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Macro Picture and Monetary Policy 1. Economic Cycle Stage Consumption Monetary Fiscal Inventory Inflation / Stagflation Equities Interest Rates Exports Policy Policy Recovery Recovery in co...

Macro Picture and Monetary Policy 1. Economic Cycle Stage Consumption Monetary Fiscal Inventory Inflation / Stagflation Equities Interest Rates Exports Policy Policy Recovery Recovery in cons & indus Expansive Expansive Recovery for Recovery low Pick up confidence / no / low future inflation taxes consumption 1xt Increase in consumption Expansive Expansive Stabilize Rallying low Pick up expansion and investments / no / low inflation taxes Full Peak in consumption and R / higher Restrictive High speed Inflation fears/ rally Start to Tightening / expansion industrial prod interest / higher stock building commodities & high peak bear market in rates taxes for high level of wages bonds sales Slowdown A slowdown in R / higher Restrictive Relax stock Stagflation = higher Start to High short consumption and interest / higher building unemployment ahead fall interest rates / industrial prod / cons & rates taxes because of low / positive inflation Decreasing long indus confidence are sales interest rates decreasing Recession Negative growth in Expansive Expansive Low levels No growth, no price Selling Low / bull consumption and / low / low pressures / no fear of off market in industrial prod / Negative interest taxes inflation bonds corporate profits / Cons & rates ahead indus confidence are faling 2. Relationship between GDP and CPI: deflation and stagflation GDP and CPI: Interlinked, as GDP growth influences price levels (CPI), and inflation impacts purchasing power, which can affect GDP. How GDP and CPI Are Related: a. Economic Growth and Inflation: a. When GDP grows, demand for goods and services often increases, which can lead to higher prices (inflation). b. Moderate inflation (captured by CPI) is normal during economic growth as wages and spending rise. b. Excessive Inflation (Overheating): a. Rapid GDP growth can lead to high inflation (demand-pull inflation). c. Recession and Deflation: a. During a recession (GDP declines), CPI may decrease due to lower demand, leading to deflation. Deflation vs. Stagflation: Deflation is falling prices with economic decline, while stagflation is high inflation paired with stagnant growth and unemployment. 3. Economic indicators: leading, lagging and coincident. Which are the most useful? Leading Indicators usually change before the economy as a whole changes. Are most valuable for forecasting and making proactive decisions. Index of consumer sentiment, Index of business sentiment: ISM (US), IFO (Germany), Tankan (Japan) Coincident Indicators are essential for understanding the current state of the economy. Labor cost, CPI, Unemployment rate Lagging Indicators usually change after the economy as a whole do. Are less useful for prediction but critical for trend confirmation and post-analysis.  GDP, Personal Income, Industrial Production, Retail Sales For strategic decision-making and proactive planning, leading indicators are the most useful as they provide insights into what may happen. However, a combination of all three types is necessary for comprehensive economic analysis. 4. Relationship between economic indicators and GDP growth: direct or indirect? Relationship Between GDP Growth and Economic Indicators Economic Indicator Relationship to GDP Growth Correlation Direct (Higher employment boosts GDP through Positive Employment greater productivity and spending) Direct (Rising income increases consumption, driving Positive Personal Income GDP growth) Direct (Higher profits lead to increased business Positive Corporate Profits investment, supporting GDP growth) Purchasing Managers Index Direct (Higher PMI indicates stronger manufacturing, Positive (PMI) boosting GDP) Direct (Higher orders signal future production, Positive Durable Goods Orders contributing to GDP growth) Industrial Production and Direct (Increased production directly contributes to Positive Capacity Utilization GDP growth) Direct (Consumer spending is a major component of Positive Consumer Spending GDP) Direct (Confidence increases spending and Positive Consumer Confidence investment, driving GDP growth) Indirect (Trade balance affects net exports, a Mixed (depends on International Trade Balance surplus/deficit) component of GDP) Indirect (Current account impacts capital flows and Mixed (depends on Current Account Balance surplus/deficit) GDP indirectly) Indirect (Inflation affects purchasing power and Mixed (low inflation is Consumer Price Index (CPI) positive) spending, influencing GDP indirectly) Indirect (Rising producer prices may reduce GDP Mixed Producer Price Index (PPI) through cost pressures) Indirect (Growth in money supply can stimulate GDP Positive (if moderate) Monetary Aggregates but risks inflation) Understanding whether an indicator’s relationship with GDP is direct or indirect helps analysts and policymakers anticipate economic changes and craft strategies accordingly. 5. Country risk analysis: definition a. Political Stability – Risks arising from changes in government, policy instability, or political events. To determine how long the current regime will be in power and whether that regime also will be willing and able to enforce its foreign investment guarantees. Greater political stability means safer investment environment. Examples: Changes in tax policy, nationalization of industries, civil unrest, war, freq of change in govt.  b. Economic Factors – to determine whether the economy is in good shape or requires a quick fix, such as expropriation to increase government revenues. Better country´s economic outlook, less likely to face political and social turmoil that will inevitably harm foreign companies. Examples: GDP, Inflation, Balance of Payments, Currency Volatility, c. Subjective Factors - general perception of the country´s attitude toward private enterprise. Examples: Free Trade index, Profit Opportunity Recommendation (POR), S&P’s rating, Moody’s rating 6. Credit rating agencies. Difference between “investment grade” and “noninvestment-grade or speculative”? Credit rating agencies such as Standard & Poor’s (S&P), Moody’s, and Fitch Ratings evaluate the creditworthiness of borrowers, including governments and corporations. They assign ratings that indicate the likelihood of default on their debt obligations. Understanding these distinctions helps investors and financial institutions manage risk and return effectively. Investment Grade bonds are considered safe and are preferred for long-term, stable investment portfolios. Examples: Bonds issued by stable governments (e.g., Germany) or large, financially solid corporations. Non-Investment Grade bonds carry higher risks and appeal to those seeking higher returns despite the risk of default. Examples: Bonds issued by financially distressed companies or economically unstable governments. Key Differences Aspect Investment Grade Non-Investment Grade (Speculative) Risk Low to moderate High Default Likelihood Low High Yield Lower Higher Borrowing Costs Lower Higher Investor Type Conservative (e.g., pensions, insurers) Risk-tolerant (e.g., hedge funds) Examples of S&P: BBB- and above, Moody’s: Baa3 and S&P: BB+ and below, Moody’s: Ba1 and Ratings above below 8. Roles of a central bank The Eurosystem, which comprises the European Central Bank and the national central banks of the Member States whose currency is the euro, is the monetary authority of the euro area. They use monetary policy instruments to control money supply, inflation, and economic activity. a. “Print” money (banknotes and coins). b. Develop and implement monetary policy. c. Management of currency exchange operations. d. Management of official reserves (foreign currencies and gold). e. Monitor of payments system and credit institutions (banks). f. Prepare statistics (Eurostat).  9. ECB: main objective (CPI below, but close to 2%). The objective of the Eurosystem is to maintain price stability: safeguarding the value of the euro. This is based in: Quantitative definition of price stability: annual growth rate of the Harmonized Index of Consumer Prices (HICP) below ("but close") to 2%. Controlling the growth of a broad monetary aggregate M3: annual growth rate of between 3% and 5% (average 4.5%). 10. Monetary aggregates: definition (M3). M3 provides the most comprehensive view of the money supply, encompassing everything from cash on hand to large financial investments. Liquidity: Less liquid than M1 and M2, as it includes assets not easily converted into cash quickly. Purpose: Tracks the total money available in an economy, including institutional-level financial instruments. Economic Significance: Monitored by central banks to gauge economic health. Used to predict inflation, liquidity levels, and long-term financial trends. 11. Monetary policy instruments: open market operations and minimum reserve requirement. Aspect Open Market Operations Minimum Reserve Requirement Primary Action Buying/selling government securities Setting a reserve percentage for banks Effect on Money Supply Adjusts liquidity through securities trading Directly impacts banks' lending capacity Flexibility Highly flexible, used frequently Less flexible, used sparingly Impact Speed Immediate effect on short-term interest rates Slower impact, structural adjustment Open Market Operations is the buying and selling of government securities (e.g., bonds) in the open market by the central bank to regulate liquidity in the economy. Regular cash injection in the interbank system. Weekly regular auctions. Minimum Reserve Requirements is the amount that banks are obliged to deposit in ECB (between 0 and 2% of the reserves according to the balance sheet). These instruments are central to managing economic stability and achieving monetary policy objectives. 12. Injection and extraction of liquidity versus economic stage. Central banks manage liquidity in the economy through monetary policy instruments such as open market operations. Liquidity Injection Definition: Central banks increase money supply by purchasing government securities, lowering interest rates, or relaxing monetary policy. Economic Stages Where Injection is Used: 1. Recession: o Objective: Stimulate economic activity by making borrowing cheaper and boosting spending. o Actions: ▪ Lower interest rates to encourage borrowing and investment.  ▪ Inject liquidity into the financial system to ensure banks have sufficient reserves. o Outcome: Promotes consumer spending, business investment, and recovery. 2. Early Recovery: o Objective: Support fragile economic growth. o Actions: ▪ Continued liquidity injection to sustain momentum. ▪ Maintain low interest rates to reinforce borrowing and consumption. o Outcome: Encourages job creation and industrial production. Liquidity Extraction Definition: Central banks reduce money supply by selling government securities, raising interest rates, or tightening monetary policy. Economic Stages Where Extraction is Used: 1. Full Expansion: o Objective: Prevent overheating of the economy and control inflation. o Actions: ▪ Raise interest rates to moderate excessive demand. ▪ Sell securities to absorb excess liquidity from the banking system. o Outcome: Reduces the risk of asset bubbles and ensures sustainable growth. 2. Slowdown (Late Expansion): o Objective: Transition to a stable growth trajectory by curbing inflationary pressures. o Actions: ▪ Gradual liquidity extraction to balance growth and inflation. ▪ Fine-tuning monetary policy based on inflation trends and output gaps. o Outcome: Stabilizes prices but may slow growth slightly. Summary Table Economic Outcome Action Objective Stage Liquidity Stimulate demand, boost growth, Recovery through increased Recession spending and investment Injection prevent deflation Early Liquidity Support fragile growth and ensure Sustained recovery and Recovery Injection adequate liquidity employment growth Full Liquidity Prevent overheating and control Stabilized prices, sustainable Expansion Extraction inflation economic growth Liquidity Manage inflation and stabilize the Balanced growth trajectory, Slowdown inflation under control Extraction economy Key Considerations Economic Indicators: Decisions to inject or extract liquidity depend on leading indicators (e.g., inflation rates, employment, GDP growth) and lagging indicators (e.g., unemployment rates). Risk Management: o Over-Injecting Liquidity: Can lead to inflation, asset bubbles, and financial instability. o Over-Extracting Liquidity: May cause economic stagnation or recession if growth slows excessively. Conclusion Central banks adjust liquidity based on the economic stage to balance growth, inflation, and financial stability. Injecting liquidity is crucial during recessions and early recovery phases, while extracting liquidity is essential during full expansion to prevent overheating. The timing and scale of these actions are critical for maintaining economic equilibrium. Fundamental Analysis 1. Differences between top-down and bottom-up analysis. Top-down (… from macro to micro) - This is a three-stage approach, involving analysis of the stock market, the industry sector and companies within the industry sector. - Economy, market and industry effects account for a significant proportion of individual stock returns. - is more strategic for aligning with economic trends - Suitable for portfolio allocation based on economic cycles (e.g., shifting into defensive sectors during slowdowns). - Useful for global or regional investment strategies. Bottom-up (… from micro to macro) - This is the stock picking approach, where individual stocks are identified. - It is possible identify undervalued stocks that will outperform regardless of the market or industry outlook. - offers a deeper focus on specific companies - Ideal for individual stock picking or active management strategies. - Best for identifying hidden gems regardless of broader economic conditions. Aspect Top-Down Analysis Bottom-Up Analysis Starting Micro-level (individual companies) Macro-level (economy-wide) Point Scope Broad (economy → sector → company) Narrow (company → sector → economy) Focus Economic trends, sectors, industries Company fundamentals, intrinsic value Economic indicators, sector Financial ratios, company reports Key Tools performance Find undervalued or high-growth Goal Identify sectors that will perform well companies Overlooks strong companies in weak Overlooks sector-level or macro trends Risk sectors 2. Differences between value and growth style of investment. Blended style. VALUE STYLE – Warren Buffet o Investing in stocks that are considered undervalued relative to their intrinsic worth. Look for “bargains” or stocks trading below their historical valuation or industry peers. o Metrics Used: ▪ Low Price-to-Earnings (P/E) ratio. ▪ Low Price-to-Book (P/B) ratio. ▪ High Dividend Yield. ▪ High Earnings Yield (EYG). o Examples: ▪ Stocks in sectors like financials or utilities. ▪ Companies with strong fundamentals but underappreciated by the market. GROWTH STYLE – George Soros  o Investing in companies with strong potential for above-average earnings or revenue growth, regardless of current valuation. Focus on companies with high future growth potential, even if they are expensive by traditional valuation metrics. o Metrics Used: ▪ High Revenue Growth Rate. ▪ High Price-to-Earnings (P/E) ratio. ▪ High Price-to-Sales (P/S) ratio. o Examples: ▪ Tech and biotech companies. ▪ Startups and disruptive firms with innovative products or services. BLENDED STYLE o A mix of value and growth investing strategies to create a more balanced portfolio. Combines the stability and income potential of value stocks with the high-return potential of growth stocks. o Focuses on companies with reasonable growth potential at a fair valuation. o Uses a mix of metrics from both styles. o Aims to balance risk and reward. Key Differences Between Value and Growth Styles Aspect Value Style Growth Style Focus Undervalued stocks High growth potential Valuation Metrics Low P/E, P/B, High Dividend Yield High P/E, P/S, High Revenue Growth Risk Profile Lower risk, slower returns Higher risk, potentially higher returns Economic Outperforms in slow growth or Outperforms in periods of economic Conditions recession growth Examples Financials, utilities Technology, biotech Fundamental Ratios Economic Fundamental Ratios Preferred Price-to-Earnings (P/E) Low (Price/( Net profit/ Tot Num shares)) (Price*Num Shares)/Cash Flow) Price-to-Cash Flow (PCF) Low market cap (price*no of shares)/ total cash flow price/cash flow per share PBV=Price/ BVPS Price-to-Book Value (PBV) Low PBV=(Price*Num Shares)/Total BV Book Value per share = Shareholders´fund / Number of shares Book Value Per share x issued Total Div/(price*num of shares) Dividend Yield (DY) High Total Div/(Price*no. of dividends) DPS/Price Return on Equity (ROE) High Net profit / Shareholders´ fund Economic Fundamental Ratios Preferred Return on Assets (ROA) High EBIT/ Total Assets Earnings Yield Gap (EYG) High 1 / PER – Bond Yield Depends (High if growth-focused, Low Retention Ratio if dividend-focused) DPS/EPS Payout X tot div / tot profit Dividends Per Share (DPS) X DPS = payout*EPS Lower P/E between the two Relative P/E = P/E Company / P/E Sector Relative P/E companies Equity Valuation 1. Balance sheet: Assets: non-current and current. Resources owned by a business or individual that have economic value and can provide future benefits. Liabilities: non-current and current. Obligations or debts that a business or individual owes to others, typically settled through payment or services. Equities: The residual interest in the assets of a business after deducting liabilities, representing ownership value. 2. P&L account The Profit and Loss account is a financial statement summarizing a company's revenues, costs, and expenses over a specific period to show its net profit or loss. 3. Definitions: EBITDA, EBIT, EBT, EAT. EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization; measures a company's profitability by focusing on core operations, excluding non-cash expenses and financing costs. EBIT: Earnings Before Interest and Taxes; represents operating profit by subtracting operating expenses from revenue, excluding the impact of interest and taxes. EBT: Earnings Before Taxes; indicates a company's profitability after deducting operating expenses and interest but before accounting for taxes. EAT: Earnings After Taxes; reflects the net income of a company after all expenses, including taxes, have been deducted. 4. Market capitalization method. What is Free-Float? Market Capitalization Method: A method of valuing a company by multiplying its current share price by the total number of outstanding shares. Free-Float: The portion of a company's shares that are publicly traded and available for purchase by investors, excluding shares held by insiders or major shareholders.  5. Beta: interpretation for a single stock Beta (Single Stock): Measures a stock's volatility relative to the overall market, with a beta of 1 indicating movement in line with the market, above 1 signaling greater volatility, and below 1 showing less volatility. Foreign Exchange Market 1. Characteristics of FOREX market. - Currencies are traded by pairs. - The value of a currency is determined by its comparison to another currency; exchange rate indicates the price of one against another. - international three-letter code (ISO 4217), so a pair is composed by six-letter code. - There is no centrally cleared market: currencies are trade over-the-counter (OTC). - Due to London’s dominance in the market, a particular currency’s quoted price is usually the London market price. Quotes are published by vendors (Reuters, Bloomberg, etc.). - 24 hours trading (except weekends – from 20:15 GMT Sunday until 22:00 GMT Friday). - No commissions (institutional market): transaction costs are included in the final price for the client. - Currencies are traded in fixed sizes (lots) 2. Market conventions: base and foreign currency ISO code. The first currency (XXX) is the base currency; the second currency (YYY) is the counter currency. 3. Market transactions: spot and forward. Spot Market - Spot transactions are two-day delivery transactions, as opposed to the forward trades, which are above two days. Forward Market – > 2 days delivery transaction (days, months, years), Forward price: Spot price + interest rates spread 4. Bid/ask (which side of the market when buying or selling). Bid: Bank buys base currency / (sells counter currency). Ask (offer): Bank sells base currency / (buys counter currency).