{"id":18981,"date":"2021-08-03T15:44:44","date_gmt":"2021-08-03T15:44:44","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=18981"},"modified":"2026-06-29T18:01:46","modified_gmt":"2026-06-29T18:01:46","slug":"explain-the-role-of-expectations-and-changes-in-expectations-in-market-valuation","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-the-role-of-expectations-and-changes-in-expectations-in-market-valuation\/","title":{"rendered":"Expectations and Market Valuation"},"content":{"rendered":"\r\n<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"If the prevailing discount rate is expected to fall, which of the following statements is most accurate?\",\r\n    \"answerCount\": 3,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"The correct answer is A. Demand for short-term investments will decrease. When prevailing discount rates are expected to fall, investors anticipate borrowing at lower rates in the future, making short-term investments less attractive. As demand for short-term investments declines, their prices tend to fall and their yields rise. At the same time, demand for long-term investments increases, pushing their prices higher and their yields lower.\"\r\n    },\r\n    \"suggestedAnswer\": [\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Demand for short-term investments will decrease.\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Price of short-term investments will increase.\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Price of long-term investments will fall.\"\r\n      }\r\n    ]\r\n  }\r\n}\r\n<\/script>\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/NFyA0qXHhww\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\r\n<p>The return on any asset is determined by the expectation of future discount rate fluctuations. If interest rates are expected to fall, short-term investments will be less attractive while long-term investments will get more attractive. Longer-term bonds will continue to give investors higher rates of return, and hence, higher values.<\/p>\r\n<p>Additionally, anticipated information influences the amounts of expected cash flows. Non-anticipated information, on the other hand, constitutes real news and requires an adjustment of the expectations. We can deduce that releases of economic information generate counterintuitive market reactions from investors. The expectations for these releases affect investors&#8217; judgment. For instance, asset prices may fall despite \u201cgood\u201d news, if the expectation was for better news.<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>If the prevailing discount rate is expected to fall, which of the following statements is <em>most accurate<\/em>?<\/p>\r\n<ol type=\"A\">\r\n\t<li>Demand for short term investments will decrease.<\/li>\r\n\t<li>Price of short-term investments will increase.<\/li>\r\n\t<li>Price of long-term investments will fall.<\/li>\r\n<\/ol>\r\n<h4>Solution<\/h4>\r\n<p><strong>The correct answer is A.<\/strong><\/p>\r\n<p>The attraction of short-term and long-term investments vary in line with expectations of future movements in discount rates. If the prevailing discount rates are expected to fall, short-term investments will be less attractive, since people expect to be able to borrow cheaply soon. The demand for short-term investments will then decrease, making their prices to fall, leading to higher returns.<\/p>\r\n<p>Conversely, the demand for long-term investments will rise, and so will their prices, leading to lower returns.<\/p>\r\n<p><strong>B is incorrect.<\/strong>\u00a0The price of short-term investments will decrease due to the decreased demand.<\/p>\r\n<p><strong>C is incorrect.<\/strong>\u00a0The price of long-term investments will increase due to the increased demand.<\/p>\r\n<\/blockquote>\r\n<p>Reading 43: Economics and Investment Markets<\/p>\r\n<p><em>LOS 43 (b) Explain the role of expectations and changes in expectations in market valuation.<\/em><\/p>\r\n\r\n<div style=\"text-align: center; margin: 30px 0;\"><a style=\"display: inline-flex; align-items: center; justify-content: center; padding: 12px 26px; border-radius: 9999px; background: #1e5bd8; color: #ffffff; font-weight: bold; text-decoration: none;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\"> Start Free Trial \u2192 <\/a> <p style=\"margin-top: 12px; font-size: 16px; line-height: 1.5;\">Review the role of expectations and changes in expectations in market valuation with CFA Level 2 study notes, practice questions, mock exams, and video lessons designed to strengthen your exam preparation.<\/p>\r\n <\/div>","protected":false},"excerpt":{"rendered":"<p>The return on any asset is determined by the expectation of future discount rate fluctuations. If interest rates are expected to fall, short-term investments will be less attractive while long-term investments will get more attractive. Longer-term bonds will continue to&#8230;<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,473],"tags":[216,564],"class_list":["post-18981","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-portfolio-management","tag-cfa-level-2","tag-portfolio-management","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.6 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Expectations &amp; Market Valuation | CFA Level II<\/title>\n<meta name=\"description\" content=\"Learn how market expectations and changes in discount rates influence valuation and investment decisions in capital markets.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, 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