LOS f: Discuss the impact that the phases of the business cycle have on short-term/long-term capital market returns.

Q1. Which asset would perform the worst during deflationary periods?

A)   Real estate financed with debt.

B)   Real estate wholly owned.

C)   Corporate bonds.

Q2. Which phase of the business cycle is characterized by rising stock prices but increased investor nervousness?

A)   Initial recovery.

B)   Slowdown.

C)   Late expansion.

LOS f: Discuss the impact that the phases of the business cycle have on short-term/long-term capital market returns. fficeffice" />

Q1. Which asset would perform the worst during deflationary periods?

A)   Real estate financed with debt.

B)   Real estate wholly owned.

C)   Corporate bonds.

Correct answer is A)

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 investor’s 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.

Q2. Which phase of the business cycle is characterized by rising stock prices but increased investor nervousness?

A)   Initial recovery.

B)   Slowdown.

C)   Late expansion.

Correct answer is C)         

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.