Based on the Gordon growth model, if all other factors remain unchanged, what effect will an increase in government bond yield have on a country’s P/E ratio? a. increase b. decrease c. no effect d. unknown
B? Increases required rate of return which increases denominator
I think it’s d) unknown The Req rate of return doesn’t necessarily increase when you increase the Rf rate - depends on the beta.
Govt-Bond Yield = INCREASES RRR calculated as = Govt-Bond Yield + Risk Prem = INCREASES Po= D1/ (r - g) as r increases, deno increases, Po decreases. Answer = B
check this out: Say Rf = 3 and beta is .75 and mkt return is 11 ke = 3 + (.75)(11-3) = 9 now increase Rf to 4 ke = 4 + .75(11-4)= 9.25, so increasing Rf increased Ke But if the beta is greater than 1… ke = 3 + 1.2(11-3) = 12.6 ke = 4 + 1.2(11-4) = 12.4, so increasing Rf decreases Ke
Ilvino got it right… I fell into the trap also. Just want everyone to be aware of these questions - the concept is basic enough but the math is tricky.
this is too much … is this Qn from Qbank ?? I logically think B. If the rate from govt bonds increse, investors would have a higher assured rate of return and hence the price multiples for risky assets like stocks would ideally decrease. In times of low returns on risk free assets, the price multiples of stocks are high as investors seek such investments rather than earn a very low rate on bonds.
I only knew it here because I’d missed a similar Q in Passmaster. And by the way, I think the answer is a load of crap - go ask wall street if they think rising interest rates help the equities market- you’d get laughed out the door.
PassMaster
B; increase r, the P/E goes down
orm - check out discussion above - it’s d.
ilvino Wrote: ------------------------------------------------------- > orm - check out discussion above - it’s d. Whaaa?
i’d go with B because it’s reasonable to assume that market premium is constant, not market return. bad question …
Yes I would agree with maratikus that market risk premium is not dependent on the risk free so I would go with B. But there is a way to justify answer D also: For MRP to be constant market return will have to change (at least mathematically) but the question states that all other factors remain unchanged. So for this question we don’t have consider any changes in the market return. If thats the case then MRP will change and I think ilvino’s answer would be correct.
kabhii Wrote: ------------------------------------------------------- > Yes I would agree with maratikus that market risk > premium is not dependent on the risk free so I > would go with B. > > But there is a way to justify answer D also: For > MRP to be constant market return will have to > change (at least mathematically) but the question > states that all other factors remain unchanged. So > for this question we don’t have consider any > changes in the market return. If thats the case > then MRP will change and I think ilvino’s answer > would be correct. Agreed.
again, it’s CFA style questions. in university, they’d say assuming risk premium remains constant, or all else being equal… but in CFA, wording is always vague. anyhow, path of least resistence is that value goes down, so i say B