Texts: The next five statements refer to diverse materials covered in the module. Four statements are true. One statement is false. Choose the false statement. (In computational problems, show the basic equation(s) you used to solve the problem. In verbal problems, briefly explain your choice and why you dismissed the other answers)
1. Assume a warrant is currently traded at $35. The conversion ratio is 3 warrants for 1 stock and the exercise price is $15. If the stock is currently traded for $130, then the warrant is "out of the money."
2. When a company splits its stock in a 2:1 ratio, the trading price of the stock should technically decrease by 50%, but the market frequently interprets the splits as a good signal for the stock, so the actual decrease (at the end of the first trading day following the split) is somewhat weaker.
3. The slow upward (downward) drift in the price of stocks with positive (negative) earnings surprise, both before the respective earnings announcements and after the respective earnings announcements, is compelling evidence for the efficiency of the financial markets that effectively integrate the earnings surprises into stock prices over less than 180 days.
4. Momentum-based arbitrage strategies that buy the stocks that have shown the strongest performance over the recent six months (say, P1 the decile of best-performing stocks) while short-selling the stocks that have exhibited the weakest performance over the recent six months (P10, the decile of worst-performing stocks) exhibit consistent profitability over long horizons, with a monthly arbitrage return approaching or fluctuating around 1%.
5. A sudden (significant) decrease in the price of a corporate bond that was purchased at 8% YTM may confuse the investor. On one hand, the decrease is "bad news" suggesting that the company's default risk has increased and the 8% locked-in YTM does not adequately compensate the investor for the risk anymore. On the other hand, if the investor liquidates the investment instantly, her actual return on investment would fall below the 8% original YTM, due to the liquidation at prices implied by higher (say, 10%) YTM. As in other economic decisions, investors should ignore the past and make decisions based on expected cash flows and risks, but prophecy is beyond our capabilities and the dilemma is there.