Deck 12: Market Efficiency

Question 1

Research suggests company insiders earn abnormal returns on their stock transactions.What does this research mean for the efficient market hypothesis (EMH)?

A)Insider trading has nothing to do with the EMH.
B)Profitable insider trading contradicts all forms of the EMH.
C)Profitable insider trading contradicts only the weak form of the EMH.
D)Profitable insider trading contradicts only the strong form of the EMH

Answer 1

D

Question 2

The January effect can be largely attributed to the exceptional performance of:

A)low P/E stocks in January.
B)winner stocks in January.
C)loser stocks in January.
D)small stocks in January.

Answer 2

D

Question 3

The momentum effect indicates that stocks with the:

A)best long-term past performance will continue to perform well.
B)best short-term past performance will continue to perform well.
C)worst long-term past performance will reverse course and perform well.
D)worst short-term past performance will reverse course and perform well.

Answer 3

B

Question 4

What is meant by the statement that an efficient market prices securities "correctly?"

A)The prices reported by the securities exchanges accurately reflect real transactions.
B)Riskier securities are priced to yield higher returns.
C)The expected return on securities is equal to the risk-free rate of return.
D)Both buyers and sellers agree that the prices are fair.

Question 5

Which of the following best describes the so-called size effect?

A)On average,small cap stocks return more than large cap stocks.
B)On average,large cap stocks return more than small cap stocks.
C)On average,small cap stocks earn abnormal returns.
D)Small cap stocks tend to perform exceptionally well during bull markets.

Question 6

Using technical analysis to consistently earn abnormal returns is consistent with which form of the Efficient Market Hypothesis?

A)None
B)Weak form
C)Semi-strong form
D)Strong form

Question 7

Which of the following statements regarding Warren Buffett's wager with Protege Funds is most accurate?

A)The index fund is outperforming the hedge funds,thus supporting market efficiency.
B)The index fund is outperforming the hedge funds,thus countering market efficiency.
C)The index fund is underperforming the hedge funds,thus supporting market efficiency.
D)The index fund is underperforming the hedge funds,thus countering market efficiency.

Question 8

What is the most important determinant of stock price in an efficient market?

A)Information about past events and beliefs about future events
B)The trading system that connects buyers and sellers within the market
C)The number of traders participating in the market
D)The ability of investors to perfectly adjust prices based on new information

Question 9

A characteristic of an efficient market is that:

A)prices adjust perfectly to new information.
B)announced information events tend to be dependent on one another.
C)investors are price takers.
D)individual investors have the ability to affect security prices.

Question 10

In an efficient market,the expected abnormal return on a security is:

A)equal to zero.
B)equal to the risk-free rate of return.
C)equal to the security's required return.
D)greater than the security's required return.

Question 11

What is meant by the expression stock prices follow a "random walk?"

A)The best prediction of next period's price change is last period's price change.
B)Stock price changes do not depend statistically on prior price changes.
C)Stock price changes tend to be positive.
D)Stock price changes do not reflect market information.

Question 12

A test which investigates whether publicly available financial accounting information can be used to generate abnormal returns is a direct test of:

A)weak form market efficiency.
B)semi-strong form market efficiency.
C)strong form market efficiency.
D)mean variance market efficiency.

Question 13

Which of the following is an investment strategy that relies on the "overreaction hypothesis?"

A)Buy and hold
B)Value investing
C)Momentum
D)Contrarian

Question 14

What is meant by the "disposition effect?"

A)Investors are more likely to sell winners than losers.
B)Investors are more likely to sell losers than winners.
C)Investors sell both winners and losers too soon.
D)Investors hold both winners and losers too long.

Question 15

According to the strong form of the efficient market hypothesis,which investors should expect to earn abnormal returns?

A)Investors with superior analytic ability
B)Investors with access to nonpublic information
C)Investors with access to public and nonpublic information
D)No investors

Question 16

Which of the following is not an investor trading bias?

A)Loss aversion
B)Framing
C)Overconfidence
D)Mean reversion

Question 17

Which of the following is the best definition of "behavioral finance?"

A)Behavioral finance studies how financial market participants behave.
B)Behavioral finance studies the ethical behavior of investors.
C)Behavioral finance studies what investors should do to optimize performance.
D)Behavioral finance studies how investor biases and emotions affect stock prices.

Question 18

An efficient market requires that:

A)all investors are rational and react quickly to new information.
B)information can be obtained at a considerable cost by investors.
C)new information does not have a significant effect on market prices.
D)investors react quickly and fully to new information.

Question 19

Research suggests that low P/E stocks outperform high P/E stocks.Why is this finding an anomaly?

A)Low P/E stocks tend to have higher risk than high P/E stocks.
B)Low P/E stocks are temporarily out of favor but may have strong prospects.
C)The low P/E effect contradicts the Efficient Market Hypothesis.
D)Low P/E stocks are often weak companies.

Question 20

Which of the following observations is most consistent with the EMH?

A)The January effect
B)The random walk
C)The low P/E effect
D)The success of the Value Line Investment Survey

Question 21

To have strong form market efficiency,semi-strong form efficiency is necessary.

Question 22

On average,small,less well-known companies have lower long-run returns than larger,more well-known companies.

Question 23

Behavioral finance integrates sociology with finance.It argues that investors often make systematic mistakes when processing social information about market participants.

Question 24

One explanation for the January effect is that tax-induced sales in December temporarily depress prices,and these prices tend to recover in January.

Question 25

The value effect suggests that investors can earn abnormal returns by holding stocks with:

A)low price multiples.
B)high price multiples.
C)small size and strong recent performance.
D)large size and strong recent performance.

Question 26

Data mining refers to the search for security return patterns by:

A)regressing firm stock returns against firm price multiples.
B)calculating CARs relative to firm earnings announcements.
C)applying various investment techniques to a set of return data.
D)applying filter tests to very large samples of return data.

Question 27

If a public company reports earnings substantially lower than expected,the stock should subsequently earn a positive abnormal return.

Question 28

The SUE effect suggests that superior performance is associated:

A)with stocks exhibiting strong recent price performance.
B)with stocks exhibiting weak long-term past price performance.
C)with stocks that have beat their earnings estimate.
D)with stocks that have low price multiples.

Question 29

In tests of market efficiency,CAR refers to:

A)cumulative average return.
B)compound average return.
C)compound annual return.
D)cumulative abnormal return.

Question 30

The overconfidence bias tends to encourage investors to:

A)trade too much.
B)trade too infrequently.
C)sell winners to early.
D)hold losers to long.

Question 31

Historically,stock returns for companies with low P/E ratios have been better than returns for stocks with high P/E ratios.

Question 32

The financial markets in the U.S.are less efficient than financial markets in less developed countries.

Question 33

"Event studies" study return patterns around specific events such as stock splits or dividend announcements.

Question 34

The SEC has laws to punish insider trading,which implies that the SEC believes in the strong form of the Efficient Market Hypothesis.

Question 35

Financial economists have tested various technical trading rules and found they fail to earn consistent abnormal returns.

Question 36

Evidence indicates that the majority of actively-managed,large cap equity funds outperform the S&P 500 Index.

Question 37

Efficient markets imply investors can not earn abnormal returns.