Deck 13: Economy/ market Analysis Must Be Considered by All Investor

Question 1

An inverted yield curve generally indicates:

A) the economy is accelerating.
B) economic activity is slowing down.
C) a pending recession.
D) rising inflation.

Answer 1

C

Question 2

The period from a peak to a trough is:

A) a cycle.
B) an inflection point.
C) a recession.
D) a depression.

Answer 2

C

Question 3

Generally, when interest rates fall, bond prices

A) rise.
B) fall.
C) remain unchanged.
D) rise or fall depending on the expected inflation premium.

Answer 3

A

Question 4

Indexes of general economic activity include all but:

A) lagging
B) emerging
C) leading
D) coincident

Question 5

In the U.S. since the end of World War II, the typical business cycle contraction consists of how many months?

A) 6.
B) 10.
C) 12.
D) 15.

Question 6

When speculation pushes asset prices to unsustainable highs, this is known as a:

A) crash.
B) contraction.
C) recession.
D) bubble.

Question 7

In the U.S. since the end of World War II, the typical business cycle consists of an expansion of how many months?

A) 57.
B) 66.
C) 75.
D) 84.

Question 8

The advance estimate of GDP predicts direction of quarterly change in real GDP growth approximately what percent of the time?

A) 10%.
B) 25%.
C) 75%.
D) 90%.

Question 9

Multinational companies often follow the U.S. lead in restructuring processes and adopting new technologies. As a consequence,

A) foreign equities markets are driven by earnings growth and political considerations, like U.S. equities markets.
B) foreign equities markets are driven by earnings growth and political considerations, unlike U.S. equities markets.
C) foreign equities markets are driven by earnings growth and interest rate changes, like U.S. equities markets.
D) foreign equities markets are driven by earnings growth and interest rate changes, unlike U.S. equities markets.

Question 10

The federal agency most involved with the money supply and interest rates is

A) the Treasury Department
B) the Federal Reserve
C) the Department of Commerce
D) the U. S. Mint

Question 11

The Bureau of Economic Analysis of the U.S. Government releases advance estimates of quarterly GDP in the first month following quarter end. In the second month, it provides a preliminary estimate. In the third, it provides a "final" estimate (though even this estimate is subject to annual revisions). Over the past 30 years, the average revision of GDP growth rate from advance to final has been approximately what fraction of a percentage point?

A) 1/4.
B) 1/3.
C) 1/2.
D) 2/3.

Question 12

Stock investors pay attention to the bond market because:

A) it is more stable than the stock market.
B) it can provide daily signals whereas stock market data tends to trend weekly, monthly or quarterly.
C) it is a more accurate measure of overall economic activity.
D) it is privy to more government information, especially from the Federal Reserve.

Question 13

_______ is a publication that compiles consensus economic forecasts.

A) The Wall Street Journal's Economic Letter
B) The Conference Board's Economic Forecast
C) The Kiplinger Letter
D) Blue Chip Economic Indicators

Question 14

Which of the following is considered to a leading indicator of a country's economy?

A) duration of unemployment
B) stock prices
C) money supply
D) interest rate spread

Question 15

Gross Domestic Product (GDP) is a basic measure of the economy, and is defined as the market value of what items produced by an economy for some time period (typically a year)?

A) final goods.
B) final goods and services.
C) final goods, services, and labor.
D) final goods, services, labor, and capital.

Question 16

In the early stages of a business cycle, yield tends to be:

A) low and upward sloping.
B) flat.
C) high and downward sloping.
D) inverted.

Question 17

In the U.S., the largest component of GDP is:

A) government spending.
B) business investment.
C) consumer spending.
D) real estate.

Question 18

The National Bureau of Economic Research that measures business cycles and officially decides when there are economic "turning points" is:

A) a division of the Department of Commerce of the U.S. Government.
B) an association of academic and professional economic forecasters.
C) a unit within the U.S. Federal Reserve.
D) a private nonprofit organization.

Question 19

Which of the following is not a component of GDP?

A) business investment spending.
B) government "investment" (really spending).
C) net exports.
D) financial transactions.

Question 20

U.S. investors can buy equities from companies that comprise more than what fraction of the world's market capitalization and what fraction of the world's GDP.

A) 1/5th world market cap, 1/4th world GDP
B) 1/4th world market cap, 1/3rd world GDP
C) 1/3rd world market cap, 1/2 world GDP
D) 1/2 world market cap, 2/3rds world GDP

Question 21

During a typical contraction, stock prices decline 25 percent from peak. During recent recessions, however, the range of decline has been:

A) less than 20 percent.
B) between 20 and 30 percent.
C) between 30 and 40 percent.
D) greater than 40 percent.

Question 22

Despite political, cultural and economic differences, foreign markets are driven by the same factors that drive U.S. markets.

Question 23

The ability of the market to predict economic recoveries is remarkably good. Stock prices almost always turn up how many months before recovery?

A) 3-5, with 4 typical.
B) 3-7, with 5 typical.
C) 4-8, with 6 typical.
D) 5-9, with 7 typical.

Question 24

If someone was to tell you that "the market" was up by two percent, they are usually referring to:

A) the DJIA.
B) the NYSE.
C) the NASDAQ.
D) GDP.

Question 25

Most analysts today agree that using money as an indicator of future economic activity is accurate.

Question 26

Many market participants believe that when the dividend yield on the Standard and Poor's 500 is ____, the market is in for a downward correction.

A) above 6 percent
B) below 6 percent
C) above 3 percent
D) below 3 percent

Question 27

Which of the following types of yield curves is typically considered to be stimulative to the economy?

A) a steep, upward-sloping yield curve
B) a flat yield curve
C) an inverted yield curve
D) a skewed yield curve

Question 28

The Fed model, which uses the E/P ratio in its calculations, :

A) is relatively complex.
B) uses the yield on the 3-month Treasury bill as the risk-free rate.
C) assumes investors can easily switch between stocks and bonds.
D) all of the above

Question 29

Estrella and Mishkin (1996) developed a somewhat successful model to predict whether the economy is going into recession using what variable?

A) spread between the 10-year U.S. Treasury Inflation Protected Security and the 3- month T-Bill.
B) spread between the 5-year U.S. Treasury Note and the 3-month T-Bill.
C) spread between the 10-year U.S. Treasury Note and the 3-month T-Bill.
D) spread between the 30-year U.S. Treasury Note and the 3-month T-Bill.

Question 30

The relationship between the stock market and the business cycle is generally considered reliable, but the stock market tends to give false signals about:

A) business cycle peaks (booms).
B) business cycle troughs (recessions).
C) business cycle inflection points between peaks and troughs, and between troughs and peaks (i.e., when the rates of decline in growth change from increasing to decreasing rates, and vice versa).
D) ex post stock market returns.

Question 31

Stock prices often peak when?

A) Two years before the start of a recession.
B) One year before the start of a recession.
C) At the start of a recession.
D) One year after the start of a recession.

Question 32

The earnings yield, which is used in the Fed model, is the:

A) same as the dividend yield.
B) inverse of the dividend yield.
C) same as the P/E ratio.
D) inverse of the P/E ratio.

Question 33

The stock market is a leading indicator of the economy because investors discount future earnings.

Question 34

Which of the following statements regarding market P/E ratios is true?

A) P/E ratios are higher when interest rates are lower.
B) P/E ratios are higher when interest rates are higher.
C) P/E ratios are higher when inflation is higher.
D) P/E ratios are lower when unemployment is higher.

Question 35

Assume that the dividend payout ratio on the S&P 500 will be 40 percent when the rate on long-term government bonds falls to 9 percent. Investors being risk averse demand an equity risk premium of 8 percent. If the growth rate of dividends is expected to be 10 percent, what will be the price of the market index if the earnings expectation is $30?

A) $384.00
B) $213.44
C) $266.56
D) $171.43
Solution: D1 = 0.40($30) = $12
K = 0.09 + 0.08 = 0.17
P₀ = D₁/(k - g)
= 12/(0.17 - 0.10) = $171.43

Question 36

Current stock prices reflect:

A) investors' confidence in the current economy.
B) investors' confidence in the current administration.
C) investors' expectations of the future.
D) investors' attitudes about the past market.

Question 37

The longest peacetime expansion ran from 1991 to 2000.

Question 38

Warren Buffett thinks long-term movements in stock prices are caused by which of the following two economic variables?

A) interest rates and realized corporate profits.
B) interest rates and expected corporate profits
C) interest rates, inflation, and unemployment
D) interest rates, inflation, and growth in GDP

Question 39

To value the market, an investor must analyze both corporate earnings and multipliers.

Question 40

P/E ratios are generally depressed when interest rates are _____ and inflation is ________.

A) high; low
B) low; high
C) high; high
D) low: low

Question 41

The financial news reports that the market is overvalued at a near record high based on the earnings multiplier. What does that mean to you?

Question 42

If the economy is prospering, investors expect corporate earnings to rise.

Question 43

During periods of restrictive Federal Reserve monetary policy, the stock market usually performs poorly.

Question 44

The Dow Jones Industrial Average provides the best representation of the performance of U.S. stocks.

Question 45

Most investors should keep a watch on the Federal Reserve because of the effect of the money supply on interest rates.

Question 46

When using the P/E valuation model, it is important to remember that the multiplier is more volatile than the earnings component.

Question 47

Approaches to assessing the stock market's likely direction include application of the ________________ model, also called the Fed model.

Question 48

Use the constant-growth dividend discount model to explain why stock prices have an inverse relationship to interest rates.

Question 49

The typical business cycle in the United States seems to lead the stock market's turning point by a few months.

Question 50

Why is there an inverse relationship between P/Es and dividend yield?

Question 51

According to available evidence, investors lose more by missing a bull market than by staying in a bear market.

Question 52

Explain how dividend yield on the S&P 500 Index can be used to make market forecasts.

Question 53

Over the past 30 years, the average P/E ratio for the S&P 500 has been 23.

Question 54

Is it useful to do a trend analysis of P/E ratios of the S&P 500 Composite Index over time and extrapolate it to project future expected P/Es?

Question 55

Why is the stock market a leading indicator of the economy? Use the constant-growth dividend discount model in your explanation.

Question 56

Assuming a constant P/E ratio, the growth in stock prices should equal the growth in earnings.

Question 57

If interest rates rise, the risk free rate of return declines.

Question 58

Stock prices have almost always risen as the business cycle is approaching a trough.

Question 59

Why do stock investors pay attention to the bond market?

Question 60

P/E ratios are generally low when interest rates and inflation are high.

Question 61

The earnings per share on a composite stock index this past year was $3.25. The earnings are expected to grow at a constant rate of 7 percent forever. The dividend payout ratio is expected to continue at its current rate of 35 percent and the dividend yield is expected to be 4 percent. Calculate the intrinsic value of the composite stock index.

Question 62

Value Line's estimated dividends on its Industrial Composite for 199X are $2.00 while estimated earnings are $4.30. The expected spread between k and g is .04.
(a) What is the P/E ratio?
(b) What is the estimated price for this Index?

Question 63

How does the increased globalization of business and finance affect business cycles and the leading, lagging, and coincident economic indicators?

Question 64

What are the implications of the article "Overcoming the Bear Market Blues" for investors?

Question 65

According to Warren Buffett, the two critical economic variables are: _______________ and _________________.

Question 66

Assume that the dividends to be paid on a particular market index next period are $20. Investors require 15 percent to invest in stocks, and expect dividends to grow at 10 percent per year. What is the value of this index?