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?

  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.


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