XAT 2017 — VARC Question 8
Read the following passage and answer the question that follows:
On Friday morning, Dieting supplement sales company Herbalife agreed to pay the US Federal Trade Commission a $200m fine. The FTC said Herbalife cheated hopeful salespeople out of hundreds of millions of dollars with a high-pressure multi-level marketing scheme.
Herbalife’s stock received an immediate 15% increase following the above news. The company also announced that it would hire a second former FTC commissioner in a press release describing the terms of the settlement.
Which of the following options would imply that the 15 percent increase in stock price is fair?
Answer & solution
- A
Cheating results in increase in the company’s stock price.
- B
When fraudulent companies are exposed, their stock price increases.
- C
When fraudulent companies are caught, their stock price initially goes down.
Acknowledgement of deceit increases the stock price of companies.
- E
Compliance with court order increases the company’s stock price.
When the company agreed to pay the fine, the market perceived it as acknowledgement of deceit and the valuation of such deceit is clear (from the fine amount). This acknowledgement of behaviour (deceit) and specifically the valuation or price of such behaviour becoming clear, gives lots more information to the market thereby increasing the stock price. Hence, 4 is the answer. Options 1 and 2 are wrong since stock price did not increase when the organization was exposed, but when the organization acknowledged. Option 3 is wrong as there is no data on stock price movement when the organization‘s âfraudâ was exposed. Acknowledgement of deceit resulted in the company's compliance with court order which is obligatory for a fraudulent company. Hence, option (e) cannot be the right answer.
Hence, the correct answer is option 4.