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Your broker suggests that the stock of QED is a good purchase at $25. You do an analysis of the firm, determining that the $1.40 dividend and earnings should continue to grow indefinitely at 8 percent annually. The firm’s beta coefficient is 1.34, and the yield on Treasury bills is 7.4 percent. If you expect the market to earn a return of 12 percent, should you follow your broker’s suggestion?
You sold a stock short for $50 and maintained the position for two years dur- ing which the stock paid an annual dividend of $2. At the end of two years, you closed your position when the stock was selling for $35. The margin requirement for short sales was 100 percent, so you could not borrow any funds. Excluding the impact of commissions, what was the annual rate of return on this investment?
Behavioral finance combines psychology and finance and identifies human traits that affect investment decisions. These emotions include being overconfident, feeling regret when investment decisions generate losses, and perceiving gains as the “house’s” money. Individuals tend to acquire assets with which they are familiar; they isolate (mentally budget) individual investment decisions and selectively remember investment results. Investors also follow a herd mentality. These are some of the personal traits that often lead to poor investment decisions. Technical analysis seeks to identify potential investments by examining the past performance of the market or individual securities. Technical analysts or “chartists” stress the past as a means to predict the future. Technical analysis removes emotion and is diametrically opposed to the fundamental analysis that stresses future earnings and dividends (i.e., cash flows) appropriately discounted back to the present. Several technical approaches such as the Dow Theory and Barron’s confidence index attempt to identify changes in the direction of the market. Because individual securities prices move together, the determination of a change in the market’s direction should identify future movements in individual stock prices. Other technical indicators such as point-and-figure charts, bar graphs, and moving averages may be applied to the market and to individual securities. By constructing various charts, the technical analyst determines when specific securities should be bought or sold. Whether technical approaches to market timing and stock selection lead to su- perior returns is an empirical question. With some exceptions, academic research has produced little support for technical analysis. These results suggest that investors may achieve similar or even superior results by purchasing and holding a well-diversified portfolio of securities.
Which Dow Jones Industrial Average stocks would be considered “dogs”? Deter- mine the Dow dogs as of January 1; invest $1,000 in each dog. At the end of a time period such as the semester or year, compare the dogs’ performance with the
1. Describe the major human traits that tend to affect investment decisions. Draw your information from the textbook and the inputs by others in this discussion during the week.
2.. What is the purpose of technical analysis and could it help the investment decision-making process? Why?