Practice Midterm Exam 1.pdf

Practice Midterm Exam 1.pdf - York University AP Econ 4410...

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York University AP Econ 4410, Practice Midterm Examination Instructions. Write your name and student number on the front of your answers book. Answer four out of six problems. Each problem has the same weight. You cannot use any notes or books. You have 75 minutes. Problem 1 . Market E¢ ciency: (a) What is the Weak-Form EMH? Give de°nition. (b) What is the Semi-Strong Form EMH? Give de°nition. (c) Give example of a hypotherical phenomenon that, if factual, would be inconsistent with Weak Form EMH (d) Give example of an actual real-world phenomenon inconsistent with the Semi-Strong EMH. (e) Weak-Form EMH implies that stock prices follow the random-walk process: p t +1 = p t + E ( r ) + " t +1 . What is assumed about E ( r ) and " t +1 ? Answers. (a). The hypothesis that prices of °nancial securities re±ect all information conveyed by historical stock prices and trade volume. In other words, that you can²t tell underpriced and overpriced stocks apart by analyzing stock price trends, cycles or other patterns. (b) The hypothesis that prices of °nancial securities re±ect all publicly avalable information, past and present. (c) Existentce of any "technical analysis" type pattern (any cycle, "head and shoulders", "support", "resistance", any usefullness of current and past trade volume in predicting future returns. (d) We went in class over three examples: (i) Value stocks overperform growth stocks, con- ditional on risk; (ii) small caps outperform large caps, conditional on risk, (iii) there appears to be too much volatility in stock market, relative to amount of new information - example in class was the 1987 crash when markets fell signi°cantly on a day when there was no news. (e) E(r) is a constant which depends on risk class of stock; " t +1 is a random variable and it is independent from historical prices (equivalently, independent from past epsilons) Problem 2 . Brie±y answer the following questions in context of the E¢ cient Market Hy- pothesis. (a) CEO of °rm X was interviewed last night on TV. The CEO provided convincing ex- planation why X was at least 40% underpriced. You bought stock X when trade opened today. Would you expect it to outperform the market? 1
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(b) Some believe a change in stock price that occur when trade volume is low is less persistent than a change occuring at high volume of trade. What is the rationale behind this idea? Is it valid under EMH? (c) Evaluate the following statement: "Under EMH, all stocks have the same expected re- turn". (d) Consider two °rms A, B that are similar (same size, industry, etc.) but A is managed much better than B. Evaluate: "If EMH is true, you cannot expext A to outperform B in the future. Therefore, there is no advantage to having better management" (e) When capital markets are booming, would you expect the ratio of [market values of] newly issued equity to newly issued debt to increase, decrease or stay constant? Explain.
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