QUESTION V: Expectations, Stock Prices and the Macroeconomy (35 Points) In Chapter 14, Blanchard formally embeds household and business expectations about the future in models that examine the determinants of stock prices. A. The equation below includes the variables that determine what a financial investor would be willing to pay for a share of stock of the Finkle, Finkle and Finagle company (FFF) on December 31, 2022($Pt), if the investor expects to sell the share two years later on December 31,2024($Pt+2e). $Pt=(1+i1t+x)$Dt+1e+(1+i1t+x)(1+i1t+1e+x)$Dt+2e+(1+i1t+x)(1+i1t+1e+x)$Pt+2e The variables in the formula are defined as: $Pt= Price that an investor would be willing to pay for a share of FFF on December 31,2022 $Dt+1c= Expected dividend to be paid by FFF on December 31,2023 $Dct2= Expected dividend to be paid by FFF on December 31,2024 $Pct+2= Expected market price of FFF shares on December 31, 2024 ilt= Market interest rate between December 31, 2022 \& December 31,2023 icit+1= Expected market interest rate between December 31, 2023 \& December 31, 2024 x = Equity premium (reflecting how risky is an investment in FFF stocks) 1. Would a prospective financial investor pay more or pay less for a share of FFF stock on December 31,2022 , if the FED announces on that day that it will engage in an expansionary monetary policy during the next two years? Briefly explain your answer using this formula. 2. Would a prospective financial investor pay more or pay less for a share of FFF stock on December 31,2022 , if on that day a consumer group files a lawsuit against the FFF company for allegedly manufacturing a defective and dangerous product? Briefly explain. 3. A prospective financial investor believes that the FFF company will earn profits and distribute dividends during the next two years, but also believes that the company will fail and go broke on December 31,2025 . Would the investor be willing to purchase a share of FFF stock on December 31,2022 , expecting to sell it on December 31,2024 , if the investor also believes that most other people expect FFF to continue to earn profits and distribute dividends after December 31,2024 ? Briefly explain. 4. What are the Fundamental Values of Stock Prices. What are Rational Speculative Bubbles? B. Financial industry participants and analysts define a concept called a company stock's price-earnings ratio as: P/Et1=Pricepershareatthecloseofatradingdaythisyear(t)Earnings(orProfits)persharelastyear(t1) 1. What factors would cause the P/Et1 ratio to change this year given the level of earnings last year? Hint: Use the analysis in part A. 2. The chart below traces the average Pt/Et1 ratio for the companies in the Standard and Poor's index and long-term interest rates between 1890 and 2021 . What do you think accounted for the major fluctuations around 1929,1981 , and 2000 in the Pt/Et1 ratio? How did the technology stock price boom of the mid-late 1990 s impact household consumer spending, the household saving rate, business investment spending, Gross Domestic Product, unemployment and the Federal budget deficit
