Lesson 10: Economics and Monetary Policy

yield curve

graphs interest rates against time until maturity, uses Treasury securities with different maturities

normal yield curve

• longer treasuries have a higher yield than short term treasuries

• most common yield curve

inverted yield curve

• short term treasuries have a higher yield than longer-term treasuries

• signals recession

flat yield curve

• short and longer term treasury yields are very close to each other

• signals economic transition

classical economics

• laissez-fair economics: no gov interference with the market

• founded by Adam Smith

Keynesian theory

• fiscal policy

• is gov tools to affect the economy → gov spending and taxation

Monetarist theory (Federal Reserve)

• use the money supply to affect the economy

• Easing: lower the discount rate, buy gov bonds, lower the bank reserve requirement → add cash to economy to spur growth

• Tighten: raise the discount rate, sell gov bonds, raise the bank reserve requirement → remove cash from the economy to curb inflation

Federal funds rate

• rate that banks charge each other for overnight loans

• lowest interest rate

Discount rate

• rate that the Fed charges banks for short-term loans

• second lowest rate

Broker call rate

• rate that a broker-dealer pays a bank to borrow money to facilitate margin loans

• second highest rate

Prime rate

• rate that banks charge their most creditworthy institutional customers

• highest rate

current assets

cash and other assets that expected to be cash within one year of the date of the balance sheet

current liability

an obligation (payment) that is due within one year of the date of the balance sheet

working capital

calculated from the balance sheet: current assets - current liabilities

exchange rate

how much one currency is worth in terms of another

purchasing power parity

helps determine exchange rate by comparing how much it would cost to buy the same basket of goods in different currencies

Who wants a strong US dollar?

• US importers

• foreign exporters

• have revenue in US dollars

Who wants a weak US dollar?

• US exporters

• foreign importers

• have revenue in foreign currencies

elasticity

the sensitivity of supply and demand of a commodity to a change of price

recession

a decline in GDP for two or more consecutive quarters

depression

at least six consecutive quarters of negative GDP growth or a decline of at least 10% in GDP

stagflation

• a period of slow economic growth accompanied by rising prices

• increased inflation combined with high unemployment

velocity of money

• rate of turnover of money or how fast it is being spent

• usually measured as a ratio comparing GDP to money supply → when money velocity is low, people are investing and saving instead of spending

Impact of inflation

• as inflation increases, interest rates also rise causing bond prices to decrease

• in a deflationary environment, interest rates fall and outstanding bonds are more attractive than new issues (lower coupons)

earnings per share (EPS)

• a company’s net income / shares outstanding

• stock splits impact EPS → a reverse stock split would increase a company’s EPS

P/E ratio

company’s stock price / earnings per share

moving average

• used to help track a stock’s price over a period of time by updating the average price continually

• the shorter the timeframe being measured, the more sensitive to price changes

trade surplus vs deficit

trade surplus: exports are greater than imports → country’s currency will appreciate

trade deficit: imports are greater than exports → country devalues its currency, importing its good becomes more attractive

Producer Price Index (PPI)

measures inflation for producers of products, such as manufacturers

cost-push inflation

• the result of higher production costs and rising prices of raw materials

• the supply of goods and services decreases because of increased production costs