There are 11 pages total and 11 sub-questions. Please see attached.
Behavioral Finance- FIN 645
Midterm Exam
Caution:
Please note this is
an individual exam only- and not a team or group effort. All relevant
UMUC policies- and especially those related to Academic Honesty- will be in
full force. So please keep that in mind at all times.
INSTRUCTIONS:
Please
answer all the following four (4) questions.
There
is a maximum of 100 points for this test. Scores for each question are
shown in the parentheses at the end of each question. For qualitative
questions, maximum allowed pages are also given at the end of each
question.
You will have until 11:59 PM EST on the due date,
to submit your answers via the
related file in your assignment folder. This gives ample time for the exam.
References
are not counted against your page numbers
I wish all of you the
very best.
Continued on next pages
QUESTION 1.
Overconfidence (that
is excessive optimism) is very commonly observed in human beings. Overconfidence leads to which types of
irrational of behavior in financial markets?
Please list 3 and explain in detail.
Note: Write-ups
that lack organization and order will lose points.
Maximum pages: 2
pages, double-space, size 12.
Grade: 20
QUESTION 2.
Details
(from Behavioral Corporate Finance, Seohee Park)
Between March and
July 2000, Intel’s stock price rose rapidly, to the point where in July Intel’s
market capitalization was above $500 billion, making it the largest firm in the
world. Then on Thursday, September 21, 2000, Intel issued a press release indicating
that its revenue for the third quarter would grow between 3 percent and 5
percent, not the 8 to 12 percent that analysts had been forecasting.
In response to
this news, Intel’s stock price dropped by 30 percent over the next five days.
Intel’s chairman, Craig Barrett, commented on the reaction, stating: “I don’t
know what you call it but an overreaction and the market feeding on itself.” An
academic study found that at the time, virtually none of the analysts following
Intel used discounted cash flow analysis to estimate the fundamental value of
Intel’s stock. Instead, the study points out that analysts react to bad news in
the same way that a bond-rating agency reacts to bad news. Just as a
bond-rating agency would downgrade the firm’s debt, analysts downgrade their
stock recommendations. After Intel’s press release, approximately one-third of
the analysts following the firm downgraded their recommendations. Some of the
recommendation changes were extreme. Notably, the cumulative return to Intel’s
stock, relative to the S&P 500, displayed a negative trend for the period
September 2000 through September 2002.
In what some might
see as a replay of history, consider an event that took place at the online
firm eBay during January 2005. Between the end of 2002 and the end of 2004,
eBay’s shares increased by over 200 percent. During December 2004, eBay’s stock
price peaked at $118, and its forward P/E ratio was 73. At the time, the firm’s
market value was $81.7 billion. Fourth-quarter earnings for eBay grew by 44
percent to $205.4 million, or 30 cents a share.
Just as Intel had
announced that its earnings growth would be lower than forecast, eBay’s actual
earnings for the fourth quarter of 2004 fell a penny below analysts’ consensus
forecasts. Meg Whitman, eBay’s CEO, stated that future earnings would be lower
because of higher advertising costs and reinvestment.
In response,
eBay’s stock price fell from $103 to $81 per share. The firm’s market value
fell to $56 billion. Many analysts immediately downgraded eBay’s stock. Rajiv
Dutta, eBay’s CFO, issued a public statement to say that his concern was
managing eBay’s long-run prospects, not its stock price.
On January 26,
2005, James Stewart wrote about eBay in his Wall Street Journal column
“Common Sense.” Stewart indicated that he would consider purchasing eBay stock
in the wake of its decline. While acknowledging that eBay could not grow at a
stratospheric rate forever, Stewart noted that eBay is in the process of
transforming world commerce and has a natural monopoly. Were he to own just one
Internet stock, Stewart said, eBay would be that stock.
Questions
What psychological phenomena may have influenced
the analysts, both generally and in their reaction to Intel’s announcement
in September 2000?
Does James Stewart’s assessment of eBay
reflects any psychological phenomena, discuss.
Discuss in what ways the events
described at Intel and eBay are similar and in what ways are they
different?
Note: Points will
be taken off for write-ups that lack organization and order.
Maximum pages: 3
pages, double-space, size 12;
Grade: 30
QUESTION 3.
Bias Identification,
please identify the biases and/or heuristics displayed by Professor French
Professor
French tells you that South Africa’s stock market undervalued and suggests
that it is a good investment. You discover that South Africa is about to
impose a new tax on security transactions, which will results in lower
liquidity. The next class you bring
this to Professor French’s attention. Simultaneously, another student
mentions that as commodity prices recover South Africa’s stock market will
rise sharply. Dr. French ignores
the information you provide and congratulates the other student on excellent
research. Which type of bias is Professor French displaying? Explain
briefly.
While
reviewing the most recent four quarters of earnings estimates for MMM,
Professor French notices that earnings growth rates were 15% per
quarter. He announces to the class
that MMM is a growth company. Which
type of bias or heuristic is Professor French falling victim too? Explain
briefly.
Professor French’s father works for
Boeing. Professor French holds 18%
of his portfolio in Boeing. Which
type of bias or heuristic is Professor French displaying? Explain briefly.
Maximum pages: 2
pages, double-space, size 12.
Grade: 20
Question 4.
Explain what is meant by an anomaly in finance?
Give 3 examples of anomalies uncovered by academic research in the
past two decades (make sure and explain these anomalies in detail
including references).
If markets are efficient what would you expect to happen to these
anomalies after they were discovered?
If the anomalies persist what financial frictions might responsible
for the persistence (make sure and cite frictions that apply to the
anomalies in part ‘b’)?
Note: Points will
be taken off for write-ups that lack organization and order.
Maximum pages: 4
page, double-space, size 12.
Grade: 30
End!
