PES INSTITUTE OF TECHNOLOGY – BANGALORE SOUTH CAMPUS
Hosur Road (1Km before Electronic City), Bangalore -560100
INTERNAL TEST # 1
Investment Management- 12MBAFM322
Course: MBA Semester III
Faculty: Divya Mathur
Date: 27/8/2013
Time Allowed: 90 Minutes
Max. Marks: 50 (Fifty Marks)
Time: 11:30 AM – 1:00 AM
Answer Key:1 (a)
(b)
Ans:-Rs.247.22
a) What is meant by APT?
Ans-arbitrage pricing theory (APT) is a general theory of asset pricing that holds that the expected return of a financial
asset can be modeled as a linear function of various macro-economic factors or theoretical market indices, where
sensitivity to changes in each factor is represented by a factor-specific beta coefficient. The model-derived rate of return
will then be used to price the asset correctly - the asset price should equal the expected end of period price discounted at
the rate implied by the model. If the price diverges,arbitrage should bring it back into line.
b)Rs. 11.95,undervalued ,buy
c
2 (a)
(b)
(c)
Ans-Beta=0.384,Characterstic line-6.54+0.384Rm
Interest rate risk is the risk of falling bond prices due to the rise in interest rates.
The bond indenture is the contract between the issuer and the holder. It specifies:
– Details regarding payment terms
– Collateral
– Positive & negative covenants
– Par or face value (usually increments of $1,000)
– Bond pricing – usually shown as the price per $100 of par value, which is equal to the percentage of the
bond’s face value
Bond Pricing Theorums:1-if the market price of the bond increases,the yield would decline and vice versa.
2.-if the bond’s yield remains the same over its life ,the discount or premium depends on the maturity period.
3.-if a bond’s yield remains constant over its life,the discount or premium amount will decrease at an increasing rate as its
life gets shorter.
4.-a rise in the bond’s price for a decline in the bond’s yield is greater than fall in the bond’s price for a rise in the yield.
5.-the change in the price will be less for a percentage in the bond’s yield if its coupon rate is higher.
•
 In 1900,a French mathematician named Louis Bachelier wrote a paper suggesting that security price fluctuations
were random.
 In 1953,Maurice Kendall in his paper reported stock price series is a wandering one.
 In 1970,Fama stated that efficient markets fully reflect the available information. Security prices reflect normal
returns for their level of risk.
Efficient Market hypothesis can be divided into three categories:
 Weak-Form Hypothesis: current prices reflect all stock market information; trading rules based on past stock
market return or volume are futile.
 Semi strong-Form Hypothesis: current prices reflect all public information; trading rules based on public information
are futile.
 Strong-Form Hypothesis: current prices reflect all public information and non-public information. All trading rules
are futile.
Weak Form of Efficient Market Hypothesis Historical Prices form the basis of information used in the weak form of efficient market hypothesis.
 According to it ,current prices reflect all the information found in past prices and traded volumes.
 Future prices cannot be predicted by analyzing past prices .
 Liquidity traders may sell their stocks without considering the intrinsic value of the shares and cause price
fluctuations.
 Buying and selling activities of the information traders lead the market price to align itself with the intrinsic value.
 In the weak form of efficient market, short-term traders may earn a positive return.
 On average, short – term traders will not outperform the blindfolded investor picking the stock with a dart.
That is, traders may earn by the naive buy-and-hold strategy and while some may incur a loss, the average buy-and-hold
strategist cannot be beaten by the chartist.
 The Random Walk Hypothesis states prices follow a random walk with price changes over time being independent
of one another.
 This hypothesis is logical if information arrives randomly, as it should, and if investors react quickly to it.
 Tests of weak form efficiency include:
 Serial correlation tests
 Runs (or signs tests)
 Testing of trading rules used by technical analysts
Semi Strong Form of Market It states that the security adjusts quickly to all publicly available information.
 Security prices fully reflect all publicly available information .
 The prices not only reflect past prices ,but also the available information regarding the earnings of the
corporation,dividends,bonus issue, right issue,mergers,acqusitions and so on.In the semi –strong efficient market,
a few insiders can earn a profit on short –run price changes rather than investors who adopt the naïve buy-hold
policy.
 The price at the equilibrium level of supply and demand represents the consensus opinion of the market.
 The intrinsic value of the and the equilibrium price are the same.
 Whenever new information arrives on the market, supply and the demand factors react to it.
 If the market processes the new information quickly ,a new price will come out of it.
 Tests of the Semi-strong Form of EMH include:
 Event (announcement) studies including ‘earnings surprises’ and corporate announcements to examine
the impact of particular events on stock prices
 Examination of the performance of investors to see if they can use publicly available information to
consistently generate abnormal returns
 Event studies examine stock returns to determine the impact of a particular event on stock prices, in particular,
what happens to the stock price, before, during and following the event.
 Events include:
 Company-specific announcements such as stock splits, takeover announcements, dividend changes,
accounting changes.
 Economy-wide changes such as unexpected interest rate changes
 Most event studies have shown that stock prices change before the announcement as demonstrated in Figure on
the following slide.
 These results demonstrate that an investor cannot move quickly enough at the time an event occurs
(announcement is made) to profit from the change, so this speaks to market efficiency in the semi-strong form,
 The strong form asserts that prices reflect all public and private information.
 If a market is strong-form efficient, then insiders could not profit from inside information not known by the public.
 Tests of this hypothesis include determining whether any group of investors has information that allows them to
earn abnormal profits consistently.




 Several studies found consistent abnormal profits
 Others found only slightly better than average returns.
Many of the tests of the strong form of EMH deal with mutual fund performances.
Financial analyst have studied the risk-adjusted rates of return from hundreds of mutual funds and found that
professionally managed funds are not able to outperform the naive –buy-hold strategist.
It is concluded that even though the analyst have a wide range of contacts and associations in both the business
and financial committees, they are unable to predict returns accurately enough to recover the research and
transaction costs.
He holds this as a striking piece of evidence for the strong form of the efficient market hypothesis.
 Weak form efficiency is very well supported, and it is reasonable to conclude that markets are weak form
efficient, although a few anomalies do exist.
 Semi-strong form efficiency is well supported; however, more contradictory evidence exists for this version
of the EMH than for the weak form.
 Strong form efficiency is not very well supported by the evidence, and it is reasonable to conclude that
markets are not strong form efficient in the strictest sense.
Case Studya)4.252
b)3.6
c)declines by .72%
OR
Rs.27