Deck 13: Efficient Capital Markets and Behavioural Finance

Question 1

Your best friend works in the finance office of the Delta Corporation.You are aware that this friend trades Delta shares 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 shares.Based on this information, you would tend to argue that the financial markets
Are at best _____ form efficient.

A)weak
B)semiweak
C)semistrong
D)strong
E)perfect

Answer 1

semistrong

Question 2

If the efficient market hypothesis holds, investors should expect:

A)to earn only a normal return.
B)to receive a fair price for their securities.
C)always be able to pick stocks that will outperform the market averages.
D)Both A and B.
E)Both B and C.

Answer 2

Both A and B.

Question 3

Which of the following would be indicative of inefficient markets?

A)Overreaction and reversion
B)Delayed response
C)Immediate and accurate response
D)Both A and B.
E)Both A and C.

Answer 3

Both A and B.

Question 4

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

A)earn extraordinary returns on a routine basis.
B)generally have positive net present values.
C)generally have zero net present values.
D)produce arbitrage opportunities on a routine basis.
E)produce negative returns on a routine basis.

Question 5

Individuals that continually monitor the financial markets seeking mispriced securities:

A)tend to make substantial profits on a daily basis.
B)tend to make the markets more efficient.
C)are never able to find a security that is temporarily mispriced.
D)are always quite successful using only well-known public information as their basis of
Evaluation.
E)are always quite successful using only historical price information as their basis of
Evaluation.

Question 6

Financial managers can create value through financing decisions that:

A)reduce costs or increase subsidies.
B)increase the product prices.
C)creating a new security.
D)Both A and B.
E)Both A and C.

Question 7

An investor discovers that for a certain group of equities, large positive price changes are always followed by large negative price changes.This finding is a violation of the:

A)moderate form of the efficient market hypothesis.
B)semistrong form of the efficient market hypothesis.
C)strong form of the efficient market hypothesis.
D)weak form of the efficient market hypothesis.
E)None of the above.

Question 8

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

A)Real asset markets are more efficient than financial markets.
B)If a market is efficient, arbitrage opportunities should be common.
C)In an efficient market, some market participants will have an advantage over others.
D)A firm will generally receive a fair price when it sells shares.
E)New information will gradually be reflected in a stock's price to avoid any sudden change
In the price of the stock.

Question 9

Efficient capital markets are financial markets:

A)in which current market prices reflect available information.
B)in which current market prices reflect the present value of securities.
C)in which there is no excess profit from using available information.
D)in which the stock price would constantly react to new information.
E)All of the above.

Question 10

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.

A)I and III only.
B)II and IV only.
C)I, II, and III only.
D)II, III, and IV only.
E)I, II, III, and IV.

Question 11

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

A)open
B)strong
C)semi-strong
D)weak
E)stable

Question 12

Under the concept of an efficient market, a random walk in stock prices means that:

A)there is no driving force behind price changes.
B)technical analysts can predict future price movements to earn excess returns.
C)the unexplained portion of price change in one period is unrelated to the unexplained
Portion of price change in any other period.
D)the unexplained portion of price change in one period that can not be explained by
Expected return can only be explained by the unexplained portion of price change in a
Prior period.
E)None of the above.

Question 13

In an efficient market when a firm makes an announcement of a new product or product enhancement with superior technology providing positive NPV, the share price will:

A)rise gradually over the next few days.
B)decline gradually over the next few days.
C)rise on the same day to the new price.
D)stay at the same price, with no net effect.
E)drop on the same day to the new price.

Question 14

If you excel in analyzing the future outlook of firms, you would prefer that the financial markets be ____ form efficient so that you can have an advantage in the marketplace.

A)weak
B)semiweak
C)semistrong
D)strong
E)perfect

Question 15

Which form of the efficient market hypothesis implies that security prices reflect only information contained in past prices?

A)Weak form
B)Semistrong form
C)Strong form
D)Hard form
E)Past form

Question 16

According to theory, studying historical prices in order to identify mispriced equities will not work in markets that are _____ efficient.
I.weak form
II.semi-strong form
III.strong form

A)I only.
B)II only.
C)I and II only.
D)II and III only.
E)I, II, and III.

Question 17

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

A)weak form efficient.
B)semi-weak form efficient.
C)semi-strong form efficient.
D)strong form efficient.
E)inefficient.

Question 18

According to the efficient market hypothesis, financial markets fluctuate daily because they:

A)are inefficient.
B)slowly react to new information.
C)are continually reacting to new information.
D)offer tremendous arbitrage opportunities.
E)only reflect historical information.

Question 19

Market regulators across the world periodically charge individuals for insider trading and claim those individuals have made unfair profits.Based on this fact, you would tend to argue that the
financial markets are at best _____ form efficient.

A)weak
B)semiweak
C)semistrong
D)strong
E)perfect

Question 20

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

A)always rise immediately upon the release of new information with no further price
Adjustments related to that information.
B)react to new information over a two-day period after which time no further price
Adjustments related to that information will occur.
C)rise sharply when new information is first released and then decline to a new stable level
By the following day.
D)react immediately to new information with no further price adjustments related to that
Information.
E)be slow to react for the first few hours after new information is released allowing time for
That information to be reviewed and analyzed.

Question 21

Which of the following is true?

A)A random walk for share price changes is inconsistent with observed patterns in price
Changes.
B)If the share market follows a random walk, price changes should be highly correlated.
C)If the share market is weak form efficient, then share prices follow a random walk.
D)All of the above.
E)Both B and C.

Question 22

An investor discovers that predictions about weather patterns published years in advance and found in the Farmer's Almanac are amazingly accurate.In fact, these predictions enable the investor
To predict the health of the farm economy and therefore certain security prices.This finding is a
Violation of the:

A)moderate form of the efficient market hypothesis.
B)semistrong form of the efficient market hypothesis.
C)weak form of the efficient market hypothesis.
D)strong form of the efficient market hypothesis.
E)None of the above.

Question 23

Ritter's study of Initial Public Offerings (IPOs) showed that the post offering share performance was:

A)less than the control group by about 2% in the five years following the IPO.
B)incorrectly priced at issuance because over the next five years the abnormal returns were
Greater than zero on average.
C)immaterial to the pricing of the IPO because future market performance is unknown at
Issuance.
D)equal across IPOs, irrespective of risk or which year they were issued.
E)All of the above.

Question 24

If the securities market is efficient, an investor need only throw darts at the equity pages to pick securities and be just as well off.

A)This is true because there are no differences in risk and return.
B)This is true because in an efficient stock market prices do not fluctuate.
C)This is false because professional portfolio managers prefer to generate commissions by
Active trading.
D)This is false because investors may not hold a desirable risk-return combination in their
Portfolio.
E)This is false because the markets are controlled by the institutional investors.

Question 25

Event studies have been used to examine:

A)IPOs, SEOs, and other equity issuances.
B)changes in earnings.
C)mergers and acquisitions.
D)most financial events.
E)All of the above.

Question 26

Market efficiency says:

A)prices may not reflect underlying value.
B)a good financial manager can time equity sales.
C)managers should make profit by speculating in foreign currency.
D)managers cannot boost share prices through creative accounting.
E)None of the above.

Question 27

A lawyer works for a firm that advises corporate firms planning to sue other corporations for antitrust damages.He finds that he can "beat the market" by short-selling the shares of the firm that
Will be sued.This finding is a violation of the:

A)moderate form of the efficient market hypothesis.
B)semistrong form of the efficient market hypothesis.
C)strong form of the efficient market hypothesis.
D)weak form of the efficient market hypothesis.
E)None of the above.

Question 28

Studies of the performance of professionally managed mutual funds find that these funds:

A)do not outperform a market index.Assuming mutual fund managers rely primarily on
Public information, this finding refutes the semistrong form of the efficient market
Hypothesis.
B)do not outperform a market index.Assuming mutual fund managers rely primarily on
Public information, this finding supports the semistrong form of the efficient market
Hypothesis.
C)outperform a market index.Assuming mutual fund managers rely primarily on public
Information, this finding refutes the strong form of the efficient market hypothesis.
D)outperform a market index.Assuming mutual fund managers rely primarily on public
Information, this finding supports the semistrong form of the efficient market hypothesis.
E)Both C and D.

Question 29

A semistrong form efficient market is distinct from a weak form efficient market in historical prices by:

A)incorporating only random movements in the price.
B)incorporating all publicly available information in the price.
C)incorporating inside information in the price.
D)incorporating all privately available information in the price.
E)None of the above.

Question 30

Suppose that firms with unexpectedly high earnings earn abnormally high returns for several months after the announcement.This would be evidence of:

A)efficient markets in the weak form.
B)inefficient markets in the weak form.
C)efficient markets in the semistrong form.
D)inefficient markets in the semistrong form.
E)inefficient markets in the strong form.

Question 31

The market price of a stock moves or fluctuates daily.This fluctuation is:

A)inconsistent with the semistrong efficient market hypothesis because prices should be
Stable.
B)inconsistent with the weak form efficient market hypothesis because all past information
Should be priced in.
C)consistent with the semistrong form of the efficient market hypothesis because as new
Information arrives daily prices will adjust to it.
D)consistent with the strong form because prices are controlled by insiders.
E)None of the above.

Question 32

An investor discovers that share prices change drastically as a result of certain events.This finding is a violation of the:

A)moderate form of the efficient market hypothesis.
B)semistrong form of the efficient market hypothesis.
C)strong form of the efficient market hypothesis.
D)weak form of the efficient market hypothesis.
E)None of the above.

Question 33

Consider the following two statements: (i) If markets are strong form efficient, the only reason that prices change is because there is news.
(ii) In strong form efficient markets, investors can ignore their risk exposure.

A)(i) is correct, (ii) is incorrect.
B)(ii) is correct, (i) is incorrect.
C)Both (i) and (ii) are correct.
D)Both (i) and (ii) are incorrect.
E)In strong form efficient markets, prices do not change.

Question 34

If a market is strong form efficiency, it also implies that:

A)semistrong form efficiency holds.
B)weak form efficiency holds.
C)one cannot earn abnormal returns with inside information.
D)Both A and C.
E)A, B and C.

Question 35

Which of the following is not true about serial correlation?

A)It measures the correlation between the current return on a security and the current return
On another security.
B)It involves only one security.
C)Positive serial correlation indicates a tendency for continuation.
D)Negative serial correlation indicates a tendency toward reversal.
E)Significant positive or negative serial correlation coefficients are indicative of market
Inefficiency in the weak form.

Question 36

In examining the issue of whether the choice of accounting methods affects share prices, studies have found that:

A)accounting depreciation methods can significantly affect share prices.
B)switching depreciation methods can significantly affect share prices.
C)accounting changes that increase accounting earnings also increases share prices.
D)accounting changes can affect share prices if the company were either to withhold
Information or provide incorrect information.
E)All of the above.

Question 37

In testing whether a market is characterized by weak form efficiency:

A)a positive coefficient of serial correlation for a particular share indicates a tendency toward
Reversal.
B)a negative coefficient of serial correlation for a particular equity indicates a tendency
Toward continuation.
C)serial correlation coefficients are consistent with weak form efficiency.
D)Both A and C.
E)Both A and B.

Question 38

If the market is weak form efficient:

A)semistrong form efficiency hold.
B)strong form efficiency must hold.
C)semistrong form efficiency may hold.
D)markets are not weak form efficient.
E)None of the above.

Question 39

Financial managers must be cognizant of market efficiency because:

A)manipulating earnings by accounting changes does not fool the market.
B)timing security sales is futile because without private information the current price reflects
All known information.
C)there is limited price pressure from any large sale of equity depressing prices momentarily
Which then recover to prior levels.
D)the market as a whole is shrewd.
E)All of the above.

Question 40

The abnormal returns for initial public offerings over longer time periods seem to call market efficiency into question because:

A)the average returns at announcement are large and positive while the long-term results
Are much lower than the returns for seasoned equity offerings.
B)the average returns at announcement are small and negative while the long-term results
Are much lower than the returns for seasoned equity offerings.
C)the average returns at announcement are zero while the long-term results are much higher
Than the returns for seasoned equity offerings.
D)the average returns at announcement are large and positive while the long-term results
Are much higher than the returns for seasoned equity offerings.
E)the average returns at announcement are insignificant while the long-term results are
Much lower than the returns for seasoned equity offerings.

Question 41

A friend of yours tells you that in order for markets to be efficient, all investors need to be rational all of the time.Is your friend correct? Why, or why not?

Question 42

Define the three forms of market efficiency.

Question 43

Why should a financial decision maker such as a corporate treasurer or CFO be concerned with market efficiency?

Question 44

Do you think the lessons from capital market history will hold for each year in the future? That is, as an example, if you buy small company shares will your investment always outperform Treasury bonds?

Question 45

Explain why it is that in an efficient market, investments have an expected NPV of zero.

Question 46

Suppose your cousin invests in the stock market and doubles her money in a single year while the market, on average, earned a return of only about 15%.Is your cousin's performance a violation of market efficiency?

Question 47

Why do we look at cumulative abnormal returns when we test whether markets are efficient?

Question 48

A good friend of yours got a job as a fund manager.He manages a high-risk tech stock fund, and can expect to earn a large bonus if he manages to outperform the market.At the end of his first year working in the job, he indeed tells you he has earned a huge bonus.If markets are efficient, what can you expect him to tell you about his bonus a year later?

Question 49

Consider the following two statements: (i) The representativeness principle results in an under reaction in share markets.
(ii) The conservatism principle can explain why share prices underreact to new information as long
As there are enough conservative investors.

A)(i) is correct, (ii) is incorrect.
B)(ii) is correct, (i) is incorrect.
C)Both (i) and (ii) are correct.
D)Both (i) and (ii) are incorrect.
E)Representativeness refers to the tendency for individual stocks to follow the market.