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CMA Final · Strategic Financial Management · Efficient Market Hypothesis

An event study of Rao Steel's share around a results announcement uses the market model: expected return = 1% + 1.2 × market return. On the announcement day the share returned 6.4% while the market index returned 3.0%. What is the abnormal return for that day?

The abnormal return is 1.8%. The market model gives an expected return of 1% plus 1.2 times 3.0%, which is 4.6%. Subtracting this from the actual return of 6.4% leaves 1.8%. Subtracting only the market return would wrongly ignore the beta and intercept.

  1. A1.8%
  2. B2.8%Correct
  3. C3.4%
  4. D0.2%

Explanation

Expected return = 1% + 1.2 × 3.0% = 4.6%. Abnormal return = actual 6.4% − expected 4.6% = 1.8%. Check: 4.6 + 1.8 = 6.4. The figure of 3.4% comes from subtracting only the market return (6.4 − 3.0), ignoring alpha and beta.

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