ch 7
A share of stock in Pria-Utang Corporation pays an annual dividend of $5. The current market price is $40. From the list of individuals below, identify who is likely to be a buyer or a seller of this stock. (Each person currently owns 100 shares.
Buy or Sell? Janey 10% 6% Buy Jimmy 12% 2% Buy Jonny 20% 5% Sell
If your broker has been right in her five previous buy and sell recommendations, you should continue to listen to her advice. Is this statement true or false?
False, although your broker has done well in the past, efficient market theory suggests that she has probably been lucky
Why might the efficient market hypothesis be less likely to hold when fundamentals suggest stocks should be at a lower level
Most investors are subject to loss aversion, so not enough short selling takes place in the market.
If stock prices did not follow a random walk, which of the following statements would be true?
There would be unexploited profit opportunities in the market and expectations would not be rational
Using the Gordon growth formula, if D1 is $1.00, ke is 10% or 0.10, and g is 5% or 0.05, then the current stock price is
$20
A share of stock in DuWop Corporation pays an annual dividend of $4. From the list of individuals below, calculate the value each person is likely to place on a share of this stock. (Round your responses to the nearest penny.)
Hannah 12% 4% $52 Henry 8% 3% $82.4 Heather 10% 6% $106.00 If the current market price is $50 and these three individuals are representative of the market as a whole, this share price is likely to rise
If higher money growth is associated with higher future inflation, and if announced money growth turns out to be extremely high but is still less than the market expected, what do you think would happen to long-term bond prices?
Long-term bond prices will increase
Which of the following is an argument in favor of the efficient market hypothesis?
Over the long term, stock prices follow a random walk and do resemble their underlying fundamental value
In the late 1990s, as information technology rapidly advanced and the Internet widely developed, U.S. stock markets soared, peaking in early 2001. Later that year, these markets began to unwind, and then crash, with many commentators identifying the previous few years as a "stock market bubble." Why was this episode considered a bubble?
Stock market prices were overvalued and rose well above their fundamental values. Investors were acting on the best information available at that time in valuing their stocks
If monetary policy becomes more transparent about the future course of interest rates, how would that affect stock prices, if at all?
Stock prices will increase, as the risk and required return on the investment will be reduced
What is the annual growth rate in the value of the dollar if we expect this value to rise 2% next (and every) week?
The annual growth rate is 180%. (Enter your response as an integer value.) Is such a change possible if our expectations are rational? no
A company has just announced a 2-for-1 stock split, effective immediately. Prior to the split, the company had a market value of $5 billion with 120 million shares outstanding. Assuming that the split conveys no new information about the company, what is the value of the company, the number of shares outstanding, and price per share after the split?
The market value of the company is $5 billion. (Round your response to the nearest whole number.) The number of shares after the split is 240 million. (120x2) The new price per share is $20.83 per share. (5,000,000,000/240,000,000.) If the actual market price immediately following the split is $24.00 per share, what does this tell us about market efficiency? A. Market efficiency is uncertain. The price could indicate both market efficiency or failure depending on whether or not the stock split actually conveyed information about the company.
Currently a share of stock is paying a dividend (cash payout C) of $4.00 to be paid in exactly one year and has a known selling price in one year (P) of $25.00. The expected return (R) of similar assets is 8.0%, and the current market price is $24.00. What is the total rate of return (R*) on this asset?
The total rate of return is 20.83. ((25-24+4)/24) Based on this information, you would expect the price of this stock to increase
The current price of DuWop (a publicly traded company) is $25. The following rules describe the random-walk behavior of price movements in the future: 1. Gains and losses are equally likely (i.e., pr(gain) = pr(loss) = .50). 2. Gains are equal to $2. 3. Losses are equal to $1.
Upper P Subscript tPt Upper P Subscript t plus 1Pt+1 Upper P Subscript t plus 2Pt+2 Upper P Subscript t plus 3Pt+3 $25 $25.50 $26.00 $26.50 You observe in time period 3 that the price, Upper P Subscript t plus 3Pt+3, of DuWop is equal to $31. Does this imply that this particular stock does not follow a random walk? No
Can a person with rational expectations, given new information about the search technology industry, expect the price of a share of Google to rise by 10% in the next month?
Yes, if this information is such that expectations of growth prospects or desired yields justify such a change
Suppose that increases in the money supply lead to a rise in stock prices. Should you go out and buy stocks?
You should not buy stocks because the rise in the money supply is publicly available information that will be already incorporated into stock prices
You read a story in the newspaper announcing the proposed merger of Dell Computer and Gateway. The merger is expected to greatly increase Gateway's profitability. If you decide to invest in Gateway stock, you can expect to earn
a normal return since stock prices adjust to reflect expected changes in profitability almost immediately
What does the stronger view of the efficient market hypothesis imply?
a security's price reflects all available information about the intrinsic value of the security
If expectations of the future inflation rate are formed solely on the basis of a weighted average of past inflation rates, then economics would say that expectation formation is
adaptive
The view that expectations change relatively slowly over time in response to new information is known in economics as
adaptive expectations
New information that might lead to a decrease in a stock's price might be
an expected decrease in the level of future dividends
Financial markets quickly eliminate unexploited profit opportunities through changes in
asset prices
Identify the cash flows available to an investor in stock
dividends and capital gains
'Forecasters' predictions of inflation are notoriously inaccurate, so their expectations of inflation cannot be rational' This statement is:
false, as expectations can be highly inaccurate and still be rational
In the generalized dividend model, if the expected sales price is in the distant future
it does not affect the current stock price
You have observed that the forecasts of an investment advisor consistently outperform the other reported forecasts. The efficient markets hypothesis says that future forecasts by this advisor
may or may not be better than the other forecasts. Past performance is no guarantee of the future
If you read in the Wall Street Journal that the "smart money" on Wall Street expects stock prices to fall, you should:
not sell all of your stocks because this is publicly available information and is already reflected in stock prices.
What basic principle of finance can be applied to the valuation of any investment asset?
present value
If a forecast is made using all available information, then economists say that the expectation formation is
rational
An expectation may fail to be rational if
relevant information is available but ignored at the time the forecast is made
If a forecast made using all available information is not perfectly accurate, then it is
still a rational expectation
In rational expectations theory, the term "optimal forecast" is essentially synonymous with
the best guess
The theory of rational expectations, when applied to financial markets, is known as
the efficient markets hypothesis
In the one−period valuation model, the current stock price increases if
the expected sales price increases
In the one−period valuation model, the value of a share of stock today depends upon
the present value of both the dividends and the expected sales price
Another way to state the efficient markets condition is: in an efficient market
unexploited profit opportunities will be quickly eliminated
A stockholder's ownership of a company's stock gives her the right to
vote and be the residual claimant of all cash flows
Rational expectations forecast errors will on average be ________ and therefore ________ be predicted ahead of time
zero; cannot
Using the one−period valuation model, assuming a year−end dividend of $0.11, an expected sales price of $110, and a required rate of return of 10%, the current price of the stock would be
$100.10
