(a) “Monetary policy is a tool used by Central Banks to bring the economy to full employment. As such, it has little impact on the stock market valuations.” State at least one reason why this statement is wrong. (5 points)

(b) Consider the following statement made by a manager of a large Australian investment fund (reported in Australian Financial Review, July 19, 2019): “Historically if you're a fund manager you would have thought the long-term interest rate is about 5 percent if we look over the last 30-odd years. Take a business growing at 4 percent a year, with a cost of equity of 10 percent based off a 5 percent risk- free rate and a 5 percent market risk premium: you would value that at around 16.6 times free cash flow. Now take a business growing at the same rate, with a 4 percent risk-free rate. At a 9 percent cost of equity that would command a 20 times multiple. At a 3 percent risk-free rate, the cost of equity is 8 percent, and the multiple is 25. Finally at 2 percent – "which is where the world is at the moment" – the same business would be worth around 33 times free cash flow.”

Interpret this statement in light of the theories studied in class and explain where the firm valuation numbers discussed in the quote come from. (15 points)