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CFA3 > Economics > Flashcards

Economics Flashcards

1
Q

Name three challenges in developing capital market forecasts, the impact on CME, and a fix

A

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.

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2
Q

What is the equation for LT GDP growth rate?

A

LT growth rate of labour force + LT growth rate in labour productivity.

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3
Q

What is the equation for LT equity growth rate?

A

LT nominal GDP growth rate + dividend yield.

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4
Q

What is two pros and two cons of econometric modelling?

A

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.

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5
Q

What is two pros and two cons of the economic indicators approach to economic forecasting?

A

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.

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6
Q

What is a pro and a con of a checklist approach to economic forecasting?

A

Limited complexity. Imposes no consistency of analysis across items or across time.

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7
Q

What are the capital market expectations in an initial recovery?

A

ST rates are low or declining. LT rates are bottoming out. Upward sloping yield curve. Riskier assets do well.

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8
Q

What are the capital market expectations in an early expansion?

A

ST rates rise. LT rates bottoming out or rising. Flattening yield curve. Riskier assets rise.

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9
Q

What are the capital market expectations in a late expansion?

A

ST and LT rates rise. Flattening yield curve. Riskier assets are rising but volatile.

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10
Q

What are the capital market expectations in a slowdown?

A

ST rates rise/peak. LT rates high then fall. Yield curve may invert. Riskier assets decline.

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11
Q

What are the capital market expectations in a contraction?

A

ST and LT rates fall. Steepening yield curve. Riskier assets do well later in recession.

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12
Q

How does cash perform below/above expectations and deflationary environment?

A

Positive (negative) impact with rising (falling) rates.
Positive impact if nominal rates have a 0% bound.

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13
Q

How do bonds perform in normal inflation times, below/above expectations and deflationary environment?

A

Normally ST yields for volatile than LT yields.
Negative impact. LT yields more volatile than ST. Coupons worth less.
Positive impact from fixed coupons.

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14
Q

How do stocks perform below/above expectations and deflationary environment?

A

Negative impact with central bank action or falling asset prices.
Negative impact as economic activity declines.

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15
Q

How does real estate perform below/above expectations and deflationary environment?

A

Positive impact as real asset values and rents rise.
Opposite with deflation.

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16
Q

What is the Taylor rule for the target nominal policy rate?

A

real neutral rate + expected inflation + 0.5(expected GDP – GDP target) + 0.5(expected inflation – inflation target)

17
Q

What is the equation for the current account?

A

(savings - investment + (taxes - government spending)

18
Q

What is the result if portfolio duration > investment horizon if rates are forecasted to fall?

A

Capital appreciation dominates reinvestment return leading to capital gain.

19
Q

What is the Grinold-Kroner model equation?

A

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.

20
Q

What is the Singer–Terhaar integrated and segmented risk premium for each asset class, and the weighted average risk premium equation?

A

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).

21
Q

What is the Singer–Terhaar model finding?

A

Move capital to markets that become more integrated because its required return will fall, increasing expected return.

22
Q

What risks to bond investors in EM countries face?

A

Weak enforcement of contract law making it difficult to recover claims.

23
Q

What additional risks do equity investors face over bond investors in EM countries face?

A

Corporate governance risks: expropriation of assets, weak disclosure and accounting practice.

24
Q

What is the LT growth rate of real estate?

A

cap rate + nominal NOI growth rate.

25
Q

What is the ST growth rate of real estate?

A

cap rate + nominal NOI growth rate – %ΔCap rate

a decrease in cap rates increases growth.

26
Q

What are two approaches to forecasting exchange rates?

A

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.

27
Q

What is a pro and a con of the sample statistic as a volatility forecaster?

A

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).

28
Q

What is a pro and a con of the factor-based statistic as a volatility forecaster?

A

Can be used if number of assets > observations. May result in some portfolios to appear riskless if some factors are redundant.

29
Q

What is a pro of the shrinkage statistic as a volatility forecaster?

A

Has the benefits of the sample and factor-based statistic without the downsides.

30
Q

What are the three phases of the Dornbusch overshooting mechanism?

A

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.

31
Q

What is the LT Grinold-Kroner model equation?

A

D/Y + nominal GDP growth

32
Q

What does a CA surplus do for one currency against another?

A

In the absence of capital flows, appreciates to address the trade imbalance.

33
Q

What is the independent MP trilemma?

A

A country can pick two of the following: open capital account, fixed exchange rate, and independent MP. It cannot pursue all three.

34
Q

What is the CIRP?

A

That currencies with higher interest rates will trade at a forward discount.

CFA3 (8 decks)

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