Page 131 - CAPE Financial Services Syllabus Macmillan_Neat

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FINANCIAL SERVICES STUDIES
UNIT 1 - PAPER 02

KEY AND MARK SCHEME

2. (a) Supporting and opposing views of the Efficient Market
Hypothesis

Supporting Views Opposing Views

Random walk behavior of January Effect: Stocks
Stock Prices: Future prices are usually
changes in stock abnormally high in
prices should for all January.
practical purposes be Excessive Volatility
unpredictable. (Market Overreaction):
Fluctuations in stock
Technical Analysis: Past prices may be greater
information cannot be than are warranted by
used as a predictor fluctuations in their
of future stock fundamentals.
prices.

2 marks for each up to a maximum of 4 marks

(b) Explanation of statement:

- The assertion that assets are always correctly valued in
an efficient market is correct.

- However, it is not correct to conclude that investors will
never lose money in an efficient market. Example: Suppose
the price of Stock A is expected to be $110 one year from
today (assume for simplicity that Stock A pays no
dividends). Suppose also that the required return for
Stock A is 10% per year.

- If the expected ending price and discount rate are based
on all available relevant information, the price of Stock
A must be the present value of $110, or $100.

- Stock A is neither undervalued nor overvalued, but the
ending price of $110 is not certain. It is entirely
possible that investors could pay the “correct” price for
Stock A today, but lose money if the ending price is less
than $100.

1 mark for each up to a maximum of 3 marks; 2 marks for
example.

(c) Validity of statement

- Yes. If this assertion is true, it refutes the semi-strong
form of EMT. (2)

- If the semi-strong form of EMT is true, you should not be
able to use publicly available information such as the
dividend yield to earn abnormal rates of return. (2)

- All available information would be incorporated in the
price (2).

1 mark for naming point; 1 mark for explanation.