Deck 10: Information and Financial Market Efficiency

Question 1

If the interest rate on a ten-year bond issued by GM is 7.8% while the interest rate on a ten-year treasury bond is 4.6%, the risk premium is

A)1.70%.
B)3.2%.
C)-3.2%.
D)12.4%.

Answer 1

3.2%.

Question 2

An asset's fundamental value equals

A)its face value.
B)its maturity value.
C)the market's best guess of the present value of the asset's expected future returns.
D)the weighted sum of its market price over the previous seven trading periods.

Answer 2

the market's best guess of the present value of the asset's expected future returns.

Question 3

Rational expectations involve the assumption that

A)market participants make use only of information on the past performance of an asset in determining what they believe its price should be.
B)market participants rarely change their minds about the correct price of an asset.
C)financial markets are good at increasing liquidity, but poor at transmitting information.
D)market participants makes use of all available information.

Answer 3

market participants makes use of all available information.

Question 4

If the dollar is expected to depreciate against the Japanese yen during the next 60 days, then

A)the 60-day forward yen/dollar exchange rate should be lower than the current exchange rate.
B)the 60-day forward yen/dollar exchange rate should be higher than the current exchange rate.
C)the yen price of dollar-denominated asset is expected to rise.
D)the foreign exchange market must not be an efficient market.

Question 5

If market participants rely only past stock prices to forecast future stock prices,

A)they will be better able to forecast future price increases than future price decreases.
B)they will be better able to forecast future price decreases than future price increases.
C)they have adaptive expectations.
D)they have rational expectations.

Question 6

The gap between the yield on a corporate bond and the yield on a U.S. Treasury bond of the same maturity represents

A)the market's evaluation of the likelihood of future inflation.
B)the market's evaluation of the likelihood of default on the bond.
C)the market's evaluation of the greater liquidity of the corporate bond.
D)evidence against the efficient markets hypothesis.

Question 7

When market participants use all available information

A)market prices become signals for financial and economic decisions.
B)spot prices converge to future prices.
C)prices of financial assets remain constant over long periods of time.
D)hedging is no longer necessary.

Question 8

If traders in a market have rational expectations, then

A)the price of an asset equals its fundamental value.
B)prices of riskier assets are higher than prices of less risky assets.
C)past prices of assets do not affect market participants' expectations of future asset prices.
D)they make use of less information than they would if they had adaptive expectations.

Question 9

Which of the following statements is true of rational expectations?

A)Rational expectations forecasts are always correct.
B)For a trader with rational expectations, the expectation of an asset's price equals the optimal price forecast.
C)If traders have rational expectations, any announcement by a company will have an effect on its stock price, even if the market was already aware of the facts being announced.
D)If a trade really has rational expectations, he or she was always earn a greater than normal return on his or her financial portfolio.

Question 10

When market participants have rational expectations,

A)they use all information available to them.
B)they only slowly adjust their expectations to news which could affect prices or returns.
C)they are less likely to make accurate forecasts than if they have adaptive expectations.
D)they are able to forecast interest rates more accurately than inflation rates.

Question 11

Which of the following is NOT a way in which prices communicate information in the markets for bonds, stocks, foreign exchange, and financial instruments?

A)Prices of financial assets represent expectations of future value.
B)Prices of financial assets reflects the preferences of policymakers.
C)Long-term bond yields provide information about expected future short-term yields.
D)Differences in interest rates in various countries reveal information about expected changes in exchange rates.

Question 12

George is trying to forecast the future price of IBM's common stock. To do so he makes use only of past prices of IBM stock. George

A)has adaptive expectations.
B)has rational expectations.
C)is likely to rapidly adjust his forecast to news affecting the future profitability of IBM.
D)is likely to make forecasts that reflect closely IBM stock's fundamental value.

Question 13

When market participants have rational expectations,

A)the information they use contains only past experiences.
B)the information they use contains not only past experiences, but also their expectations for the future.
C)the information they use contains only their expectations for the future.
D)their forecasts are always correct.

Question 14

If a company's sales begin to fall off so that it is now more likely to default on its bonds than financial markets had previously believed, the yields on the company's bonds will

A)rise to compensate investors for this greater risk.
B)fall because the company will no longer be able to afford to pay as much interest.
C)fall as investors insist on higher prices for the bonds to compensate them for the greater risk.
D)be unchanged; once issued yields on bonds do not change.

Question 15

Expectations of asset values by participants in financial markets

A)are not possible to model, given the current state of economic knowledge.
B)determine market prices, but are not related to changes in market prices.
C)are determined largely by governmental actions.
D)determine market prices and changes in market prices.

Question 16

Acme Widget has been sued. It had been expected to lose suit and to be liable for massive payments that would have imperiled the future of the company. If Acme unexpectedly wins the suit,

A)the price of its bonds will rise.
B)the price of its bonds will fall because Acme will now be able to pay higher interest.
C)the price of its bonds will fall because investors will sell Acme's bonds and buy its stock.
D)the price of its bonds will be unchanged; once issued prices on bonds do not change.

Question 17

If the dollar is expected to depreciate against the British pound during the next 60 days, then

A)the current pound/dollar exchange rate should be higher than the 60-day forward pound/dollar exchange rate.
B)the current pound/dollar exchange rate should be lower than the 60-day forward pound/dollar exchange rate.
C)buying dollars today with pounds and selling them in 60 days for pounds will yield a profit.
D)the pound price of U.S. goods sold in Britain must be expected to rise.

Question 18

When market participants have adaptive expectations

A)they use all information available to them.
B)they only slowly adjust their expectations to news which could affect prices or returns.
C)they are more likely to make accurate forecasts than if they have rational expectations.
D)they are able to forecast interest rates more accurately than inflation rates.

Question 19

Suppose it is perceived that a company is more likely to go into bankruptcy. What will happen in the market for its bonds?

A)It will have to pay a higher price on its bonds.
B)The interest rate on its bonds will decline.
C)The price of its bonds will decline.
D)The coupon rate on its previously issued bonds will rise.

Question 20

When the market price of a financial instrument equals its present value, savers and borrower can be sure that

A)the inflation rate equals the interest rate.
B)the inflation rate will be zero in the future.
C)the interest rate will be zero in the future.
D)the price communicates information about market participants' expectations of value.

Question 21

The efficient markets hypothesis

A)assumes that market participants form their expectations adaptively.
B)applies rational expectations to the pricing of assets.
C)applies to the stock market, but not to the bond market.
D)indicates that the stock market is efficient, but not rational.

Question 22

In an efficient market the price of a bond

A)is generally greater than the present value of future interest and principal payments.
B)is generally less than the present value of future interest and principal payments.
C)equals the present value of future interest and principal payments.
D)will be less than, greater than, or equal to the present value of future interest and principal payments, depending upon prevailing interest rates.

Question 23

When market participants have rational expectations, the deviation of the expected price from the actual future price is

A)zero.
B)predictable, provided all relevant information is made use of.
C)not predictable.
D)predictable under certain circumstances, but not under others.

Question 24

If major traders believe the price of a stock should be higher than its current market price,

A)they have an incentive to bid down the price of the stock.
B)their actions will result in the information they possess being incorporated into the price of the stock.
C)there is little they can do because government regulation precludes their acting on what they know.
D)they should petition the Securities and Exchange Commission to authorize an adjustment in the price of the stock.

Question 25

If P^e is the expectation of an asset's price forecast and P^f is the optimal forecast of the asset's price, then if market participants have rational expectations

A)P^e > P^f.
B)P^e < P^f.
C)P^e = P^f.
D)There is no necessary relationship between P^e and P^f.

Question 26

Prices of securities

A)change infrequently.
B)change frequently to reflect news about changes in the fundamental values of the securities.
C)change frequently as evaluations of existing information about the securities change.
D)are not allowed, under federal securities laws, to change more frequently than once a month.

Question 27

If the prices of financial assets follow a random walk, then

A)they should be easy to forecast, provided market participants have rational expectations.
B)they should be easy to forecast, provided market participants have adaptive expectations.
C)the change in price from one trading period to the next is not predictable.
D)major traders in the market must not be making use of all available information about the assets.

Question 28

Which of the following is an example of asymmetric information?

A)A borrower has information about prospects not shared with other market participants.
B)Some investors do research and obtain more information than others.
C)Information about a company's earnings may not be released until after the market closes.
D)Financial analysts may disagree on the prospects for a stock.

Question 29

An efficient financial market is one in which

A)transactions costs for trading securities are zero.
B)all information available to market participants is reflected in market prices.
C)all securities traded are very liquid.
D)there are no taxes on the gains from trading securities.

Question 30

In an efficient market, the market price of an asset

A)reflects the returns the asset has been earning previously.
B)is fixed by federal regulators after a thorough consideration of all available information.
C)equals the present value of expected future returns.
D)is largely determined on the demand side, because the supply of assets in such markets is generally fixed.

Question 31

A decline in market interest rates

A)reduces the value of future interest payments.
B)reduces the value of future principal payments.
C)increases the prices of bonds.
D)increases the prices only of newly issued bonds.

Question 32

Which of the following is the correct expression for the price of an asset at time t?

A)^Pt= ( + 1+
+1)/(1 + i)
B) = ( + 1 + ^Pt +1)/(1 + i)
C)^Pt + + 1 =
+1/(1 + i)
D)^Pt = ( + 1 +
+1)

Question 33

Which of the following will NOT result in an asset having a high price today in an efficient market?

A)It is expected to have high returns.
B)It is not very risky.
C)It has a high interest rate.
D)It is expected to rise in value in the future.

Question 34

In an efficient market with rational expectations, the actual price of an asset

A)will equal its expected price.
B)will often be below its expected price.
C)will often be above its expected price.
D)equals its expected price plus a random error term.

Question 35

According to the efficient markets hypothesis,

A)the equilibrium price of an asset equals the optimal forecast of fundamental value based on available information.
B)the actual and expected prices of an asset will be equal.
C)the actual price of an asset reflects only information on past returns on the asset.
D)the expected price of an asset incorporates only information on past returns on the asset.

Question 36

Suppose a bond is expected to be selling for $110 one year from now, its coupon payment during the year will be $10.75, and the interest rate, adjusted for the bond's risk, is 5%. If the bond market is efficient, what will be the current market price of the bond?

A)$104.76
B)$110
C)$115
D)$120.75

Question 37

Which problems may exist for a new stock market?

A)lack of liquidity
B)lack of efficient trading mechanisms
C)little information about enterprise available
D)all of the above

Question 38

Investors are better off when financial asset prices are determined in an efficient market because

A)returns on assets will be higher.
B)funds will flow from savers to investors offering the most profitable investment opportunities.
C)returns from assets traded in an efficient market are not subject to state or local taxes.
D)risky assets are not allowed to be traded in an efficient market.

Question 39

If market participants have rational expectations, then the best forecast of the price of a stock in the next period is

A)equal to an average of the prices of the stock in previous periods.
B)equal to the price of the stock in the current period.
C)dependent upon all information available in the current period, including, but not limited to, the price of the stock in the current period.
D)zero.

Question 40

An increase in expected future market interest rates

A)raises bond prices.
B)raises long-term yields relative to short-term yields.
C)raises short-term yields relative to long-term yields.
D)results from forecasts of declining inflation.

Question 41

In comparing actively managed mutual funds with those funds that simply buy and hold a large market portfolio (index funds), we would expect that

A)the actively managed funds provide a higher return than the index funds.
B)the index funds provide a higher return than the actively managed funds.
C)actively managed funds and index funds provide the same returns.
D)index funds provide a lower return than actively managed funds only if taxes are taken into consideration.

Question 42

An implication of the efficient markets hypothesis is that

A)only sophisticated investors will be able to earn above-normal profits from financial investments.
B)above-normal profits are available only to major traders.
C)above-normal profits will be eliminated in the trading process.
D)unless he or she acts recklessly, the average investor should be able to make above-normal profits.

Question 43

"Tips" published in leading commercial or financial publications are unlikely to lead to profitable trades because

A)only wealthy individuals can buy stocks in the volume necessary to take advantage of tips.
B)whatever is gained by trading on the basis of tips will be taxed away by the government.
C)the news will already be reflected in the market prices of the assets.
D)the news contained in the tips is usually inaccurate.

Question 44

Under the efficient markets hypothesis, what would be the price per share of a company whose current dividend is $10.00 and whose dividends are expected to grow by 3% per year (assume the risk-adjusted interest rate is 10%)?

A)$74.62
B)$79.23
C)$138.57
D)$147.14

Question 45

Above-normal returns on stock investments can be expected by investors who

A)possess insider information.
B)are wealthy enough to hold the stock of many different companies in their portfolios.
C)are reasonably cautious.
D)concentrate their investments in one or two stocks.

Question 46

Which of the following is a correct statement about interpreting an increase in the upward slope of the term structure?

A)An increase in the upward slope of the term structure results only from expectations of lower future real interest rates.
B)An increase in the upward slope of the term structure results only from expectations of higher future real interest rates.
C)An increase in the upward slope of the term structure results only from expectations of higher inflation.
D)An increase in the upward slope of the term structure may result either from expectations of higher real interest rates or expectations of higher inflation.

Question 47

Under the efficient markets hypothesis, what will be the percentage change in the stock price of a company whose current dividend is $10.00 and whose dividends had been expected to grow by 3% but now are expected to grow by 4% per year?

A)4.0%
B)17.8%
C)25.0%
D)33.3%

Question 48

One implication of the efficient markets hypothesis is that investors should

A)concentrate their investments in just a few well-chosen assets.
B)hold a diversified portfolio of assets.
C)buy stocks rather than bonds.
D)buy bonds rather than stocks.

Question 49

Which of the following expressions gives the present value of future dividends for a company whose current dividend is $5.00 and whose future dividends are expected to grow at rate g?

A)[$5.00(1 - g)]/(i - g)
B)[$5.00(1 + g)]/(i + g)
C)[$5.00(1 - g)]/(i + g)
D)[$5.00(1 + g)]/(i - g)

Question 50

According to the efficient markets hypothesis, who is most likely to benefit from frequently moving funds from one asset to another?

A)your broker
B)small investors
C)big investors
D)only those who consistently beat the market

Question 51

Recent research indicates that

A)value investors may earn high returns over time by assuming greater risks.
B)program trading adds significantly to stock price volatility.
C)there's a consensus that stock prices always reflect their fundamental values.
D)informed traders can profit at the expense of noise traders.

Question 52

Under the efficient markets hypothesis, what will be the percentage change in the stock price of a company whose current dividend is $10.00 and whose dividends had been expected to grow by 3% per year but now are expected to grow by 1% per year?

A)-4.0%
B)-23.7%
C)-31.1%
D)-66.0%

Question 53

According to the efficient markets hypothesis,

A)common stock prices should be constant.
B)the price of a corporation's stock is likely to fluctuate substantially in response to news about changes in the company's short-term prospects.
C)the price of a corporation's stock will fluctuate substantially only in response to news about changes in the company's long-term prospects.
D)price fluctuations in common stock are a response to fads and are only infrequently the result of changes in the expected profitability of the companies involved.

Question 54

According to the efficient markets hypothesis, the difference between today's price for a share of stock and tomorrow's price is

A)equal to today's price plus any dividends to be received between today and tomorrow.
B)equal to tomorrow's price plus any dividends to be received tomorrow.
C)unforecastable.
D)zero.

Question 55

The efficient markets hypothesis explains the fact that the stock picks of some investment analysts earn returns greater than broad-based market indexes as resulting from

A)the superior insight of these analysts.
B)the ability of these analysts to exploit loopholes in the tax laws.
C)the inside information these analysts possess.
D)chance.

Question 56

An investor will generally find that hiring an investment firm to actively manage his or her portfolio will

A)result in a higher return than would be received from an index mutual fund.
B)be less expensive than simply placing money in an index mutual fund.
C)result in a higher return, but will be more expensive than placing money in an index mutual fund.
D)result in about the same return, but be more expensive than placing money in an index mutual fund.

Question 57

Under the efficient markets hypothesis, for news about a company's prospects to have a large impact on the price of the company's stock the news must

A)have an impact on the company's profitability in the short term.
B)have an impact on the company's profitability in the long term.
C)significantly increase the likelihood that the company will go bankrupt.
D)significantly affect the liquidity of the company's stock.

Question 58

Which of the following is a correct statement about interpreting an increase in risk premiums?

A)An increase in risk premiums results only from expectations of greater default risk.
B)An increase in risk premiums results only from expectations of lower liquidity.
C)An increase in risk premiums results only from expectations of higher information costs.
D)An increase in risk premiums can result from expectations of greater default risk, lower liquidity, or higher information costs.

Question 59

Which of the following is a correct statement about interpreting an increase in bond prices?

A)An increase in bond prices results from an increase in the expected inflation rate.
B)An increase in bond prices results from an increase in default risk.
C)An increase in bond prices results from an increase in liquidity.
D)An increase in bond prices results from a lower overall level of interest rates.

Question 60

Suppose Exxon-Mobil announces that its profits in the third quarter of 2006 were $35 billion. This will cause the price of Exxon-Mobil stock to

A)rise.
B)fall.
C)remain unchanged.
D)rise, fall, or remain unchanged depending on the expectations of market participants before the announcement.

Question 61

The "greater fool" theory assumes that

A)markets are efficient.
B)bubbles cannot exist in well-organized markets.
C)an investor is not a fool to buy an asset as long as there is a greater fool to buy it later for a higher price.
D)bond market returns are always above stock market returns.

Question 62

Results supporting mean reversion are strongest for

A)large-firm stocks during the post-World War II period.
B)small-firm stocks during the post-World War II period.
C)large-firm stocks during the pre-World War II period.
D)small-firm stocks during the pre-World War II period.

Question 63

The efficient markets hypothesis predicts that an investor

A)will not be able consistently to earn above-normal profits from buying or selling stocks.
B)will be able consistently to earn above-normal profits from buying or selling stocks so long as he or she makes use of rational expectations.
C)will be able consistently to earn above-normal profits from buying or selling stocks so long as he makes us of adaptive expectations.
D)will be able consistently to earn above-normal profits so long as stock prices in general are rising.

Question 64

Suppose that research shows that by buying stocks issued by companies whose names begin with the letter G investors can earn above-normal returns in even-numbered years. From the perspective of the efficient markets hypothesis,

A)this is further evidence that the hypothesis is correct.
B)this would be considered a pricing anomaly.
C)investors must have insider information on these companies.
D)purchasers of these stocks must have been noise traders.

Question 65

Significant skepticism has been expressed about which of the following being an efficient market?

A)The market for U.S. Treasury securities
B)The stock market
C)The market for financial futures
D)The commercial paper market

Question 66

What is considered the original bubble?

A)Gold in England in the twelfth century
B)Tulips in Holland in the seventeenth century
C)Stocks in the United States in the 1920s
D)Silver in the United States in the 1830s

Question 67

Noise traders

A)tend to lose money on stock trades, but help to stabilize the market.
B)tend to make higher returns than do "buy-and-hold" investors.
C)create additional risk in the market.
D)trade only when they have inside information.

Question 68

In the context of analyzing movements in stock prices, "fads" refer to

A)trading days on which bond prices and stock prices move in opposite directions.
B)gaps between futures prices and the prices of the underlying assets.
C)trades made as a result of computer programs.
D)overreaction to good or bad news.

Question 69

The economist known for his early empirical work supporting the efficient markets hypothesis is

A)Milton Friedman.
B)John Muth.
C)Eugene Fama.
D)Glenn Hubbard.

Question 70

The January effect

A)is sometimes argued to be tax motivated.
B)refers to the gap between futures prices and the prices of the underlying securities that occurs each January.
C)was stronger during the 1980s than during previous decades.
D)reflects the effects of the Christmas season on the stock of department store chains.

Question 71

The largest stock market crash during the 1980s and 1990s took place in

A)October 1981.
B)October 1987.
C)July 1994.
D)July 1995.

Question 72

In studying the gold price of greenbacks, researchers have shown that

A)the gold price of greenbacks rose when the Union forces did well.
B)the gold price of greenback fell when the Union forces did well.
C)events in the Civil War had little impact on the gold price of greenbacks.
D)currency markets during the Civil War were not efficient.

Question 73

A researcher shows that stock prices reflect all available information, including "insider information" known only to corporate managers. This indicates that the efficient markets hypothesis has passed the test of

A)weak-form efficiency.
B)semistrong-form efficiency.
C)strong-form efficiency.
D)noise-trading efficiency.

Question 74

A bubble occurs when

A)the price of a stock is above its fundamental value.
B)inside information is used to make profits from trading a company's stock.
C)a company reports profits that are significantly above or below the expectations of financial analysts.
D)the futures price is greater than the price of the underlying asset.

Question 75

In the context of the evaluation of the efficient markets hypothesis, pricing anomalies refer to

A)the existence of trading strategies that appear to have offered above-normal returns.
B)the gap between actual and expected prices.
C)the spread between the price at which a broker will purchase stock from an investor and the price at which the broker will sell stock to an investor.
D)the difficulty in practice of computing stock prices on the basis of expectations of future dividends.

Question 76

Suppose that Google announces that its profits for the third quarter of 2006 were $1.6 billion. As a result of this announcement the price of Google's stock declines. The best explanation of this is

A)market participants were expecting Google's profits to be greater than $1.6 billion for the third quarter.
B)market participants were expected Google's profits to be less than $1.6 billion for the third quarter.
C)the stock market is not an efficient market.
D)market participants have adaptive expectations.

Question 77

Noise traders

A)pursue trading strategies without superior information.
B)make use of inside information.
C)reduce the amount of risk in the market.
D)help to ensure that asset prices reflect the fundamental values of the securities being traded.

Question 78

Excessive volatility refers to

A)the unwillingness of financial analysts to consistently recommend the same stocks.
B)the greater volatility of futures prices compared to the volatility of prices of the underlying assets.
C)the tendency for stocks with high rates of returns also to have quite variable returns.
D)the larger movements in market prices of stock than in their fundamental values.

Question 79

The small-firm effect

A)shows that investments in the stocks of small firms would have earned a below-normal return during the period beginning in the mid-1920s.
B)may be the result of the low liquidity and high information costs of small-firm stock.
C)was stronger during the 1980s than in previous decades.
D)existed only during the 1970s and 1980s.

Question 80

Mean reversion refers to the tendency for

A)futures prices to revert to the prices of the underlying securities.
B)the long-run mean return on stocks to equal the long-run mean return on bonds.
C)stocks with high returns today to experience low returns in the future and for stocks with low returns today to experience high returns in the future.
D)financial analysts whose stock picks have earned above-normal returns in the past to be unable to pick stocks that will perform as well in the future.