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CFA Level III > Economics > Flashcards

Economics Flashcards

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CFA flashcards
1
Q

Alpha

A

earning excess returns with specific strategies within an asset class

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2
Q

Capital Market Expectation Process

A
  1. determine needs
  2. look at historical performance
  3. identify valuation model
  4. collect data
  5. interpret current conditions and assign values to inputs
  6. formulate expectations
  7. monitor/ repeat
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3
Q

Capital Market Forecasts

A
  1. consistent
  2. unbiased
  3. objective
  4. well supported
  5. accurate
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4
Q

Return Estimate Methods

A
  1. arithmetic average: single period
  2. geometric average (multiply): multiple periods; dec dramatic shifts
  3. weighted average (shrinkage estimate): historical estimates
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5
Q

Gordon Growth Model

A

E(r) = D1/ P0 + g

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6
Q

Grinold-Kroner Model

A

Ri = D1/ P0 + i + g - ΔS + Δ(P/ E)

return = div yeild + inflation + growth in earnings - % change in shares outstanding + change in P/ E ratio

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7
Q

Discounted Cash Flow Assumptions

A

reinvest cash flows at the realized rate of return

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8
Q

Time Series Model

A

forecasts generated using previous values of a variable and previous values of other variables

  • volatility clustering: variance will persist for periods of time
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9
Q

Risk Premium Approach

A

YTM = rf + risk premiums(s)

rbond = rf + inflation + default risk + liquidity + taxes + maturity premiums

reqty = LT gov bond yield + eqty risk premium

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10
Q

Sharpe Ratio

A

excess return per unit of risk

( Rm - Rf )/ σm

ERPm / σm

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11
Q

β

A

systematic risk, used to value equity and fixed income sec

ρi,m σi / σm

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12
Q

Covariance

A

covi,j = βi,1βj,1σF12 + βj,1β​j,2σF22 + ( βi,1βj,1 + βj,1β​j,2 )cov(F1, F2)

covi,j = β1 β​2 σm2

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13
Q

CAPM

A

r = rf + β( rm - rf )

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14
Q

Financial Equilibrium Approach

A

ERP = ρi,m σi ( ERPm/ σm )

segmented ERP = weighted avg of fully segmented and integrated ERP + additional risk premiums

E(r) = ERP + rf

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15
Q

Inventory Cycle

A
  • 2-4 years
  • inv/ sales
  • inc I/S b/c inc I = positive
  • inc I/S b/c dec S = negative
  • LR lower inv b/c better inventory management
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16
Q

Business Cycle

A
  • 9-11 years
  • phases
  1. initial recovery
  2. early upswing
  3. late upswing
  4. slowdown
  5. recession
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17
Q

Initial Recovery

A
  • ST and LT rates = low or declining
  • inflation = dec
  • confidence = inc
  • gov = exp FP
  • bond prices = peak
  • stock prices = inc
18
Q

Early Upswing

A
  • ST and LT rates = inc
  • inflation = low
  • confidence = high
  • gov = less exp FP
  • bond prices = dec, flat yield curve
  • stock prices = inc
19
Q

Late Upswing

A
  • ST and LT rates = inc
  • inflation = inc
  • confidence = peak
  • gov = rest MP
  • bond prices = dec
  • stock prices = peak
20
Q

Slowdown

A
  • ST and LT rates = peak
  • inflation = peak
  • confidence = dec
  • gov = less rest MP
  • bond prices = inc
  • stock prices = dec
21
Q

Recession

A
  • ST and LT rates = dec
  • inflation = inc
  • confidence = low
  • gov = exp MP and FP
  • bond prices = inc
  • stock prices = inc
22
Q

Monetary Policy

A
  • stimulate econ = dec int rates
    • upward sloping yield curve
  • slow econ = inc int rates
    • downward sloping yield curve
23
Q

Deflation

A

BAD

defer spending now b/c cheaper in future, bad for econ

hard to use MP - can’t really dec rates more

24
Q

Fiscal Policy

A

changes to budget deficit

stimulate econ = inc deficit

slow econ = dec deficit

25
Q

Taylor Rule

A

r = policy neutral rate + 0.5(exp - trend GDP growth) + 0.5(exp - acceptable inflation)

used to anticipate changes in central bank policy/ int rates

26
Q

Inflation on Asset Returns

A
  • avg inf: cash, bonds, eqty, real estate = good
  • high inf: cash, real estate = good; bonds, eqty = bad
  • deflation: bonds = good; cash, eqty, real estate = bad
27
Q

MP and FP

Impact on Yield Curve and Economy

A
  • both stim: upward sloping yield curve, econ growth
  • both rest: downward sloping yield curve, econ cont
  • MP rest, FP stim: flatter yield curve, econ = ?
  • MP stim, FP rest: slightly steep yield curve, econ = ?
28
Q

Trend Rate of Economic Growth

A
  1. changes in employment
  2. changes in productivity and capital (TFP growth)
  3. consumer spending
  4. exogenous shocks
  5. gov interference/ support
29
Q

Twin Deficit Problem

A

large gov deficit (G > T) and large capital acct deficit (M > X)

potential problems when dec deficits:

  • gov spending inc int rates
  • gov inc taxes
  • inc foreign inv = dec currency value (inflation)
30
Q

Pegged Currency

A

developing country pegs their currency FX rate to that of a developed country’s currency

  • must follow econ policy of dev country
  • pegged int rates > dev country’s int rates (riskier)
  • interest rate differential changes based on confidence of peg
31
Q

Emerging Markets Warning Signs

A
  • gov debt/ GDP > 4%
  • growth < 4% (insufficient to keep up w/ pop growth)
  • current account deficit > 4% GDP
  • foreign debt/ GDP > 50%
  • foreign currency reserves < ST foreign currency debt
  • gov policies not supportive of growth
32
Q

Forecasting by Asset Class

A
  • cash/ cash eq: MP and ST int rates
  • default-free bonds: LT int rates, inflation, S/D
  • credit risky bonds: credit spread
  • inflation indexed bond: real yield, S/D
  • common stock: earnings, P/E ratio
  • emerging market stock: forecast of developed markets
  • real estate: int rates, S/D
33
Q

Forecasting Exchange Rates

A
  1. purchasing power pairity: higher relative inflation = curr dep
  2. relative econ strength: attracts capital = curr app
  3. capital flows: attracts capital = curr app
  4. savings-inv imbalances: savings/ inv = deficit, need curr app to attract inv
34
Q

Expected Growth in GDP

A

%ΔY ≅ %ΔA + α(%ΔK) + (1 − α)(%ΔL)

ΔA = managerial and technological innovation

35
Q

Gordon Growth Model

A

V0 = D1 / ( r - g )

36
Q

H-Model

A

for emerging economies

37
Q

Security Selection

A

top-down: macro analysis; identify sectors > markets > securities; manager focus on markets and industries

bottom-up: micro analysis; research firm, determine if it’s a good inv; manager focused on long-short, market neutral strategy

38
Q

Fed Model

A

EY > treasury yield, ratio > 1 - undervalued

EY < treasury yield, ratio < 1 - overvalued

CONS: ignores ERP, ignores earnings growth, compares real variable (EY) to nominal value (treasury yield)

39
Q

Yardeni Model

A

compares theoretical EY to acutal EY; variation of the constant growth DDM where earnings = div, yield on A-rated corp bonds = r and a 5 year growth forecast = g

actual EY < fair value yield - overvalued

actual EY > fair value yield - undervalued

CONS: assumed r, d varies over time, earnings estimates can be wrong

40
Q

CAPE

A

cyclically adjusted P/E ratio

CAPE > historical avg - overvalued

CAPE < historical avg - undervalued

10 yr avg earnings captures effects of business cycle and inflation

41
Q

Q Models

A

MV/ replacement cost

q > 1 - equity overvalued

q < 1 - equity undervalued

CFA Level III (12 decks)

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