Question: Suppose two assets have zero correlation and

> For each of the following scenarios, discuss whether profit opportunities exist from trading in the stock of the firm under the conditions that (1) the market is not weak-form efficient, (2) the market is weak-form but not semi strong-form efficient, (3)

> Several celebrated investors and stock pickers have recorded huge returns on their investments over the past two decades. Is the success of these particular investors an invalidation of an efficient stock market? Explain.

> Prospectors, Inc., is a publicly traded gold prospecting company in Alaska. Although the firm’s searches for gold usually fail, the prospectors occasionally find a rich vein of ore. What pattern would you expect to observe for Prospectors’ cumulative abn

> Suppose the market is semi strong-form efficient. Can you expect to earn abnormal returns if you make trades based on a. Your broker’s information about record earnings for a stock? b. Rumors about a merger of a firm? c. Yesterday’s announcement of a suc

> The Durkin Investing Agency has been the best stock picker in the country for the past two years. Before this rise to fame occurred, the Durkin newsletter had 200 subscribers. Those subscribers beat the market consistently, earning substantially higher r

> Trans Trust Corp. has changed how it accounts for inventory. Taxes are unaffected, although the resulting earnings report released this quarter is 20 percent higher than what it would have been under the old accounting system. There is no other surprise

> New tech Corp. is going to adopt a new chip testing device that can greatly improve its production efficiency. Do you think the lead engineer can profit from purchasing the firm’s stock before the news release on the device? After reading the announcemen

> Today, the following announcement was made: “Early today the Justice Department reached a decision in the Universal Product Care (UPC) case. UPC has been found guilty of discriminatory practices in hiring. For the next five years, UPC must pay $2 million

> What is their tolerance for risk? a. Average b. Below average c. Above average

> When the 56-year-old founder of Gulf & Western, Inc., died of a heart attack, the stock price immediately jumped from $18.00 a share to $20.25, a 12.5 percent increase. This is evidence of market inefficiency because an efficient stock market would have

> Aero tech, an aerospace technology research firm, announced this morning that it hired the world’s most knowledgeable and prolific space researchers. Before today, Aero tech’s stock had been selling for $100. Assume that no other information is received

> Based on the dividend growth models presented in the chapter, what are the two components of the total return of a share of stock? Which do you think is typically larger?

> You have $100,000 to invest in a portfolio containing stock X, stock Y, and a risk-free asset. You must invest all of your money. Your goal is to create a portfolio that has an expected return of 13 percent and that has only 70 percent of the risk of the

> Using the CAPM, show that the ratio of the risk premiums on two assets is equal to the ratio of their betas.

> In Problem 12, what would the risk-free rate have to be for the two stocks to be correctly priced relative to each other? Data from Problem 12: Stock Y has a beta of 1.05 and an expected return of 13 percent. Stock Z has a beta of 0.70 and an expected

> As a practical matter, most of the return you earn from investing in Treasury bills is taxed right away as ordinary income. Thus, if you are in a 40 percent tax bracket and you earn 5 percent on a Treasury bill, your after-tax return is only 0.05 × (1 −

> The returns we have examined are not adjusted for taxes. What do you suppose would happen to our estimated returns and risk premiums if we did account for taxes? What would happen to our volatility measures?

> The returns we have examined are not adjusted for inflation. What do you suppose would happen to our estimated risk premiums if we did account for inflation?

> What is the reason margin requirements exist?

> Are market timing and tactical asset allocation similar? Why or why not?

> What is the difference between asset allocation and security selection?

> Under what two assumptions can we use the constant perpetual growth model presented in the chapter to determine the value of a share of stock? How reasonable are these assumptions?

> What is the probability that the return on small stocks will be less than −100 percent in a single year (think about it)? What are the implications for the distribution of returns?

> A particular stock had a return last year of 4 percent. However, you look at the stock price and notice that it actually didn’t change at all last year. How is this possible?

> How does a high-water mark constrain hedge fund managers from earning excess performance management fees?

> Who actually owns a mutual fund? Who runs it?

> What is the open interest on a futures contract? What do you think will usually happen to open interest as maturity approaches?

> Changes in what price lead to gains and/or losses in futures contracts?

> The current yield on a bond is the coupon rate divided by the price. Thus, it is very similar to what number reported for common and preferred stocks?

> What is the P/E ratio reported for stocks in The Wall Street Journal? In particular, how is it computed?

> What are the distinguishing features of a money market instrument?

> The liquidity of an asset directly affects the risk of buying or selling that asset during adverse market conditions. Describe the liquidity risk you face with a short stock position during a market rally and a long stock position during a market decline

> Suppose Microsoft is currently trading at $50. You want to sell it if it reaches $55. What type of order should you submit?

> Suppose your broker tips you on a hot stock. You invest heavily, but, to your considerable dismay, the stock plummets in value. What recourse do you have against your broker?

> Based on the historical record, rank the following investments in increasing order of risk. Rank the investments in increasing order of average returns. What do you conclude about the relationship between the risk of an investment and the return you expe

> The town of South Park is planning a bond issue in six months and Kenny, the town treasurer, is worried that interest rates may rise, thereby reducing the value of the bond issue. Should Kenny buy or sell Treasury bond futures contracts to hedge the imp

> Jed Clampett just dug another oil well, and, as usual, it’s a gusher. Jed estimates that in two months, he’ll have 2 million barrels of crude oil to bring to market. However, Jed would like to lock in the value of this oil at today’s prices because the o

> A mutual fund that predominantly holds long-term Treasury bonds plans on liquidating the portfolio in three months. However, the fund manager is concerned that interest rates may rise from current levels and wants to hedge the price risk of the portfolio

> Suppose one of Fidelity’s mutual funds closely mimics the S&P 500 Index. The fund has done very well during the year, and, in November, the fund manager wants to lock in the gains he has made using stock index futures. Should he take a long or short posi

> Kellogg’s uses large quantities of corn in its breakfast cereal operations. Suppose the near-term weather forecast for the corn-producing states is drought like conditions, so corn prices are expected to rise. To hedge its costs, Kellogg’s decides to use

> True or false: The most important characteristic in determining the expected return of a well-diversified portfolio is the variances of the individual assets in the portfolio. Explain.

> Classify the following events as mostly systematic or mostly unsystematic. Is the distinction clear in every case? a. Short-term interest rates increase unexpectedly. b. The interest rate a company pays on its short-term debt borrowing is increased by it

> True or false: It is impossible for a single asset to lie on the Markowitz efficient frontier.

> What is a stop-loss order? Why might it be used? Is it sure to stop a loss?

> Assume you are a very risk-averse investor. Why might you still be willing to add an investment with high volatility to your portfolio?

> True or false: If two stocks have the same standard deviation of 45 percent, then any portfolio of the two stocks will also have a standard deviation of 45 percent.

> True or false: If two stocks have the same expected return of 12 percent, then any portfolio of the two stocks will also have an expected return of 12 percent.

> What is an efficient portfolio?

> If the returns on two stocks are highly correlated, what does this mean? If they have no correlation? If they are negatively correlated?

> Based on market history, what is the average annual standard deviation of return for a single, randomly chosen stock? What is the average annual standard deviation for an equally weighted portfolio of many stocks?

> What is interest rate risk? What are the roles of a bond’s coupon and maturity in determining its level of interest rate risk?

> What are the coupon rate and current yield on a bond? What happens to these if a bond’s price rises?

> What are premium, discount, and par bonds?

> What is the difference between a market order and a limit order? What is the potential downside to each type of order?

> Evaluate the following statement: “Treasury inflation protected securities (TIPS) pay a fixed coupon.”

> What are the three different types of Treasury STRIPS that are publicly traded?

> Why do you suppose rates on some money market instruments are quoted on a bank discount basis? (Hint: Why use a 360-day year?)

> What is LIBOR? Why is it important?

> Compare and contrast commercial paper and Treasury bills. Which would typically offer a higher interest rate? Why?

> What are pure discount securities? Give two examples.

> What does it mean to be a contrarian investor? How would a contrarian investor use technical analysis?

> What is the “illusion of knowledge” and how does it impact investment performance?

> In the context of behavioral finance, why do men tend to underperform women with regard to the returns in their portfolios?

> Why do 401(k) plans with more bond choices tend to have participants with portfolios more heavily allocated to fixed income?

> Refer to Figure 4.5. Look at the three-year performance for the funds listed. Why do you suppose there are so few poor performers? Hint: Think about the hit TV show Survivor. Figure 4.5: Mutual Funds: Closing Quotes 00 TO: A|B|C|D|E|G|H|J|K|L|M|N|0

> Briefly explain mental accounting and identify the potential negative effect of this bias.

> To a technical analyst, what are support and resistance areas?

> Suppose you are flipping a fair coin in a coin-flipping contest and have flipped eight heads in a row. What is the probability of flipping a head on your next coin flip? Suppose you flipped a head on your ninth toss. What is the probability of flipping a

> In the context of Dow theory, what are the three forces at work at all times? Which is the most important?

> If a market is semi strong-form efficient, is it also weak form efficient? Explain.

> Assume that markets are efficient. During a trading day, American Golf, Inc., announces that it has lost a contract for a large golfing project that, prior to the news, it was widely believed to have secured. If the market is efficient, how should the st

> The efficient markets hypothesis implies that all mutual funds should obtain the same expected risk-adjusted returns. Therefore, we can simply pick mutual funds at random. Is this statement true or false? Explain.

> Critically evaluate the following statement: “Playing the stock market is like gambling. Such speculative investing has no social value, other than the pleasure people get from this form of gambling.”

> A famous economist just announced in The Wall Street Journal his findings that the recession is over and the economy is again entering an expansion. Assume market efficiency. Can you profit from investing in the stock market after you read this announcem

> Your broker commented that well-managed firms are better investments than poorly managed firms. As evidence, your broker cited a recent study examining 100 small manufacturing firms that eight years earlier had been listed in an industry magazine as the

> If you were concerned about the liquidity of mutual fund shares that you held, would you rather hold shares in a closed-end fund or an open-end fund? Why?

> What are the implications of the efficient markets hypothesis for investors who buy and sell stocks in an attempt to “beat the market”?

> A stock market analyst is able to identify mispriced stocks by comparing the average price for the last 10 days to the average price for the last 60 days. If this is true, what do you know about the market?

> Referring to Questions 5 and 6, under what circumstances might a company choose not to pay dividends? Data from Questions 5: Why does the value of a share of stock depend on dividends? Data from Questions 6: A substantial percentage of the companies

> A substantial percentage of the companies listed on the NYSE and the NASDAQ don’t pay dividends, but investors are nonetheless willing to buy shares in them. How is this possible given your answer to Question 5?

> Why does the value of a share of stock depend on dividends?

> Why do we need to convert the typical equity beta to value a firm using FCF?

> What happens in the residual income model when EPS is negative?

> Why do growth stocks tend to have higher P/E ratios than value stocks?

> If a firm has no dividends and has negative earnings, which valuation models are appropriate?

> What is the basic principle behind dividend discount models?

> What are 12b-1 fees? What expenses are 12b-1 fees intended to cover? Many closed-end mutual funds charge a 12b-1 fee. Does this make sense to you? Why or why not?

> What are Vega’s money- (or dollar-) weighted average returns over the five-year period for Scenarios 2 and 3? Scenarlo 2 Scenario 3 a. 7.78% 7.96% b. 7.96% 7.78% с. 9.00% 7.85%

> Is it necessarily true that, all else the same, an index with more stocks is better? What is the issue here?

> There are basically four factors that differentiate stock market indexes. What are they? Comment on each.

> With regard to the NASDAQ, what are inside quotes?

> Suppose Tesla is currently trading at $200. You think that if it reaches $210, it will continue to climb, so you want to buy it if and when it gets there. Should you submit a limit order to buy at $210?

> Why would floor brokers be willing to pay $40,000 per year just for the right to trade on the NYSE?

> Why would venture capitalists provide financing in stages?

> In your local Chevrolet retailer, both a primary and a secondary market are in action. Explain. Is the Chevy retailer a dealer or a broker?

> What is the difference between a money market deposit account and a money market mutual fund? Which is riskier?

> Mr. Green and Ms. Hutchinson divided up their research into return enhancement and diversification benefits. Based upon the stated goals of their research, which of the two approaches is more likely to lead to an appropriate choice? a. Green’s research.

> Mr. Wallace is particularly interested in the effects of a steepening yield curve. Which of the following is most accurate for a steepening curve? a. The price of short-term Treasuries increases relative to long-term Treasuries. b. The price of long-term

> An open-end mutual fund typically keeps a percentage, often around 5 percent, of its assets in cash or liquid money market assets. How does this affect the fund’s return in a year in which the market increases in value? How about during a bad year? Close

> According to the expectations theory, which of the following is closest to the one-year implied forward rate one year from now? a. 6.58 percent b. 5.75 percent c. 6.25 percent