Deck 12: What Happens If Markets Are Efficient or Not?

Question 1

Debont and Thayler (1985)'s overreaction hypothesis tends to:

A) support the weak form of the EMH.
B) not support the weak form of the EMH.
C) support the semistrong form of the EMH.
D) not support the semistrong form of the EMH.

Answer 1

B

Question 2

We can expect that the U.S. stock markets will be efficient for all of the following reasons EXCEPT:

A) A large number of rational, profit-maximizing investors exist who actively participate in the U.S. market by analyzing, valuing, and trading stocks.
B) The U.S. economy is the largest in the world, with the most sophisticated investors.
C) Information is costless and widely available to market participants at approximately the same time.
D) Investors react quickly and fully to the new information, causing stock prices to adjust accordingly.

Answer 2

B

Question 3

Which of the following statements is true regarding the efficiency of foreign securities and foreign markets?

A) Foreign securities tend to be more analyzed than U.S. securities.
B) Foreign markets tend to be less efficient than U.S. markets.
C) Foreign markets often lag behind U.S. markets as much as 6 months.
D) Foreign markets tend to be as efficient as U.S. markets.

Answer 3

B

Question 4

Which of the following is NOT a test of semi-strong form efficiency?

A) Insider transactions
B) Stock splits
C) Accounting changes
D) Dividend announcements

Question 5

The weak form of the EMH is supported if successive price changes over time are

A) independent of each other.
B) negative.
C) positive.
D) lagged.

Question 6

If a market is inefficient, as new information is received about a security:

A) nothing will happen.
B) the stock price will fall at first and then later rise.
C) there will be a lag in the adjustment of the stock price
D) there will be negative demand for the stock.

Question 7

With regard to market efficiency, identify the INCORRECT statement.

A) Information is the central issue of the efficient markets concept.
B) The most stringent form of market efficiency is the strong form.
C) The efficient market concept does not require a perfect adjustment in price following new information.
D) Tests of the usefulness of price data are semi-strong form tests.

Question 8

The random walk hypothesis is most related to the:

A) weak-form EMH
B) semistrong-form EMH
C) semiweak-form EMH
D) strong-form EMH

Question 9

An efficient market is defined as one in which:

A) all participants have the same opportunity to make the same returns.
B) all participants have the same legal rights and transactions costs.
C) securities prices quickly and fully reflect all available information.
D) securities prices are completely in line with the intrinsic value.

Question 10

Which of the following markets is generally considered to be the most efficient:

A) China.
B) India.
C) Russia.
D) U.S.

Question 11

What is the result of the widespread usage of the Internet with regards to efficient markets?

A) It makes information cheaper and more accessible thus making markets more efficient.
B) It is subject to new regulation thus marking markets less efficient.
C) It increases the volatility of security prices thus making markets less efficient.
D) It increases competition among brokers thus making markets more efficient.

Question 12

Tests of the semistrong EMH include:

A) regression analysis.
B) correlation tests that compare the security returns to the overall market return.
C) tests of the speed of adjustment of stock prices to company announcements.
D) queuing line theory tests.

Question 13

Select the FALSE statement concerning efficient markets.

A) The current price of a stock reflects all known information.
B) Investors will use all relevant data in making their decisions.
C) A perfect adjustment in price follows any new information.
D) Following any adjustment, the new price does not have to be the new equilibrium price.

Question 14

All "known" information means:

A) past information only.
B) past and current information.
C) past, current, and inferred information.
D) past, current, inferred and relative information.

Question 15

All of the following conditions must occur for a market to be considered efficient except:

A) Information is costless and widely available to market participants at approximately the same time.
B) Information is generated in a specific fashion such that announcements are basically dependent on each other.
C) There are a large number of rational, profit-maximizing investors who actively participate in the market.
D) Investors react quickly and fully to the new information, causing stock prices to adjust accordingly.

Question 16

According to the weak form of the EMH,

A) successive price changes are biased.
B) successive price changes are dependent.
C) specified trading rules can prove to be extremely useful in generating excess returns.
D) successive price changes are independent.

Question 17

According to the semi-strong form of the EMH, investors who invest in a stock after a highly positive announcement concerning the stock can expect to earn

A) normal return because the stock will be fairly priced when purchased.
B) extraordinary return because the new information will not affect the price until later.
C) extraordinary loss because insiders possess non-public information.
D) zero return because the next price is expected to be the same as the last price.

Question 18

Stockholders that own more than ____% of a company's stock are considered insiders by the SEC.

A) 10
B) 20
C) 30
D) 40

Question 19

Weak form market efficiency

A) implies that the expected return on any security is zero.
B) incorporates semi-strong form efficiency.
C) involves price and volume information.
D) is compatible with technical analysis.

Question 20

The highest level of market efficiency is

A) weak form efficiency.
B) semi-strong form efficiency.
C) random walk efficiency.
D) strong form efficiency.

Question 21

In a semistrong form efficient market, investors are not able to use publicly available financial statement data to earn abnormal returns.

Question 22

If there is less efficiency in emerging markets than in developed markets, there should be higher performance in emerging markets than in developed markets.

Question 23

According to the behavioral finance, markets are always

A) informationally efficient.
B) informationally inefficient.
C) weak-form efficient.
D) semi-strong form efficient.

Question 24

Under the weak form of the EMH, technical analysis relying on the history of price information is of no value in trying to outperform the future market.

Question 25

Which of the following is true regarding the size anomaly?

A) As much as 50% of small cap outperformance is associated with the January effect.
B) Small cap stocks underperform large cap stocks in recent years.
C) Small cap stock outperformance is a NASDAQ phenomenon, not NYSE.
D) Small cap stock outperformance is unaffected by micro-cap, commission, or liquidity (i.e., bid-ask spread) concerns.

Question 26

Which of the following is frequently used to test the semistrong form of the EMH?

A) statistical tests of stock-price change independence.
B) tests of specific trading rules that use past price data.
C) event studies.
D) insider returns.

Question 27

Based on the research related to market anomalies, investors should prefer

A) low standardized unexpected earnings (SUE) and high P/E ratios.
B) low SUE, low P/E stocks.
C) high SUE, low P/E stocks.
D) high SUE, high P/E stocks.

Question 28

A lady bought 100 shares of a leading diamond mining company with an expected return of 20 percent per year. The following day the company's president announced a major new discovery in Arkansas. The stock price immediately doubled. This scenario probably best illustrates

A) weak form EMH is not valid.
B) semi-strong form of EMH is not valid.
C) market prices are random.
D) the lady was lucky.

Question 29

Studies cited in the text show technical trading rules based on price and volume data lead to investment timing decisions that

A) consistently outperform the buy-and-hold strategy.
B) minimize brokerage costs.
C) do not provide excess returns after all brokerage costs are deducted.
D) do provide excess returns to most investors who follow the rules faithfully.

Question 30

The January effect concerns:

A) large cap stocks.
B) mid-cap stocks.
C) small cap stocks.
D) foreign stocks.

Question 31

Evidence concerning the "overreaction hypothesis" indicates that

A) most overreactions occur within the first two days of an economic event.
B) investors are consistently risk-averse value maximizers.
C) the market is even more efficient than the weak-form EMH proposes.
D) investors sometimes act rationally.

Question 32

The efficiency of markets is driven largely by the vast number of participants and their quick and access to information.

Question 33

Which of the following announcements has NOT been involved in a direct test of the semi-strong form of the EMH?

A) Dividend announcements
B) Accounting changes
C) Stock splits
D) Corporate insiders' actions

Question 34

The paradox of efficient markets is that

A) even though markets are efficient overall, there are pockets of inefficiency.
B) news about anomalies makes the market less efficient.
C) investors attempting to uncover and use information about security prices help make the market more efficient (i.e., an "efficient amount of inefficiency")
D) investors make the market less efficient.

Question 35

According to the random walk hypothesis, price(s)

A) over time are independent of one another.
B) changes over time are independent.
C) levels over time are independent.
D) changes today are dependent on yesterday's price changes.

Question 36

Value Line's 1 to 5 stock ranking system of timeliness refers to:

A) absolute return potential over a 10-year period
B) probability of outperforming the market over a 3 to 5 year period
C) probable total return including dividend yield
D) probable relative price performance within the next 12 months

Question 37

Which of the following is a market anomaly?

A) A relationship between money supply growth and stock prices.
B) A relationship between P/E ratios and subsequent stock returns.
C) Independence of stock price changes.
D) Adjustment of stock prices due to accounting changes.

Question 38

All of the following are considered market anomalies EXCEPT:

A) size effect
B) January effect
C) earnings announcement anomaly
D) accounting changes effect

Question 39

If an investor searches for patterns in security returns by examining various techniques applied to a set of data and then applying the technique that works, this is known as:

A) fundamental analysis.
B) technical analysis.
C) random-walk theory.
D) data mining.

Question 40

The disposition effect relates to the fact that:

A) investors tend to overconfident regarding potential stock prices.
B) investors often experience regrets about trading decisions.
C) investors are more likely to sell winners than losers.
D) investors tend to dispose of stocks at the end of the year.

Question 41

Calendar market anomalies include the neglected firm effect, which means few analysts follow the stock, or few institutions own the stock.

Question 42

An investor who believes in the strong form of the EMH should be an active investor.

Question 43

Technical analysis involves the use of historic price and volume information to predict future price movements. What does the EMH say about technical analysis?

Question 44

Some market scholars talk about tiers of stocks in the markets. A top tier on the NYSE would be the largest, most widely held stocks. Second and third tiers would consist of stocks that are less widely held and followed by fewer analysts. Is it possible that the market might be more efficient for the top tier and progressively less efficient for the lower tiers?

Question 45

What is a market anomaly? Give examples of several market anomalies.

Question 46

Overall, the low P/E strategy should be viewed as a short run strategy.

Question 47

If securities are fairly priced, then the portfolio manager is unlikely to be able to identify undervalued stocks. What other activities could portfolio managers perform?

Question 48

The evidence obtained on weak-form efficiency casts serious doubts on fundamental analysis.

Question 49

What types of information are considered in each of the three forms of the EMH?

Question 50

An efficient market is defined as one in which prices of securities fully reflect all known ______________________ quickly and accurately.

Question 51

What forms of EMH are strongly supported by economic studies? What is some evidence?

Question 52

Value investing implies investors should always buy stocks with the lowest P/E ratios.

Question 53

Tests of the strong-form EMH include studies of corporate insiders and event studies.

Question 54

A belief in the size-effect anomaly should encourage investors to buy large-firm stocks.

Question 55

An earnings announcement effect would not be considered a good test of the weak form of the EMH.

Question 56

An oil company's P/E ratio is 15; its projected EPS is $8; and its price is $120. Expectations are that a new field will add $2 EPS the next year. If the P/E remains constant, what should happen to the price in an efficient market? How soon? Are investors that pay the price after adjustment paying a fair price and are they expected to earn a normal return?

Question 57

If an astute (or lucky) market analyst were to find a "money machine" system that consistently beat the market, would the system eventually become self-defeating?

Question 58

According to the text, the most compelling evidence about relative market efficiency is: (1) __________% of large cap equity funds failed to perform as well as the S&P 500 index; and (2) the vast majority of __________________ fail to achieve top half performance rankings or outperform their index, especially on a consistent basis.

Question 59

Calendar market anomalies include day-of-the-week, turn-of-the-month, day preceding a holiday effect.

Question 60

Insider trading is illegal in the U. S. How is this related to the strong form EMH?

Question 61

Calculate the SUE for a stock with expected second quarter earnings of $1.00 and actual second quarter earnings of $0.75. The standardization variable is 0.20. Is this stock one of interest to investors using the SUE technique?

Question 62

The Auto Company (AC) had expected returns and realized returns for the periods shown below:
$\begin{array}{ccc}\text { Period } & \text { Expected Return } & \text { Actual Return } \\\hline 1 & 15 \% & 16 \% \\215 \% & 13 \% & \\3 & 15 \% & 17 \% \\415 \% & 15 \% &\end{array}$
Calculate the cumulative abnormal return for the four periods.

Question 63

Listed below are the actual returns on two stocks X and Y, and on the market (R_M), along with their systematic risk measures (Betas) relative to the time period, t.
Stock R_i,t % R_M,t % a_i Beta
(a) What is the abnormal return for stock X when you consider its systematic risk measure?
(b) What is the abnormal return for stock Y when you consider its systematic risk measure?

Question 64

Nike Inc. reports first quarter earnings of $2.00 per share. As an investor using the SUE technique, you had estimated earnings to be $1.50 per share, with a standard error of estimate (SEE) of 0.15.
(a) Calculate the SUE for Nike.
(b) Would this stock be a good buy on the basis of this SUE?

Question 65

In terms of Venn Diagrams in terms of states of the world, explain how weak-form, semistrong form, and strong form market efficiency relate to one another.