Economics of Money, Banking and Financial Markets 4.1

Answer the questions @ 2 points, showing work

1. “Anytime it is snowing when Joe Commuter gets up in the morning, he misjudges how long it will take him to drive to work. When it is not snowing, his expectations of the driving time are perfectly accurate. Considering that it snows only once every ten years where Joe lives, Joe’s expectations are almost always perfectly accurate.” Are Joe’s expectations rational? Why or why not?

2. If the public expects a corporation to lose $5 per share this quarter and it actually loses $4, which is still the largest loss in the history of the company, what does the efficient market hypothesis predict will happen to the price of the stock when the $4 loss is announced?

3. If your broker has been right in her five previous buy and sell recommendations, should you continue listening to her advice?

4. “An efficient market is one in which no one ever profits from having better information than the rest of the market participants.” Is this statement true, false, or uncertain? Explain your answer.

5. a. Compute the price of a share of stock that pays a $1 per year dividend with an expected price in one year of $20, assuming a required return of 15%.

6. If a firm’s dividends should grow at 7% and the last dividend was $3, compute the current price of a share of the firm’s stock, assuming a required return is 18%.

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