6a) Your broker suggests that you can make consistent, excess profits by purchas
ID: 2750852 • Letter: 6
Question
6a)
Your broker suggests that you can make consistent, excess profits by purchasing stocks on the 20th of the month and selling them on the last day of the month. If that is true, then
A) Insiders will be the only investors to profit
B) The market is only semi-strong form efficient
C) The market violates even weak-form efficiency
D) Prices follow a random walk
6b)
A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk. In evaluating this asset, the decision maker should.
A) Increase the cost of capital used to evaluate the projects to reflect the higher risk of the project.
B) Increase the NPV of the asset to reflect the greater risk.
C) Increase the IRR of the asset to reflect the greater risk
D) Reject the asset, since its acceptance would increase the risk of the firm
E) Ignore the risk differential if the asset to be accepted would comprise only a small fraction of the total assets of the firm.
6c)
Modigliani and Miller suggests that the value of a firm is not affected by the firm’s dividend policy, due to _______.
A) The clientele effect
B) The optimal capital structure
C) The informational content
D) The relevance of dividends
Explanation / Answer
6a) answer c
ecxessive profit cannot be made if the market follow weak form of efficieny. This is because weak-form EMH implies that the market is efficient, reflecting all market information. This hypothesis assumes that the rates of return on the market should be independent; past rates of return have no effect on future rates..if the broker is sure that their will be excessive profit then definitely some inside information he is having and thus the market is not trabsparent to other investors.
6b. answer a)
increase the cost of capital to evaluate the project to reflect the higher risk. Cost of capital refers to the opportunity cost of making a specific investment. It is the rate of return that could have been earned by putting the same money into a different investment with equal risk. Thus, thecost of capital is the rate of return required to persuade the investor to make a given investment. thus if the project offers more return then higher risk can be taken.
6c. answer b) the optimal capital structure.
modigilani and miller studied capital structure and from their analysis, they developed the capital-structure irrelevance proposition. Essentially, they hypothesized that in perfect markets, it does not matter what capital structure a company uses to finance its operations. They theorized that the market value of a firm is determined by its earning power and by the risk of its underlying assets, and that its value is independent of the way it chooses to finance its investments or distribute dividends.
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