Question 1

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.

Accepted Answer

The efficient-market hypothesis (EMH) suggests that all available information is already reflected in stock prices, making it difficult for investors to consistently outperform the market through stock selection or market timing. For a small investor, investing in mutual funds, particularly index funds, is often recommended as it provides diversification and follows the market's overall performance, aligning with the EMH perspective that beating the market consistently is unlikely.

Question 2

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.

Accepted Answer

The negative abnormal return despite positive earnings news suggests that investors had higher expectations for the earnings increase than what was actually announced. This discrepancy led to a negative market reaction.

Question 3

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.

Accepted Answer

The answer of XRCO has a beta of 1.7. The...

Question 4

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.

Accepted Answer

The abnormal return of 0% suggests that the market had already anticipated the FDA's approval of the new cancer-fighting drug, and thus, the information was already reflected in Queen's stock price prior to the announcement.

Question 5

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.

Accepted Answer

Selection bias occurs when the researcher decides to withhold or select certain data or findings for publication based on the outcomes. In this case, the professor's choice to keep the trading rule secret instead of publishing it can lead to a bias in the publicly available information about stock-trading strategies, as only strategies that are less effective or already known might be published.

Question 6

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

Accepted Answer

Warren Buffet and Peter Lynch are renowned for their exceptional investment track records. Warren Buffet, through Berkshire Hathaway, and Peter Lynch, with his management of the Magellan Fund at Fidelity, have both achieved legendary status for their investment prowess. Phoebe Buffet, Merrill Lynch (a financial services firm, not an individual investor), and Jimmy Buffet are not recognized for personal investment achievements in the same context.

Question 7

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.

Accepted Answer

The negative abnormal return despite the announcement of higher earnings suggests that investors had higher expectations for the earnings increase than what was announced. This discrepancy between expectations and actual announcements led to a negative market reaction.

Question 8

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.

Accepted Answer

Maurice Kendall, in his 1953 study, concluded that stock prices moved in a manner that was essentially random, indicating that there were no predictable patterns in stock prices. This finding laid the groundwork for the efficient market hypothesis.

Question 9

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.

Accepted Answer

The scenario described is an example of the lucky event issue, where out of a large number of participants performing a random task (like flipping a coin), it's statistically likely that at least one will have an outcome that seems highly improbable (like flipping 20 heads in a row), simply due to chance.

Question 10

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.

Accepted Answer

Technical analysts use trendlines and resistance levels to determine proper stock prices, focusing on patterns and price movements rather than financial fundamentals.

Question 11

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

Accepted Answer

Chartists, also known as technical analysts, focus on patterns and trends in trading charts to predict future market movements. They do not typically engage in fundamental analysis, which involves evaluating a company's financial health and other economic factors, nor do they typically use regression analysis, insider analysis, or psychoanalysis in their practice.

Question 12

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.

Accepted Answer

The Capital Asset Pricing Model (CAPM) formula is used to determine the expected return of an asset, given its beta, the risk-free rate, and the market return. The formula is: Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). For Boeing, with a beta of 1.0, the expected return would be 5% + 1.0 * (11% - 5%) = 11%. Since Boeing's actual return was 14%, which is higher than the expected return of 11%, it suggests that there was good news about Boeing that led to its outperformance relative to what was expected based on market movements.

Question 13

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.

Accepted Answer

The concept of a random walk in stock prices suggests that price changes are unpredictable and follow no discernible pattern, thus making them random. This is consistent with the efficient market hypothesis, which posits that all available information is already reflected in stock prices, making it impossible to consistently predict future price movements.

Question 14

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.

Accepted Answer

The main difference between the three forms of market efficiency (weak, semi-strong, and strong) lies in the definition of information and what is already reflected in stock prices. Weak form efficiency suggests that all past trading information is reflected in stock prices, semi-strong form efficiency suggests that all publicly available information is reflected, and strong form efficiency suggests that all information, including insider information, is reflected in stock prices.

Question 15

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.

Accepted Answer

The answer of Sehun (1986) finds that the practice of...

Question 16

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.

Accepted Answer

The answer of Music Doctors has a beta of 2.25....

Question 17

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.

Accepted Answer

The abnormal return of 3% suggests that investors reacted positively to the announcement of the international joint venture, indicating they view it as good news for KWM Corporation.

Question 18

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.

Accepted Answer

Fundamental analysts focus on a company's financials, future earnings potential, dividend prospects, and macroeconomic factors such as future interest rates to determine a stock's intrinsic value. Trendlines and resistance levels are tools used in technical analysis, not fundamental analysis.

Question 19

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.

Accepted Answer

The negative abnormal return despite the positive news of a 35% increase in sales suggests that investors had higher expectations for the sales growth than what was actually announced. In an efficient market, stock prices adjust to reflect all available information, and in this case, the negative return indicates that the actual sales figures fell short of market expectations.

Question 20

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.

Accepted Answer

Given the information, the expected return for Matthews Corporation can be calculated using the Capital Asset Pricing Model (CAPM), which is: Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Plugging in the given values: Expected Return = 5% + 1.2 * (13% - 5%) = 14.6%. Since Matthews had an actual return of 17%, which is higher than the expected return of 14.6%, it suggests that there was good news about Matthews that led to its higher-than-expected performance.

Quiz 11: The Efficient Market Hypothesis

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

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

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

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

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

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

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

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

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

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

Chartists practice

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

If stock prices follow a random walk,

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

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

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

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

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

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

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