Chapter 2: Question 8B (page 259)
Which version of the efficient market hypothesis (weak, semi-strong, or strong-form) focuses on the most inclusive set of information?
The correct answer is ‘strong-form’.
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If the simple CAPM is valid, which of the situations in Problems 13 – 19 below are possible? Explain. Consider each situation independently.
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.
Growth and value can be defined in several ways. Growth usually conveys the idea of a portfolio emphasizing or including only companies believed to possess above-average future rates of per-share earnings growth. Low current yield, high price-to-book ratios, and high price-to-earnings ratios are typical characteristics of such portfolios. Value usually conveys the idea of portfolios emphasizing or including only issues currently showing low price-to-book ratios, low price-to-earnings ratios, above-average levels of dividend yield, and market prices believed to be below the issues’ intrinsic values.
a. Identify and provide reasons why, over an extended period of time, value-stock investing might outperform growth-stock investing.
b. Explain why the outcome suggested in ( a ) should not be possible in a market widely regarded as being highly efficient.
In Problems 21–23 below, assume the risk-free rate is 8% and the expected rate of return on the market is 18%.
A share of stock is now selling for \(100. It will pay a dividend of \)9 per share at the end of the year. Its beta is 1. What do investors expect the stock to sell for at the end of the year?
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.
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