Deck 16: Capital Market Efficiency

Question 1

Flukey Gold Mines makes an unexpected announcement regarding gold production at 2 pm.Shares of the company were traded at 12 pm,2.10 pm,2.30 pm and 4 pm.If the market for Flukey Gold Mines' shares is efficient,then at which trade will the newly established share price fully reflect the new information?

A)12 pm.
B)2.10 pm.
C)2.30 pm.
D)4 pm.

Answer 1

2.10 pm.

Question 2

An efficient capital market is one in which:

A)there is no thin trading.
B)transaction costs are minimal.
C)security prices fully reflect all available information.
D)there is a large number of buyers and sellers.

Answer 2

security prices fully reflect all available information.

Question 3

If fund managers display superior investment performance,it can then be said that:

A)the market is strong-form efficient.
B)the market is not strong-form efficient but is at least semi-strong-form efficient.
C)fund managers do not use past information to derive trading strategies.
D)this evidence provides an indirect test of strong-form efficiency.

Answer 3

this evidence provides an indirect test of strong-form efficiency.

Question 4

A weak-form efficient market can best be described as a market in which:

A)trading strategies based upon past share prices cannot earn abnormal profits.
B)all publicly available information is fully reflected in share prices.
C)share prices follow predictable trends.
D)trading strategies based on past information can earn abnormal profits.

Question 5

Tests of return predictability are designed to:

A)detect systematic patterns in asset prices.
B)generate abnormal returns.
C)differentiate between the forms of efficiency.
D)do none of the given options.

Question 6

Which of the following results may be inconsistent with semi-strong-form market efficiency?

A)Share returns follow a predictable trend after a profit announcement.
B)Share prices react instantaneously to profit announcements.
C)Abnormal returns are not detected around profit announcements.
D)None of the given options.

Question 7

Company insiders of XYZ consistently purchase shares of their company prior to increases in the share price and sell shares before decreases in the share price.Which of the following answers is consistent with the aforementioned observation?

A)The market is not weak-form efficient.
B)The market is semi-strong-form efficient.
C)The market is not strong-form efficient.
D)The degree of market efficiency cannot be established.

Question 8

French (1980)showed that a daily index of US share prices over the period 1953-77 showed that average returns on:

A)Mondays were negative while average returns on Fridays were positive.
B)Mondays were positive while average returns on Fridays were negative.
C)Mondays were negative while average returns on Thursdays were positive.
D)Mondays were positive while average returns on Thursdays were negative.

Question 9

Which of the following statements about market efficiency is true?

A)A market can be semi-strong-form and strong-form efficient but not weak-form efficient.
B)A market can be semi-strong-form efficient but not weak-form efficient.
C)A market can be semi-strong-form,weak-form or strong-form efficient but not all simultaneously.
D)A market must be weak-form efficient if it is semi-strong-form efficient.

Question 10

There are incentives for investors to seek information if:

A)capital markets are not weak-form efficient.
B)capital markets are not semi-strong-form efficient.
C)capital markets are not strong-form efficient.
D)all of the given options.

Question 11

An investment strategy in which the tax rules make it attractive for an investor to sell certain shares just before the end of the tax year is known as:

A)the turn of the month effect.
B)the December effect.
C)tax loss selling.
D)the tax effect.

Question 12

Returns greater or less than those which the market expects from a security are known as:

A)inferior returns.
B)normal returns.
C)abnormal returns.
D)true returns.

Question 13

Gold Ltd made an unexpected announcement at 11am that a new gold mine had been discovered.The share price established in the last trade before the announcement was 37 cents.The first trade after the announcement was also at 37 cents but the following trade took place at 52 cents,which became the new established price.With regards to the first trade after the announcement:

A)the buyer has made an abnormal profit.
B)the seller has made an abnormal profit.
C)the buyer has made a normal loss.
D)the seller has made a normal profit.

Question 14

A period in which prices rise strongly,departing from their true value,frequently followed by a sudden decrease in prices is known as a/an:

A)post-event drift.
B)bubble.
C)overreaction anomaly.
D)buy and hold period.

Question 15

Semi-strong-form efficiency can best be described as:

A)the ability of investors to earn abnormal profits from the over-reaction of share prices to news.
B)a market in which trading strategies based on past prices cannot earn abnormal profits.
C)a market in which trading strategies based on all publicly available information cannot earn abnormal profits.
D)all information,public and private,is fully impounded in share prices.

Question 16

Gold Ltd made an unexpected announcement at 11 am that a new gold mine had been discovered.The share price established in the last trade before the announcement was 37 cents.The first trade after the announcement was also at 37 cents but the following trade took place at 52 cents,which became the new established price.With regards to the second trade after the announcement:

A)the buyer has made an abnormal profit.
B)the buyer has made an abnormal loss.
C)neither the buyer nor seller has made an abnormal profit.
D)both the buyer and seller have made an abnormal profit.

Question 17

Boom Ltd made an announcement at the beginning of the week concerning the discovery of a new oil well that is expected to double its production well into the next decade.The announcement was completely unexpected,and shares of Boom Ltd had been trading at a frantic pace since the announcement.At the beginning of the week the share price was 25 cents,by mid-week 37 cents and by the end of the week 50 cents.The market for Boom Ltd shares appears to be an example of:

A)an efficient market.
B)a very efficient market.
C)an instantaneous and unbiased price reaction to new information.
D)an inefficient market.

Question 18

ABC Ltd made an unexpected announcement concerning a major new contract on Monday,but ABC shares were not traded until the following Wednesday and Friday.The closing price on Wednesday was unchanged from Monday but different to that on Friday.Trading of ABC shares appears to be an example of:

A)market efficiency.
B)an announcement imparting no 'new' news.
C)market inefficiency.
D)infrequent trading,not market inefficiency.

Question 19

If the market processes new information efficiently,the reaction of market prices to new information will be:

A)unbiased.
B)instantaneous.
C)instantaneous and unbiased.
D)fair.

Question 20

Rozeff and Kinney (1976)showed that the average return in January was more than:

A)six times larger than the average returns in the other 11 months.
B)four times larger than the average returns in the other 11 months.
C)five times larger than the average returns in the other 11 months.
D)three times larger than the average returns in the other 11 months.

Question 21

The price-earnings effect refers to the observation that:

A)risk-adjusted returns are unrelated to price-earnings ratios.
B)risk-adjusted returns are lower,the smaller the price-earnings ratio.
C)risk-adjusted returns are lower,the larger the price-earnings ratio.
D)risk-adjusted returns are higher,the smaller the price-earnings ratio.

Question 22

The dividend yield effect may be explained by the fact that:

A)if dividends are taxed more heavily than capital gains,investors will prefer a dollar of before-tax capital gains to a dollar of before-tax dividends.
B)if dividends are taxed more heavily than capital gains,investors will prefer a dollar of before-tax dividends to a dollar of before-tax capital gains.
C)investors will require high before-tax returns on shares that pay low dividends in order to compensate them for the higher tax burden that the capital gains will impose.
D)none of the given options.

Question 23

If the stock market is efficient with respect to the incorporation of publicly available information,then:

A)charting a company's share prices is likely to be profitable.
B)technical analysis is likely to be profitable.
C)fundamental analysis is unlikely to be profitable.
D)insider information is unlikely to lead to abnormal profits.

Question 24

The size effect refers to the observation that:

A)returns on shares traded exclusively on small markets are below average.
B)returns on shares traded exclusively on large markets are above average.
C)returns on shares of smaller companies are smaller than those of larger companies.
D)returns on shares of smaller companies are larger than those of larger companies.

Question 25

According to Brown,Finn and Hancock (1977),the highest positive abnormal returns are associated with the simultaneous announcement of:

A)profit increases and dividends per share decreases.
B)profit and dividends per share decreases.
C)profit and dividends per share increases.
D)profit decreases and dividends per share increases.

Question 26

Which of the following statements is the most consistent with evidence provided on the EMH?

A)It is not clear that the market can be expected to respond positively to unexpected good news.
B)Anomalies have a great capacity to generate risk-adjusted excess returns for an investor.
C)Event tests are joint tests of the asset-pricing model used and market efficiency.
D)Financial managers of small companies should interpret this evidence as an indication that shares of small companies are under-priced and shares of large companies are over-priced.

Question 27

The area of behavioural finance suggests that investors:

A)always behave rationally,which supports the EMH.
B)never behave irrationally and the market is not efficient.
C)may not behave rationally and this limits the arbitrage opportunities of rational investors.
D)None of the given options is correct.

Question 28

The January effect in Australia is explained by:

A)the tax-loss selling hypothesis.
B)the efficient markets hypothesis.
C)the random walk hypothesis.
D)none of the given options.

Question 29

Easton (1991)examined the reaction to dividend and profit announcements and found that:

A)the reaction to dividends was weaker than the reaction to profits.
B)the reaction to dividends was stronger than the reaction to profits.
C)the market takes account of the interrelation of the profit and dividend information.
D)None of the given options is correct.

Question 30

According to Shleifer (2000),the theoretical foundation of the efficient markets hypothesis is:

A)the trades of irrational investors will be random and cancel each other out,leaving prices unaffected.
B)all securities will be priced rationally if markets are competitive.
C)the trades of irrational investors will be random and cancel each other out leaving prices unaffected and all securities will be priced rationally if markets are competitive.
D)none of the given options.

Question 31

An investor discovers that for a certain group of shares,large positive price changes are always followed by large negative price changes.This finding is a violation of the:

A)semi-strong form of the EMH.
B)the moderate form of the EMH.
C)the strong form of the EMH.
D)the weak form of the EMH.

Question 32

An implication of the EMH for financial managers is that:

A)investing in a project that increases the company's true value will be reflected in the share price upon release of the information.
B)the current share price is not a good indicator of the company's true value.
C)the company's share price may overstate the true value of the company.
D)All of the given answers.

Question 33

A number of studies have found that better (or poorly)performing shares continue to perform well (poorly)in the medium term.This effect is termed the:

A)book-to-market effect.
B)price/earnings effect.
C)momentum effect.
D)None of the given answers.

Question 34

Which of the following statements is the most consistent with evidence provided on the EMH?

A)Technical analysis is a worthwhile trading strategy for most investors.
B)Most investors have access to private information.
C)Most investors should adopt a passive buy-and-hold strategy,most of the time.
D)Fundamental analysis is a worthwhile trading strategy for most investors.

Question 35

A company with a low book-to-market ratio is:

A)a company that has had good years in the past but that the market now judges to have poor prospects.
B)a company that the market judges to have good prospects.
C)a company that the market judges to have poor prospects.
D)both a company that has had good years in the past but that the market now judges to have poor prospects,and a company that the market judges to have poor prospects.

Question 36

The January effect refers to:

A)the fact that the average share return for January is smaller than any other month.
B)mispricing of shares due to New Year parties.
C)the fact that the average share return for January is larger than in any other month.
D)the fact that smaller firms,on average,earn higher returns than larger firms.

Question 37

If the stock market is efficient then:

A)investors should consider factors,such as risk preferences,when selecting a portfolio of securities.
B)investors should select their investments randomly since all securities are correctly priced anyway.
C)a portfolio of randomly selected securities will necessarily eliminate all unsystematic risk.
D)portfolio selection becomes easy since all information is impounded in share prices.

Question 38

In an efficient market,a simple buy-and-hold policy is:

A)the best strategy because trying to beat the market is almost impossible.
B)the best strategy because evidence suggests that even private information cannot yield abnormal returns.
C)not the best strategy because,as share prices change over time,portfolios warrant re-balancing.
D)not the best strategy because,in an efficient market,some investors must believe that the market is inefficient.

Question 39

People will systematically tend to underestimate the level of market efficiency because:

A)they tend to forget losses.
B)they have vested interests in denying that markets are efficient.
C)it is difficult to distinguish between ability and luck.
D)all of the given options.

Question 40

The 'representativeness heuristic' is a term to describe irrational behaviour that suggests that:

A)in forming their beliefs,individuals may be too slow in identifying a firm as an excellent or a terrible investment.
B)in forming their beliefs,individuals may be more enthusiastic about companies with better slogans.
C)in forming their beliefs,individuals may be less enthusiastic about companies with better slogans as it implies that the company is trying to detract investors from focusing on its financial performance.
D)None of the given options is correct.

Question 41

___________ studies are a research methodology commonly employed to test for semi-strong-form efficiency.

Question 42

During a 'bubble' period,prices depart from the true,fundamental value of the asset.

Question 43

______________ analysis is the use of historical prices to detect trends that can be used to predict the future short-term course of prices.

Question 44

Briefly,what are the implications of the EMH for:

A)financial managers?
B)investors in securities?

Question 45

In a market that is strong form efficient,___________ information cannot be acted upon to generate abnormal returns.

Question 46

What are some of the seasonal patterns that have been found in returns that suggest it is possible to predict returns based on these patterns?

Question 47

Outline the basic features of event study methodology and the implications of event studies for the EMH.

Question 48

In an efficient market,there should be an instantaneous and ____________ share price reaction to information.

Question 49

Fundamental analysis suggests that sometimes the market is short-sighted and a share price cannot be justified based on the fundamental features of the company.

Question 50

A _______________ policy is an investment strategy in which shares are bought and then retained in the investor's portfolio for a long period.

Question 51

In an efficient market,it is not possible (except by chance)to employ trading strategies that generate excess profits over the long-term.

Question 52

The size-effect is based on observations that the returns of large firms exceed the returns on the shares of smaller companies both before and after adjusting for beta risk.

Question 53

One weakness of the event study methodology is the difficulty in determining the instance in which information was released to the market.

Question 54

The field of behavioural finance argues that the efficiency of markets is ensured through the fallibility of human beings in competitive markets.

Question 55

Fama and French (1992)found that companies with a low book-to-market ratio tended to earn _________ returns,while companies with a high book-to-market ratio tended to earn _______ returns.