Methods and integration: money, banking, and financial markets
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Assignment 2 MBF chapter 8 + 10 + 13 + 14
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Methods and integration: money, banking, and financial markets
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Radboud Universiteit Nijmegen (RU)
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The Economics of Money, Banking and Financial Markets
Answers study book The Economics of Money, Banking and Financial Markets of Kent Matthews, Massimo Giuliodori - ISBN: 9780273731801, Edition: Druk 1, Year of publication: - (Assignment 2)
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I. Stock market and efficient market hypothesis
1. Explain what (and why) is the effect of the following events on the stock price of Shell
according to the “generalized dividend valuation model”.
a) The expectations about the profits of Shell for the next years are adjusted downward.
b) The existing expectations about the profits of Shell are confirmed by recent new
information.
c) The expectations about the interest (yield to maturity) in the bond markets for the
next years are adjusted upward.
Economists mostly agree that there is a positive relation between the interest rates set by the
central bank and the value of the currency for that country. This means, that if the interest
rates increase, the value of the currency (relative to foreign currencies) also increases. On
the 19th of January 2017 the ECB made clear that they will not change the existing interest
rates.
2. Explain, for each of the following cases, what the expectations of the market concerning
the interest rates decision of the ECB were according to the “efficient market hypothesis”.
a) The value of the Euro (relative to the Dollar) did not change up to 19-1 and did not
change after 19-1.
The expectations of the market were that the future prices would not change. The future
prices are according to this hypothesis equal to the optimal forecasts.
b) The value of the Euro (relative to the Dollar) increased up to 19-1, and decreased after
19-1.
The market’s expectations of the future securities were that they would increase until 19-1.
And the expectations afterwards were that it these prices would decrease.
c) The value of the Euro (relative to the Dollar) decreased up to 19-1, and increased after
19-1.
Current prices in a financial market will be set so that the optimal forecast of a security’s
return using all available information equals the security’s equilibrium return. So at first the
expectations were that the security prices would decrease until 19-1 and after that day the
expectation was an increase in prices.
3. A public listed firm brings out a news report that shows that the profits have increased by
10% compared to the same period last year. At that moment, the stock prices of that firm
start to decrease. Explain how this is possible according to the “efficient market hypothesis”.*
According to the efficient market hypothesis this is possible, because people expect a higher
stock price next year, therefore they start buying the stocks, so the demand rises, which
leads to a decrease in stock price. Also, the expected return on a security will have a
tendency to head toward the equilibrium return that equates the quantity demanded to the
quantity supplied.
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