FINM 2416 Asset Pricing Topic 1: EMH and Technical Analysis

FINM2416 ASSET PRICING

TOPIC 1 – EMH AND TECHNICAL ANALYSIS
TUTORIAL QUESTIONS

PROBLEM SETS (CH11)

2. A successful firm like Microsoft has consistently generated large profits for years. Is this a
violation of the EMH?

9. Which of the following most appears to contradict the proposition that the stock market is
weakly efficient? Explain.

a. Over 25% of mutual funds outperform the market on average.

b. Insiders earn abnormal trading profits.
c. Every January, the stock market earns abnormal returns.

11. Suppose that, after conducting an analysis of past stock prices, you come up with the
following observations. Which would appear to contradict the weak form of the efficient
market hypothesis? Explain.

a. The average rate of return is significantly greater than zero.

b. The correlation between the return during a given week and the return during the
following week is zero.
c. One could have made superior returns by buying stock after a 10% rise in price and
selling after a 10% fall.
d. One could have made higher-than-average capital gains by holding stocks with low
dividend yields.

12. Which of the following statements are true if the efficient market hypothesis holds?

a. It implies that future events can be forecast with perfect accuracy.

b. It implies that prices reflect all available information.
c. It implies that security prices change for no discernible reason.
d. It implies that prices do not fluctuate.

14. Which of the following would be a viable way to earn abnormally high trading profits if
markets are semi-strong-form efficient?

a. Buy shares in companies with low P/E ratios.

b. Buy shares in companies with recent above-average price changes.
c. Buy shares in companies with recent below-average price changes.
d. Buy shares in companies for which you have advance knowledge of an improvement in
the management team.

1 | UQ Business School
FINM 2416 Asset Pricing Topic 1: EMH and Technical Analysis

20. In a recent closely contested lawsuit, Apex sued Bpex for patent infringement. The jury
came back today with its decision. The rate of return on Apex was rA = 3.1%. The rate of
return on Bpex was only rB = 2.5%. The market today responded to very encouraging news
about the unemployment rate, and rM = 3%. The historical relationship between returns on
these stocks and the market portfolio has been estimated from index model regressions as:

Apex: 𝑟𝑟𝐴𝐴 = 0.2% + 1.4𝑟𝑟𝑀𝑀

Bpex: 𝑟𝑟𝐵𝐵 = −0.1% + 0.6𝑟𝑟𝑀𝑀

On the basis of these data, which company do you think won the lawsuit? (Note to students:
we will discuss the index model regression in week 7, for now, let’s focus on the stock
reaction to new information)

24. You know that firm XYZ is very poorly run. On a scale of 1 (worst) to 10 (best), you
would give it a score of 3. The market consensus evaluation is that the management score is
only 2. Should you buy or sell the stock?

PROBLEM SETS (CH12)

Use the following figure to answer Q13 and Q14.

13. Use the data from The Wall Street Journal in the figure outlined above to verify the trin
ratio for the NASDAQ. Is the trin ratio bullish or bearish?

14. Calculate breadth for the NASDAQ using the above data. Is the signal bullish or bearish?

16. Baa-rated bonds currently yield 6 %, while Aa-rated bonds yield 5%. Suppose that due to
an increase in the expected inflation rate, the yields on both bonds increase by 1%.
a. What would happen to the confidence index?
b. Would this be interpreted as bullish or bearish by a technical analyst?
c. Does this make sense to you?

2 | UQ Business School
FINM 2416 Asset Pricing Topic 1: EMH and Technical Analysis

17. Table 12A presents price data for Computers, Inc. and a computer industry index. Does
Computers, Inc, show relative strength over this period?

18. Using the data in Table 12A, compute a five-day moving average for Computers, Inc.
Can you identify any buy or sell Signals?

20. Table 12B contains data on market advances and declines. Calculate cumulative breadth
and decide whether this technical signal is bullish or bearish.

21. In Table 12B, if the trading volume in advancing shares on day 1 was 530 million shares,
while the volume in declining issues was 440 million shares, what was the trin statistic for
that day? Was the trin bullish or bearish?

3 | UQ Business School