Chapter 3 - Capital Market Expectation And Market Valuation

Question 1

The framework for developing capital market expectations involve

Answer 1

Collecting, organising, combining and interpreting investment information

Question 2

What are capital market expectations

Answer 2

Expectations concerning risk and returns prospects of an asset class

Question 3

What are the steps of the framework for capital markets

Answer 3

1. Specify the set of expectations needed, including the tine horizon(s) to which they apply
2. Research the historical record
3. Specify the methods to be used and their information requirements
4. Determine the best source of information needs
5. Interpret the current environment using the selected data and methods, applying experience and judgement
6. Provide the set of expectations and document the conclusions
7. Minitor outcomes, compare to forecasts and provide feedback

Question 4

Challenges in forecasting

Answer 4

1. Limitations of economic data
2. Data measurement errors and biases
3. Limitations of historical estimates
4. Ex Post risk being a biased measure of Ex Ante risk
5. Biases in analysts’ methods
6. Misinterpretation of correlation
7. Psychological biases
8. Model uncertainty

Question 5

Some measurement errors and biases include

Answer 5

1. Transcription errors
2. Survivorship bias
3. Appraisal (smoothed) data

Question 6

What is peso problem

Answer 6

The phenomenon that asset prices reflected the possibility of a very negative event that did not materialise in the period

Question 7

What are some preventable biases that can be introduced by an analyst

Answer 7

1. Data mining bias ( correlation does not always imply causation) - looks for a pattern until one is found in the data set
2. Time-period bias

Question 8

List the 6 Psychological biases

Answer 8

1. Anchoring bias
2. Status quo bias
3. Confirmation bias
4. Overconfidence bias
5. Prudence bias
6. Availability bias

Question 9

What are trend growth of relevance for

Answer 9

Setting long-term expectations of asset classes such as equities

Question 10

What do cyclical variation usually affect

Answer 10

Corporate profits and interest rates, which directly relate to asset class returns and risk

Question 11

Some significant shocks (both positive and negative) to economic growth include

Answer 11

1. Policy changes
2. New products and technologies
3. Geopolitics
4. Natural disaster
5. Natural resources/critical inputs
6. Financial crisis

Question 12

Government policy that promote economic growth include

Answer 12

1. Sound fiscal policy
2. Minimal intrusion on the private sector
3. Encouraging competition in the private sector
4. Support for infrastructure and human capital development
5. Sound tax policies

Question 13

The approaches to tracking short to intermediate fluctuations around the trend growth rate are

Answer 13

1. Econometric model
2. Indicators
3. Checklists

Question 14

What are some limits to econometric models

Answer 14

1. Requires the user to find adequate measures for real-world activities and relationships to be modeled (these measures may not be available)
2. Variables may be measured with error
3. Relationship among the variables may change over time (due to changes in economic conditions and/or flaws in initial assumptions)

Question 15

What are the 5 business cycles

Answer 15

1. Initial recovery
2. Early expansion
3. Late expansion
4. Slowdown
5. Contraction