The market price of stocks appears to be much more volatile than efficient market hypothesis would suggest. This could be due to Fluctuations in the real rate of interest Fluctuations in the required risk premium Fluctuations in the growth of expected future dividends ) All of the above
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- Which statement is TRUE regarding the riskiness of money market instruments and capital market instruments? * Changing economic prospects can cause very large changes in current stock values. Distant cash flows for stocks can be known with certainty, make them riskier than money market instruments. Money market instruments have predictable cash flows and mature in one year or less, so they are much more risky. The prices of long-term capital market instruments are less sensitive to changes in interest rates than prices of short-term instruments.The security market line (SML) is an equation that shows the relationship between risk as measured by beta and the required rates of return on individual securities. The SML equation is given below: If a stock's expected return plots on or above the SML, then the stock's return is sufficient to compensate the investor for risk. If a stock's expected return plots below the SML, the stock's return is insufficient to compensate the investor for risk.The SML line can change due to expected inflation and risk aversion. If inflation changes, then the SML plotted on a graph will shift up or down parallel to the old SML. If risk aversion changes, then the SML plotted on a graph will rotate up or down becoming more or less steep if investors become more or less risk averse. A firm can influence market risk (hence its beta coefficient) through changes in the composition of its assets and through changes in the amount of debt it uses. Quantitative Problem: You are given the following…Which of the following statements is true? A. Because of flotation costs, dollars raised by retaining earnings must work harder than dollars raised by selling new shares. B. All other things being equal, a call option price will increase, and a put option price will decrease if an exercise price increases. C. Security market line (SML) plots return against total risk which is measured by the standard deviation of returns. D. Because potential long-term returns, income from rent-payments, diversification, and inflation hedge, real-estate would be a good investment.
- Why will the standard deviation not be a good measure of risk when returns are negatively skewed? What are the risk implications for an investor for a returns series that exhibits fat tails? A price weighted index places more weight on stocks with a higher price, whilst a value weighted index places more weight on stocks with a higher market capitalization. Discuss.Which of the following statements is INCORRECT? A stock's beta is calculated as the covariance between the stock's price and the market portfolio return, divided by the variance of the market portfolio return. If we assume that the market portfolio (or the S&P 500) is efficient, then changes in the value of the market portfolio represent systematic shocks to the economy. The risk premium investors can earn by holding the market portfolio is the difference between the market portfolio's expected return and the risk-free interest rate. A stock’s standard deviation is a measure of the total risk.Which of the following is correct with regards to Theories of Term Structure? When the shape of the yield curve depends on investors’ expectations about prospective prevailing interest rates, the Pure Exception Theory is being applied. When the economic outlook is improving, the yield curve inverts as it reflects no changes in inflation premium. The liquidity preference theory suggests that long-term rates are generally higher than short-term rates since investors perceive more liquidity in long-term investments. Under the Market segmentation theory, there is an apparent relationship between the yield curve and the prevailing rate of returns in each market segment.
- Assume that the CAPM assumptions hold. Consider the following statements:i. A stock with a beta below zero will tend to move in the same direction as the market but will tend to move less aggressively in that direction than the market does.ii. Alpha measures the additional risk we take on top of the risk of the market portfolio.According to the Capital Asset Pricing Model (CAPM), risky stocks pay a risk premium based on their level of systematic risk. Thus, a risky stock should have a higher expected return than a risk-free security unless it has a zero or negative beta. True FalseSuppose that Federal Reserve actions have caused an increase in the risk-free rate, rRF. Meanwhile, investors are afraid of a recession, so the market risk premium, (rM − rRF), has increased. Under these conditions, with other things held constant, which of the following statements is most correct? a. The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0. b. Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices. c. The prices of all stocks would decline, but the decline would be greatest for high-beta stocks. d. The prices of all stocks would increase, but the increase would be greatest for high-beta stocks. e. The required return on all stocks would increase by the same amount.
- Which of the following is a false statement of the market price of risk found in the Capital Market Line? a) The incremental risk divided by the incremental expected return. b) Indicates the additional expected return that the market demands for an increase in a portfolios risk. c) The equilibrium price of risk in the capital market. d) The slope of the capital market line.Why do we call alpha a “nonmarket” return premium? Why are high-alpha stocks desirable investments for active portfolio managers? With all other parameters held fixed, what would hap-pen to a portfolio’s Sharpe ratio as the alpha of its component securities increased?Under the expectations hypothesis, if the yield curve is upward-sloping, the market must expect an increase in short-term interest rates. True/false/uncertain? Why?