It also permits speculative trading in the value of currencies based on the different countries’ interest rates
Foreign exchange rates, as we know, affect us all personally at least once a year when we are preparing last minute currency purchases for holidays. But of course they actually affect us all year long, as strong or weak currencies usually reflect the economic health of nations and, in Europe with the euro, a whole continent.
Outline bond markets.
A bond is, in its simplest terms, an official IOU note, more commonly referred to as a debt security. A bond can be issued by a company, a bank or a government, and is effectively a way of arranging a loan with the buyer of that bond. The bond will state when a loan must be repaid and what interest the borrower (the bond issuer) must pay to the bond holder. But because they are official IOUs, these bonds then become an asset which bond holders can buy or sell like anything else. And so banks and investors buy and trade bonds on the bond market.
This bond market is therefore another way that new debt can be created to raise money – the primary market – and where those debts can be bought and sold in the form of bonds – the secondary market. This mechanism provides long-term funding for what are sometimes huge public and private investments in areas like road, rail, construction and other infrastructure projects. Government bonds make up a huge part of bond markets because of their sheer size. In the USA alone, this runs into tens of trillions of dollars. Because they are so integral to government finances, price rises and falls in the bond market have a considerable impact on countries’ interest rates.
Outline hedge funds.
There are all sorts of investors who ‘play’ the above markets – from wealthy individuals with a bit of money at hand, to private investment funds. The latter are called ‘hedge funds’ and use a range of sophisticated strategies to maximise returns. This includes ‘hedging’, which involves making large investments into an asset to reduce the risk of price fluctuations on that asset’s value. For example, airlines can ‘hedge’ against rising oil prices by buying their fuel in advance at a set price. This means that prices rises will not affect them, although they would also not benefit from any reduction in prices. In the wake of the current global financial crisis, governments and central banks are looking in to how to better regulate this risk-taking by hedge funds.
Outline pension funds.
Another important investor group, especially in the stock markets and bond markets, are pension funds. There are thousands of these around the world looking for the safest long- term investments to secure the future pensions of their members. Their funds are huge – often running into hundreds of millions of pounds per fund – and they therefore dominate stock market assets. Pension funds’ decisions on safe investments, and their responses during financial crises, have a large influence on the markets’ rises and falls. The global recession has also affected pension funds and their ability to meet their commitments.
Outline import and export markets.
Imports are the goods and services that a country brings in from foreign countries; exports are the goods and services a country supplies to others. Together, they create international trade. This sounds simple enough, but the relationship between imports and exports is also an important indicator of a country’s economic health.
What is sometimes known as the balance of trade or, to give it its official UK title, the ‘balance of trade’, is the difference between the value of what a country imports and exports. A country has a ‘trade surplus’ if it exports more than it imports; but it has a ‘trade deficit’ if it imports more than it exports. This is sometimes known as a ‘trade gap’. This can get quite complicated, as a country’s balance of trade can be separately measured for products and services, and this can also include financial investments and borrowing, resulting in a balance of payments.
But a healthy country has, overall, more than enough goods and services for its own economy and therefore exports more than it imports. Conversely, a country which needs to import more goods than it can export is not so healthy. This balance can be affected by many factors in different countries, such as labour costs, land costs, raw material costs, tax levels, the availability of finance, the foreign exchange rate and various trade agreement and restrictions, to name just a few.
There are other markets, of course, but in terms of global economics and international finance the above markets – the stock, commodity, currency, bond and import and export markets – are literally the ones which make the world go round. Their rises and falls and changing balances can impact on each other, on different countries and continents, on various economic sectors and on the whole global economy.
Outline the 2007 financial crisis.
Starting in 2007, the world experienced what many politicians and economists called the worst financial crisis since the ‘Great Depression’ of the 1930s. Many observers have pointed to the ‘bubble’ in the US housing market as being one of the main causes of the current crisis. There were many other factors, but one was the easy availability of mortgages to poorer members of the US public – known as the ‘subprime market’. These insecure mortgages were then sold collectively as packages on international markets, where they were traded by banks, and hedge funds, at prices that in retrospect were massively overleveraged – or, in simple language, priced vastly above their real value. When the US house market collapsed, there was a resulting mass failure of subprime mortgages which could no longer be afforded by poor householders. Because these mortgages – millions of them – had been overpriced as collective assets, they were quickly worth next to nothing for the international banks and investors who owned them.
Again, there were many other factors, but this collapse of the subprime market was one of the main reasons that led, at the peak of the crisis, to the threat of collapse for several banks and other financial institutions. Governments had to provide huge subsidies and, in some cases, full or part-nationalisation to help certain banks to survive.
This had a knock-on effect on overall international trade and finance, and at times whole stock exchanges appeared to be on the brink of total collapse due to huge losses and rapidly decreasing prices of stocks and shares. This banking and financial crisis was accompanied by many other factors: rising levels of unemployment; a shortage of oil supply and therefore rising petrol and transport costs; increase in food prices; and a resulting reduction in wider consumer spending.
Outline the Eurozone debt crisis.
One of the obvious results of the global banking crisis was that debt finance became more expensive and less available across the world. This wasn’t helped by the large debts of many European countries, such as Greece and Spain, and their inability to service those debts during the recession. High public sector wages and pension commitments made things worse, as did the Eurozone’s dependence on one currency, the euro, which meant it was harder for member countries to respond individually to the crisis.
Outline the following economic indicators:
- GDP
- GDP per capita
- industrial production
- unemployment
- CPI
- balance of payments
- budget balance
- interest rates
- LIBOR
- Gross domestic product (GDP). Technical definitions of GDP can make it sound more complex than it really is. According to The World Bank, GDP “…is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsides not included in the value of the products”. That’s quite a mouthful. But in everyday language, GDP is simply the market value of everything produced by a nation in a certain period. The words ‘everything produced’ mean all products and services.
- GDP per capita. This is simply a nation’s GDP divided by its population. The measure is useful when comparing one country’s economic health against another. GDP can be expressed as a huge financial figure, but is more often seen as a percentage rise or fall. GDP figures can also be broken down into particular sectors, such as manufacturing, construction and housing.
- Industrial production. In economic terms, industrial production measures the output of a nation’s industrial sector, which includes all manufacturing, mining and utilities. Again, while this can be expressed as a huge financial figure, it has more meaning when seen as a percentage rise or fall from one defined period to the next.
- Unemployment. This measure does what it says on the tin – it records how many people were out of work in a defined period. There are several measures – one based on a survey carried out by the ONS that records ‘unemployment’ and ‘employment’ figures; another is based on the number of people claiming Jobseekers’ Allowance. There is a separate figure recording ‘youth unemployment’, and all these measures are also broken down into UK regions. The ONS produces all these reports under the heading ‘Labour market’. The figures are usually expressed both in total numbers of people involved and in percentage rises and falls from one period to the next.
- Consumer Prices Index (CPI). The CPI is the official measure of inflation of consumer prices in the United Kingdom. This is calculated from the average price increase of 600 different goods and services in 120,000 different retailing outlets. The CPI is now widely used to set any increases in payments of benefits and pensions. This was previously done with what was known as the Retail Price Index (RPI) which includes housing costs (and therefore mortgage costs), which some observers feel was a better way of measuring inflation. That debate continues.
- Balance of payments. This area was touched on when we looked at ‘imports and exports’ in the ‘global economics and international finance section’ of this unit. Basically, it measures whether a nation is a net exporter or importer of products and services, including financial aspects like investment and loans. This is sometimes referred to as the ‘current account balance’, and is referred to as being in ‘deficit’ or ‘surplus’. At its simplest level, to quote economics journalist David Smith in his book Free Lunch: Easily Digestible Economics, the balance of payments is “the sum of all a country’s transactions with the rest of the world”. The resulting current account balance is what Smith describes as “the best overall measure of an economy’s external position and whether it is ‘paying its way’ in the world.”
- Budget balance. The term budget balance is a bit of a misnomer, because it often doesn’t happen. Instead, a budget deficit occurs when government spending is greater than its tax revenues, and it then has to make up the shortfall by borrowing from the private sector. The UK budget deficit is currently measured by public sector net borrowing (PSNB). A budget surplus occurs when tax revenue is greater than government spending. This has only rarely been the case, the last time in the year 2000.
- Interest rates. There are various consumer interest rates: mortgages, savings, overdrafts, loans, etc. But in terms of a nation’s economics – or, more specifically, its monetary policy – the ‘base rate’ of interest is traditionally set either by the government or by the central bank. In the UK, this is the role of the Bank of England, which we will look at next. The base rate set by a government or central bank should not be confused with the interest rate on 10-year government bonds, which is a separate measure and another commonly used economic indicator.
- London Interbank Offered Rate (LIBOR). This is the average interest rate which a number of major banks are prepared to lend money to each other on the London money market, and it is considered to be one of the most crucial rates in the financial world. LIBOR rates are based on a number of maturity periods, from overnight to one year, and in various currencies. The British Bankers’ Association announces the official LIBOR interest rates every weekday.
What are banks?
Put more formally, banks are just like any other business except that their raw material and end product is money. They accept deposits of cash into bank accounts, and for regular and large deposits make a promise to return interest payments for doing so. They then loan that money out to other customers (bank loans, mortgages, etc), or through capital markets, to gain interest payments themselves. The idea is that the interest a bank earns is higher than the interest it pays out, and therefore it makes profits.
What is ‘fractional reserve banking’?
Because of their size and traditional reliability, banks use a system called ‘fractional reserve banking’, which means they only hold a relatively small reserve of the funds deposited, lending the rest out to make profits. This is all highly regulated to different levels within individual countries, and there are also international standards based on the Basel Accords agreement, which applies rules such as ‘minimum capital requirements’.
Outline the UK banking crisis.
This is exactly what went wrong during the banking crisis of 2007, as discussed in the first section of this unit. Basically, the toxic nature of high-risk mortgage debt – known as the ‘sub-prime’ market in the USA – meant banks who had lent huge amounts of money out on capital markets were suddenly unable to recoup the money.
As a result of this, Northern Rock became the first bank in modern times to experience a ‘bank run’ – people demanding their money back all at the same time. This consumer panic occurred when it emerged that Northern Rock had had to approach the Bank of England for a loan facility to continue operating because of defaults on its lending to international capital markets. To prevent Northern Rock’s collapse, the government had to take the bank into public ownership in 2008, effectively writing off a lot of its bad debts and stabilising its operations, before eventually selling it back into the private market to Virgin in 2012.
Northern Rock was not the only bank in trouble as a result of the international credit crunch. In early 2008, the smaller Bradford & Bingley Bank also had to be nationalised to prevent its collapse. And in October 2008, both the Royal Bank of Scotland and HBOS were reported to be within hours of failing as major investors tried to withdraw their funds. This led to Lloyds TSB taking over HBOS, supported by £17 billion of taxpayers’ money from the government, and RBS was only able to continue with a £20 billion injection of government money – both effectively part-nationalisations of these huge banks. This resulted in the infamous resignation of RBS chief executive Sir Freddie Goodwin, provoking widespread anger at the millions he personally received as part of his termination.
The above is only a snapshot of a much wider ensuing banking crisis in the UK, Europe and the world. But the snowball effect meant there had to be changes to the system that regulated banks, and in the UK this included the Bank of England’s new Financial Policy Committee (FPC) and Prudential Regulation Authority (PRA).
Outline the Bank of England.
The Bank of England is what is known as the ‘central bank’ of the UK. Founded in 1694, it was established to act as the government’s official banker – a role it still holds. Most other countries’ central banks are based on the Bank of England model. Whatever the political debates and opinions on recent economic policy, it is widely acknowledged that the Bank of England has a large influence on the UK’s domestic economy. Whether that is a successful influence or not is sometimes debated.
As well as being the main issuer of banknotes, the Bank of England has devolved power from government to set the nation’s ‘monetary policy’. This power came in 1997 when the then Chancellor of the Exchequer, Gordon Brown, gave the Bank of England operational independence – which in summary meant it had control over setting monetary policy to meet an inflation target set by the government. The Bank of England does this via the Monetary Policy Committee.
Outline the MPC.
The Bank of England’s Monetary Policy Committee (MPC) is a group of leading bankers and economists, chaired by the Bank’s governor. It meets for several days a month to analyse, discuss and debate the nation’s various economic indicators and set an interest rate. This is called the Bank of England ‘base rate’, the rate at which it lends money to banks. Banks, building societies and other financial institutions then have to set their own interest rates, commonly referred to as ‘x% above base rate’.
In March 2009, in an attempt to increase the amount of lending and activity in the economy to help the UK weather the recession, the Bank of England set the base rate at 0.5%, the lowest rate in its history. At the time of writing (August 2016), the base rate had just been lowered even further to 0.25%, mainly as a result of the UK’s Brexit referendum. The MPC also authorised a programme of ‘quantitative easing’.
What is quantitative easing?
To put it simply, quantitative easing is when the central bank injects money directly into the economy. This has often happened when interest rates have reached such low levels that economists feel there is no other way to stimulate the economy. This was the position in 2009 when the UK base rate reached an all-time low of 0.5%. There are various ways to apply quantitative easing, but the one chosen by the Bank of England’s MPC was to purchase secure government bonds from the private sector with newly created money.
How will the Bank of England be regulated in the future?
The Financial Policy Committee and Prudential Regulation Authority.
Who is the Chancellor of the Exchequer?
Despite the Bank of England’s increased role in influencing the UK’s economy and finance sector, many of the basic controls are still in the hands of the elected government. The Chancellor of the Exchequer runs these controls on the same basis as any business: revenues and costs. The revenues are created by a multitude of taxes (and borrowing), and the costs are what are spent on things like the NHS, transport infrastructure, social security, defence and all the other government departments, projects, equipment and staff that provide services for the general public.
These incomings and outgoings are continuous, with HMRC assessing, collecting and chasing taxes, and with various government departments making day-to-day decisions on the billions of pounds of expenditure. But all follow the basic principles that are set by the Chancellor in what is currently known as the Autumn Statement and then the more formal Budget. These occasions are when the Chancellor makes what in effect are financial statements and future plans, expressing a general view of the nation’s finances, describing which areas the government intends to spend (or not to spend) on, and announcing the proposed plan of taxation for the next year.
The Chancellor will state what the government intends to spend, in which areas, how this will be paid for, and what the overall affect will be on the country’s debt and deficit levels. These plans not only include investment in certain areas (eg, new schools, new roads, etc) but will also involve cuts to other areas (eg, defence, benefits). Ideally, the Chancellor wants the Budget to balance, but it’s usually more about controlling the resulting deficit, (although there have been occasions of budget surplus).
Who collects the majority of taxes?
HM Revenue and Customs.
Outline the following taxes:
- Income Tax
- Corporation Tax
- Capital Gains Tax
- National Insurance
- Inheritance Tax
- VAT
- Stamp Duty Land Tax (SDLT)
- Insurance Premium Tax
- Air Passenger Duty
- Petroleum Revenue Tax
- Vehicle Excise Duty
- Council Tax
Income Tax. This is a tax that we are all liable to pay on almost all areas of our income. Everyone has a tax allowance, which is income on which no tax is due (this was £10,000 in the 2014/15 tax year for people of working age). Increasing tax rates are then applied to income bands above that allowance. For the 2014/15 tax year: a ‘basic’ rate of 20% on earnings up to £31,865; a ‘higher’ rate of 40% on earning ups from £31,865 to £150,000; and an ‘additional’ rate of 45% on any earnings above £150,000.
These tax allowances and rates are applied to all the money you earn from the following: employment; most pensions; interest on savings; rental income; extra benefits you might get from a job (eg, a company car; and any income from a trust). You don’t pay tax on things like: income from tax-exempt accounts, Individual Savings Accounts (ISAs); Working Tax Credit; Premium Bond wins and other tax- exempt prizes (although you would be taxed on savings income from these prizes).
- Corporation Tax. This is the amount of money that companies pay to the HMRC, based on published rates that are applied to different levels of pre-tax profit. In 2014/15, the rates were 20% for ‘small profits’ of up to £300,000, and a main rate of 21% for profits above that.
- Capital Gains Tax. This is a tax on the gain or profit made when you sell, give away or otherwise dispose of an asset, such as shares or property. Everyone has an allowance of £10,900 on capital gains, with any gain or profit above that amount taxed at either 18% or 28% depending on the total amount of taxable income (2014 figures).
- National Insurance. In effect, this is another tax, although it is specifically used to fund state benefits and pensions, as opposed to going into a general tax pot. It currently (2014) applies to everyone of a working age who earns more than £153 a week, or those who are self-employed making a profit over £5,885 a year. The exact amount you pay depends on how much you earn and whether you’re employed or self-employed.
- Inheritance Tax. This is paid on an estate when somebody dies, and sometimes on trusts or gifts made during someone’s lifetime. Most estates don’t have to pay Inheritance Tax because they’re valued at less than the threshold (currently £325,000). The tax is payable at 40% on the amount over this threshold or 36% if the estate qualifies for a reduced rate as a result of a charitable donation.
There are also a number of ‘indirect taxes’ paid by you or your business on money spent on goods or services. This includes Value Added Tax (VAT). This is a sales tax charged on all a company’s revenues once its turnover exceeds a certain amount per year (in 2016, this was £83,000). VAT-registered companies pass this charge on to purchasing companies and consumers. VAT-registered companies literally collect tax for the government, and this is paid in regular instalments to the HMRC. In return, companies reclaim the VAT on all expenditure on VAT-registered products/services. VAT rates can change, but at the time of writing (August 2016) the rate was 20%. There are some VAT-exempt products (eg, newspapers).
Other indirect taxes include Stamp Duty Land Tax (SDLT) on property transactions, Insurance Premium Tax, Air Passenger Duty, Petroleum Revenue Tax and Vehicle Excise Duty (road tax). Local councils also collect Council Tax to pay for local services such as street lighting and bin collections.
Outline Keynesian and Classical economics.
- Keynesian economics. Based on the ideas of John Maynard Keynes (b.1883, d.1946). It is where a government actively manages demand in the economy with financial policies, tackling recessions with tax cuts and high public expenditure, and the opposite during a boom.
- Classical economics. Based on the ideas of Adam Smith (b.1723, d.1790). Smith talked about ‘the invisible hand of capitalism’, which basically means a laissez- faire attitude by government toward the marketplace. The ‘invisible hand’ guides
everyone’s economic activity, naturally resulting in the greatest good for the greatest number of people, and therefore economic growth.
Why has Britain’s manufacturing industry declined?
From the last quarter of the 20th century, Britain’s involvement in heavy manufacturing fell into heavy decline. Production either switched to cheaper labour found in developing countries, or to increasing technology that steadily replaced the numbers of manual workers needed. This change has been reflected in other Western economies.
Outline the service sector.
At its most basic, people employed in the service sector produce services rather than products. While manufacturers employ people on factory production lines making everything from cars and clothing to chocolate, service sector jobs include everything from housekeepers to tax advisors, from waiters to chefs, and from nursing to teaching. The service sector includes areas such as transport (eg, National Express Group), telecommunications (eg, Vodafone), financial services (eg, HSBC), legal services (eg, Irwin Mitchell), healthcare (eg, BMI Healthcare), shopping (eg, Tesco) and leisure and entertainment services (eg, Gala Coral). The list could go on – but think hotels, bars, nightclubs, and you’re talking about the service sector.
Outline privatisation.
Another change in the modern economy was mass privatisation of public organisations. What used to be nationalised sectors, such as telephones, railways, water, gas and electricity, became private companies in the latter part of the 20th century. According to some observers, this change was beneficial in that it raised much needed finance for the British government and for new investment into research, technology and new, greener energy resources. Others decry the loss of national control over such crucial sectors, and claim that too many ‘fat cat’ bosses have benefitted from profits and dividends that should have been shared by the public, or reinvested for the public. British Telecom, British Gas and Royal Mail and three good examples of former public utilities that are now private companies trading on the stock market.
