40 Questions
What are business cycles?
Cycles of economic growth and recession that occur repeatedly
How does inflation affect investment approach?
It erodes the purchasing power of money, impacting investment decisions
What is the logic for sector rotation investing around business cycles?
To invest in sectors that perform well in different phases of the business cycle
How can the S&P500 be viewed in terms of firm value?
As an aggregation of 500 firms’ discounted cash flows
Which investment offers a real rate of return that accounts for inflation?
Treasury inflation protected securities (TIPs)
Which investment is likely to see a relative decrease in mortgage payment size over time in the presence of inflation?
Taking out a mortgage with a fixed payment
Which type of investment tends to rise with inflation due to lease agreements that are updated to account for inflation?
Real estate
Which type of investment offers protection from the effects of inflation but doesn’t offer a lot of upside return?
Treasury inflation protected securities (TIPs)
Which type of investment is broadly considered to do better over times of high inflation than returns on other types of investments?
Real assets
Which investment is less sensitive to inflation due to the demand for some items persisting across all years?
Resource equities
What does the Fisher Equation help investors calculate?
Nominal interest rate
If investors are to earn a 3% real interest rate, what nominal interest rate must they earn if the inflation rate is 4%?
8%
If the inflation rate is 0%, what nominal interest rate must investors earn to achieve a 3% real interest rate?
3%
If an investment offers a 2% return per year and the inflation is 3% per year, how much will be needed in year 5 to pay for a $10,000 vacation?
$11,590
What is the 1982-1984 CPI index level set to?
100
How is inflation measured?
Using simple year-to-year differences in the CPI
Which characteristic is associated with higher beta firms?
Smaller size and higher leverage
During which phase of the business cycle are bankruptcies expected to occur?
Trough years
What tends to happen to interest rates when the economy is hot?
Rise
Which industries are sensitive to contractions and expansions?
Cyclical industries
What do leading indicators tend to do in advance of the economy?
Rise and fall
What do betas provide insight into?
How a firm's returns change across the business cycle
Which industry classification system is mentioned in the text?
Fama-French 48
Where can information on economic indicators and business cycles be found?
newyorkfed.org
What do lower beta firms tend to be?
Larger and more established
What are business cycles correlated with?
Investor expectations and other economic indicators
What marks the transition points across business cycles?
Peaks and troughs
What do higher beta firms tend to sell?
Selling discretionary items
What does the shape of the yield curve provide valuable information about?
Inflation expectations and the state of the economy
What does an inverted yield curve indicate?
An impending economic recession
What does the Consumer Price Index (CPI) measure?
Change in the purchasing power of dollars for goods and services
What does the core CPI index exclude?
Volatile items such as food and energy
What does the relation between the % change in money supply and % change in CPI (inflation) indicate?
It is noisy due to factors related to demand and supply changes
What is the potential consequence of significant growth in the US M2 money supply?
Inflation of prices for goods
What does the Fisher equation relate to?
Inflation and interest rates
What are the LEI and CEI levels used as?
Recent economic indicators
What does the 10-year treasury rate minus the 1-year treasury rate plot illustrate when the shaded region dips below 0?
An inverted yield curve
What does the Federal Reserve aim to do by 'raising rates'?
Reduce inflation
What does nominal interest rates include the effect of?
Inflation
What does the US M2 money supply growth potentially represent?
Additional funds 'chasing the same goods'
Study Notes
Understanding Inflation, Interest Rates, and Economic Indicators
- The Conference Board website displays plots showing the % change in the index level on the vertical axis.
- The Leading Economic Index (LEI) and Coincident Economic Index (CEI) levels are recent indicators.
- The shape of the yield curve provides valuable information about the economy.
- The plot depicting the 10-year treasury rate minus the 1-year treasury rate illustrates an inverted yield curve when the shaded region dips below 0.
- Inflation is the sustained increase in the general level of prices for goods and services, leading to a reduction in the purchasing power of a currency.
- The Consumer Price Index (CPI) measures the change in the purchasing power of dollars and includes all items used in US cities, with the 1982-1984 CPI index level set to 100.
- Recessions are indicated by vertical shaded regions in the CPI level chart from 1971 to 2022.
- Nominal interest rates include the effect of inflation, and the Federal Reserve "raises rates" at times to reduce inflation.
- The core CPI index measures the average price that urban consumers pay every month for the same basket of consumer goods, excluding volatile items such as food and energy.
- The relation between the % change in money supply and % change in CPI (inflation) is noisy due to factors related to demand and supply changes.
- The US M2 money supply grew significantly in 2020-2021, potentially resulting in inflation of prices for goods if the new money represents additional funds "chasing the same goods."
- The Fisher equation is used to calculate nominal or real rates, relating to inflation and interest rates, with examples provided for better understanding.
Test your knowledge of inflation, interest rates, and economic indicators with this informative quiz. Explore the relationship between the yield curve and the economy, the impact of inflation on purchasing power, and the role of indicators such as the Consumer Price Index and the Leading Economic Index. Gain insights into the influence of money supply on inflation and the use of the Fisher equation to calculate nominal and real interest rates.
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