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Problem set #5 Solution

# Problem set #5 Solution - Problem Set 5 Solutions ECON 136...

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Problem Set 5 Solutions ECON 136, Fall 2009 NOTE: mistakes have been corrected in the answers to question 1 and 3-E Question 1: Mutual Fund Expenses Mutual Fund Fee SPIAX: Mongan Stanley S&P 500 Index VFINX:Vanguard 500 Index Front Load 5.25% 0.00% Deferred Load 0.00% 0.00% Expense Ratio 0.59% 0.18% Front fees are a percent of total dollar investment paid up front and operating expenses (expense ratio) are percent per year. 33 . 11416 ) 0059 . 0 07 . 0 1 )( 0525 . 0 1 ( 10000 ) 1 )( 1 ( 3 3 3 3 3 SPIAX years SPIAX years SPIAX years W W ee operatingf rn annualretu frontfee W W 71 . 12188 ) 0018 . 0 07 . 0 1 )( 1 ( 10000 ) 1 )( 1 ( 3 3 3 3 3 VFINX years VFINX years VFINX years W W ee operatingf rn annualretu frontfee W W To find the annual return (after taking out expenses) of investing in one of these funds recall that: 1 10000 1 3 1 3 3 1 3 years Today years ann W W W R 045142 . 0 1 10000 33 . 11416 1 3 1 3 1 3 Today years SPIAX ann W W R 0682 . 0 1 10000 71 . 12188 1 3 1 3 1 3 Today years VFINX ann W W R

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Question 2: Efficient Markets A) True . Although earnings increased, the increase may have been below expectations from available information. This would be bad news and would cause the stock price to fall. B) False . If the market is efficient in the semi-strong sense, but not efficient in the strong sense, then people with inside information will start purchasing the company’s shares before the good news is announced, driving up the stock price. Thus efficiency in the semi-strong sense is consistent with a price increase just before the announcement. This is what we observed for takeover announcements in the data. C) True . The efficient markets hypothesis states that expected abnormal returns ” should be zero. Compensation for risk and the time-value of money should be reflected in expected normal returns ”. So, risky stocks having higher returns on average than safe stocks is consistent with EMH.
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Problem set #5 Solution - Problem Set 5 Solutions ECON 136...

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