Ques 11:
In ans Consumer spending 1- year trend 1.72% (1596.2/1569.2 - 1) not 4%?
Govt spending 1.85% (16.5/16.2-1) not -1.25%?
Ques 5 B
Judge whic industry is most attractive from a valuation perspective
I think industry which has the lowest Eq risk premium should be best from valuation perspective.
Any views?
lower equity risk premium - will give a lower discount rate - so a higher expected return would happen for that industry.
but watch out - this is a trick question. This return is only a compensation for the “systematic risk”. Valuation has a lot of other things - some that are seen and visible, and others that are hidden *competitive factors e.g.*. So valuation -we can say nothing about, with just the equity risk premium.
for Q 11 -> trend with respect to end 2004 - not end 2001…
so 3rd and 4th columns are used
Traditionally value investing philosophy is to invest in undervalued stocks . Usually these are undervalued because there is perception of more than ordinary level of risk with these stocks i.e. they have a risk premium relative to their peers . So from a valuation perspective , if you believe that this premium is unjustified , you would be long these stocks , so that when the market realizes there is nothing to fear they will bid these stocks higher ( maybe up to fair value ) and then you will profit.
Since these stocks are risky from a std-dev perspective you do have a higher level of systematic risk associated with them as a group. If their low price were justified in the longer term , you might even stand to lose.
All things being equal if you are merely compensated for taking systematic risk and nothing else then you might attach less value to them , than if you had some other knowledge ( from alpha research ). In the absence of this knowledge all you are taking is systematic risk.
The question is merely asking which industry is justified from a valuation i.e. a pricing measure. So go for the one which has the highest equity risk premium . Also clarify that you don’t have any other perspective than the justifiable systematic risk one.
Ya it says from the perspective of year end 2004, I was using from year end 2001…thnx