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ECMT2130 – Tutorial 2

Conceptual Questions

1) What does the random walk theory state?

2) What does the Efficient Market Hypothesis (EMH) state?

3) What are the three definitions provided by Fama (1970) of “all available information”?

4) What is the difference between technical analysis and fundamental analysis?

5) What are some advantages of using log returns instead of, say, arithmetic ones?

Numerical Questions

1) Cynthia has $150,000 in her bank account. She has three options of high-interest savings accounts to choose from:

•   Bank A offers a 5% per annum interest rate paid semi-annually. She also gets a $8,000 sign-in bonus for joining Bank A.

•   Bank B offers a 4.5% per annum interest rate paid continuously. She gets a $5,000 sign-in bonus.

•   Bank C offers a 6.5% per annum interest rate paid monthly. She gets a $4,000 sign-in bonus.

Assuming away any transaction costs, which bank offer should Cynthia choose?

2) Still on Cynthia’s situation in Question 1, Bank D offered an account paying her $170,000 at the end of year. What interest rate should each of the other banks offer to make Cynthia just indifferent between all banks?

Computational Questions in R

In this part of the tutorial, we will introduce several R commands using a script I have written for you (available on Canvas). It might be a bit overwhelming at first, but the important part here is to understand what the code is trying to do line by line (I added a few comments to make things easier). We will return to this code in future, so you don’t need to absorb everything in one go (try as much as possible).

You won’t have to do anything here, apart from running the code and understanding what was done.

Afew observations:

•   As you go in the script, click anywhere on the row you wish to run and press CTRL + ENTER (this is likely different for Mac users) to run just the line you selected. This is a good way of observing what R is doing in each row. If you wish to run all the codes at once (the whole script), type CTRL + SHIFT + ENTER.

.   In the code, I made reference to a type of series called random walk (rows 30 and 31

of the script). Formally, a random walk series follows the formula below:

pt  = μ + pt−1  + εt  ,   wℎeTe εt ~iid(0, σ 2 )

You don’t need to know the details of the series above yet (we will study it later in the course).

.   At any point, if you don’t understand what the code is doing, one of the ways to find  out is to use the “help()” command in R. For example, if you’re not familiar with the command “seq”, type “help(“seq”)” on the console and hit enter. On the bottom right panel, R will open a page with further details. Of course, you can always search for it online or ask your tutor.

.   Make sure to keep the csv file you generated.