Economics and Finance
What the domain tests
This domain tests the macro and finance concepts a broker uses to explain market moves: interest rates, inflation, growth, fiscal policy, valuation and risk. Questions often ask for the direction of an effect rather than a precise forecast.
Core rules
- SBP’s policy rate influences short-term interest rates, borrowing costs and the discount rate applied to future cash flows. A lower required return raises the present value of future earnings, all else equal.
- Inflation erodes real returns. Nominal returns must be compared with inflation to judge purchasing power.
- GDP growth affects corporate revenues and earnings; fiscal deficits can affect government borrowing, interest rates and crowding out.
- The yield curve shows the relationship between maturity and yield. Bond prices move inversely to yields.
- Equity valuation uses EPS, P/E, dividend yield and growth. Risk-return analysis uses diversification, beta and the distinction between systematic and unsystematic risk.
Worked example
A company earns Rs 10 per share and the market requires a 10% return, giving a simple P/E of 10 and a price of Rs 100 if earnings are treated as a perpetuity. If the policy rate falls and the required return drops to 9%, the same Rs 10 earnings support a P/E of about 11.1 and a price near Rs 111, assuming no change in risk or growth expectations. If inflation simultaneously rises and pushes the required return back up, the price gain can disappear. The direction of the effect depends on the required return, not on the rate cut alone.
Traps
Assuming a rate cut always raises every share price; comparing nominal returns with inflation; ignoring risk changes; confusing a bond’s coupon with its yield; treating accounting profit as cash flow.