Flashcards in S7 Deck (28):

1

## Cobb-Douglas production function

###
Y = A * K^a * L^b

a + b = 1

Total economic output = Total factor productivity * Capital stock ^ output elasticity of Capital * Labor input ^ output elasticity of labor

K = eg Spending on raw materials

2

## Economy Total Factor Productivity TFP can change over time due to

###
- changing technology

- changing restrictions on capital/labor flows

- changing trade restrictions

- changing laws

- changing division of labor

- Depleting/discovering of Natural Resources

3

## H model

### P = D0 / (r-gl) * ( ( 1+ gl ) + N / 2 * (gs-gl) )

4

## Sustainable growth rate in GDP (based on Cobb Douglas production function) ===

###
Delta Y = Delta A + a * Delta K + (1-a) * Delta L

Delta A = Solow Residual

5

## Relative value models

###
Fed model

Yardeni model

10yr MA price / earnings model

6

## Fed model ratio =

###
= S&P yield / 10yr Treasury yield

=> if larger than 1 - equities are undervalued (or larger than long term average)

where S&P yield = Operating earnings / S&P value

7

## Flaws of Fed model

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- ignores equity risk premium

- ignores earnings growth for denominator

- compares real variable (S&P index) to nominal variable (Treasury yield)

8

## Yardeni model =

###
Yardeni earnings yield = E1 / P0 = Yb - d ( LTEG )

Market undervalued if we have ">" instead of "="

Yb = yield on A-rated corporate bonds (i.e. RFR + default premium)

d = weighting factor for the importance of earnings growth = historically 0.10

LTEG = long term earnings growth

9

## Things to remember about Yardeni model

###
- incorporates a proxy for equity market risk premium (yield of A-rated bonds)

- risk premium used is actually a measure of default risk - not a true measure of equity risk

- model relies on estimate of the value investors place on earnings growth (d), which is assumed to be constant over time

- LTEG assumptions might not be an accurate estimate of LT sustainable growth

10

## 10 yr MA P/E =

###
current market value / 10 year historical average of REAL earnings

Both denominator and numerator of historical ratio are adjusted to inflation (CPI) when are compared to current ratio

11

## 10 yr MA P/E ... things to remember

###
- restating to CPI the impact of inflation is removed

- using 10 year - it captures the effects of business cycles

- doesn't consider effects of changes in accounting rules/methods

- very high and low ratios have persisted historically - limiting usefulness in forming short term expectations

12

## Tobin q model (asset based valuation model) - FORMULA and STRENGTHS / WEAKNESSES

###
= asset MV / asset replacement cost = ( MV of debt + MV of equity ) / asset replacement cost

Strength: easy to use (due to mean reversion) , demonstrated usefulness via negative correlation to equity return

Weakness: replacement costs difficult to estimate, deviations may persist

13

## Equity q (asset based model) - FORMULA and STRENGTHS / WEAKNESSES

###
= equity MV / replacement value of net worth (net assets) = market cap / (replacement value of assets - liabilities )

Strength: easy to use (due to mean reversion) , demonstrated usefulness via negative correlation to equity return

Weakness: replacement costs difficult to estimate, deviations may persist

14

## In top-down forecast, the analyst utilizes

### macroeconomic factors to estimate performance of market wide indicators

15

## In bottom-up forecast, the analyst first takes

### micro-economic perspective by focusing on the fundamentals of individual firms

16

## intrinsic price level of the index =

### DIVIDEND * (1 + g) / ( r - g )

17

## Solow residual

### % change in total factor productivity

18

## when both top down and bottom up approaches are recommended simultaneously

###
When approaching or leaving recessions, management expectations can be biased. It would be wise in these situations for the bottom-up analyst to also utilize a top-down approach to confirm earnings estimates.

1. help analyst better understand market consensus

2. reveal a gap that gives rise to significant market opportunities

19

## 1 example of investors using top-down approach

### global macro hedge fund

20

## 2 example investors using bottom-up approach

### market neutral strategies, alpha focus via stock selection

21

## Aging a problem in what BRICs?

### Russian and China

22

## GDP per capita to remain below developed countries in all BRICs except

### Russia

23

## One third of US GDP growth to come from

### Currency appreciation

24

## BRICS with expected strongest tech progress

### China Russia

25

## conditions for sustained economic growth in BRICs

###
Macroeconomic stability

Institutional efficiency

Open trade

Worker education

26

## When yield curve is flat it means that policy is

### monetary restrictive, fiscal expansionary

27

## benefits of bottom up approach

###
= can help identify attractively prices securities irrespective of attractiveness of the sector

= may be a better fit for investors who focus on a market niche

28