CHAPTER 13

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Unformatted text preview: can’t buy or sell at that value because new conditions or information have developed which make the stable price obsolete? It is the market price, the price at which you can buy or sell today, which determines value. 2. a. There is risk in almost everything you do in daily life. You could lose your job or your spouse, or suffer damage to your house from a storm. That doesn’t necessarily mean you should quit your job, get a divorce, or sell your house. If we accept that our world is risky, then we must accept that asset values fluctuate as new information emerges. Moreover, if capital markets are functioning properly, then stock price changes will follow a random walk. The random walk of values is the result of rational investors coping with an uncertain world. b. To make the example clearer, assume that everyone believes in the same chart. What happens when the chart shows a downward movement? Are investors going to be willing to hold the stock when it has an expected loss? Of course not. They start selling, and the price will decline until the stock is expected to give a positive return. The trend will ‘self­destruct.’ c. Random­walk theory as applied to efficient markets means that fluctuations from the expected outcome are random. Suppose there is an 80 percent chance of rain tomorrow (because it rained today). Then the local umbrella store’s stock price will respond today to the prospect of high sales tomorrow. The store’s sales will not follow a random walk, but its stock price will, because each day the stock price reflects all that investors know about future weather and future sales. 3. One of the ways to think about ma...
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This note was uploaded on 04/26/2013 for the course MATH 289Q taught by Professor Jamesbridgeman during the Fall '04 term at UConn.

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