Use the following scenario analysis for stocks X and Y to answer CFA Questions
Question: What are the expected returns for stocks X and Y?
The correct answer is:
E(rX ) = 20%
E(rY ) = 10%
Probability (scenario- Bear Market) = 0.2
Probability (scenario-Normal Market) = 0.5 and
Probability (scenario- Bull Market) = 0.3
Return for Stock X (all 3 scenarios) = --20%, 18% and 50%
Return for Stock Y (all 3 scenarios) = --15%, 20% and 10%
Expected return = [Probability (Scenario) x Return in Scenario]
E(rX) = [0.2 x (–20%)] + [0.5 x 18%] + [0.3 x 50%)] = 20%
E(rY) = [0.2 x (–15%)] + [0.5 x 20%] + [0.3 x 10%)] = 10%
If the simple CAPM is valid, which of the situations in Problems 13 – 19 below are possible? Explain. Consider each situation independently.
Which of the following statements are true if the efficient market hypothesis holds?
a. It implies that future events can be forecast with perfect accuracy.
b. It implies that prices reflect all available information.
c. It implies that security prices change for no discernible reason.
d. It implies that prices do not fluctuate.
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