Investor Behavior and Capital Market Efficiency

1. Assume that the CAPM is a good description of stock price returns. The market expected return is 7% with 10% volatility and the risk-free
rate is 3%. New news arrives that does not change any of these numbers but it does change the expected return of the following stocks:

Expected Return Volatility Beta

Green Leaf 12% 20% 1.5

Nat Sam 10% 40% 1.8

HanBel 9% 30% 0.75

Rebecca Automobile 6% 35% 1.2

a. At current market prices which stocks represent buying opportunities?

b. On which stocks should you put a sell order in?

2. Consider the price paths of the following two stocks over six time periods:

1 2 3 4 5 6

Stock 1 10 12 14 12 13 16

Stock 2 15 11 8 16 15 18

Neither stock pays dividends. Assume you are an investor with the disposition effect and you bought at time 1 and right now it is time 3.
Assume throughout this question that you do no trading (other than what is specified) in these stocks.

a. Which stock(s) would you be inclined to sell? Which would you be inclined to hold on to?

b. How would your answer change if right now is time 6?

c. What if you bought at time 3 instead of 1 and today is time 6?

d. What if you bought at time 3 instead of 1 and today is time 5?