Best Undervalued Stocks by sja16996

VIEWS: 17 PAGES: 3

More Info
									             CHAPTER 9: THE EFFICIENT MARKET HYPOTHESIS


1.   The statements consistent with efficient markets are (i) and (iii). Competition
     among participants (statement i) leads to efficient markets. Statement (iii) is the
     result of efficient markets.

2.   Zero. If not, one could use returns from one period to predict returns in later periods
     and make abnormal profits.

3.   c. This is a predictable pattern in returns which should not occur if the weak-form
        EMH is valid.

4.   c. This is a classic filter rule which should not work in an efficient market.

5.   b. This is the definition of an efficient market.

6.   d.

7.   c. The P/E ratio is public information and should not predict abnormal security
        returns.

8.   No. Intel’s continuing high return on assets does not imply that stock market
     investors who purchased Intel shares after its success already was evident would
     have earned a high return on their investments.

9.   No. This empirical tendency does not provide investors a tool to earn abnormal
     returns -- in other words, it does not suggest that investors are failing to use all
     available information. You could not use this phenomenon to choose undervalued
     stocks today. The phenomenon instead reflects the fact that stock splits occur as a
     response to good performance (positive abnormal returns) which drives up the stock
     price above a desired "trading range" and leads managers to split the stock. After
     the fact, the stocks that happen to have performed the best will be split candidates,
     but this does not imply that you can identify the best performers early enough to
     earn abnormal returns.

10. While positive beta stocks will respond well to favorable new information about the
    economy’s progress through the business cycle, they should not show abnormal
    returns around already anticipated events. If a recovery, for example, already is
    anticipated, the actual recovery is not news. The stock price already should reflect
    the coming recovery.

11. Expected rates of return will differ because of differential risk premiums.




                                            9-1
12. The market responds positively to new news. If the eventual recovery is anticipated,
    then the recovery already is reflected in stock prices. Only a better-than-expected
    recovery should affect stock prices.


13. Over the long haul, there is an expected upward drift in stock prices based on their
    fair expected rates of return. The fair expected return over any single day is very
    small (e.g., 12% per year is only about .03% per day), so that on any day the price is
    virtually equally likely to rise or fall. However, over longer periods, the small
    expected daily returns cumulate, and upward moves are indeed more likely than
    downward ones.

14. Buy. The firm is in your view not as bad as everyone else believes it to be.
    Therefore, you view the firm as undervalued by the market. You are less pessimistic
    about the firm’s prospects than the beliefs built into the stock price.


15. Assumptions supporting passive management are

     a. informational efficiency

     b. primacy of diversification motives

     Active management is supported by the opposite assumptions, in particular, pockets
     of market inefficiency.


16. a. The grandson is recommending taking advantage of (i) the small firm in January
       anomaly and (ii) the weekend anomaly.

     b. (i) Concentration of assets in stocks having very similar attributes may expose
        the portfolio to more risk than is desirable. The strategy limits diversification
        potential.

         (ii) Even if the study results are correct as described, each such study covers a
         specific time period. There is no assurance that future time periods would yield
         similar results.

         (iii) After the results of the studies became publicly known, investment
         decisions might nullify these relationships. If these firms in fact offered
         investment bargains, their prices may be bid up to reflect the now-known
         opportunity.


17. a. Consistent. Half of managers should beat the market based on pure luck in any year.




                                             9-2
     b. Inconsistent. This would be the basis of an "easy money" rule: simply invest
        with last year's best managers.

     c. Consistent. Predictable volatility does not convey a means to earn abnormal
        returns.

     d. Inconsistent. The abnormal performance ought to occur in January when
        earnings are announced.

     e. Inconsistent. Reversals offer a means to earn easy money: just buy last week's
        losers.


18. Implicit in the dollar-cost averaging strategy is the notion that stock prices fluctuate
    around a “normal” level. Otherwise, there is no meaning to statements like, “when
    the price is high.” How do we know, for example, that a price of $25 today will
    turn out to be viewed as high or low compared to the stock price in 6 months?

19. No. Any value associated with dividend predictability already will be reflected in
    the stock price.

20. The market may have anticipated even greater earnings. Compared to prior
    expectations, the announcement was a disappointment.

21. The low P/E effect and small size effect could be used to enhance portfolio
    performance if one could expect them to persist in the future. However,
    concentration in these stocks would lead to departures from efficient diversification.
    In this case, beta would no longer be an adequate descriptor of portfolio risk
    because non-systematic risk would remain in the portfolio.

22. Reasons to avoid the strategy:

     a. You might believe that these effects will no longer work now that they are
        widely known.

     b. You might decide that too much diversification must be sacrificed to exploit
        these effects.

     c. The level of risk resulting from a low P/E, small capitalization emphasis might
        be inappropriate.

     d. You might decide that these "effects" are in fact a reward for bearing risk of a
        nature not fully captured by the beta of the stock. In other words, it may be that
        the abnormal returns on these strategies would not appear so high if we could
        more accurately risk-adjust performance.




                                            9-3

								
To top