Question

1. In 2000, the P/E ratio of the stock market reached about 10. If you assume that these corporations will grow roughly at the overall economy’s (GDP) growth rate of 4.5% per year, what should investors have reasonably expected in terms of a likely future rate of return implied by the stock market’s level? Show your work.

Answer 1

Price to earning ratio of stock markets went down after correction in 2002 to almost 10 and when it was expected that the growth rate of the economy would be 4.5% for year then expectation of the investors in terms of capital appreciation would have been much for like similar to 4.5% and if the economy would have been too optimistic, than it would have resulted into unexpected return of investors of more than 10% because after the crash the economy has a tendency to bounce back in the short run, but then resume its correction in the long run.

so, when there would be an expectation of a growth rate of 4.5%, it would be resulting into stock prices increasing up to the range of 10% as forward looking approach of the stock market is discounted by the investors and they would be driven by the optimism in order to discount those growth into the overall value of the company, so an expectation up to 10% of increase into the overall capital value would be fair on the part of an investor.