Chapter 12 - Macroeconomic and Industry Analysis
CHAPTER 12
MACROECONOMIC AND INDUSTRY ANALYSIS
1. A top-down approach to security valuation begins with an analysis of the global and
domestic economy. Analysts who follow a top-down approach then narrow their
attention to an industry or sector likely to perform well, given the expected
performance of the broader economy. Finally, the analysis focuses on specific
companies within an industry or sector that has been identified as likely to perform
well. A bottom-up approach typically emphasizes fundamental analysis of individual
company stocks and is largely based on the belief that undervalued stocks will perform
well regardless of the prospects for the industry or the broader economy. The major
advantage of the top-down approach is that it provides a structured approach to
incorporating the impact of economic and financial variables, at every level, into
analysis of a company’s stock. One would expect, for example, that prospects for a
particular industry are highly dependent on broader economic variables. Similarly, the
performance of an individual company’s stock is likely to be greatly affected by the
prospects for the industry in which the company operates.
2. The yield curve, by definition, incorporates future interest rates. As such, it reflects
future expectations and is a leading indicator.
3. c. A defensive firm. Defensive firms and industries have below-average sensitivity to
the state of the economy.
4. It would be considered a supply shock which affects production capacity and costs.
5.
a. Financial leverage increases the sensitivity of profits in the business cycle since
the interest payments have to be made regardless of the business cycle.
Companies would thus become more sensitive to the business cycle while
increasing their financial leverage.
b. Firms with high fixed costs are said to have high operating leverage. As small
swings in business conditions can have large impacts on profitability, they are
more sensitive to the business cycle.
6. d. Asset play. Some of the valuable assets of the company are not currently reflected in
the present value.
7. A peak is the transition from the end of an expansion to the start of a contraction. A
trough occurs at the bottom of a recession just as the economy enters a recovery.
Contraction is the period from peak to trough. Expansion is the period from trough to
peak.
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
, Chapter 12 - Macroeconomic and Industry Analysis
8. a. Monetary policy is expansive and fiscal policy is expansive. This is consistent with a
steeply upward-sloping yield curve because, while the expansionary policies stimulate
the economy and decrease the short-term rate, high inflation in the future is expected
which forces up the yield in longer maturity.
9. a. A redistributive tax system is a demand-side management approach.
10. Companies tend to pay very low, if any, dividends early in their business life cycle
since these firms need to reinvest as much capital as possible in order to grow.
1+ Nominal Interest Rate
11. 1+ Real Interest Rate =
1+ Inflation Rate
Given nominal interest rate, R, is 5% and inflation rate, i, is 3%, we can solve for the
real interest rate, r:
1.05
1+r= = 1.0194 r = 1.94%
1.03
12. ATech’s operating leverage, as measured by Degree of Operating Leverage (DOL),
Fixed Costs 7
equals 1 + = 1+ = 2.75
Profits 4
Fixed Costs 5
ZTech’s operating leverage is 1 + = 1+ = 2.25
Profits 4
a. Using DOL, ATech has the higher level of operating leverage.
b. ATech. Since small swings in business conditions have a large impact on
profitability for firms with high operating leverage, ATech’s higher operating
leverage will yield higher profits.
13. This exercise is left to the student.
14. Expansionary (i.e., looser) monetary policy to lower interest rates would help to
stimulate investment and expenditures on consumer durables. Expansionary fiscal
policy (i.e., lower taxes, higher government spending, increased welfare transfers)
would directly stimulate aggregate demand.
15. A depreciating dollar makes imported cars more expensive and American cars cheaper
to foreign consumers. This should benefit the U.S. auto industry.
16.
a. Gold Mining. Gold is traditionally viewed as a hedge against inflation.
Expansionary monetary policy may lead to increased inflation, and could thus
enhance the value of gold mining stocks.
b. Construction. Expansionary monetary policy will lead to lower interest rates
which ought to stimulate housing demand. The construction industry should
benefit.
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
CHAPTER 12
MACROECONOMIC AND INDUSTRY ANALYSIS
1. A top-down approach to security valuation begins with an analysis of the global and
domestic economy. Analysts who follow a top-down approach then narrow their
attention to an industry or sector likely to perform well, given the expected
performance of the broader economy. Finally, the analysis focuses on specific
companies within an industry or sector that has been identified as likely to perform
well. A bottom-up approach typically emphasizes fundamental analysis of individual
company stocks and is largely based on the belief that undervalued stocks will perform
well regardless of the prospects for the industry or the broader economy. The major
advantage of the top-down approach is that it provides a structured approach to
incorporating the impact of economic and financial variables, at every level, into
analysis of a company’s stock. One would expect, for example, that prospects for a
particular industry are highly dependent on broader economic variables. Similarly, the
performance of an individual company’s stock is likely to be greatly affected by the
prospects for the industry in which the company operates.
2. The yield curve, by definition, incorporates future interest rates. As such, it reflects
future expectations and is a leading indicator.
3. c. A defensive firm. Defensive firms and industries have below-average sensitivity to
the state of the economy.
4. It would be considered a supply shock which affects production capacity and costs.
5.
a. Financial leverage increases the sensitivity of profits in the business cycle since
the interest payments have to be made regardless of the business cycle.
Companies would thus become more sensitive to the business cycle while
increasing their financial leverage.
b. Firms with high fixed costs are said to have high operating leverage. As small
swings in business conditions can have large impacts on profitability, they are
more sensitive to the business cycle.
6. d. Asset play. Some of the valuable assets of the company are not currently reflected in
the present value.
7. A peak is the transition from the end of an expansion to the start of a contraction. A
trough occurs at the bottom of a recession just as the economy enters a recovery.
Contraction is the period from peak to trough. Expansion is the period from trough to
peak.
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
, Chapter 12 - Macroeconomic and Industry Analysis
8. a. Monetary policy is expansive and fiscal policy is expansive. This is consistent with a
steeply upward-sloping yield curve because, while the expansionary policies stimulate
the economy and decrease the short-term rate, high inflation in the future is expected
which forces up the yield in longer maturity.
9. a. A redistributive tax system is a demand-side management approach.
10. Companies tend to pay very low, if any, dividends early in their business life cycle
since these firms need to reinvest as much capital as possible in order to grow.
1+ Nominal Interest Rate
11. 1+ Real Interest Rate =
1+ Inflation Rate
Given nominal interest rate, R, is 5% and inflation rate, i, is 3%, we can solve for the
real interest rate, r:
1.05
1+r= = 1.0194 r = 1.94%
1.03
12. ATech’s operating leverage, as measured by Degree of Operating Leverage (DOL),
Fixed Costs 7
equals 1 + = 1+ = 2.75
Profits 4
Fixed Costs 5
ZTech’s operating leverage is 1 + = 1+ = 2.25
Profits 4
a. Using DOL, ATech has the higher level of operating leverage.
b. ATech. Since small swings in business conditions have a large impact on
profitability for firms with high operating leverage, ATech’s higher operating
leverage will yield higher profits.
13. This exercise is left to the student.
14. Expansionary (i.e., looser) monetary policy to lower interest rates would help to
stimulate investment and expenditures on consumer durables. Expansionary fiscal
policy (i.e., lower taxes, higher government spending, increased welfare transfers)
would directly stimulate aggregate demand.
15. A depreciating dollar makes imported cars more expensive and American cars cheaper
to foreign consumers. This should benefit the U.S. auto industry.
16.
a. Gold Mining. Gold is traditionally viewed as a hedge against inflation.
Expansionary monetary policy may lead to increased inflation, and could thus
enhance the value of gold mining stocks.
b. Construction. Expansionary monetary policy will lead to lower interest rates
which ought to stimulate housing demand. The construction industry should
benefit.
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
