Solutions for Chapter 8: Questions and Problems
CHAPTER 8
Economic and Industry Analysis
Answers to Questions
1. The top-down valuation process begins by examining the influence of the general
economy on all firms and the security markets. The next step is to analyze the various
2. It is intuitively logical that aggregate market analysis precede industry and company
analysis because the government and federal agencies can exert influence on the
aggregate economy via fiscal (changes in government spending, taxes, etc.) and monetary
(changing money supply, interest rates, etc.) policy. Further, inflation, another aggregate
3. All industries would not react identically to changes in the economy simply because of
the different nature of business. The auto industry for instance tends to do much better
than the economy during expansions but also tends to do far worse during contractions as
Solutions for Chapter 8: Questions and Problems
4. The reason for the strong relationship between the aggregate economy and the stock
market is obvious if one considers that stock prices reflect changes in expectations for
5. Stock prices turn before the economy for two reasons: First, investors attempt to estimate
future earnings and thus current stock prices are based upon future earnings and
6. Virtually all research has shown the existence of a strong relationship between money
supply and stock prices as is evident from high R2s when money supply is used to explain
7. Excess liquidity is the year-to–year percentage change in the M2 money supply less the
year-to–year percentage change in nominal GDP. The economy’s need for liquidity is
8. If the market fully anticipates the rise in inflation, the long bond rate should rise. If we
9. Most of the inputs in determining the price of a bond are known – for instance, the
promised coupon payments, the principal amount, and the dates on which those payments
Solutions for Chapter 8: Questions and Problems
10. Although corporate earnings may rise by 12% next year, that information by itself
is not sufficient to forecast an increase in the stock market. The market level is a product
11. The fourth stage of the industrial life cycle is stabilization and market maturity. During
this stage, sales grow in line with the economy. If sales per share for an industry in this
12. As an investor, you would like to discover a firm just entering the rapid accelerating
13. An industry that experienced the kind of explosive growth characteristics of stage two
(rapid accelerating growth) was the internet-related industry in the late 1990s.
Solutions for Chapter 8: Questions and Problems
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CHAPTER 8
Answers to Problems
1. Student Exercise
2. Student Exercise
3. The industry (I) would have a lower P/E than the market (M) because:
(a) ROE for the industry is lower than the market ROE;
(b) Growth for the industry is lower than for the market; and
4. Student Exercise
5. Student Exercise