Deck 9: Market Efficiency, Behavioral Finance, and Technical Analysis

Question 1

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.

Answer 1

A

Question 2

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.

Answer 2

B

Question 3

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.

Answer 3

B

Question 4

The market reaction to quarterly earnings announcements tends to support the strong form of the efficient market hypothesis.

Question 5

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) the price movements of stocks follow a "flag" formation such that charting prices can help an investor better time his or her security purchases.
D) support levels and resistance lines, when combined with basic chart formations, yield both buy and sell signals.

Question 6

Which one of the following best describes the term "efficient market"?

A) The commissions on large transactions are smaller than the commissions on small transactions.
B) New information is quickly reflected in security prices.
C) Little time and effort are spent on marketing securities to the public.
D) The cost of receiving, processing, executing, and reporting securities orders is small.

Question 7

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 8

Available evidence does not support the strong form of the efficient market hypothesis.

Question 9

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 10

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)Accounting information accurately portray a company's economic situation.
IV)Events which affect the market occur randomly.

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

Question 11

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

Question 12

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 13

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

Question 14

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

Question 15

Advocates of the weak-form efficient market hypothesis claim that past price movements are the best predictors of future price movements.

Question 16

In an efficient market, fundamental analysis still provides value to an investor.

Question 17

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

Question 18

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) supports the notion that random price movements are indicative of inefficient markets.

Question 19

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

Question 20

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 21

Which of the following accurately reflect appropriate investment guidelines?
I)always invest in last year's 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 22

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

Question 23

Some behavioral characteristics cause investors to realize lower investment returns.

Question 24

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

Question 25

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

Question 26

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

Question 27

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 28

Investor overconfidence leads to

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

Question 29

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 30

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 31

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 32

The tendency to hold onto losing stocks in the hope that they will recoup is called

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

Question 33

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) biased self-attribution.

Question 34

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 35

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 36

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 37

Analysts tend to issue similar recommendations on individual securities.

Question 38

Investors who obsessively monitor their last few stock purchases while paying little attention to the rest of their portfolio are exhibiting the tendency known as

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

Question 39

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

Question 40

Based on the semi-strong form of the efficient market theory, an investor reacting immediately to a news flash on the television generally

A) can make an abnormal profit.
B) is guaranteed to make a reasonable profit.
C) is too late to make an exceptional profit.
D) will suffer a loss.

Question 41

Resources for technical analysis are readily available on the internet.

Question 42

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 43

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

Question 44

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

Question 45

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 46

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 47

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

Question 48

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 49

Evidence suggests that growth stocks tend to outperform value stocks.

Question 50

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

Question 51

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 52

Which of the following are included in technical analysis?
I)charting price movements
II)tracking trading volume
III)determining the investor's risk tolerance
IV)monitoring odd-lot trading

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

Question 53

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

Question 54

Technical analysis primarily monitors shifts in the ________ in the market.

A) level of risk
B) supply and demand forces
C) volume of trading
D) rate of return

Question 55

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

Question 56

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 57

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 58

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

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

Question 59

Investors should never combine fundamental analysis and technical analysis.

Question 60

Market bubbles such as the technology bubble of the 1990's 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 61

Technical analysis is used for which of the following purposes?
I)Deciding when to enter the market.
II)Deciding whether to sell a stock.
III)Deciding which stocks to buy.
IV)Deciding whether basic economic conditions are favorable for investing.

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

Question 62

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

Question 63

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

Question 64

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

Question 65

You are most likely better off doing the opposite of what most investment newsletter experts advise doing.

Question 66

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

Question 67

Charts are only used to confirm past trends.

Question 68

The confidence index indicates a strong stock market when the

A) ratio of the average yield on high-grade corporate bonds to the average yield on low-grade corporate bonds rises.
B) ratio between the average yield on S&P 500 stocks to the average yield on high-grade corporate bonds rises.
C) consumer confidence index rises above its long-term trend.
D) demand for bonds declines relative to the demand for equity securities.

Question 69

Charts are useful as a means of spotting developing trends.

Question 70

The Dow theory holds that a change in the primary trend has occurred when a rise or fall in the Dow Jones Industrial Averages is confirmed by a similar movement in

A) the S&P 500 Index.
B) the Dow Jones Transportation Average.
C) the market volatility index (VIX).
D) the NASDAQ 100 Index.

Question 71

Which of the following are classified as trading action approaches to market analysis?
I)Super Bowl effect
II)Primary trend with confirmation effect
III)January effect
IV)White House re-election effect

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

Question 72

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

Question 73

The Dow Theory is used to predict when the markets will change direction based on the long-term trends in the market.

Question 74

The Dow Theory

A) concentrates on the secondary trends in both the industrial and the transportation averages.
B) is used to predict long-term trends in the market based on confirming actions by the transportation average.
C) contends that the long-term trend of the market remains constant until the industrial average confirms a shift in direction as first seen in the transportation average.
D) states that the market's performance can be described by long-term price trends.

Question 75

Which of the following are used as indicators of a strong market in the future?
I)The advance-decline spread is increasing at a time when the advances outnumber the declines.
II)The level of short interest is relatively high.
III)The net difference of odd-lot purchases minus odd-lot sales begins increasing.
IV)The trading volume increases in a declining market.

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

Question 76

The odd-lot trading theory advocates that small investors

A) tend to buy high and sell low.
B) react in a manner which generally forecasts the future direction of the market.
C) are the first to react to market changes.
D) tend to be the first to speculate on a bull market.

Question 77

The principal objective of technical analysis is

A) determining the best time to get into the market.
B) maintaining the lowest level of risk possible.
C) avoiding all unpleasant surprises in the market.
D) increasing trading to improve overall profits.

Question 78

Technical analysis is a mechanical approach to investing.

Question 79

Investors who live in cities with NFL teams should be especially happy when their team wins the Super Bowl.

Question 80

An oversold market is generally considered to be overvalued.