Question

If the optimal forecast of the return on a security exceeds the equilibrium return, then _______.A. the market is inefficient. B. an unexploited profit opportunity exists. C. the market is in equilibrium. D. only A and B of the above are true. E. only B and C of the above are true.

Answer 1

Answer:

D. only A and B of the above are true.

• A. the market is inefficient.
• B. an unexploited profit opportunity exists.

Explanation:

In simple words, this question is asking why the optimal return or best possible return of an investment is actually higher than the real market return. Generally this can be explained by opportunity costs and profits, or maybe even market inefficiencies caused by external factors (e.g. taxes).

In economics, efficient companies operating in competitive markets will always have 0 economic profit in the long run, that means that the company has maximized its accounting profits and there is no other alternative investment that can provide the same returns.

The same concept applies here, when you maximize your potential returns, it means that there is no other security or investment should yield the same returns. If your returns are actually, it only means that you are missing an opportunity profit (by investing in some other security) or some type of market inefficiency or external factor has decreased the actual return of your investment.