solution manual for 《investment analysis and portfolio management》 ch12.doc

CHAPTER 12MACROECONOMIC AND MARKET ANALYSIS: THE GLOBAL ASSET ALLOCATION DECISIONAnswers to Questions1. The reason for the strong relationship between the aggregate economy and the stock market is obvious if one considers that stock prices reflect changes in expectations for firms and the results for individual firms are affected by the overall performance of the economy. In essence, you would expect earnings of firms to increase in an expansion. Then, if the P/E ratio remains constant or increases because of higher expectations and there is no reason why it should not, you would expect an increase in stock prices.2. Stock prices turn before the economy for two reasons: First, investors attempt to estimate future earnings and thus current stock prices are based upon future earnings and dividends, which in turn are determined by expectations of future economic activity. The second possible reason is that the stock market reacts to various economic series that are leading indicators of the economy - e.g., corporate earnings, profit margins, and money supply.3. Virtually all research has shown the existence of a strong relationship between money supply and stock prices as is evident from high R2s when money supply is used to explain stock price changes. However, it is not possible to use money supply changes to predict changes in stock prices, and this is not contradictory, since the stock market apparently reacts immediately to changes in money supply or investors attempts to predict this important variable. As a result, it is impossible to derive excess profits from watching current or recent past changes in the growth rate of the money supply.4. Excess liquidity is the year-to-year percentage change in the M2 money supply less the year-to-year percentage change in nominal GDP. The economys need for liquidity is given by its nominal growth. Any growth in M2 greater than that indicates excess liquidity that is available for buying securities, which would drive up prices.On the other hand, monetary growth in excess of GDP growth may lead to expected inflation. The rise in expected inflation would cause the nominal RFR to rise, in turn causing the required return to rise. This effect would lead to a decline in stock prices.5. If the market fully anticipates the rise in inflation, the long bond rate should rise to 10%. If we assume annual coupons, the 15-year 8% bond will go from a price of $1,091.03 to $847.89. 6. Most of the inputs in determining the price of a bond are known for instance, the promised coupon payments, the principal amount, and the dates on which those payments will be received. The one variable to be estimated is the required return, which can be found easily by comparing the bond in question to a similar existing bond.In contrast, the payments on common stock are not known, nor the dates on which they might be received. Further, the required return is more difficult to estimate.7. Based on the economic projections, there will be a low correlation of stock prices among the various countries. As a result, the investor can reduce risk by diversifying his holdings among various countries. The relationships between the various countries economic variables are reinforced in Exhibits 12.13 and 12.14. These show a fairly high correlation of stock returns between the United States and Germany, France and Italy, and one of the lowest relationships between the United States and Japan, although this correlation has tended to increase over time as the two economies become more interdependent.8. While the German market appears better with the 13% return compared to the U.S. return of 10%, one must also take the exchange rate into account. In the first case, the exchange rate goes from 0.90/$ to 0.75/$; that is, the dollar depreciates against the Euro, or the euro appreciates against the dollar. At the end of the investment period the Euro will buy more dollars than before, thus increasing the dollar return. Clearly in this case the German market would be the better investmentIn the second case, the exchange rate goes from 0.90/$ to 1.1/$. Here the dollar appreciates or the Euro depreciates. Thus the Euro will buy fewer dollars than before, reducing the total return in dollars. In this case we would need to compute the exact numbers to find out which is better. In the first case, assume $1,000 to invest. In the U.S. market, that $1,000 is expected to grow to $1,100. In the German market, we first convert $1,000 to 900. We expect this to grow 13% to 1,017. Given the exchange rate at the end of the investment period, that amount of Euros is equal to 1,017/.75 = $1,356. This reinforces what we said above, that the German market was better in case number 1.In the second case, 1,017 would convert back to 1,017/1.1 = $924. In this case, the U.S. market is better. CHAPTER 12Answers to Problems1. Student Exercise2. CFA Examination I (June 1983)2(a).1. The National Bureau of Economic Research has conducted extensive analysis of leading, coincident, and lagging indicators of general economic activity. Business Conditions Digest classifies economic indicators by their participation in the stage of the economic process and their relationship to business cycle movements.The leading indicators include those economic time series that usually reach peaks or troughs before the corresponding points in aggregate economic activity. The group includes 12 series. One of the 12 leading series is common stock prices, which has a median lead of nine months at peaks and four months at troughs. Another leading series is the money supply in constant dollars, which has a median lead of ten months at peaks and eight months at troughs.2(a).2. Leading indicators have historically been a good tool for anticipating the economy. Investment managers should be aware of this information and, where possible, investment decisions might reflect projected trends. However, these indicators are by no means infallible. They often generate false signals. A downturn in leading indicators might precede only a retardation of growth rather than a full blown recession if the downturn is shallow or brief. One of the most consistent leading indicators is stock prices represented by the S&P 500 Stock Composite Index. Thus, we are dealing with indicators that are roughly coincident with the most significant determinant of stock returns and price changes. An efficient market should already reflect this information. Thus, the attainment of aboveaverage returns using only these series is questionable.2(b).Interest rate forecasts are usually important in investment management for the following reasons:Interest rates help determine the relative competitiveness of stocks versus bonds;They have an effect on the stock returns from interest rate sensitive industries;They help determine the maturity structure of bond portfolios;They significantly affect investment in interest futures;They affect the discount rate used in various equity valuation models.2(c).Three economic time series, indicators, or data items that might be of key relevance to an auto analyst would be disposable personal income, consumer interest rate series, and consumer confidence survey results. An increase in disposable personal income might mean more discretionary income is available with which to purchase consumer durables such as automobiles. A decline in consumer interest rates might make the effective price of a car, including borrowing charges, more affordable. Survey results that showed a high and growing level of consumer confidence about the future of the economy would likely have a positive psychological effect on consumer willingness to commit to new, largeticket purchases.In summary, the following variables constitute likely indicators of profits and performance in the automobile industry:Real disposable personal income per capita to indicate affordability of automobiles;Installment debt as a percent of disposable income to indicate ability of consumer to finance new car purchases;待添加的隐藏文字内容1The replacement cycle indicating the average age of cars on the road, suggesting the inclination of consumers to consider new car purchases;Trends in the cost of major components of auto production, including the prices charged by major suppliers.3.CFA Examination III (June 1985)3(a). Overall, both managers added value by mitigating the currency effects present in the Index. Both exhibited an ability to “pick stocks” in the markets they chose to be in (Manager B in particular). Manager B used his opportunities not to be in stocks quite effectively (via the cash/bond contribution to return), but neither of them matched the passive index in picking the country markets in which to be invested (Manager B in particular).Manager AManager BStrengthsCurrency ManagementCurrency ManagementStock SelectionUse of Cash/Bond FlexibilityWeaknessesCountry SelectionCountry Selection(to a limited degree)3(b). The column reveals the effect on performance in local currency terms after adjustment for movements in the U.S. dollar and, therefore, the effect on the portfolio. Currency gains/ losses arise from translating changes in currency exchange rates versus the U.S. dollar over the measuring period (three years in this case) into U.S. dollars for the U.S. pension plan. The Index mix lost 12.9% to the dollar, reducing what would otherwise have been a very favorable return from the various country markets of 19.9% to a net return of only 7.0%.4. Student Exercise5. Student Exercise6. Student Exercise