Different Facets of the Macro Economy - Essay Example

Different facets of the Macro Economy Question one Which one of the following are essential elements of models in which noise traders’ important effects on equilibrium assets prices despite the presence of rational arbitrageurs? a) Limits to arbitrage Y b) Investment sentiments Y c) Perfectly elastic curves N d) Inflation illusion Y e) Excessive risk aversion Y Discussion From behavioral economics, there exist three vital effects of noise traders on assets equilibrium prices. To start with, noise creates a situation of risk by the noise trader. There was a development of model of trader risk that insinuated that decisions on investments are done with reference to market noise, and these decisions are not rational and hence unpredictable from the simple fact that they are affected by the sentiments of an investor. This makes the idiot traders a threat in markets of finance. Secondly, noise existence provides opportunists with information that enables them to exploit and take advantage of the situation in the market. These opportunists may engage in strategies of stealth trading where these investors extend their trade with time. Lastly, the irrationality by the noisy traders may lead to movement of assets’ prices from their basic values hence making the market to destabilize. Contrary to that, investors who are rational would act in a manner opposing a noisy trader hence stabilizes the market equilibrium. There is a prediction that institutional investors fail in encountering activities that are irrational by the noisy traders. The examination of the essential effects of the noisy traders on ADR market is as explained. ADR return falls or increases if the investors are not rationally pessimistic or optimistic. In the period of low noise, ADRs that are owned by high institutions exhibit autocorrelation that is same to ADRs being owned by low institutions. Nevertheless, in periods of high noise, ADRs that are owned by high institutions exhibit autocorrelation that is higher compared to the ones owned by low institutions. This creates an implication that there must have been an engagement in stealth trading by investors for exploitation of an irrational market. Via a regression of Granger causality, there is evidence of ADR portfolio returns with high institutions ownership which confirms that these traders make a reflection of the market information which is in the long run converted to securities. Finally, investors of an institution aid in the reduction of ADR returns of Europe. Though, for other continents ADRs, the stabilizing magnitude of positions of arbitrage that is taken by investors of an institution is not significant (De Long et al. 1990) Question two Consider a model with both noisy traders and rational arbitragers. Suppose there are no limits of arbitrage. Then arise in investment sentiments among the noisy traders: a) Shifts the asset demand curve of the noisy traders N b) May lead to increased short sales Y c) Has no effect on the equilibrium asset price N d) Affects the distribution of assets holding between the two groups of investors Y e) Affect the total gross supply of the assets in the market Y Discussion In case of existence of the noisy trader and an arbitrager in a market, given that there are no limits of arbitrage and a situation of arising of sentiments, a) there would not be shifts in the demand curve of the noisy traders. The explanation for this is straightforward because given an irrational trader who takes risk which give rise to investment sentiment; the prices of assets are mainly affected. In economics, the price of commodities affects demand in that the increase or decrease in prices leads to a movement of the curve and not a shift. Therefore, the statement of demand shifting is wrong as the main factor influencing demand of asset in this case is the price. b) The action may lead to increased short sales in that, in any case the noisy trader tries to sell the assets at prices that are lower than the market’s with the presence of arbitragers, the arbitragers may take advantage and make huge purchases within a short time. Therefore, the changes in prices without a rational consideration lead to c) destabilization of the equilibrium. This is because irrational increase or decrease of prices of assets leads to abnormal changes in demand. That is an acute fall in price leads to arbitragers making huge purchases. This, in turn, leads to acute d) shortages in supply of assets. From the shortages, there will be high demand, and in order to make the situation stable, the trader is forced to increase price due to low quantity of supply. In so doing, the initial equilibrium point is disturbed as it moves up as the quantity is reducing as the price is increased. e) Distribution of asset holding is affected in that one of the two parties takes any slightest opportunity to acquire the assets. Therefore, at no any moment are they in a position to have assets evenly distributed between them. The action also affects the total gross supply as one of the parties is bound to hold more of the assets. Question three Which of the following are characteristics of the 1970’s? a) High risk prima Y b) High real interest rates Y c) A flight to quality N d) Low dividend/price ratio Y e) Low stock prices Y Discussion In the 1970’s the whole world experienced very hard times in the respective economies. The economies went into recession. This in led to inflation which has varied effects on the economy. First of all is evidence of a) high risk premium. This is the payment for hazards on investments. This is because during this, time there was high risk in investing and, therefore; an investor had to pay for a compensation fee in case of any loss. Because of the high risks that were involved in investing, there were high interest rates on investments in order to attract more individuals. b) High real interest rates played a role of attracting investors because by then the economy was very unstable and, therefore, most individual had no interest in investments. There was c) no flight to quality as by that time economies were struggling to stabilize their state. d) Dividend ratio is the ratio of dividend against net income. During the 1970s, the net income of the households was high compared to the dividend ratio. This is because the net income was opted for savings compared to investments making the dividends be low. Hence the dividend ratio was low as it is arrived by dividend/net income. Similarly, price ratio was also low as earnings per share were more than the current shares. Lastly, there were e) low stock prices as investments general were low. Question four In a standard efficient markets model, which of the following are-all else equal-conducive to volatile stock prices? a) Rapid arrival of contradictory pieces of information about future dividend tax rates Y b) Low real interest rates Y c) Low risk aversions N d) High inflation Y Discussion Volatile stock prices are the quick fall and rise of prices while the upward trend is maintained. a) Rapid arrival of contradictory pieces of information about future dividend tax may rapidly affect the financial prices. In any case there is a possibility of dividend tax increasing in the future, the investors are likely to offload their shares, and this leads to a quick fall of the price of shares due to the low demand of shares. Likewise, if there is a possibility of dividend tax decreasing in the future, the investors are likely to increase their demand for investing. The action hence leads to the rapid rise in prices due to the high demand. b) Low interest rates may result from rapid drop in prices that lead to increased demand for investment. Due to the increased demand, interest rates are lowered to discourage the number of investment. c) Low risks aversion is difficult as there is quick fall and rise in prices. Lastly, d) high inflation is similar to volatile stock prices as it is the rapid increase in prices. The effects caused by the volatile stock price increase apply to the effects caused by high inflation. For instance, high inflation makes the household to increase the demand for investment hence the lowering of interest rates. Inflation also makes an economy to go back to recession where the currency of the economy loses its strength against other currencies. Question five Which if any of the following New Deal policies probably did not lead to an increase in total weekly hours of work? a) Devaluation of dollar against gold N b) The NIRA Y c) Overall rise in the budget deficit N d) Public works project N e) Social security Y Discussion a) Devaluation of dollar against gold led to addition of weekly hours. The addition of working hours came by the need of addition of quality to gold. There had to be an increase in production of gold of high quality without incurring unnecessary costs. This was accomplished by working with available labor but increasing the weekly working hours. b) NIRA needed additional hours in a week as it was designated to recover the economy’s state in the shortest time possible. The c) overall rise in the budget deficit needed no addition of weekly hours. Budget deficit occurs when the difference between the exports and imports is negative. It means that the imports are more than the exports making an economy to be in deficit. This is always as a result of working for fewer hours in an economy. The more time committed to work the more the volume of production. Therefore, the rise in the budget deficit is due to a reduction in the level of production. d) Public works project led to increase in the number of working hours as the project was within a given period of time that had to be met. The project was concerned with the general upgrade of the entire public facilities. e) Social security did not lead to additional weekly of hours as it was not an urgent objective by the state. In it was to be a long time initiative that needed no urgency and hence it needed no additional hours in a week. Question six Which of the following are relevant to understanding why the gold standard was probably an important part of explanation of the great depression? a) The gold ratios in many countries Y b) It helped to transmit the depression from the united states to the rest of the world N c) Deflationary pressure Y d) Interest rates to ward off speculative attacks on countries gold stock N e) It inhibits domestic monetary policy Y Discussion In the explanation of the great depression, one has to consider the factors that cause the depression which is like a period of recession. a) The gold ratios are roofed hence more individuals tend to invest in the gold due to high interest rates. This leads to the concentration of money on the speculative need to be more than what is spent on the transaction and precautionary needs. Therefore, depression is experience as the economy is not operating fully. The c) deflationary pressure also leads to depression in that a gap is created due to low prices from low demand hence depression. Depression e) inhibits domestic monetary policies in that it affects the money in circulation. The central bank is forced to purchase the stock that is highly valued using large amounts of the economies money. Question seven Which of the following arguments would be good debating points for those who would argue that the gold standards was actually not an important part of the explanation for depression in the united states in particular? a) The US had large enough gold reserves to defend against external drain N b) Because of capital controls there was really not a fully pledged gold standard in the first place Y c) The real bill doctrines would have led to a contractory monetary policy stance even if there had been no gold standard Y d) Gresham’s law would have operated in a highly contractory way whether or not there was a gold standard Y e) The devastating bank failures experienced in the united states were due to “internal drain” that was not obviously linked to the issues of “external drain” Y Discussion a) The US had large enough gold reserves to defend against external drain is not the best for debates as if there could be large reserve they could not go into a depression as they could have traded them. b) Because of capital controls there was really not a fully pledged gold standard in the first place as Americans imposed taxes on imports which led to poor trade in the economy. c) The real bill doctrines would have led to a contractory monetary policy stance even if there had been no gold standard because the bill did not support the quantity theory of which there could be a possibility of less money supply with rise in price levels. d) Gresham’s law would have operated in a highly contractory way whether or not there was a gold standard because the law insinuates that bad money exchanges with the country’s money value hence there is low circulation of a countries currency. e) The devastating bank failures experienced in the United States were due to “internal drain” that was not obviously linked to the issues of “external drain. This is true because people lost their savings as by then banks were not insured. Question eight Which of the following might help account for a high rent/price ratio in the market for apartment buildings? a) Current rents are higher than rents are expected to be in the long run N b) A rapid rate of construction at present is likely to lead to a fall in the prices over the next several years Y c) Owing an apartment building is a risky proposition because of armed gangs roaming the streets Y d) The fed is expected to keep the real interest rate high for a long time to come Y e) Landlords are very risk averse Y Discussion a) Current rents are higher than rents are expected to be in the long run is not true. This is because the high ratio reflects low rent prices compared to buying a building. b) A rapid rate of construction at present is likely to lead to a decline in the prices over the next several years and therefore the rent/price ration is high. This is a speculative perspective of the rents. The landlords speculate that rents in the future will be high as there will be high supply compared to the demand for the apartments. c) Owing an apartment building is a risky proposition because of armed gangs roaming the streets is a reason for the high ratio as the price of rent will be less compared to owning one as it is accompanied by various costs. d) The fed is expected to keep the real interest rate high for a long time to account for a high rent/price ratio in the market for apartment buildings in that there are established rates that increase with time as apartments are appreciating assets likewise to the rates on them. Therefore, the increase in rent ratios is due to the increase in the rates. Lastly, e) landlords are exposed to some risks. For instance, the risk of fire burning down the apartment forces a landlord to insure the apartment. This cost is then passed to rent and hence it increases the rent ratio. Question nine Empirical evidence suggests that high dividend/price ratio in the stock market is likely to indicate that: a) Dividend growth is likely to be low for the foreseeable future Y b) The equity premium is high Y c) Stock prices will tend to rise relatively rapidly over the next decade Y d) Overall inflation is higher than average Y e) There is “negative bubble” in the stock market Y Discussion a) Dividend growth is likely to be low for the foreseeable future because the high dividend ratio shows few investments made. This shows that the organization might be flopping and with continued trend, the growth of dividend might be low. b) The equity premium is high if the dividend/price ratio is also high. The high ratio suggests that there are increased investments at high interest rates. If there is high increased rates of interest in investments the dividends will be consequently high hence the high ratio. If there is increased dividend/price ratio the equity also increases making it to be high. The rise in the number of investments implies that in speculations of the future. The speculation mostly revolves around c) increase in the prices of stock rapidly in the near future. If d) inflation at any point in the economy is higher than average it insinuates that the lot of investments have been done as individuals hold more than their relative income. e) There is “negative bubble” in the stock market can a sign of high dividend ratio because due to the negative pressure that may prevail in the economy, there may be few earnings per share in relation to a large amount of dividends per share. Question ten Large high frequency movements in the stock market, accompanied by high trading volume are likely to be due to: a) Purely technical considerations, like computer driven portfolio N b) Major news about fundamentals Y c) Turnover associated with major disagreements across market participants Y d) Dramatic newspaper stories N e) Ongoing efforts to the process conflicting evidence about fundamentals N Discussion A high movement in the stock market with high trading volume is due to various inclusive of major news made on the basics of a firm. Purely technical considerations, like computer driven portfolio cannot cause any movement as trading is all about the value in the market and not the technicality. b) The major news made plays a bigger role as it creates awareness of the shares in the market hence giving potential investor the option of choosing on where to invest. The news shows the value of shares and their stability in the stock market. c) Turnover associated with major disagreements across market participants also plays a major role in movement of investors and the high volumes of trade. Turnover creates the value of stock and shows the worth and growth of that specific company. d) Dramatic news cannot affect the stock market as shares cannot be speculated as they are evident in the stock market. No individual can invest or trade on the basis of rumors. e) Ongoing efforts to the process conflicting evidence about fundamentals do not cause any movements as the investors are not sure of whether to invest or not. \ Works Cited De Long, J Bradford, et al. "Positive Feedback Investment Strategies and Destabilizing Rational Speculation." Journal of Finance, American Finance Association (1990): 379-395. Read More