BKM ch 11
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Problem Set Assignment - BKM - Chapter 11
Dhruv Bhimani
1. If markets are efficient, what should be the correlation coefficient between
stock returns for two nonoverlapping time periods?
The correlation coefficient between stock returns for two non-overlapping
periods should be zero. If not, one could use returns from one period to predict
returns in later periods and make abnormal profits.
4. Steady Growth Industries has never missed a dividend payment in its 94-year
history. Does this make it more attractive to you as a possible purchase for your
stock portfolio?
No. The value of dividend predictability would be already reflected in the stock
price.
8. If prices are as likely to increase as decrease, why do investors earn positive
returns from the market on average?
Investors earn positive returns on average because financial markets are
generally driven by long-term economic growth and corporate profitability.
While prices may fluctuate in the short term, historical trends indicate an overall
upward trajectory. Additionally, investors are compensated for taking on market
risk through factors such as dividends, earnings growth, and the potential for
capital appreciation over time.
9. Which of the following (hypothetical) observations would most contradict the
proposition that the stock market is weakly efficient? Explain.
a. Over 25% of mutual funds outperform the market on average.
b. Insiders earn abnormal trading profits.
c. Every January, the stock market earns abnormal returns
Ans: b. Insiders earn abnormal trading profits
12. Which of the following statements are true if the efficient market hypothesis
holds?
a. It implies that future events can be forecast with perfect accuracy.
b. It implies that prices reflect all available information.
c. It implies that security prices change for no discernible reason.
d. It implies that prices do not fluctuate.
ANS: b. It implies that prices reflect all available information.
13. Respond to each of the following comments. a. If stock prices follow a
random walk, then capital markets are little different from a casino. b. A good
part of a company’s future prospects are predictable. Given this fact, stock
prices can’t possibly follow a random walk. c. If markets are efficient, you
might as well select your portfolio by throwing darts at the stock listings in The
Wall Street Journal.
a. The statement misunderstands the concept of a random walk; it doesn't imply
complete randomness but rather that prices reflect available information.
b. Acknowledging some predictability in a company's future doesn't negate the
random walk hypothesis; it focuses on short-term, unpredictable price
movements.
c. The comment questions market efficiency, suggesting randomness in stock
selection; however, the Efficient Market Hypothesis allows for information-
based decision-making, not pure randomness.
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E (r) E-1P(s)r (s)
Var (r) = o² = s-1p(s)[r (s) - E(r)]²
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Beta is based on historical values.
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Σ=1p(s)r(s)
Var (r) = o² = Σ³-1 P (s)[r (s) — E (r)]²
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SD (r) = o = √Var (r)
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Suppose financial analysts believe that there are four equally likely
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not. The return predictions are as follows:
States of the economy
Allos Inc. Returns (RA)
Orangus Inc.Returns (Rg)
snäur
Depression
-20%
Recession
20%
%10%
Normal
-12%
%6
Required:
1. For each company calculate:
i. the expected returns
ii. the Variance
2. Assuming you are an investor with GHS100 available. If you invest
GHS60 and GHS40 in Allos Inc. and Orangus Inc. respectively,
jii. the Standard deviation
what will be your portfolio returns?
3. Calculate the Standard deviation of the portfolio.
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-9.00%
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