On January 1, 2008, the S&P 500 index stood at 1,268 with a price-to-book ratio of...
On January 1, 2008, the S&P 500 index stood at 1,268 with a price-to-book ratio of 2.6. Expected earnings for the index for calendar year 2008 were $72.56. These earnings estimates, compiled from analysts’ consensus earnings forecasts for the 500 stocks in the index, are in the same dollar units as the index.
a) What is the forecast of return on common equity (ROCE) for the index for 2008?
b) If you expect residual earnings growth for the corporate sector to equal the GDP growth rate of 4 percent for the economy as a whole, what is the implied expected return to buying the S&P 500 at 1,468?
c) The risk-free rate in 2008 was 3 percent. If you require a risk premium of 5 percent to buy equities, would you have bought an index fund that tracks the S&P 500 index in 2008? Why (or why not)?
d) In 1999, the price-to-book ratio for the S&P 500 was much higher, at 5.4 (!!!). Forward ROCE was 16 percent. With the same GDP growth rate for growth in residual earnings, calculate the implied expected return to buying the S&P 500 at that point in time. The risk-free rate (implied equity risk premium) was 4 (5) percent in 1999. Would you have purchased a market index fund that tracks the S&P 500 index in 1999? Why (or why not)?
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