Deck 13: Efficient Markets and Behavioral Finance

Question 1

Predictable cycles in stock price movements

A)tend to persist for a long time.
B)tend to self-destruct as soon as investors recognize them.
C)never appear, since stock returns change randomly.
D)tend to persist for a long time; tend to self-destruct as soon as investors recognize them; and never appear, since stock returns change randomly.

Answer 1

tend to self-destruct as soon as investors recognize them.

Question 2

Stock price cycles or patterns tend to 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 the New York Stock Exchange.
C)trading by investors.
D)the actions of corporate treasurers.

Answer 2

trading by investors.

Question 3

Which of the following statements is (are) true if the strong-form efficient market hypothesis holds?

A)Analysts can easily forecast stock price changes.
B)Financial markets are irrational.
C)Analysts can easily forecast stock price changes and stock returns follow a particular pattern.
D)Stock prices reflect all available information.

Answer 3

Stock prices reflect all available information.

Question 4

Which of the following is a statement of weak-form efficiency?

A)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.
B)If markets are efficient in the weak form, then prices will adjust immediately to public information.
C)If markets are efficient in the weak form, then prices will adjust immediately to public information and prices reflect all information.
D)If markets are efficient in the weak form, then prices reflect all information.

Question 5

Generally, a firm is able to find positive-NPV opportunities among its

A)financing decisions.
B)financing decisions and short-term borrowing decisions.
C)short-term borrowing decisions.
D)capital investment decisions.

Question 6

A large firm received a loan guarantee from the government.Due to the guarantee, the firm can borrow $50 million for five years at 8 percent interest rate per year instead of 10 percent 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)$3.99 million

Question 7

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

A)+$126,371
B)+$348,369
C)-$501,595
D)-$137,391

Question 8

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

A)a positive-NPV transaction.
B)a zero-NPV transaction.
C)a negative-NPV transaction.
D)No general trend exists for such transactions.

Question 9

The statement that stock prices follow a random walk implies that

A)successive price changes are independent of each other.
B)successive price changes are positively related and successive price changes are negatively related.
C)the autocorrelation coefficient is either +1 or -1.
D)successive price changes are negatively related.

Question 10

The statement that stock prices follow a random walk implies that

A)the correlation coefficient between successive price changes (auto correlation) is not significantly different from zero.
B)successive price changes are positively related.
C)successive price changes are positively related and are negatively related.
D)the autocorrelation coefficient is positive.

Question 11

Financing decisions differ from investment decisions for which of the following reasons?

A)You cannot use NPV to evaluate financing decisions.
B)Markets for financial assets are more active than for real assets.
C)It is easier to find financing decisions with positive NPV than to find investment decisions with positive NPV.
D)You cannot use NPV to evaluate financing decisions, and it is easier to find financing decisions with positive NPV than to find investment decisions with positive NPV.

Question 12

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

A)+1.25 percent
B)-0.75 percent
C)+0.25 percent
D)+2 percent

Question 13

Financing decisions differ from investment decisions because

A)financing decisions are easier to reverse.
B)financing decisions are easier to reverse and markets for financial assets are generally more competitive than real asset markets.
C)financing decisions are easier to reverse, markets for financial assets are generally more competitive than real asset markets, and markets for financial assets are generally more competitive than real asset markets.
D)markets for financial assets are generally more competitive than real asset markets and markets for financial assets are generally more competitive than real asset markets.

Question 14

Weak-form efficiency implies that past stock returns

A)form patterns that tend to repeat.
B)are major inputs to investors for forming trading strategies.
C)do not help to predict future returns.
D)are difficult to explain.

Question 15

Which of the following is a statement of semistrong form efficiency?

A)Stock prices will adjust immediately to public information.
B)Stock prices reflect all information.
C)Stock prices reflect all information and stock prices will adjust to newly published information after a long time delay.
D)Stock prices will adjust to newly published information after a long time delay.

Question 16

If the efficient market hypothesis holds, investors should expect

A)to receive a fair price for their security.
B)to earn a normal rate of return on their investments.
C)to be able to pick stocks that will outperform the market.
D)to receive a fair price for their security and to earn a normal rate of return on their investments.

Question 17

If the weak form of market efficiency holds, then

A)technical analysis is useless.
B)technical analysis is useless and stock prices reflect all information contained in past prices.
C)technical analysis is useless, stock prices reflect all information contained in past prices, and stock price returns follow a random walk.
D)technical analysis is useless and stock price returns follow a random walk.

Question 18

Strong-form market efficiency states that the market incorporates all information into stock prices.Strong-form efficiency implies that

A)an investor can only earn risk-free rates of return.
B)an investor can always rely on technical analysis.
C)professional investors cannot consistently outperform the market.
D)an investor can only earn risk-free rates of return and can always rely on technical analysis, and professional investors cannot consistently outperform the market.

Question 19

Informational efficiency in financial markets results in stock prices being

A)higher.
B)lower.
C)fairer.
D)easier to predict.

Question 20

The different forms of market efficiency are

A)weak form only.
B)weak form and semistrong form.
C)weak form and strong form.
D)weak form, semistrong form, and strong form.

Question 21

In order to test the strong form of market efficiency, researchers have examined the

A)recommendations of professional security analysts.
B)recommendations of professional security analysts and performance of mutual funds.
C)recommendations of professional security analysts, performance of mutual funds, and performance of pension funds.
D)performance of mutual funds and performance of pension funds.

Question 22

For most stocks, a scatter plot chart of stock returns versus past stock returns will appear as

A)a shotgun pattern centered close to the origin.
B)a random pattern mostly concentrated in the top-right and lower-left quadrants.
C)a random pattern mostly concentrated in the upper-left and upper-right quadrants.
D)None of the options are correct.

Question 23

The conviction of Raj Rajratnam for insider trading supplies evidence against which form of the efficient markets hypothesis?

A)Weak-form efficiency
B)Semistrong form efficiency
C)Strong-form efficiency
D)It is evidence against all forms.

Question 24

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

A)5 percent
B)3 percent
C)8.15 percent
D)8 percent

Question 25

The semistrong form of efficiency focuses on the economic ineffectiveness of the following type of information:

A)insider information.
B)publicly available information.
C)privileged information.
D)only information provided by the SEC.

Question 26

One important implication of the efficient markets hypothesis is that most investors

A)should avoid active trading.
B)can benefit by purchasing high-beta stocks.
C)should trade actively to help ensure the highest overall gain in their portfolios.
D)should hold IPO stock issues for the longterm.

Question 27

The study of behavioral finance has best helped explain which of the following investor behaviors?

A)Investors are often unable to short-sell unfavorable stocks.
B)Investors often create undiversified portfolios.
C)Investors tend to sell their losing stocks and retain stocks that have capital gains.
D)Investors are generally too slow to update their beliefs in the face of new evidence.

Question 28

The semi strong form of the efficient markets hypothesis has been tested by measuring how rapidly security prices react to various news items like

A)earnings announcementsand dividend announcements.
B)earnings announcements, dividend announcements, and news of takeovers.
C)macroeconomic information.
D)earnings announcements, dividend announcements, news of takeovers, and macroeconomic information.

Question 29

Strong-form efficiency implies that mutual fund managers should

A)buy the index that maximizes diversification and minimizes the cost of managing portfolios.
B)actively seek underperforming stocks and buy them.
C)generally earn superior returns each year.
D)attempt to earn superior returns by using technical analysis.

Question 30

Analysis of past monthly movements in IBM's stock price produces the following estimates: α = 2.5 percent and β = 1.6.If the market index subsequently rises by 12 percent in one month and IBM's stock price increases by 20 percent, what is the abnormal change in IBM's stock price?

A)+1.7 percent
B)+8 percent
C)-1.7 percent
D)+2.5 percent

Question 31

The following are anomalies countering the efficient market hypothesis except

A)the small-firm effect.
B)the small-firm effectandthe earnings announcement puzzle.
C)the small-firm effect, the earnings announcement puzzle, and the new-issue puzzle.
D)trading rules based on patterns.

Question 32

The various lessons of market efficiency are

A)markets have no memory and trust market prices only.
B)markets have no memory, trust market prices, read the entrails, and the do-it yourself alternative.
C)markets have no memory and seen one stock, seen them all.
D)markets have no memory; trust market prices; read the entrails; the do-it yourself alternative; and seen one stock, seen them all.

Question 33

An abnormal stock return is calculated as the

A)return on the stock minus the expected stock return.
B)return on the stock minus the return on the market.
C)return on the stock for the current period minus the return on the stock for the previous period.
D)return on the stock minus the return on a comparable firm.

Question 34

Which of the following observations would provide evidence against the strong form of efficient market theory?

A)Mutual fund managers do not on average make superior returns.
B)In any year, approximately 50 percent of all pension funds outperform the market.
C)Managers who trade in their own firm's stocks make superior returns.
D)Mutual fund managers do not on average make superior returns and, In any year, approximately 50 percent of all pension funds outperform the market.

Question 35

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 which theory?

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

Question 36

Analysis of past monthly movements in Wal-Mart's stock price has produced the following estimates: a = -0.45 percent and b = 0.5.If the market index subsequently rises by 5 percent while Wal-Mart's stock price rises by 3 percent, what is the abnormal change in Wal-Mart's stock price?

A)-0.45 percent
B)+0.95 percent
C)+0.05 percent
D)+2.50 percent

Question 37

If markets are efficient, which of the following investors should achieve superior returns over time?

A)Investors who choose stocks by throwing darts at a list of stocks 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 options are correct.

Question 38

Suppose that 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 firms that will be sued.This hypothetical finding would violate the

A)weak-form hypothesis of market efficiency.
B)semistrong form hypothesis of market efficiency.
C)strong-form hypothesis of market efficiency.
D)none of the hypotheses of market efficiency.

Question 39

In order to test the weak form of the efficient-market hypothesis, 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 options are methods used for testing weak-form market efficiency.

Question 40

In order to test the semistrong form of the efficient-market hypothesis, researchers have mostly relied on the

A)estimation of the serial correlation coefficients (autocorrelations) for securities and markets.
B)measurement of the performance of technical trading strategies over the years.
C)measurement of how rapidly security prices adjust to different news items.
D)All of the options are correct.

Question 41

State the important differences between investment decisions and financing decisions.

Question 42

The small-firm effect may constitute evidence against market efficiency.

Question 43

List the three forms of market efficiency and explain the bases for them.

Question 44

State the semistrong form of market efficiency and its implications.

Question 45

The collections of evidence against market efficiency are referred to as "puzzles" or anomalies.

Question 46

State the weak form of market efficiency and its implications.

Question 47

If stock returns follow a random walk pattern, then knowing the history of stock returns is not useful for predicting future stock returns.

Question 48

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

Question 49

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

Question 50

Behavioral finance and technical analysis are basically the same theory.

Question 51

A majority of research supports the theory that past stock movements can predict future asset prices.

Question 52

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

Question 53

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

Question 54

In an efficient market, information is costless.

Question 55

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

Question 56

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

Question 57

If a stock's returns follow a random walk pattern, then one should expect to calculate a statistically insignificant autocorrelation coefficient, calculated between each successive day's stock returns.

Question 58

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

Question 59

State the strong form of market efficiency.

Question 60

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

Question 61

What are puzzles and anomalies?

Question 62

List the five lessons of market efficiency.

Question 63

Briefly discuss some of the important findings of behavioral finance studies.