Question 1

If the markets are efficient, which of the following investors should have above normal return on assets over time?
A) Those who choose their stocks by throwing darts at a list of stocks found in the financial pages of a newspaper.
B) Analysts who spend considerable time evaluating the best stocks to buy.
C) Mutual fund managers who manage other people's money for a living.
D) None of the above

Accepted Answer

If the markets are efficient, it means that all available information and factors affecting the price of assets are reflected in the market price, and it is impossible to consistently outperform the market without insider information or luck. Therefore, all investors should have an average return on assets over time, and no one should have an above-normal return consistently.

Question 2

Analysis of past monthly movements in IBM's stock price produces the following estimates: α = 2. 5% and β = 1. 6. If the market index subsequently rises by 12% in one month and IBM's stock price increases by 20%, what is the abnormal change in IBM's stock price?
A) +1.7%
B) +8%
C) -1.7%
D) None of the above

Accepted Answer

The answer of Analysis of past monthly movements in IBM's...

Question 3

Studies on behavioral finance have been developed using:
A) market evidence
B) economic evidence
C) psychological evidence
D) none of the above

Accepted Answer

Behavioral finance studies have been developed using psychological evidence, as it seeks to understand how human behavior and emotions impact financial decisions and markets. It differs from traditional finance theories which assume rationality and efficiency in markets. Market and economic evidence may be used as part of the analysis, but the focus of behavioral finance is on the psychological factors at play.

Question 4

The "event study" methodology is used in the test of:
A) weak form efficiency
B) semi-strong form efficiency
C) strong form efficiency
D) none of the above

Accepted Answer

The "event study" methodology is used to test semi-strong form efficiency of the market. It examines the impact of an event, such as a corporate announcement or economic report, on the stock prices of the relevant companies. The fact that the market reacts to such events suggests that semi-strong form efficiency is not fully realized.

Question 5

The semi-strong form of efficiency deals with the following type of information:
A) insider information
B) publicly available information
C) privileged information
D) all of the above

Accepted Answer

The semi-strong form of efficiency deals with publicly available information, which means all investors have equal access to the same information. This includes information from financial statements, news releases, and market data. Insider information and privileged information are not included in the semi-strong form of efficiency as they are not available to all investors.

Question 6

If the abnormal return for a stock during the first week is +5% and during the second week is +3%, what is the abnormal return for the two-week period?
A) 5%
B) 3%
C) 8.15%
D) None of the above

Accepted Answer

To find the abnormal return for the entire two-week period, we need to calculate the cumulative abnormal return (CAR). CAR is calculated by adding the abnormal returns of each week. In this case, CAR = 5% + 3% = 8%. However, we need to convert this to a percentage relative to the starting price. To do this, we use the formula (1 + CAR/100) * (1 + CAR/100) - 1. Plugging in the numbers, we get (1 + 8/100) * (1 + 8/100) - 1 = 0.0815, which is 8.15%. Therefore, the abnormal return for the two-week period is 8.15%.

Question 7

One important implication of the efficient markets hypothesis is that:
A) investors should hold a diversified portfolio and avoid active trading.
B) investors can benefit by engaging in day trading.
C) investors should trade actively help to ensure the highest overall gain in their portfolios.
D) all of the above.

Accepted Answer

The efficient markets hypothesis suggests that it is difficult to consistently beat the market, as all available information is already reflected in stock prices. Therefore, investors should focus on holding a diversified portfolio and avoiding active trading, as this will help to minimize risk and maximize long-term returns. Day trading and active trading may actually harm an investor's overall performance, as they can lead to unnecessary trading costs and emotional decisions.

Question 8

Adjusted stock return is calculated as:
A) actual stock return-expected stock return
B) return on stock-return on market
C) return on stock for the current period-return on stock for the previous period
D) none of the above

Accepted Answer

The answer of Adjusted stock return is calculated as:
A) actual...

Question 9

In order to test the strong form of market efficiency, researchers have:
I. examined the recommendations of professional security analysts
II. performance of mutual funds
III. performance of pension funds
A) I only
B) I and II only
C) I, II, and III only
D) II and III only

Accepted Answer

Testing the strong form of market efficiency involves examining whether any group, including professional analysts, mutual funds, and pension funds, can consistently achieve returns above the market average, implying all information (public and private) is reflected in stock prices.

Question 10

The semi-strong form of has been tested by measuring how rapidly security prices react various news items like:
I. earnings announcements II) dividend announcements
III. news of takeovers
IV. macroeconomic information
A) I and II only
B) I, II and III only
C) IV only
D) I, II, III and IV

Accepted Answer

The semi-strong form of the efficient market hypothesis states that all publicly available information, including both historical and current information, is immediately reflected in stock prices. Therefore, to test this form, various news items such as earnings announcements, dividend announcements, news of takeovers, and macroeconomic information need to be tested. Therefore, option D is the correct answer, as it includes all of the given news items.

Question 11

In order to test the efficient-market hypothesis in the weak form, researchers have used the following methods except:
A) Estimation of the serial correlation (autocorrelation) for securities and markets
B) Measurement of the profitability of trading rules used by technical analysts
C) Measurement of how rapidly security prices adjust to different news items
D) All of the above are methods used for testing weak-form market efficiency

Accepted Answer

The weak form of the efficient-market hypothesis focuses on past price and volume data, so testing it involves methods like serial correlation and profitability of trading rules, not how prices adjust to news, which relates to semi-strong form efficiency.

Question 12

The annual expected dividend on the S&P index was about 154.6. If the dividend is expected to grow at a steady rate of 8% a year and the required annual rate of return is 10%, what is the value of the index?
A) 1193
B) 1700
C) 7730
D) None of the above

Accepted Answer

Using the Gordon Growth Model:
V = D/(r-g)
where V is the value of the index, D is the annual dividend, r is the required annual rate of return, and g is the expected annual growth rate of the dividend.
Thus, V = 154.6/(0.10-0.08) = 7730.

Question 13

Analysis of past monthly movements in Wal-Mart's stock price has produced the following estimates: α = -0.45% and β = 0. 5. If the market index subsequently rises by 5% one month and Wal-Mart's stock price rises by 3%, what is the abnormal change in Wal- Mart's stock price?
A) -0.95%
B) +0.95%
C) +0.05%
D) None of the above

Accepted Answer

Using the CAPM equation: 
Expected return on Wal-Mart's stock = risk-free rate + beta*(expected market return - risk-free rate) + alpha
Given alpha = -0.45% and beta = 0.5
Expected return on Wal-Mart's stock = risk-free rate + 0.5*(5%) - 0.45%
Solving for expected return on Wal-Mart's stock, we get:
Expected return on Wal-Mart's stock = 2.55%
Abnormal change in Wal-Mart's stock price = actual change in Wal-Mart's stock price - expected change in Wal-Mart's stock price
Actual change in Wal-Mart's stock price = 3%
Expected change in Wal-Mart's stock price = 2.55%
Abnormal change in Wal-Mart's stock price = 3% - 2.55% = 0.45%
Therefore, the abnormal change in Wal-Mart's stock price is +0.45%, which is closest to option B) +0.95%.

Question 14

Strong-form efficiency implies that mutual fund managers:
A) Buy the index that maximizes diversification and minimizes cost of managing portfolios
B) Actively seek under performing stocks and buy them
C) Fund mangers can consistently earn superior returns year after year
D) None of the above

Accepted Answer

Strong-form efficiency implies that all available information is reflected in the prices of securities, so mutual fund managers cannot consistently earn superior returns year after year by actively seeking under performing stocks and buying them.

Question 15

The following are anomalies associated with market efficiency except:
I. the small-firm effect
II. the earnings announcement puzzle
III. the new-issue puzzle
IV. trading rules based on patterns
A) I only
B) I and II only
C) I, II, and III only
D) IV only

Accepted Answer

Anomalies associated with market efficiency refer to situations where market efficiency is violated or appears to be violated. Anomalies include findings such as the small-firm effect, the earnings announcement puzzle, and the new-issue puzzle. However, trading rules based on patterns go against the idea of market efficiency as they suggest that prices can be predicted based on past patterns and trends, which is not consistent with the efficient market hypothesis. Therefore, IV is not an anomaly associated with market efficiency, but rather a violation of it.

Question 16

In order to test the efficient-market hypothesis in the semi-strong form, researchers have used (the):
A) Estimation of the serial correlation (autocorrelation) for securities and markets
B) Measurement of the performance of mutual fund managers over the years
C) Measurement of how rapidly security prices adjust to different news items
D) All of the above

Accepted Answer

The semi-strong form of the efficient-market hypothesis suggests that security prices adjust rapidly to publicly available new information. Therefore, testing this form involves measuring how quickly prices respond to news.

Question 17

The various lessons of market efficiency are:
I. Markets have no memory
II. Trust market prices
III. Read the entrails
IV. There are no financial illusions V) The do-it yourself alternative
VI. Seen one stock, seen them all
A) I and II only
B) I, II, III and IV only
C) I, II, III, IV and V only
D) I, II, III, IV, V and VI

Accepted Answer

The answer of The various lessons of market efficiency are:
I....

Question 18

Which of the following observations would provide evidence against the strong form of efficient market theory?
I. Mutual fund managers do not on average make superior returns
II. In any year approximately 50% of all pension funds outperform the market
III. Managers who trade in their own firm's stocks make superior returns
A) I only
B) II only
C) III only
D) I and II only

Accepted Answer

The strong form of efficient market theory states that all information, including insider information, is immediately reflected in stock prices, making it impossible to consistently earn superior returns by trading on such information. However, observation III suggests that managers who trade in their own firm's stocks are able to make superior returns, contradicting the theory. Observations I and II are not evidence against the strong form of efficient market theory, as mutual fund managers and pension funds are not insider traders and are subject to informational disadvantages that could prevent them from consistently outperforming the market.

Question 19

A lawyer works for a firm that advises corporate firms planning to sue other corporations for antitrust damages. He finds that he can "beat the market" by short selling the stock of the firm that will be sued. This finding is in violation of the:
A) Weak form market efficiency
B) Semi-strong form market efficiency
C) Strong form market efficiency
D) None of the above

Accepted Answer

Strong form market efficiency states that all information, both public and private, is reflected in stock prices. The lawyer's ability to profit from insider information (the knowledge of an impending lawsuit) indicates a violation of strong form market efficiency.

Question 20

Abnormal stock return is calculated as:
A) actual stock return-expected stock return
B) return on stock-return on market
C) return on stock for the current period-return on stock for the previous period
D) none of the above

Accepted Answer

Abnormal stock return is the difference between the actual stock return and the expected stock return, which is based on the performance of the overall market and the company's industry. Therefore, option A is the correct choice. Options B and C do not accurately define abnormal stock return. Option D is incorrect as well, as one of the other options is correct.

Quiz 13: Efficient Markets and Behavioral Finance

If the markets are efficient, which of the following investors should have above normal return on assets over time?

Analysis of past monthly movements in IBM's stock price produces the following estimates: α = 2. 5% and β = 1. 6. If the market index subsequently rises by 12% in one month and IBM's stock price increases by 20%, what is the abnormal change in IBM's stock price?

Studies on behavioral finance have been developed using:

The "event study" methodology is used in the test of:

The semi-strong form of efficiency deals with the following type of information:

If the abnormal return for a stock during the first week is +5% and during the second week is +3%, what is the abnormal return for the two-week period?

One important implication of the efficient markets hypothesis is that:

Adjusted stock return is calculated as:

In order to test the strong form of market efficiency, researchers have: I. examined the recommendations of professional security analysts II. performance of mutual funds III. performance of pension funds

The semi-strong form of has been tested by measuring how rapidly security prices react various news items like: I. earnings announcements II) dividend announcements III. news of takeovers IV. macroeconomic information

In order to test the efficient-market hypothesis in the weak form, researchers have used the following methods except:

The annual expected dividend on the S&P index was about 154.6. If the dividend is expected to grow at a steady rate of 8% a year and the required annual rate of return is 10%, what is the value of the index?

Analysis of past monthly movements in Wal-Mart's stock price has produced the following estimates: α = -0.45% and β = 0. 5. If the market index subsequently rises by 5% one month and Wal-Mart's stock price rises by 3%, what is the abnormal change in Wal- Mart's stock price?

Strong-form efficiency implies that mutual fund managers:

The following are anomalies associated with market efficiency except: I. the small-firm effect II. the earnings announcement puzzle III. the new-issue puzzle IV. trading rules based on patterns

In order to test the efficient-market hypothesis in the semi-strong form, researchers have used (the) :

The various lessons of market efficiency are: I. Markets have no memory II. Trust market prices III. Read the entrails IV. There are no financial illusions V) The do-it yourself alternative VI. Seen one stock, seen them all

A lawyer works for a firm that advises corporate firms planning to sue other corporations for antitrust damages. He finds that he can "beat the market" by short selling the stock of the firm that will be sued. This finding is in violation of the:

Abnormal stock return is calculated as: