Expert answer:stock prices (marketing), business and finance hom

Answer & Explanation:IMPORTANT NOTE: The questions must be addressed in its full context. These questions are an opportunity to go outside the box to demonstrate your analytical, integrative, problem- solving and critical thinking skills using the knowledge acquired in your readings. As a result, it is very important to pay close attention to the questions and be able to conduct your discussions in the context of your question.  – Please keep this in mind when you complete this assignment.You must expand your ideas further. Analysis must be deep and very instructive. ANSWER THE FOLLOWING QUESTIONS. Each question should be answered in at least 300 words. Quality of content and use of course and outside-of-course resources to support your position or analysis. The answers should not be in the form of essay, just straight to the point- Work must be original and cite your sources.Please be sure to answer the question completely but specifically in well-written complete sentences. Use the attached lecture to help you answer these questions, and conduct your own research QuestionsWhat are the three forces which simultaneously affect stock prices as described by the Dow theory?Identify three innovations in the bond market and describe each.Under the expectations hypothesis, if the yield curve is upward sloping, the market must expect an increase in short-term interest rates. Is this true or false and why?Under the expectations hypothesis, if the yield curve is downward sloping, the market must expect an increase in short-term interest rates. Is this true or false and why?What are the strong points of the behavioral critique of the efficient market hypothesis?  What are some problems with the critique?What is the option embedded in a callable bond? A puttable bond?chap009.pptxchap010.pptx
chap009.pptx

chap010.pptx

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Behavioral Finance and
Technical Analysis
Bodie, Kane, and Marcus
Essentials of Investments,
9th Edition
McGraw-Hill/Irwin
9
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
9.1 Behavioral Critique
• Behavioral Finance
• Financial market model emphasizing potential
implications of psychological factors affecting
investor behavior
• Existence of irrational investors is not
sufficient to render capital markets
inefficient
9-2
9.1 Behavioral Finance
• Information Processing
• Forecasting errors
• People overvalue recent experience compared
to prior belief when forecasting
• Overconfidence
• People overestimate precision of beliefs or
forecasts, and overestimate abilities
9-3
9.1 Behavioral Finance
• Information Processing
• Conservatism bias
• Investors too slow in updating beliefs in
response to recent evidence
• Sample size neglect and representativeness
• People prone to believe small sample is
representative of population, infer patterns too
quickly
9-4
9.1 Behavioral Finance
• Behavioral Biases
• Framing
• Decisions affected by how choices are posed,
i.e. gains relative to low baseline level or
losses relative to higher baseline
• Mental accounting
• Form of framing; people segregate certain
decisions
9-5
9.1 Behavioral Finance
• Behavioral Biases
• Regret avoidance
• People blame themselves for unconventional
choices that turn out badly, avoid regret by
making conventional decisions
• Prospect theory
• Investor utility depends on gains/losses from
starting position, rather than levels of wealth
9-6
9.1 Behavioral Critique
• Limits to Arbitrage
• Fundamental risk
• Market changes or irrationality can eliminate
profits
• Implementation costs
• Exploiting overpricing is difficult; costs and
time limits can eliminate profits
• Model risk
• Inaccurate models generate inaccurate stock
values
9-7
Figure 9.1A Conventional Utility Function
9-8
Figure 9.1B Utility Function under Prospect Theory
9-9
9.1 Behavioral Critique
• Limits to Arbitrage and Law of One Price
• “Siamese twin” companies
• Dual-listed companies can appear to violate
Law of One Price
• Equity carve-outs
• Can violate Law of One Price due to inability to
short sell
9-10
9.1 Behavioral Critique
•
9-11
Figure 9.2 Pricing of Royal Dutch Relative to Shell
9-12
9.1 Behavioral Critique
• Bubbles and Behavioral Economics
• Evidence of irrational investor behavior
• Easier to identify once over
• Evaluating Behavioral Critique
• No coherent theory
• Most empirical support from one time period:
late ‘90s
9-13
9.2 Technical Analysis and Behavioral Finance
• Trends and Corrections
• Moving average
• Average price over given interval, interval
updated over time
• Attempts to identify underlying price directions
9-14
Figure 9.3 Share Price, 50-Day Moving Average for Intel
9-15
Figure 9.4 Moving Averages
9-16
Table 9.1 Stock Price History
9-17
9.2 Technical Analysis and Behavioral Finance
• Trends and Corrections
• Point and figure charts
• Traces significant upward/downward
movements in prices without regard to timing
• X denotes price increase, O denotes decrease
• Sell/Buy signals generated when stock
penetrates previous lows/highs
• Congestion area: Horizontal band of Xs/Os
created by price reversals
9-18
Figure 9.5 Point and Figure Chart for Table 9.1
9-19
Figure 9.6 Point and Figure Chart for Atlantic Richfield
9-20
9.2 Technical Analysis and Behavioral Finance
• Trends and Corrections
• Breadth
• Extent to which broad market index
movements affect individual stock prices
• Relative Strength
• Recent performance of given stock/industry
compared to that of broad market index
9-21
Figure 9.7 Market Diary
9-22
Table 9.2 Breadth
9-23
9.2 Technical Analysis and Behavioral Finance
• Sentiment Indicators
• Trin statistic
• Ratio of average volume in declining issues to
average volume in advancing issues
• Confidence index
• Ratio of top-rated corporate bond yield to
intermediate-grade bond yield
9-24
9.2 Technical Analysis and Behavioral Finance
• Sentiment Indicators
• Short interest
• Total number of shares currently short-sold in
market
• Put/call ratio
• Ratio of put options to call options outstanding
on stock
9-25
9.2 Technical Analysis and Behavioral Finance
• A Warning
• People perceive patterns where none exist
• Data mining generates apparent patterns within
limited data sets
• When evaluating rules, ask whether rule would
be reasonable before looking at data
9-26
Figure 9.8A Actual Stock Price Levels, 52 Weeks
9-27
Figure 9.8B Simulated Stock Price Levels, 52 Weeks
9-28
Figure 9.9A Actual Weekly Stock Price Changes, 52 Weeks
9-29
Figure 9.9B Simulated Weekly Stock Price Changes, 52 Weeks
9-30
Bond Prices and Yields
Bodie, Kane, and Marcus
Essentials of Investments,
9th Edition
McGraw-Hill/Irwin
10
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
10.1 Bond Characteristics
• Bond
• Security that obligates issuer to make payments to
holder over time
• Face Value, Par Value
• Payment to bondholder at maturity of bond
• Coupon Rate
• Bond’s annual interest payment per dollar of par
value
• Zero-Coupon Bond
• Pays no coupons, sells at discount, provides only
payment of par value at maturity
10-2
Figure 10.1 Prices/Yields of U.S. Treasury Bonds
U.S. Treasury Quotes: Treasury note and bond data are representative
over-the-counter quotations as of 3pm Eastern time.
Maturity
Coupon
Bid
Asked
Change
Asked
Yield
8/15/2012
1.750
101.570
101.594
-0.016
0.151
8/15/2014
4.250
111.547
111.594
-0.094
0.358
12/31/2015
2.125
105.789
105.820
-0.164
0.769
8/15/2017
4.750
120.219
120.266
-0.234
1.234
2/15/2020
8.500
152.063
152.094
-0.344
1.847
8/15/2023
6.250
137.406
137.438
-0.688
2.598
2/15/2027
6.625
145.547
145.594
-0.719
2.941
2/15/2031
5.375
130.266
130.297
-0.953
3.263
11/15/2039
4.375
111.766
111.813
-0.813
3.697
5/15/2041
4.375
111.719
111.750
-0.938
3.718
10-3
10.1 Bond Characteristics
•
10-4
Figure 10.2 Listing of Corporate Bonds
10-5
10.1 Bond Characteristics
• Corporate Bonds
• Call provisions on corporate bonds
• Callable bonds: May be repurchased by issuer
at specified call price during call period
• Convertible bonds
• Allow bondholder to exchange bond for
specified number of common stock shares
10-6
10.1 Bond Characteristics
• Corporate Bonds
• Puttable bonds
• Holder may choose to exchange for par value
or to extend for given number of years
• Floating-rate bonds
• Coupon rates periodically reset according to
specified market date
10-7
10.1 Bond Characteristics
• Preferred Stock
• Commonly pays fixed dividend
• Floating-rate preferred stock becoming more
popular
• Dividends not normally tax-deductible
• Corporations that purchase other
corporations’ preferred stock are taxed on
only 30% of dividends received
10-8
10.1 Bond Characteristics
• Other Domestic Issuers
• State, local governments (municipal bonds)
• Federal Home Loan Bank Board
• Farm Credit agencies
• Ginnie Mae, Fannie Mae, Freddie Mac
10-9
10.1 Bond Characteristics
• International Bonds
• Foreign bonds
• Issued by borrower in different country than
where bond sold, denominated in currency of
market country
• Eurobonds
• Denominated in currency (usually that of
issuing country) different than that of market
10-10
10.1 Bond Characteristics
• Innovation in the Bond Market
• Inverse floaters
• Coupon rate falls when interest rates rise
• Asset-backed bonds
• Income from specified assets used to service debt
• Pay-in-kind bonds
• Issuers can pay interest in cash or additional
bonds
• Catastrophe bonds
• Higher coupon rates to investors for taking on risk
10-11
10.1 Bond Characteristics
•
10-12
Table 10.1 Principal and Interest Payments
Principal and interest payments for a Treasury Inflation
Protected Security
10-13
10.2 Bond Pricing
10-14
10.2 Bond Pricing
• Prices fall as market interest rate rises
• Interest rate fluctuations are primary source
of bond market risk
• Bonds with longer maturities more sensitive
to fluctuations in interest rate
10-15
Figure 10.3 Inverse Relationship between Bond Prices and Yields
10-16
Table 10.2 Bond Prices at Different Interest Rates
10-17
10.2 Bond Pricing
• Bond Pricing between Coupon Dates
• Invoice price = Flat price + Accrued interest
• Bond Pricing in Excel
• =PRICE (settlement date, maturity date, annual
coupon rate, yield to maturity, redemption value
as percent of par value, number of coupon
payments per year)
10-18
Spreadsheet 10.1 Valuing Bonds
6.25% coupon
bond,
maturing
August 15,
2023
Formula in column B
4.375% coupon bond,
8%
coupon
bond,
maturing Nov 15, 2039
30-year
maturity
Settlement date
8/15/2011 =DATE(2011,8,15)
8/15/2011
1/1/2000
Maturity date
8/15/2023 =DATE(2023,8,15)
11/15/2039
1/1/2030
0.0625
0.04375
0.08
0.02598
0.03697
0.1
100
100
100
2
2
2
111.819
81.071
92
0
184
182
1.094
0
112.913
81.071
Annual coupon rate
Yield to maturity
Redemption value (% of face value)
Coupon payments per year
Flat price (% of par)
Days since last coupon
Days in coupon period
Accrued interest
Invoice price
137.444 =PRICE(B4,B5,B6,B7,B8,B9)
0 =COUPDAYBS(B4,B5,2,1)
184 =COUPDAYS(B4,B5,2,1)
0 =(B13/B14)*B6*100/2
137.444 =B12+B15
10-19
10.3 Bond Yields
• Yield to Maturity
• Discount rate that makes present value of
bond’s payments equal to price.
• Current Yield
• Annual coupon divided by bond price
• Premium Bonds
• Bonds selling above par value
• Discount Bonds
• Bonds selling below par value
10-20
Spreadsheet 10.2 Finding Yield to Maturity
Semiannual
coupons
Settlement date
Maturity date
Annual coupon rate
Bond price (flat)
Redemption value (% of face value)
Coupon payments per year
Yield to maturity (decimal)
Annual
coupons
1/1/2000
1/1/2030
0.08
127.676
100
2
1/2/2000
1/2/2030
0.08
127.676
100
1
0.0600
0.0599
The formula entered here is =YIELD(B3,B4,B5,B6,B7,B8)
10-21
10.3 Bond Yields
• Yield to Call
• Calculated like yield to maturity
• Time until call replaces time until maturity; call
price replaces par value
• Premium bonds more likely to be called than
discount bonds
10-22
Figure 10.4 Bond Prices: Callable and Straight Debt
10-23
10.3 Bond Yields
• Realized Compound Returns versus Yield to
Maturity
• Realized compound return
• Compound rate of return on bond with all coupons
reinvested until maturity
• Horizon analysis
• Analysis of bond returns over multiyear horizon, based
on forecasts of bond’s yield to maturity and investment
options
• Reinvestment rate risk
• Uncertainty surrounding cumulative future value of
reinvested coupon payments
10-24
Figure 10.5 Growth of Invested Funds
10-25
10.4 Bond Prices Over Time
• Yield to Maturity versus Holding Period
Return (HPR)
• Yield to maturity measures average RoR if
investment held until bond matures
• HPR is RoR over particular investment period;
depends on market price at end of period
10-26
Figure 10.6 Price Paths of Coupon Bonds in Case of
Constant Market Interest Rates
10-27
10.4 Bond Prices Over Time
• Zero-Coupon Bonds and Treasury STRIPS
• Zero-coupon bond: Carries no coupons,
provides all return in form of price appreciation
• Separate Trading of Registered Interest and
Principal of Securities (STRIPS): Oversees
creation of zero-coupon bonds from couponbearing notes and bonds
10-28
Figure 10.7 Price of 30-Year Zero-Coupon Bond over
Time at Yield to Maturity of 10%
10-29
10.4 Bond Prices Over Time
• After-Tax Returns
• Built-in price appreciation on original-issue
discount bonds constitutes implicit interest
payment to holder
• IRS calculates price appreciation schedule to
determine taxable interest income for built-in
appreciation
10-30
10.5 Default Risk and Bond Pricing
• Investment grade bond
• Rated BBB and above by S&P or Baa and
above by Moody’s
• Speculative grade or junk bond
• Rated BB or lower by S&P, Ba or lower by
Moody’s, or unrated
10-31
Figure 10.8 Bond Rating Classes
10-32
10.5 Default Risk and Bond Pricing
• Determinants of Bond Safety
• Coverage ratios: Company earnings to fixed costs
• Leverage ratio: Debt to equity
• Liquidity ratios
• Current: Current assets to current liabilities
• Quick: Assets excluding inventories to liabilities
• Profitability ratios: Measures of RoR on assets or
equity
• Cash flow-to-debt ratio: Total cash flow to
outstanding debt
10-33
Table 10.3 Financial Ratios and Default Risk
10-34
10.5 Default Risk and Bond Pricing
• Bond Indentures
• Indenture
• Defines contract between issuer and holder
• Sinking fund
• Indenture calling for issuer to periodically
repurchase some proportion of outstanding
bonds before maturity
10-35
10.5 Default Risk and Bond Pricing
• Bond Indentures
• Subordination clause
• Restrictions on additional borrowing stipulating
senior bondholders paid first in event of
bankruptcy
• Collateral
• Specific asset pledged against possible default
• Debenture
• Bond not backed by specific collateral
10-36
10.5 Default Risk and Bond Pricing
• Yield to Maturity and Default Risk
• Stated yield is maximum possible yield to
maturity of bond
• Default premium
• Increment to promised yield that compensates
investor for default risk
10-37
Figure 10.10 Yield Spreads between Corporate and
10-Year Treasury Bonds
20
Aaa -rated
18
Baa-rated
B-rated
14
12
10
8
6
4
2
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
0
1997
Yield spread (%)
16
10-38
10.5 Default Risk and Bond Pricing
• Credit Default Swaps (CDS)
• Insurance policy on default risk of corporate
bond or loan
• Designed to allow lenders to buy protection
against losses on large loans
• Later used to speculate on financial health of
companies
10-39
Figure 10.11A Prices of CDSs, U.S. Banks
10-40
Figure 10.11B Prices of CDSs, German Sovereign Debt
10-41
10.6 The Yield Curve
• Yield Curve
• Graph of yield to maturity as function of term to
maturity
• Term Structure of Interest Rates
• Relationship between yields to maturity and
terms to maturity across bonds
• Expectations Hypothesis
• Yields to maturity determined solely by
expectations of future short-term interest rates
10-42
Figure 10.13 Returns to Two 2-Year Investment Strategies
10-43
10.6 The Yield Curve
•
10-44
10.6 The Yield Curve
•
10-45
Figure 10.14 Illustrative Yield Curves
10-46
Figure 10.15 Term Spread: Yields on 10-Year versus
90-day Treasury Securities
16
10-year Treasury
12
Difference
8
4
0
2012
2009
2006
2003
2000
1997
1994
1991
1988
1985
1982
1979
1976
1973
-4
1970
Interest rate (%)
90-day T-bills
10-47
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