Question

Interpreting stock price changes (LO 6-6)

On July 10, 2012, Advanced Micro Devices (AMD) announced that it expected its revenues for the second quarter to be about $1.4 billion. At the time of the announcement, financial analysts expected AMD’s second quarter revenue to be about $1.6 billion.

Required:

Would AMD’s announcement cause a change in the company’s stock price on the date of the announcement? Explain why or why not. (Assume the announcement was made while the market was open.)

Consider the following two scenarios:

The $200 million difference between AMD’s management forecast and analysts’ forecast is completely attributable to a previously reported monthlong labor strike at one of AMD’s manufacturing facilities.

The $200 million difference between AMD’s management forecast and analysts’ forecast is attributable to AMD’s previously undisclosed decision to cut prices to meet those of a competitor.

Do you expect the magnitude of the stock price change to be greater under scenario (a) or scenario (b)?

Answer 1

Answer: 1. Yes it will cause a change.

2. Magnitude of the stock price change will be greater under scenario (b) than scenario (a).

Step-by-step explanation:

1. There is a negative $200 million discrepancy between what Analysts expected and what the company announced. This means that the company's revenue was less than anticipated and will cause a REDUCTION in stock price because the market will be open and the stock price will need to reflect this new information to signify that the stock is not as valuable anymore.

2. Scenario a represents a situation where the cause of the reduction in revenue was WELL KNOWN and so it will be expected. The financial analysts would have accounted for this but evidently, not very well. Therefore the magnitude of the change will not be as large because it was SOMEWHAT EXPECTED.

Scenario b though refers to a situation where investors DID NOT KNOW or ANTICIPATE the cause of the discrepancy and as such will react more to it. This will mean that the magnitude of change in stock price will be larger here than in Scenario a.