California State University Northridge Economics Question

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Your data indicates that the stock market indices of all the countries studied increased between 2005 and 2006. Unexpectedly, interest rates for all but one country also increased during that period. Perhaps this is partially due to the positive inflation rates in all of these countries. You would like to find out more information. However, there are variations in the direction and in the size of these changes for each country and this complicates your analysis.

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OMNI MARKETS INVESTMENT, INC.
Omni Markets Investment, Inc. (Omni) provides global financial services to businesses and individuals. It
invests in global markets, primarily by buying and selling stocks, on the New York, London, and Tokyo
exchanges. As an employee, you have been asked to evaluate a proposed method of global investing.
The firm will use your study as a basis for recommending global investments to its clients.
The rise of the global economy has changed the way investment firms manage their portfolios. The free
flow of savings and capital across national borders allows today’s investment firms to diversify their stock
portfolios by transacting in the stock markets of foreign countries. Many financial analysts believe that
global investing hedges their risk exposure to a particular country because the economic performance of
countries can differ. For example, the U.S. economy boomed from 1991 to 2001, while the Japanese
economy remained in a deep recession. Holding stocks in multiple countries can diversify such countryspecific risk. In any given period, some countries may slip into recession while others may move toward
rapid growth.
Investment firms must decide which foreign markets to invest in when diversifying their portfolios. In one
method of global investing, advocated by a number of your colleagues at Universal, macroeconomic
variables are used to guide the selection of stocks. Economic indicators, such as interest and
unemployment rates, are used to predict when the stock market in one country may outperform the stock
markets in other countries. The theory is that market prices would be related to these economic
indicators. Thus, an analyst must determine which indicators are best for predicting market performance.
Not all of the financial analysts at Universal subscribe to this method of global investing. Some view
investing in global stocks, especially in emerging markets, as one of the riskiest forms of investment.
They also believe that economic indicators are not good predictors of future stock market returns.
Instead of relying on macroeconomic variables, these financial analysts use the performance of individual
firms to guide their selection of stocks.
Based on your research, you have concluded that statistical analysis is needed to assess whether
investment decisions should be guided by macroeconomic data. Your research has also uncovered that
there are a number of macroeconomic variables available to test the relationship between stock market
performance and economic performance in a country. These variables include inflation, per capita gross
national income (GNI), the unemployment rate, and interest rates.
Previous empirical work has shown that interest rates might be an important factor in explaining a
country’s stock market performance. The primary reasons are fairly straightforward. The current price of
a share of stock is the value today of owning the rights to a stream of future expected profits. The future
expected profits must be discounted by the existing interest. If interest rates rise, the present value of a
future expected earning is smaller. (At a higher interest rate one could invest a smaller amount today to
get back the equivalent of the expected future profit.) A rise in interest rates is therefore often (though not
always) associated with a fall in stock prices. Secondly, if the interest rate that a firm must pay to borrow
is increased, and nothing else effecting future profits has changed, the higher cost of borrowing may
lower expected future returns. Lower expected returns would also lower the stock price today.
You want to test the hypothesis that national interest rates are a good predictor of a country’s stock
market performance. To test this hypothesis, and to investigate other ideas, you have collected the data
in Table 1. The eighteen countries listed all have branch offices of Universal Investments. (These data
are also available in a downloadable Excel file named stock prices.xls on the course web site.)
Table 1
Selected Economic Statistics for 2005 and 2006 by Country*
Country
2005
Market
Index**
2006
Market
Index
2005
Interest
Rates***
2006
Interest
Rates
2006
Per Capita
GNI 1000’s $
2006
Inflation
Rate
2006
Unemployment Rate
Australia
312.5
400.6
5.46
5.81
35.86
3.5
4.8
Belgium
321.2
427.5
2.02
2.73
38.46
1.8
8.2
Canada
369.4
425.7
2.73
4.03
36.65
2.0
6.3
France
273.3
365.7
2.03
3.05
36.56
1.6
9.2
Germany
224.3
302.8
2.03
3.08
36.81
1.7
9.8
Indonesia
79.0
128.0
6.78
9.18
1.42
13.1
NA
Italy
213.8
280.6
2.17
3.18
31.99
2.1
6.8
Japan
113.5
115.8
0.01
0.12
38.63
0.2
4.1
Malaysia
119.5
158.9
2.48
3.23
5.62
3.6
NA
Mexico
360.1
501.0
9.20
7.19
7.83
3.6
NA
Netherlands
309.6
401.8
2.02
3.07
43.05
1.1
3.9
Singapore
176.3
249.4
2.04
2.95
28.73
1.4
NA
Spain
288.6
422.1
2.19
3.26
27.34
3.5
8.5
Sweden
378.3
542.6
1.72
1.75
43.53
1.4
7.0
Switzerland
452.5
577.6
0.71
1.36
58.05
1.1
4.0
76.7
81.3
2.62
4.64
3.05
4.6
NA
United Kingdom
217.6
278.3
4.55
4.65
40.56
3.2
5.3
United States
302.4
343.2
3.15
4.72
44.71
3.2
4.6
Thailand
* Source: U.S. Census Bureau and United Nations
** Dow-Jones World Stock Index
*** Treasury Bill Rates, if NA Money Market Rates
Required
Prepare a report for your supervisor to carefully explain your findings. (Follow the writing guide for a
report posted on the class website).
In preparing your report be sure to review statistics concepts 1, 2, 3, 4, and 7 as well as macroeconomic
concepts 2, 3, 4, and 7.
Selected Economic Statistics for 2005 and 2006 by Country*
2005
Market
Index**
Country
Australia
312,5
Belgium
321,2
Canada
369,4
France
273,3
Germany
224,3
Indonesia
79,0
Italy
213,8
Japan
113,5
Malaysia
119,5
Mexico
360,1
Netherlands
309,6
Singapore
176,3
Spain
288,6
Sweden
378,3
Switzerland
452,5
Thailand
76,7
United Kingdom
217,6
United States
302,4
2006
2005
2006
2006
Per 2006
2006
% Change in
Market Interest Interest Capita GNI Inflation Unemployment
Market
Index
Rates*** Rates
1000’s $
Rate
Rate
Indices
400,6
5,46
5,81
35,86
3,5
4,8
28,19
427,5
2,02
2,73
38,46
1,8
8,2
33,09
425,7
2,73
4,03
36,65
2,0
6,3
15,24
365,7
2,03
3,05
36,56
1,6
9,2
33,81
302,8
2,03
3,08
36,81
1,7
9,8
35,00
128,0
6,78
9,18
1,42
13,1
NA
62,03
280,6
2,17
3,18
31,99
2,1
6,8
31,24
115,8
0,01
0,12
38,63
0,2
4,1
2,03
158,9
2,48
3,23
5,62
3,6
NA
32,97
501,0
9,20
7,19
7,83
3,6
NA
39,13
401,8
2,02
3,07
43,05
1,1
3,9
29,78
249,4
2,04
2,95
28,73
1,4
NA
41,46
422,1
2,19
3,26
27,34
3,5
8,5
46,26
542,6
1,72
1,75
43,53
1,4
7,0
43,43
577,6
0,71
1,36
58,05
1,1
4,0
27,65
81,3
2,62
4,64
3,05
4,6
NA
6,00
278,3
4,55
4,65
40,56
3,2
5,3
27,90
343,2
3,15
4,72
44,71
3,2
4,6
13,49
* Source: U.S. Census Bureau and United Nations
** Dow-Jones World Stock Index
*** Treasury Bill Rates, if NA Money Market Rates Used
% Change in
Interest Rates
6,41
35,15
47,62
50,25
51,72
35,40
46,54
1100,00
30,24
-21,85
51,98
44,61
48,86
1,74
91,55
77,10
2,20
49,84
Omni Markets Investment, Inc.
Student Coaching Slides
1
Concepts Covered
?
Global nature of business and economics
?
Macroeconomics
– Introduction to macroeconomic variables
– Interest rates & market of loanable funds
– Money & inflation
2
Concepts Covered
?
Statistics
– Descriptive statistics
– Hypothesis testing
– Regression analysis
– Variation & uncertainty
3
Questions 1, 2, and 3:
Doing Statistics on Excel
?
If you wish to review doing statistics on
Excel, read the Using Excel for
Statistics PowerPoint on the course
web site. Use version appropriate for
Excel 2003 or Excel 2007.
?
The Excel data file for Omni Markets
Investment, Inc. is also on the course
web site.
4
Question 1:
Hypothesis Tests
?
Should you use a z, t, or p test? Look
at the data and the sample size.
?
Hint: No change is the null hypothesis.
5
Question 2:
Scatter Plot
?
?
?
From scatter plot, is there a
relationship between changes in
market indices and interest rates?
As changes in interest rates increases,
do changes in stock market indices
appear to increase or decrease?
What country, if any, is an outlier ?
6
Question 2:
Regression Analysis
?
R Square – Coefficient of Determination – percent
variation in change in market indices (Y) accounted for
by variation in change in interest rates (X) – small
value does not mean relationship is weak.
?
Regression Coefficients – coefficient on X-variable
measures the slope of the trend Line. (positive sign positive relationship, negative sign – negative
relationship)
?
p-Value is used to indicate the level of significance.
7
Question 3: Foreign Inflation
& Return for U.S. Investor
?
How will inflation in one country affect
the value of that currency relative to
other countries? (E.g. Will it take more
or less yen to buy a dollar?)
?
How would the adjusting exchange
rate affect the apparent return to a
U.S. investor?
8
Question 4: Macroeconomic
Variables and Foreign Investments?
?
?
?
All economies go through business cycles,
periods of more and less rapid expansion
or contraction in productivity.
Some macroeconomic variables tend to
increase earlier in the business cycle and
are called “leading indicators.”
Be sure to consider foreign government
policies and stability.
9
Question 5: Should National
Interest Rates be Considered?
?
This is an open-ended question. Lots of
good answers are possible.
?
Be sure to consider statistical results and
macroeconomic factors.
10

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