Question

The S&P 500 Index is one of the most commonly used benchmark indices for the U.S. equity markets. Consisting of 500 companies, it is a market value-weighted index. This means that each company's performance is reflected in the index, weighted by the ratio of the company's value to the total value of all the companies. Based on your understanding of P/E ratios, in which of the following situations would the average trailing P/E ratio (current price divided by earnings per share over the previous 12 months) of the S&P 500 Index be higher?
a. The outlook for the economy and the markets is for a downturn.
b. The outlook for the economy and the markets is for improvement.
You invest $100,000 in 40 stocks, 20 bonds, and a certificate of deposit (CD). What kind of risk will you primarily be exposed to?
a. Stand-alone risk
b. Portfolio risk
Generally, investors would prefer to invest in assets that have:
a. A higher-than-average expected rate of return given the perceived risk
b. A lower-than-average expected rate of return given the perceived risk

Answer 1

Answer:

1. Based on my understanding of P/E ratios, in which of the following situations would the average trailing P/E ratio (current price divided by earnings per share over the previous 12 months) of the S&P 500 Index be higher?

Th e correct option is (b). The outlook for the economy and the markets is for improvement.

2. You invest $100,000 in 40 stocks, 20 bonds, and a certificate of deposit (CD). What kind of risk will you primarily be exposed to?  

Th e correct option is (b). Portfolio risk  

3. Generally, investors would prefer to invest in assets that have:  

a. A higher-than-average expected rate of return given the perceived risk

Explanation:

1. Based on my understanding of P/E ratios, in which of the following situations would the average trailing P/E ratio (current price divided by earnings per share over the previous 12 months) of the S&P 500 Index be higher?

Th e correct option is (b). The outlook for the economy and the markets is for improvement. If the outlook of the economy and the market prospects of the stocks are for improvements, it then means that the Price Per Earning of the stock will be increasing, which is a positive economic trend.

Moreover, since we are talking about the average P/E it can be inferred that in the very long run, average of the S&P 500 Price to Earnings (PE) ratio (since 1900) is approximately 15.8, and the ratio since 1946 (the post-World War II period) is 17.3, so, it is fair to call a "normal" PE ratio about 16.5, which is relatively stable over the years.

 2. You invest $100,000 in 40 stocks, 20 bonds, and a certificate of deposit (CD). What kind of risk will you primarily be exposed to?  

Th e correct option is (b). Portfolio risk  is the chance that the combination of assets or units, within the investments that you own, fail to meet financial objectives. Each investment within a portfolio carries its own risk, with higher potential return typically meaning higher risk. It can be computed as  the risk of the  two-securities portfolio, first take the square of the weight of  40 Stocks ($100,000.00)  and multiply it by square of standard deviation of  the 40 stocks. Repeat the calculation for 20 Bonds and a Certificate of Deposit.

3. Generally, investors would prefer to invest in assets that have:  

a. A higher-than-average expected rate of return given the perceived risk Yes they will because a higher -than average expected rate of return will inform the investor the type of strategies to adopt to guarantee the expected earnings containing the risk.