Chapter 2: Q8-14I (page 259)
Steady Growth Industries has never missed a dividend payment in its 94-year history.
Does this make it more attractive to you as a possible purchase for your stock portfolio?
The correct answer is ‘No’. It is not a more attractive possible purchase.
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A zero-investment well-diversified portfolio with a positive alpha could arise if:
a. The expected return of the portfolio equals zero.
b. The capital market line is tangent to the opportunity set.
c. The law of one price remains un-violated.
d. A risk-free arbitrage opportunity exists.
Which one of the following would provide evidence against the semi-strong form of the efficient market theory?
a. About 50% of pension funds outperform the market in any year.
b. You cannot make abnormal profits by buying stocks after an announcement of strong earnings.
c. Trend analysis is worthless in forecasting stock prices.
d. Low P/E stocks tend to have positive abnormal returns over the long run.
Question: Don Sampson begins a meeting with his financial adviser by outlining his investment philosophy as shown below:
Statement Number | Statement |
1 | Investments should offer strong return potential but with very limited risk. I prefer to be conservative and to minimize losses, even if I miss out on substantial growth opportunities. |
2 | All nongovernmental investments should be in industry-leading and financially strong companies. |
3 | Income needs should be met entirely through interest income and cash dividends. All equity securities held should pay cash dividends. |
4 | Investment decisions should be based primarily on consensus forecasts of general economic conditions and company-specific growth. |
5 | If an investment falls below the purchase price, that security should be retained until it returns to its original cost. Conversely, I prefer to take quick profits on successful investments. |
6 | I will direct the purchase of investments, including derivative securities, periodically. These aggressive investments result from personal research and may not prove consistent with my investment policy. I have not kept records on the performance of similar past investments, but I have had some “big winners.” |
Select the statement from the table above that best illustrates each of the following behavioral finance concepts. Justify your selection.
i. Mental accounting.
ii. Overconfidence (illusion of control).
iii. Reference dependence (framing).
Suppose two factors are identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 4% and IR 6%. A stock with a beta of 1 on IP and .4 on IR currently is expected to provide a rate of return of 14%. If industrial production actually grows by 5%, while the inflation rate turns out to be 7%, what is your best guess for the rate of return on the stock?
If the simple CAPM is valid, which of the situations in Problems 13 – 19 below are possible? Explain. Consider each situation independently.
Portfolio | Expected Return | Standard Deviation |
A B | 30% 40 | 35% 25 |
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