CFA 2018 level 3 schweser practice exam CFA 2018 level 3 question bank 05 economics questions

ECONOMICS QUESTION HAS TWO PARTS (A, B, C) FOR A TOTAL OF MINUTES Lindsey Buckingham, CFA, Chief Economist at World Financial Management (WFM), is being interviewed by a prominent financial reporter Buckingham explains that the global economy is still sluggish Short-term interest rates in the United States are significantly lower than long term rates The U.S economy is still feeling the effects of a major recession, brought on in part by the mortgage crisis and financial disaster The federal government is using its two primary tools to close the output gap A Identify the two primary tools that Buckingham refers to and explain what the government is doing with each tool (4 minutes) B Explain why these two actions produce a strongly upward sloping yield curve (2 minutes) As the meeting is ending the reporter asks Buckingham, “What is the best time to buy equity and sell bonds? Is it the initial slowdown, the recession, or late in the upswing?” C State and justify which stage of the business cycle will be relatively best for stock rather than bond returns (3 minutes) QUESTION HAS TWO PARTS (A, B) FOR A TOTAL OF MINUTES Jenny Franke, a reporter for the financial cable news program Buy Now, is reporting on the current state of the stock market Franke states the S&P 500 index is currently over-valued using the Fed and Yardini models based on the data given in Figure She goes on to explain that since the models indicate the index is currently over-valued, investors should allocate a higher percentage of their portfolio to bonds Figure $81 earnings estimate for the index 1,221 current value of the index 3% yield on 10-year Treasury bond 4.5% annual 5-year growth forecast for the index 4.87% current yield on A-rated Corporate bonds 0.1 weighting factor for the importance of earnings growth A State whether you agree or disagree with Franke’s statement the Fed and Yardeni models indicate an over-valued stock market Justify your answer and show your calculations (6 minutes) Franke concludes her program by reporting that companies are in aggregate increasing their repurchase programs B Explain the effect of the repurchase yield on stock returns using the Grinold-Kroner model (3 minutes) QUESTION HAS FOUR PARTS (A, B, C, D) FOR A TOTAL OF 15 MINUTES Steve Summer works in the capital marketing forecasting unit of Global Asset Management (GAM) He has been asked to review the firm’s long-term bond market return expectations for Country X His unit has been using bond YTM (yield to maturity) as estimated return, but Summer is expecting significant changes in interest rates and believes the reinvestment assumptions inherent in the YTM approach are unrealistic He decides to apply two other approaches: horizon analysis and a build-up model Summer expects stimulative monetary and fiscal policy, leading to rising interest rates and higher reinvestment rates for an extended future period The current 1-year government bond nominal yield is 3.10%, and Summer’s projects the following risk premiums: Estimated inflation Default premium for AAA to govt bonds Default premium for A to AAA bonds Default premium for BBB to A bonds Maturity premium for 20 to 1-year bonds Tax premium for corporate to govt bonds 2.00% 20 bp 30 bp 35 bp 10 bp bp A Using only the data provided and a build-up approach, estimate the return for 20 year Arated corporate bonds Show your work (3 minutes) B Given Summer’s view of government policy and future reinvestment rates, state whether horizon analysis or the build-up model is more appropriate to project bond market returns over the long run Explain your statement The explanation must be related to Summer’s views (3 minutes) GAM’s Investment Policy Committee has become concerned by recent economic and political trends While they think each is a very low probability event, they ask Summer to consider how asset classes are most likely to behave if the economy enters either a period of rapidly increasing and double digit inflation, or a period of deflation (negative inflation and widespread declines in consumer product prices) Summer focuses his analysis on four asset classes:  Cash equivalents (CE)  Bonds (B) in the form of default-free government bonds  Equity (E)  Real estate (RE) in the form of income-producing rental property C For each of the scenarios, the committee has asked Summer to consider, explain which asset class(es) is(are) likely to perform well Scenario: i ii Rapidly increasing inflation Deflation (4 minutes) Summer is also preparing an analysis of two emerging market economies, Esatn and Mstan He has prepared data for several key variables to consider: Variable: Estan Mstan Expected nominal GDP 6% 4.5% trend growth Population growth rate 4.0% 2.5% Court system Well developed with relatively Judges are appointed and independent judges removed frequently Central bank The central bank was just placed A quasi-independent entity under direct control of the country’s following a Taylor rule president and guarantees an “easy approach money policy” Foreign debt to GDP 75% 40% Foreign ST debt to foreign 150% 80% currency reserves Capital flows approach to Depreciation of currency value Appreciation of currency currency forecast value D Explain which emerging market economy Summer will classify as higher risk, and support the classification with three reasons based on the data provided (5 minutes) ... govt bonds 2.00% 20 bp 30 bp 35 bp 10 bp bp A Using only the data provided and a build-up approach, estimate the return for 20 year Arated corporate bonds Show your work (3 minutes) B Given Summer’s... Explain the effect of the repurchase yield on stock returns using the Grinold-Kroner model (3 minutes) QUESTION HAS FOUR PARTS (A, B, C, D) FOR A TOTAL OF 15 MINUTES Steve Summer works in the capital... with relatively Judges are appointed and independent judges removed frequently Central bank The central bank was just placed A quasi-independent entity under direct control of the country’s following