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CMA Final · Strategic Financial Management · Efficient Market Hypothesis

Using the market model, the expected return on a share of Kaveri Ltd is Ri = 2% + 1.2 × Rm. On the announcement day of a bonus issue, the market index return was 3% and Kaveri's actual return was 8.1%. What is the abnormal return on that day in an event study?

Abnormal return is actual return minus the return expected from the market model. Expected return is 2% plus 1.2 times 3%, which equals 5.6%. Subtracting this from the actual 8.1% gives an abnormal return of 2.5% on the announcement day.

  1. A2.5%Correct
  2. B4.1%
  3. C1.8%
  4. D5.1%

Explanation

Expected return = 2% + 1.2 × 3% = 5.6%. Abnormal return = actual 8.1% − expected 5.6% = 2.5%. Option B ignores the intercept (8.1 − 3.6 = 4.5 is not it, but 8.1 − 4.0 gives 4.1 by ignoring beta); option D simply subtracts the market return (8.1 − 3 = 5.1).

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