# Economics Flashcards Preview

## CFA Level III > Economics > Flashcards

Flashcards in Economics Deck (41)
1
Q

Alpha

A

earning excess returns with specific strategies within an asset class

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
3
Q

Capital Market Forecasts

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

Gordon Growth Model

A

E(r) = D1/ P0 + g

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

7
Q

Discounted Cash Flow Assumptions

A

reinvest cash flows at the realized rate of return

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
9
Q

A

YTM = rf + risk premiums(s)

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

reqty = LT gov bond yield + eqty risk premium

10
Q

Sharpe Ratio

A

excess return per unit of risk

( Rm - Rf )/ σm

ERPm / σm

11
Q

β

A

systematic risk, used to value equity and fixed income sec

ρi,m σi / σm

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

13
Q

CAPM

A

r = rf + β( rm - rf )

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

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
16
Q

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

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

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