Economics Flashcards
Name three challenges in developing capital market forecasts, the impact on CME, and a fix
RoR alters the relationship between risk and return and can be fixed by using data that reflects one regime.
Data-mining bias leads to unreliable variables used in forecasting and fix by testing out of sample.
Misinterpretation of correlation (thinking its causation) may lead to a spurious relationship and fix is understanding the linkages between the variables.
What is the equation for LT GDP growth rate?
LT growth rate of labour force + LT growth rate in labour productivity.
What is the equation for LT equity growth rate?
LT nominal GDP growth rate + dividend yield.
What is two pros and two cons of econometric modelling?
Robust and can examine the impact of multiple variables and can forecast exogenous shocks. Can give a false sense of precision and bad at forecasting turning points.
What is two pros and two cons of the economic indicators approach to economic forecasting?
Requires only a small number of statistics and can forecast turning points well. Vulnerable to data revisions and can give a false signal on the economic outlook.
What is a pro and a con of a checklist approach to economic forecasting?
Limited complexity. Imposes no consistency of analysis across items or across time.
What are the capital market expectations in an initial recovery?
ST rates are low or declining. LT rates are bottoming out. Upward sloping yield curve. Riskier assets do well.
What are the capital market expectations in an early expansion?
ST rates rise. LT rates bottoming out or rising. Flattening yield curve. Riskier assets rise.
What are the capital market expectations in a late expansion?
ST and LT rates rise. Flattening yield curve. Riskier assets are rising but volatile.
What are the capital market expectations in a slowdown?
ST rates rise/peak. LT rates high then fall. Yield curve may invert. Riskier assets decline.
What are the capital market expectations in a contraction?
ST and LT rates fall. Steepening yield curve. Riskier assets do well later in recession.
How does cash perform below/above expectations and deflationary environment?
Positive (negative) impact with rising (falling) rates.
Positive impact if nominal rates have a 0% bound.
How do bonds perform in normal inflation times, below/above expectations and deflationary environment?
Normally ST yields for volatile than LT yields.
Negative impact. LT yields more volatile than ST. Coupons worth less.
Positive impact from fixed coupons.
How do stocks perform below/above expectations and deflationary environment?
Negative impact with central bank action or falling asset prices.
Negative impact as economic activity declines.
How does real estate perform below/above expectations and deflationary environment?
Positive impact as real asset values and rents rise.
Opposite with deflation.
What is the Taylor rule for the target nominal policy rate?
real neutral rate + expected inflation + 0.5(expected GDP – GDP target) + 0.5(expected inflation – inflation target)
What is the equation for the current account?
(savings - investment + (taxes - government spending)
What is the result if portfolio duration > investment horizon if rates are forecasted to fall?
Capital appreciation dominates reinvestment return leading to capital gain.
What is the Grinold-Kroner model equation?
expected return = D/Y + (%ΔE-%ΔS) + %ΔP/E
where:
%ΔE = nominal earnings growth + corporate bond premium.
%ΔE-%ΔS = earnings per share growth rate.
Net share repurchases increases return via buybacks.
What is the Singer–Terhaar integrated and segmented risk premium for each asset class, and the weighted average risk premium equation?
fully integrated risk premium = correlation with global market × s.d. × global SR.
fully segmented risk premium = s.d. × segmented SR.
Weighted average = Rf + w(integrated) + (1-w)(segmented).
What is the Singer–Terhaar model finding?
Move capital to markets that become more integrated because its required return will fall, increasing expected return.
What risks to bond investors in EM countries face?
Weak enforcement of contract law making it difficult to recover claims.
What additional risks do equity investors face over bond investors in EM countries face?
Corporate governance risks: expropriation of assets, weak disclosure and accounting practice.
What is the LT growth rate of real estate?
cap rate + nominal NOI growth rate.
What is the ST growth rate of real estate?
cap rate + nominal NOI growth rate – %ΔCap rate
a decrease in cap rates increases growth.
What are two approaches to forecasting exchange rates?
Trade in goods and services: flow of X and M, FX impacted by CA, PPP and inflation.
Capital flows: funds seek the highest risk adjusted rate of return and FX reflects return premiums.
What is a pro and a con of the sample statistic as a volatility forecaster?
Unbiased and consistent. Cannot be used if number of assets > observations. (large sampling error if number of assets to observations is less than 10:1).
What is a pro and a con of the factor-based statistic as a volatility forecaster?
Can be used if number of assets > observations. May result in some portfolios to appear riskless if some factors are redundant.
What is a pro of the shrinkage statistic as a volatility forecaster?
Has the benefits of the sample and factor-based statistic without the downsides.
What are the three phases of the Dornbusch overshooting mechanism?
Capital moves into the market with higher returns leading to currency appreciation. There is a period of consolidation as investors expect a reversal. A reversal of all or some of the original FX move.
What is the LT Grinold-Kroner model equation?
D/Y + nominal GDP growth
What does a CA surplus do for one currency against another?
In the absence of capital flows, appreciates to address the trade imbalance.
What is the independent MP trilemma?
A country can pick two of the following: open capital account, fixed exchange rate, and independent MP. It cannot pursue all three.
What is the CIRP?
That currencies with higher interest rates will trade at a forward discount.
