True and False

1. If interest rates rise, the risk free rate of return declines. (FALSE )
2. If the economy is prospering, investors expect corporate earnings to rise. (TRUE)
3. Stock prices have almost always risen as the business cycle is approaching a trough.
(TRUE )
4. The utility industry is a good example of a countercyclical industry. (FALSE )
5. Both counter cyclical and defensive stocks will rise during recession. (FALSE )

Essay Question

1. What is the business cycle?

The business cycle can also be defined as the downward and upward
fluctuations of gross domestic product (GDP) along with its natural growth rate
over a long period of time. Cycle has an expected sequence of phases,
alternating between expansion and contraction. Such phases occur at about the
same time throughout the economy. Cycles are recurrent but not periodic and
it typically lasts between 1 and 12 years.

2. Explain the relationship between business cycle and yield curve by using
graphs.
● Shows relationship between bond yields and time, holding issuer constant.
● Reflects bond traders’ views about the future.
● Shape is related to business cycle.
○ Upward sloping and steepening curve implies accelerating
economic activity
○ Flat structure implies a slowing economy
○ Inverted curve may imply a recession

3. Assume investor can determine the business cycle, when should stocks be

purchase?

As the stock prices generally lead the economy (turn first), the market is the

most sensitive indicator of business cycle. The investor should purchase the

stock before the trough.

 4. Why investors are concern about consumer spending?

If consumers spend too much of their income now, future economic growth could

be compromised because of insufficient savings and investment. The more money

consumers spend at a given company, the better that company tends to perform. For

this reason, it is unsurprising that most investors and businesses pay a great amount

of attention to consumer spending figures and patterns. Investors and businesses

closely follow consumer spending statistics when making forecasts.

5. What are the stages in the life cycle for an industry? Can you think of other stages

to add?

Embryonic ● Slow growth - Customers are not familiar with the products
(startup) ● High prices - Volumes are not sufficient to achieve economies of
scale
● Significant investment required
● High risk - High failure risk

Growth ● Rapidly increasing demand - More customers entering the market

● Improving profitability - Economies of scale are achieved
● Falling prices - Economies of scale are achieved
● Low competition - Although barriers to entry are low, rapidly
increasing demand relax the competition
● Companies typically reinvest their earnings rather than paying
dividends.

Shakeout ● Slowing growth - Less new customers

● Intense competition - Growth becomes dependent on market share
gains.
● Declining profitability - Prices cutting to boost volumes/sales to fill
excess capacity.
● Companies focus on reducing cost structure and building brand
 loyalty.

Mature ● Little or no growth - Market is completely saturated

● Industry consolidation - Industry may consolidate and become
oligopolies (market is dominated by a few firms).
● High barriers to entry - The surviving companies have brand loyalty
and relatively efficient cost structure.
● Limited reinvestment opportunity (more likely of paying dividends
to shareholders).

Decline ● Negative growth - Development of substitutes or social changes.

● Excess capacity - Declining of demand.
● High competition - Price wars due to excess capacity.

Introduction Stage (after embryonic)

● Infancy
● focused strategy to stress the uniqueness of the new product or service to a small group
of customers.
● profits are usually negative at this stage
● profits generated are typically reinvested into the company to solidify its position and
help fund continued growth
● requires a significant cash outlay

6. Why is industry life cycle useful to an investor doing analysis?

Industry analysis is able to provide the investors with essential information such as
the growth opportunity and future challenges. With this information, the investor is
able to know the worth and the risk of investing in the firm.
For example, only risk taking investors would willingly invest in a start-up company
as it is still new and has a higher default risk compared to a mature company.
However, due to the high risk, these kinds of companies would usually provide a
larger amount of return to attract investors as they are often in need of funds.
Hence, an industry analysis is essential for investors to establish their position
depending on their preference.
7. What is the essential factor of Porter’s analysis?

Power of suppliers
This analyses the ability of suppliers to control the price and availability of their product.
When the number of suppliers are limited, they are able to control the price as they are
dominating the market.
For example, if the suppliers were to increase the price unnecessarily, buyers would not have
much choice but to proceed as they do not have much choices.
Suppliers could also make the supplied product scarce, in order to increase the price of the
product whenever there is a high demand for it.

Power of buyers
This analyses the bargaining power of buyers for a lower price or even better quality
products.
When there is a smaller number of buyers/customers compared to the seller (more supply
than demand), the buyers would have a higher bargaining power as they are free to search
around for a seller which suits their needs perfectly.

Rivalry among competitors

An industry would face an intense competition against their competitors if the industry:
i. consist of many small firms
ii. has high fixed costs
iii. undifferentiated products
iv. high exit barrier
Firms in that industry would pressure each other and limit the overall profit potential.

Threat of entry
This is an analysis of the ability of outsiders to establish a new firm in this industry.
Industries with a lower entry barrier would indicate that there is a high competition in the
industry as others could easily just start up a new business easily.
This is usually due to the low initial capital requirement or large customer base.
The profit of the industry would then be divided among the new entrants which eventually
reduces the profit of each firm.
For example, the opening of new hospitals do not occur often due to the huge initial capital
requirement eventhough, they have a large customer base.

Threat of substitutes
This is the availability of various products in the industry which are able to equally satisfy
the needs of consumers.
When an industry/product has a large threat of substitutes, the pricing power in the industry
would be affected as the sellers are unable to sell at a higher price due to the possibility
where their customer would switch out their product for another.