Question: From 1982 through 2000, the S&P 500 stock price index rose an average of 14.7% per year (all figures in this problem are annual averages). Over the same period, the Aaa corporate bond rate fell from 13.8% to 7.6%. Corporate profits adjusted for IVA and CCA grew at an annual rate of 8.5%, compared to a 6.3% average annual gain in GDP.
(A) How much would you have expected the S&P index to rise if there were no changes in the underlying risk factor?
(B) If in fact the risk factor dropped from 6% to 3.5%, how much of the remaining difference could be explained by that factor?
(C) The average P/E ratio for 2000 - as opposed to peak levels - was 27.5. Based on the formulas given in this chapter, how much was that above its equilibrium level?
(D) The P/E ratio subsequently declined to a trough of 16 before the market rebounded. How much of that change do you think was due to (a) decline in corporate earnings, (b) change in the risk factor, (c) overvaluation of the market at its peak, (d) undervaluation of the market at its trough?