FINE 441 Midterm Summer 2013 Solutions

Explainbelowhowyouexpectthestrategytoperformbasedonthe

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Unformatted text preview: tegy is as follows: whenever Warren Buffet publicly announces that he has purchased a stock, the fund will purchase the same stock based on the view that Warren Buffet is a very skilled investor who must be able to identify undervalued stocks based on superior information. Explain below how you expect the strategy to perform based on the following alternative assumptions? a) Assume that Warren Buffet is indeed highly skilled, and the market fully understands just how skilled he is. In this case the price will adjust to its new fair value upon the public announcement and the strategy will neither perform well or bad as it would just be buying fairly priced securities. b) Assume that Warren Buffet is indeed highly skilled, but that the market does not realize that he is skilled. In this case the strategy will perform well as the price does not react on the news announcement so the fund can still buy it at a “cheap” price. c) Assume that Warren Buffet is slightly skilled, but that the market thinks he is more skilled than he actually is. Although Buffet will make money, the fund strategy will perform poorly. Example: Buffet buys at 99.5 when fair value is 100. When public announcement is made, the market overreacts, and the price goes to say 101 (because people think that Buffet found a great deal, when really he only found a decent deal). So the fund buys at 101, when the fair value is only 100. Eventually the market realizes thatthe stock is only worth 100. Page 3 of 10 /10 3) Given the following information: Expected return on the market portfolio = 13% Standard deviation of the market portfolio = 20% Risk free rate = 3% The CAPM holds and you can trade the risk free asset a) Construct an optimal portfolio that has a standard deviation of 30%. % % wm = 1.5 wf = ‐0.5 b) Construct an optimal...
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