Grinold-Kroner Question (2009 exam)

CFA Level III
#1

in the 2009 AM exam:

Exhibit 1 U.K. Capital Market Data Historical Data (past 100 years) Equity compounded annual growth rate (%) 11.2 Equity risk premium (%) 5.3 Dividend yield (%) 4.0 Equity repurchase yield (%) –0.5 Nominal earnings growth return (%) 4.6 Current and Forward Looking Data Current equity price-to-earnings ratio 14.6 Expected equities real earnings growth rate (%) 2.7 Expected long-term inflation rate (%) 2.5 A. Determine, using the information in Exhibit 1 and the Grinold-Kroner model, the component sources of the historical nominal return for U.K. equities: i. income return ii. earnings growth iii. repricing return _____ ii. earnings growth they say is given at 4.6%. I see how this could be the case by why is it also not right to add the expected i + g = 2.7 + 2.5 = 5.2?

#2

They gave you the nominal growth ratew which is historical. GK uses expected inflation and expect growth so I’m not sure.

#3

They are asking you to “calculate the component sources of the HISTORICAL nominal return,” so you use the historical data given. Adding 2.7 & 2.5 would be used if you needed to calculate expected, forward-looking returns.

#4

because they specifically asked for the historical components, not what is to be expected in the future.

#5

Please read the question carefully. It is asking for “historical nominal return for U.K. equities” so you should be using 4.6% fo i+g.

#6

ahh those little words are tricky!

#7

sneaky…

Btw, Equity compounded annual growth rate (%) here means Equity price compounded annual growth rate (%)?

#8

It would mean total return. If you subtract the income component and the nominal earnings growth component from the equity compounded annual growth rate, you’ll get the repricing (p/e expansion) component… I believe

#9

Thanks!