Download File: Ch12 Type: Multiple Choice 1. An efficient market is said to

File: Ch12
Type: Multiple Choice
1. An efficient market is said to price all securities correctly. What is meant by pricing securities
“correctly”?
a) The prices reported by the NYSE and other exchanges accurately report real transactions.
b) Riskier securities are priced to yield higher returns, as described by CAPM.
c) The prices of trades in the NYSE and other exchanges reflect book value of the companies.
d) Both buyers and sellers agree that the prices are fair.
Ans: B
EASY
Response: The greater the risk, the greater the expected reward. Section: The Concept of an
Efficient Market.
2. What is the most important determination of stock prices in markets that are said to be
efficient?
a) Information about past events, and beliefs about future events.
b) The high technology system that connects buyers and sellers in US stock markets.
c) Large participants have much more influence over prices than smaller participants.
d) The “irrational” behavior of some market participants.
Ans: A
EASY
Response: Information makes markets efficient. Section: The Concept of an Efficient Market.
3. Which of the following statements is most correct?
a) Financial research over the past 40 years has determined that fully developed financial
markets are completely efficient.
b) There is no consistent way to measure market efficiency.
c) A truly efficient market implies that fundamental analysis and technical analysis cannot lead
to better returns.
d) The degree of market efficiency an investor observes depends on the size of the investment.
Ans: C
EASY
Response: If markets are efficient, the probability of beating the market is very small. Section:
The Concept of an Efficient Market.
4. The definition of "Efficient Market" is a market in which prices completely reflect all
available information. Which of the following is NOT included in "all available information"?
a)
b)
c)
d)
The investor's estimate of quarterly profits for the next 3 years.
Management's announcement of expected earning in the current quarter.
Announcement of price cutting by a major competitor.
Large upward movement in the stock price, on large volume.
Ans: A
EASY
Response: All available information includes past and current information, but not individual
forecasts of future events. Section: The Concept of an Efficient Market.
5. The text lists four events, all of which are required for an efficient market to exist. Which of
the following factors is NOT one of the events required for an efficient market?
a) A few large investors dominate the market.
b) Information is costless
c) Information is generated randomly.
d) Investors react quickly to information.
Ans: A
EASY
Response:Information is readily available, and almost costless. In general, most events cannot
be predicted. Investors in general do react quickly and fully to information. Section: The
Concept of an Efficient Market.
6. Which of the following is evidence that foreign stock markets are less efficient than US stock
markets?
a) Foreign markets use the currency of the country in which they are located.
b) Mutual fund managers are more likely to beat a European index, or a developing market
index.
c) US investors have more funds invested in US securities.
d) Foreign companies pay lower taxes than U.S. companies
Ans: B
EASY
Response: Historically, managers have tended to outperform certain overseas markets more than
in the U.S. Section: The Concept of an Efficient Market.
7. Which of the forms of the Efficient Market Hypothesis implies that even using "inside
information" does not consistently lead to abnormal returns?
a) Weak form of Efficient Market Hypothesis
b) Semistrong form of Efficient Market Hypothesis
c) Strong form of Efficient Market Hypothesis
d) No market efficiency - inside information can make excellent, but illegal, profits
Ans: C
MEDIUM
Response: The strong form asserts that all information, both public and private, is already
reflected in market prices. Section: How to Test for Market Efficiency.
8. Technical analysis is based on finding and interpreting patterns in the past price movements
in financial securities. Technical analysis is consistent with which form of the Efficient Market
Hypothesis?
a) Weak form of Efficient Market Hypothesis
b) Semi-strong form of Efficient Market Hypothesis
c) Strong form of Efficient Market Hypothesis
d) Technical analysis is incompatible with all EMH forms.
Ans: D
EASY
Response: Tests of the weak form EMH show that technical trading rules cannot earn enough to
pay brokerage costs. Section: How to Test for Market Efficiency.
9. What is meant by the expression that stock prices follow a “random walk”?
a) Stock price changes do not depend statistically on prior price changes.
b) Stock price changes cannot be predicted.
c) Stock prices changes do not reflect market information.
d) Stock market participants do not make rational decisions.
Ans: A
EASY
Response: Random Walk theory is similar to weak form efficiency of the EMH. Section: How to
Test for Market Efficiency.
10. Which of the following best describes the “Overreaction Hypothesis”?
a) The Efficient Market Hypothesis says prices quickly and fully reflect new information.
b) When major news stories affect some stocks positively, buyers pay too much for these stocks.
c) The Overreaction Hypothesis is consistent with the Random Walk.
d) Investors cannot profit form new events.
Ans: B
EASY
Response: Investors will often drive prices to unsustainable highs or lows, based on new
information. Section: Market Anomalies.
11. Research suggests that company insiders can earn abnormal returns on their stock
transactions.
What does this research mean for the Efficient Market Hypothesis (EMH)?
a) Insider trading has nothing to do with the EMH.
b) Profitable insider trading contradicts all forms of the EMH.
c) Profitable insider trading contradicts only the strong form of the EMH.
d) Profitable insider trading contradicts only the weak form of the EMH
Ans: C
MEDIUM
Response: Research has shown that companies with high incidences of insider buying have
outperformed those with high incidences of insider selling. Section: How to Test for Market
Efficiency.
12. Which of the following is the best definition of Behavioral Finance”?
a) Behavioral Finance studies how human behavior is paid for.
b) Behavioral Finance studies how Wall Street brokers and bankers act in social situations.
c) Behavioral Finance studies how investor biases and emotions affect stock prices.
d) Behavioral Finance studies what “rational” behavior means for investors.
Ans: C
EASY
Response: The stock market is the ultimate gauge of human emotion, ranging from fear to greed.
Section: Behavioral Finance.
13. Which of the following is an investment strategy that relies on the Overreaction Hypothesis?
a) Buy and Hold strategy.
b) Passive strategy.
c) Buying index funds
d) Contrarian investing strategy.
Ans: D
MEDIUM
Response: Contrarians will try to arbitrage the overreaction in a stock. Section: Market
Anomalies.
14. What is meant by the “disposition effect”?
a) Investors are more likely to sell winners than losers.
b) Investors are more likely to sell losers than winners.
c) Investors sell both winners and losers too soon.
d) Investors hold both winners and losers too long.
Ans: A
EASY
Response: Human emotion is often backwards with investing, as holding on to losers and selling
winners surely results in weaker returns. Section: Behavioral Finance.
15. Research suggests that low P/E stocks outperform high P/E stocks. Why is this finding
considered an anomaly?
a) It appears to be a successful investing strategy.
b) Low P/E stocks are temporarily out of favor, but may have strong prospects.
c) The low P/E effect contradicts the Efficient Market Hypothesis.
d) Low P/E stocks are often weak companies.
Ans: C
HARD
Response: This is one example of a market anomaly. Section: Market Anomalies.
16. Which of the following is a possible explanation for the so-called size effect?
a) Some researchers have shown that small cap stocks often out-perform large cap stocks.
b) Small cap stocks may be difficult to buy or sell, thus justifying higher returns.
c) About half of the Small Cap effect occurs in January.
d) Small cap stocks are mainly in hi-tech industries.
Ans: B
HARD
Response: Small cap stocks have typically outperformed large cap stocks over time, but have
also been much more volatile. Section: Market Anomalies.
17. Which of the following strategies produced the best investment results?
a) Invest in Value Line Group 1 stocks
b) Invest in low P/E stocks
c) Invest in small cap stocks
d) Invest in low price / book value stocks.
Ans: A
MEDIUM
Response: The Value Line Investment Survey is the largest, and perhaps best-know, investment
advisory service in the U.S. Section: Market Anomalies.
18. Which of the following anomalies is most consistent with EMH?
a) The January effect
b) The neglected firm effect
c) The low P/E effect
d) The success of the Value Line Investment Survey
Ans: B
MEDIUM
Response: Stocks that are covered by few analysts would be expected to be less efficient than
those more widely covered. Section: Market Anomalies.
19. Investors are attempting to find and exploit information in the stock market. In doing so,
these investors help improve the efficiency. What is the best explanation of this paradox?
a) It is becoming more and more difficult to beat the market.
b) Academic studies confirm that markets are very efficient.
c) As the investors seek to profit from private information, the price movements reveal it to
others.
d) Investors who can consistently profit in today’s market are smarter or harder working than the
average investor.
Ans: C
EASY
Response: Because so many investors are trying to beat the market with new information, this jus
serves to make the market that much more efficient. Section: Some Conclusions About Market
Efficiency.
20. All of the following have been identified as trading biases for investors EXCEPT:
a) Loss Aversion
b) Efficient Market Hypothesis
c) Overconfidence
d) The Herding Effect
Ans: B
MEDIUM
Response: The framing concept is another trading bias observed in investing. Section:
Behavioral Finance.
Type: True-False
1. The financial markets in the US are more efficient that financial markets in less developed
countries.
Ans: True
Response: Section: The Concept of an Efficient Market.
2. For the 20 years ending in 2003, 90 percent of large capitalization equity funds were
outperformed by the S&P 500 Index.
Ans: True
Response: Section: Some Conclusions about Market Efficiency.
3. Efficient markets imply that investors cannot earn unusual returns.
Ans: False
Response: If markets are efficient, investors can sometimes earn excess profits, due to luck.
Section: Market Anomalies.
4. Financial economists have tested various technical trading rules, and found that none earn
enough consistent returns to return a profit after subtracting commission and other trading costs.
Ans: True
Response: Even if stock prices do have small trends, the trends are so small that trading on these
trends does not cover trading costs. Section: How to Test for Market Efficiency.
5. “Event studies” study the effect on stock prices of specific events, such as stock splits or
dividend announcements.
Ans: True
Response: Event studies test the speed of price adjustments to public announcements. Section:
The Concept of an Efficient Market.
6. We see that the SEC has laws to punish insider trading. This implies that the SEC believes in
the strong form of the Efficient Market Hypothesis.
Ans: False
Response: The strong form EMH states that prices react quickly to al information, including
private information. If the strong form EMH held, even insiders could not make consistent
profits. Section: How to Test for Market Efficiency.
7. Over a 30+ year period, of the mutual funds in existence for the entire period, 139, there
were only 20 winners by 2 percentage points or more.
Ans: True
Response: Section: Some Conclusions About Market Efficiency.
8. If a public company reports earnings substantially higher than expected, the price of the stock
should go up in excess of the return on the stock considering risk and market return.
Ans: True
Response: Stock prices do react to unexpected earnings reports, but slower than would be
expected if the market were efficient. Section: Market Anomalies.
9. If a company has a high P/E ratio, an investor can expected a better price performance than if
the stock had a low P/E ratio.
Ans: False
Response: An efficient market should lead to equivalent price performance, but research
suggests than lower P/E ratio stocks have better price performance. Section: Market Anomalies.
10. Large, well-known companies have lower long-run returns, on average than smaller
companies.
Ans: True
Response: Many studies, including Banz, have shown that small stocks tend to out-perform
larger stocks. Section: Market Anomalies.