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ACT370H1 (9)
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January 8.docx

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Actuarial Science
Jack Pitt

January 8, 2014 Why would someone buy stock? - Performance (price might go up), investment/speculation -> R - Diversification -> R - Hedging against inflation -> R - Control (eg. Board membership) - Lower commission than other investment opportunities - Dividends - Support your favourite company, public relations - (liquidity) trading time very short - Reduce number of shares on the market (for accounting reasons) - Other benefits of ownership (eg. Discounts, getting financial reports, voting rights, attending shareholder meetings) - *Cover another trade -> R + bad luck - Mistake (eg. TWTRQ) R – rational investor model Irrational buyers pay outside the bid-ask spread and drive the market Covering a trade: A promises to be able to deliver 100,000 shares to B (probably b/c of option). A hopes it will not have to deliver, but if A must deliver and doesn’t already own the stock, A buys to cover. What assumptions weaken our theory? - No commission/transaction cost - Existence/availability of risk-free rate - No arbitrage - Unlimited supply of stock (market shortage, liquidity, market volume) - Risk-averse investor (minimize risk) - Transaction does not affect market price - Constant interest rate - Investor profile not diverse - No inflation - No tax - EMH (efficient market hypothesis) -
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