1. (It) points) Which of the following information would provide evidence against the semi-strong form of the eicient market hypothesis {assuming that each of the statements themselves is true)? Circle all that apply (no explanation necessary). i. ii- iii. iv. Companies with predicted earnings announcements this month tend to have abnormally high returns Stocks with high investment last year tend to have abnormally low returns Companies have high returns in February when they have had high returns in the past ve Februaries Markets have higher expected returns when risk aversion is high Stock prices for takeover targets on average rise in the days before the announcement 10. (10 points) Suppose an investor is considering buying a stock, and likes its expected return. He is considering two other properties of the stock: i) its standard deviation, and ii) its correlation with the market Explain how he should weight these two properties if the stock is going to be a) his entire portfolio, or b) an addition to a portfolio he has with 30 other stocks 11. (10 points) Suppose you are considering two new trading strategies. One is an anomaly recently published in the Journal of Finance and written up in the Wall Street Journal, based on CEO stock trades. The other is a strategy you have coded up yourself and haven't told people about, based on mispricing of certain geographic traits of companies. Both strategies have the same mean and standard deviation of returns up until 2020. Ignore the economic basis of each strategy (ie. your thoughts about the underlying reasons for the returns), and assume that neither calculation has any errors in the code. Which would you prefer, or would you be indifferent? Please explain your reasoning. 12. (10 points) Consider the following graph of post earnings announcement drift Cumulative abnormal return (*) 10200 100 6.00 4.00 2 00 1.00 w -6.00 8.00 -10.00 -50 -40 -30 20 -10 +10 #20 +30 +40 +50 Event time in trading days relative to earnings announcement day Source: Goings Posing Chin Open and Terry Sen. Lamig: Bae The line marked '10' shows the cumulative abnormal returns of stocks with the largest positive earnings surprises on announcement day (day 0). The line marked 1' shows the cumulative abnormal returns of stocks with the largest negative earnings surprises on announcement day. Abnormal returns are measured relative to the CAPM model. Which of the following are correct given the above graph? Circle all that apply (no explanation necessary) i) The positive returns after the announcement for firms with positive earnings surprises are inconsistent with semi-strong form market efficiency under the CAPM ii) The positive returns before the announcement for firms with positive earnings surprises are inconsistent with semi-strong form market efficiency under the CAPM iii) The high returns to stocks after positive earnings surprises may be due to risk exposure if the CAPM is not the correct model of risk iv) Markets are overreacting to the information in earnings announcements, leading to subsequent negative surprises after positive earnings news.2. (1\" points) Consider the following 5 portfolios, A, B, C, D and E. The expected returns and standard deviations of each are plotted on the graph below. Which of the following statements are true? Circle all that apply (no explanation A E C O(R) i) Under the CAPM, D has higher idiosyncratic risk than B ii) F requires the ability to borrow at the risk-free rate lil) Under the CAPM, B and A have the same Beta iv) E is on the efficient frontier regardless of whether the investor has access to a risk-free asset3. (31] points) Which of the following situations may be consistent with the CAPM? Please explain your reasoning. Expected Corr (Ri ,Rm) Standard Return Deviation 2 0 D a) (15 points) \" \f4. (20 points) You are trying to investigate a new trading strategy with which to possibly open a hedge fund. You sort firms on their depreciation expense as a fraction of assets. The assumption is that high depreciation reduces earnings, but isn't actually bad economic news. If investors treat this like other earnings, they might be overly pessimistic about these firms, and so high depreciation firms will do better in the future (so the hypothesis goes). You form the portfolio of high past depreciation firms minus low past depreciation firms, and then use the portfolio returns over the last 6 years to run two regressions: one, a CAPM regression where you regress the monthly excess return of the portfolio (i.e. Rp= rp-rf where if is the risk-free rate) on the excess returns of the market (RM= rM-rf), as well as a three factor regression where the portfolio excess returns are regressed on the excess returns of the market as well as the SMB and HML portfolios from Ken French's website. In all regressions, returns are included as decimals (so a return of 1% is written as 0.01). Results for the two regressions are presented below: CAPM Regression: Regression Statistics R Square 0.617 Adjusted R Square 0.611 Observations 72 Standard Coefficients Error t Stat Intercept 0.0086 0.0027 3.19 Mktrf 0.8613 0.0982 8.77 Fama French 3 Factor ModelFama French 3 Factor Model Regression Statistics R Square 0.732 Adjusted R Square 0.728 Observations 72 Standard Coefficients Error t Stat Intercept 0.0072 0.0032 2.25 Mktrf 0.8956 0.0972 9.21 SMB 0.0364 0.0913 0.40 HML 0.6432 0.0865 7.44a) (10 points) Is the strategy liker to be attractive to investors who evaluate funds according to a CAPM'? Please explain. b) (10 points) A rival fund manager evaluates your trading idea as follows. "High depreciation firms are likely to be value firms. When you sort on depreciation, you might find high CAPM alphas, but this is just picking up the value premium, and not actually abnormal returns under a three factor model." Based on the returns above, do you agree or not with each of the manager's statements in his last sentence?5. (30 points) Suppose we have the following properties E(RA) = 0.12 E(RB) = 0.15 E(RM) = 0.13 RF = 0.03 Std Dev(RA) = 0.16 Std Dev(RB) = 0.22 Corr(RA, RB) = 0.6 BA = 0.8 BB = 1.1 a) (15 points) What is the composition of the tangency portfolio formed between A and B?\f6. (It! points) "Which of the following is evidence for why,Ir the accruals anomaly is considered an example of mispricing under the three factor model? Circle all 1hat apply (no explanation needed). i. ii. iii. iv. A portfolio of stocks that buys low accruals stocks and shorts high accruals stocks has positive excess returns A portfolio of stocks that buys low accruals stocks and shorts high accnials stocks has a positive CAPM alpha A portfolio of stocks that buys low accruals stocks and shorts high accruals stocks has a positive alpha when regressing it on excess market returns, SMB and HML A portfolio of stocks that buys low accruals stocks and shorts high accruals stocks has a higher Sharpe ratio than the market portfolio All of the above 7. (20 points) Your friend Reginald is considering buying shares in Kodak. He describes his order submission strategy as follows: "The current bid is $8.41, and the current ask is $8.47. My plan is to put in a limit buy order at $7. I think the stock is okay at its current price, but I'm not wild about it. My order probably won't execute, but if it does, I'll have purchased the stock at a bargain price - $7 instead of $8.47. And if it doesn't, well I haven't lost anything". Explain whether you think this is a good trading plan. If it is, explain why. If not, explain what the problem is, and what alternative strategy he could use if he is able to set up alerts on his phone to tell him if a specific price level has been reached.8. (10 points) Which of the following might be expected to decrease the price of a stock through a discount rate channel? Circle all that apply (no explanation necessary). i) Investors become more willing to hold risky assets in general ii) A lightning strike causes a major factory for the company to burn to the ground iii) A major bank collapse significantly increases uncertainty in the economy iv) The firm's CEO, who was talented at increasing sales, dies in a plane crash.9. (20 points) You are trying to evaluate two different assets - an S&P 500 index fund with an expected return of 8% and a standard deviation of 18%, and a mutual fund with an expected return of 11% and a standard deviation of 27%. The risk-free rate is 2%. You friend has recently read an article in Zero Hedge alleging that the mutual fund is actually just a levered up version of the S&P 500 fund, taking investors' money, borrowing more at the risk free rate, and investing all of it in S&P 500 index funds. You want to investigate this claim. a) (10 points) Explain how, under the Capital Allocation Line, you can use the Sharpe Ratio to test if the mutual fund looks like a levered up version of the S&P 500 fund.b) (10 points) Does the fund look like it might be a levered up version of the S&P 500, or not? Please explain your reasoning