FINA3080B_solution_Chap008 - Chapter 08 The Efficient...

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Chapter 08 - The Efficient Market Hypothesis FINA3080B CHAPTER 08 THE EFFICIENT MARKET HYPOTHESIS 1. The correlation coefficient should be zero. If it were not zero, then one could use returns from one period to predict returns in later periods and therefore earn abnormal profits. 2. The phrase would be correct if it were modified to say “expected risk adjusted returns.” Securities all have the same risk adjusted expected return, however, actual results can and do vary. Unknown events cause certain securities to outperform others. This is not known in advance so expectations are set by known information. 3. Over the long haul, there is an expected upward drift in stock prices based on their fair expected rates of return. The fair expected return over any single day is very small (e.g., 12% per year is only about 0.03% per day), so that on any day the price is virtually equally likely to rise or fall. However, over longer periods, the small expected daily returns cumulate, and upward moves are indeed more likely than downward ones. 4. No, this is not a violation of the EMH. Microsoft’s continuing large profits do not imply that stock market investors who purchased Microsoft shares after its success already was evident would have earned a high return on their investments. 5. No. Random walk theory naturally expects there to be some people who beat the market and some people who do not. The information provided, however, fails to consider the risk of the investment. Higher risk investments should have higher returns. As presented, it is possible to believe him without violating the EMH. 6. b. This is the definition of an efficient market. 7. d. It is not possible to offer a higher risk risk-return trade off if markets are efficient. 8. Strong firm efficiency includes all information; historical, public and private.
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This note was uploaded on 02/19/2011 for the course FINANCE 3080B taught by Professor Pepperchan during the Spring '10 term at HKU.

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FINA3080B_solution_Chap008 - Chapter 08 The Efficient...

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