If a central bank observes that due to increased spending and income growth, there are signs of inflation in the system, what are the options available to them to react to this and what could be implications to each of those actions.
1) Increase interest rates - It makes borrowing expensive and reduces the supply of credit in the system. It also makes existing borrowing more expensive to finance, and people start spending less. Done in excess, it could contract economic growth and lead to currency appreciation that might hurt exports. 2) Open Market Operations: The central bank could sell the government bonds held in their reserve of financial assets and suck out the excess liquidity from the system. This reduces the availability of liquidity for asset purchases, thus driving the prices of assets lower and helping people afford things (e.g. housing) The response is normally a combination of both of these policy tools.
If the business manager has $10 million to spend and 2 options where he/she could invest the money, how would he/she go about the process of evaluating the projects.
The business manager has to start modelling the expected cashflows from these projects and assessing the risk to evaluate the discount factor. Once they complete this step, we can evaluate the NPV (net present value) and IRR (internal rate of return) expected from these projects. The net present value would make the projects comparable provide us a indication of the additional value that the projects would add to the companies earning ability over the life of the project. The IRR would help us understand if the project would generate the minimum needed to beat the hurdle rate (i.e. the minimum rate of return a company would want to earn from any project that the company invests in)
When you are looking to compare the stock price of two companies in the same industry and decide which one is cheaper, how would you do it?
We could use ratios, one such ratio is called the P/E (Price to earning ratio), which represented the amount of money one is ready to pay for a one dollar of earnings. Looking at that multiple helps us understand that one company is trading relatively higher or lower that the other. This is often to a good starting point to start understanding the differences between the two companies in question.