63) If the simple CAPM is valid and all portfolios are priced correctly, which o
ID: 2759783 • Letter: 6
Question
63) If the simple CAPM is valid and all portfolios are priced correctly, which of the situations below is possible? Consider each situation independently, and assume the risk-free rate is 5%.
A)
B)
C)
D)
which of the situations below is possible?
Option C Option A Option D Option B
71) Which of the following stock price observations would appear to contradict the weak form of the efficient market hypothesis?
a) The correlation between the market return one week and the return the following week is zero.
b) You could have consistently made superior returns by forecasting future earnings performance with your new Crystal Ball forecast methodology.
c) You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.
d) The average rate of return is significantly greater than zero.
Portfolio ExpectedReturn Beta A 11 % 1.2 Market 11 % 1.0
Explanation / Answer
Solution:-
63) Ans:- D
Reasons for each parts :-
A) This is not possible because the beta of "A" is higher than market, so ti should have higher expected return as per CAPM model.
B)Not Possible there because there cannot be security outside the efficient frontier.
c) Not possible because ,As per CAPM model
Expected return = Rf+beta(Rm-Rf)
=5%+1.2*(9%-5%)=9.8%
D) Possible because ,As per CAPM model
Expected return = Rf+beta(Rm-Rf) = 5%+2.3(11%-5%)=18.8%
71) Ans:- c) You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.
Reason:-
a) As per weak hypothesis the future stock prices are random , have no relation with past prices.
b) Weak form of hypothesis assumes that the market has taken into all the past publically available information , not the future one. Hence if we have future information which is not publically available we can gain from that.
c) This hypothesis assumes that the movement of price is random, does not follow the pattern. When the price movement is random when buyinr at 10% increase and selling after 10% will not result in consistent profit. Hence this is not correct.
d) This is correct.
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