I&A

Chapter 1- Intro and Investment concepts

⁃ Efficient market -> fully, quickly, rationally and accurately incorporates all information into prices
⁃ If informationally efficient -> prices react only to new undercounted news surprises, harvest risk
premium is the compensation for volatility due to new information, here passive investments are better as price =
IV, active managers underperform after fees
⁃ If inefficient - trading on IV vs Price can lead to sustained profit, active investment could beat
benchmark e.g. private markets, EMEQ, small caps
⁃ Inefficient markets becoming more efficient over time due to technological advancement, regulatory
requirements and scaling up of professional investing industry
⁃ What makes a market more efficient?
⁃ Structure
⁃ Better information dissemination i.e. higher analyst coverage
⁃ Fair and equal access to information -> insider trading laws (Chinese walls)
⁃ More trading activity relative by information flow, helped by low trading costs
⁃ Participants
⁃ Better investors -> lower retail share, fewer behavioural biases, more rational
⁃ More investors, ideally of different types -> long, short term and institutional
⁃ More active investors, smaller share of passive ownership e.g. index mutual funds, ETFs
⁃ Fewer investment mandate restrictions e.g. on small caps
⁃ The more efficient a market is, the better the allocation of limited resources to higher value added
projects, and the smaller the scope for consistent excess returns from active management net of fees

Chapter 2: Investment concepts

⁃ Diversification is a free lunch -> if assets are not fully correlated, they can be combined to a profile
whose risk is less than the weighted average risk of assets themselves
⁃ A portfolio offers weighted returns of individual securities, but at less than the weighted volatility.
Desirable as people are typically risk averse to volatility
⁃ Steps to derive optimal portfolio;
⁃ How much of each asset for a desired target return? Efficient portfolio of risky assets = min volatility for
desired target return
⁃ How much of each asset, with no particular target return in mind? Find efficient frontier of risky
portfolios, find optimal risky portfolio with highest Sharpe ratio
⁃ How much of asst at optimal combination i.e. how much cash/leverage?
⁃ Risk aversion - everyone is typically averse to volatility, and needs to be compensated by additional
expected returns for taking on more risk. Risk neutral - only highest possible returns matter. Indifference curves in
north west, as usually higher utility and are preferred
⁃ How to construct optimal portfolio;
⁃ Construct efficient frontier of risky portfolios from efficient asset weights by minimising variance subject
to target returns
⁃ Combine risk free and efficient risky to find the efficient frontier
⁃ Steepest CAL = CAL tangential to efficient frontier -> optimal risky portfolio
⁃ Allow lending and borrowing & superimpose utility curves on CAL
⁃ Investors hold different portfolios instead of just one because they have different expectations, and
identical utility functions
⁃ Shortcomings of mean variance optimisation;
⁃ Inputs are all historical
⁃ Efficient weights are very sensitive to changes in the inputs
⁃ No consideration of loss aversion
⁃ Assumes that returns are normally distributed, however this is not always true as they tend to be
skewed to the left for equities
⁃ Diversification does not work during periods of market stress - during this period all sectors go down
together
⁃ Ray Dalio - picking 1000 stocks does not provide much more diversification that picking just 5 - there is
a limit

Chapter 3 - Equity Investing

⁃ Assets = Liabilities + Equity

⁃ Debt as an amplifier of fcality of profitability - RoE = Net Income/Equity
⁃ Debt disadvantages vs equity;
⁃ Requires pre-scheduled, future interest and principal payments
⁃ Creditors can force al liquidation if scheduled payments are missed i.e. more debt = greater
opportunity cost of not making optimal decisions;
⁃ Inability to negotiate long-term supply contracts
⁃ Loss of customers due to lack of confidence in warranties
⁃ Sale of productive asset or inventory to generate cash
⁃ Advantages debt vs equity;
⁃ Interest payments are tax deductible
⁃ Creditors have superior claim on asserts and income over equity in the case of liquidation -> less risk
to investors -> lower required return than equity = cheaper to issue
⁃ Cost of equity -> shareholders expect a return in exchange for their investment = cost to firm, if not
achieved then the equity funding would dry up
⁃ Holding period returns - what the stock has actually delivered - share price return = change in price/no
of shares = (change in sales * change in earnings/sales * change in price/earnings) / change in number of
shares. Total return will further add dividends and change in FX
⁃ CAPM model = E(R) = Rf + beta*(E(Rm)-Rf)
⁃ Beta ism the stocks regressions against the market i.e. stock returns vs market returns
⁃ Estimate equity risk premium - looking at backwards returns, less risk-free rate
⁃ Can also use the French fama 3 factor model - that accounts for returns on small stocks vs big stocks
and returns to value stocks minus return to growth stocks
⁃ IV - one’s own estimate of the true price of the stock however has not reached there due to problems
with market structure and behavioural issues e.g. over reaction. However, one picks these using models and
inputs to come up with own thesis, then account for a margin of error.
⁃ Catalyst -> usually needed to unlock value and convergence to IV
⁃ Dividend discount model - finds the present value of future dividends of a business assuming that
business is a going concern . Good for mature stocks. However, tricky to have a view on dividend stream and
payout ratio so far out. PV = D1/r-g
⁃ Equity indices - price of the market, underlying for ETFs, proxies, etc. Can be of different types i.e.
equal weighted, market cap weighted, fundamentally weighted, price weighted
⁃ Justified PE - p/r-g whereby p is the payout ratio. Investors prefer higher payout ratio, stronger growth,
lower cost of capital, lower interest rates
⁃ Porter’s 5 forces -> help assess the growth prospects of an industry. They include; threat of entry,
threat of substitutes, power of buyers, power of suppliers, all leading to rivalry amongst existing competitors e.g.
disruption of the disrupters whereby the big giants are disrupted frequently

Chapter 4 - Equity Investing

⁃ Asset quality matters for ability to generate earnings, and cover liabilities in case of liquidation
⁃ GAAP vs Pro-forma excludes expenses and incomes that are one off - non recurring
⁃ Signs of poor earnings quality -> poor accounting disclosures, frequent management or director
turnover, pressure to meet earnings targets, incentive compensation tied to stock price, previous issues, debt
covenant pressures
⁃ Active portfolio management -> markets are inefficient, hence can be beaten, Measure performance
against benchmark which your manager will o/w or u/w from the benchmark
⁃ Drawbacks of market-cap weighted indices -> expensive securities have higher weight, heavily
indebted have greater weight e.g. Italy
⁃ Sharpe vs Information ratio - Sharpe -> absolute returns vs a benchmark. IR -> relative returns vs
benchmark. R(A) - is the active return/value add and it’s standard deviation is the tracking error. Best manager
will maximise IR, put money where IR is max
⁃ What does IR depend upon? Manager forecasting skill, manager portfolio structuring skill, breadth/
how many investing decisions they make, aggressiveness - tracking error
⁃ How to evaluate manager ->
⁃ hit ratio - ratio between number of winning trades vs all s. Insight on skill in forecasting. No insight on
forecasting by how much will go up, and matching with smaller/larger bets
⁃ Win/Loss ratio - average size of P&L of winning vs losing positions. Insight on sizing in positions, no
insight on how many correct/wrong
⁃ Portfolio concentration - better stock picking skills -> more concentration -> higher tracking error
⁃ Active share - number of bets that a manager deviates from benchmark in number and size of bets,
unreasonable to pay high fees to a benchmark hugger
⁃ Turnover - share of average stock holding per year traded/ turned over per year
⁃ Headline risk
⁃ Risk premia need to be taken out to alpha so returns are not influenced by systemic factors -> true
apple which is based on regressing realised returns of a manager on systemic factors.
⁃ True alpha -> picking idiosyncratically outperforming/underperforming stocks, factor timing not just
permanent exposure, raising cash to borrowing (beta timing), timing exposure to sectors, regions, etc
⁃ Style replicators - value (cyclical), growth(late cycle) , momentum(trending) , low vol, quality(defensive)
⁃ Discretionary bottom up-> buy/sell stocks, emphasise firm-specific characteristics, PMs know a lot
about firms firms, conduct management meetings, more qualitative management assessments, typically
concentrate and lower turnover
⁃ Systematic bottom-up -> quant models, PMs know little about many firms, typically high turnover,
research on exploring and developing factors
⁃ Discretionary top-down -> macro process, pay attention to business cycle, buy/sell baskets of stocks,
typically concentrated

Chapter 5 - Derivatives

⁃ Futures -> obligation for a buyer of future to buy an underlying asset from a seller at a specific later
date and a specific price. Traded on exchange,. Parties provide intial and maiintaince margin, settled for cash or
physical commodities. Not traded directly as no markets. Key features: underlying, expiry, price, multiplier,
number of contracts. Multiplier is contract size. If underlying moves by 1 point, how much loss or gain
⁃ Short-end rates futures -> allows view on whether rates will be higher or lower than what’s currently
priced either at expiry or earlier
⁃ Options -> butter pays seller and receives right not obligation to either buy or sell underlying asset at a
certain fixed price either on a specific expiration date or any time before expiration. Against a rally long call
option, against a sell-off long put option. Better than trading underlying as can express sophisticated P&L profiles
⁃ Premium of options based on -> price of underlying, level of volatility, time to expiration, out-of-
moneyness, level of interest rates - calls delta the point of time at which a stick may be bought -> before call
maturity, the money can be invested, hence higher rates, would lead to greater value of call. Puts delay point of
time before underlying is sold -> higher rates, lower value of put
⁃ Put call parity - s0 + p0 = co + X/(1+r)^T
⁃ Risk reversals -> risk reversal - buy upside call, sell downside put, get upside protection by taking
downside risk. Bearish RR -> buy downside put, sell upside call. Key to consider skew here i.e. the price of puts
vs calls on the same thing, sometimes can be wide
⁃ Call and put spread -> how to show a view and save some money. Call spread -> buy upside call, sell
even further out call. Put spread -> buy downside put, sell even further downside put
⁃ VIX - average implied volatilise (expected standard deviation of returns of underlying asset) implied/
backed out of market prices of options on the S&P 500 across a range of maturities and strikes assuming US
treasury bill rates
⁃ Move index - index of implied vols backed out of 1 month options on 2,5,10, 30 year bonds
⁃ Implied vol surface - analysis of options pricing, based on term structure and moneyness skew

Chapter 6 - Bonds

⁃ Bonds - oblige borrower to pay specified amounts of money at specific dates. Features -> issuer,
maturity, par value, coupon rate & coupon frequency, currency, default provisions e.g. seniority, covenants,
collateral.
⁃ Price - PV of future cash-flows, however trade on YTM (assumes held till maturity, no default, re-
investment of coupon at same yield. Yield determined by risk free rate, expected inflation risk, credit risk,
technicals.
⁃ Nominal government bonds yield -> changes discounted inflation expectation, real rate
⁃ Duration -> interest rate sensitivity of a bond price, roughly number of years to hold bond until half of
discounted cash-flow is received. Convexity -> sensitivity to duration to changes in yield. For smaller yields
changes in yield have a bigger price impact due to curvature
⁃ High duration -> longer maturity, smaller coupons, smaller YTM
⁃ Forward rates-> spot rates and holding them at different maturities
⁃ Slope of yield curve -> pure-expectations (forwards), liquidity-preference (prefer shorter over longer as
less risky hence compensation on shorter smaller, upwards sloping yield curve). Segmented markets & preferred
habitat (prefer only certain maturities, technicals of demand and supply determine yields)
⁃ Low term premium -> treasury purchases by FED, Great moderation i.e. decline in realised and
expected inflation volatility and China large USD reserve holdings (Greenspan conundrum)
⁃ Great moderation -> shift in US GDP from volatile goods to more stable, contributed to decline in
volatility of inflation and growth, as supply of digital can expand more quickly and internet provides greater
transparency over prices hence less uncertainty, flatter yield curve
⁃ Curve inversion - imply expectation of falling short-end rates due to central bank easing in light of
falling growth and inflation -> pure expectations theory
⁃ Corporate spread widens in economic growth concerns rise -> higher corporate bond yield -> lower
price. Changes typically negatively correlated with equities

Chapter 7 - Behavioural Finance

⁃ Investors should behave in a rational way. Rational investors are self-interested utility maximisers,
have diminishing marginal utility of consumption i.e. homo economics/ rational economic man. Assumes that
humans make no mental shortcuts, have no emotions and no cognitive errors. Leads to markets being efficient
and all investors holding the mean-variance efficient portfolio
⁃ Risk aversion - determines location of optimal portfolio on capital allocation line
⁃ Barnewall two-way model - describes risk aversion of investors. Passive investors have made their
wealth without great risk leading to them being more risk averse. Active investors become rich by risking their
own wealth -> less risk averse
⁃ Sources of alpha
⁃ Market inefficiency - markets are informationally inefficient due to inefficient market structure, bounded
rationality, behavioural biases exist due to behavioural and psychological biases
⁃ Superior investment process - allows control of our own behavioural biases, fundamental law of active
management - productivity depends on quality of skills, and frequency in which they are applied
⁃ Bounded rationality - relaxes assumption that all relevant info is sought and completely processed,
people have intellectual and computational limits -> investors seek to make satisfactory decisions, not optimal
that satisfice
⁃ Behavioural finance - actual investment decisions decisions deviate from optional due to behavioural
biases. Can find anomalies however, only in SR -> alpha opportunity
⁃ Cognitive errors - faulty processing of info - systematic overestimation of Low probability events e.g.
lottery
⁃ Emotional biases - impulses and intuitions
⁃ Nudges - can be designed to overcome biases
⁃ Behavioural biases
⁃ Status quo bias/ anchoring - staying in default investments, even though risk tolerance and market
changes -> lack of effort to change -> nudge: auto-pilot pension plans that reduces high volatility assets as plan
holders age -> opposite: excessive trading activity -> e.g. continued buying of equities after QE ends
⁃ Loss aversion - investors psychologically dislike losses more than comparable gains -> leads to
insufficient risk-taking, overreaction to bad news -> developed through evolution as losses can be more harmful
than gains are beneficial e.g. no food
⁃ Herding - buy and sell with others despite superior personal info -> resulting in serial correlation, can
lead to over-reaction - bubbles.
⁃ Overconfidence - insufficient processing of information due to excessive optimism -> investors do not
diversify enough, hold huge idiosyncratic risk. Also shown by corporate managements in speeches, etc however
can be picked out by natural language processing
 ⁃ Confirmation bias - investors seek out affirmative information and ignore contradictory information
⁃ Availability bias - people use heuristics/ mental shortcuts to make decisions using the most readily
availability info and using mental shortcuts to get to solution
⁃ Home bias - allocation mostly to domestic securities i.e not diversifying and excessive reliance on
familiar features
⁃ Framing bias - investors decisions depends upon how a problem is presented to them i.e. context
provides information
⁃ Representativeness bias - excessively simplify reduction of investment problem e.g. market melt-up in
1998/99, escape windows in mid-2000 or taking 1 valuation indicator as representative for true valuation
⁃ Illusion of Knowledge - collection of excessive but only marginally relevant information
⁃ Mental accounting - compartmentalism investment decisions ignoring total portfolio optimal it’s i.e.
instead of mean variance optimisation consider different trances of investment
⁃ Self-attribution bias - excessive belief in investment skills
⁃ Short termism - professional asset manager often focused on short term to maximise their returns, and
uncertainty for the investor. This can create opportunity for time -horizon arbitrage by long term investors e.g.
bottom fishing when market is fearful
⁃ Market anomalies/ inefficiencies - persistent market patterns due to behavioural biases that leads to
exceptions in market efficiency. These include: Misprinting vs Instrisic Value, Over/Under reaction to new
information, Bubbles, Trends/Momentum i.e. autocorrelation in returns, Holiday effects - lower liquidity means
over-reaction takes longer to be arbitraged away, Value effect - cheaper value stocks outperform growth stocks
as people are overconfident in projecting excessively high growth, Size effect - small caps outperform due to
mandate constraints
⁃ Financial bubble has the following components;
⁃ High valuation
⁃ Price Action - returns are serially correlated, especially at the top, volatility increases
⁃ Psychology/Greed - great sentiment regarding new technology, justifying high prices and projections
e.g. oversubscribed IPOs at top of cycle Uber 2019. Greater fool theory - mass irrationality, insufficient
diversification and overconfidence
⁃ Leverage & Liquidity - minks leverage cycle;
⁃ Hedge finance - cashflows cover principal + interest
⁃ Speculative finance - cashflows cover only interest
⁃ Ponzi Finance - cashflows cover neither interest nor principal, but hope of asset appreciation to allow
for debt re-service
⁃ Moral Hazard - excessive risk taking, due to expectation of safety net for losses e.g. central bank
⁃ Rational participation in a bullish
⁃ - eer risk but greater fool theory still in place. Would also take part if fundamental belief in above-moral
growth e.g. due to innovations/ increase liquidity
⁃ Group investment decision biases - normally should lead to less bias, but can increase ones bias if
people conform to others, and if people respect seniority and don’t contradict. Can be fixed through diversity,
respect + scepticism, feedback, safe to speak, effective chairperson, etc
⁃ Bailard, Biehl and Kaiser Five-way model - 2 dimensions of investor psychology i.e. risk aversion +
analytical rigour
⁃ 3 front office investment professionals; Analyst - cares about depth of analysis/ finding the truth, Trader
- cares about SR market technicals, PM - enjoys taking risk
⁃ Nudges to counter behavioural biases; Greater sophistication, discipline & systematic approach,
Awareness of biases - e.g. trader knows his flaw, Seeking out counterarguments - avoid confirmation bias,
Feedback on analysis and decisions - incentives for success, assign directly responsible person, analyse
portfolio through paper portfolio, and do “post-mortem” after decision, Precise and recorded forecasts &
investment conclusions - assign probabilities to outcomes

Chapter 8 - FX

⁃ Structure of FX market; Participants - exporters, importers, investors, speculators, MNCs,

governments, banks. MNCs - weaker domestic FX leads to stronger equities due to translation gains and higher
export competitiveness, however higher external debt funding costs and expensive imports. Quoting conventions
- USDJPY - how many JPY for 1 USD. GBPUSD: cable, EURGBP: sterling, AUDUSD: Aussie, NZDUSD: kiwi
⁃ Buy side forex - real money accounts, leverage accounts, retail accounts, government, central banks,
sovereign wealth funds. Sell side forex - dealing banks, other financial institutions. Bid/Ask spreads - money that
the bankers make, by charing a little higher when they sell, and buying at a little lower than spot. Cross-rates -
rates using triangular arbitrage, to find spot rates for currency pairs that are otherwise not traded
⁃ Forward rates - buying or selling in the future - does not reflect anyone’s views, just the interest rates
through a no arbitrage condition
⁃ Interest rate parity - if you are getting a higher interest rate in a country, FX is bound to depreciate,
while low yielding FX will appreciate -> no free lunch. Forms relationship between spot and forward under no-
arbitrage condition considering the interest rates in both countries. Carry trade - Interest Rate Parity does not
hold in SR
⁃ Drivers of FX; Demand/Supply - FDI, speculation, and portfolio flow, To accommodate changes in
inflation - rising inflation in the SR would lead to appreciation as tighter monetary policy and higher rates however
in LR would lead to weaker FX due to loss of competitiveness - loss of relative PPP, Funding problems -> FX
crisis -> during current account deficits, they need to be funded through borrowing
⁃ QE/QT and USD - at the end of QE in 2014, there was expectation of FED to increase rates to curb
inflation -> Stronger USD
⁃ Abeeconomics and JPY -> expectations of increase in asset purchases due to weak growth and
inflation led to weaker JPY from 2012-2015
⁃ Fx valuation -> relative PPP -> nominal exchange rates will just in the medium term to offset inflation
differentials in a frictionless manner through, open trade and capital flows. However, this can take 3-5 years, and
arbitrage is blocked by non-identical goods and trade barriers, tariffs, etc
⁃ Absolute PPP -> prices of goods and services should be same as in domestic currency -> doesn’t
hold.
⁃ Real exchange rate stabilises in LR around it’s average due to change in nominal FX and relative
inflation as people take advantage of arbitrage cross-border e.g. buy from bangkok sell in singapore
⁃ Real FX is a tool to apply PPP -> it is the nominal FX adjusted by relative CPI or Unit labour costs ->
shows relative competitiveness. E.g. If UK CPI > US CPI then GBP appreciates, and loses competitiveness in
real terms, and will eventually depreciate to erase competitiveness lost. Real exchange rate appreciates due to
higher inflation or nominal exchange rate appreciation. In 1980s - Japan REER appreciated 50% due to
appreciation of nominal interest rate
⁃ Balassa-Samuelson effect - emerging markets can sustain appreciating REER as long as it is justified
by stronger growth in productivity which will lead to higher wages, inflation and hence higher REER

Chapter 9 - FX continued

⁃ Balance of payments;
⁃ Current account - trade balance, net investment income, net remittances, net government transfers.
Defecit can be funded by FDI, foreigners, portfolio inflows and the central bank selling FX reserves. Capital
account - net FDI, net portfolio inflows
⁃ J-curve effect - when there is depiction of currency, trade balances initially worsens, as imports get
more expensive, then import volumes fall and exports rise, leads to rise in GDP and current account balance
improving
⁃ Marshall-Lerner theory - effectiveness of devaluation on trade depends on price of elasticity of imports
and exports. Highly elastic - high changes
⁃ Fx management by government - objectives - smooth volatility in market, keep FX artificially a bit
cheaper to allow for more exports or a bit more expensive to defend unwarranted outflows
⁃ Often governments buy USD, sell local FX -> unsterlized to expand monetary base of economy,
sterilised to issue government bonds to mop up liquidity
⁃ Governments sell USD, buy local FX to support local FX -> often to avoid current crisis, keep exports
competitive, sometimes last effort to avoid de-pegging and devaluation
⁃ China in 2000s -> kept FX artificially cheaper, closed capital account to allow for independent
monetary policy
⁃ Impossible trinity - central banks have 2 choose 2 of 3 -> free capital flows, independent monetary
policy (not pegged) and fixed exchange rate. Under free-market anyone would prefer independent monetary
policy to offset domestic shocks or reign in inflation, and free capital flow to attract flow of free capital, however
then have to let FX float
⁃ Floating FX is good; Exports remain competitive in LR, even if domestic inflation or wages are high,
Can help offset domestic negative growth shock, Allows independent monetary policy and capital mobility
 ⁃ Floating FX is bad; Uncertainty in corporate planning, Depreciation can trigger domestic inflation,
Weaker FX makes corporate debt service more expensive -> more defaults possible, Transmits trading partner
economic fluctuations into domestic economy ,Import of credible monetary regime, leads to less inflation
⁃ If pegging currency, then must mirror monetary policy of country pegging with e.g currencies peg to
USD in 2014/2015, excessive appreciation led to pain for emerging market USD credit, as their local currencies
depreciated
⁃ Types of FX regimes; No seperate legal tender - fixed - use another currency in your country , Shared
currency - fixed - monetary union e.g. EU , Currency board system - fixed - use other country currency in reserve,
maintaining a fixed parity , Active & passive crawling pegs - peg - adjust exchange rate against single currency
with adjustments for inflation , Managed float - float - allow exchange rate to float, but intervene to targets ,
Independently floating rates - float - market determined exchange rate
⁃ Currency crisis - foreign investors suddenly unwilling to find country current account deficit. Signs are;
Fixed Fx - preventing gradual depreciation , Overvalued Fx on PPP imports > exports , Domestic credit boom -
rise in imports for consumption , Deterioration in terms of trade -> commodity price swing. Terms of trade = export
prices/import prices, Fast Capital account liberation -> large short term inflows vs FDI -> leads to reversal of
portfolio inflows , Global rise in rise aversion , Prior to crisis - central bank tries to prop up exchange rate with
sales of FX reserves
⁃ Pakistan Fx crisis - early 2018 - stronger oil price, weak current account, large hot money inflows,
weak global equity markets led to rise in global risk aversion -> no longer fund deficits of current account
⁃ Not all pegged back though - Vietnam is good due to strong current account -> central bank manages
against USD and CNY using crawling peg, weakening every year, with slightly higher inflation to maintain
competitiveness -> Balassa-samuelson to move to higher value-add products for which export prices are less
price sensitive
⁃ EU forex crisis -> loss of relative competitiveness due too fast-rising unit labour cots in south -> FX
devaluation not a tool as EU. To restore competitiveness; Grow wages slower than competitors , Capital invested
in disadvatanged regions , Fiscal transfers , Labour has to move away from uncompetitive regions
⁃ Technical analysis - trends and patterns repeat themselves, hence exploitable e.g. momentum and
mean reversion.

Chapter 10 - Macro

⁃ Long term growth determined by -> capital deepening, labour force growth, productivity growth
⁃ Short-term growth -> business cycle, output gap, monetary and fiscal policy
⁃ Equities -> GDP growth -> sales growth -> EPS growth -> increasing returns. SR GDP surprises that
were not discounted will move the markets
⁃ Bonds trend growth should be long-end interest rates. Shorter end rates -> Rising growth -> margin
higher inflation -> tighter monetary policy -> rising SR rates -> rising LR rates
⁃ Long term GDP growth not equal to EPS growth;
⁃ China EPS growth < GDP growth; Dilution from capital raising , Declining margins due to rising
wages , Different composition of listed companies -> lots of old economy companies listed
⁃ US EPS growth > GDP growth , On-going share repurchases , Rising margins - low input inflation cost
due to china manufacturing - low wage pressures domestically and falling tariffs, corporate tax cuts, falling
interest rates, increased industry concentration, more branding through intangibles/moats , Composition - new
economy companies high growth e.g. FAANGS, Buybacks contribute to 1-2% EPS growth yearly. In 2018 cash
reparation boosted buybacks. Buybacks can only be outside earnings periods, however brokers can anytime
⁃ To achieve high structural growth, economy needs;
⁃ Capital deepening - through giving workers more machines shows diminishing returns through m1I
would usarginal productivity of capital decreasing. Innovation and technology progress can shift production
function up
⁃ Growth in labour force - raising labour stock through rase immigration, raise birth rate, raise labour
force participation
⁃ Total factor productivity growth - residual of GDP growth that can’t be attributed to labour or capital
stock growth
⁃ Japan productivity bust in 1990s due to limits on technological progress and limits on to capital
deepening as corporates could deploy more capital because over-levered. Can raise productivity by technological
innovation and capital deepening
⁃ Development economics - why some countries prosper ;
 ⁃ Need to accumulate capital - domestic savings - if low, then need to import capital, deficit current
account, bad. However, if importing investment goods then good especially if using FDI. Also accumalate through
strong financial system , strong property rights
⁃ Demographics
⁃ High productivity growth - more capital, more education
⁃ EM markets should: runs trade deficit to import machinery -> grow capital stock -> growth above
steady state -> growth slows as investment declines, trade deficit falls. However, doesn’t work due to un-
rewarded risks e.g. currency crisis, political regime shifts, etc

Chapter 11 - macro contd

⁃ Key barriers to growth;

⁃ Dutch disease - access to natural resources is needed for economic growth, however not necessary to
produce own. Could even slow economic development through failure to develop institutions, violent conflicts,
exports exposed to commodity prices, currency appreciation from exports can lead to uncompetitive in other
global markets (Dutch disease), depletion of natural resources
⁃ Example: Aramaco diversification - diversify economy, develop alternative sources of revenue,
increase non oil-imports, develop private sector and reduce government spending on citizens , NEOM as show
city
⁃ Middle income trap - export driven growth model, focuses on low-value added manufacturing, leading
to increase in domestic wages -> fall in price competitiveness and lack of tech oological edge -> falling growth
rate -> no convergence to developed market
⁃ Solutions to avoid: move to higher value added exports through education, bolster domestic demand
from exports to consumption e.g. China remains cheap for low value manufacturing due to clustering effects can
escape EM through focus on technology, and domestic consumption increase
⁃ Business cycle -> recurrent expansion -> peak -> contraction -> recession -> trough -> expansion
repeating
⁃ Drivers of fluctuations in growth and inflation -> exogenous shock, households consumption,
companies investment and hiring, monetary policy, fiscal policy
⁃ Output gap -> difference between actual vs potential level of GDP. Negative: Unemployment > NAIRU
(non-accelerating inflation rate of unemployment) -> inflation falling -> monetary and fiscal policy should be loose.
Positive: Unemployment rate < NAIRU -> inflation rising -> monetary and fiscal policy should be tight. If equal
then economy is in equilibrium, inflation is stable
⁃ Business cycle theories;
⁃ Behavioural - greed & fear, overconfidence, extrapolation and mis-planning
⁃ Minsky - excessive credit growth and financial speculation grows in stages.
⁃ Stage 1: hedge financing -> asset cash flow = interest + principal
⁃ Stage 2: speculative financing -> asset cash flow = interest
⁃ Stage 3: Ponzi financing -> cash flow < interest i.e. borrowing for asset purchase in expectation of
asset price appreciation. Leads to Minsky moment -> credit crunch. Low risk premia at market peak due to
overconfidence
⁃ Austrian School - misplaced government intervention fiscal and monetary causes boom and bust
cycles e.g. too accommodative and too predictable monetary policy in early 2000s may have lead to house
speculation and caused financial crisis
⁃ Tian - unclear what causes downturns, contractions can feed on themselves and thus require counter-
cyclical policy. Even policy can be ineffective.
⁃ Criticisms; temptation for fiscal spending leads to credit problems later, time lag, insufficient policy may
not be enough
⁃ Recessions ->
⁃ bad -> economics problems e.g. unemployment, falling wages, rising deficits social problems e.g. rise
in suicide divorce, etc
⁃ Good -> creative destruction schumpeterian -> innovation makes existing industries redundant,
recessions flush out unproductive zombie companies. E.g. amazon vs brick and mortar
⁃ Economic indictors -> leading, coincident, lagging e.g. unemployment. Some leading - advertising
spend, demand for wallboards, eating out, durables spending .e.g auto, corporate management sentiment
⁃ Monetary policy objectives -> inflation, full employment, financial stability in that order
⁃ Mechanisms -> setting of base interest rates of which other rates are based, and affecting quantity of
money in circulation
⁃ Types of money: M0 - narrow money, M2,3: broad money - all money including commerical bank
reserves
⁃ Quantitative easing -> central bank purchases government bonds, paying through creation of deposits
of commercial banks, allowing then to lend more against reserves.
⁃ Impact ->
⁃ Primary -> increase in money base M0 increased bank lending
⁃ Secondary impact -> lower bond yields in the US, cheaper borrowing more spending. Wealth effect
due to increased private consumption
⁃ Teritary -> signals EMU breakup unlikely as return to lira -> sharp depreciation in lira -> Italian bonds
denominated in EU -> default likely -> ECB would face large asset impairments
⁃ Why controversial -> Rich got sicker e.g. equities holders , Central bank assumes credit risk ,
Commercial bank lending didn’t increase much , Distortion of finical markets, valuations expensive, difficult to
wind down , Leads to inflation , Didn’t work in Japan in early 2000s, Taper-tantrum - mid 2013, stock market did
not want to stop the tapering hard to stope even if economy is looking good, ben Bernanke had tough job

Chapter 12 - Macro contd

⁃ Fiscal policy
⁃ Objective: full employment, ideally to be used counter-cyclically
⁃ Tools: Spending e.g. infrastructure, welfare etc, works with a time lag. Taxes - works more quickly
⁃ Fiscal multiplier - impact of government spending on demand, as demand changes though economy
as household does not spend all the money they get through transfers, instead save some. M = 1/ (1-c*(1-t))*G, c
is the share of disponsible income spent on consumption. Usually lower in economic expansion highest in
recessions hence counter cyclical fiscal policy is better
⁃ Issues - re-distributional, raises public debt, leads to crowding out due to more debt and higher interest
rates
⁃ Free trade
⁃ Advantages; Provides EM development part via access to export markets , Allows specialisation ,
More efficient resource allocation , Economies of scale , More choice for consumers and producers , Better
products for consumers , Greater competition - lower prices , Greater aggregate wealth
⁃ Disadvantages , Increased global competition for corporates and people , Painful adjustments in low-
value added business in DM -> requires compensation , Rising income inequality in US -> requires redistribution ,
Very strong MNCs vs national government hence could use tax arbitrage -> global legislation , Can lead rot terms
of trade swing massively e.g. commodity boom in Australia where pricing power is very limited, not differentiated,
trade at world prices
⁃ Ricardian model of trade
⁃ absolute advantage -> country is more productive i.e. can produce more of something for same
amount of labour
⁃ Comparative advantage -> country has lower opportunity costs in terms of labor inputs for production,
due to differences in education and technology i.e. relative labor productivity. Companies should aim to invest in
sectors which has a future comparative advantage due to changing labor productivity on the back of
developments in technology
⁃ Heckscher-Ohlin Model
⁃ Comparative advantage - country has lower opportunity cost in terms of resource input for production,
due to differences in the relative endowment of production factors e.g. capital, labour
⁃ Specialisation - production is intensive in the factor with which the country is highest endowed. E.g.
EM more labour, DM more capital -> EM specialise in more labour intensive exports, DM in capital intensive
⁃ Implications - Invest in sectors for which comparative advantage in terms of relatively greater resource
abundance. Redistribution - domestic prices of exports increase, imports fall -> wages rise in sectors that use
more of the resources that country is better endowed in -> leads to equalisation of wages
⁃ Protectionism;
⁃ Trade restrictions - , export restrictions, export subsidy, import quota, voluntary export restraints
⁃ Objectives - protection of infant industries, raising domestic employment in disrupted industries e.g. US
steel, avoiding technology transfer e.g. for national security reasons, generating government revenues
⁃ Impact -> disruption of free trade -> global aggregate welfare loss
⁃ Tariff -> make imports more expensive -> reduces competitiveness of exporter
 ⁃ Impacts;
⁃ Loss for exporters -> forced to reduce prices or sell less e.g. retaliation may be a problem
⁃ Gain for domestic competitor with imports -> inefficient domestic production
⁃ Gain for government of importing country through tariff income
⁃ Loss for domestic consumer -> higher input costs being passed onto consumers
⁃ Welfare impact;
⁃ Consumer surplus - difference between total amount consumers are willing to pay, and what they end
up paying in aggregate
⁃ Producer surplus - difference between the amount a producer receives from selling a good and the
lowest amount that a producer is willing to accept for it