Topic 3: Parts 2 and 3, Topic 4

Question 1

Firms are typically considered risk-averse

Answer 1

.

Question 2

Scenario Analysis

Answer 2

Scenario analysis asks the question of how a project performs under given circumstances.
-attribute specific values to each of the factors, then calculate the NPV

Question 3

Sensitivity Analysis

Answer 3

Sensitivity analysis is a particular type of scenario analysis which only considers uni variate changes.

• one variable changes
• predicted variables for all but one
• can asses relative importance of each factor

Question 4

Simulation Analysis

Answer 4

Simulation analysis asks the question of how a project performs under all possible circumstances.
-any number of variables change

Question 5

Mean-Variance Rule

Only if firms are risk-averse

Answer 5

Project X is preferred to Y is:
•higher expected return and the same risk
•same expected return and lower risk

Question 6

Departures from Risk-Aversion Assumption

Answer 6

• distressed firms may be GAMBLING for resurrection
• firms with a LARGE DEBT OVERHANG may take excessive risk
• SMALL-SCALE INVESTMENTS which are very risky

Question 7

Risk with multiple projects

Answer 7

To reduce overall risk, firms often aim to implement projects with a negative correlation.

Question 8

Information Efficiency

Answer 8

Information efficiency measures the extent to which available information is impounded into the current set of (stock market) prices.

Question 9

Weak form of market efficiency

Answer 9

Security prices reflect all information found in past trading patterns.

Question 10

Semi-strong form of market efficiency

Answer 10

Security prices reflect all publicly available information.

Question 11

Strong form of market efficiency

Answer 11

Security prices reflect all information, public and private.

Question 12

Mutual Fund Performance

Semi-strong for of efficiency

Answer 12

• public information is already impounded into stock prices
• hence fund managers should not be able to beat the market consistently unless they have access to illegal inside information

Question 13

Mutual Fund Performance

Answer 13

Evidence for semi-strong:
•actively managed funds fail to consistently beat the market
•little persistence in fund performance from year to year
•investing in an index-linked passive fund is often more appropriate for a long term investors

Question 14

Technical Analysis

Answer 14

Technical analysis of the history of share prices and trading patters is the attempt to identify and exploit repetitive patterns.

Question 15

Turn of the Year Anomaly

Answer 15

Stocks which have a bad performance at the end of the (tax) year tend to outperform markets at the start of the new year.
-sell, undervalued, reversion to fundamental value

Question 16

Turn of the Week Anomaly

Answer 16

Stock tends to move more on Fridays than Mondays.

• investors are optimistic at the end of the week
• over the weekend, they fret but cannot trade until Monday

Question 17

Mean Reversion Anomaly

Answer 17

Stocks at either end of the performance spectrum tend to revert course in the following period
-strongest performing stocks are more likely to be somewhat overvalued relative to fundamentals

Question 18

Stock Market Bubble

Answer 18

A stock market bubble occurs when stock market participants drive prices well above their fundamental value.

Question 19

Why may firms change their risk?

Answer 19

• distressed firms gambling for resurrection
• firms with large debt overhang may take excessive risk
• small scale investments which are very risky

Question 20

Opportunity to scrap a project

Answer 20

If we are able to scrap a project after a few periods, our expected NPV increases.

Question 21

Mean-Variance Rule

Answer 21

Project X is preferred to Y:
•higher expected return and equal risk
•same expected return and less risk

Question 22

Negatively correlation

Answer 22

It is better to have negatively correlated projects to reduce overall riskiness.

Question 23

3 arguments for stock market being semi-strong form efficient

Answer 23

• actively managed funds fail to consistently beat the market
• little persistence in fund performance from year to year
• investing in an index-linked passive fund is often more appropriate for a long term investor

Question 24

Why is the weak performance of actively managed funds evidence in favour of semi-strong?

Answer 24

If the semi-strong form of efficiency holds, public information is already impounded into prices and hence fund managers should not be able to beat the market consistently unless they have access to illegal insider information.

Question 25

Argument against strong form efficiency

Answer 25

•strong form efficiency suggests that even insider information does not yield profitable trading opportunities
•some studies exist, ever though insider trading is prohibited, and suggest that insider trading is abnormally profitable
-abnormal returns: returns exceeding the expected return

Question 26

Technical analysis

Answer 26

Technical analysis of the history of share prices and trading patterns is the attempt to identify and exploit repetitive patterns
-focus on past trading pieces and patters to predict whether stock price moves up or down

Question 27

Technical analysis

Answer 27

Technical analysis is bound to yield no profits if the stock market is at least weak form efficient because any information contained in analysis is already impounded into price.
-past trading patterns already analysed and impounded into price

Question 28

Scenario analysis

Answer 28

Scenario analysis asks the question of how a project performs under given circumstances
-multiple uncertain factors, attribute specific values, NPV

Question 29

Sensitivity analysis

Answer 29

Sensitivity analysis is a particular type of scenario analysis which only considers univariate changes

• one variable changes
• predicted variables for all but one

Question 30

Simulation analysis

Answer 30

Simulation analysis asks the question of how a project performs under all possible circumstances
-any number of variables change