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Reading 23: Capital Market Expectations-LOS f

CFA Institute Area 6: Economics
Session 6: Economic Concepts for Asset Valuation in Portfolio Management
Reading 23: Capital Market Expectations
LOS f: Discuss the impact that the phases of the business cycle have on short-term/long-term capital market returns.

Which phase of the business cycle is characterized by rising stock prices but increased investor nervousness?

A)Early expansion.
B)Initial recovery.
C)Slowdown.
D)
Late expansion.


Answer and Explanation

The late expansion phase of the business cycle is characterized by high confidence and employment, increases in inflation, rising bond yields, and rising stock prices. Investor nervousness increases risk during this period. The central bank also limits the growth of the money supply.

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Which asset would perform the worst during deflationary periods?

A)Real estate wholly owned.
B)
Real estate financed with debt.
C)Corporate bonds.
D)Government bonds.


Answer and Explanation

Deflation reduces the value of investments financed with debt. In the case of real estate, if the property is levered with debt, losses in its value lead to steeper declines in the investors equity position. As a result, investors flee in an attempt to preserve their equity and prices fall further. Bond prices will rise during deflationary periods when inflation and interest rates are declining.

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