EMH Recap Exercises.

To follow up on the EMH lectures, we solve a set of relevant exercises:

• Solve the following end of chapter problems from chapter 11

– problem 4.
– problem 8.
– problem 9.
– problem 11.

• Solve problem 2 from the 2018 retake exam. (attached here)

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Problem 2 2018 retake exam
a) A researcher examines stock price reactions to announcements of stock
repurchases. Based on a large sample of companies, the researcher
has computed cumulative abnormal returns around the time of the
stock repurchase announcements. News about stock repurchases often
lead to positive reactions on the stock market. The figure plots the
cumulative abnormal return from 10 days before the announcement
date to 10 days after the announcement date. Explain whether the
time series pattern in the cumulative abnormal return is consistent
with the efficient market hypothesis.

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Cumulative abnormal return(%)

-1
-10 -8 -6 -4 -2 0 2 4 6 8 10
Days relative to announcement date

b) An investor reads the financial news and stumbles upon a news story
about a company, which yesterday had announced that its earnings
were going to increase by 50% during the next year. In the news article,
a number of stock analysts made statements that the 50% increase in
earnings was fully realistic and, as a consequence, they recommended
to buy the stock. The investor decides to buy the stock the following
day, as he is fully convinced that the stock price will increase the next
couple of days, and then afterwards he will sell the stock again. Discuss
whether this strategy is appropriate.

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c) Discuss whether the following statements are consistent with the effi-
cient market hypothesis:

i) There is a correlation of zero between today’s and yesterday’s

stock market returns.
ii) On average, it is possible to earn higher returns on small stocks
than on big stocks.
iii) It is possible to obtain valuable information about future move-
ments on the stock market by using technical analysis.
iv) It is to a certain degree possible to predict a company’s future
stock price by carefully reading its annual report.

d) Assume that the risk-free rate is 1% and the expected market return is
5%.

i) If a stock has a beta of 1.1, what is then the expected return on

the stock?
ii) If a stock has a beta of 0.9 and an expected return of 5.6%, what
is then the alpha of the stock?