1. Assume you have several stocks in the portfolio.

How the CAPM beta of this portfolio depends on betas of each asset. If it is possible provide exact formula. 2. What puzzles of CAPM do you know? List them and their possible explanations. 3. List the measures of risk adjusted returns. Provide rationale for each, indicate advantages and disadvantages of using them
1) What is the difference between unit trust, closed-end fund, and exchange traded funds? 2) What is implied by "walks like a duck" style analysis? 3) What is the main statement of the prospect theory? 1. Descibe forms of Efficient Market Hypothesis (EMH). Does the fact that one always outperforms the market violates one of the EMH form? 2. What is the goal of event study? Where it was used? 3. Why do hedge fund managers close their funds after just one year of losses, while the previous performance and investors` confidence in hedge fund are strong?

Question: What is an advantage of SPIDER mutual funds over simple mutual funds? Answer: The advantage is a tax consideration. When you sell a share to a mutual fund, a manager should sell a part of the portfolio on the market and pay taxes, if he or she sells it at a profit. Thus, all the members of a fund pay these taxes. When you want to sell a share of SPIDER, a manager simply gives your share and you sell it by your own and thus pay taxes. You admit such a condition since you usually sell a share at a profit and when you need it. Question: List and briefly describe at least three trading strategy which may be used to measure market efficiency. In what types of markets (emerging or developed) these strategies will work? Answer: 1. Short-term reversal strategy. The strategy is in the following. Buy last week losers and sell last week winners after waiting for a week to control for microstructure effects. This strategy will work on both types of markets. 2. Momentum strategy. The stocks that performed well during previous six months will likely perform well in the next months. And vice versa: the stocks that performed bad will do the same in the following months. Thus, the strategy is to sort stocks and choose top - 10% and bottom 10%. After 6 months buy winners and sell losers and keep for the next 6 months. It seems that on emerging markets this strategy will not work. 3. Exploiting the incomplete incorporation of earnings into stock prices. It is found (Griffin, Kelly, Nardari 2010) that there is a price drift after the announcement of earnings which is present in both emerging and developed markets. 1Question: What are the main difficulties with long horizons event studies? Answer: Risk adjustment. Even a small error in the estimation of risk may be crucial since over long period it becomes huge because of compounding. Moreover, the choice of a condi- tional mean specification is very important because our estimates of abnormal returns depend on the model. If we specify the model incorrectly then we will get unreliable results.

 Cross-sectional correlations. If one ignores the cross-sectional correlations then he or she will too small variance of the estimates and thus get a wrong size of a test.

Question 1. Using riskless asset and the efficient frontier without riskless asset, prove that Capital Allocation Line is in fact a straight line, tangent to that frontier. What is the frontier if we cannot borrow at risk free rate? What does it imply about CAPM relation? Provide some ideas on how to organize a test under these conditions, whether some portfolio is indeed a market portfolio. The idea is that to the right of market portfolio, frontier would go along efficient parabola. It will no longer be a straight line, and therefore a test should change. One possible solutions is to test separately two parts: a)to the left of market portfolio (when CAL is a straight line). Here the test should be similar (only the we should restrict ourselves to those assets that has variance less than the variance of market portfolio) b)to the right of market portfolio. This one is a little bit trickier, because the regression is no longer linear (but we know that it is a parabola, so we can still test it using a nonlinear regression) Probably there's a better way to test it but it's just off the top of my head.

Question 2. (this one would be easy for those who attended the lectures, but it has a really nice intuition) Desribe what is Sharpe ratio and Treynor ratio. Suppose you own only a few shares and want to add one more. What measure is better to use when you decide which asset to add? What if you already own a welldiversified portfolio?

And since the exam is A4, Question 3: Describe different test statistics used in multiple event studies. Discuss how they differ from each other. Present at least one example where each of these statistics is well suited.

1) [picture from slide 14 of event study lecture] Please describe the study showing us that picture. What is the aim of this study? What are the conclusions? 2)Comment the following statement "Advanced investors do not use mutual funds because they do not find any value added by funds managers" 3) Provide several mutual funds performance measures and briefly describe their essence.

1. For which kind of portfolio it is possible to improve its riskreturn ratio? How one can do it? 2. Is it possible to fully diversufy away all firm-specific risk? How? 3. What is "small firm" effect? What is explanation for it?

1. Suppose you evaluate an event study analysis of some event of one firm. Abnormal return for date 0 is positive and significant. But other abnormal returns are insignificant. Please, interpret your results. 2. Further to question 1 suppose that cumulative abnormal returns are insignificant. Can we conclude that that news had not impact on the value of the firm? 3. Suppose you are a manager of one company and you have bad news for investors. At what day of the week do you prefer to release this information to minimize impact on prices of your company? Why?

Final exam questions 1) Propose some measure that could be used to measure liquidity of a company stock 2) What is abnormal return and propose at least two models for normal returns 3) Why can alpha significantly different from zero mean inefficiency of the market portfolio in CAPM? Does alpha significantly different from zero always mean inefficiency?

1. What are rational explanations for the Small Firm Effects anomaly?

2. What period returns are the best for estimating beta of a particular stock in Market Model and why? 3. Why do not the mutual funds with high returns in past several years attract new investors?

1) What is Small Firm in January effect? What rational explanation has it? 2) What is Rolls critique about? 3) Describe briefly general event study methodology. 4) What is Head-and-Shoulders pattern in technical analysis? Can we use it to get riskfree profit? Why or why not? 5) Why is it important to ground proposed behavioral finance model in the psychological literature? If our behavioral finance explains some fact known beforehand, what should we do to provide additional evidence for our theory? Why is providing additional evidence in such cases especially important for behavioral models? Extra Credit: 3 Final exam questions
1) How are the RW1, RW2 and RW3 hypotheses related? Which is the weakest form of the random walk hypotheses? (question for 3- grade)

2) Describe three main approaches used to construct multi-factor models of stock returns. Which seems most suitable for the Russian market, taking into account its specifics? (question for 4- grade)

3) Why are tests usually based on CARs rather than ARs in event study analysis? (question for 4- grade)

4) How to solve the problem of thin trading in the event period (infrequently traded stocks) in event study analysis? (question for 5- grade)

1. Why are there more mutual funds than stocks, especially while most of the funds follow indexes (to some extent)? 2. How is the effectiveness of markets (as well as procedures for its estimation) affected by the descreteness of prices? 3. Why historically the empirical distributions of stock prices are right-skewed?

1) You are surely understand how important the news about some events are when examining the value of the firm. But what do you think whether these

new have the same degree of importance if it is occurred that it is just rumours? If there is a difference explain why. 2) Suppose you are an investor who is going to buy a share in any mutual fund. Which parameters are more important for you while choosing the preferable fund: Sharp ratio, Treynor ratio or Jensens Alpha? 3) How skewness of distribution influence the results when analyzing risks? Question 1: a) What is the disposition effect? b) Why is prospect theory one possible explanation for the disposition effect? c) Can you think of another possible explanation? d) How the disposition effect might influence stock returns? Answer: a) Disposition effect: Investors have the tendency to sell shares whose price is increasing, while keeping assets that have dropped in value,so they tend to ''sell winners too early and ride losers too long b) Past prices serve as a reference point. Different risk attitude for gains and losses: risk seeking in the loss domain (convex value function), risk averse in the gain domain (concave value function). Therefore, sell winners too early and ride losers too long. c) Investors may also believe that winners and losers will mean revert. However, it is a misunderstanding of random processes and stock market efficiency. d) The Disposition effect may affect the supply of stocks: If stock prices rise above the reference point: Investors will be more willing to sell thereby increasing the supply of stocks. temporary downward pressure on current stock prices drift in stock returns If stock prices fall below the reference point: Investors will be averse to sell thereby restricting supply temporary upward pressure on current stock prices drift in stock returns Question 2: Illustrate necessary steps for implementing event studies. Answer: 1. Identify the event of interest (Share repurchases, dividend payments, M&As, new products, firing/hiring of executives) 2. Define the event windows Event window: several days around the event date. Long enough to capture the significant effect of the event and short enough to exclude confounding effects. 3. Selection of the sample: firms impacted by the event Eliminate firms that experience other relevant events during the event window 4. Compute the appropriate return measures: abnormal returns (AR), Cumulative abnormal returns (CAR) 5. Analyze results.

Question 3: True/False. Explain: The existence of enough technical analysts in financial markets assures that the weak form market efficiency holds, while the existence of enough fundamental analysts does the same for the semi-strong form. Define the mentioned forms of market efficiency. Answer: True Weak form efficiency: prices reflect all information contained in past prices. Semi-strong form efficiency: weak form + all publicly available information. Technical analysts should find any existing patterns in prices and exploit them. If there are enough of the analysts, they will compete to exploit the opportunity. Eventually, all beneficial trading strategies disappear. Competition among fundamental analysts makes sure that prices also reflect all publicly available information, and thereby it ensures the semi-strong form efficiency to hold.

3 Final Exam Questions

1. Assume that you want to perform an event study for a company's stock returns. The chosen firm is a quite typical company in some industry (e.g. one of three largest mobile operators in Russia). Suppose that after a relatively long period without any significant events (for the chosen firm) the government passes a law which regulates prices for mobile network services. One week later the serious shifts take places in the board of administration of the chosen company. Propose an empirical strategy to test the impact of only the last event on the company's stock returns using the necessary data on returns, indices, prices etc. available on the market. 2. Suppose you have a data on returns of three different funds. You know that among these funds are index mutual fund, active mutual fund and hedge fund. First of all, discuss the purposes and main investment strategies of such types of funds. Then think out about which of the given returns belongs to the certain kind of funds, discuss briefly your answer and provide intuition. Finally, propose appropriate

hypotheses as well as formal empirical strategies to detect the fund's type given the return performance and using the necessary data available on the market. 3. On the lectures we have discussed the behavioral viewpoint on the momentum factor (when winners continue to win and losers continue to lose). Now try to provide as many behavioral explanations as you can of the size factor (when small stocks outperformed large stocks), the book-to-market factor (when stocks with high BtM outperform stocks with low BtM) and the reversal factor (when the stock which have been growing for several years tends to fall for the next several years). Despite we have mentioned some of these empirical evidences in behavioral prospect during the classes, some of proposed explanations can be supplemented. Try to specify your answer with the names of behavioral theories (e.g. "according to Kahneman & Tversky theory, disposition effect, etc"). You also can propose your own relevant explanation (rational or behavioral) of such empirical evidence.
1) You expect that stock market will grow for 15% this year. There are two funds on market: A and B. A takes 3% commission from investments and 2% management fee each year. B takes 4% commission for withdrawal investments and 1% management fee each year. Which fund would you choose if you want to invest $100 for one-year period? Answer: 1-year investment in A will give $9.32; in B will give $9.30. 2) Discuss, should you choose for event study this situation: 4-th quarter financial report of Development Company in Russia. Answer: the event should be something unexpected. But in Russia, the Development business is sleeping during the winter. There is nothing unexpected in 4th quarter financial report, because major news was released in 3th quarter report and in 4th quarter there were little changes. 3) Why the price change of a stock could be zero at the end of a day? Answer: stock exchange does not work at this day (holiday, trade stopping), there were no deals on this stock, and the price changed somehow but finally returned to the open point

Questions for Empirics of Financial Markets

I came up with more questions because I do not know whether all of them are suitable for the exam. Question 1: How can you justify usage of technical analysis? In fact, a lot of people use it and make money, but at the same time it may work even on randomly generated data (e.g. random walk). Answer 1: First of all, not all the tools of technical analysis are as ridiculous as shoulders and many of them (e.g. different indicators), try to grab correlations in data and, hence, when stock prices do have some intrinsic dependence (especially when time intervals are short), technical analysis may work. Moreover, one another justification may be used. A lot of people know the rules of technical analysis and when all of them see that the market should go in a certain direction they use the same strategy and, hence, are likely to pull the market in the direction they expect it should move. Question 2: Do you think the demand for riskier assets is greater in a bullish market or in a bearish one? Support your answer by argumentation. Answer 2: In accordance with one of the last lectures, people are risk loving in losses (there are constraints for short selling and the probability of loss is anyway greater in a bearish market). Hence, when the market falls (it is bearish) investors are likely to take more risks. Then the demand for assets with high exposure to risk grows. Thus, the answer is in bearish. Question 3: Comment on the statement: Markets are more likely to demonstrate efficient behavior when we look at them during long time periods rather than short ones. Answer 3: We have seen at lectures about event study that sometimes it takes quite long periods of time for a market to absorb news. Therefore, if we consider very short periods of time, we are not likely to find any signs of efficiency. But if we consider long periods of time when the market manages to absorb all the news we can see that efficiency may be present (i.e. prices reflect all the relevant information etc.). Thus, the statement seems to be valid. Question 4: Give an example when event study (here by event study we mean the procedure we used in our home assignment and discussed in class) fails but news is likely to be relevant for the stock price. Answer 4: It may be the case for a low liquid stock. In periods when it is traded, its price has to absorb all the news, but different news can have different effects and

together they may result in something that is not likely to demonstrate non-zero abnormal returns. Question 5: Explain why people invest in mutual funds since even if they outperform the market almost all the results of their nice performance stay in the pockets of fund managers? Moreover, mutual funds on average do not have very good performance Answer 5: There may be several reasons. First of all, many small investors simply do not have enough money to buy expensive financial instruments. Also, some people may not want to bother themselves with how to invest; they want somebody else to think for them. Another reason is quite obvious; mutual funds can have very persuasive advertising campaign. Questions:
1) Why do people perceive equal gains and losses differently? 2) Is it possible to eliminate all risk using diversification? Explain your answer. 3) How quickly does stock price change when new information comes to market?

Dear Patrick, Here are my questions: 1. Describe several examples of peoples behavioral biases and how they can be replicated in financial data. 2. What academic paper on empirics in finance (that may be considered in the course or may not) do you consider to deserve no publication? What empirical issue did the authors attacked? What methods did they apply? Why did they fail to get a worthwhile result? (This question arose during the last lecture). Name an academic paper on finance that you consider to be one of the most influential? Describe in brief the new theoretical concepts or / and empirical findings that the paper presented. 3. What types of mutual funds do you know? What are the distinctive features of different types of funds? What are the benefits to individual investors of investing in a mutual fund? Describe all approaches you know to measure funds performance. 1) If CAPM has so many problems with it, and requires a lot of assumption to make, than why economists still use it? What is important in CAPM besides failures seeing in empirical researches? 2) Do firms have incentives to wrench their public information? Why these incentives could appear? 3) Why some agents in economy could irrational? What is failures of assumption stay after irrationality?


1. Describe briefly how one could test whether some even affected the stock price or not. 2. What are the main ideas of behavioral finance you know? Provide some examples. 3. What is the idea of SPIDeR funds? How they differ from classical mutual funds?

Questions: 1. Why do most successful investment funds tend to show lower return over time? 2. Why did Fama and French introduce three-factor model in place of CAPM? What is the criticism for using SMB and HML as risk factors? 3. What is the evidence in favor of behavioral explanation of return predictability? Is it enough to explain why price-scaled variables such as book-to-market predict returns? 1. What kind of market efficiency can be tested by the event studies approach? What are the key components of a successful event study? 2. Why the old Morning Star ranking was abandoned? Is the new one flawless? 3. Why do most mutual funds report the Sharpe ratio and Jensens alpha? What are the advantages of these two measures over the Treynor ratio? 4. Why a good company does not necessarily mean a good stock to buy? 1). Event study. While computing test statistic for cumulative abnormal return one can estimate standard error using the whole estimation period. Now consider the possibility of heteroskedasticiy in returns. Discuss the trade-off between different lengths of the window. More precisely, describe the biases which can arise a) In small estimation periods. b) In large estimation periods. 2).CAPM As we now CAPM model is based on several assumptions including so called mean- variance criterion. Briefly describe the gist of this assumption. What is happening with the coefficient of the model if the utility of investors is biased to the variance component? To the mean component? 3). Consider the problem of estimation CAR around the publication of annual report of the company. Assume that the news to be announced dont include any important information. We also assume that the estimation window is symmetric. Describe a scenario when we have: a) Positive CAR

b) Negative CAR Hint: consider different expectations of investors about the news to be announced. Questions by 1. Suppose an investor who believes in CAPM and is ready to take the risk that little more than risk of market portfolio. For each of described situations, please specify the types of assets (i.e. stocks bond or mix) which the investor will hold in her portfolio: a. Perfect markets. b. There is no opportunities for investor to borrow money. c. Perfect markets but the deposit rate differs from the rate at which investor can borrow money. Answers a. She will hold a portfolio that is at the market line and this portfolio consist of bonds and stocks little to the right side from the market potfolio b. She will hold a portfolio at efficient frontier to the right side from the market portfolio, that portfolio consists only of stocks, because market line ends at market portfolio. c. She will hold a portfolio at efficient frontier to the right side from the market portfolio, that portfolio consists only of stocks, because slope of market line is less than the slope of efficient frontier near the market portfolio. 2. Assume you are ready to take risk that is the same as a market risk, and you invest in one of the SPIDeR fund. Your friend told to you that the manager of fund youve invested took more than market risk. How you can verify that your friend right/wrong Answer: to estimate fund performance on historical data, for example run regression of excess returns on different factors returns. 3. Please, briefly describe the impact of event window widening on your conclusions about event significance during event study. Answer: See slides 33-36 in Calculating Test Statistics for EventStudies in Detail presentation.
1. What it is the RW3 hypothesis? Propose at least three ways for testing it. How do you think are markets efficient? Provide some evidence.

2. Name the main models for measuring normal performance during event studies. Propose a method for choosing the best of them. 3. What is the main difference between mutual and hedge funds? Provide at least two examples for each of them.

1) Please describe The Small Firm Effects. 2) Could you name the test that is robust to event induced volatility changes. 3) After what period of time according to the theory returns of the momentum strategy is zero.

Assume you have several stocks in the portfolio. How the CAPM beta of this portfolio depends on betas of each asset. If it is possible provide exact formula. 2. What puzzles of CAPM do you know? List them and their possible explanations. 3. List the measures of risk adjusted returns. Provide rationale for each, indicate advantages and disadvantages of using them
1.

1.

What are the Treynor and the Sharpe ratios for risk reward? What is the

difference between the two? Which one is into use when considering addition of a single stock to the well-diversified portfolio? Why? 2. 3. How many portfolios are needed (and sufficient) to construct all portfolios from Describe a general methodology of conducting event studies. Additionally, the efficient mean-variance frontier? What are they?

explain the issues of the event study timeline selection. Describe how to find data on market returns for both US and Russian stock markets. Provide one of the expressions for t-statistic used for testing whether an event changed shares price significantly. Explain where the expression comes from. How is it possible that SPiDeRs can maintain such low fees as 0,1% per year? Regular operations in stock market are much more expensive.

1. What is a momentum strategy? Describe how to implement it in details. How may you rebalance winners and losers portfolios? What are pros and cons of different ways of rebalancing? Why the momentum strategy may be profitable? Does profitability of this strategy contradict market efficiency hypothesis? 2. What are weak, semi-strong and strong forms of market efficiency? Describe several ways to test weak form of market efficiency.

3. How to evaluate mutual fund performance? What are pros and cons of different approaches? Could fund managers manipulate performance results? How? What could authorities do to prevent manipulation?

1. Formulate the null hypothesis implied by CAPM. What is the Fama-MacBeth approach to testing the null hypothesis? 2. Formulate the hypothesis for market efficiency and provide some ways for testing it. How do you think are they efficient in real life? Provide some evidence. 3. What is the difference between Treynor ratio and Sharp ratio? When should we use each of them?

4. Assume you have several stocks in the portfolio. How the CAPM beta of this portfolio depends on betas of each asset. If it is possible provide exact formula. 5. What puzzles of CAPM do you know? List them and their possible explanations. 6. List the measures of risk adjusted returns. Provide rationale for each, indicate advantages and disadvantages of using them
1. Define liquidity of a stock and describe several methods of measuring it. What are the sourses of illequidity? 2. What is an efficient protfolio? How to construct efficient portfolio and to test its efficiency? 3. What might be alternative reasons behind event studies others than measuring the speed of information incorporation? 1. What main idea is implied by the EMH? What are possible ways to test EMH? 2. What is main idea behind CAPM ? its modifications (C-CAPM, ICAPM) ? What are the statistical evidences say about the CAPM and how those evidences connected with its popularity? 3. Can minimum variance portfolio coincide with optimal portfolio?

1) What is CAPM for? List please all major applications 2) Could it be the case, when we observe one type of efficincy, but not the others. Consider all possible combanations of observed/unobserved efficincies.

3) What are the reasons for short-run(2-3 days) inefficiency, if in general (lond-run) we observe market efficiency (information and other)? 1. Suppose you are testing the hypothesis that the Steve Ballmer's announcement on coming official PC support of the new Kinect controller had a significant impact on Microsoft's stock performance. However, the t-test does not show you any evidence that returns of the stock were different. Give at least 5 different reasons for why it might be the case. 2. Suppose you are running the CAPM regression of Microsoft stock risk premium on S&P risk premium. You got a significant positive value for beta and an insignificant value for alpha. However, the Rsquared of your regression is just about 25%. Does it imply that the market is not efficient? That investors are limited in arbitrage? Can it be explaining by the presence of noise trader risk? 3. Do you expect returns of equal-weighted portfolio or valueweighted portfolio to be more likely to pass the variance ratio test? 1)What is market efficiency? How one could test whether markets are efficient and what results he or she is likely to get? 2)What is referred to as a December effect? Does it violate market efficiency? 3)What is CAPM? Which regressions one could run to test it? What is the economic interpretation of estimated coefficients in those regressions?

1. The two fund separation theorem implies that there are only two funds needed to get any point on the efficient frontier in CAMP framework. The question is why there are actually no these two funds in the real market as they would probably find great potential demand from investors that wish to create their own optimal market portfolios with custom risk/reward profiles? 2. It is usually assumed that the stock prices follow some diffusion process and that implies normal distribution of returns. What is the reason for skewness that can normally be seen in returns distribution? 3. Is there a way to identify or estimate who of the investors is more risk-averse and who is less risk-averse in CAPM framework? 1. What is the Mean-Variance Criterion? Give definitions of the Capital Market Line and the Efficient Frontier Curve. Where can they be applied? 2. What are the main types of mutual funds? What are the main approaches to evaluation of their performance? Compare them to each other.

3. What are the main irrationalities in investors behavior? To what extent do they affect prices? What are possible ways of treating them in behavioral economics? 1. Provide some arguments for the next statement: "small firms in general have higher returns". 2. Analyzing the trades of individuals investors Odean finds that investors are more wlling to sell winners and hold on to losers. Provide some common behavioral explonations of that fact. 3. Using what instruments/actions investors could achieve returns above the return of the market portfolio?