Deck 9: Efficient Markets and Anomalies

Question 1

In an efficient market environment, it is reasonable to assume that the higher the premium on a target company's stock, the less the risk of cancellation.

Answer 1

False

Question 2

Before investing in a new stock issue, the investor should consider the management of the firm, past performance record, and intended use of funds.

Answer 2

True
Explanation: As part of their research, before investing in a new stock issue, the investor should consider the management of the firm, past performance record, and intended use of funds.

Question 3

Abnormal returns refer to gains beyond what the market would normally provide after adjustment for risk.

Answer 3

True
Explanation: Special, or abnormal, returns refer to gains beyond what the market would normally provide after adjustment for risk. This is also referred to as an anomaly. Transactions costs must also be covered to qualify as an anomaly.

Question 4

Results of research studies make it easy to identify characteristics of potential acquisition candidates.

Question 5

Cash tender offers in mergers have tax advantages as compared to stock tender offers.

Question 6

Under-pricing of new stock issues helps ensure the investment banker that the issue will be fully subscribed to at the initial market price.

Question 7

The stock price of an acquiring company generally changes parallel to that of the target.

Question 8

There is rarely a significant change in stock price when an OTC stock becomes listed on a national exchange.

Question 9

When a merger becomes relatively certain, arbitrageurs come in and attempt to lock in profits.

Question 10

There is a good opportunity to achieve abnormal gains by investing in either the acquiring company's or acquired company's stock.

Question 11

Large, prestigious investment banking houses generally provide lower initial returns to investors on new issues underwritten.

Question 12

The greatest profit, and the greatest risk, arises from trying to identify an acquisition candidate before the announcement.

Question 13

Most companies attempt to avoid the effects of synergy in putting a merger or acquisition together.

Question 14

To take maximum advantage of new issues, an investor should own a stock for at least one year.

Question 15

After-market performance refers to the price experiences of new issues immediately after going public.

Question 16

The stock of acquiring companies often increases by 60% or more as a result of a merger.

Question 17

The Small Firm Effect asserts that there is a positive correlation between market capitalization and risk-adjusted returns.

Question 18

In a leveraged buyout, the company's balance sheet serves as a collateral base to make the borrowing possible.

Question 19

There is a strong upward movement in the price of OTC securities which are to be listed on an exchange, but this increase generally tapers off after the listing.

Question 20

Research indicates that large, prestigious investment bankers generally provide lower initial returns to investors than smaller investment banking houses.

Question 21

A stock split has no effect on the par value of a stock.

Question 22

Value Line Group 5 Stocks tend to have the strongest performance.

Question 23

In the bull market of the 1990s, many firms repurchasing their own shares were among the strongest and most respected companies on Wall Street.

Question 24

An investor in a new issue should be somewhat skeptical when the new funds are being used to buy out old stockholders or to acquire property from existing stockholders.

Question 25

The study by Barry and Jennings of new stock issues indicates that 90% of the gain occurs in the opening transaction.

Question 26

Research indicates that stocks tend to peak in value on Friday and generally decline in value on Monday.

Question 27

The delisting of a stock from the New York Stock Exchange tends to have a neutral effect on the stock on the last day of trading. However, the stock normally has downward movement approximately six months later.

Question 28

The primary reason for the upward market movement in the value of the acquisition candidate is the low premium that is offered over current market value in a merger or acquisition.

Question 29

Positive abnormal returns on stocks may represent a measurement error.

Question 30

Book value is not as important as the P/E and size effect, according to Professors Fama and French.

Question 31

The best strategy in a new public offering is often to sell the stock shortly after it becomes public.

Question 32

The requirements for an exchange listing tend to be highly restrictive.

Question 33

Of particular interest to stock repurchases is the fact that most of the negative market movement comes on after the announcement, rather than before it.

Question 34

Institutional investors often take advantage of the small firm effect.

Question 35

An investment banker overprices an issue in order to satisfy the corporate issuer.

Question 36

The January Effect refers to the observation that in January small stocks seem to under-perform the market.

Question 37

Recent research indicates little opportunity to profit from repurchase situations.

Question 38

Professors Fama and French maintain that the ratio of book value to market value is more important than either the size effect or the P/E effect in explaining superior stock performance.

Question 39

Stocks that report unexpected earnings surprises seem to provide superior performances relative to the market.

Question 40

A stock split has no effect on the retained earnings account.

Question 41

Legal methods for attempting to profit through mergers and acquisitions include all of the following, except identifying

A)an insider close to the information.
B)candidates through financial or operating characteristics.
C)securities which are undergoing unusual volume or pricing patterns.
D)industries where companies are being absorbeD.

Question 42

In a merger, a white knight is:

A)a helpful investment banker that makes sure the merger is successful.
B)a third company that buys the acquisition target before an unwanted suitor can.
C)an investor who pays a high price to buy at least 5% of the shares of the acquisition target.
D)a commercial banker that provides a guarantee that the financing for the merger will be available.

Question 43

The weak form of the EMH is generally confirmed by research evidence.

Question 44

The strong form of the efficient market hypothesis suggests that only insiders are able to show superior risk-adjusted returns.

Question 45

New stock issues are considered a special investment situation, because

A)they exhibit a very good long-term investment potential.
B)the spread is greater than that in the secondary market.
C)there is some evidence that new issues are under-priced.
D)More than one of the above

Question 46

To be guilty of insider trading, one must be an officer of the company involved.

Question 47

The major problem associated with trying to profit from mergers and acquisitions is

A)that contradictory information is available.
B)pinpointing reasons for stock price changes.
C)the threat of cancellation.
D)None of the above

Question 48

From the time prior to announcement until an acquisition takes effect, the value of the stock of the acquiring company will likely:

A)rise sharply.
B)rise sharply, then slowly fall.
C)remain largely unchanged.
D)fall slowly, then rise sharply.
E)None of the above

Question 49

Which of the following is a characteristic of an unfriendly takeover?

A)Usually there is a high premium on stock price
B)An unacceptable suitor attempts to buy out the target company
C)The White Knight may succeed in rescuing the target company
D)All of the above

Question 50

Analysts generally are not influenced by accounting changes that have no economic consequences.

Question 51

The semi-strong form of the EMH is generally confirmed by research evidence, with some exceptions.

Question 52

Acceptance of the weak form of the EMH would indicate that charting can lead to profits.

Question 53

An acquisition may be canceled because of any of the following except:

A)antitrust action.
B)an unusually high premium on stock price.
C)a lawsuit brought by stockholders.
D)disapproval of the target company's management.

Question 54

"Special or abnormal returns" refer to:

A)the Efficient Market Hypothesis.
B)gains in excess of the market risk-adjusted average.
C)convertibles and warrants, etc.
D)More than one of the above

Question 55

The stock price of an acquisition candidate changes dramatically prior to announcement because of:

A)the candidate's estimated cost of capital.
B)the high premium offered for the stock of the candidate.
C)information leaks.
D)More than one of the above

Question 56

Under the weak form of the efficient market hypothesis, stock prices are considered to be independent over time.

Question 57

All of the following are reasons why an investment banker may under-price a new stock issue, except:

A)to stimulate demand for the issue.
B)to reduce unwanted inventory.
C)to insure adequate demand in the secondary market.
D)None of the above

Question 58

The strong form of the EMH is generally confirmed by research evidence.

Question 59

OTC stocks may not uphold the semi-strong form of the efficient market hypothesis, while listed stocks generally do.

Question 60

Specialists and mutual fund managers tend to enjoy superior market performance on a risk-adjusted basis.

Question 61

All of the following are minimum listing requirements for a New York Stock Exchange listing except:

A)the market value of publicly held shares should be at least $100 million.
B)there should be at least 2,000 round lot holders.
C)there should be at least 1,200 employees.
D)a total of at least 1,100,000 shares should be held publicly.

Question 62

Banz's research on the small firm effect was criticized because

A)the stocks were too small.
B)it was highly influenced by a depression and a major war.
C)the stocks were too large.
D)it was highly influenced by inflation and a devaluation of the dollar.

Question 63

Which of the following is NOT a reason for the failure of investment in small firms to catch on as an important strategy?

A)There is a lack of institutional investors
B)Information on these smaller firms increases the efficiency of the market
C)Some investors are not properly positioned for the segmented market
D)All of the above are reasons

Question 64

A study indicated that what type of stock had the best performance four years after announcement of a stock repurchase?

A)Growth stocks
B)Convertible preferred stocks
C)Low-yield stocks
D)Value-oriented stocks

Question 65

The Small Firm Effect is the theory that:

A)firms with small market capitalization outperform the market.
B)small firms have greater market capitalization.
C)transaction costs associated with dealing in larger capitalization firms might severely cut into profit potential.
D)More than one of the above

Question 66

Why does a stock repurchase improve the after-tax position of stockholders over cash dividends?

A)The theoretical increase in value is taxed at the lower capital gains rate
B)Reduced shares outstanding increase earnings per share
C)Cash dividends are taxed as ordinary income
D)All of the above

Question 67

Firms with low P/E ratios that are often neglected by major investors seem to provide:

A)an inferior risk-adjusted return.
B)a superior risk-adjusted return.
C)a superior return, not adjusted for risk, though.
D)No return

Question 68

When should an investor in OTC stock approved for listing sell the stock, if the objective is to maximize profit?

A)Immediately prior to approval
B)When the approval is published
C)On the date of listing
D)Four to six weeks after the date of listing

Question 69

An unexpected earnings surprise refers to the situation where:

A)announced earnings were in line with analysts' favorable earnings expectations.
B)announced earnings were better or worse than the analysts' forecast number.
C)announced earnings were significantly below last year's earnings.
D)the operating and financial leverage caused earnings to accelerate coming out of the trough of a business cycle.

Question 70

One reason a firm may repurchase its own shares is:

A)that management views the firm's future prospects to be bright.
B)to go public.
C)to qualify for an exchange listing.
D)to adhere to SEC requirements on number of shares outstanding.

Question 71

Studies have shown that the best time to sell an unseasoned issue is:

A)prior to announcement of a merger.
B)shortly after the initial distribution.
C)after one year of trading.
D)More than one of the above

Question 72

Once management announces that it will buy back one million shares over a given time period, as circumstances become appropriate,

A)it is legally obligated to buy all one million shares back.
B)it is not legally obligated to buy all one million shares back.
C)it must buy back the number of shares that are equal to income in a given year (up to one million shares).
D)it must buy back the number of shares that are equal to income minus common stock dividends in a given year (up to one million shares).

Question 73

Prominent research on the small firm effect has been done by:

A)Fama and Roll.
B)Fama and French.
C)French and Roll.
D)Banz and Reinganum.

Question 74

Value Line's Ranking System, covering 1,700 companies, has demonstrated:

A)that stocks ranked one under-perform the market.
B)that stocks ranked five perform about at the market average.
C)that stocks ranked one outperform the market.
D)that stocks ranked five outperform the market.

Question 75

What is market capitalization?

A)The total owners' equity in a firm
B)The total marketable assets of a firm
C)Shares outstanding multiplied by the market value of the stock
D)None of the above

Question 76

Which of the following is NOT an advantage of listing a stock on an exchange?

A)A market for the stock is maintained by a specialist
B)Minimum size and performance criteria for listing are quite restrictive
C)There is usually a significant increase in stock price upon approval for listing
D)More than one of the above

Question 77

A good reason for a stock repurchase is:

A)that management believes that the stock is undervalued in the market.
B)so the company can escape the threat of a future merger or acquisition.
C)to avoid obligations under an employee stock ownership plan.
D)None of the above

Question 78

Studies of the small-firm effect indicate that there may be superior return potential in investing in smaller-capitalization firms, because:

A)the high P/E ratios of many of these firms eventually lead to superior returns.
B)smaller firms have fewer expenses, therefore, making more money for their investors.
C)there is less efficiency in this segment of the market, due to minimal institutional participation.
D)smaller firms are always growing, along with the returns that their investors receive.

Question 79

The study by Fama and French maintains that the lower the ratio of market value to book value, the:

A)more overvalued the stock price.
B)higher the potential return on the stock.
C)higher the expected growth in earnings.
D)lower the expected growth in earnings.

Question 80

Besides management and prior performance, what primary factors should be considered by the investor in a new issue?

A)The intended use of funds from the issue
B)Expected stock price in the secondary market
C)The investment banker handling the distribution
D)More than one of the above