Deck 7: Rational Expectations, Efficient Markets, and the Valuation of Corporate Equities

Question 1

Forecasts satisfying rational expectations are unbiased.

Answer 1

True

Question 2

The price of a stock is directly related to the expected future price and earnings.

Answer 2

True

Question 3

Forecasts satisfying rational expectations are too high or too low with equal probability.

Answer 3

True

Question 4

An investor with rational expectations can perfectly forecast future asset prices.

Question 5

If a market is strongly efficient, insider information does not help investors make profits.

Question 6

Earnings for a corporation are an example of a fundamental quantity determining the price of that corporation's stock.

Question 7

If investors have rational expectations, asset markets are strongly efficient.

Question 8

Forecasts satisfying rational expectations are probably precisely accurate.

Question 9

All public corporations must pay a fraction of their profits as dividends.

Question 10

If a market is weakly efficient, insider information does not help investors make profits.

Question 11

Expectations are rational if they are formed using all relevant information.

Question 12

The relevant interest rate when pricing a stock is called the required rate of return.

Question 13

The price of a stock is directly related to earnings and the required rate of return.

Question 14

Investors using technical analysis have rational expectations.

Question 15

If a corporation stops paying dividends, its stock price will fall, ceteris paribus.

Question 16

Markets for financial assets are more efficient than the market for labor.

Question 17

If investors do not have rational expectations, asset markets are not strongly efficient.

Question 18

Investors who use trends to make forecasts have rational expectations.

Question 19

Hedge funds were created to reduce risk for investors.

Question 20

According to the Gordon Growth Model, the price of a stock is directly related to the expected growth rate of earnings.

Question 21

If fundamental analysis does not help stock market investors make profits, then the stock market is

A) allocationally efficient.
B) weakly efficient.
C) semi-strongly efficient.
D) all of the above.

Question 22

Allocational efficiency means that past data on prices and fundamentals are fully reflected in the price.

Question 23

According to the Gordon Growth Model, an increase in the growth rate of earnings would lead to an increase in the current value of a stock.

Question 24

If insider information does help investors, the market cannot be

A) allocationally efficient.
B) weakly efficient.
C) strongly efficient.
D) The market can satisfy all these forms of efficiency.

Question 25

When an asset can be purchased with cheap, borrowed money, it is a good candidate for the development of a bubble.

Question 26

If the annual earnings for a company are $30, the expected future price of its stock is $100, and the required rate of return is 30%, then the current price of the stock should be

A) $97.
B) $100.
C) $130.
D) $169.

Question 27

Due to their risk, hedge funds are highly regulated mutual funds.

Question 28

If technical analysis cannot prove profitable information to investors, markets satisfy

A) weak efficiency.
B) semi-strong efficiency.
C) strong efficiency.
D) all of the above.

Question 29

If a market is semi-strongly efficient, investors cannot use fundamental analysis to make profits.

Question 30

Sectoral asset allocation is an investment strategy which can be described as not putting all of your eggs in one basket.

Question 31

Behavioral finance explains how investors form rational expectations.

Question 32

Markets are efficient if they allocate resources to their most highly valued use and if profit opportunities frequency occur.

Question 33

Portfolio diversification means investing heavily in stocks and other risky assets when young but shifting into less volatile assets, like short term bonds, as one nears retirement.

Question 34

Bubbles in financial markets are evidence that they are not strongly efficient.

Question 35

An analyst says that inside information would not have helped investors forecast the collapse of the stock market in 2008. This is true if markets satisfy

A) weak efficiency.
B) semi-strong efficiency.
C) strong efficiency.
D) all of the above.

Question 36

Mutual funds are inherently more risky than owning shares of a single stock.

Question 37

If an asset market is not weakly efficient, then it cannot be

A) semi-strongly efficient.
B) strongly efficient.
C) both of the above.
D) neither of the above.

Question 38

The small firm effect might be due to high liquidity of those stocks.

Question 39

The required rate of return measures the opportunity cost of making an investment.

Question 40

Weakly efficient markets could have bubbles.

Question 41

If the _____ for a stock rise(s), the current price of the stock rises.

A) earnings
B) volatility
C) required rate of return
D) none of the above

Question 42

If the annual earnings for a company are $12, the expected future price of its stock is $110, and the current price is $90, then the required rate of return on the stock is

A) 10.9%.
B) 22.2%.
C) 35.6%.
D) none of the above.

Question 43

Behavioral finance uses insights from

A) psychology
B) the neurosciences
C) sociology
D) all of the above

Question 44

If the annual earnings for a company are $25, the expected future price of its stock is $100, and the required rate of return is 5%, then the current price of the stock should be

A) $119.05.
B) $123.80.
C) $131.25.
D) none of the above.

Question 45

Which of the following could be examples of inefficiencies in financial markets data?

A) random walk
B) high volatility
C) bubbles
D) all of the above

Question 46

Which of the following is evidence of irrationality in financial markets?

A) random walk
B) high volatility
C) bubbles
D) none of the above

Question 47

Earnings for a corporation are $10, its stock price is $550 and the required rate of return is 12%. What is the growth rate of dividends implied by the Gordon Growth Model?

A) 1.8%.
B) 10%.
C) 20%.
D) none of the above.

Question 48

While most investors' valuations are incorrect, the market's value is, given the information available at that moment, is always _____, though in a circular way only.

A) incorrect
B) correct
C) about 10% incorrect
D) about 20% incorrect

Question 49

If the _____ for a stock rises, the current price of the stock rises.

A) expected future price
B) volatility
C) required rate of return
D) none of the above

Question 50

Which of the following could be examples of inefficiencies in financial markets data?

A) January effect
B) small firms effect
C) bubbles
D) all of the above

Question 51

If the Gordon Growth Model took the uncertainty about future dividends into account, the price of a stock would be _____, ceteris paribus.

A) higher
B) lower
C) the same
D) less volatile

Question 52

The earnings for a company are $10 and they are expected to grow at 2% annually. According to the Gordon Growth Model, if the required rate of return is 5%, then the price of the company's stock should be

A) $210.
B) $510.
C) $525.50.
D) none of the above.

Question 53

Transparency laws are intended to reduce

A) efficiency.
B) earnings.
C) asymmetric information.
D) all of the above.

Question 54

If the annual earnings for a company are $10, the expected future price of its stock is $110, and the current price is $100, then the required rate of return on the stock is

A) 10%.
B) 20%.
C) 30%.
D) none of the above.

Question 55

Forecasting stock prices using trends of past data should not be an effective method for making trading decisions if asset markets are

A) weakly efficient.
B) semi-strongly efficient.
C) strongly efficient.
D) all of the above.

Question 56

Laws that require companies to fully inform investors about debts and loans on their balance sheets are intended to increase

A) transparency.
B) efficiency.
C) volatility.
D) all of the above.

Question 57

If the annual earnings for a company are $10, the expected future price of its stock is $100, and the required rate of return is 8%, then the current price of the stock should be

A) $100.
B) $102.59.
C) $118.
D) none of the above.

Question 58

Earnings for a corporation are $20, its stock price is $525, and the growth rate of dividends is 5%. What is the required rate of return implied by the Gordon Growth Model?

A) 6%.
B) 8%.
C) 9%.
D) None of the above.

Question 59

Increased transparency should lead to increased

A) efficiency.
B) volatility.
C) asymmetric information.
D) all of the above.

Question 60

If the _____ for a stock fall(s), the current price of the stock rises.

A) earnings
B) expected price
C) required rate of return
D) none of the above

Question 61

If the annual earnings for a company are $6, the expected future price of its stock is $70, and the current price is $65, what is the implied required rate of return?

Question 62

If fundamental analysis helps investors to make profits, what does that say about the efficiency of the market?

Question 63

Why would transparency contribute to asset market efficiency?

Question 64

Which of the following have experienced bubbles?

A) agricultural commodities
B) precious metals
C) derivatives
D) all of the above

Question 65

The earnings for a company are $6 and they required rate of return is 9%. According to the Gordon Growth Model, if the current price of the stock is $100, what is growth rate of dividends?

Question 66

What is an allocationally efficient market?

Question 67

If the annual earnings for a company are $15, the expected future price of its stock is $90, and the current price is $100, what is the implied required rate of return?

Question 68

What is a portfolio diversification investment strategy?

Question 69

The earnings for a company are $12, and they are expected to grow at 5% annually. According to the Gordon Growth Model, if the required rate of return is 15%, then the price of the company's stock should be

Question 70

The earnings for a company are $20, and they are expected to grow at 4% annually. According to the Gordon Growth Model, if the required rate of return is 9%, what is the price of the company's stock?

Question 71

The earnings for a company are $10 and they are expected to grow at 3% annually. According to the Gordon Growth Model, if the current price of the stock is $200, what is the implied required rate of return?

Question 72

Why are technical analyses useless in a weak form market?

Question 73

If the annual earnings for a company are $15, the expected future price of its stock is $80, and the required rate of return is 4%, what is the current price of the stock?

Question 74

If the annual earnings for a company are $10, the expected future price of its stock is $100, and the required rate of return is 6%, what is the current price of the stock?

Question 75

How do portfolio diversification and sectoral asset allocation help investors earn average market returns?

Question 76

What is the most compelling evidence for a lack of efficiency in financial markets? Can any type of efficiency be justified?

Question 77

What is short selling?

Question 78

Does technical analysis produce forecasts that satisfy rational expectations? Explain.

Question 79

If insider information helps investors to make profits, what does that say about the efficiency of the market?

Question 80

What is a sectoral asset allocation investment strategy?