Suppose you know with certainty that the Clark Capital Corporation will pay a dividend of $10 per share on ever January 1 forever. The continuously compounded risk-free rate is 5% (also forever).
a. Graph the price path of Clark Corporation Capital common stock over time.
b. Is this (highly artificial) example a random walk? A matingale? A submartingale? Why?
10.5 The efficient market hypothesis implies that abnormal returns are expected to be zero. Yet in order for markets to be efficient , arbitrageurs must be able to force prices back into equilibrium. If they earn profits in doing so, is this fact inconsistent with market efficiency?
10.6 (a) In a poker a game with six players, you can expect to lose 83% of the time. How can this still be a martingale?
(b) In the options market, call options expire unexercised over 80% of the time. Thus the option holders frequently lose all their investment. Does this imply that the options market is not a fair game? Not a martingale? Not a submartingale?
10.8 From time to time the federal government considers passing into law an excess profits tax on U.S. corporations. Given what you know about efficient markets and the CAPM, how would you define excess profits? What would be the effect of an excess profits tax on the investor ?
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