Question 1. Consider the following data for a one-factor economy. All portfolios are well diversified.

Portfolio                        E(r)                                     Beta

A                                  12%                                    1.2

F                                   6%                                     0.0

Suppose that another portfolio, portfolio E, is well diversified with a beta of .6 and expected return of 8%. Would an arbitrage opportunity exist? If so, what would be the arbitrage strategy?

Question 2. Suppose that the market can be described by the following three sources of systematic risk with associated risk premiums.

The return on a particular stock is generated according to the following equation:

r= 15%+ 1.0l + .5R + .75C + e

Find the equilibrium rate of return on this stock using the APT. The T-bill rate is 6%. Is the stock over- or underpriced? Explain.

Question 3. Jeffrey Bruner, CFA, uses the capital asset pricing model (CAPM) to help identify mispriced securities. A consultant suggests Bruner use arbitrage pricing theory (APT) instead. In comparing CAPM and APT, the consultant made the following arguments:

a. Both the CAPM and APT require a mean-variance efficient market portfolio.

b. Neither the CAPM nor APT assumes normally distributed security returns.

c. The CAPM assumes that one specific factor explains security returns but APT does not.

Question 4. Which of the following most appears to contradict the proposition that the stock market is weakly efficient? Explain.

a. Over 25% of mutual funds outperform the market on average.

b. Insiders earn abnormal trading profits.

c. Every January, the stock market earns abnormal returns.

Question 5. Good News, Inc., just announced an increase in its annual earnings, yet its stock price fell. Is there a rational explanation for this phenomenon?

Question 6. Assume that a company announces an unexpectedly large cash dividend to its shareholder‘: efficient market without information leakage, one might expect:

a. An abnormal price change at the announcement.
b. An abnormal price increase before the announcement.
c. An abnormal price decrease after the announcement. 7-d. No abnormal price change before or after the announcement.

Question 7. Which one of the following would provide evidence against the semistrong form of the .e -1 market theory? )
a. About 50% of pension funds outperform the market in any year.
b. All investors have learned to exploit signals about future performance.
c. Trend analysis is worthless in determining stock prices.
d. Low P/E stocks tend to have positive abnormal returns over the long run.

Question 8. Match each example to one of the following behavioral characteristics.

Example                                                                                                                            - Characteristic

a.  Investors are slow to update their beliefs when given new evidence.                                          i. Disposition effect. 

b.  Investors are reluctant to bear losses caused by their unconventional decisions.                          ii. Representative Bias

c.   Investors exhibit less risk tolerance in their retirement accounts versus their other stock accounts. iii.Regret avoidance

d.  Investors are reluctant to sell stocks with "paper" losses.                                                           iv. Conservatism Bias

e.  Investors disregard sample size when forming views about the future from the past.                        v. Mental accounting

Question 9. Use the data from The Wall Street Journal in Figure 12.5 to verify the trin ratio for the NYSE. Is the trin ratio bullish or bearish?

Question 10. Calculate breadth for the NYSE using the data in Figure 12.5. Is the signal bullish or bearish?