I am not sure about the explanation of question 8 as to how would the returns which got depressed due to the millitary confrontation be expected to bias the historical equity risk premium estimate downwards. Can someone please let me know the reasoning behind this question?
In the question 10 of the same item set, CFAI has considered to choose real growth rate in the public sector of 5% over long term GDP growth rate of 4%. According to Schweser, Ibbotson-chen earning model account for growth in the real GDP. I am not sure why there is a discrepency between CFAI and Schweser. Can anyone help me with this?
Can someone please take a look at these questions for me?
Remember, you are calculating a risk premium based on historical estimates, to predict future returns under sunny conditions.
During 2004-2006, there were military conftrontations. So, the Market return (MR) will be less and risk premium MR - Riskfree will also be less. This is only an outlier and the war is not on recurring basis. If you formulated historical risk premium estimates based on this condition, to predict future returns, your futre returns may be biased downward. As an analyst you may have to adjust the risk-premium upwards.
I may not be quite right on this. But, in Ibottson-Chen formula, you should use long-term real growth of GDP of 5%. The given 4% GDP is just an estimate until 2009. I don’t have Scwheser with me.
Hope thios helps.
@rockmania Thanks for the help! Definitely it does help a lot.
I am still not sure about the second one. You said 4% is just an estimate until 2009. However, in the question 4% is given as, “country will be on the path of 4% real GDP growth by 2009”. As far as I understand, this should be the long term growth in GDP as nothing is given after 2009. What does growth of earnings in the public corporate sector mean? This is the one which is given as 5%. I am not sure if this is supposed to be the GDP growth rate.
You are right, it is not clear.
But the text bpook says, you can use an index based tracking (which represents public corporations). May be they want to say you can use S&P 500 index real growth rate.
The problem is that if both of these could be used then I would expect both of these values to be equal in the question. In Schweser, they have used GDP growth rate but here they are using this value. which value to use in which instance is going to be the biggest problem. I think I would follow CFAI text approach and if public corporation growth is given then I would rather use this then using the GDP growth rate.