Assignment: 2

1. How can a fund manager make profits when the market is going to face a downturn? [4 marks]
- Short sell: borrow shares and sell them at a lower price than buy back the shares when the
prices go down.
- Invest in negative beta stocks, negative beta stocks move opposite to the market

2. Give an account of two scenarios where the markets are not efficient. Describe than how
equilibrium is reached. [6 marks]
- intrinsic value: the fair value of a firm which is calculated by discounting back the future Cash
flows expected to be generated by the firm.
- market value is the current value of the firm/shares
- if markets are not efficient than the market value will not equal intrinsic value
- intrinsic value is greater than market value meaning the shares are undervalued
- undervalued shares will reach equilibrium when the prices of the stocks rise, managers would
want to buy such securities as their prices would rise. Demand of such shares increases
therefore the prices of shares go up.
- overvalued shares will reach equilibrium when the prices of the stocks go down, managers
would want to short sell such securities as their prices would drop in the future as the
information about the firm will be translated and reflected in the share price. Demand of such
shares decreases therefore the prices of shares go down.

3. What is rouge trading? Which risk umbrella does it fall under? [6 marks]
- Rogue trading is when a fund manager is taking trading positions without the knowledge or
approval of the top management. Unauthorized trading positions.
- In the past companies have gone bankrupt due to the magnitude of losses occurring due to
rouge trading
- It falls under the umbrella of operational risk
- Operational risk: losses occurring from people, within the firm