“If all securities are fairly priced, all must offer equal expected rates of return.” Comment
The phrase should have been tweaked to say “expected risk adjusted returns”.
True to its name, the expected risk adjusted returns measures the profit earned from the investment relative to the risk it carried.
In the above scenario, it would have been more appropriate to say “expected risk adjusted returns”.
All the securities have same risks adjusted expected returns. However because of certain unforeseen events, their results may vary. Since these are not known in advance hence the known information is used to set in the expectation.
a. Suppose you forecast that the standard deviation of the market return will be 20% in the coming year. If the measure of risk aversion in Equation 5.13is A 5 4, what would be a reasonable guess for the expected market risk premium? b. What value of A is consistent with a risk premium of 9%? c. What will happen to the risk premium if investors become more risk tolerant? (LO 5-4)
Suppose that, after conducting an analysis of past stock prices, you come up with the following observations. Which would appear to contradict the weak form of the efficient market hypothesis? Explain.
a. The average rate of return is significantly greater than zero.
b. The correlation between the return during a given week and the return during the following week is zero.
c. One could have made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.
d. One could have made higher-than-average capital gains by holding stocks with low dividend yields.
Which of the following sources of market inefficiency would be most easily exploited?
a. A stock price drops suddenly due to a large block sale by an institution.
b. A stock is overpriced because traders are restricted from short sales.
c. Stocks are overvalued because investors are exuberant over increased productivity in the economy.
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