i was gonna ask where has the old ACD guard gone. Mav keep posting the quizzes i'll try completing but going to be very busy for the next two weeks so you probably wont see me posting.
Someone offers you a game where there is a 1% chance of the market going down and a 99% chance of it going up. If the market goes down then it goes down by 1,000 points and if it goes up then it goes up by 10 points. Is this a fair game?
Price an option on a stock currently trading at $100. In a month's time the stock can either go up to $110 or go down to $90 with equal probability of 50%. Price a one month at the money option on this stock (ignore the discounting factor).
Mav you have turned this thread into a prop shop interview. 5. You are given a choice between buying two assets. Asset A you expect to return 7% over the next year (avg return of market). Asset B you expect to have a random return. Both assets are highly correlated to the sp 500. You have to hold both assets for one year. Asset B allows you the opportunity to time your sale. Which asset has the higher expected return mathematically? Which asset would you buy and why? this is really the question though. Will choose asset A. Asset B could be VRX.
No sir King. No interview here. Just keeping your tools sharp in the shed. The correct answer is asset B.
Since I don't contribute much here, I'll try today. The game is not "fair". Given plenty of time and money to play, the downside provides a 10 point edge per 100 plays. Regarding the option: Assuming a binary monthly outcome of $90 or $110, the the one month option would be fairly priced at $5--or $10 for the straddle. Digressing a little and revisiting efficient markets: A recent interview recounted the behavior of mortgage stocks as the housing bubble was starting to deflate. Monthly data points on mortgage delinquencies were rising which should be bad for the stocks. When the stocks failed to react materially to the monthly releases, they would recover and make new highs. So bad news, good action! This went on for a couple of months before reality set in. Ultimately, many of the stocks collapsed. I think the guest cited Countrywide or maybe New Century. The market was ultimately efficient, but not nearly as efficient as that theory might expect. History has plenty of other examples but the above has the nice correspondence of data that the market doesn't immediately incorporate. Keynes' quote "Markets can stay irrational far longer than you can stay solvent." will probably stand the test of time well into the future. It would be interesting to have him around to participate in the Efficient Market debate from an academic standpoint.
Regarding question 5 from earlier, if we have to hold the assets for a year, how are we able to time our sale on Asset B?
" You are given a choice between buying two assets. Asset A you expect to return 7% over the next year (avg return of market). Asset B you expect to have a random return. Both assets are highly correlated to the sp 500. You have to hold both assets for one year. Asset B allows you the opportunity to time your sale. Which asset has the higher expected return mathematically? Which asset would you buy and why? this is really the question though. Will choose asset A. Asset B could be VRX. No sir King. No interview here. Just keeping your tools sharp in the shed. The correct answer is asset B. " So there were 2 terms that jumped out at me in this statement, one was random in this context I assume unknown return vs expected return. The second was mathematically? if the return and timing of asset sale is random I am not sure how one could say b has a higher mathematical return. My problem is that if the return is random then it could be very very high or very very low, the latter being problematic. I am guessing you are trying to make a point about variance will wait for you to clarify....