Q1. (15 points) True or False? Explain. No points without proper explanations.
In the context of the Capital Asset Pricing Model (CAPM), the relevant measure of risk is the standard deviation of returns.
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Efficient Market Hypothesis (EMH) requires that all traders be rational.
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If all securities are fairly priced, all must offer equal expected rates of returns.
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The expected return of the underlying stock is a factor relevant to the value of an option.
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All else equal, a put option with a high exercise price is worth more than one with a low exercise price.
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Q2. (15 points) Which of the following phenomena would be either consistent with or a violation of the efficient market hypothesis? State either consistent or violated, and explain briefly.
Nearly half of all professionally managed mutual funds are able to outperform the S&P 500 in a typical year.
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Money managers that outperform the market in one year are likely to outperform in the following year.
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Stock prices tend to be predictably more volatile in January than in other months.
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Stock prices of companies that announce increased earnings in January tend to outperform the market in February.
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Stocks that perform well in one week perform poorly in the following week.
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Q3. (10 points)
Suppose the risk-free rate is 4%. Suppose also that the expected return required by the market for a portfolio with a beta of 1.0 is 9%. Suppose you consider buying a share of stock at a price of $42. The stock is expected to pay a dividend of $3 next year and to sell then for $41. The stock risk has been...