Global Capital Markets History and Valuation

Question 1

Equity Premium

Answer 1

Excess return of stock / the risk-free return. The return you get for taking on the risk of equities (beyond that of “safe” investments (the risk-free rate).
= (1+r)/(1+r(f)) -1

If the S&P 500 returned 10% and the RFR is 3% = 1.10/1.03 -1 = 6.8%

Question 2

Shiller’s Ratio/CAPE

Answer 2

Cyclically-adjusted PE Ratio.

= share price / 10-yr earning average adjusted for inflation

Question 3

Bulldogs Inc has a price per share of $112 and EPS of $5.12. Over the last 10 years it has average EPS of $3.89/share, with an EPS adjusted for inflation of $3.40 over the same period. What is the Shiller Ratio? What is the Current PE?

Answer 3

Shiller = share price / 10yr earnings avg adj for inflation = 112/3.40 = 33

Current PE = 112/5.12 = 22

Question 4

Q Ratio

Answer 4

= total market value of firm / total replacement cost (ie assets-liabilities)

states that actual value of company should be equal to the replacement cost of their assets

> 1 stock is overvalued
<1 stock is undervalued

Question 5

Since 1955, Treasury bond yields and earnings yields on stocks were _______________.

positively correlated
nearly perfectly correlated
negatively correlated
uncorrelated

Answer 5

Positively Correlated

The earnings yield on stocks equals the expected real rate of return on the stock market, which should be equal to the yield to maturity on Treasury bonds plus a risk premium, which may change slowly over time.

Question 6

Which of the following investments has the highest historical correlation with the S&P 500 index over the long-term?

high-yield bonds
aggregate bond index
long-term treasuries
mortgage-backed bonds

Answer 6

High-yield (junk) bonds have higher correlation to stocks vs. an aggregate bond index. An aggregate bond index has higher correlation to stocks compared to short and medium term U.S. Treasuries.

Question 7

Which of the following statements regarding equity market valuations are accurate over the last 20 years?

I. Valuations of developed markets are approximately the same now as they were 20 years ago.

II. The spread between the valuations of emerging and developed markets got much wider during the financial crises.

III. Valuations of developed markets were usually lower than those of emerging markets over the last 20 years.

IV. Valuations of emerging markets overall have declined over the last 20 years.

IV and I only
III and IV only
I and II only
II and III only

Answer 7

IV and I only

CIMA Section I.C. Global Capital Markets History and Valuation

Valuations are approximately the same for developed markets as they were 20 years ago despite having risen in the late 1990’s and subsequently fallen through the financial crises only to rebound since 2009. The spread between the valuations of emerging and developed markets was very narrow during the financial crises. The valuations of emerging markets have been considerably lower than that of developed markets for most of the last 20 years. Valuations of emerging markets have declined over the last 20 years by roughly 20%.

Question 8

Which of the following statements about international investing are accurate?

I. Investing in ADRs is typically an attractive way to invest in international companies.

II. Hedging broadly diversified international equity positions is not typically a necessary strategy to manage currency risk.

III. Hedging broadly diversified international bond positions is not typically an essential strategy to manage currency risk.

IV. Investing in multi-national companies offers strong international diversification benefits.

III and IV only
IV and I only
II and III only
I and II only

Answer 8

I and II only

Investing in ADRs is typically an attractive way to invest in international companies (CIMA text, page 266). Hedging broadly diversified international equity positions is not typically a necessary strategy to manage currency risk (CIMA text, page 261). Hedging broadly diversified international bond positions is typically considered a necessary strategy to manage risk (CIMA text, page 303). Investing in most multi-national companies does not offer strong international diversification benefits (CIMA text, page 268).

Question 9

Which of the following statements about interest rates, inflation and real returns are not historically accurate or justified over the last half century in the U.S. and in most developed countries?

I. When inflation is rising, the real return on treasury bonds is expected to decline.
II. When inflation is declining, the real return on treasury bonds is usually positive but expected to decline.
III. Real returns on treasury bonds are expected to be negative during deflationary periods.
IV. Real returns on treasury bonds are expected to be negative during disinflationary periods.

I, III only
III, IV only
I, II only
II, IV only

Answer 9

III, IV only

Question 10

Requiring gold reserves to back up or guarantee paper currency should, in theory, help manage inflation. Assuming that the amount of gold available is fixed, this can actually have a(n) _____________ effect.

deflationary
expansionary
inflationary
hyper-inflationary

Answer 10

deflationary

The Gold Standard

Ramifications

Requiring gold reserves to back up or guarantee paper currency should, in theory, help manage inflation. Assuming that the amount of gold available is fixed, this can actually have a deflationary effect.

Potential Benefits

Stabilizes prices; can reduce uncertainty in trade; acts as a check and balance in keeping governments from creating units of their own currency at will; a system such as the gold standard can help prevent dishonest governments from manipulating economies and financially systems.

Potential Drawbacks

Applying a gold standard system is not convenient, is not very flexible and may not be sufficiently scalable; can create large short-term swings in value and price; such a standard can also be manipulated or controlled through war and other means.