sol_hw3 - University of Hong Kong Department of Economics...

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1 University of Hong Kong Department of Economics and Finance FINA 2802C – Investment and Portfolio Analysis First Semester: 2007-2008 Dr. Kam-Ming Wan Answers to Problem Set 3 (1) a) Not true. If everyone believes that patterns exist, all will look for these patterns and all will trade based on such patterns. But such trading will itself destroy these patterns. Remember, we cannot all get rich simultaneously. b) Random-walk theory as applied to efficient markets means that fluctuations from the expected outcomes are random. Suppose there is an 80 percent chance of rain tomorrow (because it rained today). Then the local umbrella store's stock price will respond today to the prospect of higher sales tomorrow. The store's sales will not follow a random walk, but its stock price will, because each day it reflects all investors know about future weather and future sales. (2) The discount rate can be calculated using the CAPM, i.e., ER=4%+1.24*8%= 13.92%. Therefore, the present value of the new project will be:
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sol_hw3 - University of Hong Kong Department of Economics...

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