Question & Answer

Explain the difference between weak-form, semistrongform, and strong-form efficiency. Which of these forms of efficiency is most difficult to test? Which is most likely to be refuted? Explain how to test weakform efficiency in the stock market. (LO6)

In the movie Wall Street, Bud Fox is a broker who conducts trades for Gordon Gekko’s firm. Gekko purchases shares of firms that he believes are undervalued. Various scenes in the movie offer excellent examples of concepts discussed in this chapter. (LO3, LO4, LO6)

a. Bud Fox comments to Gordon Gekko that a firm’s breakup value is twice its market price. What is Bud suggesting in this statement? How would employees of the firm respond to Bud’s statement?

b. When Bud informs Gekko that another investor, Mr. Wildman, is secretly planning to acquire a target firm in Pennsylvania, Gekko tells Bud to buy a large amount of this stock. Why?

c. Gekko says “Wonder why fund managers can’t beat the S&P 500? Because they are sheep.” What is Gekko’s point? How does it relate to market efficiency?

Explain how to estimate the beta of a stock. Explain why beta serves as a measure of the stock’s risk. (LO4) 

Identify the factors that affect a stock portfolio’s volatility and explain their effects. (LO4)

Explain how stock volatility changed during the credit crisis of 2008–2009. (LO4)

What are the risks of investing in stocks in emerging markets? (LO7)

Why can expectations of an acquisition affect the value of the target’s stock? (LO3)

How do earnings surprises affect valuations of stocks? (LO3)

Describe the January effect. (LO3)

Explain why investor sentiment can affect stock prices. (LO3)

Explain how the value of the dollar affects stock valuations. (LO3) 

Assume that the expected inflation rate has just been revised upward by the market. Would that change affect the return required by investors who invest in the stocks? Explain. (LO3)

How are the interest rate, the required rate of return on a stock, and the valuation of a stock related? (LO3)

Explain how economic growth affects the valuation of a stock. (LO3)

Describe the dividend discount valuation model. What are some limitations when using this model? (LO1)

Explain the use of the price-earnings ratio for valuing a stock. Why might investors derive different valuations for a stock when using the PE method? Why might investors derive an inaccurate valuation of a firm when using the PE method? (LO1)

Write a short essay explaining why there is so much uncertainty surrounding the valuation of a firm that is engaged in an IPO. Why do you think some investors overvalue firms at the time of their IPO?

Describe ESG investing and how it is allowing firms to become more focused on environmental, social, and governance issues. (LO6)

Describe the role of the designated market maker on the New York Stock Exchange. (LO5)

Explain how underwriters use the overallotment option in IPOs. (LO3)

Explain why private equity funds use a very high degree of financial leverage, and how this affects their risk and potential return on investment. (LO1)

What are some possible disadvantages to investors who invest in stocks listed on a private stock market? (LO5)

Describe the dilemma of securities firms that served as underwriters for Facebook’s IPOs when attempting to satisfy Facebook and the institutional investors that invested in Facebook’s stock. Do you think that those securities firms satisfied Facebook or the investors in the IPO? Explain. (LO3)

Explain why some public firms decided to go private in response to the passage of the Sarbanes-Oxley (SOX) Act. (LO6)

Venture capital firms commonly attempt to cash out as soon as possible following IPOs. Describe the likely effect that would have on the stock price at the time of lockup expiration. Would the effect be different for a firm that relied more heavily on VC firms than on other investors for its funds? (LO3)