Investment Management Assignment
A business cycle seen as expansions and contractions in the economy is significantly affected by the monetary and fiscal policies. The policies refer to the steps taken by the government or changes/ amendments made by the government in the existing structure related to taxation, financing rates, spending norms, supply and so on.
The fiscal policies mainly deal with government’s actions towards spending and taxation. If government takes positive steps towards spending of goods and services, they will create increase in demand for goods and services which will require continuous supply to meet the demand and thus increase in production which increases the need for resources including human resources thus creating new employment opportunities. Thus this results in growing phase of the economy and thus is initiated through fiscal policy changes (Reilly & Brown, 2011).
Similarly, the monetary policies referring to norms taken by government towards money supply and financing rates affect the economy depending on the government means to raise money. This will in turn affect the inflation thus affecting the economy and business cycle.
Thus monetary and fiscal policies have significant influence over economy (Grimsley, 2016).
The three factors that affect the sensitivity of earnings towards business cycle include:
• Sensitivity to Sales
• Operating Leverage
• Financial Leverage
Sensitivity to Sales refers to the type of the goods. Sales of goods or services become sensitive to the business cycle depending on its nature. Necessity goods do not get affected with the business cycle as these goods are necessary while luxury or discretionary goods fall during bad economy and rise during growing phases of economy. Thus this is how the first factor, Sensitivity to Sales, determine the sensitiveness of the earnings of the firm on the business cycle.
Operating Leverage is the second factor which leverages between the fixed and variable costs in production. Higher the fixed costs less sensitive is the effect on costs and thus on earnings level based on business performance. Thus firm earnings become more flexible to respond with the market performance or business cycle if variable cost components are to the higher extent.