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CMA Final · Strategic Financial Management · Efficient Market Hypothesis

Stock Z's price before an earnings announcement was Rs 200. The market model gives expected daily return of 0.1% plus 1.2 times market return. On announcement day the market rose 2% and Z rose 4.5%. What is the abnormal return on Z for that day?

Expected return is 0.1% plus 1.2 times 2%, which is 2.5%. Subtracting this from the actual 4.5% gives an abnormal return of 2.0%. The market model adjusts for market movement and beta before measuring the announcement effect.

  1. A2.0%
  2. B2.4%
  3. C2.1%Correct
  4. D4.4%

Explanation

Expected return = 0.1% + 1.2 x 2% = 2.5%. Abnormal return = 4.5% - 2.5% = 2.0%. Check: expected 2.5% is on Rs 200 = Rs 5, actual Rs 9, difference Rs 4 = 2%. Correct value is therefore 2.0%.

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