QUESTION 2 HAS TWO PARTS A, B FOR A TOTAL OF 9 MINUTES Jenny Franke, a reporter for the financial cable news program Buy Now, is reporting on the current state of the stock market.. Figu
Trang 1ECONOMICS QUESTION 1 HAS TWO PARTS (A, B, C) FOR A TOTAL OF 9 MINUTES
Lindsey Buckingham, CFA, Chief Economist at World Financial Management (WFM), is being interviewed by a prominent financial reporter Buckingham explains that the global economy is still sluggish Short-term interest rates in the United States are significantly lower than long term rates The U.S economy is still feeling the effects of a major recession, brought on in part by the mortgage crisis and financial disaster The federal government is using its two primary tools to close the output gap
A Identify the two primary tools that Buckingham refers to and explain what the government
is doing with each tool
(4 minutes)
B Explain why these two actions produce a strongly upward sloping yield curve
(2 minutes)
As the meeting is ending the reporter asks Buckingham, “What is the best time to buy equity and sell bonds? Is it the initial slowdown, the recession, or late in the upswing?”
C State and justify which stage of the business cycle will be relatively best for stock rather
than bond returns
(3 minutes)
Trang 2QUESTION 2 HAS TWO PARTS (A, B) FOR A TOTAL OF 9 MINUTES
Jenny Franke, a reporter for the financial cable news program Buy Now, is reporting on the current state of the stock market Franke states the S&P 500 index is currently over-valued using the Fed and Yardini models based on the data given in Figure 1 She goes on to explain that since the models indicate the index is currently over-valued, investors should allocate a higher
percentage of their portfolio to bonds
Figure 1
$81 earnings estimate for the index
1,221 current value of the index
3% yield on 10-year Treasury bond
4.5% annual 5-year growth forecast for the index
4.87% current yield on A-rated Corporate bonds
0.1 weighting factor for the importance of earnings growth
A State whether you agree or disagree with Franke’s statement the Fed and Yardeni models
indicate an over-valued stock market Justify your answer and show your calculations
(6 minutes)
Franke concludes her program by reporting that companies are in aggregate increasing their repurchase programs
B Explain the effect of the repurchase yield on stock returns using the Grinold-Kroner model
(3 minutes)
Trang 3QUESTION 3 HAS FOUR PARTS (A, B, C, D) FOR A TOTAL OF 15 MINUTES
Steve Summer works in the capital marketing forecasting unit of Global Asset Management (GAM) He has been asked to review the firm’s long-term bond market return expectations for Country X His unit has been using bond YTM (yield to maturity) as estimated return, but Summer is expecting significant changes in interest rates and believes the reinvestment
assumptions inherent in the YTM approach are unrealistic He decides to apply two other
approaches: horizon analysis and a build-up model
Summer expects stimulative monetary and fiscal policy, leading to rising interest rates and higher reinvestment rates for an extended future period The current 1-year government bond nominal yield is 3.10%, and Summer’s projects the following risk premiums:
Default premium for AAA to govt bonds 20 bp
Default premium for A to AAA bonds 30 bp
Default premium for BBB to A bonds 35 bp
Maturity premium for 20 to 1-year bonds 10 bp
Tax premium for corporate to govt bonds 8 bp
A. Using only the data provided and a build-up approach, estimate the return for 20 year A-rated corporate bonds Show your work
(3 minutes)
B. Given Summer’s view of government policy and future reinvestment rates, state whether
horizon analysis or the build-up model is more appropriate to project bond market returns
over the long run Explain your statement The explanation must be related to Summer’s
views
(3 minutes)
Trang 4GAM’s Investment Policy Committee has become concerned by recent economic and political
trends While they think each is a very low probability event, they ask Summer to consider how
asset classes are most likely to behave if the economy enters either a period of rapidly increasing
and double digit inflation, or a period of deflation (negative inflation and widespread declines in
consumer product prices) Summer focuses his analysis on four asset classes:
Cash equivalents (CE)
Bonds (B) in the form of default-free government bonds
Equity (E)
Real estate (RE) in the form of income-producing rental property
C. For each of the scenarios, the committee has asked Summer to consider, explain which asset
class(es) is(are) likely to perform well Scenario:
i Rapidly increasing inflation
ii Deflation
(4 minutes)
Summer is also preparing an analysis of two emerging market economies, Esatn and Mstan He
has prepared data for several key variables to consider:
Expected nominal GDP
trend growth
6% 4.5%
Court system Well developed with relatively
independent judges
Judges are appointed and removed frequently Central bank The central bank was just placed
under direct control of the country’s president and guarantees an “easy
A quasi-independent entity following a Taylor rule approach
Trang 5D. Explain which emerging market economy Summer will classify as higher risk, and support the classification with three reasons based on the data provided
(5 minutes)