a.The efficient market hypothesis (EMH) evolved in the 1960s from the doctoral dissertation of Professor Eugene Fama. Currently, Professor Fama is the Robert R. McCormick Distinguished Service Professor at the University of Chicago and he is the Nobel Memorial Prize laureates in Economics in 2013 for his contribution in empirical analysis of asset prices. Professor Fama persuasively made the argument that in an active market that includes many well-informed and intelligent investors, securities will be appropriately priced and reflects all available information. Thus, in an efficient market, no information or analysis 1 could be expected to result in out-performance of an appropriate benchmark. Dow Jones Industrial Average (DJIA), Standard and Poor 500 (S&P500), FT-100 (Financial Times) and Hang Seng Index (HSI) are best known as the appropriate benchmarks. According to Professor Famas argument, the investors in Hong Kong should only invest their wealth in Hang Seng Index as the benchmark. Do you think this is the proper way of investing your wealth? Why or Why not? Explain. (15 marks)

b. In the following two cases, discuss how Mr. Chan might use Hang Seng Index (HSI) futures to protect a well-diversified stock portfolio.

b1. Mr. Chan expects to receive a Lunar New Year bonus paycheck in next month and would like to invest in Hong Kong stock market. He thinks that the current stock prices are very attractive and knowing now is the best time to buy Hong Kong stock. (5 marks)

b2. The financial secretary has said in the public that the unemployment rate in Hong Kong will continue to rise over the next couple of months. After Mr. Chan has heard this news, he expects the stock market to decline significantly very soon but realize that quickly liquidating the current stock portfolio would result in large transactions costs. (5 marks)