Deck 13: Efficient Capital Markets and Behavioral Challenges

Question 1

Financial managers can create value through financing decisions that:

A)reduce costs or increase subsidies.
B)create a new security.
C)increase the product prices.
D)Both A and B.
E)Both A and C.

Answer 1

Both A and B.

Question 2

Efficient capital markets are financial markets

A)in which there is no excess profit from using available information.
B)in which current market prices reflect the present value of securities.
C)in which current market prices reflect available information.
D)All of the above.
E)None of the above.

Answer 2

All of the above.

Question 3

Which one of the following statements is correct concerning market efficiency?

A)A firm will generally receive a fair price when it sells shares of stock.
B)In an efficient market, some market participants will have an advantage over others.
C)If a market is efficient, arbitrage opportunities should be common.
D)Real asset markets are more efficient than financial markets.
E)New information will gradually be reflected in a stock's price to avoid any sudden change in the price of the stock.

Answer 3

A firm will generally receive a fair price when it sells shares of stock.

Question 4

The U.S.Securities and Exchange Commission periodically charges individuals for insider trading and claims those individuals have made unfair profits.Based on this fact,you would tend to argue that the financial markets are at best _____ form efficient.

A)weak
B)semiweak
C)strong
D)perfect
E)semistrong

Question 5

Insider trading does not offer any advantages if the financial markets are:

A)inefficient.
B)semiweak-form efficient.
C)strong-form efficient.
D)semistrong-form efficient.
E)weak form efficient.

Question 6

In an efficient market when a firm makes an announcement of a new product or product enhancement with superior technology providing positive NPV the price of the stock will:

A)stay at the same price, with no net effect.
B)rise on the same day to the new price.
C)decline gradually over the next few days.
D)rise gradually over the next few days.
E)drop on the same day to the new price.

Question 7

The notion that actual capital markets,such as the NYSE,are fairly priced is called the:

A)Law of One Price.
B)Efficient Market Hypothesis (EMH).
C)Laissez-Faire Axiom.
D)Open Markets Theorem.
E)Monopoly Pricing Theorem.

Question 8

Which of the following tend to reinforce the argument that the financial markets are efficient?
I.Information spreads rapidly in today's world.
II.There is tremendous competition in the financial markets.
III.Market prices continually fluctuate.
IV.Market prices react suddenly to unexpected news announcements.

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

Question 9

Financial markets fluctuate daily because they:

A)are inefficient.
B)are continually reacting to new information.
C)slowly react to new information.
D)only reflect historical information.
E)offer tremendous arbitrage opportunities.

Question 10

An efficient capital market is one in which:

A)brokerage commissions are zero.
B)taxes are irrelevant.
C)securities always offer a positive rate of return to investors.
D)security prices are guaranteed by the U.S.Securities and Exchange Commission to be fair.
E)security prices reflect available information.

Question 11

If the financial markets are efficient,then investors should expect their investments in those markets to:

A)earn extraordinary returns on a routine basis.
B)generally have zero net present values.
C)generally have positive net present values.
D)produce arbitrage opportunities on a routine basis.
E)produce negative returns on a routine basis.

Question 12

According to theory,studying historical prices in order to identify mispriced stocks will not work in markets that are _____ efficient. I.weak-form
II)semistrong-form
III)strong-form

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

Question 13

Individuals that continually monitor the financial markets seeking mispriced securities:

A)tend to make substantial profits on a daily basis.
B)are never able to find a security that is temporarily mispriced.
C)tend to make the markets more efficient.
D)are always quite successful using only well-known public information as their basis of evaluation.
E)are always quite successful using only historical price information as their basis of evaluation.

Question 14

The hypothesis that market prices reflect all publicly available information is called _____ form efficiency.

A)open
B)strong
C)semistrong
D)weak
E)stable

Question 15

In an efficient market,the price of a security will:

A)always rise immediately upon the release of new information with no further price adjustments related to that information.
B)react to new information over a two-day period after which time no further price adjustments related to that information will occur.
C)rise sharply when new information is first released and then decline to a new stable level by the following day.
D)react immediately to new information with no further price adjustments related to that information.
E)be slow to react for the first few hours after new information is released allowing time for that information to be reviewed and analyzed.

Question 16

If you excel in analyzing the future outlook of firms,you would prefer that the financial markets be ____ form efficient so that you can have an advantage in the marketplace.

A)strong
B)semiweak
C)semistrong
D)weak
E)perfect

Question 17

If the efficient market hypothesis holds,investors should expect:

A)to always be able to pick stocks that will outperform the market averages.
B)to receive a fair price for their securities.
C)to earn only a normal return.
D)Both A and B.
E)Both B and C.

Question 18

Your best friend works in the finance office of the Delta Corporation.You are aware that this friend trades Delta stock based on information he overhears in the office.You know that this information is not known to the general public.Your friend continually brags to you about the profits he earns trading Delta stock.Based on this information,you would tend to argue that the financial markets are at best _____ form efficient.

A)weak
B)semiweak
C)semistrong
D)strong
E)perfect

Question 19

The hypothesis that market prices reflect all historical information is called _____ form efficiency.

A)open
B)strong
C)semistrong
D)weak
E)stable

Question 20

The hypothesis that market prices reflect all available information of every kind is called _____ form efficiency.

A)stable
B)weak
C)semistrong
D)strong
E)open

Question 21

The abnormal return in an event study is described as:

A)the return earned on the day of announcement for the stock.
B)the excess return earned on the day of announcement for the stock.
C)the total return earned for the investment holding period.
D)All of the above.
E)None of the above.

Question 22

If a market is strong form efficiency,it also implies that:

A)semistrong efficiency holds.
B)weak form efficiency holds.
C)one cannot earn abnormal returns with inside information.
D)Both A and C.
E)A,B and C.

Question 23

If the weak form of efficient markets hold,then:

A)technical analysis is useless.
B)stock prices reflect all information contained in past prices.
C)stock prices follow a random walk.
D)All of the above.
E)None of the above.

Question 24

An investor who picks a portfolio by throwing darts at the financial pages:

A)believes that riskier portfolios earn the same as less risky portfolios.
B)believes that efficient markets will protect the portfolio from harm as all information is priced.
C)does so because stock prices do not matter; only cash flow generated matters.
D)Both A and C.
E)Both B and C.

Question 25

Event studies attempt to measure:

A)the influence of information release to the market on returns in days surrounding the announcement.
B)if the market is at least semistrong efficient.
C)whether there is a significant reaction to public announcements.
D)All of the above.
E)None of the above.

Question 26

The semistrong form of the efficient market hypothesis states that:

A)security prices reflect all publicly available information.
B)all information is reflected in the price of securities.
C)future prices are predictable.
D)Both A and C.
E)None of the above

Question 27

The market price of a stock moves or fluctuates daily.This fluctuation is:

A)inconsistent with the semistrong efficient market hypothesis because prices should be stable.
B)inconsistent with the weak form efficient market hypothesis because all past information should be priced in.
C)consistent with the semistrong form of the efficient market hypothesis because as new information arrives daily prices will adjust to it.
D)consistent with the strong form because prices are controlled by insiders.
E)None of the above.

Question 28

Which of the following would be indicative of inefficient markets?

A)Overreaction and reversion
B)Delayed response
C)Immediate and accurate response
D)Both A and B.
E)Both A and C.

Question 29

Which of the following is not true about serial correlation?

A)Significant positive or negative serial correlation coefficients are indicative of market inefficiency in the weak form.
B)It involves only one security.
C)Negative serial correlation indicates a tendency toward reversal.
D)Positive serial correlation indicates a tendency for continuation.
E)It measures the correlation between the current return on a security and the current return on another security.

Question 30

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 a violation of the:

A)moderate form of the efficient market hypothesis.
B)semistrong form of the efficient market hypothesis.
C)strong form of the efficient market hypothesis.
D)weak form of the efficient market hypothesis.
E)None of the above.

Question 31

An investor discovers that predictions about weather patterns published years in advance and found in the Farmer's Almanac are amazingly accurate.In fact,these predictions enable the investor to predict the health of the farm economy and therefore certain security prices.This finding is a violation of the:

A)moderate form of the efficient market hypothesis.
B)semistrong form of the efficient market hypothesis.
C)weak form of the efficient market hypothesis.
D)A, B, and C
E)None of the above.

Question 32

When the stock price follows a random walk,the price today is said to be equal to the prior period price plus the expected return for the period with any remaining: difference to the actual return due to

A)a predictable amount based on the past prices.
B)a component based on new information unrelated to past prices.
C)the security's risk.
D)the risk free rate.
E)None of the above.

Question 33

Suppose that firms with unexpectedly high earnings earn abnormally high returns for several months after the announcement.This would be evidence of:

A)efficient markets in the weak form.
B)inefficient markets in the weak form.
C)efficient markets in the semistrong form.
D)inefficient markets in the semistrong form.
E)inefficient markets in the all forms.

Question 34

Which of the following is true?

A)A random walk for stock price changes is inconsistent with observed patterns in price changes.
B)If the stock market follows a random walk,price changes should be highly correlated.
C)If the stock market is weak form efficient,then stock prices follow a random walk.
D)All of the above.
E)Both B and C.

Question 35

Evidence on stock prices finds that the sudden death of a chief executive officer causes stock prices to fall and the sudden death of an active founding chief executive officer causes stock price to rise.This contrary evidence happens because:

A)markets are inefficient and unsure of the real value of the events.
B)death is inevitable and market prices are random.
C)the value of the founding executive was a negative to the firm.
D)things simply happen.
E)None of the above.

Question 36

Studies of the performance of professionally managed mutual funds find that these funds:

A)do not outperform a market index.Assuming mutual fund managers rely primarily on public information,this finding supports the semistrong form of the efficient market hypothesis.
B)do not outperform a market index.Assuming mutual fund managers rely primarily on public information,this finding refutes the semistrong form of the efficient market hypothesis.
C)outperform a market index.Assuming mutual fund managers rely primarily on public information,this finding supports the semistrong form of the efficient market hypothesis.
D)outperform a market index.Assuming mutual fund managers rely primarily on public information,this finding refutes the semistrong form of the efficient market hypothesis.
E)Both C and D.

Question 37

Under the concept of an efficient market,a random walk in stock prices means that:

A)there is no driving force behind price changes.
B)technical analysts can predict future price movements to earn excess returns.
C)the unexplained portion of price change in one period is unrelated to the unexplained portion of price change in any other period.
D)the unexplained portion of price change in one period that can not be explained by expected return can only be explained by the unexplained portion of price change in a prior period.
E)None of the above.

Question 38

A semistrong efficient market is distinct from a weak form efficient market in historical prices by:

A)incorporating only random movements in the price.
B)incorporating inside information in the price.
C)incorporating all publicly available information in the price.
D)All of the above.
E)None of the above.

Question 39

An investor discovers that stock prices change drastically as a result of certain events.This finding is a violation of the:

A)moderate form of the efficient market hypothesis.
B)semistrong form of the efficient market hypothesis.
C)strong form of the efficient market hypothesis.
D)weak form of the efficient market hypothesis.
E)None of the above.

Question 40

Which form of the efficient market hypothesis implies that security prices reflect only information contained in past prices?

A)Past form
B)Semistrong form
C)Hard form
D)Strong form
E)Weak form

Question 41

Market efficiency says:

A)managers cannot boost stock prices through creative accounting.
B)managers may profitably speculate in foreign currency.
C)a good financial manager can time stock sales.
D)prices may not reflect underlying value.
E)None of the above.

Question 42

Define the three forms of market efficiency.

Question 43

Which of the following is true?

A)Markets are strong form efficient.
B)Markets are semistrong efficient.
C)Markets are weak form efficient.
D)All of the above.
E)We do not know for certain; different studies reflect support for different theories.

Question 44

If behaviorial finance holds,this implies:

A)all investors are irrational some of the time.
B)all investors are irrational all the time.
C)some investors are irrational some of the time.
D)some investors are irrational all of the time.
E)all investors are irrational none of the time.

Question 45

If the securities market is efficient,an investor need only throw darts at the stock pages to pick securities and be just as well off.

A)This is true because there are no differences in risk and return.
B)This is true because in an efficient stock market prices do not fluctuate.
C)This is false because professional portfolio managers prefer to generate commissions by active trading.
D)This is false because investors may not hold a desirable risk-return combination in their portfolio.
E)This is false because the markets are controlled by the institutional investors.

Question 46

One of the conditions of market efficiency,rationality:

A)always holds.
B)might not hold in the realm of behaviorial finance.
C)never holds.
D)means investors will never visit a casino.
E)None of the above.

Question 47

Ritter's study of Initial Public Offerings (IPOs)showed that the post offering stock performance was:

A)less than the control group by about 2% in the five years following the IPO.
B)incorrectly priced at issuance because over the next five years the abnormal returns were greater than zero on average.
C)immaterial to the pricing of the IPO because future market performance is unknown at issuance.
D)equal across IPOs, irrespective of risk or which year they were issued.
E)All of the above.

Question 48

Suppose your cousin invests in the stock market and doubles her money in a single year while the market,on average,earned a return of only about 15 percent.Is your cousin's performance a violation of market efficiency?

Question 49

If the market is weak form efficient:

A)semistrong form efficiency may hold.
B)markets are not weak form efficient.
C)semistrong form efficiency must hold.
D)strong form efficiency must hold.
E)None of the above.

Question 50

In examining the issue of whether the choice of accounting methods affects stock prices,studies have found that:

A)accounting depreciation methods can significantly affect stock prices.
B)accounting changes can affect stock prices if the company were either to withhold information or provide incorrect information.
C)accounting changes that increase accounting earnings also increases stock prices.
D)switching depreciation methods can significantly affect stock prices.
E)All of the above.

Question 51

The thought that investors might be too slow in adjusting their beliefs to new information is called:

A)liberalism.
B)conservatism.
C)representativeness.
D)weak form efficiency.
E)None of the above.

Question 52

Do you think the lessons from capital market history will hold for each year in the future?
That is,as an example,if you buy small stocks will your investment always outperform U.S.Treasury bonds?

Question 53

Explain why it is that in an efficient market,investments have an expected NPV of zero.

Question 54

The abnormal returns for initial public offerings over longer time periods seem to call market efficiency into question because:

A)the average returns at announcement are large and positive while the long-term results are much lower than the returns for seasoned equity offerings.
B)the average returns at announcement are small and negative while the long-term results are much lower than the returns for seasoned equity offerings.
C)the average returns at announcement are zero while the long-term results are much higher than the returns for seasoned equity offerings.
D)the average returns at announcement are large and positive while the long-term results are much higher than the returns for seasoned equity offerings.
E)the average returns at announcement are insignificant while the long-term results are much lower than the returns for seasoned equity offerings.

Question 55

An example of financially irrational behavior is:

A)gambling in Las Vegas.
B)when a firm announces an increase in earnings and the stock price enjoys an immediate surge in value which is captured in one day.
C)when a firm announces an increase in earnings and the stock price enjoys three days of large abnormal returns.
D)Both A and B.
E)Both A and C.

Question 56

Behaviorial finance argues that:

A)investors may be irrational.
B)irrationality may be related across investors rather than canceling out across investors.
C)arbitrage strategies may involve too much risk to eliminate market efficiencies.
D)A, B, and C
E)None of the above.

Question 57

Which of the following statements is true?

A)In efficient markets, a stock's price should change with the arrival of new information.
B)Average stock returns are higher in January than other months.
C)Studies by Fama and French and others find the fact that returns of high book to market stocks are much higher than low book to market value stocks is consistent with the efficient market hypothesis.
D)All of the above.
E)None of the above.

Question 58

Financial managers must be cognizant of market efficiency because:

A)manipulating earnings by accounting changes does not fool the market.
B)timing security sales is futile because without private information the current price reflects all known information.
C)there is limited price pressure from any large sale of stock depressing prices momentarily which then recover to prior levels.
D)All of the above.
E)None of the above.

Question 59

Why should a financial decision maker such as a corporate treasurer or CFO be concerned with market efficiency?

Question 60

Event studies have been used to examine:

A)IPOs, SEOs, and other equity issuances.
B)changes in earnings.
C)mergers and acquisitions.
D)most financial events.
E)All of the above.

Question 61

What is behavioral finance?
Explain the principles behind behavioral finance.