Winter 2010 Assignment 2 solF10

# Winter 2010 Assignment 2 solF10 - AP/ADMS 3531 Winter 2010...

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AP/ADMS 3531, Winter 2010 Solutions to homework assignment #2 1. (20 points) In early February 2010, Baker Drug Inc. and Quality Pharmaceuticals Ltd. each received government approval for new prescription drugs. The Baker approval was announced on February 5. The Quality approval (for a different drug) was announced on February 8. Both announcements were made in the middle of the day, when stock markets were open. No other information was released during this period. Given the information below, calculate the cumulative abnormal return (also known as the cumulative average residual) for these stocks as a group. Assume both companies have expected returns equal to the market return. Follow the approach used in the solution to Question 5 on page 271 in the textbook. Like in the textbook solution, present both a table and a graph, from day -4 to day 4. Do the results support the semistrong form of market efficiency? (Note that there is a typo in the data for Ross Co. on p. 271. The company return for July 17 should be -0.3%, not -20.3%.) Date Market Return % Baker Return % Quality Return % 2/1 -0.1 0.0 -0.2 2/2 0.7 1.4 1.0 2/3 1.2 0.6 0.3 2/4 -2.6 -2.1 -2.4 2/5 0.4 3.7 0.1 2/8 -1.3 4.1 3.8 2/9 -0.5 4.2 3.3 2/10 1.8 5.2 7.3 2/11 0.7 0.6 5.1 2/12 -0.2 -0.3 -0.1 The table below is in the same style as the textbook solution. Consider the first row in the table, 4 days before the announcement. This is February 1 for Baker, when its return abnormal return was 0.0 – (-0.1) = 0.1%. For Quality, day -4 is on February 2, when its return of 1.0 was 0.3 percentage points higher than the market return. Adding together gives a sum of 0.4. Divide by two to get the average of 0.2. For the column of cumulative average residuals, start with the 0.2 entry from day -4 and then add each additional abnormal return for the subsequent days. Abnormal returns (R i – R M ) Days from announcement Baker Quality Sum Average Abnormal ret. Cumulative avg. residual -4 0.1 0.3 0.4 0.2 0.2 -3 0.7 -0.9 -0.2 -0.1 0.1

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-2 -0.6 0.2 -0.4 -0.2 -0.1 -1 0.5 -0.3 0.2 0.1 0.0 0 3.3 5.1 8.4 4.2 4.2 1 5.4 3.8 9.2 4.6 8.8 2 4.7 5.5 10.2 5.1 13.9 3 3.4 4.4 7.8 3.9 17.8 4 -0.1 0.1 0.0 0.0 17.8 (show graph) The market reacts favorably to the announcements. However, in a semistrong efficient market, the reaction should be entirely on day 0, with essentially no change in the CARs during the days before and after the announcement. In this example, the abnormal returns remain strongly positive for each of the three days after the announcement. There is a delayed reaction which should not happen in an efficient market. 2. (10 points) Compute 3-day and 20-day simple moving averages for AAPL (Apple Inc.) from the closing prices for each trading day in February 2010. Use January 2010 prices where needed in the calculations. Historical prices can be obtained from Yahoo Finance and other websites. On which days in February did these two moving averages give a buy signal? On which days did they give a sell signal? (As noted in the Microsoft example on page 297, some technical analysts
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Winter 2010 Assignment 2 solF10 - AP/ADMS 3531 Winter 2010...

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