It is Monday morning at Blue Rock Capital and as Head of Trading you are debating the
Question:
It is Monday morning at Blue Rock Capital and as Head of Trading you are debating the merits of different strategies as promoted by the Heads of various trading Desks, namely Commodities, Equities and Bonds all of whom have different approaches. As Head of Trading you are sceptical of activist trading strategies and prefer a buy-and-hold strategy.
The Head of Commodities favours Technical Trading Methods and has made the following argument: In the last two years his team have generated an average monthly return of 2% or 24% per year. According to the Head of Commodities this is proof that Technical Trading works and that there is information in historical prices from which future market directions may predicted.
The Head of Equities is an advocate for Algorithmic Trading. Her team has recently developed a model for trading equity shares which they intend to implement with a computer program to ensure consistent and disciplined trading execution.
For your information, in the mode, D/E is the Debt to Equity Ratio and Size is a measured by Sales Revenues and ε is the error term. The model has an adjusted R-Squared of 78%, an F-Statistic of 17.5. All the independent variables have good t-statistics. According to the Head of Equities the accuracy of the model is shown by being able to explain twenty years of share price movements.
Lastly, the Head of Corporate Bonds is an advocate for Fundamental Analysis...that through examining financial information found in Balance Sheets, Income Statements, etc. of a firm, one may be able to predict future prices. Research conducted by his Team of Corporate Bonds over ten years showed evidence that the impending costs of bankruptcy were reflected in Bond Yields and thus changes to such costs indicate when the Prices of Bonds may move. Using this method, the Bond Desk has earned 5% return on Risk Capital in the last two years.
Q- According to the Head of the Bond desk, using their Fundamental Analysis, they were able to predict the direction of prices (Yields) with a probability of 60% and that this is proof against Market Efficiency. Do you agree and what level of predictive accuracy must they beat as evidence?
Intermediate Accounting
ISBN: 978-0324300987
10th Edition
Authors: Loren A Nikolai, D. Bazley and Jefferson P. Jones