CFA III SS 7 Economic Concepts for Asset Valutation.txt

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  1. Cobb Douglas Equation: Pure and Expected
    • Pure: Image Upload
    • Expected: Image Upload

    • Y = total economic output
    • A = total factor productivity
    • K = capital stock
    • L = labor input
    • alpha = output elasticity of K
    • beta = output elasticity of L (1-alpha)

    changes are all in percentage
  2. Solow Residual
    Image Upload

    changes are all in percentage
  3. Short term vs long term changes in output
    ex. one time costs incurred to meet increased environmental restrictions will only have a short term effect

    ex. changes such as new, permanent import restrictions would have a long term effect
  4. H model
    Image Upload
  5. Top down vs bottom up valuation general description
    • top down: analyst uses macro factors to estimate market-wide indicators
    • successive steps would be to identify sectors that will outperform; may go down to individual stocks
    • bottom up: analyst takes micro perspective by analyzing individual stocks; assesses firms willingness/ability to adopt tech necessary to grow firm; may use CF analysis
  6. Use top down or bottom up?
    1. long-short market neutral
    2. allocation among markets or industries

    Pitfalls of each
    • 1. bottom up
    • 2. top down

    • top down: models generally based on historical relationships and slow to reflect changes
    • bottom up: analysts are overly emotional and optimistic about companies they cover; also, overly optimistic in expansion and overly pessimistic in recession
  7. Name the four relative value models
    • fed model
    • yardeni model
    • 10 year moving p/e model
    • q models
  8. Fed model definition; pros and cons
    • Image Upload
    • Earnings Yield = Image Upload

    Ratio > 1 => market is undervalued

    Pros: easy; consistent with CF analysis - higher discount rates (treasury yields) should result in lower stock values

    Cons: no equity risk premium; ignores growth; compares a real value (s&p) to a nominal value (treasury)
  9. Yardeni model definition; pros and cons
    • compare actual earnings Image Upload to fair value earnings Image Upload where
    • Yb = yield on A rated corporate bonds
    • d = adjustment factor for how analysts value growth (historically 0.1)

    LTEG = long term (5 year) earnings growth forecast

    actual < fair => market is overvalued

    Pros: as compared to fed model, incorporates some equity risk using A rated corp bonds; includes earnings growth

    Cons: true equity risk premiums are higher than A rated bonds; earnings estimate can be wrong; assumes constant discount rate; d is a "fudge factor," though there is some correlation to the cycle the market is in
  10. 10 year average PE model definition; pros and cons
    current P/E > 10 year MA P/E => overvalued

    inflation adjusted to make market prices comparable

    Pros: removes effect of business cycle and inflation

    Cons: accounting changes can make comparison inappropriate; periods of high or low P/Es can persist for long periods of time
  11. q model definition; pros and cons
    • Tobins q: Image Upload
    • Equity q: Image Upload
    • q > 1 => overvalued

    Pros: supported by economic theory and evidence that in the long run values should equal cost

    Cons: Estimating replacement value is difficult; divergence from 1.0 can persist for long periods of time
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CFA III SS 7 Economic Concepts for Asset Valutation.txt
2014-04-19 21:49:13

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