Economics 136. Financial Economics
Suggested solution, Midterm 2, Fall 2009
1. True or false. (25 points, 5 each)
(i) False. Historically, low dividendprice ratios predicted low (negative) subsequent price growth and
no changes in dividends.
(ii) False. The semistrong form claims that prices incorporate public information; but before the
public announcement, information is still private, and hence it need not be fully incorporated in the
price.
(iii)
False.
Stocks
with
high
price
earnings
ratios,
called
growth
stocks,
have
historically
underperformed stocks with low price earnings ratios, called value stocks.
(iv) False. A call option is typically riskier than the underlying stock, since you may lose your entire
investment if the stock price S
T
<X. Hence the expected return on a call is generally higher than on the
underlying stock.
(v) False, in our opinion. The Golden Gate is more beautiful. [All students get full score for this
question.]
2. CAL and portfolio choice (25 points, 5 each)
(a) See the figure.
(b) See the figure. A portfolio that has 50% stocks and 50% riskfree has an expected return of
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 Fall '08
 SZEIDL
 Standard Deviation, Probability theory

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