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FIN 300
Scott Anderson

CHAPTER 12 SOME LESSONS FROM CAPITAL MARKET HISTORY Answers to Concepts Review and Critical Thinking Questions 1. They all wish they had! Since they didnt, it must have been the case that the stellar performance was not foreseeable, at least not by most. 2. As in the previous question, its easy to see after the fact that the investment was terrible, but it probably wasnt so easy ahead of time. 3. No, stocks are riskier. Some investors are highly risk averse, and the extra possible return doesnt attract them relative to the extra risk. 4. On average, the only return that is earned is the required returninvestors buy assets with returns in excess of the required return (positive NPV), bidding up the price and thus causing the return to fall to the required return (zero NPV); investors sell assets with returns less than the required return (negative NPV), driving the price lower and thus the causing the return to rise to the required return (zero NPV). 5. The market is not weak form efficient. 6. Yes, historical information is also public information; weak form efficiency is a subset of semi-strong form efficiency. 7. Ignoring trading costs, on average, such investors merely earn what the market offers; the trades all have zero NPV. If trading costs exist, then these investors lose by the amount of the costs. 8. Unlike gambling, the stock market is a positive sum game; everybody can win. Also, speculators provide liquidity to markets and thus help to promote efficiency. 9. The EMH only says, within the bounds of increasingly strong assumptions about the information processing of investors, that assets are fairly priced. An implication of this is that, on average, the typical market participant cannot earn excessive profits from a particular trading strategy. However, that does not mean that a few particular investors cannot outperform the market over a particular investment horizon. Certain investors who do well for a period of time get a lot of attention from the financial press, but the scores of investors who do not do well over the same period of time generally get considerably less attention from the financial press. 10. a. If the market is not weak form efficient, then this information could be acted on and a profit earned from following the price trend. Under ii, iii, and iv, this information is fully impounded in the current price and no abnormal profit opportunity exists. b. Under ii, if the market is not semi-strong form efficient, then this information could be used to buy the stock cheap before the rest of the market discovers the financial statement anomaly. Since ii is stronger than i, both imply that a profit opportunity exists; under iii and iv, this information is fully impounded in the current price and no profit opportunity exists. c. Under iii, if the market is not strong form efficient, then this information could be used as a profitable trading strategy, by noting the buying activity of the insiders as a signal that the stock 121
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