Reading 1

Question 1

Cross Sectional Consistency

Answer 1

Consistency across asset classes regarding portfolio risk and return characteristics

Question 2

Intertemporal consistency

Answer 2

Consistency over various investment horizons regarding portfolio decisions over time

Question 3

9 problems in producing forecasts

Answer 3

1. Limitations to using economic data
2. data measurement error and bias
3. limitations of historical estimates
4. use of ex-post risk and return measures
5. non-repeating data patterns
6. failing to account for conditioning information
7. misinterpreting of correlations
8. psychological bias
9. model uncertainty

Question 4

Transcription bias

Answer 4

misreporting or incorrect recording of information and most serious if biased in one direction

Question 5

Asynchronous data

Answer 5

more frequent data points are often more likely to have missing or outdated values and can result in distorted correlation calculations

Question 6

Conditioning information

Answer 6

Historical data reflect performance over many different business cycles and economic conditions. Thus analysts should account for current conditions in their forecasts since for eg relationship between security returns and economic variables is not constant over time.

Question 7

Anchoring Bias (cognitive)

Answer 7

first information received is overweighted

Question 8

status quo bias (behavioral)

Answer 8

predictions are highly influenced by the recent past

Question 9

getting over overconfidence bias

Answer 9

to counter - consider a range of potential outcomes

Question 10

prudence bias (cognitive)

Answer 10

forecasts are overly conservative to avoid regret from making extreme forecasts that could end up being incorrect. can be mitigated by considering a range of potential outcomes.

Question 11

Availability bias (cognitive)

Answer 11

what is easiest to remember often an extreme event) is overweighted

Question 12

Econometric analysis

Answer 12

uses statistical methods to explain economic relationships and formulate forecasting models. Structural models are based on economic theory, while reduced form models are compact versions of structural approaches.

Question 13

Diffusion index

Answer 13

observing the number of indicators pointing toward expansion versus contraction in the economy

Question 14

Business cycle phases

Answer 14

1. Initial recovery
2. early expansion
3. late expansion
4. slowdown
5. contraction

Question 15

Initial Recovery Phase of Business Cycle signs

Answer 15

1. duration of a few months
2. business confidence rising
3. government stimulus provided by low interest rates and/ or budget deficits
4. decelerating inflation
5. large output gap
6. low or falling short term interest rates
7. bond yields bottoming out
8. rising stock prices
9. cyclical, riskier assets such as small cap stocks and high yield bonds doing well.

Question 16

Early expansion

Answer 16

1. duration of a year to several years
2. increasing growth with low inflation
3. increasing confidence
4. rising short-term interest rates
5. output gap is narrowing
6. stable or rising bond yields
7. rising stock prices

Question 17

Late expansion

Answer 17

1. high confidence and employment
2. output gap eliminated and economy at risk of overheating
3. rising inflation
4. central bank limits growth of money supply
5. rising short term interest rates
6. bond yields rising
7. rising/ peaking stock prices with increased risk and volatility

Question 18

Slowdown

Answer 18

1. duration of a few months to a year or longer
2. declining confidence
3. inflation still rising
4. short-term interest rates at peak
5. bond yields peaking and possibly falling, resulting in rising bond prices
6. possible inverting yield curve
7. falling stock prices

Question 19

Contraction

Answer 19

1. duration of 12-18m
2. declining confidence and profits
3. increase in unemployment and bankruptcies
4. inflation topping out
5. falling short-term interest rates
6. falling bond yields, rising prices
7. stock prices increasing during the latter stages, anticipating the end of a recession

Question 20

Disinflation

Answer 20

Deceleration in the rate of inflation

Question 21

Deflation is a severe treat to economic activity because

Answer 21

1. encourages default on debt obligations
2. with negative interest rates decline to near zero and this limits the ability of central banks to lower interest rates and stimulate the economy

Question 22

Quantitative easing

Answer 22

Traditionally central banks did OMO, but QE includes other security types like mortgage backed securities and corporate bonds and the intent was long-term increase in bank reserves

Question 23

Neutral Rate

Answer 23

The rate that most central banks strive to achieve as they attempt to balance the risks of inflation and recession

Question 24

Taylor Rule Formula for Target Nominal short-term interest rate

Answer 24

Neutral real short term interest rate + expected inflation + [0.5 * (expected - long term trend GDP)] + 0.5 [(expected inflation - target inflation)]

Question 25

2 important aspects of fiscal policy

Answer 25

1. it is not the level of the budget deficit that matters, but the change in the deficit. 2. changes in the deficit that occur naturally over the course of the business cycle are not stimulative or restrictive. in an expanding economy, deficits will decline because tax receipts increase and disbursements to the unemployed decrease. opposite occurs during recession. Therefore, only changes in deficit directed by government policy will influence growth.

Question 26

Yield curve shapes acc to fiscal and monetary policies

Answer 26

1. if both policies stimulative: steep yield curve 2. if both restrictive: inverted yield curve 3. monetary restrictive but fiscal expansive: yield curve is flat and implications for economy are less clear 4. monetary policy stimulative and fiscal restrictive: yield curve moderately steep and implications for economy

Question 27

Pegging of currency

Answer 27

Linkage between business cycles of the 2 economies will increase as the pegged currency country must follow economic policies of the country to which it has pegged its currency. if not, investors will favor one currency over the other and the peg will fail.

Question 28

Interest rate differential between pegged currencies

Answer 28

Generally interest rate of pegged currency will exceed interest rate of the currency to which it is linked, and the interest rate differential will fluctuate with the market's confidence in the peg. high confidence = low rate differential.

Question 29

Inflation within expectations: impact on asset classes

Answer 29

cash: real rate of interest bonds: short term yields more volatile than long term yields equity: no impact given predictable economic growth real estate: neutral impact with typical rates of return

Question 30

inflation above or below expectations

Answer 30

cash: + or - impact with increasing or decreasing yields bonds: longer term yields more volatile than shorter term yields equity: negative impact given the potential for central bank action or falling asset prices, though some companies may be able to pass rising costs to customers real estate: positive impact as real asset values increase with inflation

Question 31

Deflation impact on assets

Answer 31

cash: positive if nominal rates are bound by 0 bonds: positive impact as fixed future cash flows have greater purchasing power assuming no default on bonds equity: negative impact as economic activity and business declines real estate: negative impact as property values generally decline

Question 32

Process of setting up CME

Answer 32

SIIV D Interpret Formulate - Monitor ka dabba 1. specify set of expectations needed, including time horizons to which they apply 2. research historical record 3. specify the methods or models to be used and their information requirements 4. determine the best sources of information needs 5. interpret the current investment environment using the selected data and methods, applying experience and judgement 6. provide the set of expectations needed, documenting conclusions 7. monitor actual outcomes and compare them with expectations, providing feedback to improve the expectation setting process.

Question 33

Wakuluk started her career when the global markets were experiencing significant volatility and poor returns; as a result, she is now careful to base her conclusions on objective evidence and analytical procedures to mitigate any potential biases.

Answer 33

Availability Bias Wakuluk started her career when the global markets were experiencing significant volatility and poor returns. She is careful to base her conclusions on objective evidence and analytical procedures to mitigate potential biases, which suggests she is seeking to mitigate an availability bias. Availability bias is the tendency to be overly influenced by events that have left a strong impression and/or for which it is easy to recall an example.

Question 34

Non-stationarity of data

Answer 34

Different periods in the time series have different statistical properties and create problems with standard statistical methods

Question 35

How do you counter confirmation bias?

Answer 35

Give all evidence equal scrutiny and seek out contrary opinion

Question 36

How do you get over overconfidence bias?

Answer 36

Consider a range of potential outcomes

Question 37

How do you get over prudence bias?

Answer 37

Consider a range of potential outcomes

Question 38

How do you counter availability bias?

Answer 38

Base predictions on objective data rather than emotions or recollections of the past

Question 39

Parameter Uncertainty

Answer 39

estimation errors in model parameters

Question 40

What are the 3 approaches to economic forecasting?

Answer 40

1. Econometric modeling: structural (based on economic theory) & reduced form (compact version of structural) 2. use of economic indicators 3. checklist approach: more subjective like what is the latest report on business investment? etc

Question 41

How does yield curve change with business cycle?

Answer 41

As the cycle moves towards expansion, the curve tends to flatten. At the top of the cycle, the yield curve will likely be flat to inverted. During contraction, the curve will begin to re-steepen.

Question 42

How is interest rate differential between pegged and currency to which it is pegged impacted?

Answer 42

Generally, the interest rates of the pegged currency will exceed the interest rates of the currency to which it is linked and the differential fluctuates with the market's confidence in the peg. If high confidence - differential is small. If there is doubt about the peg - larger differential.

Question 43

What is availability bias?

Answer 43

Tendency to be overly influenced by events that have left a strong impression and/or for which it is easy to recall an example

Question 44

Given a developed and a developing country - which country is most likely to have a significant adjustment to their estimate of the future growth trend?

Answer 44

Developing Less developed markets are likely to be undergoing more rapid structural changes, which may require the analyst to make more significant adjustments relative to past trends

Question 45

If a country is in the initial recovery stage, what do you think about interest rates?

Answer 45

Must be low and bottoming

Question 46

What impact does increase in transfer payments and introduction of progressive tax regime have on trend growth rate of a country?

Answer 46

both are pro-growth government policies and should have a positive impact on the trend rate of growth for a business cycle that is in slowdown or contraction. Transfer payments help mitigate fluctuations in disposable income for the most vulnerable households, while progressive tax regimes imply that the effective tax rate on private sector is pro-cyclical (rising as economy expands and falling as economy contracts)

Question 47

How does appraisal data impact correlations with other assets?

Answer 47

Correlation with other assets tend to be understated,