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Penn State - RUS 100 - Can Financing Decisions Create Value 13 - Study

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Penn State - RUS 100 - Can Financing Decisions Create Value 13 - Study

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background image Can Financing Decisions Create Value? 13.1 a. What rule should a firm follow when making financing decisions? b. How can firms create valuable financing opportunities? A Description of Efficient Capital Markets 13.2 Define the three forms of market efficiency.  13.3 Which of the following statements are true about the efficient markets hypothesis? a. It implies perfect forecasting ability.   b. It implies that prices reflect all available information.  c. It implies an irrational market. d. It implies that prices do not fluctuate.  e. It results from keen competition among investors. 13.4 Aerotech, an aerospace-technology research firm, announced this morning that it has hired the 
world’s most knowledgeable and prolific space researchers.  Before today, Aerotech’s stock had 
been selling for $100.  Assume that no other information is received over the next week and the 
stock market as a whole does not move.  
a. What do you expect will happen to Aerotech’s stock? b. Consider the following scenarios: i. The stock price jumps to $118 on the day of the announcement.  In  subsequent days it floats up to $123, then falls back to $116.   ii. The stock price jumps to $116 and remains at that level.   iii. The stock price gradually climbs to $116 over the next week. Which scenario(s) indicate market efficiency?  Which do not?  Why? 13.5 When the 56-year-old founder of Gulf & Western, Inc., died of a heart attack, the stock price 
immediately jumped from $18.00 a share to $20.25, a 12.5 percent increase.  This is evidence of 
market inefficiency, because an efficient stock market would have anticipated his death and 
adjusted the price beforehand.  Assume that no other information is received and the stock market 
as a whole does not move.  Is this statement true or false?  Explain.  
 
13.6
On January 10, 1985, the following announcement was made: “Early today the Justice Department
reached a decision in the Universal Product Care (UPC) case.  UPC has been found guilty of 
discriminatory practices in hiring.  For the next five years, UPC must pay $2 million each year to a
fund representing victims of UPC’s policies.”  Should investors not buy UPC stock after the 
announcement because the litigation will cause an abnormally low rate of return?  Assume market 
efficiency.  Explain.
13.7 Newtech Corp. is going to adopt a new chip-testing device that can greatly improve its production 
efficiency.  Do you think the lead engineer can profit from purchasing the firm’s stock before the 
news release on the device?  After reading the announcement in The Wall Street Journal, should 
you be able to earn an abnormal return from purchasing the stock?  Assume market efficiency.  
13.8 Trans Trust Corp. has changed how it accounts for inventory.  Taxes are unaffected, although the 
resulting earnings report released this quarter is 20 percent higher than what it would have been 
under the old accounting system.  There is no other surprise in the earnings report and the change 
in the accounting treatment was publicly announced.  Assume market efficiency.  Will the stock 
price be higher when the market learns that the reported earnings are higher?
Copyright 2003, McGraw-Hill.  All rights reserved.
background image 13.9 A hypothetical study has documented that firms usually experience a period of price run-up before
their public stock offerings.  After reading this study, Alex Johnson invests in firms that have just 
carried out new stock offerings.  Based on the study’s conclusion that these firms have generally 
performed very well before the stock offering, can Alex make money using this strategy if market 
efficiency holds?  
13.10 The Durkin Investing Agency has been the best stock picker for the past two years.  Before the rise
to fame occurred, the Durkin newsletter had 200 subscribers.  Those subscribers beat the market 
consistently, earning substantially higher returns after adjustment for risk and transaction costs.  
Subscriptions have skyrocketed to 10,000.  Now, when the Durkin Investing Agency recommends 
a stock, the stock price instantly rises several points.  The subscribers currently earn only a normal
return when they buy recommended stock because the price rises before anybody can act on the 
information.  Briefly explain this phenomenon.  Is Durkin’s ability to pick stocks consistent with 
market efficiency?  
13.11 Your broker commented that well-managed firms are better investments than poorly-managed 
firms.  As evidence, he cited a recent study examining 100 small manufacturing firms that, eight 
years earlier, had been listed in an industry magazine as the best-managed small manufacturers in 
the country.  In the ensuing eight years, the 100 firms have not earned more than the normal 
market return.  Your broker continued to say that if the firms were well managed, they should have
produced better-than-average returns.  Assume market efficiency.  Do you agree with your broker?
13.12 A famous economist just announced in The Wall Street Journal his findings that the recession is 
over and the economy is again entering an expansion.  Assume market efficiency.  Can you profit 
from investing in the stock market after you read this announcement?
13.13 Some investors claim to observe patterns in stock market prices.  Are such patterns consistent with
the efficient markets hypothesis?  If so, what form of market efficiency is violated?
13.14 Suppose the market is semi-strong form efficient.  Can you expect to earn excess returns if you 
make trades based on:
a. Your broker’s information about record earnings for a stock? b. Rumors about a merger of a firm? c. Yesterday’s announcement of a successful new product test? 13.15 Imagine a particular macroeconomic variable that influences your firm’s net earnings is positively 
serially correlated.  Assume market efficiency.  Would you expect price changes in your stock to 
be serially correlated?  Why or why not?
13.16 The efficient markets hypothesis implies that all mutual funds should obtain the same expected 
risk-adjusted returns.  Therefore, we can simply pick mutual funds at random.  Is this statement 
true or false?  Explain.
13.17 Assume that markets are efficient.  During a trading day, American Golf Inc. announces that it has 
lost a contract for a large golfing project, which, prior to the news, was widely believed to have 
been secured.  How should the stock price react to this information if no additional information is 
released?
a. The share price will decrease over an extended period of time as investors begin to sell 
shares of the company.
b. The share price will decrease below fair value because of the greatly decreased demand 
for the shares.  Eventually, the price would rise back to the correct level.
c. The share price will decrease immediately to reflect the new information. d. More information is needed to determine the movement in the stock price. Copyright 2003, McGraw-Hill.  All rights reserved.

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School: Pennsylvania State University
Department: Russian
Course: Corporate Finance
Term: Spring 2014
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Description: Can Financing Decisions Create Value? 13
Uploaded: 07/08/2017
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