FINA 385 Chapter Notes - Chapter 9: Abnormal Return, Pure Luck, Capital Asset Pricing Model

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amberfrog615

25 Apr 2015

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If not, one could use returns from one period to predict returns in later periods and make abnormal profits: c. this is a predictable pattern in returns which should not occur if the weak-form. 3: this is a classic filter rule which should not work in an efficient market, b. This is the definition of an efficient market: c. the p/e ratio is public information and should not be predictive of abnormal security returns. 6: semi-strong efficiency implies that market prices reflect all publicly available information concerning past trading history as well as fundamental aspects of the firm. 7: the full price adjustment should occur just as the news about the dividend becomes publicly available. If low p/e stocks consistently provide positive abnormal returns, this would represent an unexploited profit opportunity that would provide evidence that investors are not using all available information to make profitable investments. In an efficient market, no securities are consistently overpriced or underpriced.

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Which of the following statements is correct?

A. Semistrong-form market efficiency implies that as soon as any public or private information comes into being it is incorporated into stock prices.

B. Weak-form market efficiency implies that recent trends in stock prices are of no use in predicting future stock prices.

C. Market efficiency implies that all stocks should have the same expected return.

D. According to strong-form market efficiency, insiders would find it possible to consistently earn abnormal returns in the stock market even if they have superior knowledge about the company.

E. Studies of the Efficient Markets Hypothesis suggest that neither the weak-form nor the semi-strong forms of efficiency hold, especially for larger companies. However, the market appears to be strong-form efficient because institutional traders make abnormal profits.

azurekangaroo326

Please write a 250 word response to the below discussion. Please provide 2 scholarly sources.

The efficient market hypothesis states that share prices reflect all relevant information, and that it is impossible to beat the market or achieve above-average returns on a sustainable basis. There are many critics of this theory, such as behavioral economists, who believe in inherent market inefficiencies. The Efficient Market Hypothesis (EMH) states that securities are very efficient in reflecting the truth about a stock. In other words, when new information is available about a stock, it is incorporated into the price adjustments of the stock quickly enough to reflect the actual state of the market (Malkiel, 2003). EHM debunks the idea that financial analysis and forecasting are useful tools to shop for stocks. In other words, because securities accurately reflect the status of that stock, it is not possible to use financial analysis to find an undervalued stock or predict trends in the market in order to buy low with the future insight to sell high. There are three levels, or degrees, of the efficient market hypothesis: weak, semi-strong, and strong. The weak form assumes that current stock prices reflect all available information, and that past price performance has no relationship with the future. In other words, this form of the hypothesis says that using technical analysis to achieve exceptional returns is impossible. The semi-strong form says that stock prices have factored in all available public information. Because of this, it's impossible to use fundamental analysis to choose stocks that will beat the market's returns. Finally, the strong form of the efficient market hypothesis says that all information, public as well as private, is incorporated into current stock prices. This form of the efficient market hypothesis essentially assumes a perfect market, and isn't plausible when there are insider trading restrictions (VanBergen, 2011). Yes, I believe that financial statement analysis can provide a significant advantage to an investor. The key is that empirical analysis, specifically statistical models aimed at forecasting future trends based on historical data, are simply another tool to be taken in to account. They are not a single source of the definitive answer. But, through the use of high power computing and mathematically rigorous modeling tools, forecasting is a powerful tool to provide additional insight to decision makers to include the financial industry. In support of my position, (Malkiel 2003) reports the findings of several empirical studies which demonstrate positive statistical correlations in short-run return analysis and the successful prediction of up to 40% of variation in long-term return analysis through time-series statistical models, which are able to take into account seasonal fluctuations (Malkiel 2003). One experimental study demonstrated with statistical significance that the Ohlson model provides predictive ability for future stock price movements (Lee, Chen and Tsai, 2014).

crimsonmammoth143

Please answer all of the following questions

1) In a CAPM framework, prohibiting short sales:

a. will prohibit investors from holding the market portfolio in equilibrium.

b. will make the security market line steeper.

c. will encourage investors to hold more riskless assets.

d. will not change the equilibrium.

2) The beta of an efficient portfolio:

a. must be 1 since an efficient portfolio is perfectly positively correlated with the market portfolio.

b. is proportional to 1, depending on the proportion invested in the market portfolio.

c. is equivalent to the portfolio's standard deviation, since standard deviation is the measure of risk for an efficient portfolio.

d. is always less than 1.

3) Which of the following is not a general conclusion of studies of stock prices?

a. The serial correlation in daily returns in U.S. stocks is positive.

b. The serial correlation in longer period returns (monthly, annual) in U.S. stocks is negative.

c. Filter rules greater than 1% generally do not make money.

d. Stocks that have done well in the past are also likely to do well in the future.

e. There are more runs in daily stock prices than we would expect to find under a random walk.

4) In case of a simple CAPM being used to estimate a time series data:

a. the mean of a residual risk should be equal to zero.

b. the regression coefficient should be equal to zero.

c. the difference between the market return and the riskfree rate of return should be equal to zero.

d. the beta of the portfolio should be equal to zero.

5) The fact that superior returns can not be made by selling stocks that cut dividends is evidence of:

a. weak-form efficiency.

b. semi-strong-form efficiency.

c. strong-form efficiency

6) Which of the following is an implication of market efficiency?

a. Resources are allocated among firms that put them to the best use.

b. No investor will do better than the S&P 500 in any time period.

c. No investor will do better than the S&P 500 consistently after adjusting for risk.

d. No investor will do better than the S&P 500 consistently after adjusting for risk and transactions costs.

7) Which of the following is an attribute of futures contract?

a. There are no limits on the size of the position that any investor can take in financial futures markets.

b. Futures contracts are marked to the market on a daily basis

c. Margins for futures are more relative to other types of markets.

d. Almost all futures positions are settled by delivery.

FINA 385 Chapter Notes - Chapter 9: Abnormal Return, Pure Luck, Capital Asset Pricing Model

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