Business Cycle and Types of Industries

Business Cycle Phases

• Expansion: Period of economic growth.
• Peak: The height of economic growth.
• Contraction: A decline in economic activity.
• Trough: The lowest point in the economic cycle.
• Recession: At least two consecutive quarters of decline in GDP.
• Depression: At least six consecutive quarters of decline in GDP.

Types of Industries

1. Growth Industries: Low to no dividends, opportunity for appreciation.
2. Defensive Industries: Resist market cycles (e.g., alcohol, tobacco, pharmaceuticals, oil and gas, public utilities).
3. Cyclical Industries: Thrive during expansion (e.g., steel, heavy equipment, capital goods, home appliances, auto industry).
4. Counter-Cyclical Industries: Expand during contraction (e.g., gold mining stocks).

Fiscal and Monetary Policy

Fiscal Policy

• Controlled by Congress and the President.
• Includes changes in tax laws and budgetary changes.

Monetary Policy

• Controlled by the Federal Reserve.
• Open Market Operations: Main tool for managing the economy.
  • Quantitative Easing: Fed buys U.S. government securities to stimulate the economy.
  • Quantitative Tightening: Fed sells U.S. government securities to rein in inflation.
• Interest Rates:
  • Federal Funds Rate: Target rate for overnight loans between member banks.
  • Discount Rate: Rate at which the Fed lends to member banks.
  • Prime Rate: Rate set by commercial banks for their best customers based on Federal Funds Rate and Discount Rate.
• Reserve Requirements: Amount of cash banks must have on hand.

Macroeconomic Theories

1. Keynesian: Lower taxes and higher government spending can get the U.S. out of a recession.
2. Classical: Less government regulation promotes free market efficiency.
3. Monetarist: Money supply determines overall price levels and economic activity.
4. Supply-Side: Lowering taxes and decreasing regulation fosters economic growth.

Yield Curve and Credit Spread

Yield Curve

• Positive (Normal) Yield Curve: Upward slope, low yields in near-term, high yields in long-term.
• Flat Yield Curve: No slope.
• Negative (Inverted) Yield Curve: Downward slope, low yields in long-term, high yields in near-term.

Credit Spread

• Difference in yield between U.S. government debt and corporate debt.
• Widening Spread: Negative indicator.
• Narrowing Spread: Positive sign.

Marketplaces and Economic Indicators

Forex Market

• 24-hour over-the-counter market for trading currencies.

Economic Indicators

• Leading Indicators: Predict economy's direction (e.g., average manufacturing workweek, building permits, money supply, etc.).
• Coincident Indicators: Move with the current phase of the business cycle (e.g., industrial production, personal income).
• Lagging Indicators: Reflect changes after the economy has moved to the next phase (e.g., average duration of employment, total amount of loans outstanding).

Financial Reports

1. Income Statement: Shows income and expenses over time.
   • Gross profit margin: (Income - Cost of Goods Sold) / Income.
2. Balance Sheet: Snapshot of assets, liabilities at a point in time.
   • Assets = Liabilities + Shareholder's Equity.
3. Cash Flow Statement: Adds back non-cash items to net income (e.g., depreciation).

Components of Shareholders' Equity

• Preferred stock at par
• Common stock at par
• Paid-in surplus
• Retained earnings

Filing Requirements

• 8K: Significant events within 4 business days.
• 10Q: Quarterly reports (unaudited).
• 10K: Annual reports (audited).
• Audit opinions: Qualified, Unqualified, No Opinion.
• Shareholders receive annual reports; mutual fund shareholders receive semi-annual and annual reports.

Accounting Systems

• Cash Basis: Income booked when received, expenses when paid.
• Accrual Basis: Income booked when invoiced, expenses when billed.

Financial Ratios and Metrics

1. Liquidity Ratios:
   • Current Ratio: Current assets / Current liabilities.
   • Quick (Acid Test) Ratio: (Current assets - Inventory) / Current liabilities.
2. Leverage Ratios:
   • Debt-to-Equity Ratio: Debt / (Debt + Equity).
3. Efficiency Ratios:
   • Working Capital: Current assets - Current liabilities.
   • Earnings per Share: Earnings available to common shareholders / Number of shares outstanding.
4. Valuation Ratios:
   • Price-Earnings Ratio: Market Price / Earnings per Share.
   • Current Yield on Stocks: Annual dividends / Market price.
   • Current Yield on Bonds: Annual interest / Market price.

Investment Metrics and Risks

1. Beta: Measures volatility relative to the market (S&P 500).
   • Beta of 1: Moves with the market.
   • Beta of -1: Moves opposite to the market.
   • Beta between 0 and 1: Less volatile than market.
2. Standard Deviation: Measures dispersion around the average return.
   • Lower standard deviation: More predictable returns.
3. Sharpe Ratio: Risk-adjusted return.
   • Formula: (Actual Return - Risk-Free Return) / Standard Deviation.
4. Net Present Value (NPV) and Internal Rate of Return (IRR):
   • Positive NPV: Worthwhile investment.
   • IRR exceeds hurdle rate: Good investment.
   • Zero NPV: IRR equals discount rate.

Risks in Investment

Systematic Risks

• Market Risk: Affects all investments.
• Inflation (Purchasing Power) Risk: Decrease in purchasing power.
• Interest Rate Risk: Impact of interest rates on investments.

Unsystematic Risks

• Business Risk: Poor management decisions.
• Credit (Default) Risk: Issuer cannot meet financial obligations.
• Liquidity Risk: Difficulty converting assets to cash.
• Political Risk: Political changes affecting investments.
• Currency Exchange Rate Risk: Fluctuations in foreign exchange rates.

Other Concepts

• Opportunity Cost: Return lost when choosing a riskier investment.
• Sunk Costs: Money already spent, non-recoverable.

Order of Payment in Liquidation

1. Secured creditors
2. Unsecured creditors
3. Preferred stockholders
4. Common stockholders
5. Foreign investors

Time Value of Money

• Rule of 72: Determines how long to double investment at a known rate.
  • Formula: 72 / Rate of Return = Number of Years