Solutions to Lab Problems for Chapter 10

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Unformatted text preview: Solutions to Lab Problems for Chapter 10 30. Section: 10.6 Learning Objective: 10.6 Step 1: Implications of EMH Level of difficulty: Difficult N.B. If you purchase the dividend on or after the ex ­dividend date, you are no longer entitled to the dividend. a. If the announcement is a surprise, I would expect a reaction on March 15. The sign of the reaction will depend on how the market interprets the news: does starting to pay dividends indicate that the firm has stopped its high growth period (negative) or does it mean that the firm is confident of high future cash flows (positive news)? In general, I would expect a positive reaction. b. I would not expect a reaction; everyone already knows this. So, the announcement provides no new information. c. The day that the firm goes ex ­dividend I expect the stock price to drop by the amount of the dividend. Note that this is not a change in price due to information; everyone knows when the stock will go ex ­dividend. Rather, it is a reaction to the fact that the buyer of the stock will no longer be entitled to the dividend and therefore is not willing to pay for it. 33. Section: 10.5 Learning Objective: 10.5 Step 1: Behavioural Finance Level of difficulty: Difficult a. This is an example where human emotions, more than fundamentals, of finance are at play in the market. At the time the incorrect news hit the market, the atmosphere was already volatile with the Lehman firm going bankrupt and Meryll Lynch in trouble. Investors had seen their investments in Lehman drop from $65 per share to 26 cents a share. The news of another big one falling must have caused a panic sale leading to the massive drop in the share prices. b. This is an open ­ended question designed to force students to think outside the box. A possible explanation proposed by current research in the field is that investors tend to be more sceptical of bad news than of good news. In the above example, investors react strongly to the bad news by trying to sell the United shares, thereby pushing the prices down. Even after the truth is revealed, the scepticism lingers among the investors, resulting in relatively slower recovery. 1 c. Yes, at least in the short run. The prices are seemingly driven by non ­ informational factors. 35. Section: 10.5 Learning Objective: 10.5 Step 1: Behavioural Finance Level of difficulty: Difficult Investors tend to become more overconfident as they accumulate more information and develop seeming familiarity with a given financial asset. To that extent, access to Internet will, in general, lead to more overconfidence among investors. 2 ...
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