Question 1

If you live in a remote area with limited access to the news but do a lot of historical research on firms,you would prefer that the financial markets be ____ form efficient so you can have an advantage in the marketplace.

Accepted Answer

If the financial markets were weak-form efficient, it would mean that historical information (such as the research on firms that the individual in the remote area has access to) would not be fully reflected in current market prices. This would give the individual an advantage in the marketplace as they could potentially make trades based on information that is not yet fully priced into the market.

Question 2

Efficient markets require which one of these?

Accepted Answer

Efficient markets do not rely solely on rational investors but can also function with a mix of investor behaviors, including irrational ones, as long as these irrationalities counterbalance each other. This diversity in behavior helps ensure that securities are fairly priced, reflecting all available information, as the effects of various irrational decisions can cancel out.

Question 3

Which of these are arguments that support the position that the efficient market hypothesis fails in actual application?
I.Arbitrage may involve too much risk to offset irrational behaviour
II.Investors may be irrational
III.Irrationalities are contervailing
IV.Irrationality may be related across investors

Accepted Answer

Arguments II and IV are commonly used to criticize the efficient market hypothesis. Argument I points out a limitation to arbitrage that can also impact the efficient market hypothesis, as it assumes that arbitrage will correct any mispricings in the market. However, argument III is not a common argument used against the efficient market hypothesis.

Question 4

Weak form efficiency is best defined as a market where current prices are based on:

Accepted Answer

Weak form efficiency, a concept from the Efficient Market Hypothesis, posits that current asset prices already reflect all historical prices and returns information. This implies that past price movements or trends cannot be used to predict future price movements to earn excess returns.

Question 5

The efficient market hypothesis says that on average managers will:

Accepted Answer

The efficient market hypothesis states that all information is reflected in a stock's price, so there is no way for managers to consistently earn excess returns by using their skill or knowledge. Therefore, they will not be able to earn an excess return, which is the answer choice B.

Question 6

Which of these help prevent arbitrage from totally correcting market mispricings?
I.Trading costs
II.Market domination by rational professionals
III.Number of amateur investors
IV.Near-term risk

Accepted Answer

Trading costs, the number of amateur investors, and near-term risk can all prevent arbitrage from fully correcting market mispricings. Trading costs can reduce the profitability of arbitrage opportunities. Amateur investors may not act rationally, leading to persistent mispricings. Near-term risk can deter arbitrageurs from exploiting mispricings due to potential losses. Market domination by rational professionals would typically help correct mispricings, not prevent it.

Question 7

Which of the following tend to reinforce the argument that the financial markets are efficient?
I.Information spreads rapidly in today's world.
II.There is tremendous competition in the financial markets.
III.Market prices continually fluctuate.
IV.Market prices react suddenly to unexpected news announcements.

Accepted Answer

The answer of Which of the following tend to reinforce...

Question 8

Based on the efficient market hypothesis,a stock's abnormal return at Time t is an indicator of:

Accepted Answer

According to the efficient market hypothesis, all publicly available information is already reflected in a stock's price. Therefore, any abnormal return at Time t can only occur if new information is released, which is option C. Options A, B, D, and E imply inefficiencies in the market, but the efficient market hypothesis assumes that markets are efficient and there are no opportunities for abnormal returns beyond those that may be expected by chance.

Question 9

Your best friend works in the finance office of the Delta Corporation.You are aware that this friend trades Delta stock based on information he overhears in the office.You know that this information is not known to the general public.Your friend continually brags to you about the profits he earns trading Delta stock.Based on this information,you would tend to argue that the financial markets are at best _____ form efficient.

Accepted Answer

This scenario indicates that your friend is profiting by trading on insider information, which is not available to the general public. This violates the semistrong form of market efficiency, which states that all publicly available information is already reflected in stock prices. If the markets were strong form efficient, even insider information would not give an edge in trading. However, this scenario does not necessarily indicate that the markets are weak or semiweak form efficient.

Question 10

Which one of these is an indicator that a market is efficient?

Accepted Answer

Normal rates of return are an indicator that a market is efficient. This means that investors are able to earn a fair rate of return based on the risk they are willing to take on and the information available to them. In an efficient market, abnormal returns (i.e. returns that are significantly higher or lower than expected based on the given risk) are unlikely to persist, as market participants will quickly assess the available information and adjust their trading accordingly to eliminate any potential mispricings.

Question 11

The U.S.Securities and Exchange Commission periodically charges individuals for insider trading and claims those individuals have made unfair profits.Based on this fact,you would tend to argue that the financial markets are at best _____ form efficient.

Accepted Answer

The answer of The U.S.Securities and Exchange Commission periodically charges...

Question 12

The hypothesis that market prices reflect all available information of every kind is called _____ form efficiency.

Accepted Answer

The hypothesis that market prices reflect all available information of every kind is called strong form efficiency. This means that all information, whether it is public or private, is already reflected in the market price. Therefore, insiders cannot use their information advantage to make abnormal profits. This is the most advanced and controversial form of market efficiency.

Question 13

Market prices can be efficiently priced if:

Accepted Answer

Market prices can be efficiently priced if a number of interested traders use the publicly available information to make informed decisions about buying and selling securities. This process is referred to as "information efficiency" and is a key concept in finance. The other options listed are not necessarily relevant to determining market efficiency.

Question 14

Which one of these terms is used to describe a market where investors draw conclusions from insufficient data?

Accepted Answer

Representativeness is a cognitive bias where investors make decisions based on insufficient or irrelevant data, often leading to incorrect conclusions.

Question 15

Given the vast resources available to mutual fund managers,these managers on average have generally:

Accepted Answer

Despite their vast resources, on average mutual fund managers have underperformed the market on a risk-adjusted basis. This is known as the "active management paradox," which suggests that while managers may be skilled, their efforts to outperform the market are offset by the high fees they charge and the difficulty in consistently beating the market.

Question 16

Which one of the following statements is correct concerning market efficiency?

Accepted Answer

In an efficient market, prices reflect all available information. Therefore, when a firm sells shares of stock, the price at which it sells should be fair, meaning it accurately reflects the firm's value based on current information. This is a fundamental principle of market efficiency, as described by the Efficient Market Hypothesis.

Question 17

The hypothesis that market prices reflect all publicly available information is called _____ form efficiency.

Accepted Answer

The hypothesis that market prices reflect all publicly available information is called semistrong form efficiency. Weak form efficiency refers to the idea that market prices reflect all past market-trading information such as price and volume. Strong form efficiency takes into account all public and private information. Open and stable are not commonly used terms to describe market efficiency.

Question 18

In an efficient market,the price of a security will:

Accepted Answer

In an efficient market, the price of a security will react immediately to new information and adjust to the new information without any further adjustments. This is because all available information is already reflected in the price of the security, making it difficult to arbitrage and profit from any price differences. Thus, the price responds immediately and efficiently to any new information.

Question 19

Insider trading does not offer any advantages if the financial markets are:

Accepted Answer

Strong form efficiency implies that all information, both public and private, is already incorporated into current stock prices. Therefore, insider trading would not offer any advantages as insider information is already reflected in the stock price.

Question 20

If the financial markets are efficient,then investors should expect their investments in those markets to:

Accepted Answer

In efficient financial markets, prices reflect all available information, meaning that it's not possible to consistently achieve returns higher than the market average without taking on additional risk. Investments would be priced fairly, leading to a net present value of zero, as future cash flows would be discounted at the appropriate rate that reflects their risk, leaving no room for arbitrage or extraordinary profits simply from buying undervalued assets or selling overvalued ones.

Quiz 13: Efficient Capital Markets and Behavioral Challenges