978-0073382395 Chapter 12 Concepts Review and Critical Thinking Questions

Type

Quiz

Book Title

Fundamentals of Corporate Finance Standard Edition 9th Edition

ISBN 13

978-0073382395

April 3, 2019

CHAPTER 12

SOME LESSONS FROM CAPITAL

MARKET HISTORY

Answers to Concepts Review and Critical Thinking Questions

1. They all wish they had! Since they didn’t, it must have been the case that the stellar performance was

not foreseeable, at least not by most.

2. As in the previous question, it’s easy to see after the fact that the investment was terrible, but it probably

wasn’t so easy ahead of time.

3. No, stocks are riskier. Some investors are highly risk averse, and the extra possible return doesn’t attract

them relative to the extra risk.

4. On average, the only return that is earned is the required return—investors buy assets with returns in

excess of the required return (positive NPV), bidding up the price and thus causing the return to fall to

5. The market is not weak form efficient.

6. Yes, historical information is also public information; weak form efficiency is a subset of semi-strong

form efficiency.

7. Ignoring trading costs, on average, such investors merely earn what the market offers; stock investments

all have a zero NPV. If trading costs exist, then these investors lose by the amount of the costs.

8. Unlike gambling, the stock market is a positive sum game; everybody can win. Also, speculators

provide liquidity to markets and thus help to promote efficiency.

9. The EMH only says, within the bounds of increasingly strong assumptions about the information

processing of investors, that assets are fairly priced. An implication of this is that, on average, the

typical market participant cannot earn excessive profits from a particular trading strategy. However, that

10. a. If the market is not weak form efficient, then this information could be acted on and a profit earned

from following the price trend. Under (2), (3), and (4), this information is fully impounded in the

buy the stock “cheap” before the rest of the market discovers the financial statement anomaly.

Since (2) is stronger than (1), both imply that a profit opportunity exists; under (3) and (4), this

information is fully impounded in the current price and no profit opportunity exists.

c. Under (3), if the market is not strong form efficient, then this information could be used as a

profitable trading strategy, by noting the buying activity of the insiders as a signal that the stock is

underpriced or that good news is imminent. Since (1) and (2) are weaker than (3), all three imply

Solutions to Questions and Problems

NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps.

Due to space and readability constraints, when these intermediate steps are included in this solutions

manual, rounding may appear to have occurred. However, the final answer for each problem is found

without rounding during any step in the problem.

Basic

1. The return of any asset is the increase in price, plus any dividends or cash flows, all divided by the

initial price. The return of this stock is:

2. The dividend yield is the dividend divided by price at the beginning of the period price, so:

Dividend yield = $2.40 / $91 = .0264 or 2.64%

3. Using the equation for total return, we find:

R = [($83 – 91) + 2.40] / $91 = –.0615 or –6.15%