Deck 9: Market Efficiency and Behavioral Finance

Question 1

Which one of the following activities is likely to be useful if the market is only weak form efficient?

A)attempting to find the best times to buy and sell
B)attempting to find repeating pattern in stock price behavior
C)attempting to determine if stock prices have upward or downward momentum
D)None of the above would be useful.

Answer 1

D

Question 2

According to the semi-strong form of the efficient market hypothesis, which of the following might lead to extraordinary profits?

A)studying charts of a stock's past price behavior
B)thoroughly analyzing the state of the economy, the industry and the company's fundamentals
C)possessing private information not available to other investors
D)carefully timing trades to buy when the price is low and sell when the price is high

Answer 2

C

Question 3

If stock prices move randomly, charting and technical analysis are useful investment tools.

Answer 3

False

Question 4

Followers of the efficient market hypothesis believe that

A)very few investors actually analyze or evaluate stocks before they make a purchase decision.
B)the needed information to assess the market is available only to corporate insiders.
C)investors react quickly and accurately to new information.
D)individual traders can have a significant impact on the price of a security.

Question 5

If a company's revenues and earnings are highly predictable, it's stock price will also be highly predictable.

Question 6

The efficient market hypothesis means that trades can be executed quickly, easily, and inexpensively.

Question 7

Which of the following activities would be most useful in an efficient market?

A)buying and holding a diversified portfolio
B)searching for patterns in charts based on stock price movements
C)analyzing financial ratios based on accounting data
D)buying only securities that have performed well in the recent past

Question 8

The efficient market hypothesis rests on which of the following assumptions?
I.Information is widely available to all investors almost simultaneously.
II.Investors react quickly to new information.
III.Investors correctly interpret all available information.
IV.Events which affect the market occur randomly.

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

Question 9

A type of mutual fund with particular appeal to investors who accept the efficient market hypothesis is

A)index fund.
B)asset allocation fund.
C)growth opportunities fund.
D)emerging markets fund.

Question 10

An efficient market reflects

A)only historical information.
B)only the information related to events that have already occurred.
C)all publicly known information related to past events and announced future events.
D)all information including predictions about future information.

Question 11

Investors skilled in exploiting behavioral errors and market anomalies can consistently outperform the market by a wide margin.

Question 12

In an efficient market, prices appear to move randomly because

A)investors do not process new information correctly.
B)only new information affects stock prices.
C)insider trading has an unpredictable effect on stock prices.
D)the number of investors who can forecast prices correctly is too small to have any effect.

Question 13

For most companies, the stock price follows the same seasonal pattern as revenues and earnings.

Question 14

Even if the semi-strong version of the efficient market hypothesis is true, it might be possible to earn extraordinary returns from private information not available to other investors.

Question 15

Security markets have been described as random walks and efficient markets.What does each of these terms mean and how do they relate to the stock market? What makes a market efficient and what are the consequences of efficiency for fundamental and technical analysis?

Question 16

The weak form of the efficient market theory contends that

A)past price performance is useless in predicting future price movements.
B)past performance can help determine the general direction of future price movements.
C)any publicly available information is useless in predicting future price movements.
D)price movements are not random but follow a general trend over a period of time.

Question 17

Even if weak form market efficiency is true, it does not mean that studying charts of past prices and searching for repeating pattern is useless.

Question 18

In an efficient market, the only means of achieving high returns is to invest in high-risk securities.

Question 19

The strong form of the efficient market hypothesis contends that

A)a select few institutional investors can earn abnormal profits.
B)abnormal profits are randomly distributed.
C)no one can consistently earn a profit.
D)no one can consistently earn abnormal profits.

Question 20

Historically higher returns on the stocks of small companies can be completely explained by their higher risk.

Question 21

There is evidence to support the contention that company insiders

A)cannot earn abnormal profits because they are not permitted to trade shares in their company's stock without a one-month advance notice to the SEC.
B)can profit in a manner that counters the strong form of the efficient market hypothesis.
C)generally earn a profit equal to that of public investors.
D)have no distinct advantage when trading shares of their company's stock.

Question 22

Behavioral finance suggests that investors react to new information in an efficient manner such that security prices accurately reflect the new information.

Question 23

Which one of the following statements is correct?

A)The weekend effect states that security prices tend to rise between Friday afternoon and Monday morning.
B)The market responds immediately to reflect the information contained in quarterly earnings reports.
C)Low P/E stocks tend to outperform high P/E stocks on a risk-adjusted basis.
D)The market fully anticipates the information contained in an earnings announcement prior to the actual announcement.

Question 24

The process that quickly eliminates price discrepancies in efficient markets is known as

A)arbitration.
B)market correction.
C)arbitrage.
D)random fluctuation.

Question 25

The process of buying an underpriced security and selling an equivalent overpriced security until the prices converge is known as arbitrage.

Question 26

There is strong evidence that investors who trade frequently outperform the market.

Question 27

Most investors quickly sell their losers and hold on to their winners.

Question 28

Which one of the following statements concerning the random walk hypothesis is correct?

A)Stock price movements are predictable but only over short periods of time.
B)Random price movements support the weak form efficient market hypothesis.
C)Stock prices in general follow repetitive patterns but the actions of individual investors are random in nature.
D)Random price movements indicate that investors can earn abnormal profits on a routine basis.

Question 29

Even if the semi-strong form of the efficient market hypothesis is true, trading on illegal insider information may lead to abnormal profits.

Question 30

Which of the following is true?

A)Historically, high P/E or growth stocks have outperformed low P/E or value stocks.
B)Historically, low P/E or value stocks have outperformed high P/E or growth stocks.
C)After adjusting for risk, high P/E or growth stocks and low P/E or value stocks have performed about the same over time.
D)the P/E effect is limited to U.S.stocks.

Question 31

Believers in efficient markets tend to explain away market anomalies as
I.random occurrences that create an illusion of causality.
II.errors resulting from inaccurate measures of risk.
III.the result of illegal price manipulation by corporate insiders.
IV.the effect of normal human emotions such as fear and greed.

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

Question 32

Loss aversion is the behavior of excessively conservative investors.

Question 33

Market anomalies are caused by

A)investors' efforts to avoid or postpone taxes.
B)different levels of risk.
C)statistical quirks.
D)some poorly understood combination of factors.

Question 34

Most investors are slow to accept evidence that contradicts their strongly held beliefs.

Question 35

Self-attribution bias causes investors to attribute their successes to skill and failures to chance.

Question 36

Followers of the random walk hypothesis believe that

A)security analysis is the best tool to utilize when investing in the stock market.
B)the price movements of stocks are unpredictable, and therefore security analysis will not help to predict future market behavior.
C)that traders can earn higher than normal returns by exploiting market anomalies such as the small-firm effect.
D)support levels and resistance lines, when combined with basic chart formations, yield both buy and sell signals.

Question 37

The random walk hypothesis

A)implies that security analysis is unable to predict future market behavior.
B)suggests that random patterns appear but only over long periods of time.
C)has been disproved based on recent computer simulations.
D)accounts for market anomalies such as calendar effects.

Question 38

The apparent randomness of stock price movements is powerful evidence against market efficiency.

Question 39

Individuals tend to invest in mutual funds that have recently been performing well.

Question 40

Fund managers tend to have too little confidence in their abilities leading them to be excessively cautious.

Question 41

What are some of the more important disagreements between the efficient market hypothesis and the findings of behavioral finance?

Question 42

Which of the following statements correctly present recommendations based on behavioral finance?
I.Don't hesitate to sell a losing stock.
II.Trade frequently.
III.Chase performance.
IV.Be humble and open-minded.

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

Question 43

The tendency of investors to blame others for their failures and take personal credit for their successes is referred to as

A)loss aversion.
B)representativeness.
C)narrow framing.
D)self-attribution bias.

Question 44

Investors who buy mutual funds that have had large gains over the last few years are exhibiting a tendency known as

A)overconfidence.
B)narrow framing.
C)loss aversion.
D)representativeness.

Question 45

The efficient market hypothesis has some trouble explaining the existence of market anomalies.

Question 46

Heather has the equivalent of one year's income in an insured savings account.Her 401-K fund offers a choice of a government bond fund, an S&P 500 Index fund, and a balanced fund that holds roughly equal amounts of stocks and bonds.If she decided to allocate 1/3 of her retirement investments to each fund, she may be a victim of

A)overconfidence.
B)narrow framing.
C)loss aversion.
D)representativeness.

Question 47

Four "decision traps " identified by behavioral finance are

A)overconfidence, representativeness, loss aversion, narrow framing.
B)lack of confidence, representativeness, overreaction, narrow framing.
C)overconfidence, representativeness, loss aversion, comprehensive framing.
D)overconfidence, unfamiliarity bias, loss aversion.narrow framing.

Question 48

Which of the following characteristics are referred to as representativeness?
I.hesitating to sell stocks at a loss
II.basing conclusions on small samples
III.underestimating the effects of random chance
IV.underestimating the level of risk in an investment

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

Question 49

The most important lesson investors can learn from behavioral finance is

A)to understand psychological factors influencing long-term price movement.
B)to have the humility to let professionals manage their investments.
C)how to avoid letting their emotions and biases affect their investment decisions.
D)to have confidence in their instincts and first impressions.

Question 50

The tendency of investors to take greater risks after a large loss and fewer risks after a large gain can be attributed to

A)overconfidence.
B)the "house money" effect.
C)loss aversion.
D)representativeness.

Question 51

Evidence suggests that the price of a stock continues to move up or down for a period of

A)a decade or more.
B)3 to 5 years.
C)1 to 3 years.
D)6 to 12 months.

Question 52

Jason has decided to sell his stock in an energy company because gas and oil prices as well the price of his stock have declined in 5 of the last 6 months.Jason has most likely fallen into the trap known as

A)loss aversion.
B)representativeness.
C)narrow framing.
D)biased self-attribution.

Question 53

Some behavioral characteristics cause investors to realize lower investment returns.

Question 54

Recent academic studies in behavioral finance confirm that markets are even more efficient than previously believed.

Question 55

Which of the following are common but dysfunctional investor behaviors?
I.overinvesting in companies with familiar names
II.dividing their funds equally among available choices, even if several of the choices serve the same purpose
III.holding on to a stock that has dropped in value because you would be willing to buy it at its current price
IV.overestimating one's ability to pick successful investments

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

Question 56

Which of the following accurately reflect appropriate investment guidelines?
I.Always invest in last years best performing mutual fund.
II.Trade frequently to increase your investment returns.
III.Sell losing stocks unless you are willing to buy them at the current price.
IV.Take corrective action when so indicated.

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

Question 57

People tend to

A)ignore information that contradicts their current beliefs.
B)overestimate the effects of random chance.
C)be underconfident in their judgment of investments.
D)look at the entire situation when analyzing an individual security.

Question 58

Investor overconfidence leads to

A)too little trading.
B)an overestimation of risk.
C)overly optimistic predictions.
D)narrow framing.

Question 59

Market bubbles such as the technology bubble of the 1990s and the housing bubble of 2004-2007 are best explained by

A)the efficient market hypothesis.
B)behavioral finance and economics.
C)rational expectations theory.
D)anomaly theory.

Question 60

Evidence suggests that growth stocks tend to outperform value stocks.

Question 61

A principal objective of technical analysis is trying to determine when to invest.

Question 62

The odd-lot theory supports buying into the market when the number of odd-lot trades rises.

Question 63

Technical analysis is so called because it relies on sound scientific principles rather than intuition.

Question 64

A relatively high level of short sales is an indicator of a current bull market.

Question 65

From a behavioral perspective, the anomaly known as post-earnings announcement drift or momentum is best explained by

A)self attribution bias.
B)loss aversion.
C)representativeness.
D)familiarity bias.

Question 66

The tendency of small firms to have higher returns than large firms , even after adjusting for risk, may be attributable to

A)representativeness.
B)overconfidence.
C)familiarity bias.
D)loss aversion.

Question 67

Market volume is a function of market demand for and supply of stocks.

Question 68

Stocks of small companies have a historical tendency to do especially well in the month of January.

Question 69

The new high-new lows measure suggests that buying opportunities occur when new lows outnumber new highs.

Question 70

Even after adjusting for risk, ________ firms have, over long periods of time, earned higher returns than ________ firms.

A)small; large
B)large; small
C)new; old
D)old; new

Question 71

Barb and Ken purchased a house for $300,000 in 2005.When they needed to sell because of a job transfer in 2009, the house was appraised for $250,000 but they put it on the market for $300,000 anyway.The house is still on the market.Behavioral tendencies at work here may include

A)representativeness and narrow framing.
B)overconfidence and representativeness.
C)familiarity bias and self attribution bias.
D)loss aversion and anchoring.

Question 72

The breadth of the market refers to the spread between the number of stocks advancing and those declining in value.

Question 73

The stock of PHRM, the price declined by 30% when the FDA did not approve a promising new therapy the company was developing.Patrick holds on to the stock and constantly searches the internet looking for favorable stories about the company while ignoring a cascade of negative reports.This is an example of

A)anchoring.
B)overconfidence.
C)belief perseverance.
D)loss aversion

Question 74

The tendency of naive investors to buy high (after prices have risen for several periods)and sell low (after prices have dropped for several periods)can be explained by the behavioral tendency known as

A)anchoring.
B)overconfidence.
C)familiarity bias.
D)loss aversion.

Question 75

One of the calendar effect market anomalies indicates that ________ in value during January.

A)large cap stocks tend to decline
B)equities in general tend to decline
C)small cap stocks tend to increase
D)equities in general tend to increase

Question 76

The anomaly known as post-earnings announcement drift or momentum describes the tendency of stock prices to rise or fall for several ________ after unexpectedly good or bad earnings announcements.

A)months
B)weeks
C)days
D)hours

Question 77

The stock market is considered strong when the market volume decreases in a declining market.

Question 78

Resources for technical analysis are readily available on the Internet.

Question 79

For technical analysts, the forces of supply and demand have an important effect on the prices of securities.

Question 80

Investors should never combine fundamental analysis and technical analysis.