Question

1. (a) If a corporation announces that it expects quarterly earnings to increase by 22 percent and it sees an increase of 25 percent, what should happen to the price of the corporation's stock if the efficient markets hypothesis holds, everything else held constant?

(b) Your best friend calls and gives you the latest stock market "hot tip" that he heard at the health club. Should you act on this information? Why or why not?

2. (a) If the U.S. federal government raises the income tax rates, would this have any impact on a state government's bonds? Please explain your answer.

(b) In the fall of 2008, AIG, the largest insurance company in the world at the time, was at risk of defaulting due to the severity of the global financial crisis. As a result, the U.S. government stepped in to support AIG with large capital injections an ownership stake. How would this affect the yield on AIG corporate debt, if at all?

Answer 1

Q1 a) The corporation announced that it expects quarterly earnings to increase by 22 percent and it sees an increase of 25 percent. It can be seen that the earnings have increased more than the expectation. In this case, the price of the stock should increase. As the actual earnings is more than the expected, the price of the stock will change (and in this case increase) to accommodate the new information.

Q1 b) The answer to this is NO. As the information is readily available in public domain and it is already factored in the price of the stock so you should not act on the information.

Note: For remaining questions, please post it separately to be answered.