s7-1 answer

Schweser Printable Answers - S7-1

Test ID#: 11

Question 1 - #92993

In which of the following BRIC countries is technological progress projected to be weaker?

Your answer: B was incorrect. The correct answer was A) Brazil and India.

In Brazil and India, technological progress is projected to be weaker than in China and Russia over the next 20 years because of a less educated workforce and a weaker infrastructure. Eventually though, technological progress in Brazil and India should converge to that in the developed world.

This question tested from Session 7, Reading 20, LOS c.

Question 2 - #92671

Which of the following best characterizes the relationship between investment capital and economic output in emerging markets?

Your answer: B was correct!

Developing economies have the potential to increase returns on capital and productivity because they are currently operating below the levels of more mature, developed countries. Because developing countries currently utilize relatively low amounts of capital, an increase in investment capital will result in a relatively high level of output.

This question tested from Session 7, Reading 20, LOS b.

Question 3 - #127222

Using the data provided, rank the following variables in descending order of their impact on real economic output: change total factor productivity (TFP), change in labor input (labor), and change in capital input (capital).

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A) Brazil and India.

B) Russia and Brazil.

C) Russia and China.

A) Investment capital is unrelated to the level of output in emerging countries due to structural inefficiencies.

B) An increase in investment capital will result in a high level of output.

C) An increase in investment capital will result in a low level of output.

Expected growth in real economic output

2%

Expected growth in total factor productivity 1%

Expected growth in the labor 1%

Expected growth in capital stock, α = 0.4 1%

A) TFP, labor, capital.

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Your answer: A was correct!

From the Cobb-Douglas production function we know that real economic output will change by: the same percentage change as TFP, α times the percentage change in capital input, and (1 − α) times the change in labor input. Consider a 1% increase in each of the three variables individually while holding the others constant. Using the Cobb-Douglas function below and an alpha of 0.4, we can see that ∆y = 1.0% for a 1% change in TFP (%∆A), 0.4% for a 1% change in capital, and 0.6% for a 1% change in labor.



The following table reflects economic data for market EM.

Using the Cobb Douglas production function and the data provided, the Solow residual is closest to:




The following table reflects economic data for Market Q:

Using the Cobb-Douglas production function and the data provided, the expected growth (percentage change) in real economic output for Market Q is closest to:

B) Labor, capital, TFP.

C) Capital, TFP, labor.

%∆Y

= %∆A + α(%∆K) + (1 − α)(%∆L)

� = 1.0% + 0.4(1.0%) + (0.6)(1.0%)

Expected growth in real economic output 3.0%

Expected growth in the labor 2.0%

Expected growth in capital stock, α = 0.7 1.2%

A) 1.6%.

B) 1.2%.

C) 2.0%.

Solow residual

= %∆TFP = %∆Y − α(%∆K) − (1 − α)%∆L

� = 3.0% − 0.7(1.2%) − 0.3(2.0%) = 1.56%

Expected growth in total factor productivity 1.0%

Expected growth in the labor 2.0%

Expected growth in capital stock, α = 0.4 1.2%

A) 2.7%.




%∆Y = %∆A + α(%∆K) + (1 − α)(%∆L) = 1.0% + 0.4(1.2%) + 0.6(2.0%) = 2.68%

This question tested from Session 7, Reading 19, LOS a.

Question 6 - #92890

Which of the following projections best characterizes BRIC country economies in 2050?


By 2040, the total size of the BRIC economies may surpass that of the G6. The stronger economic growth for emerging markets should result in higher stock returns. Furthermore, the increased growth in these markets will increase the demand for capital, which should strengthen their currency values. As a result, the market capitalization of these markets should increase by 2050.

This question tested from Session 7, Reading 20, LOS e.


Which of the following statements is least characteristic of the bottom-up method of forecasting investment returns?


The analyst comparing the expected performance of indices to general asset classes, such as equities, bonds, and alternatives to identify which class of assets will be expected to under- or out-perform is considered part of a macro-analysis top-down method of forecasting.

In a bottom-up forecast, the analyst first takes a microeconomic perspective by focusing on the fundamentals of individual firms. The analyst starts the bottom-up analysis by looking at an individual firm抯 product or service development relative to the rest of the industry. The analyst should assess the firm抯 management and its willingness and ability to adopt the technology necessary to grow or even maintain its standing in the industry. Given the analyst抯 expectations for the firm, the analyst uses some form of cash flow analysis to determine the firm抯 investment potential (i.e., expected return).


Question 8 - #92701

What percent of BRIC GDP growth (measured in U.S. dollars) should likely come from changes in BRIC

B) 3.0%.

C) 3.2%.

A) Increased stock market capitalization and GDP less than in the G6.

B) Increased stock market capitalization and GDP greater than in the G6.

C) Decreased stock market capitalization and GDP greater than in the G6.

A) The analyst compares expected performance of various indices to general asset classes.

B) Cash flow analysis is used to determine a firm抯 investment potential.

C)Assessing a firm抯 management to determine its willingness and ability to adopt technology to remain competitive in the market place.



currency values?


About a third of the BRIC GDP growth projected until 2050, as measured in U.S. dollar terms, should come from rising BRIC currency values.


Question 9 - #92660

Which of the following best characterizes the relationship between per capita income and currency values in emerging markets? Their currencies are currently:


When countries have low per capita income levels, their currencies tend to be weak and below levels predicted by Purchasing Power Parity (PPP). As the developing countries mature and income rises, their currencies will appreciate and converge toward the value predicted by PPP.



Which of the following BRIC countries has the weakest educational system?


Research has demonstrated that higher levels of education are associated with increased economic growth in a country. Although some BRIC countries have made some progress in this area, the primary and secondary education systems in India are relatively poor.

This question tested from Session 7, Reading 20, LOS d.


Which of the following best characterizes the relationship between technological advances, exchange rates, and economic output (in U.S. dollars) in BRIC countries?

A) A third.

B) A half.

C) A quarter.

A) below levels predicted by Purchasing Power Parity and will fall in value as per capita income increases.

B)below levels predicted by Purchasing Power Parity and will rise in value as per capita income increases.

C) above levels predicted by Purchasing Power Parity and will rise in value as per capita income increases.

A) Brazil.

B) India.

C) China.




Stronger technological progress should result in higher economic growth and a stronger currency. In Brazil and India, technological progress is projected to be weaker than in China and Russia over the next 20 years because of a less educated workforce and a weaker infrastructure.


Question 12 - #127223

The following data pertains to an equity market index.

Using the data in the table, the intrinsic price level of the equity market index is closest to:

Your answer: C was correct!

We are provided with a constant rate of growth, so we can use the constant growth dividend discount model for equity valuation:



From the discussion of BRIC country prospects, which of the following best represents the forecast regarding their attractiveness as an investment? BRIC country stocks are:

Your answer: A was incorrect. The correct answer was B) an attractive investment in part because higher currency values will strengthen the return from them.

A) Technological progress results in depreciating currencies and technological progress in Russia may lag that of Brazil, due in part to a weaker infrastructure.

B) Technological progress results in appreciating currencies and technological progress in Brazil may lag that of Russia, due in part to a weaker infrastructure.

C) Technological progress results in appreciating currencies and technological progress in Russia may lag that of Brazil, due in part to a weaker infrastructure.

Last dividend (D0) 100

Forecast earnings per share 300

Current and sustainable long-term growth rate 2.5%

Required return 7.5%

Yield on 10-year government bond 6.0%

A) 2,000.

B) 2,929.

C) 2,050.

A)an attractive investment in part because developed country 揵aby boomers� will turn to them as alternative investments.

B) an attractive investment in part because higher currency values will strengthen the return from them.

C) not an attractive investment in part because high inflation will detract from their returns.



The stronger economic growth for emerging markets may result in higher stock returns. Furthermore, the increased growth in these markets will increase the demand for capital, which should strengthen their currency values. Although developed country 揵aby boomers� may turn to them as alternative investments, this is not mentioned in the review.


Question 14 - #127226

Which of the following statements most accurately describes the relationship between the intrinsic value of an equity market index and the input variables in the H model? The intrinsic value of an index is:


In the H-model shown below the intrinsic value of a market (P0) is positively related to: the length of the period of decline in years (N), both the sustainable (gL) supernormal (gs) growth rates, and negatively related to the required return on equity (r). We can see that as the required return (r) increases the denominator of the equation increases causing P0, the intrinsic value, to decrease resulting in a negative relationship between r and the intrinsic value P0.


Question 15 - #127235

Which of the following is the best interpretation of the 10-Year Moving Average Price/Earnings Ratio (also referred to as the P/10-year MA(E))?

Your answer: A was incorrect. The correct answer was C) The numerator of the P/10-year MA(E) is the value of the S&P 500 price index, and the denominator is the average of the previous ten years� reported earnings.

The numerator of the P/10-year MA(E) is the value of the S&P 500 price index, and the denominator is the average of the previous ten years� reported earnings. Both are adjusted for inflation using the consumer price index. Similar to a trailing P/E ratio, the P/10-year MA(E) compares the inflation adjusted price of the market at a point in time to the market抯 average real earnings over the previous ten years. The other answer choices are probable ways of valuing the market by comparing an historical average P/E ratio to the current P/E but the P/10-year MA(E) ratio is defined differently.

This question tested from Session 7, Reading 19, LOS f.

A) negatively related to the growth rate but positively related to the length of the period of decline and required return.

B) positively related to the growth rate and required return but negatively related to the length of the period of decline.

C) positively related to the growth rate and length of the period of decline but negatively related to the required return.

A) By comparing the 10 year moving average P/E ratio for a market to the current P/E ratio we can determine whether or not the market is over or under priced.

B) A 10 year moving average P/E ratio greater than the current P/E ratio for a market indicates the market is currently undervalued.

C) The numerator of the P/10-year MA(E) is the value of the S&P 500 price index, and the denominator is the average of the previous ten years� reported earnings.



Question 16 - #127239

Given an S&P 500 forward earnings yield of 7.2% and 10-year Treasury notes yielding 2.68%, which of the following interpretations of this data using the Fed model is most accurate?

Your answer: C was incorrect. The correct answer was A) The S&P 500 earnings yield is higher than the Treasury yield indicating that equities are undervalued and should increase in value.

The Fed model assumes that the expected operating earnings yield on the S&P 500 (i.e., expected aggregate operating earnings divided by the current index level) should be the same as the yield on long-term U.S. Treasuries:

If the S&P 500 earnings yield is higher than the treasury yield, the interpretation is that the index value is too low relative to earnings. Equities are undervalued and should increase in value.

This question tested from Session 7, Reading 19, LOS g.


Which of the following best characterizes the relationship between technological advances, exchange rates, and economic output (in U.S. dollars) in emerging markets? Emerging countries currently utilize:


The rate of technological progress in emerging countries will eventually catch up to that in developed countries. Stronger technological progress should result in higher economic growth and a stronger currency. When measured in U.S. dollars, economic growth in developing countries will increase as a result of both growth itself and an appreciating currency.


Question 18 - #127234

The Yardeni model is best explained as:

A) The S&P 500 earnings yield is higher than the Treasury yield indicating that equities are undervalued and should increase in value.

B) The spread between the S&P 500 earnings yield and the Treasury notes is too great to make an informed decision.

C) Since the S&P 500 is earning significantly more than the Treasuries this indicates the S&P 500 equity market is overvalued.

A) low amounts of technology but output will increase as more is used. However, depreciating currencies will detract from growth.

B) low amounts of technology but output will increase as more is used due in part to appreciating currencies.

C) normal amounts of technology but output will increase as more is used due in part to appreciating currencies.

A)a variation of the constant growth dividend discount model in which earnings are used instead of dividends.

a variation of the constant growth dividend discount model in which earnings are used instead of




The Yardeni model for estimating the equilibrium earnings yield (i.e., the fair earnings yield) is based on a variation of the constant growth dividend discount model (CGM), in which investors value total earnings rather than dividends:

We can restate the CGM to show that the earnings yield must be the difference between the required return on equity and expected long-term growth. This is logical, since we assume the total return on equity, r, must be the sum of the earnings yield, E1 / P0, and growth (i.e., capital gains), g:

Yardeni incorporates risk into his model by using the yield on A-rated corporate bonds, YB, as the required return on equity, r. The difference between the yields on A-rated corporates and risk-free treasuries serves as a proxy, although most likely understated, for the equity risk premium. Also, instead of the long-term growth assumed in the CGM, Yardeni uses a 5-year growth forecast, LTEG, for the S&P 500. The model becomes:

The Yardeni model can be applied as a ratio:



From the discussion of BRIC country prospects, which of the following best represents the conclusion drawn about their attractiveness as an investment? BRIC country stocks are:

B) dividends, the yield on A-rated corporate bonds is substituted for r the required return on equity, and a 5 year growth forecast is substituted for the growth rate.

C) being able to value the market by applying the model as a ratio with a value greater than 1 indicating the market is overvalued.

A) an attractive addition to a portfolio even though their currencies are expected to depreciate.

an attractive addition to a portfolio because their stronger economic growth may result in higher




The stronger economic growth for emerging markets may result in higher stock returns. Furthermore, their currencies should strengthen in value.


Question 20 - #127231

A long-short, market neutral strategy is most likely indicative of which kind of forecasting technique to predict returns?


A long-short, market neutral strategy utilizes a trading strategy where an overvalued stock is shorted and a similar stock within the same industry thought to be undervalued is bought indicative of a bottom up strategy in which the analyst first takes a microeconomic perspective by focusing on the fundamentals of individual firms.


Question 21 - #127236

Which of the following statements regarding Tobin抯 q and the equity q is least accurate?

Your answer: B was incorrect. The correct answer was C) The equilibrium value for both Tobin抯 q and the equity q is 1.

The equilibrium value of both Tobin抯 q and the equity q can be based on historical long-run average values that could be greater or less than 1. In the absence of any information the equilibrium value of both Tobin抯 q and the equity q is assumed to be 1.0.

Tobin抯 q compares the current market value of a company to the replacement cost of its assets. The thinking is that the sum of the market (replacement) values of the individual assets should be the same as their aggregate market value, as reflected in the sum of the market values of the firm抯 debt and equity. The theoretical value of Tobin抯 q is 1.0. If the current Tobin抯 q is above (below) 1.0 the firm抯 stock is presumed to be overpriced (underpriced).

The equity q focuses on equity values. It compares the aggregate market value of the firm抯 equity to the market value of the firm抯 net worth (i.e., net assets) measured as the market value of its assets less the market value of its liabilities. Again, the expected value of the ratio is 1.0.

Both ratios are considered mean-reverting. A q value above 1.0 would be expected to fall because it indicates

B) stock returns.

C) not an attractive addition to a portfolio because their risk does not justify their return.

A) Top down.

B) Combination of both top down and bottom up.

C) Bottom up.

A) Tobin抯 q compares the current market value of a company to the replacement cost of its assets.

B)The equity q compares the aggregate market value of the firm抯 equity to the market value of the firm抯 net worth.

C) The equilibrium value for both Tobin抯 q and the equity q is 1.



that the firm抯 net assets, as measured by the market value of equity, are currently overvalued. Using the opposite argument, a value less than 1.0 would be expected to rise.


Question 22 - #127219

Which of the following statements about the Cobb Douglas production function is least accurate? The Cobb朌ouglas production function assumes the:

Your answer: C was incorrect. The correct answer was B) growth in economic output must be less than the growth in corporate earnings.

The Cobb-Douglas production function (CD) uses the country抯 labor input and capital stock to estimate the total real economic output. The general form of the function is:

Y = AKαLβ

Y = total real economic output A = total factor productivity (TFP) K = capital stock L = labor input α = output elasticity of K (0 < α < 1) β = output elasticity of L (α + β = 1)

An assumption of the Cobb-Douglas production function is that economic growth and growth in corporate earnings are equal. In the short-term the two can be quite different, but over the long-term the assumption is reasonable. The Cobb-Douglas production function also assumes constant returns to scale. Thought of as efficiency, constant returns to scale implies that total factor productivity (TFP) remains constant (∆TFP is zero). α and β are the output elasticities of capital and labor, respectively. The model assumes 0 < α < 1.0 and β = (1 � α) so that the sum of α and β is 1.0.



During the period 1960 to 2000, which of the following countries best illustrated the fact that as developing countries mature, their productivity slows?

Your answer: B was incorrect. The correct answer was C) Japan.

As developing countries mature, their returns on capital and productivity will slow. Japan and Germany had very high rates of growth in the post-war 1960s and 1970s, but their growth slowed in later years.


Question 24 - #127232

A) output elasticities of capital and labor, α and β, sum to 1.0.

B) growth in economic output must be less than the growth in corporate earnings.

C) growth in total factor productivity (TFP) is zero when constant returns to scale are present.

A) Russia.

B) Brazil.

C) Japan.



Which of the following is least likely to be a bias in the top-down analysis model?


Individual managers being overly optimistic is a bias in the bottom-up approach. Individual managers tend to be overly optimistic about their firm抯 future thus aggregating individual manager expectations can lead to significantly over estimating industry expectations. Biases found in the top-down approach can occur when models are sometimes slow in capturing structural changes to the individual factors used in the model since historical data is used. Also, the models may be incorrectly specified since the variables used in the past may no longer be appropriate.



Which of the following best characterizes the relationship between technological progress, the growth in capital stock, and economic output in the BRIC countries?

Your answer: B was incorrect. The correct answer was A) Technological progress can have a large impact on economic growth but the growth in capital stock is less important for economic growth.

Changes in technological progress can have a large impact on economic growth. The growth in capital stock is less important for economic growth than technological progress but does have an impact on economic growth. Reducing the projected growth in capital stock by 5% would reduce GDP levels by 13% in the BRIC countries in 2050.



Which of the following best characterizes the future investment environment in BRIC countries? BRIC country stock markets will be characterized by currency:


The increased growth in emerging markets will increase the demand for capital, which should strengthen their currency values. As a result, the market capitalization of these markets will increase, justifying their representation in a well-diversified portfolio.


A) Individual managers tend to be more optimistic than is warranted by the model.

B) Econometric models may be slow in capturing changes in individual factors.

C) Models may be incorrectly specified using the wrong variables.

A) Technological progress can have a large impact on economic growth but the growth in capital stock is less important for economic growth.

B) Both technological progress and the growth in capital stock can have a large impact on economic growth.

C) The growth in capital stock can have a large impact on economic growth but technological progress is less important for economic growth.

A) depreciation and increased market capitalization.

B) appreciation and increased market capitalization.

C) depreciation and decreased market capitalization.




Which of the following BRIC countries has had the most trouble with inefficient institutions?

Your answer: A was incorrect. The correct answer was C) Russia.

If the institutions in an economy operate efficiently, an economy can produce goods and services more efficiently. Inefficient institutions are often symptomatic of other chronic problems. BRICs have had trouble in this area, particularly in the case of Russia.


Question 28 - #127225

An analyst has gathered the following data for a developed market index:

If the next expected dividend is 150 and the required equity return is 8%, the intrinsic price level of the equity index is closest to:

Your answer: B was incorrect. The correct answer was C) 2,564.

Using the Cobb-Douglas production function and the data provided, the long-term sustainable growth rate in GDP is:

%∆Y = %∆A + α(%∆K) + (1 − α)(%∆L) = 1.0 + 0.7(1.0) + 0.3(1.5) = 2.15%

Using the constant growth dividend discount model and the growth rate of 2.15%, the intrinsic value is estimated to be:


Question 29 - #127224

An equity market抯 forecasted EPS is 15.30. Assuming a required real return on equity of 8%, a current dividend of 10, current supernormal growth of 9.5%, a long-term sustainable rate of growth of 2.0%, and a 20-year period of linear growth decline, the estimated forward price-earnings ratio (P0/E1) of the market is closest

to:

A) India.

B) Brazil.

C) Russia.

% Growth in Total Factor Productivity

% Growth in Capital

Stock

% Growth in Labor

Input

Output Elasticity of Capital (α)

Output Elasticity of

Labor (1 − α)

1.0 1.0 1.5 0.7 0.3

A) 2,396.

B) 2,620.

C) 2,564.



Your answer: B was incorrect. The correct answer was A) 19.3.

With the data provided, we use the H-model for equity valuation to solve for the intrinsic value of the index:



What is the projected annual increase in global spending for BRIC countries, compared to G6 countries (measured in U.S. dollar terms) by 2050?

Your answer: A was incorrect. The correct answer was C) The increase in global spending for BRIC countries should be four times as large.

Currently, the annual increase in global spending, measured in U.S. dollar terms, is about the same for the G6 and the BRICs as a whole. But by 2050, the annual change in spending should be four times larger in the BRIC countries.



Which of the following BRIC countries will experience the most rapid aging of its population?


Although BRIC countries have a relatively young population, they are expected to experience a decline in their working age population, albeit later than that in the G6. The aging will be more rapid in Russia and China and less rapid in India and Brazil.



A) 19.3.

B) 15.4.

C) 23.1.

A) The increase in global spending for BRIC countries should be two times as large.

B) The increase in global spending for BRIC countries should be equal.

C) The increase in global spending for BRIC countries should be four times as large.

A) Russia and Brazil.

B) India and China.

C) Russia and China.



Which of the following BRIC countries has been the slowest to open their economy?

Your answer: B was incorrect. The correct answer was A) India.

An open economy is one in which trade and capital flows freely across its borders. With an open economy, an economy gains increased access to technology, inputs, and markets. Research has verified that openness in an economy results in higher growth. Some BRICs have had more success at opening up their economy; India has been particularly slow to do so.


Question 33 - #127240

Given a current P/10-year MA(E) of 18.35 and an historical mean of 16.3, which of the following statements is the most accurate interpretation of this data?

Your answer: C was incorrect. The correct answer was B) The market is over-valued and will revert back to the historical mean of 16.3.

In the 10-year moving average price/earnings ratio, P/10-year MA(E), the numerator is the value of the S&P 500 price index, and the denominator is the average of the previous ten years� reported earnings. Both are adjusted for inflation using the consumer price index. Similar to a trailing P/E ratio, the P/10-year MA(E) compares the inflation adjusted price of the market at a point in time to the market抯 average real earnings over the previous ten years.

To use the P/10-year MA(E) the analyst compares its current value to its historical average to determine whether the market is over- or under-priced. If the current ratio is greater than the historical average, the current price (i.e., level of the index) is high relative to earnings. The index would be considered over-priced and would be expected to revert to its historical mean.


Question 34 - #127238

A Tobin抯 q value for an equity market of greater than 1 can be interpreted as the:

Your answer: A was incorrect. The correct answer was B) market is over or under-valued depending upon the equilibrium value.

Tobin抯 q compares the current market value of a company (or equity market) to the replacement cost of its assets. If no equilibrium value is available the theoretical value of Tobin抯 q is 1.0. If the current Tobin抯 q is above (below) 1.0 the firm抯 stock (or equity market) is presumed to be overpriced (underpriced). A long run

A) India.

B) China.

C) Russia.

A) The market is under-valued and will revert back to the historical mean of 16.3.

B) The market is over-valued and will revert back to the historical mean of 16.3.

C) The earnings would need to be adjusted to reflect "real earnings" before an interpretation could be made.

A) market is over-valued and will revert back to a value of 1.

B) market is over or under-valued depending upon the equilibrium value.

C) replacement cost of assets is over stated.



average could be used for the equilibrium value which could be greater or less than 1. For example if the long run equilibrium value for an equity market is 1.5 and we observe a Tobin抯 q for that market of 1.2 then even though Tobin抯 q is greater than 1 the market would still be considered undervalued compared to the long run average equilibrium value.


Question 35 - #127237

Given the relationship, , which of the following statements is most accurate?

Your answer: A was incorrect. The correct answer was B) The market is under-valued.

The Yardeni model is:

It can also be applied as a ratio:


Question 36 - #127227

When using dividend discount models to evaluate the sensitivity of equity market value estimates to changes in input variables, which input variable remains constant?

Your answer: C was incorrect. The correct answer was B) The current dividend (D0) since it is not an

A) The market is over-valued.

B) The market is under-valued.

C) The market is fairly valued.

A) The number of years (N) to reach the sustainable growth rate because it is assumed to decline in a constant linear fashion.

B) The current dividend (D0) since it is not an estimate.

C) The sustainable growth rate since it is assumed to remain at a constant stable rate.



estimate.

The current dividend is the only input variable that is not an estimate thus it is assumed to be constant when evaluating the sensitivity of equity market value estimates to changes in input variables when using the H-model and constant growth dividend discount model. The other input variables (the length of the growth decline period (N) in the H-model, the sustainable and supernormal growth rates, and the required return) are all varied to see their impact on the intrinsic value calculated using either model.


Question 37 - #127230

Of the following investment strategies, which one would benefit most from a bottom-up forecasting approach in predicting equity returns?


In a bottom-up forecasting approach, the analyst first takes a microeconomic perspective by focusing on the fundamentals of individual firms indicative of buying and selling individual securities to capture short-term pricing inefficiency.

In a top-down forecasting approach, the analyst utilizes macroeconomic factors (e.g., interest rate expectations, expected growth in GDP) to estimate the performance of market-wide indicators, such as the S&P 500. Successive steps include identifying sectors in the market that will perform best given market expectations.



Karen Doyle and Amy Rodriguez are economists for a large U.S. investment advisory firm, Woodlawn Advisors. Doyle and Rodriguez use their independent research on developed country stock markets and emerging stock markets to provide advice for the firm抯 network of advisors. As the senior economist at Woodlawn, Doyle is a partner in the firm and is Rodriguez抯 supervisor. Rodriguez has worked for Woodlawn for the past four years. At a lunch meeting, the two economists discuss the growth prospects in BRIC (Brazil, Russia, India, and China) countries and compare them to the countries of the G6 (U.S., Japan, U.K., Germany, France, and Italy).

In their discussions, Doyle states that forecasted growth for the BRIC countries is quite impressive, especially in those countries with stable economic environments. She states that, by the year 2050, the per capita income in U.S. dollar terms in the majority of BRIC countries will exceed that in the G6 countries. Rodriguez is also very interested in BRIC country prospects, particularly in the factors necessary to sustain economic growth in the BRICs. She states that inflation need not hinder BRIC future growth, and that double-digit inflation may be necessary for BRICs to sustain future growth. Otherwise, she states, restrictive monetary policy can impede growth in an emerging economy.

Turning their attention next to currency valuation in the BRIC countries, Doyle states that currency values can be compared to that predicted by Purchasing Power Parity (PPP). For example, she states that if the current value of the Brazilian real is $0.53, then the value predicted by PPP should be higher, at say $0.60. Rodriguez states that, by the year 2050, the value predicted by PPP and the actual currency value should converge to a level higher than the current.

Doyle and Rodriguez then discuss the risks faced by investors in emerging markets. Doyle states that because many emerging countries have unstable political and social systems, the investor must carefully

A) Allocating invested funds across various markets.

B) A macro hedge fund manager allocating funds among currency markets.

C) Buying and selling individual securities to capture short-term pricing inefficiency.



analyze the risk in these countries. She states that bond investors should examine the deficit to GDP ratio. Ratios greater than four percent indicate substantial credit risk of the country抯 bonds. Rodriguez states that these small economies are often heavily dependent on the technology industry and their undiversified nature makes them susceptible to volatile capital flows and economic crises.

The next day, Doyle and Rodriguez provide an educational session for new employees at Woodlawn Advisors. In their presentation, they discuss the factors that result in higher economic growth for emerging countries. As part of their session, they ask the employees to determine which of the following emerging countries is likely to be most successful in promoting growth.

Doyle and Rodriguez then provide a discussion on valuing the Chinese stock market using the H-model given the following data:

Current annual dividend rate for the index of 8.1 Renminbi. An inflation-adjusted equity discount rate of 7.9%. A 30 year decline in dividend growth rates from an initial growth rate of 8.5%. A terminal sustainable growth rate to perpetuity of 4.0%.

The next day, talking amongst themselves, Doyle and Rodriguez discuss the currency risk in more detail. Doyle states that, in developed country stock markets, the currency value and the stock value often fall together because, when investors lose confidence in the currency, they also typically lose confidence in the stock market. Rodriguez states that if an investor wishes to add a manager with expertise in currencies to his or her existing investment policy, then the investor would use a balanced mandate approach.

Part 1) With respect to the statements regarding the per capita income and inflation in BRIC countries:

Your answer: C was incorrect. The correct answer was A) Doyle is incorrect; Rodriguez is incorrect.

Doyle is incorrect. Although she is correct that forecasted growth for the BRIC countries is quite impressive especially when there are stable economic environments, she is incorrect in her statement regarding per capita income. By 2050, the per capita income in the majority of BRIC countries (except in Russia) is projected to be below that in G6 countries.

Rodriguez is incorrect. The ability to sustain growth in a country is influenced by its macroeconomic stability which is characterized by stable inflation, responsible fiscal policies, stable currency values, and accommodating governmental policies. High inflation hampers growth because it discourages investment in the economy by households and businesses. As such, governmental fiscal and monetary policies should focus on controlling inflation. (Study Session 7, LOS 20.a)


Karen Doyle and Amy Rodriguez are economists for a large U.S. investment advisory firm, Woodlawn Advisors. Doyle and Rodriguez use their independent research on developed country stock markets and emerging stock markets to provide advice for the firm抯 network of advisors. As the senior economist at Woodlawn, Doyle is a partner in the firm and is Rodriguez抯 supervisor. Rodriguez has worked for Woodlawn for the past four years. At a lunch meeting, the two economists discuss the growth prospects in BRIC (Brazil,

Average tariff on imported goods and services

Military expenditures as a percent of GDP

Annual standard deviation of currency value

Annual growth in population

Country A None 5.1% 14.9% -0.4%

Country B 10% 4.4% 11.4% 1.8%

Country C None 7.3% 11.2% 1.9%

A) Doyle is incorrect; Rodriguez is incorrect.

B) Doyle is correct; Rodriguez is correct.

C) Doyle is correct; Rodriguez is incorrect.



Russia, India, and China) countries and compare them to the countries of the G6 (U.S., Japan, U.K., Germany, France, and Italy).



Doyle and Rodriguez then discuss the risks faced by investors in emerging markets. Doyle states that because many emerging countries have unstable political and social systems, the investor must carefully analyze the risk in these countries. She states that bond investors should examine the deficit to GDP ratio. Ratios greater than four percent indicate substantial credit risk of the country抯 bonds. Rodriguez states that these small economies are often heavily dependent on the technology industry and their undiversified nature makes them susceptible to volatile capital flows and economic crises.





Part 2) With respect to the statements regarding the valuation of the Brazilian real according to Purchasing Power Parity:






Country A None 5.1% 14.9% -0.4%

Country B 10% 4.4% 11.4% 1.8%


A) Doyle is incorrect; Rodriguez is correct.

B) Doyle is correct; Rodriguez is incorrect.

C) Doyle is correct; Rodriguez is correct.



Doyle is correct. When countries have low per capita income levels (as in BRIC countries), their currencies tend to be weak and below levels predicted by PPP. If the current value of the Brazilian real is $0.53 and the value predicted by PPP is $0.60, then the currency is undervalued by PPP standards.

Rodriguez is correct. As the BRIC countries mature and income rises, their currencies will appreciate and converge toward the value predicted by PPP. (Study Session 7, LOS 20.a)









The next day, talking amongst themselves, Doyle and Rodriguez discuss the currency risk in more detail. Doyle states that, in developed country stock markets, the currency value and the stock value often fall





Country A None 5.1% 14.9% -0.4%

Country B 10% 4.4% 11.4% 1.8%




together because, when investors lose confidence in the currency, they also typically lose confidence in the stock market. Rodriguez states that if an investor wishes to add a manager with expertise in currencies to his or her existing investment policy, then the investor would use a balanced mandate approach.

Part 3) With respect to the statements regarding the risks faced by investors in emerging markets:

Your answer: B was incorrect. The correct answer was A) Doyle is correct; Rodriguez is incorrect.

Doyle is correct. Emerging countries have unstable political and social systems. For the bond investor, the primary risk is credit risk � does the country have the capacity and willingness to pay back its debt. One measure of the ability to pay is the government deficit to GDP ratio. Ratios greater than four percent do indicate substantial credit risk of the country抯 bonds.

Rodriguez is incorrect. Although emerging countries have undiversified economies, their economies are often heavily dependent on the sale of commodities, not technology. In fact, emerging countries typically lag behind the developed world in terms of technological development. (Study Session 7, LOS 20.e)







A) Doyle is correct; Rodriguez is incorrect.

B) Doyle is incorrect; Rodriguez is incorrect.

C) Doyle is correct; Rodriguez is correct.

Average tariff on imported goods

Military expenditures as

Annual standard deviation of







Part 4) Which of the following emerging countries is most likely to be most successful in promoting growth?


Country C is most likely to be the most successful in promoting growth in Doyle and Rodriguez抯 table. It has an open economy (no tariffs), lowest currency risk, and the highest population growth. An open economy is one in which trade and capital flows freely across its borders. With an open economy, an economy gains increased access to technology, inputs, and markets. A stable macroeconomic environment promotes economic growth and is characterized by stable inflation, responsible fiscal policies, stable currency values, and accommodating governmental policies. A higher population and employment growth favors faster economic growth. Note that military expenditures as a percent of GDP are not mentioned in the review as a distinguishing characteristic of successful emerging countries. (Study Session 7, LOS 20.d)




Turning their attention next to currency valuation in the BRIC countries, Doyle states that currency values can be compared to that predicted by Purchasing Power Parity (PPP). For example, she states that if the current value of the Brazilian real is $0.53, then the value predicted by PPP should be higher, at say $0.60. Rodriguez states that, by the year 2050, the value predicted by PPP and the actual currency value should converge to a

and services a percent of GDP

currency value

Country A None 5.1% 14.9% -0.4%

Country B 10% 4.4% 11.4% 1.8%


A) Country A.

B) Country C.

C) Country B.



level higher than the current.






Part 5) Using the data given, what is the index level for the Chinese stock market implied by the H model?


The H model is calculated as follows:

V0 = (207.6923)[1.04 + 15(0.045)]

V0 = 207.6923(1.04 + 0.675)

V0 = 207.6923(1.715) = 356.19





Country A None 5.1% 14.9% -0.4%

Country B 10% 4.4% 11.4% 1.8%


A) 208.

B) 421.

C) 356.



(Study Session 7, LOS 19.d)










Part 6)





Country A None 5.1% 14.9% -0.4%

Country B 10% 4.4% 11.4% 1.8%




With respect to the statements regarding currency/stock correlations and managing currency risk in a portfolio:

Your answer: A was incorrect. The correct answer was B) Doyle is incorrect; Rodriguez is incorrect.

Doyle is incorrect. Her statement that the currency value and the stock value often fall together is true in emerging markets, but not developed markets. In developed markets, the correlation is usually negative, because when the domestic currency depreciates, the firm typically earns more from overseas sales.

Rodriguez is incorrect. If an investor wishes to add a manager with expertise in currencies to his or her existing investment policy, then the investor would use a currency overlay or currency as a separate asset allocation approach, not a balanced mandate approach. The two former approaches utilize a separate manager with currency expertise. In the currency overlay approach, the currency exposure is managed within the guidelines of the investment policy statement. In the currency as a separate asset allocation approach, the currency exposure is managed under its own separate investment guidelines. (Study Session 7, LOS 20.c)


Question 39 - #127228

A top-down forecast of earnings per share for an equity market index is best described as:


In a top-down forecast, the analyst utilizes macroeconomic factors (e.g., interest rate expectations, expected growth in GDP) to estimate the performance of market-wide indicators, such as the S&P 500. Successive steps include identifying sectors in the market that will perform best given market expectations. The other answer choices refer to the bottom-up method of forecasting.


Question 40 - #127233

Which of the following is least likely a criticism of the Fed model?


The Fed model has the following weaknesses:

Compares a real variable to a nominal variable. The S&P 500 earnings yield will not automatically

A) Doyle is correct; Rodriguez is correct.

B) Doyle is incorrect; Rodriguez is incorrect.

C) Doyle is correct; Rodriguez is incorrect.

A) taking a microeconomic perspective by focusing on the fundamentals of individual firms.

B) looking at an individual firm抯 product development relative to the rest of the industry.

C) using macroeconomic factors to estimate the performance of market-wide indicators.

A) It inappropriately mixes real and nominal yields by comparing the real yield on Treasuries to the nominal S&P earnings yield.

B) The Fed model ignores the risk premium found in equities by saying the yield on Treasuries is the same as the earnings yield of the S&P 500.

C) The Fed model ignores the growth component of earnings by assuming the yield on Treasuries is the same as the earnings yield of the S&P 500.



adjust to incorporate changes in inflation and could be considered real. The yield on a treasury is adjusted to incorporate changes in inflation and is thus considered nominal.

Ignores the equity risk premium. Assuming the yield on treasuries is the same as the earnings yield on the S&P ignores the inherent risk of equities.

Ignores earnings growth. Growth expectations affect earnings, but treasury yields have no growth components. By assuming the yield on a treasury should be the same as corporate earnings yield, the model implicitly assumes zero growth in earnings.


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