Let's say that financial investors, who at least potentially are interested in buying stocks about market conditions. Their fear is such that it would take pretty significant returns to buy stocks. From what we learned in lecture, we know that this will tend to drive stock prices up because the risk-free interest rate will rise down because dividends will rise O down because dividends will fall down because the risk premium will rise
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- Question 1 We understand standard deviation of returns as a measure of risk and rational investors would like to minimize risk. Notwithstanding this, you may have read that as the standard deviation of returns of the underlying asset increases the value of an option rises. If standard deviation is a measure of risk and investors do not particularly like it, why does it lead to an increase in an option's value? Question 2 Assume that you have some shares of stock in ABC Inc. Why do we say that if you also purchase a put option on the same stock, the price paid to buy the put option is like paying an insurance premium?1. If a company has a Beta = 1.7, this stock is riskier than the S&P 500 index. That means its price fluctuates more than the market average. We can also say that the company’s stock price is more volatile than average. What’s good about a Beta > 1 and what’s bad about it? 2. T or F? Higher risk investments give the investor a higher return. If this is true, why don’t we all invest in the riskiest investments we can find? What’s the difference between fundamental analysis and technical analysis? Don’t simply define them both. Figure out what’s different. 3. If the value > price, then BUY according to value investors If the value < price, the DON’T BUY or maybe sell or hold according to value investors Would “momentum” investors say Buy or Don’t Buy? What would “income investors” want to know in order to make a BUY decision?If you read in the Wall Street Journal that the “smartmoney” on Wall Street expects stock prices to fall,should you follow that lead and sell all your stocks?
- Answer the following questions: A. Explain why the price of many individual stocks still goes down, even when the overall stock market goes up. b. How can you avoid the value of your stock from going down?Rate of return, standard deviation, coefficient of variation Personal Finance Problem Mike is searching for a stock to include in his current stock portfolio. He is interested in Hi-Tech Inc.; he has been impressed with the company's computer products and believes Hi-Tech is an innovative market player. However, Mike realizes that any time you consider a technology stock, risk is a major concern. The rule he follows is to include only securities with a coefficient of variation of returns below 1.00. Mike has obtained the following price information for the period 2015 through 2018: Hi-Tech stock, being growth-oriented, did not pay any dividends during these 4 years. a. Calculate the rate of return for each year, 2015 through 2018, for Hi-Tech stock. b. Assume that each year's return is equally probable and calculate the average return over this time period. c. Calculate the standard deviation of returns over the past 4 years. (Hint: Treat this data as a sample.) d. Based on b and c…What are efficient markets? Imagine if the price of a stock is going up and financial markets are efficient what can you tell us about the nature of the stock? What if the markets are inefficient then how would you react to increasing prices for a particular stock?
- Q1: Respond to each of the following comments: If stock prices follow a random walk, then capital markets are little different from a casino. A good part of a company’s future prospects is predictable. Given the ace, stock prices cannot possibly follow a random walk. If markets are efficient, you might as well select your portfolio by throwing darts at the stock listings in the The Wall Street Journal.7. Consider the following information about Stocks I and II: Probability of Rate of Return if State Occurs State of Economy Recession Normal Irrational exuberance State of Economy .25 .50 .25 Stock I .02 .21 .06 Stock Il -.25 .09 .44 The market risk premium is 8 percent, and the risk-free rate is 4 percent. Which stock has the most systematic risk? Which one has the most unsystematic risk? Which stock is "riskier"? Explain.6 The risks and expected cash flows for Stock A and Stock B are the same. Indeed, these two stocks are identical, but their liquidity differs. Stock A trades substantially more frequently than Stock B. The stock market is perfectly competitive. (i) Briefly explain why the equilibrium price of Stock A should be higher than that of Stock B. ii) Do you expect the difference in equilibrium prices between Stock A and Stock B to become larger or smaller during a financial crisis? Briefly explain your answer
- A4 6 b b. Suppose we observe two stocks with the following characteristics: Stock Expected return Beta M 20% 1.6 N 12% 0.9 An asset is said to be undervalued if its price is too low given its expected return and risk. The risk-free rate is currently 6%. Is one of the two stocks undervalued relative to the other? Explain your answer fully (i.e., provide reasons why you think the stock is or is not undervalued).Consider the following information about Stocks I and II. State of Economy Recession Normal Irrational exuberance Probability of State of Economy 0.15 0.55 0.30 The market risk premium is 7.5 percent, and the risk-free rate is 4 percent. (a) Compute and identify the stock that has the most systematic risk. (b) Compute and justify the stock that has the most unsystematic risk. (c) Identity and justify which stock is "riskier". Rate of Return if State Occurs Stock I Stock II 0.11 -0.25 0.18 0.11 0.08 0.31History suggests that all stock market bubbles will eventually pop and cause severe financial loss for many of those who purchased stock. Given this history, do you think that stock market bubbles will continue to occur? Why or why not?