Assignment 1 for Investment Analysis and Portfolio Management (Master Degree) Eugene Fama from the University of Chicago and Kenneth R. French from the Yale School of Management examined the validity...

Fama & French 1
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Fama & French 2
How did the researchers in the article “Rethinking Stock Returns” define value versus
growth stocks? What relevance did their findings have on investing?
As per the article, the value stocks are those stocks that have higher book to market value
that is these are the stocks that are pegged higher by the market because of market and investor
sentiments. On the other hand, growth stocks are those stocks that tend to have a lower book to
market value (Fama and French, n.d.). Value stocks are those stocks that have higher market
value, and their book value is always less than the market value. The market perception about the
value stocks is that they are relatively distressed that is the reason for lower book value over the
market price.
In contrary, growth stock prices are lower in the market, and there are chances where
there book value can be higher than their market worth (Fama and French, 1997.). In this case,
the perception about value stock and growth stock are not appropriate. As per the article, they
work in an opposite manner when compared to the perception of the investor or the market.
Market perception about certain stocks makes their value higher and increases the value stock
worth. There are more chances of growth stock creating more value to the investor in reality
when compared to the value stock.
What factors did Fama and French examine that may explain stock returns?
They determined two important factors that are associated with the stock return and not
being captured by the CAPM model. The first factor is the size factor, and the next factor is the
value. The size of the company that is whether it is large or small has influence over the overall
risk associated with the stock. The size of the company primarily influences the return from the
stock (Fama and French, 1997). Large size companies are perceived to carry a lower level of risk
Fama & French 3
when compared to small size companies as the volatility in the small size company’s stock prices
is higher than large size companies. Next is the value of the stock that is whether the stock is a
high-value stock or a low-value stock regarding the stock price (Fama and French, n.d.).
When the stock price changes the level of trading in the stock, demand for the stock and
the price fluctuating pattern of the stock differs. It highly influences the overall stock price and
the return generating a capacity of the stock. Therefore, including the size and value factors
along with the CAPM will yield better accuracy in the analysis.
The CAPM is built on a single measure of risk that explains asset returns. What measures
of risk did Fama and French conclude were necessary to explain stock returns?
Size risk and value risk are the major influencing factors as per Fama and French. The
size of the company plays a major role in the trading activities. The perception and level of
confidence over the large companies by the investors are significantly higher when compared to
the small size companies. It is increasing the level of risk for a small size company compared to
a large size company (Fama and French, 1997).
When the level of risk increases the expectation of return from this stock increases, and
thus, it is a major risk that influences the return on the stock. Next is the value of the stock, when
the share prices are too high the number of participation will be lesser and mostly high-level
investors or mutual funds participate in the trading when compared to the small traders.
On the other hand, the stock with lower price will attract more investors to take part in
the trading activities (Fama and French, n.d.). It will result in more price fluctuation. It is another...