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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.