ECON 3420 Sample Mid-term (Answer)

ECON 3420 Sample Mid-term (Answer) - ECON 3420 Financial...

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ECON 3420 Financial Economics Sample Mid-term Examination (2011-12 Term 1) (Closed-Book) Answer Guide 1. (a) What is the major difference between risky arbitrage and riskless arbitrage? (b) Suppose the market cap of a company is $50 million. This company holds assets that are worth at least $75 million. If you believe in the efficient market hypothesis, what would you do? (c) If the company is controlled by some substantial shareholders, cite some reasons that might convince you not to take arbitraging actions. (a) risky arbitrage = binding contract cannot be drawn, riskless arbitrage = it can (b) Efficient market hypothesis (EMH) implies the market is always right in pricing assets, the pricing gap implies an opportunity for arbitraging, therefore buy the shares and wait for price increase (c) Even if the company is underpriced, the company cannot be acquired, and the assets may continue to be locked up inside the company, it may be a long time before the gap closes (c.f. Mitchell et al., 2002). 2. (a) Explain briefly the filter rule and the “buy-and-hold” strategies. (4 marks) (b) Explain how the filter rule might beat “buy-and-hold” in rate of return where the efficient market hypothesis does not hold. (5 marks) (a) Book work (b) When EMH does not hold, price may follow a cyclical pattern, if sensitivity is set right, the filter rule make gains through each cycle, beats buy and hold. 3. “Financial economics may suggest feasible and sustainable ways to lift the poor out of poverty. For instance, many poor people are living in undeveloped areas where farming can bring large extra income. Instead of giving money and food to these people, a better way is to lend them money so that they could buy the necessary equipment and materials to start farming. In the long term, markets will develop so
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This note was uploaded on 03/03/2012 for the course ECON 3420 taught by Professor Kwong during the Spring '11 term at CUHK.

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ECON 3420 Sample Mid-term (Answer) - ECON 3420 Financial...

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