Deck 11: Efficient Markets and Behavioral Finance

Question 1

Informational efficiency in financial markets result in stock prices being:

A) higher
B) lower
C) fairer
D) none of the above

Answer 1

fairer

Question 2

Generally, a firm is able to find positive NPV opportunities with:
I. Financing decisions
II. Capital investment decisions
III. Short-term borrowing decisions

A) I only
B) I and III only
C) III only
D) II only

Answer 2

II only

Question 3

The statement that stock prices follow a random walk implies that:
I. The correlation coefficient between successive price changes (auto correlation) is not significantly different from zero.
II. Successive price changes are positively related.
III) Successive price changes are negatively related.
IV) The autocorrelation coefficient is positive.

A) I only
B) II only
C) II and III only
D) IV only

Answer 3

I only

Question 4

If the efficient market hypothesis holds, investors should expect:
I. to receive a fair price for their security
II. to earn a normal rate of return on their investments
III. to be able to pick stocks that will outperform the market

A) I only
B) II only
C) III only
D) I and II only

Question 5

Predictable cycles in stock price movements:
I. persist for a long time
II. self destruct as soon as investors recognize them
III. never appear as the stock price movements are random

A) I only
B) II only
C) III only
D) I, II, and III

Question 6

Weak form efficiency implies that past stock price(s)

A) patterns tend to repeat itself in the future
B) are major inputs to the investors for forming trading strategies
C) do not matter
D) none of the above

Question 7

The statement that stock prices follow a random walk implies that:
I. Successive price changes are independent of each other
II. Successive price changes are positively related
III. Successive price changes are negatively related
IV. The autocorrelation coefficient is either +1 or -1

A) I only
B) II and III only
C) IV only
D) III only

Question 8

A small business is receiving a five-year $1,000,000 loan at a subsidized rate of 3% per year. The firm will pay 3% annual interest payment each year and the principal at the end of five years. If market interest rate on similar loans is 6% per year, what is the NPV of the loan? (Ignore taxes.)

A) +$127,371
B) +$348,369
C) -$501,595
D) None of the above

Question 9

Which of the following is a statement of weak form efficiency?
I. If markets are efficient in the weak form, then it is impossible to make consistently superior profits by using trading rules based on past returns
II. If the markets are efficient in the weak form, then prices will adjust immediately to public information
III. If the markets are efficient in the weak form, then prices reflect all information

A) I only
B) II only
C) II and III only
D) III only

Question 10

Different forms of market efficiency are:
I. Weak form
II. Semi-strong form
III. Strong form

A) I only
B) I and II only
C) I and III only
D) I, II and III

Question 11

If the capital markets are efficient, then the sale or purchase of any security at the prevailing market price is:

A) Always a positive NPV transaction
B) Generally a zero NPV transaction
C) Is always a negative NPV transaction
D) None of the above

Question 12

Financing decisions differ from investment decisions for which of the following reasons?
I. You cannot use NPV to evaluate financing decisions
II. The market for financial assets is more active
III. It is easier to find financing decisions with positive NPV than to find investment decisions with positive NPV

A) I only
B) II only
C) III only
D) I and III only

Question 13

If the weak form of market efficiency holds then:
I. Technical analysis is useless
II. Stock prices reflect information contained in past prices
III. Stock price changes follow a random walk

A) I only
B) I and II only
C) I, II, and III
D) I and III only

Question 14

A large firm is receiving a loan guarantee from the government. Because of the guarantee, the firm is able to borrow $50 million for five years at 8% interest rate per year instead of
10% per year. Calculate the value of the guarantee to the firm. (Ignore taxes.)

A) +$53.79 million
B) +$3.79 million
C) -$3.79 million
D) None of the above

Question 15

Stock price cycles or patterns self-destruct as soon as investors recognize them through:

A) stock market regulation by the Securities and Exchange Commission (SEC)
B) price fixing by the specialists on New York Stock Exchange
C) trading by the investors
D) none of the above

Question 16

Financing decisions differ from investment decisions because:
I. it is easy to reverse a financing decision
II. the market for financial assets is very competitive
III. generally, financing decisions have zero NPV

A) I only
B) I and II only
C) I, II, and III
D) II and III only

Question 17

Strong form market efficiency states that the market incorporates all information in the stock price. Strong form efficiency implies that:
I. An investor can only earn risk-free rates of return
II. An investor can always rely on technical analysis
III. An insider or corporate officer can not outperform the market by trading on the inside information

A) I only
B) II only
C) III only
D) I, II, and III

Question 18

A random walk process consists of the toss of a fair coin at the end of each day. If the outcome is heads stock price increases by 1.25% and if the outcome is tails the stock price decreases by 0.75%. What is the drift of such a process?

A) +1.25%
B) -0.75%
C) +0.25%
D) None of the above

Question 19

Which of the following statement(s) is/are true if the efficient market hypothesis holds?
I. It implies perfect forecasting ability
II. It implies market is irrational
III. It implies that prices follow a particular pattern
IV. It implies that prices reflect all available information

A) I only
B) II only
C) I and III only
D) IV only

Question 20

Which of the following is a statement of semi-strong form efficiency?
I. If the markets are efficient in the semi-strong form then prices will adjust immediately to public information
II. If the markets are efficient in the semi-strong form then prices reflect all information
III. If the markets are efficient in the semi-strong form then prices will adjust to newly published information after a long time delay

A) I only
B) II only
C) II and III only
D) III only

Question 21

The various lessons of market efficiency are:
I. Markets have no memory
II. Trust market prices
III. Read the entrails
IV. There are no financial illusions
V. The do-it yourself alternative
VI. Seen one stock, seen them all

A) I and II only
B) I, II, III and IV only
C) I, II, III, IV and V only
D) I, II, III, IV, V and VI

Question 22

In order to test the efficient-market hypothesis in the semi-strong form, researchers have used (the):

A) Estimation of the serial correlation (autocorrelation) for securities and markets
B) Measurement of the performance of mutual fund managers over the years
C) Measurement of how rapidly security prices adjust to different news items
D) All of the above

Question 23

The following are anomalies associated with market efficiency except:
I. the small-firm effect
II. the earnings announcement puzzle
III. the new-issue puzzle
IV. trading rules based on patterns

A) I only
B) I and II only
C) I, II, and III only
D) IV only

Question 24

The semi-strong form of efficiency deals with the following type of information:

A) insider information
B) publicly available information
C) privileged information
D) all of the above

Question 25

Adjusted stock return is calculated as:

A) actual stock return-expected stock return
B) return on stock-return on market
C) return on stock for the current period-return on stock for the previous period
D) none of the above

Question 26

In order to test the efficient-market hypothesis in the weak form, researchers have used the following methods except:

A) Estimation of the serial correlation (autocorrelation) for securities and markets
B) Measurement of the profitability of trading rules used by technical analysts
C) Measurement of how rapidly security prices adjust to different news items
D) All of the above are methods used for testing weak-form market efficiency

Question 27

The semi-strong form of has been tested by measuring how rapidly security prices react various news items like:
I. earnings announcements
II. dividend announcements
III. news of takeovers
IV. macroeconomic information

A) I and II only
B) I, II and III only
C) IV only
D) I, II, III and IV

Question 28

Strong-form efficiency implies that mutual fund managers:

A) Buy the index that maximizes diversification and minimizes cost of managing portfolios
B) Actively seek under performing stocks and buy them
C) Fund mangers can consistently earn superior returns year after year
D) None of the above

Question 29

Abnormal stock return is calculated as:

A) actual stock return-expected stock return
B) return on stock-return on market
C) return on stock for the current period-return on stock for the previous period
D) none of the above

Question 30

One important implication of the efficient markets hypothesis is that:

A) investors should hold a diversified portfolio and avoid active trading.
B) investors can benefit by engaging in day trading.
C) investors should trade actively help to ensure the highest overall gain in their portfolios.
D) all of the above.

Question 31

In order to test the strong form of market efficiency, researchers have:
I. examined the recommendations of professional security analysts
II. performance of mutual funds
III. performance of pension funds

A) I only
B) I and II only
C) I, II, and III only
D) II and III only

Question 32

If the abnormal return for a stock during the first week is +5% and during the second week is +3%, what is the abnormal return for the two-week period?

A) 5%
B) 3%
C) 8.15%
D) None of the above

Question 33

The annual expected dividend on the S&P index was about 154.6. If the dividend is expected to grow at a steady rate of 8% a year and the required annual rate of return is 10%, what is the value of the index?

A) 1193
B) 1700
C) 7730
D) None of the above

Question 34

The "event study" methodology is used in the test of:

A) weak form efficiency
B) semi-strong form efficiency
C) strong form efficiency
D) none of the above

Question 35

Analysis of past monthly movements in IBM's stock price produces the following estimates: α = 2. 5% and β = 1. 6. If the market index subsequently rises by 12% in one month and IBM's stock price increases by 20%, what is the abnormal change in IBM's stock price?

A) +1.7%
B) +8%
C) -1.7%
D) None of the above

Question 36

Analysis of past monthly movements in Wal-Mart's stock price has produced the following estimates: α = -0.45% and β = 0. 5. If the market index subsequently rises by 5% one month and Wal-Mart's stock price rises by 3%, what is the abnormal change in Wal- Mart's stock price?

A) -0.95%
B) +0.95%
C) +0.05%
D) None of the above

Question 37

If the markets are efficient, which of the following investors should have above normal return on assets over time?

A) Those who choose their stocks by throwing darts at a list of stocks found in the financial pages of a newspaper.
B) Analysts who spend considerable time evaluating the best stocks to buy.
C) Mutual fund managers who manage other people's money for a living.
D) None of the above

Question 38

Studies on behavioral finance have been developed using:

A) market evidence
B) economic evidence
C) psychological evidence
D) none of the above

Question 39

A lawyer works for a firm that advises corporate firms planning to sue other corporations for antitrust damages. He finds that he can "beat the market" by short selling the stock of the firm that will be sued. This finding is in violation of the:

A) Weak form market efficiency
B) Semi-strong form market efficiency
C) Strong form market efficiency
D) None of the above

Question 40

Which of the following observations would provide evidence against the strong form of efficient market theory?
I. Mutual fund managers do not on average make superior returns
II. In any year approximately 50% of all pension funds outperform the market
III. Managers who trade in their own firm's stocks make superior returns

A) I only
B) II only
C) III only
D) I and II only

Question 41

State the weak form of market efficiency and its implications.

Question 42

Behavioral finance and technical analysis are basically the same theory.

Question 43

The small-firm effect is cited as evidence against market efficiency.

Question 44

In a competitive market, security prices follow a random walk.

Question 45

The evidence against market efficiency are called puzzles or anomalies.

Question 46

Investors are particularly averse to the possibility of even a very small loss and need a high return to compensate for it. Such a concept is related to what theory?

A) Market efficiency theory
B) Random walk theory
C) Convergence trading
D) Prospect theory

Question 47

State the important differences between investment decisions and financing decisions.

Question 48

The weak form of efficient market theory implies that technical analysis is valuable.

Question 49

State the semi-strong form of market efficiency and its implications.

Question 50

How does the random walk theory explain market crashes?

Question 51

For a corporation, financing decisions are harder to reverse than investment decisions.

Question 52

In an efficient market, information is costless.

Question 53

What are puzzles and anomalies?

Question 54

Briefly explain why, in a competitive securities market, successive price changes are random.

Question 55

State the strong form of market efficiency.

Question 56

In an efficient market, investors will not pay others what they can do equally well themselves.

Question 57

When a firm announces a dividend change or publishes its latest earnings, the major part of the price adjustment takes place within a few minutes of the announcement.

Question 58

If capital markets are efficient, then the purchase or sale of any security at the prevailing market price is never a positive-NPV transaction.

Question 59

Behavioral finance deals with the idea that individual investors have built-in biases and misconceptions that can drive prices away from fair values.