Question

Are these two statements correct?
Statement 1: Alpha is the difference between a real return and a benchmark return. If the benchmark is
too low (high), the alpha will be too high (low). This is the “joint hypothesis problem.” Any test of
market efficiency is also jointly a test of the underlying assumed equilibrium model.
Statement 2: Long-run abnormal returns are more difficult to establish than short-run abnormal returns.
A. Both statements are correct.
B. Both statements are incorrect.
C. Only Statement 1 is correct.
D. Only Statement 2 is correct.

4. Are these two statements correct?
Statement 1: Because empirical researchers established that excess returns were proportional to betas,
Fama and French were motivated to develop the Fama-French Three Factor Model.
Statement 2: Two of the “net stock” anomalies concern SEO’s and share repurchases. The anomaly is
that firms issuing shares and firms repurchasing shares experience abnormal negative returns (relative
to their peers or relative to benchmarks) for 3-5 years following the event.
A. Both statements are correct.
B. Both statements are incorrect.
C. Only Statement 1 is correct.
D. Only Statement 2 is correct.

Answer 1

Statement 1)

Alpha is the difference between the Actual return and the expected return on the portfolio. Actual return can be said as real return and expected return can be said as benchmark return. It is obvious that too low or high benchmark rate will lead to too high or low alpha, as they hold an inverse relationship. Therefore the statement is correct.

Tests of market efficiency look at whether specific investment strategies earn excess returns. In every case, a test of market efficiency is a joint test of market efficiency and the efficacy of the model used for expected returns. Therefore it can be said that any test of market efficiency is also jointly a test of the underlying assumed equilibrium model.

Statement 2) Yes,long run abnormal losses are more difficult to establish, than short run abnormal returns as compounding abnormal returns on a long run, can create bias in the results.

Ans: A. Both statements are correct.

4. Statement 1) Yes, Fama and French were motivated to develop the Fama-French Three Factor Model i.e. CAPM, because of empirical researchers established that excess returns were proportional to beta.

Statement 2) On the issue of shares, the ownership of the existing shareholders get diluted and hence the price should reduce. Buyback will boost the share price in the near term, but in long run the buyback may or may not be beneficial to shareholders. There is the anomaly that firms issuing shares and repurchasing shares experience abnormal negative returns for 3-5 years following the event.

Ans. A. Both the statements are correct.