Problem set 11
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Jan 9, 2024
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Dec 17, 2023
PROBLEM SET ASSIGNMENT 11
KINJAL DESAI
FIN627 INVESTMENT MANAGEMENT
Stevens Institute of Technology
–
Fall 2023
1 |
P a g e
CHAPTER : 11
Q.1: If markets are efficient, what should be the correlation coefficient between stock returns for two
nonoverlapping time periods?
→
When comparing stock returns across two nonoverlapping periods, there should be no link at all.
→
If not, returns from one era can be used to forecast returns from other periods, resulting in atypical gains.
Q.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 stock price would already be reflecting the importance of dividend predictability.
Q.8:
If prices are as likely to increase as decrease, why do investors earn positive returns from the
market on average?
→
Based on their reasonable expected rates of return, stock values are predicted to rise over time.
→
Since there is very little difference between the fair expected return over a single day (e.g., 12% year is
only approximately 0.03% every day), the price is almost equally likely to grow or fall on any given day.
→
The tiny predicted daily returns add up over longer time periods, making upward movements more likely
than downward ones.
→
Keep in mind that stock values often follow economic growth and economies grow over time, so an
upward drift in equities prices makes sense.
Q.9:
Which of the following most appears to 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.
→
The correct response is option c.
→
This return pattern is predictable and should not exist if the weak-form EMH is correct.
Q.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.
→
The right response is option b.
→
This is how an efficient market is defined.
Q.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.
2 |
P a g e
→
Even while intraday price fluctuations and stock prices seem to follow a random walk, there is long-term
compensation for taking on market risk and for the time value of money.
→
Investing is not like playing at a casino; over time, an investor is paid for taking these risks, but a player at
a casino has less favorable chances.
b.
A good part of a company’s
prospects is
predictable. Given this fact, stock prices can’t possibly
follow a random walk.
→
Any foreseeable future possibilities of a business have already been factored into the stock's existing value
in an efficient market.
→
As a result, the price of a stock can still randomly walks.
c.
If markets are efficient, you might as well select your portfolio by throwing darts at the stock listings
in The Wall Street Journal.
→
Even while efficient markets seem to automatically provide randomness in dart board selection, rational
portfolio management is still important.
→
It exists to guarantee a well-diversified portfolio, evaluate the investor's risk tolerance, and account for
difficulties related to the tax code.
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Exhibit 5.5
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Page 7 of 33
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Quèstion 12
What is the covariance of returns between stocks A and B? Expected returm of A is 30% and B's expected retum = 23.333333%
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Return B
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40%
55%
2016
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O 0.025
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O 0.095
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-0.1
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Normal 0.5
Expansion 0.3
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