CHAPTER 12 B-225
b. Under (2), if the market is not semi-strong form efficient, then this information could be used to
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
that a profit opportunity exists. Note that this assumes the individual who sees the insider trading is
the only one who sees the trading. If the information about the trades made by company
management is public information, it will be discounted in the stock price and no profit
opportunity exists. Under (4), this information does not signal any profit opportunity for traders;
any pertinent information the manager-insiders may have is fully reflected in the current share
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.
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%
And the dividend yield and capital gains yield are: