Reading 23: Capital Market Expectations－LOS q trends, factors, expected, investment

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CFA Institute Area 6: Economics
Session 6: Economic Concepts for Asset Valuation in Portfolio Management
Reading 23: Capital Market Expectations
LOS q: Recommend and justify changes in the component weights of a global investment portfolio based on trends and expected changes in macroeconomic factors.

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Suppose the U.S. has higher inflation than Japan. The U.S. is in the late expansion phase of the business cycle and Japan is in the initial recovery phase. Using only the PPP relationship for forecasting currency values and using the relationship between asset class returns and the business cycle, which asset should the manager invest in?

A) Japanese stocks.

B) Japanese bonds.

C) U.S. stocks.

D) U.S. bonds.

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Answer and Explanation

The PPP relationship states that countries with high inflation will see their currency depreciate, so the manager should invest in Japan. Within Japan, the investor should invest in stocks because stock prices have just started to rise and will continue to do so for some time. Bond yields will soon rise and their prices will fall as the economy expands.

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During which phase of the business cycle would TIPS be least useful to a portfolio manager?

A) Initial recovery.

B) Early expansion.

C) Late expansion.

D) Slowdown.

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Answer and Explanation

U.S. Treasury Inflation Protected Securities (TIPS) are protected against increases in inflation. They would be needed the least when inflation is falling. During the initial recovery phase of the business cycle, inflation is falling.

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