Question 1

Which one of the following statements is correct?
A)Company insiders are not permitted to trade their employer's securities.
B)Only tippers can be accused of illegal insider trading.
C)Tippees are permitted to trade securities based on information they know is private.
D)Trading on private information that you just happen to overhear is legal.
E)Any trading based on information known to be private is illegal.

Accepted Answer

Insider trading involves the use of non-public or private information to make trades in securities, and it is illegal. Tippees (those who receive insider information from a tipper) are also prohibited from trading based on the information they received. Trading on private information that one overhears or any trading based on non-public information is likewise illegal. Company insiders may trade their employer's securities, but only if the trades are made in compliance with applicable insider trading regulations and policies.

Question 2

If you believe that stock market prices follow a random walk, then:
A)historical price information provides no benefit in predicting future prices.
B)there is no financial benefit from investing in the stock market.
C)having inside information will not lead to abnormal profits.
D)studying past price movements will lead to abnormal profits.
E)you also believe the market is strong form efficient.

Accepted Answer

If stock market prices follow a random walk, then historical price information provides no benefit in predicting future prices because future movements cannot be predicted based on past movements.

Question 3

Dover Lumber announced last week that its unpopular CEO had resigned. In response to this announcement, the firm's stock price increased from $17 a share to $23 a share. The following day the price declined to $21 a share and has remained constant at that level. This is an example of a(n):
A)overreaction and correction.
B)underpricing.
C)delayed reaction.
D)pre-activity action.
E)efficient market reaction.

Accepted Answer

The increase in stock price after the CEO's resignation suggests an initial overreaction by the market, followed by a correction the next day to a more reasonable price level. This is an example of overreaction and correction, which is a common occurrence in efficient markets.

Question 4

Which one of the following best describes the type(s)of information included in a strong form efficient market?
A)historical
B)historical and public
C)private and public
D)current and public
E)historical and private

Accepted Answer

In a strong form efficient market, all information, including both public and private (or insider) information, is already reflected in stock prices. This means that no one can consistently achieve higher returns by trading on any information, whether it is publicly available or privately held.

Question 5

If the financial markets were regulated such that the markets maintained strong form efficiency, then:
A)insider trading laws would be unnecessary.
B)all investors would earn equivalent rates of return.
C)risk premiums would vanish.
D)all investors would become arbitrage traders.
E)securities would tend to be continually underpriced.

Accepted Answer

Strong form efficiency implies that all information, including insider information, is already reflected in the current market prices. Therefore, insider trading laws would be unnecessary as there would be no advantage gained by having insider information. However, it does not guarantee that all investors would earn equivalent rates of return, that risk premiums would vanish, or that all investors would become arbitrage traders. Securities could still be overpriced or underpriced at any given time.

Question 6

Which one of the following involves the study of a firm's stock price for the few days surrounding a news announcement?
A)web survey
B)market analysis
C)event study
D)auditing review
E)trend study

Accepted Answer

Event study involves analyzing the impact of a particular event, such as a news announcement, on a firm's stock price. It specifically looks at the few days surrounding the event to see how the market reacts. A web survey, market analysis, auditing review, and trend study are not directly related to analyzing a firm's stock price in response to a specific event.

Question 7

Tom is an engineer for Talbot Tech and has just discovered a revolutionary method for strengthening metals. He knows this knowledge will add value to Talbot Tech's stock. Tom happens to mention this discovery and its value to his neighbor, Fred. Fred can be charged with insider trading if he:
A)continues to hold the Talbot Tech shares of stock he already owns.
B)shares this information with another neighbor.
C)sells his shares in Talbot Tech immediately after the news of the discovery is announced.
D)provides this information to a friend who will trade the stock and split the profits with him.
E)buys shares in Talbot Tech immediately after the news is announced and then shortly thereafter sells the shares at a profit.

Accepted Answer

Fred can be charged with insider trading if he provides the information to a friend who will trade the stock and split the profits with him. This action would give the friend an unfair advantage in the market and would be considered illegal insider trading.

Question 8

Two weeks ago Acme Electronics announced that it had developed a new chip design, which was being considered by major companies for use in future smart phone development. At the close of trading the day before the announcement, Acme common stock closed at $20. On the day following the announcement, Acme closed at $21. Two days after the announcement the stock closed at $22.50. Four days after the announcement, the stock traded at $23. Last week, Acme stock traded at $26, a level it has maintained since then. This is an example of a(n):
A)overreaction and correction.
B)underpricing.
C)delayed reaction.
D)pre-activity action.
E)efficient market reaction.

Accepted Answer

The stock price gradually increased over several days following the announcement, indicating a delayed reaction to the news rather than an immediate adjustment to the new information.

Question 9

Ann uses two approaches to trading stocks. First, she trades on what she believes is a repetitive pattern as seen in Dotson Co.'s historical prices. Secondly, she analyzes the financial statements of The Allen Co. to compute changes in the return on equity as a predictor of future stock prices for that firm. She trades based on both strategies. Ann earns abnormal profits on her return on equity strategy but not on her historical prices strategy. This suggests that the market is at least ________ efficient but less than ________ efficient.
A)weak form; mild form
B)mild form; semistrong form
C)weak form; semistrong form
D)semistrong form; full form
E)semistrong form; strong form

Accepted Answer

Ann's ability to earn abnormal profits using her return on equity strategy suggests that the market is not semistrong efficient (which assumes all publicly available information is reflected in stock prices) but weak form efficient (which assumes only historical price information is reflected in stock prices). However, since Ann is not earning abnormal profits with her historical prices strategy, this suggests the market is at least weak form efficient but potentially less than semistrong form efficient. Therefore, the best answer is C, which includes both weak form and semistrong form efficiency as possibilities.

Question 10

Which one of the following is most apt to be considered insider trading?
A)Amy overhears Mary say she is being promoted to accounts payables manager and then she purchases shares in Mary's employer.
B)Jennifer compiles the financial statements and knows that net income for the latest quarter is significantly below analyst's forecasts but continues to hold shares of her employer's stock.
C)Kathy is an outside auditor and has found what she believes are significant accounting irregularities in a company's financial reports but owns no shares in the firm.
D)Lee buys stock in Winter's Wear after he overhears a conversation between the firm's president and vice-president concerning a proposed acquisition.
E)Jeff buys shares of stock in his employer's firm through the company retirement plan on a regular monthly basis.

Accepted Answer

Insider trading involves trading on non-public information, which Lee obtained through overhearing a conversation between the firm's President and Vice-President. This is considered insider trading and is illegal. Options A, B, C, and E do not involve insider trading as the information is either public or the individual does not possess non-public information.

Question 11

Which of the following will lead to abnormal profits in a semistrong form efficient market?
I. private financial information
II. historical price trends
III. financial analysts reports
IV. unreleased merger plans
A)I only
B)I and IV only
C)II and III only
D)I, II, and III only
E)I, III, and IV only

Accepted Answer

According to semi-strong form efficiency, all publicly available information is already reflected in the current market price. Therefore, only private financial information and unreleased merger plans (which are not yet public) can lead to abnormal profits. Historical price trends and financial analysts reports are both publicly available information and therefore, will not lead to abnormal profits in a semi-strong form efficient market.

Question 12

If the market is semistrong form efficient, then which one of the following statements is true?
A)Neither technical nor fundamental analysis leads to abnormal profits.
B)Technical analysts have the ability to earn abnormal profits but fundamental analysts cannot.
C)Fundamental analysts can earn abnormal profits but technical analysts cannot.
D)Both technical and fundamental analysts earn abnormal profits based on their research.
E)No answer can be determined as the form of market efficiency is unrelated to abnormal returns.

Accepted Answer

Semistrong form efficiency implies that all publicly available information is already reflected in the stock prices. Therefore, neither technical nor fundamental analysis can help an investor to earn abnormal profits as all information is already incorporated in the prices.

Question 13

You analyze a firm's financial statements and invest based upon the results of this analysis. Which form of market efficiency may exist if you are able to earn abnormal profits on these investments?
A)weak form
B)historical form
C)semistrong form
D)strong form
E)mild form

Accepted Answer

In a market characterized by weak form efficiency, all past trading information is already reflected in stock prices, but it may still be possible to earn abnormal profits by analyzing a firm's financial statements, which is not based on past trading information. This suggests that not all publicly available information (like financial statements) is reflected in the stock prices, which is a characteristic of weak form efficiency.

Question 14

Which of the following are ineffective strategies for producing abnormal returns if the market is semistrong form efficient?
I. graphing past prices searching for patterns
II. watching the daily market movements
III. studying the latest analyst's reports
IV. analyzing a firm's financial statements
A)I and III only
B)I and IV only
C)I, II, and III only
D)II, III, and IV only
E)I, II, III, and IV

Accepted Answer

In a semistrong form efficient market, all publicly available information, including past prices, market movements, analyst reports, and financial statements, is already reflected in stock prices, making these strategies ineffective for producing abnormal returns.

Question 15

Research on semistrong form efficient markets indicates which one of the following is correct?
A)Identifying a stock with repetitive price movements is generally the best method of active investing.
B)Future returns on large company stocks tend to closely follow past pricing patterns.
C)Buying and holding a broad market index is one of the best investment strategies.
D)Predicting future stock prices is relatively easy for academic researchers.
E)Trading costs have little, if any, impact on investment returns.

Accepted Answer

Semistrong form efficient markets suggest that it is difficult, if not impossible, to consistently identify stocks that will outperform the market based on repetitive price patterns or past performance. Therefore, buying and holding a broad market index is considered one of the best investment strategies. This is because the market is already efficient at processing and reflecting all available public information in stock prices. Trading costs can still have an impact on investment returns, so minimizing these costs is important.

Question 16

Which form of market efficiency exists if the market is efficient only in regard to historical information?
A)mild form
B)weak form
C)historical form
D)semistrong form
E)strong form

Accepted Answer

The weak form of market efficiency exists when the market is efficient only in regard to historical information. This means that past stock prices and trading volumes cannot be used to profitably predict future stock prices, but other types of information (such as insider information) may still provide an advantage in the market.

Question 17

Last week, Newtown Plastics announced that it had developed a new plastic container that is stronger and more durable, yet easier to recycle. In response to this announcement, the firm's stock price rose from $21 a share to a high of $27 a share and has remained at that level. This is an example of a(n):
A)overreaction and correction.
B)post-activity reaction.
C)delayed reaction.
D)pre-activity action.
E)efficient market reaction.

Accepted Answer

This is an example of an efficient market reaction, as the announcement of a new, more durable and recyclable product is likely to have a positive impact on the firm's financial performance and therefore, investors reacted by buying shares and increasing the stock price. The fact that the stock price remained at the high level indicates that the market responded efficiently to the news.

Question 18

Which one of the following would best reveal how stock prices react when competitive firms merge?
A)financial analysis
B)field testing
C)risk analysis
D)event study
E)market survey

Accepted Answer

An event study is the best choice as it analyzes the impact of a specific event, in this case, a competitive merger, on the stock prices of the firms involved. It measures the abnormal returns generated by the event and provides valuable insights into the reactions of the stock market to the merger. Financial analysis, risk analysis, and market surveys may provide some information, but they are not specifically designed to reveal how stock prices react to mergers. Field testing is unrelated to stock market reactions.

Question 19

In an efficient market, daily abnormal returns:
A)are very volatile.
B)reflect news within the past week.
C)reflect news since the prior trading day.
D)remain constant.
E)do not exist.

Accepted Answer

In an efficient market, daily abnormal returns reflect all news and information that has been released since the prior trading day, meaning that choice C is the correct answer. This is because an efficient market is one where all available information is quickly and accurately reflected in stock prices, so any news that is released between trading days will be reflected in the next day's abnormal returns. Choices A, B, D, and E are incorrect because an efficient market is not volatile, abnormal returns do not reflect only recent news, abnormal returns are not constant, and abnormal returns do exist in a well-functioning market.

Question 20

Which of the following sources of information are used by informed traders?
I. financial statements
II. inside information
III. internet reports
IV. analysts reports
A)I and IV only
B)II and III only
C)III and IV only
D)I, III, and IV only
E)I, II, III, and IV

Accepted Answer

The answer of Which of the following sources of information...

Quiz 7: Stock Price Behavior and Market Efficiency

Which one of the following statements is correct?

If you believe that stock market prices follow a random walk, then:

Dover Lumber announced last week that its unpopular CEO had resigned. In response to this announcement, the firm's stock price increased from $17 a share to $23 a share. The following day the price declined to $21 a share and has remained constant at that level. This is an example of a(n) :

Which one of the following best describes the type(s) of information included in a strong form efficient market?

If the financial markets were regulated such that the markets maintained strong form efficiency, then:

Which one of the following involves the study of a firm's stock price for the few days surrounding a news announcement?

Tom is an engineer for Talbot Tech and has just discovered a revolutionary method for strengthening metals. He knows this knowledge will add value to Talbot Tech's stock. Tom happens to mention this discovery and its value to his neighbor, Fred. Fred can be charged with insider trading if he:

Which one of the following is most apt to be considered insider trading?

Which of the following will lead to abnormal profits in a semistrong form efficient market? I. private financial information II. historical price trends III. financial analysts reports IV. unreleased merger plans

If the market is semistrong form efficient, then which one of the following statements is true?

You analyze a firm's financial statements and invest based upon the results of this analysis. Which form of market efficiency may exist if you are able to earn abnormal profits on these investments?

Which of the following are ineffective strategies for producing abnormal returns if the market is semistrong form efficient? I. graphing past prices searching for patterns II. watching the daily market movements III. studying the latest analyst's reports IV. analyzing a firm's financial statements

Research on semistrong form efficient markets indicates which one of the following is correct?

Which form of market efficiency exists if the market is efficient only in regard to historical information?

Which one of the following would best reveal how stock prices react when competitive firms merge?

In an efficient market, daily abnormal returns:

Which of the following sources of information are used by informed traders? I. financial statements II. inside information III. internet reports IV. analysts reports