Chapter 5 - Analysis of Equity Securities I - Economic and Industrial Analysis - 4.75% Flashcards
What are the components of GDP calculation?
GDP = C+ I + G + X - M
C = Consumption I = Private Investment G = Government Spending X = Exports M = Imports
In which phase of the industry life cycle are initial public offerings (IPOs) most likely to occur? A. Emerging growth. B. Rapid growth. C. Stable growth. D. Declining growth.
B is correct.
Companies in the rapid growth stage are generally characterized by healthy and continuous growth prospects. More importantly, companies in this stage of growth have made it through the highly volatile pioneer or emerging growth phase. They have established product lines and many years of growth ahead. Thus, prospects for the future are stronger in this stage of the industry life cycle compared with other stages.
Which is the correct definition of GDP?
A. Consumption + Private Investment+ Government Spending + Exports.
B. Consumption + Private Investment+ Government Spending + Imports.
C. Consumption + Private Investment+ Government Spending + (Imports – Exports).
D. Consumption + Private Investment+ Government Spending + (Exports – Imports).
D is correct.
Start-up Company A has developed a new product that it believes can compete on price and quality with Company B, the current industry leader. However, Company A fails to gain meaningful market share and attributes this to the strong brand loyalty demonstrated by consumers for Company B's product. What barrier to entry do new entrants to this industry face? A. Product differentiation. B. Absolute advantage. C. Economies of scale. D. Low product pricing.
A is correct.
Product differentiation represents a barrier to entry whereby brand identity or brand loyalty makes it very difficult for new entrants to compete and survive. Without a unique product characteristic or an ability to win over market share, Company A will likely fail. Absolute advantage refers to a situation where a company might have lower costs due to a patent or proprietary technology making it prohibitively expensive for a new entrant to compete. Companies that exhibit economies of scale are generally the low cost providers within the industry, making it difficult for new entrants to compete at a price level that generates profit.
Industry A’s product prices are government-regulated. The economy has been expanding at a strong rate over the past several quarters, yet Industry A’s growth continues to lag that of the overall economy. The forecast is for continued growth over the next eight quarters. You are looking to add risk-adjusted value to client portfolios. Other things equal, how would you specifically classify Industry A and what decision would you make in regards to an investment in this industry given the economic data?
A. Cyclical industry over-weight position
B. Defensive industry under-weight position
C. Growth industry over-weight position.
D. Cyclical-growth industry under-weight position.
B is correct.
Government-regulated product pricing and a growth rate that lags the market rate during an expansion are both characteristic of a defensive industry. The economic information points to continued growth. Adding risk-adjusted value would, most likely, require an overweight position in a cyclical or growth industry.
What type of ranking lists industries according to their performance over the past several periods and is often used in a sector rotation strategy? A. Utilization rankings. B. Classification rankings. C. Consensus rankings. D. Momentum rankings.
D is correct.
Momentum rankings list industries according to their performance over the past several periods and are useful in assessing the consistency of an industry’s performance over the past several periods.
Industry X experienced tremendous revenue and earnings growth in the past two years. This year, however, a dramatic increase in the number of firms entering the industry triggered a fierce price war and resulted in substantial losses for many companies. Some were unable to compete and were forced out of business. Industry X is likely in which of the following stages of the industry life cycle? A. Emerging growth. B. Rapid growth. C. Mature. D. Declining.
A is correct.
The outstanding growth rates available to companies during the emerging growth stage provide an incentive for new companies to enter the industry. When this happens, market share and price competition within the industry has a tendency to force out inefficient or poorly managed companies.
What type of barrier to entry exists when the marginal cost of manufacturing a product declines as output levels rise? A. Absolute advantage. B. Product differentiation. C. Cost-push pricing. D. Economies of scale.
D is correct.
Significant barriers to entry exist when established firms within the industry have the ability to sell their products at prices below those of newer entrants. These established firms can do so because they have managed to lower their production costs by spreading these costs over higher output levels. This makes the cost of entering the industry prohibitively high for new entrants.
What is true of an economy growing below its potential growth rate?
I. There is excess supply.
II. Inflation slows.
III. Interest rates rise.
I and II are correct.
The potential rate of growth is the rate at which the economy should grow when all resources (labour and capital) are fully utilized. When an economy grows at a rate below its potential growth rate, excess capacity and ultimately disinflation are created, which normally prompts a central bank to lower rates.
Which is an example of a sector rotation strategy?
I. Switching between industries with low correlation.
II. Switching between industries with different activities.
III. Switching between industries with similar economic sensitivities.
I and II are correct.
Sector rotation involves adjusting the portfolio weights of different economic sectors or industry categories in anticipation of stock market trends. Prices of industries with similar economic sensitivities or with similar activities tend to move together. They will display highly positive return correlations. Thus, dissimilar economic sensitivities, different activities, and low correlations will enhance the effectiveness of a sector rotation strategy.
Which industry life cycle stage is potentially the most profitable but also the most risky for investors? A. Pioneer stage. B. Expansion stage. C. Stable stage. D. Decline stage.
There are four industry life cycle stages: pioneer or emerging growth, expansion or rapid growth, stable or mature, and declining. Each stage is associated with different growth rates and risks. In a pioneering industry with rapid growth expectations, the risk of company failure is high. Demand is usually growing and may exceed supply, which can lead to quick expansion by companies and outstanding rates of return. This is potentially the most profitable – but also the riskiest – stage for investors.
Which statement(s) is/are true regarding the whisper estimate?
I. It is more accurate than the consensus estimate.
II. It is not an official estimate.
III.It is formulated by market participants.
II and III are correct.
Since there are often situations in which interim information arrives after the consensus is calculated but before the actual data release, the market often formulates what is called a whisper estimate. You will not find this estimate printed anywhere.
Economic growth has averaged 4.2% over the past four quarters, capacity utilization is showing a strong positive trend, and the unemployment rate has remained stable at 7% for the past two years. What does this likely imply for the state of the economy?
A. There is excess capacity and this requires stronger growth to reduce the unemployment rate.
B. There is excess demand and this may prompt the central bank to begin raising interest rates.
C. There is excess supply and this may lead to disinflation next year.
D. There is excess rigidity in the market and this requires lower interest rates to improve labour market conditions.
B is correct.
An economy can only grow to a certain point before an imbalance is created between what the economy can supply and what consumers can purchase. Ultimately, there is a potential level of growth the economy can attain when all resources are fully utilized. When the economy operates above its potential, that is, when actual GDP runs ahead of potential GDP, excess demand conditions lead to higher prices and rising inflation. The Bank of Canada keeps a close watch on capacity utilization rates and GDP growth rates, among other indicators, waiting for a signal that the economy may be overheating. The remedy for such situations is a tightening of monetary policy through higher short-term interest rates.
By and large, why are a number economic indicators “seasonally adjusted”?
A. Because not all economic data is released at the same time.
B. Because quarterly or semi-annual data is often less precise than annual data.
C. To ensure that all months in a data series are averaged over an equal time period.
D. To analyze indicators independent of their predictable patterns.
D is correct.
Because many economic indicators tend to change fairly predictably in certain time periods, economists adjust the data by isolating the time periods that have the most influence on changes in the variable. When the effects of seasonality have been removed, the data can then be compared to other months in which seasonal influences are less severe.
The consensus forecast for third quarter GDP is 2.5%, with the release of the actual report slated for the end of the month. A week before data is to be released new information becomes available, leading your firm's trading desk to formulate a separate estimate that they will compare to data in the actual report. What is this estimate called? A. The noise estimate. B. The whisper estimate. C. The industry trend estimate. D. The market survey estimate.
B is correct.
The consensus forecast is arrived at by polling several economists about their expectations for a certain variable, for example quarterly GDP, and then averaging those forecasts into one concise estimate. However, as the actual release date approaches, new information about the variable may become available. As there may not be enough time to go through the process of determining a revised consensus, the market will often formulate what is called a whisper estimate. Once the actual data is released, market reaction is based on deviations from the whisper estimate and not the consensus forecast.
