ASSIGNMENT 2

Investment Analysis and Portfolio Management

ANSWER:

1. Describe the general goal of behavioural finance.

Behavioral finance ventures with private investor psychology and how it influences
people actions as investors, analysts, and portfolio managers. Bahavioral finance aims
to learn how individual judgments influence markets and to be able to foretell those
outcomes. Behavioral finance looks to reveal irregularities that can arise in markets due
to psychological factors.

2. Why do the advocates of behavioural finance contend that the standard finance theory is
incomplete?

This is because the conduct of financial specialists is not rational. The standard finance
theory implies that when suggestions of a particular choice could be overall not
guaranteed that financial experts will react that way. This will lead to financial
institutions making better decisions in the future.The advocate contends the theory to
be incomplete the theory does not take into consideration the behavior of individual
members.

3. What does the EMH imply for the use of technical analysis?

The technical analysis in entirely different from EMH. Technical analysis mainly
considers the share prices, follow a trend and that any information available in the
market is not immediately available to all the investors. The information is first access
to the aggressive investors and then to all public investors. The EMH says that the
information available in the market will influence the share price, but according to
technical analysis, the share price depends upon the historical data.

4. What does the EMH imply for fundamental analysis? Discuss specifically what it does
not imply.
The advocates of fundamental analysis promote that at one point in time there is a
significant intrinsic value for the aggregate stock market, alternative industries, and
individual securities and if this inherent value is considerably modified from the current
market value, the investor should make the relevant investment decision. The
circumstances of the efficient market hypothesis, however, if the measurement of the
primary intrinsic value is based individually on past data, it will be of little value in
providing above-average returns. Alternatively, if the principal analysist makes
superior predictions of the relevant variables influencing stock prices then, by the
efficient market hypothesis, he could expect to outperform the market. The assumption
is that even with an outstanding valuation model if you rely solely on past data, you
cannot wait to do better than a buy-and-hold policy

5. In a world of efficient capital markets, what do you have to do to be a superior analyst?

How would you test whether an analyst was superior?

Being superior analyst, must provide more detailed estimations of the significant facts
to the valuation models and be distinct from the consent. Meet both these factors
because if the calculation is only correct and not different, which means predictions that
the consensus was right which involves that there was no surprise or any unusual
movement. You can test whether an analyst is preferred based on their portfolio’s
performance. It the analysist’s recommendations have performed very well and show
consistency in their portfolio, they can be considered as superior.

6. Compute the abnormal rates of return for the following stocks during period t (ignore
differential systematic risk):

Stock Rit Rmt

B 11,5% 4.0%
F 10.0 8.5
T 14.0 9.6
C 12.0 15.3
E 15.9 12.4

Rit = Return for stock I during period t

Rmt = return for the aggregate market during period t

ARit = Rit – Rmt

 ARBt = 11.5% – 4% = 7.5%

 ARFt = 10% – 8.5% = 1.5%
 ARTt = 14% – 9.6% = 4.4%
 ARCt = 12% – 15.3% = - 3.3%
 AREt = 15.9% – 12.4% = 3.5%

7. Compute the abnormal rates of return for the five stocks in Problem 6 assuming the
following systematic risk measures (betas):

Stock Βi
B 0.95
F 1.25
T 1.45
C 0.70
E -0.30

ARit = Rit – (beta)(Rmt)

 ARBt = 11.5% – (0.95) (4%) = 7.7 %

 ARFt = 10% – (1.25) (8.5%) = - 0.625 %
 ARTt = 14% – (1.45) (9.6%) = 0.8 %
 ARCt = 12% – (0.7) (15.3%) = 1.29 %
 AREt = 15.9% – (-0.3) (12.4%) = 19.62 %

8. Compare the abnormal returns in Problems 6 and 7 and discuss the reason for the
difference in each case. You are given the following data regarding the performance of a
group of stocks recommended by an analyst and a set of stocks with matching betas:
 Stock Beginning Price Ending Price Dividend
C 43 47 1.50
C-match 22 24 1.00
R 75 73 2.00
R-match 42 38 1.00
L 28 34 1.25
L-match 18 16 1.00
M 52 57 2.00
M-match 38 44 1.50
S 63 68 1.75
S-match 32 34 1.00