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ECMT2130
Conceptual Questions
1) According to the random walk theory/hypothesis, historical prices cannot help us forecast
future prices for a given set of information. In other words, historical share prices do not
exhibit clear patterns, so studying them to make better forecasts is fruitless.
2) According to the EMH, all available information (however you want to define “available
information”) is already reflected on the price of a security (remember that we are focusing
on the share market, but our techniques are extendable to other markets as well). So, unless
you have information not available to the market, you cannot generate returns higher than
those the market would normally obtain. In other words, with all information available to
market players, one cannot beat the market, except if they are lucky. When a new piece of
information appears, market players quickly analyse it and change their price expectations,
resulting in a change in price consistent with the information. This process presumably
happens in a split second, resulting in prices that instantaneously adjust to news. If this
mechanism is observed, then a market is called efficient.
3) They are (1) weak form, (2) semi-strong form and (3) strong form. More details on Lecture
1 slides and in Chapter 11 of the BKM text.
4) In a nutshell, technical analysts (sometimes called “chartists”) study the behaviour of past
security prices to forecast future movements. They attempt to find patterns in the series of
prices in the hope of taking advantage of them when they happen in future (and make money
out of them). Fundamental analysts on the other hand focus on the financial situation of firms
in the hope of understanding where share prices are likely to go. For example, assume an
analysis is concerned about the share price of a company whose main input is wheat. If this
analyst focuses on the behaviour of prices historically to predict future prices, this is viewed
as technical analysis. If the analyst is more concerned about the state of the balance sheet of
the company given the recent events in Ukraine (a major wheat exporter), then this analysis is
fundamental.
5) Basically, two advantages: (1) the operations carried out are usually simpler. For instance,
calculating cumulative returns normally involve a simple summation whereas for arithmetic
returns it involves multiplications. This naturally results in the second advantage: (2) it’s
often computationally faster (particularly, for calculations involving a large number of
observations).
Numerical Questions
1) After one year, Cynthia’s balance for each offer is:
Bank A
($150,000 + $8,000) ∗ (1 +
5%
2
) ∗ (1 +
5%
2
) = $165,998.75
Bank B
($150,000 + $5,000) ∗ 4.5% = $162,134.32
Bank C
($150,000 + $4,000) ∗ (1 +
6.5%
12
)
12
= $164,313.67
Because Cynthia’s balance is higher on Bank A’s case, she should go for Bank A’s offer.
2)
Bank A
($150,000 + $8,000) ∗ (1 +
%
2
)
2
= $170,000
% = 2 ∗ (√
170
158
− 1) ↔ % ≅ 7.46%
Bank A would need to offer a rate of around 7.46% per annum.
Bank B
($150,000 + $5,000) ∗ % = $170,000
% = ln (
170
155
) ↔ % ≅ 9.24%
Bank B would need to offer a rate of around 9.24% per annum.
Bank C
($150,000 + $4,000) ∗ (1 +
%
12
)
12
= $170,000
% = 12 ∗ [(
170
154
)
1
12
− 1] ↔ % ≅ 9.93%
Bank C would need to offer a rate of around 9.93% per annum.