Week 2 – discussion questions in class

Scenario 1

There are four/five time periods

At time 0, nothing happens

At time 1, an important customer goes bankrupt

At time 2, management of our company find out

At time 3, they announce to the market that an important customer has gone bankrupt

At time 4, they announce earnings for the year, earnings are very low because of the customer

Questions

Draw a price graph and volume chart.

 assume semi-strong form market efficiency.

Repeat for:

 strong form and

 weak form.

Note: weak form efficiency is a hard question – there’s no one correct answer.

Strong and semi-strong form have (basically) only one correct answer

Challenge question: investors underreact, but otherwise semi-strong form. Draw the graph, explain
how you would trade using fundamental analysis.
Scenario 2

New management are appointed for a listed company. Investors expect profits of $4.90 per share.
The company never used to give profit estimates.

In October of their first year management announce a profit estimate of $5.10 per share for the year
ending 31 Dec. They say they will always give profit estimates every year.

In January they report earnings were $5.00 per share for the year ended 31 Dec.

In the second year the same happens: estimate $5.10, report $5.00.

In the third and fourth year the same happens.

Questions

Note: probably a good idea to state any assumptions (market efficiency?)

1. In the first year what effect does the profit estimate have? Refer to price, volume, spread
and liquidity.
2. In the first year what effect does the earnings announcement have? Just refer to price and
volume.
3. In the fourth year what effect does the profit estimate have?
4. In the fourth year how does spread and liquidity compare to your answer to 1)

Hard: what happens to price and volume on Dec 31 of the first year?