c) Explain why a (naked) short position in the S&P500; futures contract is expec

Question

c) Explain why a (naked) short position in the S&P500; futures contract is expected to lose money assuming that spot-futures parity holds. How can the negative expected return on a risky short position be explained in an efficient market? (2 marks) d) Bad News Inc., just announced a large decrease in sales and earnings, yet its stock price on the announcement day rose significantly. Explain how this phenomenon can be consistent with an efficient market. (2 marks) Suppose that as the economy moves through a business cycle, risk premiums also change. For example, in a recession when people are concerned about their jobs, risk tolerance might be lower and risk premiums on risky securities might be highei. Explain how a cycle of increasing and decreasing risk premiums might explain an appearance of stock price over-reaction-first falling excessively and then seeming to recover- in an efficient market. e) (2 marks)

Explanation / Answer

Because of dividend yield, futures price might increase and hence short psoition might lose money.

the decrease in sales and earnings might be lower than expected or future guidance might be good

if risk premium increases, required return increases and as required return is on denominator the stock price decreases
if risk premium decreases, required return decreases and as required return is on denominator the stock price increases

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