The Dividend Discount Model (DDM) can be used to think about an entire market index…


The P/E Bearing and the S&P 500. The Dividend Discount Model (DDM) can be used to deem encircling an solid negotiate refutation such as the S&P 500 in the selfselfsame way it is used to deem encircling an idiosyncratic solid. In this problem we use the DDM after a while a faithful part-amongnd development rebuke and faithful discount rebukes to deem encircling the valuation of the U.S. supply negotiate aggravateall during a distinctly thrilling end. As of August 1999, the value-weighted medium P/E (price-earnings) bearing for the U.S. supply negotiate (or, aggravate certainly, for the S&P 500 Index) was at a literal excellent of 36. In dissimilarity, aggravate the end from 1/1968 to 12/2000, the S&P’s medium P/E bearing was 16. For the forthcoming problems, claim the part-amongnd payout bearing on the S&P 500 Refutation is 50% (which is its literal medium from 1/1968 to 12/2000) and that it does not transmute in any of the scenarios considered. Hint: Use the perpetuity-version of the DDM to specific the figure as a employment of the contiguous part-amongnd (DIV 1 ), the require of consummate (r), and the development rebuke (g) of expected lawfuls (and hence part-amongnds loving the faithful payout bearing). Then make that contiguous end’s lawfuls per part-among (EPS 1 ) can be rewritten as EPS 0 (1+g). Then part-among the figure by EPS 0 to succeed the P/E bearing. Now you possess an specificion continuity the P/E bearing to r, g, and the part-amongnd payout bearing (DIV/EPS). From this specificion, you can defense the forthcoming. Note: Robert J. Shiller of Yale—Nobel Laureate in Economics in 2013—used resembling calculations in his best-selling capacity “Irrational Exuberance”, published in 2000, lawful precedently the shatter of the Dot-com fancy. 1. Backing out expected income. First, presume that, aggravate the solid end, the expected development rebuke of lawfuls was a faithful 7.2%. (Note that, if the expected development rebuke and the payout bearing are faithful, mutation aggravate space in the P/E bearing must produce mutation in the expected produce.) What was the medium expected produce on the negotiate (i.e. r) aggravate this end, domiciled on the literal medium P/E bearing of 16? 2. Backing out expected income, cont'd. First, presume that, aggravate the solid end, the expected development rebuke of lawfuls was a faithful 7.2%. (Note that, if the expected development rebuke and the payout bearing are faithful, mutation aggravate space in the P/E bearing must produce mutation in the expected produce.) What was the expected produce on the negotiate (i.e. r as of 8/1999), when the S&P's P/E bearing was 36? 3 . Backing out expected development rebukes. Contiguous presume instead that, aggravate the solid end, the expected produce on the negotiate was a faithful 10.55%. (Note that, if the expected produce and the payout bearing are faithful, mutation aggravate space in the P/E bearing must produce mutation in the expected lawfuls development rebuke.) What was the medium expected development rebuke of lawfuls aggravate this end, domiciled on the literal medium P/E bearing of 16? 4 . Backing out expected development rebukes, cont'd. Contiguous presume instead that, aggravate the solid end, the expected produce on the negotiate was a faithful 10.55%. (Note that, if the expected produce and the payout bearing are faithful, mutation aggravate space in the P/E bearing must produce mutation in the expected lawfuls development rebuke.) What was the expected development rebuke of lawfuls as of 8/1999, when the S&P's P/E bearing was 36?