Deck 13: Efficient Capital Markets and Behavioral Challenges

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.

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

Answer 1

weak

Question 2

Efficient markets require which one of these?

A)Dart thrower investors
B)Only rational investors
C)Overly optimistic amateur investors
D)Countervailing irrationalities
E)Investors adhering to the conservatism principle

Answer 2

Countervailing irrationalities

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

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

Answer 3

I,II,and IV only

Question 4

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

A)totally rational decisions.
B)historical prices.
C)information known to any person or organization.
D)all publicly available information.
E)irrational decisions by amateur investors.

Question 5

The efficient market hypothesis says that on average managers will:

A)tend to earn below average rates of returns.
B)not be able to earn an excess return.
C)outperform investors with inside information.
D)tend to outperform most market participants.
E)earn the same rate of return over time regardless of the risk assumed.

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

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

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.

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 8

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

A)semistrong form inefficiency.
B)cumulative market expectations.
C)a release of information at Time t.
D)conservatism.
E)weak form inefficiency.

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.

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

Question 10

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

A)Positive serial correlation coefficients equal to or greater than 1
B)Lack of daily price movement
C)Lack of any adjustment for degree of risk
D)Repetitive price patterns
E)Normal rates of return

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.

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

Question 12

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

A)stable
B)weak
C)semistrong
D)strong
E)open

Question 13

Market prices can be efficiently priced if:

A)brokerage commissions are zero.
B)a number of interested traders use the publicly available information.
C)securities always offer a positive rate of return to investors.
D)the prices are guaranteed by the U.S.Securities and Exchange Commission.
E)taxes are irrelevant.

Question 14

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

A)Representativeness
B)Synergy
C)Conservatism
D)Arbitrage
E)Independent deviations from rationality

Question 15

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

A)outperformed the overall market on a risk-adjusted basis.
B)eliminated excess profits for arbitrageurs.
C)beat broad-based indexes.
D)proved the market to be strong form efficient.
E)underperformed the market on a risk-adjusted basis.

Question 16

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

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

Question 17

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

A)open
B)strong
C)semistrong
D)weak
E)stable

Question 18

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

A)react immediately to 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)always rise immediately upon the release of 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 19

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

A)inefficient.
B)semiweak form efficient.
C)semistrong form efficient.
D)strong form efficient.
E)weak form efficient.

Question 20

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

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

Question 21

Which one of these is a finding of Ritter's study of initial public offerings (IPOs)?

A)Firms with either IPOs or SEPs tend to outperform their control groups for the 5-year period following the issue of the new securities.
B)IPOs are generally incorrectly priced at issuance because over the next five years the IPO firm's abnormal returns exceeded 6 percent on average.
C)The annual returns for IPO firms during the 5-year period following an IPO are about two percent lower than their control group.
D)Comparable IPO and non-IPO firms had similar returns for the 5-year period following an IPO.
E)IPO firms tend to lose 10 percent or more of their market value in the two years following their IPO.

Question 22

Which one of these would generally be considered the most rational action for a tax-paying investor?

A)Trading frequently
B)Selling their losing and holding their winning securities
C)Throwing darts to select their portfolio holdings
D)Holding a less than fully diversified portfolio of securities
E)Ignoring taxes when making investment decisions

Question 23

The cause of the October 19,1987 stock market crash:

A)is related to actions taken on that date by the Federal Reserve Bank.
B)has been identified as the result of major internet company announcements on the prior day.
C)resulted from losses in international markets.
D)has yet to be determined.
E)was the result of regulatory changes that were implemented that morning.

Question 24

Which of these are reasons why people do not accept the efficient market hypothesis?
I.Optical illusions
II.Normal profits
III.Earnings surprises
IV.Market bubbles

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

Question 25

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 26

The principle that investors might be too slow in adjusting their beliefs to new information is referred to as:

A)conservatism.
B)liberalism.
C)representativeness.
D)weak form efficiency.
E)the timing decision.

Question 27

Keim's research presents evidence that the difference in performance between small capitalization stocks and large capitalization stocks is largest in the month of:

A)January.
B)April.
C)May.
D)August.
E)October.

Question 28

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

A)the decision between LIFO and FIFO for inventory accounting can significantly affect stock prices.
B)a firm can affect its stock price if it either withholds information or provides incorrect information.
C)accounting changes that increase accounting earnings also increase stock prices.
D)switching depreciation methods can significantly affect stock prices.
E)the choice between the percentage-of-completion or the completed-contract method for construction projects affect stock prices.

Question 29

Serial correlation:

A)indicates a reversal in the direction of returns when the coefficient is positive.
B)involves only one security.
C)indicates a tendency toward reversal when its coefficient is positive.
D)measures the cumulative difference between the returns on two similar securities.
E)measures the current relationship between the returns on two securities.

Question 30

The efficient market hypothesis supports which one of these statements?

A)Market prices do not reflect the underlying value of securities.
B)Managers can profitably speculate in foreign currency.
C)Financial managers can time stock and bond sales.
D)Managers cannot boost stock prices through creative accounting.
E)Market prices are uncaused.

Question 31

Which one of these can be used as an argument that independent deviations from rationality are not generally random?

A)Conservatism
B)Stockholder disinterest
C)Arbitrage
D)Insider trading
E)Continuation

Question 32

The abnormal return in an event study is described as the:

A)actual return on a security minus the market rate of return on the same date.
B)total return earned by a security on the date of an announcement affecting that security.
C)total return earned on a security for the 7-day period commencing three days prior to an announcement affecting that security.
D)change in market value of a security on the day of an announcement affecting that security.
E)any change in the market price of a security that exceeds five percent over a 7-day period.

Question 33

What does weak form efficiency imply?

A)Portfolio diversification is ineffective as all prices are interrelated.
B)Past price movement is unrelated to the movement of future prices.
C)Abnormal returns will disappear within a trading day.
D)Price patterns that existed in the past will reappear in the future.
E)A stock with a highly positive serial correlation in the past will maintain that correlation in the future.

Question 34

Even though no final conclusion is currently warranted,a number of research papers,including those of Fama and French,have argued that:

A)there is no noticeable difference in the returns of growth versus value stocks.
B)growth stocks outperform value stocks.
C)stocks with high book-value-to-stock-price ratios outperform stocks with low ratios.
D)no observable differences in returns can be associated with varying price-earnings ratios.
E)stocks with low earnings-to-price ratios outperform stocks with high ratios.

Question 35

The research done by Ikenberry,Lakonishok,and Vermaelen supports the argument that mangers:

A)effectively time IPOs but not SEOs.
B)cannot effectively time IPOs.
C)cannot effectively time either stock sales or repurchases.
D)effectively time stock repurchases.
E)can effectively time stock sales but not repurchases.

Question 36

Which one of these serial coefficient values is most consistent with weak form market efficiency?

A)-1
B)-.5
C)0
D)+.5
E)+1

Question 37

Stock prices fluctuate daily.In relation to the efficient market hypothesis,these fluctuations are:

A)inconsistent with the semistrong form of efficiency because prices should be stable.
B)inconsistent with all forms of market efficiency.
C)consistent with the semistrong form because new information arrives daily.
D)consistent with the strong form because prices and information are controlled by insiders.
E)consistent with all forms of market efficiency provided the prices do fluctuate on a daily basis.

Question 38

If the market is fully efficient,then an announcement by a firm of a new product with a high net present value will cause the market price of that firm's stock to:

A)remain constant.
B)rise gradually over the next few days.
C)decline gradually over the next few days.
D)immediately increase to a new level equivalent to the increased value of the firm.
E)immediately decline to a new level equivalent to the decreased value of the firm.

Question 39

If behavioral finance holds,this implies:

A)all investors are irrational some of the time.
B)all investors are irrational all the time.
C)some investors are irrational some of the time.
D)some investors are irrational all of the time.
E)all investors are rational all of the time.

Question 40

Sam,an avid day trader,has noticed that a particular stock has increased in value in each of the last three trading days.Given this trend,he believes the stock price will increase over the next two trading days.This is an example of:

A)a timing decision.
B)irrational exuberance.
C)representativeness.
D)conservatism.
E)arbitrage.

Question 41

What key item should managers look for when considering an acquisition?

Question 42

Why do you think it is difficult for researchers to agree on principles related to behavioral finance?

Question 43

Franklin Mills announced at Time t that it just sold its worst performing division.There were no other announcements affecting the firm.The firm's stock had daily returns of -.1,+.3,+.8,-.1,+.3 for Time _{t - 2} to Time _{t + 2},respectively.The daily returns on the market were +.2,-.2,+.1,-.2,and +.1 for Time _{t - 2} to Time _{t + 2},respectively.What is the cumulative abnormal return for these five days?

A)+.7
B)+.8
C)+1.1
D)+1.2
E)+.6

Question 44

Southern Goods announced at Time t that it was replacing its CEO.There were no other announcements affecting the firm.The stock had daily returns of -.3,+.2,-.2,-.1,+.3 for Time _{t - 2} to Time _{t + 2},respectively.The daily returns on the market were -.4,+.2,-.4,-.2,and +.2 for Time _{t - 2} to Time _{t + 2},respectively.What is the cumulative abnormal return for these five days?

A)+.1
B)+.3
C).5
D)-.1
E)-.3

Question 45

ALLGO announced at Time t that it was acquiring DoLittle Industries.There were no other announcements affecting these firms.ALLGO's stock had daily returns of -.2,+.1,-.5,-.1,+.1 for Time _{t - 2} to Time _{t + 2},respectively.The daily returns on the market were -.1,+.2,+.1,-.2,and +.2 for Time _{t - 2} to Time _{t + 2},respectively.What is the cumulative abnormal return for these five days?

A)-.7
B)-.8
C)-.5
D)-.10
E)-.3

Question 46

Define the three forms of market efficiency.

Question 47

What are the basic principles behind behavioral finance?

Question 48

Explain why in an efficient market investments have an expected net present value (NPV)of zero.