Question 1

Psychologists have found that people tend to be ________ in their own judgments.

Accepted Answer

Research has consistently shown that people tend to be overconfident in their judgments, often underestimating their chances of making mistakes or being wrong. This is known as the overconfidence bias.

Question 2

Your best friend calls and gives you the latest stock market "hot tip" that he heard at the health club. Should you act on this information? Why or why not?

Accepted Answer

The answer of Your best friend calls and gives you...

Question 3

If in an efficient market all prices are correct and reflect market fundamentals, which of the following is a false statement?

Accepted Answer

In an efficient market, past performance of a stock is not a reliable indicator of future performance as all available information is already reflected in the current price. Therefore, a stock that has done poorly in the past may not necessarily do well in the future.

Question 4

For small investors, the best way to pursue a "buy and hold" strategy is to

Accepted Answer

For small investors pursuing a "buy and hold" strategy, buying no-load mutual funds with low management fees is the best option. This approach provides diversification while minimizing costs and reducing the need for frequent buying and selling, which can lead to higher fees and taxes. Load mutual funds and individual stock trading typically come with higher costs and may require more active management, making them less suitable for a long-term investment strategy.

Question 5

If in an efficient market all prices are correct and reflect market fundamentals, which of the following is a false statement?

Accepted Answer

In an efficient market, prices reflect all available information, including past performance. Therefore, there is no indication that a stock that has done poorly in the past is more likely to do well in the future. This statement implies that there is a predictable pattern in stock performance, which contradicts the notion of efficient markets.

Question 6

The efficient markets hypothesis implies that prices in the stock market

Accepted Answer

The efficient markets hypothesis implies that stock market prices are unpredictable, as all available information is already reflected in the current price of a security. This means that any new information that becomes available is quickly incorporated into the stock price, making it difficult to consistently predict future movements.

Question 7

Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is

Accepted Answer

According to the efficient markets hypothesis, all available information is already reflected in the current stock price. Therefore, if the earnings announcement was not as high as anticipated by the market, the stock price may fall as the market adjusts to the new information. This is consistent with the efficient markets hypothesis.

Question 8

________ is the field of study that applies concepts from social sciences such as psychology and sociology to help understand the behavior of securities prices.

Accepted Answer

Behavioral finance is the field of study that applies concepts from social sciences such as psychology and sociology to help understand the behavior of securities prices.

Question 9

The advantage of a "buy-and-hold strategy" is that

Accepted Answer

A buy-and-hold strategy reduces the number of transactions, thereby lowering brokerage commissions. This strategy does not guarantee profits, eliminate losses, or ensure that the price of a stock will always increase over time.

Question 10

You read a story in the newspaper announcing the proposed merger of Dell Computer and Gateway. The merger is expected to greatly increase Gateway's profitability. If you decide to invest in Gateway stock, you can expect to earn

Accepted Answer

Stock prices adjust quickly to new information, including expected changes in profitability due to events like mergers, so investors typically earn a normal return based on this efficient market hypothesis.

Question 11

If a corporation announces that it expects quarterly earnings to increase by 25% and it actually sees an increase of 22%, what should happen to the price of the corporation's stock if the efficient markets hypothesis holds, everything else held constant?

Accepted Answer

The answer of If a corporation announces that it expects...

Question 12

________ means people are more unhappy when they suffer losses than they are happy when they achieve gains.

Accepted Answer

Loss aversion is a psychological phenomenon where people are more strongly affected by losses than by gains of the same size. This occurs because people feel the pain of loss more acutely than the pleasure of gain.

Question 13

The number and availability of discount brokers has grown rapidly since the mid-1970s. The efficient markets hypothesis predicts that people who use discount brokers

Accepted Answer

The efficient markets hypothesis suggests that all information about a security is already reflected in its price, making it difficult to consistently outperform the market. Therefore, there is no evidence to suggest that full-service brokers can consistently outperform the market. Using a discount broker, who charges lower commissions, can result in greater net returns for investors, but their investment returns are expected to be about the same as those who use full-service brokers.

Question 14

If a mutual fund outperforms the market in one period, evidence suggests that this fund is

Accepted Answer

While outperforming the market in one period is a good sign, it is not a guarantee that the fund will continue to do so in subsequent periods. There are many factors that can impact the performance of a fund, including changes in the market, shifts in the economy, and fluctuations in investor sentiment. Therefore, it is not likely that the fund will consistently outperform the market in subsequent periods.

Question 15

The efficient markets hypothesis suggests that investors

Accepted Answer

The efficient markets hypothesis suggests that it is difficult to consistently beat the market by using fundamental or technical analysis. Therefore, instead of trying to beat the market, investors should focus on minimizing their costs by purchasing no-load mutual funds with low management fees.

Question 16

________ and ________ may provide an explanation for stock market bubbles.

Accepted Answer

Overconfidence in the market and the social contagion effect of investors following each other's lead may lead to stock market bubbles.

Question 17

Studies of mutual fund performance indicate that mutual funds that outperformed the market in one time period usually

Accepted Answer

Studies have shown that mutual funds that outperform the market in one time period typically do not continue to outperform in the subsequent time period. This is known as the “persistence of performance” problem, and it is often cited as evidence in favor of passive investing strategies like index funds. Therefore, choice D is the best answer.

Question 18

The efficient markets hypothesis indicates that investors

Accepted Answer

The efficient markets hypothesis suggests that markets are efficient and all available information is already reflected in asset prices. As a result, it is difficult for investors to consistently outperform the market over the long-term. Therefore, a "buy and hold" strategy (i.e. investing for the long-term and not trying to time the market) is generally seen as the most effective approach for investors. Option A is incorrect because technical analysis is based on the idea that historical price trends can be used to predict future price movements, which is inconsistent with the efficient markets hypothesis. Option C is incorrect because the efficient markets hypothesis implies that there are few, if any, unexploited profit opportunities available. Option D is incorrect because loaded mutual funds charge higher fees, which can reduce investor returns.

Question 19

If a market participant believes that a stock price is irrationally high, they may try to borrow stock from brokers to sell in the market and then make a profit by buying the stock back again after the stock falls in price. This practice is called

Accepted Answer

Short selling involves borrowing stock from brokers and selling it in the market with the intention of buying it back at a lower price to make a profit. It is often used when a market participant believes that a stock price is overvalued or irrationally high.

Question 20

Loss aversion can explain why very little ________ actually takes place in the securities market.

Accepted Answer

Loss aversion refers to the idea that people feel the pain of losses more acutely than the pleasure of gains. In the context of the securities market, this means that many investors are hesitant to sell stocks they already own because they fear the regret of potentially missing out on future gains or feeling the pain of a loss. This can make short selling (betting against a stock's performance), which involves selling borrowed stocks in the hopes of buying them back at a lower price later, a less common occurrence in the market.

Quiz 7: The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis

Psychologists have found that people tend to be ________ in their own judgments.

Your best friend calls and gives you the latest stock market "hot tip" that he heard at the health club. Should you act on this information? Why or why not?

If in an efficient market all prices are correct and reflect market fundamentals, which of the following is a false statement?

For small investors, the best way to pursue a "buy and hold" strategy is to

If in an efficient market all prices are correct and reflect market fundamentals, which of the following is a false statement?

The efficient markets hypothesis implies that prices in the stock market

Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is

________ is the field of study that applies concepts from social sciences such as psychology and sociology to help understand the behavior of securities prices.

The advantage of a "buy-and-hold strategy" is that

You read a story in the newspaper announcing the proposed merger of Dell Computer and Gateway. The merger is expected to greatly increase Gateway's profitability. If you decide to invest in Gateway stock, you can expect to earn

If a corporation announces that it expects quarterly earnings to increase by 25% and it actually sees an increase of 22%, what should happen to the price of the corporation's stock if the efficient markets hypothesis holds, everything else held constant?

________ means people are more unhappy when they suffer losses than they are happy when they achieve gains.

The number and availability of discount brokers has grown rapidly since the mid-1970s. The efficient markets hypothesis predicts that people who use discount brokers

If a mutual fund outperforms the market in one period, evidence suggests that this fund is

The efficient markets hypothesis suggests that investors

and may provide an explanation for stock market bubbles.

Studies of mutual fund performance indicate that mutual funds that outperformed the market in one time period usually

The efficient markets hypothesis indicates that investors

If a market participant believes that a stock price is irrationally high, they may try to borrow stock from brokers to sell in the market and then make a profit by buying the stock back again after the stock falls in price. This practice is called

Loss aversion can explain why very little ________ actually takes place in the securities market.