Question 1

Why do the arithmetic average return and the geometric return differ?

Accepted Answer

The answer of Why do the arithmetic average return and...

Question 2

If an investor holds a stock for three years, the value at the end of three years will always be the initial cost of the stock times (1 + arithmetic average return) to the third power.

Accepted Answer

This statement is not true. The value of a stock after three years can vary depending on market conditions and other factors, and cannot be determined solely by the initial cost of the stock and arithmetic average return.

Question 3

Which of the following is consistent with the semi-strong form efficient market hypothesis?
A) so-called value stocks outperform growth stocks.
B) stocks that have performed well over the past year continue to perform well for several more months.
C) a company announces higher than expected sales and earnings. The stock price immediately increases by 10%.
D) a company announces higher than expected sales and earnings. The stock price remains unchanged.

Accepted Answer

The semi-strong form of the efficient market hypothesis posits that all publicly available information is already reflected in stock prices. Therefore, when a company announces higher than expected sales and earnings (new public information), the immediate adjustment of the stock price (in this case, an increase by 10%) is consistent with the semi-strong form. This suggests that the market quickly incorporates new public information into stock prices.

Question 4

An investor who wishes to hold a stock for five years will be most interested in the geometric average rather than in the arithmetic average return.

Accepted Answer

The geometric average return is better suited for measuring long-term investment performance because it accounts for compounding returns. The arithmetic average only takes into account the simple average of each year's returns, which can be deceptive over longer periods of time. Therefore, an investor who wishes to hold a stock for five years will be most interested in the geometric average return.

Question 5

If an investor earns 10% on her investment in the first year and loses 10% the next year, she will have neither a gain nor a loss.

Accepted Answer

This statement is false. Let's assume that the investor starts with $100. After the first year, she earns 10% which gives her a return of $10, bringing the total to $110. However, in the second year, she loses 10% of $110 which is $11, leaving her with $99. Therefore, she has a loss of $1 or 1% overall.

Question 6

Under the efficient market hypothesis, would securities be properly priced.

Accepted Answer

The answer of Under the efficient market hypothesis, would securities...

Question 7

Jayden spends a lot of time studying charts of stocks past performance, but his investment return are only average. This outcome supports
A) the weak-form efficient market hypothesis.
B) the semi-strong form efficient market hypothesis.
C) the strong form efficient market hypothesis.
D) all of the above.

Accepted Answer

The answer of Jayden spends a lot of time studying...

Question 8

Strategies that exploit market inefficiencies tend to lose their effectiveness when they become widely known.

Accepted Answer

When a market inefficiency is widely known, other investors will take advantage of it, which increases competition and reduces the opportunity for profits. This, in turn, makes the strategy less effective.

Question 9

Work by the behavioral economists Robert Shiller and Daniel Kahnemann strongly supports the weak and semi-strong forms of the Efficient Market Hypothesis.

Accepted Answer

Work by Shiller and Kahnemann actually challenges the Efficient Market Hypothesis, particularly its strong form. They argue that market prices are frequently influenced by irrational and emotional factors, suggesting that the market is not always efficient in processing and reflecting all available information.

Question 10

If a market is weak form efficient, an investor can make higher than expected profits by studying the past price patterns of a stock.

Accepted Answer

If a market is weak form efficient, studying past price patterns of a stock will not yield higher than expected profits as all past information is already incorporated in the current stock price.

Question 11

Each of the following would tend to weaken the semi-strong form Efficient Market Hypothesis EXCEPT:
A) There is publicly available information that Boeing Aircraft has procured a contract to build 25 planes for the U.S. Government and the price of Boeing quickly goes up.
B) ACG, Inc. performed well for the past six months, but they just lost a major distribution contract, but the price of ACG stock continues to go up.
C) Louisville Slugger, Inc., gets a contract to supply bats for Little League play, a contract it never had before, and stock price remains stable.
D) Muguet Company consistently underperforms the market in October, but outperforms the market in May.

Accepted Answer

The semi-strong form of the Efficient Market Hypothesis (EMH) posits that all publicly available information is already reflected in stock prices. Therefore, if the price of Boeing quickly goes up after the public announcement of a new contract, it supports the semi-strong EMH, as the market is efficiently incorporating new public information into the stock price.

Question 12

If an individual with inside information can make higher than expected profits, the market is no more than semi-strong form efficient.

Accepted Answer

In semi-strong form efficiency, all publicly available information, including news and financial reports, is reflected in the stock prices. However, inside information is not considered to be publicly available and therefore, if an individual with inside information can make higher than expected profits, it implies that the market is not fully incorporating all the available information, making it no more than semi-strong form efficient.

Question 13

Madison was hired to design and decorate the offices of a large pharmaceutical company. She accidentally read a report indicating that a new drug had just been approved by the Food and Drug administration. She immediately bought the company's stock which doubled in price over the following week. This outcome is inconsistent with
A) the weak-form efficient market hypothesis.
B) the semi-strong form efficient market hypothesis.
C) the strong form efficient market hypothesis. Her action was probably illegal.
D) all of the above.

Accepted Answer

The strong-form efficient market hypothesis assumes that all information, including insider information, is instantly and fully reflected in the market price. If Madison was able to profit from insider information, then the market is not strong-form efficient. And, as she obtained the information accidentally, her action was probably illegal. The weak-form and semi-strong form efficient market hypothesis do not preclude the possibility of obtaining an abnormal return from publicly available information, such as past stock prices or financial statements.

Question 14

Are markets moving toward being more efficient or toward being less efficient?

Accepted Answer

The answer of Are markets moving toward being more efficient...

Question 15

If markets are efficient, stock prices go up when there is positive information about a company, and go down when there is negative information about the company.

Accepted Answer

This is a basic principle of the efficient market hypothesis, which states that all relevant information about a company is reflected in its stock price, and that prices adjust quickly to new information. Therefore, positive news about a company will lead to an increase in demand for its stock, which pushes up the price, while negative news will lead to a decrease in demand, which pushes down the price.

Question 16

Once market inefficiencies become known, they will be exploited by traders until they disappear.

Accepted Answer

This is known as the efficient market hypothesis, which suggests that any market inefficiencies will be quickly exploited by traders, resulting in prices reflecting all available information. However, some argue that certain inefficiencies can persist due to factors such as information asymmetry or behavioral biases.

Quiz 7: An Introduction to Risk and Return-History of Financial Market Returns