Fed model

CFA Level III
#1

equity market valuation, p 156, example 8

-difference, on average, is 0.70

now on p . 159, example 10 part 1

-difference is 0.40, indicating it’s undervalued. however, because the historical average difference is 0.70, the smaller difference of 0.40 --> overvalued.

my question is, then, on the exam, let’s say there was a question where we had to calculate the yield difference to see if equities are undervalued/overvalued. would we have to keep the historical average (0.70) in mind and compare it to the calculated answer to see if they’re undervalued or not?

thanks!

#2

No, if they provide the historical average of difference in yield we use that as B/M to discern whether over/under valued.

If not stated otherwise, we would believe that both yield should be equal for equities to be fairly valued.