Deck 8: The Efficient Market Hypothesis and Behavioral Finance

Question 1

DeBondt and Thaler (1985) found that the poorest performing shares in one time period experienced ________ performance in the following period and the best performing shares in one time period experienced ________ performance in the following time period.

A)good, good
B)good, poor
C)poor, good
D)poor, poor

Answer 1

B

Question 2

You are looking to invest in one of three shares. Share A has high expected earnings growth, Share B has only modest expected earnings growth and Share C is expected to generate poor earnings growth. Which share is likely to generate the greatest alpha for you?

A)Share A
B)Share B
C)Share C
D)You cannot tell from the information given

Answer 2

D

Question 3

The tendency when the ________ performing shares in one period are the best performers in the next and the current ________ performers are lagging the market later is called the reversal effect.

A)worst, best
B)worst, worst
C)best, worst
D)best, best

Answer 3

A

Question 4

The semi-strong form of the EMH states that ________ must be reflected in the current share price.

A)all security price and volume data
B)all publicly available information
C)all information including inside information
D)all costless information

Question 5

Most people would readily agree that the share market is not ________.

A)weak form efficient
B)semi-strong form efficient
C)strong form efficient
D)efficient at all

Question 6

Random price movements indicate ________.

A)irrational markets
B)that prices cannot equal fundamental values
C)that technical analysis to uncover trends can be quite useful
D)that markets are functioning efficiently

Question 7

You believe that you can earn 2% more on your portfolio if you engage in full time share research. However, the additional trading costs and tax liability from active management will cost you about 0.5%. You have a $800 000 share portfolio. What is the most you can afford to spend on your research?

A)$4 000
B)$8 000
C)$12 000
D)$16 000

Question 8

Share prices that are stable over time ________.

A)indicate that prices are useful indicators of true economic value
B)indicate that the market is not incorporating new information into current share prices
C)ensure that an economy allocates its resources efficiently
D)indicates that returns follow a random walk process

Question 9

Even if the markets are efficient, professional portfolio management is still important because it provides investors with ________.
I) low cost diversification
II) a portfolio with a specified risk level
III) better risk-adjusted returns than an index

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

Question 10

The primary objective of fundamental analysis is to identify ________.

A)well run firms
B)poorly run firms
C)mis-priced shares
D)high P/E shares

Question 11

The weak form of the EMH states that ________ must be reflected in the current share price.

A)all past information including security price and volume data
B)all publicly available information
C)all information including inside information
D)all costless information

Question 12

According to recent research securities markets fully adjust to earnings announcements ________.

A)instantly
B)in 1 day
C)in 1 week
D)gradually over time

Question 13

You are an investment manager who is currently managing assets worth $6 billion. You believe that active management of your fund could generate an additional one-tenth of 1% return on the portfolio. If you want to make sure your active strategy adds value, how much can you spend on security analysis?

A)$12 000 000
B)$6 000 000
C)$3 000 000
D)$0

Question 14

Which of the following beliefs would not preclude charting as a method of portfolio management?

A)The market is strong form efficient.
B)The market is semi-strong form efficient.
C)The market is weak form efficient.
D)Share prices follow recurring patterns.

Question 15

Evidence suggests that there may be ________ momentum and ________ reversal patterns in share price behaviour.

A)short-run, short-run
B)long-run, long-run
C)long-run, short-run
D)short-run, long run

Question 16

Joe bought a share at $57 per share. The price promptly fell to $55. Joe held on to the share until it again reached $57 and then he sold once he had eliminated his loss. If other investors do the same to establish a trading pattern this would contradict ________.

A)the strong-form EMH
B)the weak-form EMH
C)technical analysis
D)the semi-strong-form EMH

Question 17

A mutual fund which attempts to hold quantities of shares in proportion to their representation in the market is called a ________ fund.

A)share
B)index
C)hedge
D)money market

Question 18

Fama and French have suggested that many market anomalies can be explained as manifestations of ________.

A)regulatory effects
B)high trading costs
C)information asymmetry
D)varying risk premiums

Question 19

________ is the return on a share beyond what would be predicted from market movements alone.

A)A normal return
B)A subliminal return
C)An abnormal return
D)An excess return

Question 20

Fundamental analysis is likely to yield best results for ________.

A)NYSE shares
B)neglected shares
C)shares that are frequently in the news
D)fast growing companies

Question 21

Which of the following is not a concept related to explaining abnormal excess share returns?

A)January effect
B)Neglected firm effect
C)P/E effect
D)Preferred share effect

Question 22

Important characteristic(s) of market efficiency is that ________.
I) there are no arbitrage opportunities
II) security prices react quickly to new information
III) active trading strategies will not consistently outperform passive strategies

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

Question 23

A technical analyst is most likely to be affiliated with which investment philosophy?

A)Active management
B)Buy and hold
C)Passive investment
D)Index funds

Question 24

Growth shares usually exhibit ________ price-to-book ratios and ________ price-to-earnings ratios.

A)low, low
B)low, high
C)high, low
D)high, high

Question 25

Studies show that the bid-ask spread for the least liquid shares may be as high as ________.

A)3%
B)5%
C)9%
D)12%

Question 26

A market anomaly refers to ________.

A)an exogenous shock to the market that is sharp but not persistent
B)a price or volume event that is inconsistent with historical price or volume trends
C)a trading or pricing structure that interferes with efficient buying and selling of securities
D)price behaviour that differs from the behaviour predicted by the efficient market hypothesis

Question 27

In an efficient market and for an investor that believes in a passive approach to investing, what is the primary duty of a portfolio manager?

A)Accounting for results
B)Diversification
C)Identifying undervalued shares
D)No need for a portfolio manager

Question 28

If the daily returns on the share market are normally distributed with a mean of 0.05% and a standard deviation of 1.00%, the probability that the share market would have a return of -23.00% or worse on one particular day (as it did on Black Monday) is approximately ________.

A)0.0%
B)0.1%
C)1.0%
D)10.0%

Question 29

Which of the following would violate the efficient market hypothesis?

A)Intel has consistently generated large profits for years.
B)Prices for shares before share splits show on average consistently positive abnormal returns.
C)Earning abnormal returns after a firm announces surprise earnings.
D)High earnings growth shares fail to generate higher returns for investors than low earnings growth shares.

Question 30

Value shares may provide investors with better returns than growth shares if ________.
I) value shares are out of favor with investors
II) prices of growth shares include premiums for overly optimistic growth levels
III) value shares are likely to generate positive earnings surprises.

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

Question 31

The tendency of poorly performing shares and well performing shares in one period to continue their performance into the next period is called the ________.

A)fad effect
B)martingale effect
C)momentum effect
D)reversal effect

Question 32

Testing many different trading rules until you find one that would have worked in the past is called ________.

A)data mining
B)perceived patterning
C)pattern searching
D)behavioural analysis

Question 33

The ________ effect may explain much of the small firm anomaly.
I) January effect
II) neglected effect
III) liquidity effect

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

Question 34

Someone who invests in the Vanguard Index 500 mutual fund could most accurately be described as using what approach?

A)Active management
B)Arbitrage
C)Fundamental analysis
D)Passive investment

Question 35

According to the semi-strong form of the efficient markets hypothesis ________.

A)share prices do not rapidly adjust to new information
B)future changes in share prices cannot be predicted from any information that is publicly available
C)corporate insiders should have no better investment performance than other investors even if allowed to trade freely
D)arbitrage between futures and cash markets should not produce extraordinary profits

Question 36

The broadest information set is included in the

A)weak form efficiency argument
B)semi-strong form efficiency argument
C)strong form efficiency argument
D)technical analysis trading method

Question 37

According to Markowitz and other proponents of modern portfolio theory which of the following activities would not be expected to produce any benefits?

A)Diversification
B)Investing in Treasury bonds
C)Investing in shares of utility companies
D)Engaging in active portfolio management to enhance returns

Question 38

The semi-strong form of the efficient market hypothesis implies that ________ generate abnormal returns and ________ generate abnormal returns.

A)technical analysis cannot; fundamental analysis can
B)technical analysis can; fundamental analysis can
C)technical analysis can; fundamental analysis cannot
D)technical analysis cannot; fundamental analysis cannot

Question 39

Which of the following is not a topic related to the debate over market efficiency?

A)IPO results
B)Lucky event issue
C)Magnitude issue
D)Selection bias

Question 40

Which of the following statements is/are correct?

A)If a market is weak form efficient it is also semi- and strong form efficient
B)If a market is semi-strong efficient it is also strong form efficient
C)If a market is strong form efficient it is also semi-strong but not weak form efficient
D)If a market is strong form efficient it is also semi- and weak form efficient

Question 41

Technical analysis focuses on ________.

A)finding opportunities for risk-free investing
B)finding repeating trends and patterns in prices
C)changing prospects for earnings growth of particular firms or industries
D)forecasting technical regulatory changes

Question 42

If you believed in the reversal effect, you should ________.

A)buy bonds this period if you held shares last period
B)buy shares this period that performed poorly last period
C)buy shares this period that performed well last period
D)do nothing if you held the share last period

Question 43

Which one of the following best describes fundamental risk?

A)A share is overpriced but your fund does not allow you to engage in short sales.
B)Your models indicate a share is mispriced but you are not sure if this is a real profit opportunity or a model input error.
C)You buy a share that you believe is underpriced and the underpricing persists for a long time, hurting your short term results.
D)A share is trading in two different markets at two different prices.

Question 44

The tendency of investors to hold on to losing investments is called the ________.

A)overweighting effect
B)head-in-the-sand effect
C)disposition effect
D)prospector effect

Question 45

An investor holds a very conservative portfolio invested for retirement but she takes some extra cash she earned from her year-end bonus and buys gold futures. She appears to be engaging in ________.

A)overconfidence
B)representativeness
C)forecast errors
D)mental accounting

Question 46

If investors overweight recent performance in forecasting the future they are exhibiting ________.

A)representativeness bias
B)framing error
C)memory bias
D)overconfidence

Question 47

The only way for behavioural patterns to persist in prices is if ________.

A)markets are not weak form efficient
B)there are limits to arbitrage activity
C)there are no significant trading costs
D)market psychology is inconsistent over time

Question 48

Conventional finance theory assumes investors are ________ and behavioural finance assumes investors are ________.

A)rational; irrational
B)irrational; rational
C)greedy; philanthropic
D)philanthropic; greedy

Question 49

According to technical analysts, a shift in market fundamentals will ________.

A)be reflected in share prices immediately
B)lead to a gradual price change that can be recognised as a trend
C)lead to high volatility in share market prices
D)leave prices unchanged

Question 50

Behaviouralists point out that even if market prices are ________ there may be ________.

A)distorted; limited arbitrage opportunities
B)distorted; fundamental efficiency
C)allocationally efficient; limitless arbitrage opportunities
D)distorted; allocational efficiency

Question 51

An investor needs cash to pay some bills. He is willing to use his dividend income to pay the bills but he will not sell any shares to do so. He is engaging in ________.

A)overconfidence
B)representativeness
C)forecast errors
D)mental accounting

Question 52

If investors are too slow to update their beliefs about a share's future performance when new evidence arises they are exhibiting ________.

A)representativeness bias
B)framing error
C)conservatism
D)memory bias

Question 53

Your two best friends each tell you about a person they know who successfully started a small business. That's it, you decide, if they can do it so can you. This is an example of ________.

A)mental accounting
B)framing bias
C)conservatism
D)representativeness bias

Question 54

Problems with behavioural finance include:
I) the behaviouralists tell us nothing about how to exploit any irrationality
II) the implications of behavioural patterns are inconsistent from case to case, sometimes suggesting overreaction, sometimes underreaction
III) like technical trading rules, behaviouralists can always find some pattern in past data that supports a behaviouralist trait

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

Question 55

An investor has her money segregated into checking, savings and investments. The allocation between each category is subjective, yet the investor spends freely from the checking account and not the others. This behaviour can be explained as ________.

A)loss aversion
B)mental accounting
C)overreaction
D)winner's curse

Question 56

Investors gravitate towards the latest hot share even though it has never paid a dividend. Even though net income is projected to fall over the current and next several years, the price of the share continues to rise. What behavioural concept may explain this price pattern?

A)Overconfidence
B)Loss aversion
C)Mental accounting
D)Calendar bias

Question 57

Models of financial markets that emphasize psychological factors affecting investor behaviour are called ________.

A)data mining
B)fundamental analysis
C)charting
D)behavioural finance

Question 58

On day 1, the share price of Ford was $81 and the automotive share index was 324. On day 2, the share price of Ford was $85 and the automotive share index was 335. Consider the ratio of Ford to the automotive share index at day 1 and day 2. Ford is ________ the automotive industry and technical analysts who follow relative strength would advise ________ the share.

A)outperforming, buying
B)outperforming, selling
C)underperforming, buying
D)underperforming, selling

Question 59

Which one of the following focuses more on past price movements of a firm's share than on the underlying determinants of its future profitability?

A)Credit analysts
B)Fundamental analysts
C)Systems analysts
D)Technical analysts

Question 60

A possible limit on arbitrage activity that may allow behavioural biases to persist is ________.

A)technical trends in prices
B)momentum effects
C)fundamental risk
D)trend reversals