Question 1

The small-firm effect

Accepted Answer

The small-firm effect is thought to be the result of the low liquidity and high information costs of small-firm stock, which makes trading in these stocks more difficult and increases the risk premium investors demand for holding them.

Question 2

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

Accepted Answer

Studies have consistently shown that index funds tend to outperform actively managed funds after expenses due to their lower fees and turnover rates. While some actively managed funds may provide higher returns in certain years, their higher fees and trading costs can eat away at those returns over the long term. As for taxes, index funds are generally more tax-efficient due to their lower turnover and fewer capital gains distributions, which can further increase their advantage over actively managed funds.

Question 3

Suppose Exxon-Mobil announces that its profits in the third quarter of 2011 were $40 billion.This will cause the price of Exxon-Mobil stock to

Accepted Answer

The stock price reaction depends on whether the announced profits meet, exceed, or fall short of market expectations. If the profits are higher than expected, the stock price may rise; if lower, it may fall; if in line with expectations, it may remain unchanged.

Question 4

The January effect

Accepted Answer

The January effect largely disappeared after receiving attention in the 1980s, as investors began to anticipate and take advantage of the perceived market anomaly.

Question 5

Mean reversion refers to the tendency for

Accepted Answer

Mean reversion refers to the tendency for 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. This phenomenon is observed in the stock market and is often used as a strategy by investors.

Question 6

Suppose Apple announces that its earnings for the fourth quarter of 2011 rose to $2 billion.As a result of this announcement the price of Apple's stock does not change.The best explanation of this is

Accepted Answer

The stock price did not change because the earnings announcement matched the market participants' expectations.

Question 7

The efficient markets hypothesis predicts that an investor

Accepted Answer

The efficient markets hypothesis predicts that all available information will be reflected in the stock prices, making it impossible for investors to consistently earn above-normal profits from buying or selling stocks. This means that even if an investor has access to rational or adaptive expectations, it will not guarantee their ability to consistently earn above-normal profits. Therefore, choice A is the correct answer.

Question 8

What should affect the fundamental value of a stock according to the efficient markets hypothesis?

Accepted Answer

The answer of What should affect the fundamental value of...

Question 9

The efficient markets hypothesis implies that stock investments should have the same expected return after adjusting for

Accepted Answer

The efficient markets hypothesis (EMH) posits that all available information is already reflected in stock prices, implying that stocks always trade at their fair value. Therefore, after adjusting for differences in risk, information costs, and liquidity, all stocks should offer the same expected return. This is because the EMH suggests that no investor can consistently achieve higher returns without assuming additional risk, incurring higher information costs, or facing liquidity constraints.

Question 10

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,

Accepted Answer

According to the efficient markets hypothesis, it is not possible for investors to consistently earn above-normal returns based on historical data or patterns, such as buying stocks only from companies whose names begin with the letter G in even-numbered years. Therefore, this would be considered a pricing anomaly, or a deviation from the efficient markets hypothesis.

Question 11

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

Accepted Answer

Pricing anomalies refer to the existence of trading strategies that appear to have offered above-normal returns, which contradicts the efficient markets hypothesis. If markets were truly efficient, no such strategies should exist, as all available information would already be reflected in stock prices.

Question 12

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

Accepted Answer

Eugene Fama is the economist known for his early empirical work supporting the efficient markets hypothesis.

Question 13

Suppose that Google announces that its profits for the third quarter of 2011 were $1.6 billion.As a result of this announcement the price of Google's stock declines.The best explanation of this is

Accepted Answer

The decline in the stock price indicates that market participants were expecting Google's profits to be higher than $1.6 billion for the third quarter. This suggests that the market had higher expectations for the company's performance, and the announcement of lower profits led to a decline in the stock price.

Question 14

How can the Gordon Growth model help explain the major decline in stock indexes during 2007-2009?

Accepted Answer

The Gordon Growth model states that the price of a stock is equal to the expected dividend payment divided by the difference between the required return on equities and the expected growth rate of dividends. During 2007-2009, there was an increase in the required return on equities due to the global financial crisis, and a decrease in the expected growth rate of dividends due to the economic recession. Therefore, the Gordon Growth model would suggest that there was a decrease in stock prices, which is consistent with the major decline in stock indexes during that time period. Choice A is the best answer as it accurately reflects the increase in required return and decrease in expected growth rate.

Question 15

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

Accepted Answer

The efficient market hypothesis suggests that news or information is quickly reflected in market prices. Therefore, any tips published in leading commercial or financial publications are likely already priced in, making it difficult to profit from them. The other answers are irrelevant or untrue.

Question 16

Excess volatility refers to

Accepted Answer

Excess volatility refers to the situation where market prices of stocks move more than their fundamental values. This means that the fluctuations in the stock prices are not justified by changes in the underlying assets or earnings of the firm. This can be caused by various factors such as market sentiment, speculation, or irrational behavior by investors.

Question 17

What is the difference between adaptive expectations and rational expectations?

Accepted Answer

The answer of What is the difference between adaptive expectations...

Question 18

Momentum investing can be described as

Accepted Answer

Momentum investing refers to the practice of investing in stocks or other assets that have had high returns over the recent past, and selling those that have had poor returns. This is based on the idea that trends tend to continue in the short term, and the idea that investors may be slow to react to information, leading to momentum in prices. The saying "the trend is your friend" is often associated with this strategy. It is not consistent with the efficient markets hypothesis, which would suggest that all available information is already reflected in prices, but it is also not similar to mean reversion, which involves buying assets that have had low recent returns in the hope that they will revert to the mean. Following the picks of successful investors is more akin to a "copycat" strategy than a true momentum strategy.

Question 19

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

Accepted Answer

According to the efficient markets hypothesis, the future price of a share of stock cannot be predicted or forecasted based on currently available information. Therefore, the difference between today's price and tomorrow's price is unforecastable.

Question 20

According to the efficient markets hypothesis,who should earn the highest risk-adjusted return on stocks?

Accepted Answer

The answer of According to the efficient markets hypothesis,who should...

Quiz 6: The Stock Market, information, and Financial Market Efficiency