Deck 11: The Efficient Market Hypothesis

Question 1

Banz (1981) found that, on average, the risk-adjusted returns of small firms

A) were higher than the risk-adjusted returns of large firms.
B) were the same as the risk-adjusted returns of large firms.
C) were lower than the risk-adjusted returns of large firms.
D) were unrelated to the risk-adjusted returns of large firms.
E) were negative.

Answer 1

A

Question 2

If you believe in the reversal effect, you should

A) buy bonds in this period if you held stocks in the last period.
B) buy stocks in this period if you held bonds in the last period.
C) buy stocks this period that performed poorly last period.
D) go short.
E) buy stocks this period that performed poorly last period and go short.

Answer 2

C

Question 3

If you believe in the _______ form of the EMH, you believe that stock prices only reflect all information that can be derived by examining market trading data, such as the history of past stock prices, trading volume or short interest.

A) semistrong
B) strong
C) weak
D) All of the options are correct.
E) None of the options are correct.

Answer 3

C

Question 4

A common strategy for passive management is

A) creating an index fund.
B) creating a small firm fund.
C) creating an investment club.
D) creating an index fund and creating an investment club.
E) creating a small firm fund and creating an investment club.

Question 5

Proponents of the EMH typically advocate

A) buying individual stocks on margin and trading frequently.
B) investing in hedge funds.
C) a passive investment strategy.
D) buying individual stocks on margin, trading frequently, and investing in hedge funds.
E) investing in hedge funds and a passive investment strategy.

Question 6

Jaffe (1974) found that stock prices _________ after insiders intensively bought shares.

A) decreased
B) did not change
C) increased
D) became extremely volatile
E) became much less volatile

Question 7

The debate over whether markets are efficient will probably never be resolved because of

A) the lucky event issue.
B) the magnitude issue.
C) the selection bias issue.
D) All of the options are correct.
E) None of the options are correct.

Question 8

The difference between a random walk and a submartingale is the expected price change in a random walk is ______, and the expected price change for a submartingale is ______.

A) positive; zero
B) positive; positive
C) positive; negative
D) zero; positive
E) zero; zero

Question 9

Jaffe (1974) found that stock prices _________ after insiders intensively sold shares.

A) decreased
B) did not change
C) increased
D) became extremely volatile
E) became much less volatile

Question 10

_________ below which it is difficult for the market to fall.

A) An intrinsic value is a value
B) A resistance level is a value
C) A support level is a value
D) An intrinsic value and a resistance level are values
E) A resistance level and a support level are values

Question 11

__________ focus more on past price movements of a firm's stock than on the underlying determinants of future profitability.

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

Question 12

___________ the return on a stock beyond what would be predicted from market movements alone.

A) An irrational return is
B) An economic return is
C) An abnormal return is
D) None of the options are correct.
E) All of the options are correct.

Question 13

Basu (1977, 1983) found that firms with high P/E ratios

A) earned higher average returns than firms with low P/E ratios.
B) earned the same average returns as firms with low P/E ratios.
C) earned lower average returns than firms with low P/E ratios.
D) had higher dividend yields than firms with low P/E ratios.

Question 14

_________ above which it is difficult for the market to rise.

A) A book value is a value
B) A resistance level is a value
C) A support level is a value
D) A book value and a resistance level are values
E) A book value and a support level are values

Question 15

A hybrid strategy is one where the investor

A) uses both fundamental and technical analysis to select stocks.
B) selects the stocks of companies that specialize in alternative fuels.
C) selects some actively-managed mutual funds on their own and uses an investment advisor to select other actively-managed funds.
D) maintains a passive core and augments the position with an actively-managed portfolio.

Question 16

If you believe in the _________ form of the EMH, you believe that stock prices reflect all available information, including information that is available only to insiders.

A) semistrong
B) strong
C) weak
D) All of the options are correct.
E) None of the options are correct.

Question 17

When Maurice Kendall examined the patterns of stock returns in 1953, he concluded that the stock market was __________. Now, these random price movements are believed to be _________.

A) inefficient; the effect of a well-functioning market
B) efficient; the effect of an inefficient market
C) inefficient; the effect of an inefficient market
D) efficient; the effect of a well-functioning market
E) irrational; even more irrational than before

Question 18

Proponents of the EMH typically advocate

A) an active trading strategy.
B) investing in an index fund.
C) a passive investment strategy.
D) an active trading strategy and investing in an index fund.
E) investing in an index fund and a passive investment strategy.

Question 19

Basu (1977, 1983) found that firms with low P/E ratios

A) earned higher average returns than firms with high P/E ratios.
B) earned the same average returns as firms with high P/E ratios.
C) earned lower average returns than firms with high P/E ratios.
D) had higher dividend yields than firms with high P/E ratios.

Question 20

The stock market follows a

A) nonrandom walk.
B) submartingale.
C) predictable pattern that can be exploited.
D) nonrandom walk and predictable pattern that can be exploited.
E) submartingale and predictable pattern that can be exploited.

Question 21

In an efficient market,

A) security prices react quickly to new information.
B) security prices are seldom far above or below their justified levels.
C) security analysis will not enable investors to realize superior returns consistently.
D) one cannot make money.
E) security prices react quickly to new information, security prices are seldom far above or below their justified levels, and security analysis will not enable investors to realize superior returns consistently.

Question 22

On November 22, the stock price of Coca Cola was $69.50, and the retailer stock index was 600.30. On November 25, the stock price of Coca Cola was $70.25, and the retailer stock index was 605.20. Consider the ratio of Coca Cola to the retailer index on November 22 and November 25. Coca Cola is _______ the retail industry, and technical analysts who follow relative strength would advise _______ the stock.

A) outperforming; buying
B) outperforming; selling
C) underperforming; buying
D) underperforming; selling
E) equally performing; neither buying nor selling

Question 23

Studies of positive earnings surprises have shown that there is

A) a positive abnormal return on the day positive earnings surprises are announced.
B) a positive drift in the stock price on the days following the earnings surprise announcement.
C) a negative drift in the stock price on the days following the earnings surprise announcement.
D) a positive abnormal return on the day positive earnings surprises are announced and a positive drift in the stock price on the days following the earnings surprise announcement.
E) a positive abnormal return on the day positive earnings surprises are announced and a negative drift in the stock price on the days following the earnings surprise announcement.

Question 24

A finding that _________ would provide evidence against the semistrong form of the efficient-market theory.

A) low P/E stocks tend to have positive abnormal returns
B) trend analysis is worthless in determining stock prices
C) one can consistently outperform the market by adopting the contrarian approach exemplified by the reversals phenomenon
D) low P/E stocks tend to have positive abnormal returns and trend analysis is worthless in determining stock prices
E) low P/E stocks tend to have positive abnormal returns and one can consistently outperform the market by adopting the contrarian approach exemplified by the reversals phenomenon

Question 25

A market decline of 23% on a day when there is no significant macroeconomic event ______ consistent with the EMH because ________.

A) would be; it was a clear response to macroeconomic news
B) would be; it was not a clear response to macroeconomic news
C) would not be; it was a clear response to macroeconomic news
D) would not be; it was not a clear response to macroeconomic news

Question 26

Two basic assumptions of technical analysis are that security prices adjust

A) rapidly to new information, and market prices are determined by the interaction of supply and demand.
B) rapidly to new information, and liquidity is provided by security dealers.
C) gradually to new information, and market prices are determined by the interaction of supply and demand.
D) gradually to new information, and liquidity is provided by security dealers.
E) rapidly to information and to the actions of insiders.

Question 27

Cumulative abnormal returns (CAR)

A) are used in event studies.
B) are better measures of security returns due to firm-specific events than are abnormal returns (AR).
C) are cumulated over the period prior to the firm-specific event.
D) are used in event studies and are better measures of security returns due to firm-specific events than are abnormal returns (AR).
E) are used in event studies and are cumulated over the period prior to the firm-specific event.

Question 28

Studies of stock price reactions to news are called

A) reaction studies.
B) event studies.
C) drift studies.
D) reaction studies and event studies.
E) event studies and drift studies.

Question 29

The weather report says that a devastating and unexpected freeze is expected to hit Florida tonight during the peak of the citrus harvest. In an efficient market, one would expect the price of Florida Orange's stock to

A) drop immediately.
B) unable to determine.
C) increase immediately.
D) gradually decline for the next several weeks.
E) gradually increase for the next several weeks.

Question 30

Studies of negative earnings surprises have shown that there is

A) a negative abnormal return on the day that negative earnings surprises are announced.
B) a positive drift in the stock price on the days following the earnings surprise announcement.
C) a negative drift in the stock price on the days following the earnings surprise announcement.
D) a negative abnormal return on the day that negative earnings surprises are announced and a positive drift in the stock price on the days following the earnings surprise announcement.
E) a negative abnormal return on the day that negative earnings surprises are announced and a negative drift in the stock price on the days following the earnings surprise announcement.

Question 31

Proponents of the EMH think technical analysts

A) should focus on relative strength.
B) should focus on resistance levels.
C) should focus on support levels.
D) should focus on financial statements.
E) are wasting their time.

Question 32

Work by Amihud and Mendelson (1986, 1991)

A) argues that investors will demand a rate of return premium to invest in less liquid stocks.
B) may help explain the small firm effect.
C) may be related to the neglected firm effect.
D) may help explain the small firm effect and may be related to the neglected firm effect.
E) All of the options are correct.

Question 33

The likelihood of an investment newsletter's successfully predicting the direction of the market for three consecutive years by chance should be

A) between 50% and 70%.
B) between 25% and 50%.
C) between 10% and 25%.
D) less than 10%.
E) greater than 70%.

Question 34

The weak form of the efficient-market hypothesis contradicts

A) technical analysis but supports fundamental analysis as valid.
B) fundamental analysis but supports technical analysis as valid.
C) both fundamental analysis and technical analysis.
D) technical analysis but is silent on the possibility of successful fundamental analysis.

Question 35

A support level is the price range at which a technical analyst would expect the

A) supply of a stock to increase dramatically.
B) supply of a stock to decrease substantially.
C) demand for a stock to increase substantially.
D) demand for a stock to decrease substantially.
E) price of a stock to fall.

Question 36

Studies of mutual-fund performance

A) indicate that one should not randomly select a mutual fund.
B) indicate that historical performance is not necessarily indicative of future performance.
C) indicate that the professional management of the fund insures above market returns.
D) indicate that one should not randomly select a mutual fund and indicate that historical performance is not necessarily indicative of future performance.
E) indicate that historical performance is not necessarily indicative of future performance and indicate that the professional management of the fund insures above market returns.

Question 37

The weak form of the efficient-market hypothesis asserts that

A) stock prices do not rapidly adjust to new information contained in past prices or past data.
B) future changes in stock prices cannot be predicted from past prices.
C) technicians cannot expect to outperform the market.
D) stock prices do not rapidly adjust to new information contained in past prices or past data, and future changes in stock prices cannot be predicted from past prices.
E) future changes in stock prices cannot be predicted from past prices, and technicians cannot expect to outperform the market.

Question 38

In an efficient market the correlation coefficient between stock returns for two nonoverlapping time periods should be

A) positive and large.
B) positive and small.
C) zero.
D) negative and small.
E) negative and large.

Question 39

Banz (1981) found that, on average, the risk-adjusted returns of large firms

A) were higher than the risk-adjusted returns of small firms.
B) were the same as the risk-adjusted returns of small firms.
C) were lower than the risk-adjusted returns of small firms.
D) were unrelated to the risk-adjusted returns of small firms.
E) were negative.

Question 40

Fama and French (1992) found that the stocks of firms within the highest decile of book-to-market ratios had an average annual return of _______, while the stocks of firms within the lowest decile of book-to-market ratios had an average annual return of ________.

A) 15.6%; 13.1%
B) 17.2%; 11.1%
C) 13.2%; 16.4%
D) 11.1%; 17.2%

Question 41

According to proponents of the efficient-market hypothesis, the best strategy for a small investor with a portfolio worth $40,000 is probably to

A) perform fundamental analysis.
B) exploit market anomalies.
C) invest in Treasury securities.
D) invest in derivative securities.
E) invest in mutual funds.

Question 42

XRCO just announced yesterday that its fourth quarter earnings will be 35% higher than last year's fourth quarter. You observe that XRCO had an abnormal return of −1.7% yesterday. This suggests that

A) the market is not efficient.
B) XRCO stock will probably rise in value tomorrow.
C) investors expected the earnings increase to be larger than what was actually announced.
D) investors expected the earnings increase to be smaller than what was actually announced.
E) earnings are expected to decrease next quarter.

Question 43

XRCO has a beta of 1.7. The annualized market return yesterday was 13%, and the risk-free rate is currently 3%. You observe that XRCO had an annualized return yesterday of 20%. Assuming that markets are efficient, this suggests that

A) bad news about XRCO was announced yesterday.
B) good news about XRCO was announced yesterday.
C) no significant news about XRCO was announced yesterday.
D) interest rates rose yesterday.
E) interest rates fell yesterday.

Question 44

The Food and Drug Administration (FDA) just announced yesterday that they would approve a new cancer-fighting drug from Queen. You observe that Queen had an abnormal return of 0% yesterday. This suggests that

A) the market is not efficient.
B) Queen stock will probably rise in value tomorrow.
C) Queen stock will probably fall in value tomorrow.
D) the approval was already anticipated by the market.

Question 45

Your professor finds a stock-trading rule that generates excess risk-adjusted returns. Instead of publishing the results, she keeps the trading rule to herself. This is most closely associated with

A) regret avoidance.
B) selection bias.
C) framing.
D) insider trading.

Question 46

Which of the following are investment superstars who have consistently shown superior performance?I) Warren BuffetII) Phoebe BuffetIII) Peter LynchIV) Merrill LynchV) Jimmy Buffet

A) I, III, and IV
B) II, III, and IV
C) I and III
D) III and IV
E) I, III, IV, and V

Question 47

Nicholas Manufacturing just announced yesterday that its fourth quarter earnings will be 10% higher than last year's fourth quarter. Nicholas had an abnormal return of −1.2% yesterday. This suggests that

A) the market is not efficient.
B) Nicholas' stock will probably rise in value tomorrow.
C) investors expected the earnings increase to be larger than what was actually announced.
D) investors expected the earnings increase to be smaller than what was actually announced.
E) earnings are expected to decrease next quarter.

Question 48

When Maurice Kendall first examined stock price patterns in 1953, he found that

A) certain patterns tended to repeat within the business cycle.
B) there were no predictable patterns in stock prices.
C) stocks whose prices had increased consistently for one week tended to have a net decrease the following week.
D) stocks whose prices had increased consistently for one week tended to have a net increase the following week.
E) the direction of change in stock prices was unpredictable, but the amount of change followed a distinct pattern.

Question 49

At freshman orientation, 1,500 students are asked to flip a coin 20 times. One student is crowned the winner (tossed 20 heads). This is most closely associated with

A) regret avoidance.
B) selection bias.
C) overconfidence.
D) the lucky event issue.

Question 50

Which of the following are used by technical analysts to determine proper stock prices?I) TrendlinesII) EarningsIII) Dividend prospectsIV) Expectations of future interest ratesV) Resistance levels

A) I and V
B) I, II, and III
C) II, III, and IV
D) II, IV, and V
E) All of the items are used by fundamental analysts.

Question 51

Chartists practice

A) technical analysis.
B) fundamental analysis.
C) regression analysis.
D) insider analysis.
E) psychoanalysis.

Question 52

Boeing has a beta of 1.0. The annualized market return yesterday was 11%, and the risk-free rate is currently 5%. You observe that Boeing had an annualized return yesterday of 14%. Assuming that markets are efficient, this suggests that

A) bad news about Boeing was announced yesterday.
B) good news about Boeing was announced yesterday.
C) no news about Boeing was announced yesterday.
D) interest rates rose yesterday.
E) interest rates fell yesterday.

Question 53

If stock prices follow a random walk,

A) it implies that investors are irrational.
B) it means that the market cannot be efficient.
C) price levels are not random.
D) price changes are random.
E) price movements are predictable.

Question 54

The main difference between the three forms of market efficiency is that

A) the definition of efficiency differs.
B) the definition of excess return differs.
C) the definition of prices differs.
D) the definition of information differs.
E) they were discovered by different people.

Question 55

Sehun (1986) finds that the practice of monitoring insider trade disclosures, and trading on that information, would be

A) extremely profitable for long-term traders.
B) extremely profitable for short-term traders.
C) marginally profitable for long-term traders.
D) marginally profitable for short-term traders.
E) not sufficiently profitable to cover trading costs.

Question 56

Music Doctors has a beta of 2.25. The annualized market return yesterday was 12%, and the risk-free rate is currently 4%. You observe that Music Doctors had an annualized return yesterday of 15%. Assuming that markets are efficient, this suggests that

A) bad news about Music Doctors was announced yesterday.
B) good news about Music Doctors was announced yesterday.
C) no news about Music Doctors was announced yesterday.
D) interest rates rose yesterday.
E) interest rates fell yesterday.

Question 57

KWM Corporation just announced yesterday that it would undertake an international joint venture. You observe that KWM had an abnormal return of 3% yesterday. This suggests that

A) the market is not efficient.
B) KWM stock will probably rise in value again tomorrow.
C) investors view the international joint venture as bad news.
D) investors view the international joint venture as good news.
E) earnings are expected to decrease next quarter.

Question 58

Which of the following are used by fundamental analysts to determine proper stock prices?I) TrendlinesII) EarningsIII) Dividend prospectsIV) Expectations of future interest ratesV) Resistance levels

A) I, IV, and V
B) I, II, and III
C) II, III, and IV
D) II, IV, and V
E) All of the items are used by fundamental analysts.

Question 59

Music Doctors just announced yesterday that its first quarter sales were 35% higher than last year's first quarter. You observe that Music Doctors had an abnormal return of −2% yesterday. This suggests that

A) the market is not efficient.
B) Music Doctors stock will probably rise in value tomorrow.
C) investors expected the sales increase to be larger than what was actually announced.
D) investors expected the sales increase to be smaller than what was actually announced.
E) earnings are expected to decrease next quarter.

Question 60

Matthews Corporation has a beta of 1.2. The annualized market return yesterday was 13%, and the risk-free rate is currently 5%. You observe that Matthews had an annualized return yesterday of 17%. Assuming that markets are efficient, this suggests that

A) bad news about Matthews was announced yesterday.
B) good news about Matthews was announced yesterday.
C) no news about Matthews was announced yesterday.
D) interest rates rose yesterday.
E) interest rates fell yesterday.

Question 61

Using finance terminology, Billy Bean discovered a better estimate of ________________.

A) intrinsic value.
B) inflation.
C) market efficiency.
D) discount rates.

Question 62

What factor of fundamental analysis has been found to have a negative impact on returns over a 3-12 month time horizon?

A) intrinsic value
B) inflation
C) volatility
D) discount rates

Question 63

If you believe in the reversal effect, you should

A) sell bonds in this period if you held stocks in the last period.
B) sell stocks in this period if you held bonds in the last period.
C) sell stocks this period that performed well last period.
D) go long.
E) sell stocks this period that performed well last period and go long.

Question 64

What phrase actually measures the positive result of market inefficiency?

A) CAMP
B) beta
C) volatility
D) alpha

Question 65

Billy Bean and his success chronicled in Moneyball by Michael Lewis illustrates that teams were________________.

A) mispricing the value of players.
B) paying too much for players.
C) hampered by the salary cap.
D) able to win using statistical analysis.

Question 66

Patell and Woflson (1984) report that most of the stock-price response to corporate dividend or earnings announcements occurs within ____________ of the announcement.

A) 10 minutes
B) 45 minutes
C) 2 hours
D) 4 hours
E) 2 trading days

Question 67

Expert firms must maintain detailed records of conversations in the event authorities decide to investigate ____________.

A) tax evasion.
B) insider trading.
C) excess profits.
D) FDA violations.
E) SEC violations.

Question 68

Del Guerico and Reuter (2014) report that the average underperformance of actively-managed mutual funds is driven largely by

A) sector mutual funds.
B) index funds.
C) direct-sold funds.
D) broker-sold funds.
E) bank-sold mutual funds.