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Chapter 9 Solutions

Discussion in 'SA7' started by Sean Cahill, Feb 19, 2019.

  1. Sean Cahill

    Sean Cahill Member

    Hi all,

    I noticed that the solution of q9.1 uses the following for the dividend yield and yield gap respectively:
    • d=r+ERP+g_div
    • d-GRY=ERP-IRP-g_div-inflation expectations
    Thought this looked unfamiliar so had a look back into notes/exams from my old CA1 days and the equivalent formulae are:

    • d+g=r+ERP + expected inflation [so inflation expectations are included on RHS of equation for total return vs being excluded above, and g has diff sign as that above]
    • d-GRY=ERP-IRP-g [as inflation expectations cancel out between TR of bond and equity equations]
    { See q5 CA1(2) Sep 2010}

    Where am I going wrong here?

    Thanks
     
    Sean Cahill, Feb 19, 2019
    #1
  2. Colin McKee

    Colin McKee ActEd Tutor Staff Member

    Hi, This relates to the first end of chapter question in chapter 9. The formula as you say, uses a version without inflation. But the key is that the version in this chapter has a small "r" above the d (for real dividend growth). If you take the formula that you are familiar with, split the dividend growth up into "real dividend growth + inflation" then cancel out the inflation you will get the versions that are used in SA7.

    It is not to say that one is any better than the other. I generally assume that dividend growth will be inflation plus a margin (although this is not always the case) so I tend to cancel inflation out.

    I hope this helps.

    Colin
     
    Colin McKee, Mar 11, 2019
    #2

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