CME R3

Question 1

Role of CME in Portfolio Management

Answer 1

CME helps in formulating the SAA. It can also help in identifying mispricings in the market to inform the TAA

Question 2

Limitations in developing capital market forecasts

Answer 2

Data reporting lag, inconsistencies

Data subject to bias and errors (survivorship bias, smoothing)

Historical data may not be appropriate for changing economic conditions

Ex-poste underestimates ex-ante

Data Mining

Model Error

Correlation does not equal causation

Question 3

How exogenous shocks may affect economic growth trends

Answer 3

Unanticipated events that happen outside the normal course of an economy (may be positive or negative)

Question 4

Forecasting a countries long-term growth rate

Answer 4

Decomposed into two factors:

Employment levels (based on Population Growth and labour force participation)

Productivity (capital inputs and technological change)

Question 5

Major approaches to economic forecasting

Answer 5

Econometric analysis - uses statistical methods to forecast (can range from simple to complex)

Economic Indicators - Characterized the stage of the business cycle, seperated into lagging, coincident, and leading indicators

Checklist approach - checks off a list of quetions relating to growth and then applies judgement

Question 6

How business cycles affect short and long term forecasting

Answer 6

1) Initial Recovery
Inflation falling, Short Yields Bottom

2) Early Expansion
Low/stable inflation, Short Yields Rise

3) Late Expansion
Inflation picks up, Short Yield rise

4) Slowdown
Inflation continues to rise, Inverted yield curve

5) Contraction
Inflation peaks, short rates drop

Question 7

Relationship of inflation to business cycle and how it affects asset classes

Answer 7

Equities provide and inflation hedge against moderate inflation. Extreme inflation causes central banks to increase rates rapidly and slows growth.

Deflation encourages debt defaults/slows borrowing (reduces value of real estate)

Bonds rise with falling inflation/rates, vice versa

Question 8

Effects of monetary and fiscal policy on business cycle (Taylor Rule)

Answer 8

Target Rate = neutral rate + expected inflation + (0.5 * expected GDP - trend GDP) + (0.5 * expected inflation - target inflation)

Note: NOMINAL RATE adds expected inflation and real doesn’t

Question 9

Interpret the shape of the yield curve as a predictor

Relationship between yield curve and fiscal + monetary policy

Answer 9

Fiscal: Expansionary, Monetary: Expansionary = Upward Sloping

Fiscal: Contractionary, Monetary: Expansionary = Upward Sloping, less slope

Fiscal: Expansionary, Monetary: Contractionary= Flat Curve

Fiscal: Contractionary, Monetary: Contractionary= Inverted Curve

Question 10

Macroeconomic, interest rate, and exchange rate linkages
between economies

Answer 10

Macroeconomic links such as trade could be affect a country if a trading partner enters a recession (trade volumes)

Pegging currency helps reduce exchange rate volatility. With interest rates reflecting the differences in risk. Interest rates may also reflect monetary and fiscal policy differences