PPT 1

Definition of economics
"Economics is the study of the use of scarce resources which have alternative uses

Agency Problem
A conflict of interest arising between creditors, shareholders and management because
of differing goals. For example, an agency problem exists when management and
stockholders have conflicting ideas on how the company should be run.

Scarcity Principle
Although we have boundless needs and wants, the resources available to us are
limited. So having more of one good thing usually means having less of another

Compensating Balances Plan

A type of premium paid by an insured business. Compensating balances plans allow
firms to subtract various expenses from the premiums that they pay to their carriers.
This allows the business to divert this portion of the premium to a separate account from
which it can draw.
Compensating balances plans allow insured firms to subtract costs like the cost of
carrying the policy, premium taxes and profit from the premiums that they pay. This plan
effectively lowers the cost of insurance for businesses. Firms can use the money
diverted into their account for practically any reason they choose."

Microeconomics
"the study of the behaviour of individual markets, workers, households and FIRMS.

Fiat Money
"Currency that a government has declared to be legal tender, despite the fact that it has
no intrinsic value and is not backed by reserves. Historically, most currencies were
based on physical commodities such as gold or silver, but fiat money is based solely on
faith.
Most of the world's paper money is fiat money. Because fiat money is not linked to
physical reserves, it risks becoming worthless due to hyperinflation. If people lose faith
in a nation's paper currency, the money will no longer hold any value."

Macroeconomics
analysing economy-wide phenomena such as GROWTH, INFLATION and
UNEMPLOYMENT

Aggregration
"This is a time saving accounting method for larger corporations. It helps consolidate
resources and identify project costs efficiently.
The main purpose of aggregation is to ensure accurate reporting and compliance with
regulations regarding the permitted levels of speculative limits for a single commodity."

Paradox Of Thrift
One person’s spending is another person’s income. the paradox of thrift is that when
people increase savings in a bank, the bank has more money to lend, which will
generally decrease the interest rate and spur lending and spending.

Factors affecting macro economy

Policy variables (fiscal, monetary, industry, foreign economy policy,etc) along with the
external variables (foreign output, weather, war, revolution, terrorism, etc) interact to
determine output, prices, employment and net export

Absolute Advantage
The ability of a country, individual, company or region to produce a good or service at a
lower cost per unit than the cost at which any other entity produces that good or
service.If one person, firm or country can produce more of something with the same
amount of effort and resources, they have an absolute advantage over other producers

Comparative Advantage
A situation in which a country, individual, company or region can produce a good at a
lower opportunity cost than a competitor.Let's break this down into a simple example.
Suppose that two firms both produce two main products: ice cream and bicycles. The
first firm, the Danish Ice Cream and Bicycle Co., is located in Denmark, where dairy milk
is abundant; the second firm, the Gobi Ice Cream and Bicycle Co., is smack in the
middle of the Gobi Desert.
The Gobi Ice Cream and Bicycle Co. must spend a lot of money to make ice cream,
whereas the Danish Ice Cream and Bicycle Co. spends way less to produce the same
amount. The two firms are dead even in their production costs for bicycles.
Because the Danish Ice Cream and Bicycle Co. has a comparative advantage with ice
cream production, it should probably consider turning exclusively to ice cream. Along
the same vein, the Gobi Ice Cream and Bicycle Co. should probably give up the ice
cream and focus on the product in which it is the least disadvantaged (bicycles)."

Free trade
The ability of people to undertake economic transactions with people in other countries
free from any restraints imposed by governments or other regulators

Exchange Rate
The PRICE at which one currency can be converted into another.

Fiscal Policy
"Government spending policies that influence macroeconomic conditions. These
policies affect tax rates, interest rates and government spending, in an effort to control
the economy. It comprises PUBLIC SPENDING and TAXATION, and any other
GOVERNMENT income or assistance to the private sector (such as tax breaks). It can
be used to influence the level of demand in the economy, usually with the twin goals of
getting UNEMPLOYMENT as low as possible without triggering excessive INFLATION.

Full Employment
"Jobs for all that want them. Full employment means that everyone who wants work and
is willing to work at the market wage is in work.

Gross Domestic Product (GDP)

a measure of the total outflow of goods and services produced by the economy over a
specified time period, normally a year. It is obtained by valuing outputs of goods and
services at market prices and then aggregating

Revenue Budget
the revenue receipts (tax and non-tax) of the government and the expenditure met from
these.

Capital Budget
"This shows the capital receipts and payments of the government. Principal items are
market loans, borrowing from the RBI and other parties through the sale of Treasury
Bills, loans from foreign governments. Capital payments are those made on
infrastructure and acquisition of assets.

Inflation
The rate at which the general level of prices for goods and services is rising, and,
subsequently, purchasing power is falling. As inflation rises, every dollar will buy a
smaller percentage of a good. For example, if the inflation rate is 2%, then a $1 pack of
gum will cost $1.02 in a year.
Most countries' central banks will try to sustain an inflation rate of 2-3%."

Business Cycle
The recurring and fluctuating levels of economic activity that an economy experiences
over a long period of time. The five stages of the business cycle are growth (expansion),
peak, recession (contraction), trough and recovery. At one time, business cycles were
thought to be extremely regular, with predictable durations, but today they are widely
believed to be irregular, varying in frequency, magnitude and duration.Boom and bust. -
The long-run pattern of economic GROWTH and RECESSION

Central Bank
The entity responsible for overseeing the monetary system for a nation (or group of
nations). Central banks have a wide range of responsibilities, from overseeing monetary
policy to implementing specific goals such as currency stability, low inflation and full
employment. Central banks also generally issue currency, function as the bank of the
government, regulate the credit system, oversee commercial banks, manage exchange
reserves and act as a lender of last resort.

Debt
An amount of money borrowed by one party from another. Many
corporations/individuals use debt as a method for making large purchases that they
could not afford under normal circumstances. A debt arrangement gives the borrowing
party permission to borrow money under the condition that it is to be paid back at a later
date, usually witha price,i.e, interest.

Devaluation
deliberate downward adjustment to a country's official exchange rate relative to other
currencies. In a fixed exchange rate regime, only a decision by a country's government
(i.e central bank) can alter the official value of the currency.There are two implications
for a currency devaluation. First, devaluation makes a country's exports relatively less
expensive for foreigners and second, it makes foreign products relatively more
expensive for domestic consumers, discouraging imports. As a result, this may help to
reduce a country's trade deficit.

Invisible trade
Business transactions that occur with no exchange of tangible goods. Invisible
trade involves the transfer of non-tangible goods and/or services, including
customer service, intellectual property and patents. The items involved in
invisible trade are associated with a value and can be exchanged for tangible
goods.

Debt
An amount of money borrowed by one party from another. Many
corporations/individuals use debt as a method for making large purchases that
they could not afford under normal circumstances. A debt arrangement gives the
borrowing party permission to borrow money under the condition that it is to be
paid back at a later date, usually witha price,i.e, interest.

LIBOR
Short for London interbank offered rate, the rate of INTEREST that top-quality BANKS
charge each other for loans. As a result, it is often used by banks as a base for
calculating the INTEREST RATE they charge on other loans. LIBOR is a floating rate,
changing all the time.

MIXED ECONOMY
A market economy in which both private-sector FIRMS and firms owned by
GOVERNMENT take part in economic activity.

OPEN ECONOMY
An economy that allows the unrestricted flow of people, CAPITAL, goods and
SERVICES across its borders; the opposite of a CLOSED ECONOMY

Open Market Operations

The buying and selling of government securities in the open market in order to
expand or contract the amount of money in the banking system. Purchases inject
money into the banking system and stimulate growth while sales of securities do
the opposite.Open market operations are the principal tools of monetary policy.
(The discount rate and reserve requirements are also used.) The U.S. Federal
Reserve's goal in using this technique is to adjust the federal funds rate--the rate
at which banks borrow reserves from each other.

Optimal Currency Area

The primary test for the theory of optimal currency areas is the introduction of the euro
as a common currency in many European nations. Eurozone countries matched well
with Mundell's criteria for successful monetary union, providing the impetus for the
introduction of a common currency. While the eurozone has seen many benefits from
the introduction of the euro, it has also experienced problems such as the Greek debt
crisis. Thus, the long-term outcome of monetary union under the theory of optimal
currency areas remains a subject of debate.

Philips Curve
An economic concept developed by A. W. Phillips stating that inflation and
unemployment have a stable and inverse relationship. According to the Phillips
curve, the lower an economy's rate of unemployment, the more rapidly wages
paid to labor increase in that economy.

Regressive Tax
A tax that takes a larger percentage from low-income people than from high-
income people. A regressive tax is generally a tax that is applied uniformly. This
means that it hits lower-income individuals harder.Some examples include gas
tax and cigarette tax. For example, if a person has $10 of income and must pay
$1 of tax on a package of cigarettes, this represents 10% of the person's income.
However, if the person has $20 of income, this $1 tax only represents 5% of that
person's income.

Structural Unemployment
Unemployment resulting from changes in the basic composition of the economy.
These changes simultaneously open new positions for trained workers.An
example of structural unemployment is the technological revolution. Computers
may have eliminated jobs, but they also opened up new positions for those who
have the skills to operate the computers.

Lender of Last Resort

One of the main functions of a CENTRAL BANK. When financially troubled BANKS
need cash and nobody else will lend to them, a central bank may do so, perhaps with
strings attached, or even by taking control of the troubled bank, closing it or finding it a
new owner.

STERILISED INTERVENTION
When a GOVERNMENT or CENTRAL BANK buys or sells some of its RESERVES of
foreign currency this can affect the country’s MONEY SUPPLY. Selling reserves
decreases the supply of the domestic currency; buying reserves increases the domestic
money supply. Governments or central banks can sterilise (that is, cancel out) this effect
of foreign exchange intervention on the money supply by buying or selling an equivalent
amount of SECURITIES. For example, if the GOVERNMENT increases reserves by
buying foreign currency the domestic money supply will increase, unless it sells
securities such as TREASURY BILLS to mop up the extra DEMAND.

What Does Moral Suasion Mean?

A persuasion tactic used by an authority (i.e. Federal Reserve Board) to influence and
pressure, but not force, banks into adhering to policy. Tactics used are closed-door
meetings with bank directors, increased severity of inspections, appeals to community
spirit, or vague threats. A good example of moral suasion is when the Fed Chairman
speaks on the markets - his opinion on the overall economy can send financial markets
falling or flying.

What Does Sovereign Wealth Fund - SWF Mean?

Pools of money derived from a country's reserves, which are set aside for investment
purposes that will benefit the country's economy and citizens. The funding for a
sovereign wealth fund (SWF) comes from from central bank reserves that accumulate
as a result of budget and trade surpluses, and even from revenue generated from the
exports of natural resources. The types of acceptable investments included in each
SWF vary from country to country; countries with liquidity concerns limit investments to
only very liquid public debt instruments.

What Does Tobin Tax Mean?

A means of taxing spot currency conversions that was originally suggested by American
economist James Tobin (1918-2002). The Tobin tax was developed with the intention of
penalizing short-term currency speculation, and to place a tax on all spot conversions of
currency. Rather than a consumption tax paid by consumers, the Tobin tax was meant
to apply to financial sector participants as a means of controlling the stability of a given
country's currency.

What Does Gross Domestic Product - GDP Mean?

The monetary value of all the finished goods and services produced within a country's
borders in a specific time period, though GDP is usually calculated on an annual basis.
It includes all of private and public consumption, government outlays, investments and
exports less imports that occur within a defined territory. GDP = C + G + I + NX where:
"C" is equal to all private consumption, or consumer spending, in a nation's economy
"G" is the sum of government spending "I" is the sum of all the country's businesses
spending on capital "NX" is the nation's total net exports, calculated as total exports
minus total imports. (NX = Exports - Imports)

What Does Arbitrage Mean?

The simultaneous purchase and sale of an asset in order to profit from a difference in
the price. It is a trade that profits by exploiting price differences of identical or similar
financial instruments, on different markets or in different forms. Arbitrage exists as a
result of market inefficiencies; it provides a mechanism to ensure prices do not deviate
substantially from fair value for long periods of time.

What Does Hedge Fund Mean?

An aggressively managed portfolio of investments that uses advanced investment
strategies such as leveraged, long, short and derivative positions in both domestic
and international markets with the goal of generating high returns (either in an
absolute sense or over a specified market benchmark).
Legally, hedge funds are most often set up as private investment partnerships that are
open to a limited number of investors and require a very large initial minimum
investment. Investments in hedge funds are illiquid as they often require investors
keep their money in the fund for at least one year.

What Does Sarbanes-Oxley Act Of 2002 - SOX Mean?

An act passed by U.S. Congress in 2002 to protect investors from the possibility of
fraudulent accounting activities by corporations. The Sarbanes-Oxley Act (SOX)
mandated strict reforms to improve financial disclosures from corporations and
prevent accounting fraud. SOX was enacted in response to the accounting scandals
in the early 2000s. Scandals such as Enron, Tyco, and WorldCom shook investor
confidence in financial statements and required an overhaul of regulatory standards

What Does Speculative Bubble Mean?

A spike in asset values within a particular industry, commodity, or asset class. A
speculative bubble is usually caused by exaggerated expectations of future growth,
price appreciation, or other events that could cause an increase in asset values. This
drives trading volumes higher, and as more investors rally around the heightened
expectation, buyers outnumber sellers, pushing prices beyond what an objective
analysis of intrinsic value would suggest.
The bubble is not completed until prices fall back down to normalized levels; this
usually involves a period of steep decline in price during which most investors panic
and sell out of their investments.

What Does Inflation Targeting Mean?

A central banking policy that revolves around meeting preset, publicly displayed
targets for the annual rate of inflation. The benchmark used for inflation targeting is
typically a price index of a basket of consumer goods, such as the Consumer Price
Index (CPI) in the United States.
Along with inflation target rates and calendar dates to be used as performance
measures, an inflation targeting policy may also have established steps that are to be
taken depending on how much the actual inflation rate varies from the targeted level,
such as cutting lending rates or adding liquidity to the economy

What Does Interest Rate Mean?

The amount charged, expressed as a percentage of principal, by a lender to a
borrower for the use of assets. Interest rates are typically noted on an annual basis,
known as the annual percentage rate (APR). The assets borrowed could include,
cash, consumer goods, large assets, such as a vehicle or building. Interest is
essentially a rental, or leasing charge to the borrower, for the asset's use. In the case
of a large asset, like a vehicle or building, the interest rate is sometimes known as the
“lease rate”.
When the borrower is a low risk party, they will usually be charged a low interest rate;
if the borrower is considered high risk, the interest rate that they are charged will be
higher.

What Does Fiscal Policy Mean?

Government spending policies that influence macroeconomic conditions. These
policies affect tax rates, interest rates and government spending, in an effort to control
the economy.

What Does Monetary Policy Mean?

The actions of a central bank, currency board or other regulatory committee that
determine the size and rate of growth of the money supply, which in turn affects
interest rates. Monetary policy is maintained through actions such as increasing the
interest rate, or changing the amount of money banks need to keep in the vault (bank
reserves).

What Does Absolute Advantage Mean?

The ability of a country, individual, company or region to produce a good or service at
a lower cost per unit than the cost at which any other entity produces that good or
service.

What Does Fixed Exchange Rate Mean?

A country's exchange rate regime under which the government or central bank ties the
official exchange rate to another country's currency (or the price of gold). The
purpose of a fixed exchange rate system is to maintain a country's currency value
within a very narrow band. Also known as pegged exchange rate.

What Does Floating Exchange Rate Mean?

A country's exchange rate regime where its currency is set by the foreign-exchange
market through supply and demand for that particular currency relative to other
currencies. Thus, floating exchange rates change freely and are determined by
trading in the forex market. This is in contrast to a "fixed exchange rate" regime

What Does Deflation Mean?

A general decline in prices, often caused by a reduction in the supply of money or
credit. Deflation can be caused also by a decrease in government, personal or
investment spending. The opposite of inflation, deflation has the side effect of
increased unemployment since there is a lower level of demand in the economy,
which can lead to an economic depression. Central banks attempt to stop severe
deflation, along with severe inflation, in an attempt to keep the excessive drop in
prices to a minimum.

What Does Devaluation Mean?

A deliberate downward adjustment to a country's official exchange rate relative to
other currencies. In a fixed exchange rate regime, only a decision by a country's
government (i.e central bank) can alter the official value of the currency. Contrast to
"revaluation"

What Does Moral Hazard Mean?

The risk that a party to a transaction has not entered into the contract in good faith,
has provided misleading information about its assets, liabilities or credit capacity, or
has an incentive to take unusual risks in a desperate attempt to earn a profit before
the contract settles.

What Does Asymmetric Information Mean?

A situation in which one party in a transaction has more or superior information
compared to another. This often happens in transactions where the seller knows more
than the buyer, although the reverse can happen as well. Potentially, this could be a
harmful situation because one party can take advantage of the other party’s lack of
knowledge.

What Does J Curve Mean?

A theory stating that a country's trade deficit will worsen initially after the depreciation
of its currency because higher prices on foreign imports will be greater than the
reduced volume of imports.