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Chapter 8 The Efficient Market Hypothesis Study Guide

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Chapter 08 - The Efficient Market Hypothesis
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
CHAPTER 08
THE EFFICIENT MARKET HYPOTHESIS
1. The correlation coefficient should be zero. If it were not zero, then one could use returns from
one period to predict returns in later periods and therefore earn abnormal profits.
2. The phrase would be correct if it were modified to say “expected risk adjusted returns.”
Securities all have the same risk adjusted expected return if priced fairly; however, actual
results can and do vary. Unknown events cause certain securities to outperform others. This is
not known in advance, so expectations are set by known information.
3. Over the long haul, there is an expected upward drift in stock prices based on their fair
expected rates of return. The fair expected return over any single day is very small (e.g., 12%
per year is only about 0.03% per day), so that on any day the price is virtually equally likely to
rise or fall. However, over longer periods, the small expected daily returns cumulate, and
upward moves are indeed more likely than downward ones.
4. No, this is not a violation of the EMH. Microsoft’s continuing large profits do not imply that
stock market investors who purchased Microsoft shares after its success already was evident
would have earned a high return on their investments.
5. No. The notion of random walk naturally expects there to be some people who beat the
market and some people who do not. The information provided, however, fails to consider the
risk of the investment. Higher risk investments should have higher returns. As presented, it is
possible to believe him without violating the EMH.
6. b. This is the definition of an efficient market.

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