Discus The Stock Market the Theory of Rational Expectations

Discus The Stock Market the Theory of Rational Expectations
1. What basic principle of finance can be applied to the
valuation of any investment asset?
*2. Identify the cash flows available to an investor in
stock. How reliably can these cash flows be estimated?
Compare the problem of estimating stock cash flows
to estimating bond cash flows. Which security would
you predict to be more volatile?
3. Compute the price of a share of stock that pays a $1
per year dividend and that you expect to be able to
sell in one year for $20, assuming you require a 15%
return.
*4. After careful analysis, you have determined that a
firm’s dividends should grow at 7% on average in the
foreseeable future. Its last dividend was $3. Compute
the current price of this stock, assuming the required
return is 18%.
5. Some economists think that the central banks should
try to prick bubbles in the stock market before they
get out of hand and cause later damage when they
burst. How can monetary policy be used to prick a
bubble? Explain how it can do this using the Gordon
growth model.
Discus The Stock Market the Theory of Rational Expectations
*6. “Forecasters’ predictions of inflation are notoriously
inaccurate, so their expectations of inflation cannot be
rational.” Is this statement true, false, or uncertain?
Explain your answer.
7. “Whenever it is snowing when Joe Commuter gets up
in the morning, he misjudges how long it will take
him to drive to work. Otherwise, his expectations of
the driving time are perfectly accurate. Considering
that it snows only once every ten years where Joe
lives, Joe’s expectations are almost always perfectly
accurate.” Are Joe’s expectations rational? Why or
why not?
*8. If a forecaster spends hours every day studying data to
forecast interest rates but his expectations are not as
accurate as predicting that tomorrow’s interest rates
will be identical to today’s interest rate, are his expectations rational?
9. “If stock prices did not follow a random walk, there
would be unexploited profit opportunities in the market.” Is this statement true, false, or uncertain? Explain
your answer.