Unit 12 - Economic Analysis

12.1 - the business cycle

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(4) stages of the business cycle

Expansion

Peak

Contraction

Trough

Recession

extended period of contraction that continues for six months (two quarters) or longer

Depression

contraction continues for 18+ months

Which state of the business cycle is characterized by rising consumer demand and higher wages?

A)

Trough

B)

Expansion

C)

Recession

D)

Contraction

B

Economic data shows that the gross domestic product (GDP) has been declining steadily over the past two quarters. This would suggest

A)

inflation.

B)

expansion.

C)

a recession.

D)

a depression.

C

12.2 - Economic Indicators

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Gross Domestic Product (GDP)

annual economic output of goods and services

Gross National Product (GNP)

like GDP, measures the total good and services produced, but estimates the value of the FINAL products and services manufactured by a country

___ measures the value of everything produced within a country's borders, while ___ measures the value of what is produced by a country's citizens and businesses, globally

GDP, GNP

Example

Foreign Motor Corporation, based in Japan, builds a new auto assembly line in Texas. This economic activity would add to GDP (it was built in the United States), but it would not add to GNP because the company is not a U.S. entity.

.

Consumer Price index (CPI)

measures changes in the cost of goods and services

CPI is published how often?

monthly

Real GDP

adjusted GDP measure that accounts for inflation in the prices of goods and services

Leading Indicators

tend to change direction ahead of the overall economy. Used as predictors

List of leading indicators:

Money supply (M2)

Building permits (housing starts)

Average weekly initial claims for state unemployment compensation

Average work week in manufacturing

New orders for consumer goods

Machine tool orders

Changes in inventories of durable goods

Changes in sensitive materials prices

Stock prices (as measured by the S&P 500 Index)

Changes in business and consumer borrowing

Coincident Economic Indicators

change direction with the economy as a whole. Used as confirmation for leading indicators

List of Coincident Indicators:

Number of hours worked (as a proxy for personal income)

Employment levels (as measured by the rate of unemployment)

Nonagricultural employment

Personal income

Industrial production

Manufacturing and trade sales

GDP

Lagging Indicators

change direction after the economy has started a new trend. Used as confirmation of a new trend

List of lagging indicators:

Corporate profits

Average duration of unemployment

Labor cost per unit of output (manufacturing)

Ratio of inventories to sales

Commercial and industrial loans outstanding

Ratio of consumer installment credit to personal income

Inflation

general increases in prices

Mild inflation can ________ economic growth, high inflation _____ economic growth

encourage, hurt

Deflation

General decline in prices

Stagnation

low growth, low inflation, high unemployment

A measure of economic activity that would exclude the overseas activity of U.S. companies is which of the following?

A)

Gross domestic product

B)

Foreign Exclusionary Index

C)

Gross national product

D)

Consumer Price Index

A

How often is the Consumer Price Index published?

A)

Quarterly.

B)

Weekly

C)

Monthly

D)

Annually.

C

Which of the following would be a leading economic indicator?

A)

Industrial production

B)

S&P 500 Index

C)

Duration of unemployment

D)

Gross domestic product (GDP)

B

When prices of goods in the general economy are declining, the nation is experiencing which of these?

A)

Inflation

B)

Deflation

C)

Stagflation

D)

Destabilization

B

12.3 - industries and the economy

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Cyclical Industries

highly sensitive to business cycles and inflation trends

Most cyclical industries produce....

durable goods -- heavy machinery and automobiles

Steel and other industrial metals

Autos

Heavy equipment

Capital goods, also called durable goods (washers, dryers, refrigerators, etc.)

Noncyclical/Defense Industries

least affected by business cycles

Most defense industry companies produce...

Consumer goods - nondurable

explain the nature of stock prices for Defense Industry companies

Don't go down as much as others during recession, but prices don't raise that much during booms

Countercyclical Industries

perform better during bad times. Gold is the common example

Growth Industry

does well regardless of the economy. Eventually these companies mature and fall in line with the economy

Special Situation

applies to a specific company that shows either unusual profit potential or unusual downside risk.

- Hostile takeovers or cultural shift

The economy appears to be moving into a recession. Which of the following companies will likely deliver the best returns if the recession fears prove accurate?

A)

Hinckley Gold and Silver Mining

B)

Seabird Airlines

C)

Southern Company Trucking and Transport

D)

Butterfly Heavy Equipment

A

12.4 - Corporate Financial Statements

.

The balance sheet provides a...

snapshot of a company's financial position at a specific time

Basic Balance Sheet Equation

Net Worth = Assets - Liabilities

Assets =

Liabilities + Net Worth

Types of Assets (3)

Current Assets

Fixed Assets

Other assets

Current Assets

cash and assets that can be easily converted to cash (securities, Accounts Receivable, inventory)

Fixed Assets

difficult to liquidate (real estate, furniture, equipment)

Other Assets

things difficult to value (IP, trademarks, copyright, reputation)

Types of Liabilities (2)

Current Liabilities

Long-term liabilities

Current Liabilities

due now or within the next 12 months (accrued wages, accrued taxes, accounts payable, interest payments)

Long-Term Liabilities

debt that won't be paid off in the near future (notes/bonds)

Interest payments are a ________ _________, the principal payment is a ___________ ___________

Current Liability, Long Term Liability

(4) Components of Net Worth (shareholder equity):

Preferred Stock

Common Stock

Capital in excess of par

Retained Earnings

Capital in excess of par

money received from the sale of common stock in excess of the par value

Retained earnings

company earnings that haven't been paid out as dividends

(4) balance sheet numbers to remember:

Working Capital

Current Ratio

Acid-Test Ratio

Debt Ratio

Working Capital

the amount of money that a company can spend (lose) and remain operational

Current Ratio =

Current Assets / Current Liabilities.

Measures short term liquidity

Acid-Test Ratio =

(Current Assets - Inventory) / Current Liabilities

Measures short term liquidity

For current ratio and acid test ratio, the higher the ratio, the more...

short-term liquidity the company has

Debt Ratio =

Long Term Debt / (Long Term Debt + Net Worth)

The higher the debt ratio, the...

less long-term liquidity a company has

Income statement is also called a...

P&L (Profit and Loss statement)

Income Statement

summarizes a corporation's revenues and expenses for a fiscal period (one quarter up to a full year)

Income statement compares....

Revenue with costs/expenses

Operating Income

earnings before taxes and interest

(2) income statement calculations that may appear on the exam:

Earnings per share (EPS)

Price-to-earnings (P/E) ratio

Earnings Per Share (EPS)

Earnings / outstanding shares

P/E ratio =

CMV / EPS

Example

The ABC Corporation has earnings of $20 million and has 10 million outstanding shares. It has a CMV of $32.

Calculate EPS.

EPS = earnings / outstanding shares

EPS = $20 million / 10 million

EPS = $2

Calculate P/E ratio.

P/E = CMV / EPS

P/E = 32 / 2

P/E = 16

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Profits that are not distributed to shareholders are called

A)

retained earnings.

B)

capital surplus.

C)

dividends.

D)

interest.

A

Which of the following is not a measure of short-term liquidity?

A)

Acid ratio

B)

Debt ratio

C)

Working capital

D)

Current ratio

B

A corporation's earnings can be found in which of the following reports?

A)

Income statement

B)

Balance sheet

C)

Trade blotter

D)

General ledger

A

ABC common stock is trading at $20 per share. Earnings available to the shareholders is $40 million. ABC has 10 million shares outstanding. What is the company's P/E ratio?

A) 2

B) 5

C) 10

D) 4

B

12.5 - Exchange Rates

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Exchange Rate

the value of one currency against another

A dollar that is strong in comparison to foreign currencies means...

imports will be less expensive

A strong dollar also leads to,,,

low inflation

Balance of trade:

When the value of the dollar is strong, exports tend to decrease and imports tend to increase

When the value of the dollar is weak, exports tend to increase and imports tend to decrease

Balance of payments:

Surplus - more money flowing into the US than out

Deficit - more money flowing out of the US than in

Why might a deficit occur when the interest rates in another country are high?

money flows to where it earns the highest return

What does Credit represent on a Balance of Payments sheet?

Money flowing in (exports, foreign investment)

What does Debits represent on a Balance of Payments sheet?

Money flowing out (imports, US investment in foreign countries)

What effect will a strengthening dollar have on the price of a U.S. export?

A)

The price will first decrease, then rise dramatically.

B)

The price will increase in the foreign market.

C)

The price is unaffected by this.

D)

The price will decrease in the foreign market.

B

All of the following situations could cause a fall in the value of the U.S. dollar in relation to the Japanese yen except

A)

U.S. investors buying Japanese securities.

B)

an increase in Japan's trade surplus over that of the United States.

C)

a general decrease in U.S. interest rates.

D)

Japanese investors buying U.S. Treasury securities.

D

12.6 - Fiscal Policy and Monetary Policy

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Fiscal Policy

the government's budget decisions and tax policy enacted by the president and congress

Monetary Policy

managed by the FED

_______ policy moves slowly and takes time to implement, __________ policy moves can be made quickly

Fiscal, Monetary

Keynesian Theory summarized

active government is vital to the health of an economy

Keynesian theory promoted "Demand-Side theory", which means

demand for goods controls employment and prices

(Keynesian) to increase activity, government should....

Lower taxes, raise spending

(Keynesian) to decrease activity, government should...

Raise taxes, lower spending

Supply-Side Theory summarized

market forces should determine prices

Supply-Side theory believes that government should always....

lower taxes, lower spending

Which act established the Federal Reserve (FRB)?

Federal Reserve Act of 1913

What does the FRB manage?

Money Supply - cash available within the US economy

Increasing the money supply...

expands the economy and creates jobs, but can lead to inflation

The (3) measures of money supply the FRB uses

M1

M2

M3

M1

readily available money to spend (cash in demand deposit accounts

M2

M1 + Consumer Savings Deposits (money easily moved to demand deposit accounts)

M3

M2 + large time deposits (money that is less accessible)