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CMA Final · Strategic Financial Management · Efficient Market Hypothesis

A company announces a surprise bonus issue. The market model for its stock is Expected return = 0.2% + 1.1 x Market return. On the announcement day the Nifty returned 1.0% and the stock returned 3.5%. What is the abnormal return on that day?

The abnormal return is 2.20%. The market model gives an expected return of 0.2% plus 1.1 times 1.0%, which is 1.3%. Subtracting this from the actual return of 3.5% leaves 2.2%, the part of the return attributable to the announcement rather than market movement.

  1. A2.20%Correct
  2. B2.40%
  3. C1.20%
  4. D3.30%

Explanation

Expected return = 0.2% + 1.1 x 1.0% = 1.3%. Abnormal return = actual 3.5% - expected 1.3% = 2.2%. Option 2.40% would result from ignoring the beta (0.2 + 1.0 x... mis-computing), and 3.30% ignores the intercept and market effect partly, subtracting only 0.2%.

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