Economics Chapter 20: Global Activity Analysis

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Questions and Answers

What approach do money managers often use to evaluate potential investments?

Bottom-up analysis

Market-driven analysis

Sector-specific analysis

Top-down analysis (correct)

Which measure is considered an important indicator of economic health?

Net Domestic Product (NDP)

Human Development Index (HDI)

Consumer Price Index (CPI)

Gross Domestic Product (GDP) (correct)

What does nominal GDP reflect?

Value based on international comparisons

Value of output adjusted for inflation

Dollar value of output in current year terms (correct)

Constant price value of output over time

Which factor is NOT considered in a bottoms-up analysis?

Economic cycles Signup and view all the answers

What is the primary goal of understanding global economic activity and industry analysis?

To anticipate economic movements Signup and view all the answers

What does real GDP measure that nominal GDP does not?

Economic activity adjusted for inflation Signup and view all the answers

What does top-down analysis start with?

A big picture view of the global economy Signup and view all the answers

How can monetary and fiscal policies impact economic activity?

They can influence investment decisions and economic growth. Signup and view all the answers

What does Real GDP represent?

Nominal GDP adjusted for inflation Signup and view all the answers

Why is Real GDP preferred for measuring economic growth?

It accounts for inflation, giving a more accurate picture of growth Signup and view all the answers

If a country's nominal GDP increases by 9.3% but experiences an inflation rate of 7.1%, what is the real growth rate?

2.2% Signup and view all the answers

What correlation value demonstrates the relationship between GDP and equity market valuations?

0.97 Signup and view all the answers

What are the four stages of the business cycle?

Peak, Contraction, Trough, Expansion Signup and view all the answers

Which sectors are typically more sensitive to changes in the business cycle?

Cyclical sectors Signup and view all the answers

What is a characteristic of defensive sectors regarding the business cycle?

They perform relatively stable regardless of the economic climate Signup and view all the answers

In the context of investment decisions, why should investors consider GDP growth?

It provides a better measure for making long-term investment decisions Signup and view all the answers

What characterizes defensive sectors in an economic context?

They perform relatively better in a climate of weak growth. Signup and view all the answers

Which type of economic indicator is primarily used for predicting future economic conditions?

Leading indicators Signup and view all the answers

What is a notable characteristic of the stock market as an economic indicator?

It usually looks ahead approximately six months. Signup and view all the answers

What factors must be considered when analyzing global investments related to exchange rates?

The appreciation or depreciation of the currency. Signup and view all the answers

If the exchange rate at the beginning of the year is $1.29/€ and increases to $1.18/€ by year-end, what does this indicate for the Euro?

The Euro has depreciated against the dollar. Signup and view all the answers

What would best describe a lagging economic indicator?

It reflects changes in economic activity after they occur. Signup and view all the answers

Which of the following is NOT typically classified as a coincident economic indicator?

Stock prices Signup and view all the answers

When investing in foreign markets, what should an investor be mindful of regarding currency?

Currency fluctuations can affect overall returns. Signup and view all the answers

What does the depreciation of the euro mean for U.S. investors?

The net return will be less than expected. Signup and view all the answers

How much did a U.S. investor convert $10,000 into euros at the beginning of the year?

7,751.94€ Signup and view all the answers

What was the ending value of the investment after a 10 percent increase?

8,527.13€ Signup and view all the answers

What was the dollar-denominated return on the investment?

1.62 percent Signup and view all the answers

What percentage of the labor force was unemployed in early 2019 in the U.S.?

3.9 percent Signup and view all the answers

How is the labor force participation rate calculated?

Labor force divided by the nonmilitary population. Signup and view all the answers

Which of the following groups is included in the labor force definition?

Employed and unemployed but seeking employment. Signup and view all the answers

What is the purpose of the Consumer Price Index (CPI)?

To gauge inflation over time. Signup and view all the answers

What does an increase in the CPI indicate in terms of inflation?

There is a percentage change in prices Signup and view all the answers

Which of the following components are typically included in the CPI basket?

Transportation and medical care Signup and view all the answers

How does high inflation typically affect Real GDP growth?

It reduces economic growth Signup and view all the answers

What is Core CPI?

A measure that excludes food and energy prices Signup and view all the answers

According to the Wall Street rule of thumb, what should the market price-to-earnings (P/E) ratio be when inflation is 6 percent?

About 14 Signup and view all the answers

What relationship exists between money supply growth and stock prices?

A positive correlation Signup and view all the answers

What happens when the economy is given too much money according to responsible monetary policy?

Inflation rises Signup and view all the answers

What is the formula for calculating the inflation rate based on CPI values?

$rac{CPI_{new} - CPI_{old}}{CPI_{old}}$ Signup and view all the answers

What is included in the M1 measure of money supply?

Currency and checking deposits Signup and view all the answers

Which of the following is a primary tool used by the Federal Reserve to achieve its goals?

Changing interest rates Signup and view all the answers

What happens to the money supply when the Federal Reserve buys Treasury bonds?

It increases as money is injected into the system Signup and view all the answers

How does the federal funds rate relate to the discount rate?

The federal funds rate generally changes with the discount rate Signup and view all the answers

What does the fractional reserve banking system require banks to do?

Keep only a fraction of deposits on reserve Signup and view all the answers

What impact does reducing the discount rate have on the demand for loans?

It stimulates demand for loans Signup and view all the answers

Which of the following is NOT a goal of the Federal Reserve?

Ensure high interest rates Signup and view all the answers

Why does adding money to the financial system have a rippling effect?

It allows banks to loan more money based on reserves Signup and view all the answers

Study Notes

Chapter 20: Global Economic Activity and Industry Analysis

This chapter analyzes global economic activity and industry analysis, aiming to answer general questions about economic activity.
A quote from President Herbert Hoover is included: "Blessed are the young, for they will inherit the national debt."
Learning objectives include understanding top-down analysis, measuring economic activity (globally and domestically), the relation of monetary and fiscal policies to economic activity, and industry sensitivity to business cycles.
The goal of the chapter is to predict economic movements to guide investment decisions.

Top-Down Analysis

Some money managers use a "bottom-up" approach to select securities, which does not consider economic cycles or industry-specific information.
A more common approach is "top-down" analysis.
Money managers use a "big picture" perspective of the global economy and filter/sort potential investments into smaller groups.
The process resembles a funnel, starting with all potential investments and narrowing down to the best possible investments through economic, industry, and company analyses.

Key steps in Global Economic Analysis:

Filter 1: Global Economic Analysis (business cycles, monetary and fiscal policy, economic indicators)
Filter 2: Industry Analysis (industry structure, competition, government regulation, business cycle exposure)
Filter 3: Company Analysis (earnings, cash flow, financial ratios).

Global Macroeconomic Activity

Gross Domestic Product (GDP) is a key measure of economic health.
GDP is the market value of goods and services produced over a specific time period.
It is an indicator of a country's standard of living.
Nominal GDP is the dollar value of output in a current year. Real GDP is nominal GDP adjusted for inflation, allowing for comparisons across time.
Analysts care about real GDP because it reflects economic growth adjusted for inflation.
Real GDP growth rates are useful for investors in deciding which countries to invest in.
GDP and market values are strongly correlated. Countries with higher GDP generally have higher equity market valuations.

Business Cycles

A nation's GDP levels fluctuate, going through periods of ups and downs. This is called the business cycle.
Cyclical industries(industrial and tech) have above-average sensitivity to business cycles, performing best during strong growth.
Defensive industries (health care and consumer staples) show below-average sensitivity to business cycles and perform relatively better during weak growth.
The four stages of the business cycle are peak, contraction, trough, and expansion.

Economic Indicators

Investors need to identify economic indicators to help forecast future economic conditions.
Leading economic indicators are used by many economists.
Other indicators include lagging indicators and coincident indicators that measure economic activity.
Stock prices (S&P 500) are a well-known leading economic indicator but reflect the market conditions six months ahead.

Exchange Rates

Exchange rates affect the returns on global investments.
The depreciation of a currency can reduce the net return for investors.
Currency appreciation is a key factor in deciding which currencies to invest in.

Labor Market Indicators

Economists categorize the nonmilitary working-age population into employed, unemployed (seeking employment), and unemployed (not seeking employment).
The labor force includes all nonmilitary working-age people who are employed or unemployed (but seeking employment).
The unemployment rate is the percentage of the labor force that is unemployed but seeking employment.

The Consumer Price Index (CPI)

The CPI measures inflation (percentage change in the prices of a basket of goods and services).
Parts, like housing, transportation, food, and beverages, are included in the CPI basket, alongside other minor categories like medical care or apparel.
Core CPI excludes food and energy prices.
High inflation leads to higher interest rates, reducing demand for loans and dampening overall economic growth as a result.
There is a noticeable inverse relationship between inflation and Real GDP.

Monetary Policy

The money supply is considered the "gas" for an economy, and the goal of monetary policy is to keep the economy from overheating or cooling too quickly.
Money supply growth, measured by M1, M2 etc., is positively correlated with stock prices.
The Fed has the power to "pump" money into the financial system through open market operations. This is done through bonds.

Fiscal Policy

Federal tax rates and spending levels are components of fiscal policy.
Fiscal policy significantly impacts the overall economy.
Governments use fiscal policy to stimulate investment, for example, using measures like tax deductions. Sustained budget deficits can be detrimental to long-run economic prosperity and should be considered by investors.
National debt is a critical factor for investors considering country investment allocations.
Fiscal considerations include the level of Federal tax rates and spending.

Industry Analysis

Economic information is useful for analyzing specific industries.
Industry analysis involves evaluating sectors and firms within industries, and evaluating their potential growth or decline.
Methods to analyze industries include understanding industry life cycles and using Porter's Five Forces to assess competitive intensity.
Industry life cycles are characterized by start-up, consolidation, maturity, and decline stages.
Porter's Five Forces are: Threat of new entrants, bargaining power of buyers, bargaining power of suppliers, threat of substitute products, intensity of rivalry.

Useful Internet Sites

Useful websites for relevant data are provided.

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Description

This quiz explores Chapter 20, focusing on global economic activity and industry analysis. It covers concepts such as top-down analysis, economic measurement, and the impact of monetary and fiscal policies on business cycles. Understanding these elements aims to enhance investment decision-making.