Reading 49 - EOCs #3 and #17

CFA Level II Portfolio Management
#1

So I am working through the inter-temporal rate of substitution/consumption outcomes, some real sticky stuff to say the least.

EOC #3 in the curriculum, I understand why the answer is A. If the risk-averse investor expects the future price of a risky asset to be high, that means economic times are good and the risk-investor will prefer current consumption over future consumption. However, this same logic failed me in EOC #17.

In EOC #17, I am trying to understand why the answer is B, not C. If the investor is demanding a larger equity risk premium, wouldn’t economic times be bad? And thus future consumption would be higher and equity returns would be lower? The logic I applied in EOC #3 is not working here and I am hoping someone can help. Thanks!

#2

The intuition with question 17 is that if the investor foresees that their future level of consumption will be higher, it will require a greater incentive for them to hold off on their consumption and instead substitute for an investment. As a result, they are likely to demand a greater return on their investment, which naturally is associated with the application of a greater risk premium.