MGF301 Summer 2010 Assignment 3 - answers

MGF301 Summer 2010 Assignment 3 - answers - Question 1 A 1...

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Unformatted text preview: Question 1 A 1 2 3 4 5 6 7 8 9 10 11 12 B C (a) Ford Walmart Beta 2.67 0.20 Rf 0.01 0.01 (b) Walmart has a lower expected return because Walmart has a low level o when the economy goes into a recession, Walmart does not fall as much as gains customers in a recession. In contrast, Ford has a high level of market are heavily dependent on the state of the economy. So Ford has a higher e for the extra market risk. Page 1 Question 1 D 1 2 3 4 5 6 7 E F G E(Rm) 0.09 0.09 E(r)=Rf - Beta(E(Rm)-Rf) 0.22 0.03 8 use Walmart has a low level of market risk. In other words, 9 lmart does not fall as much as the market because Walmart 10 ord has a high level of market risk because sales of new cars 11 nomy. So Ford has a higher expected return to compensate 12 Page 2 Question 2(a) #4 An example of a company with an announcement that caused the stock price to increase by more shown below. The news was that the company had successfully arranged for an increased line of cr was available before the market opened for trading on Friday. So Wed, Thur were the two days bef and Friday was the day the announcment was first reflected in the price. In terms of market efficien reaction to the information because the price jumped immediately. After the initial jump, however, be a bit of an under-reaction as the price kept climbing, followed by an over-reaction because price over the next day. Both the delayed intial reaction and the downward movement of price the day aft Question 2(a) 2. Geothermal corporation issued a press release before the stock market opened announcing that its earnings have d Explain how the following individual scenarios can be consistent with the semi-strong form of market efficiency. (a) When trading opened after the announcement and throughout the fir (b) The stock price of Geothermal increased slowly over the 30 days be (c) The stock price increased by 10% immediately following the annou 5(a). It is consistent with semi-strong market efficiency if there is no news revealed in the that earnings are 30% higher than last year. In other words, if market investors expected e by 30%, then there is no new information revealed when earnings are announced as incre 5(b). The slow increase in stock price before the announcement does not violate the semi market efficiency if there were no events over that period where news was announced. In if the overall market has slowly increased over this period, then the stock of Geothermal w increase and it does not violate the semi-strong form of market efficiency. Only if there wa public announcement and a subsequent slow price reaction to the announcement would th 5(c). The only way this can be consistent with the semi-strong form is if the initial price inc then additional bad news comes out during the day that causes the price to decrease (or th in the price of oil throughout the day which, in an efficient market, would cause a steady de Question 2(a) e stock price to increase by more than 1% is FMT ranged for an increased line of credit. This news ed, Thur were the two days before the announcement price. In terms of market efficiency, there was a quick After the initial jump, however, there appears to y an over-reaction because price trended down rd movement of price the day after the announcement are inconsistent with market efficiency. Question 2(a) ed announcing that its earnings have decreased by 30% over the last year earnings. i-strong form of market efficiency. e announcement and throughout the first day, there was no stock price change after the company announced the 30% increase in al increased slowly over the 30 days before the announcement of the 30% increase in earnings. 10% immediately following the announcement but then decreased throughout the day so that the closing price was only 2% abo re is no news revealed in the announcement if market investors expected earnings to increase nings are announced as increasing 30%. ent does not violate the semi-strong form of ere news was announced. In other words, en the stock of Geothermal would be expected to et efficiency. Only if there was a to the announcement would there be a violation of the theory. g form is if the initial price increase is to the correct level after the announcement, but es the price to decrease (or the market itself goes down). An example would be a slow increase rket, would cause a steady decrease in the price of a stock that is hurt by the higher oil price. Question 2(a) Question 2(a) unced the 30% increase in earnings. ng price was only 2% above the previous day. e a slow increase igher oil price. 1 (a) Percentage Return = ((14*1000) - (25*1000) + (.60*1000))/(25*1000) Percentage Return = (b) Dividend Yield = (.6*1000)/(25*1000) Dividend Yield = 0.024 or 2.4% -0.416 or -41.6% Percentage Capital Gain = ((14*1000) - (25*1000))/(25*1000) Percentage Capital Gain = (c ) 1 + real return = (1 + nominal return)/(1+ inflation rate) 1 + real return = real return = 56.70% -43.30% -0.440 or -44.0% 1 (25*1000) (a) Price (each outcome) $2 $26 $36 $45 $60 Probability 10% 20% 30% 30% 10% Actual Return -94% -19% 13% 41% 88% Expected Return (b) Actual Return -94% -19% 13% 41% 88% Expected Variance Standard Deviation r - E(r ) -105.31% -30.31% 0.94% 29.06% 75.94% (r - E(r ))^2 p x (r-E(r )^2) 110.91% 9.19% 0.01% 8.45% 57.67% 11.09% 1.84% 0.00% 2.53% 5.77% 21.23% 46.08% (c) No. The beta depends on the covariance of the stock with the market. Knowing does not tell us anything about the tendency of this stock to move with the mark market (which is what beta measures). =pxR -9.4% -3.8% 3.8% 12.2% 8.8% 11.56% h the market. Knowing the std dev of each to move with the market or independently of ...
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This note was uploaded on 07/07/2010 for the course MGF 301 taught by Professor Mohr during the Spring '08 term at SUNY Buffalo.

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