Deck 8: The Efficient Market Hypothesis

Question 1

When the market risk premium rises, stock prices will ________.

A) rise
B) fall
C) recover
D) have excess volatility

Answer 1

B

Question 2

The small-firm effect is strongest in which month?

A) January
B) June
C) July
D) December

Answer 2

A

Question 3

Random price movements indicate ________.

A) irrational markets
B) that prices cannot equal fundamental values
C) that technical analysis to uncover trends can be quite useful
D) that markets are functioning efficiently

Answer 3

D

Question 4

Which of the following is not a method employed by followers of technical analysis?

A) charting
B) relative strength analysis
C) earnings forecasting
D) trading around support and resistance levels

Question 5

In a 1953 study of stock prices, Maurice Kendall found that ________.

A) there were no predictable patterns in stock prices
B) stock prices exhibited strong serial autocorrelation
C) day-to-day stock prices followed consistent trends
D) fundamental analysis could be used to generate abnormal returns

Question 6

If you believe in the ________ form of the EMH, you believe that stock prices reflect all relevant information, including information that is available only to insiders.

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

Question 7

The primary objective of fundamental analysis is to identify ________.

A) well-run firms
B) poorly run firms
C) mispriced stocks
D) high P/E stocks

Question 8

Evidence suggests that there may be ________ momentum and ________ reversal patterns in stock price behavior.

A) short-run; short-run
B) long-run; long-run
C) long-run; short-run
D) short-run; long-run

Question 9

The semistrong form of the EMH states that ________ must be reflected in the current stock price.

A) all security price and volume data
B) all publicly available information
C) all information, including inside information
D) all costless information

Question 10

The weak form of the EMH states that ________ must be reflected in the current stock price.

A) all past information, including security price and volume data
B) all publicly available information
C) all information, including inside information
D) all costless information

Question 11

________ is the return on a stock beyond what would be predicted from market movements alone.

A) A normal return
B) A subliminal return
C) An abnormal return
D) None of these options

Question 12

Which of the following is not a method employed by fundamental analysts?

A) analyzing the Fed's next interest rate move
B) relative strength analysis
C) earnings forecasting
D) estimating the economic growth rate

Question 13

Stock prices that are stable over time ________.

A) indicate that prices are useful indicators of true economic value
B) indicate that the market is not incorporating new information into current stock prices
C) ensure that an economy allocates its resources efficiently
D) indicates that returns follow a random-walk process

Question 14

If you believe in the ________ form of the EMH, you believe that stock prices reflect all publicly available information but not information that is available only to insiders.

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

Question 15

The strong form of the EMH states that ________ must be reflected in the current stock price.

A) all security price and volume data
B) all publicly available information
C) all information, including inside information
D) all costless information

Question 16

Most of the stock price response to a corporate earnings or dividend announcement occurs within ________.

A) about 30 seconds
B) about 10 minutes
C) 6 months
D) 2 years

Question 17

The tendency when the ________ performing stocks in one period are the best performers in the next and the current ________ performers are lagging the market later is called the reversal effect.

A) worst; best
B) worst; worst
C) best; worst
D) best; best

Question 18

You believe that stock prices reflect all information that can be derived by examining market trading data such as the history of past stock prices, trading volume, or short interest, but you do not believe stock prices reflect all publicly available and inside information. You are a proponent of the ________ form of the EMH.

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

Question 19

Which of the following beliefs would not preclude charting as a method of portfolio management?

A) The market is strong-form efficient.
B) The market is semistrong-form efficient.
C) The market is weak-form efficient.
D) Stock prices follow recurring patterns.

Question 20

Proponents of the EMH typically advocate ________.

A) a conservative investment strategy
B) a liberal investment strategy
C) a passive investment strategy
D) an aggressive investment strategy

Question 21

Fama and French have suggested that many market anomalies can be explained as manifestations of ________.

A) regulatory effects
B) high trading costs
C) information asymmetry
D) varying risk premiums

Question 22

You are looking to invest in one of three stocks. All other things being equal, Stock A has high expected earnings growth, stock B has only modest expected earnings growth, and stock C is expected to generate poor earnings growth. According to LaPorta's 1996 study, which stock is likely to generate the greatest alpha for you?

A) Stock A
B) Stock B
C) Stock C
D) The answer cannot be determined from the information given.

Question 23

According to 1968 research by Ball and Brown, securities markets fully adjust to earnings announcements ________.

A) instantly
B) in 1 day
C) in 1 week
D) gradually over time

Question 24

Fundamental analysis is likely to yield best results for ________.

A) NYSE stocks
B) neglected stocks
C) stocks that are frequently in the news
D) fast-growing companies

Question 25

Most people would readily agree that the stock market is not ________.

A) weak-form efficient
B) semistrong-form efficient
C) strong-form efficient
D) efficient at all

Question 26

Evidence supporting semistrong-form market efficiency suggests that investors should ________.

A) rely on technical analysis to select securities
B) rely on fundamental analysis to select securities
C) use a passive trading strategy such as purchasing an index fund or an ETF
D) select securities by throwing darts at the financial pages of the newspaper

Question 27

When stock returns exhibit positive serial correlation, this means that ________ returns tend to follow ________ returns.

A) positive; positive
B) positive; negative
C) negative; positive
D) positive; zero

Question 28

Which of the following is not an issue that is central to the debate regarding market efficiency?

A) the magnitude issue
B) the tax-loss selling issue
C) the lucky event issue
D) the selection bias issue

Question 29

Joe bought a stock at $57 per share. The price promptly fell to $55. Joe held on to the stock until it again reached $57, and then he sold it once he had eliminated his loss. If other investors do the same to establish a trading pattern, this would contradict ________.

A) the strong-form EMH
B) the weak-form EMH
C) technical analysis
D) the semistrong-form EMH

Question 30

You are an investment manager who is currently managing assets worth $6 billion. You believe that active management of your fund could generate an additional one-tenth of 1% return on the portfolio. If you want to make sure your active strategy adds value, how much can you spend on security analysis?

A) $12,000,000
B) $6,000,000
C) $3,000,000
D) $0

Question 31

A mutual fund that attempts to hold quantities of shares in proportion to their representation in the market is called an ________ fund.

A) stock
B) index
C) hedge
D) money market

Question 32

You believe that you can earn 2% more on your portfolio if you engage in full-time stock research. However, the additional trading costs and tax liability from active management will cost you about .5%. You have an $800,000 stock portfolio. What is the most you can afford to spend on your research?

A) $4,000
B) $8,000
C) $12,000
D) $16,000

Question 33

"Buy a stock if its price moves up by 2% more than the Dow Average" is an example of a ________.

A) trading rule
B) market anomaly
C) fundamental approach
D) passive trading strategy

Question 34

In their 2010 study, Fama and French used a four-factor model to analyze excess returns on equity mutual funds. They found that the funds ________.

A) had negative alphas before fees were considered
B) had positive alphas after fees were considered
C) had negative alphas after fees were considered
D) had negative alphas before fees were considered and had negative alphas after fees were considered

Question 35

Choosing stocks by searching for predictable patterns in stock prices is called ________.

A) fundamental analysis
B) technical analysis
C) index management
D) random-walk investing

Question 36

Basu found that firms with high P/E ratios ________.

A) earned higher average returns than firms with low P/E ratios
B) earned the same average returns as firms with low P/E ratios
C) earned lower average returns than firms with low P/E ratios
D) had higher dividend yields than firms with low P/E ratios

Question 37

Small firms have tended to earn abnormal returns primarily in ________.

A) the month of January
B) the month July
C) the trough of the business cycle
D) the peak of the business cycle

Question 38

In a 1988 study, Fama and French found that the return on the aggregate stock market was ________ when the dividend yield was higher.

A) higher
B) lower
C) unaffected
D) more skewed

Question 39

Proponents of the EMH think technical analysts ________.

A) should focus on relative strength
B) should focus on resistance levels
C) should focus on support levels
D) are wasting their time

Question 40

Jaffe found that stock prices ________ after insiders intensively bought shares and ________ after insiders intensively sold shares.

A) decreased; decreased
B) decreased; increased
C) increased; decreased
D) increased; increased

Question 41

If the U.S. capital markets are not informationally efficient, ________.

A) the markets cannot be allocationally efficient
B) systematic risk does not matter
C) no type of analysis can be used to generate abnormal returns
D) returns must follow a random walk

Question 42

The term random walk is used in investments to refer to ________.

A) stock price changes that are random but predictable
B) stock prices that respond slowly to both old and new information
C) stock price changes that are random and unpredictable
D) stock prices changes that follow the pattern of past price changes

Question 43

The Fama and French evidence that high book-to-market firms outperform low book-to-market firms even after adjusting for beta means that ________.

A) high book-to-market firms are underpriced or the book-to-market ratio is a proxy for a unique risk factor
B) low book-to-market firms are underpriced or the book-to-market ratio is a proxy for a systematic risk factor
C) either high book-to-market firms are underpriced or the book-to-market ratio is a proxy for a systematic risk factor
D) high book-to-market firms have more post-earnings drift

Question 44

Stock market analysts have tended to be ________ in their recommendations to investors.

A) slightly overly optimistic
B) overwhelmingly optimistic
C) slightly overly pessimistic
D) overwhelmingly pessimistic

Question 45

The effect of liquidity on stock returns might be related to:
I) The small-firm effect
II The book-to-market effect
III The neglected-firm effect
IV) The P/E effect

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

Question 46

According to the semistrong form of the efficient markets hypothesis, ________.

A) stock prices do not rapidly adjust to new information
B) future changes in stock prices cannot be predicted from any information that is publicly available
C) corporate insiders should have no better investment performance than other investors even if allowed to trade freely
D) arbitrage between futures and cash markets should not produce extraordinary profits

Question 47

Most tests of semistrong efficiency are ________.

A) designed to test whether inside information can be used to generate abnormal returns
B) based on technical trading rules
C) unable to generate any evidence of market anomalies
D) joint tests of market efficiency and the risk-adjustment measure

Question 48

According to results by Seyhun, ________.

A) investors cannot usually earn abnormal returns by following inside trades after knowledge of the trades are made public
B) investors can usually earn abnormal returns by following inside trades after knowledge of the trades are made public
C) investors cannot earn abnormal returns by following inside trades before knowledge of the trades are made public
D) investors cannot earn abnormal returns by trading before insiders

Question 49

"Active investment management may at times generate additional returns of about .1%. However, the standard deviation of the typical well-diversified portfolio is about 20%, so it is very difficult to statistically identify any increase in performance." Even if true, this statement is an example of the ________ problem in deciding how efficient the markets are.

A) magnitude
B) selection bias
C) lucky event
D) allocation

Question 50

Even if the markets are efficient, professional portfolio management is still important because it provides investors with:
I) Low-cost diversification
II) A portfolio with a specified risk level
III) Better risk-adjusted returns than an index

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

Question 51

Assume that a company announces unexpectedly high earnings in a particular quarter. In an efficient market one might expect ________.

A) an abnormal price change immediately after the announcement
B) an abnormal price increase before the announcement
C) an abnormal price decrease after the announcement
D) no abnormal price change before or after the announcement

Question 52

J. M. Keyes put all his money in one stock, and the stock doubled in value in a matter of months. He did this three times in a row with three different stocks. J. M. got his picture on the front page of the Wall Street Journal. However, the paper never mentioned the thousands of investors who made similar bets on other stocks and lost most of their money. This is an example of the ________ problem in deciding how efficient the markets are.

A) magnitude
B) selection bias
C) lucky event
D) small firm

Question 53

If the daily returns on the stock market are normally distributed with a mean of .05% and a standard deviation of 1%, the probability that the stock market would have a return of -23% or worse on one particular day (as it did on Black Monday) is approximately ________.

A) )0%
B) )1%
C) 1%
D) 10%

Question 54

Banz found that, on average, the risk-adjusted returns of small firms ________.

A) were higher than the risk-adjusted returns of large firms
B) were the same as the risk-adjusted returns of large firms
C) were lower than the risk-adjusted returns of large firms
D) were negative

Question 55

Among the important characteristics of market efficiency is (are) that:
I) There are no arbitrage opportunities.
II) Security prices react quickly to new information.
III) Active trading strategies will not consistently outperform passive strategies.

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

Question 56

The broadest information set is included in the ________.

A) weak-form efficiency argument
B) semistrong-form efficiency argument
C) strong-form efficiency argument
D) technical analysis trading method

Question 57

DeBondt and Thaler (1985) found that the poorest-performing stocks in one time period experienced ________ performance in the following period and that the best-performing stocks in one time period experienced ________ performance in the following time period.

A) good; good
B) good; poor
C) poor; good
D) poor; poor

Question 58

Market anomaly refers to ________.

A) an exogenous shock to the market that is sharp but not persistent
B) a price or volume event that is inconsistent with historical price or volume trends
C) a trading or pricing structure that interferes with efficient buying and selling of securities
D) price behavior that differs from the behavior predicted by the efficient market hypothesis

Question 59

Which of the following contradicts the proposition that the stock market is weakly efficient?

A) Over 25% of mutual funds outperform the market on average.
B) Insiders earn abnormal trading profits.
C) Every January, the stock market earns above-normal returns.
D) Applications of technical trading rules fail to earn abnormal returns.

Question 60

The ________ effect may explain much of the small-firm anomaly.
I) January
II) neglected
III) liquidity

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

Question 61

One type of passive portfolio management is ________.

A) investing in a well-diversified portfolio without attempting to search out mispriced securities
B) investing in a well-diversified portfolio while only seeking out passively mispriced securities
C) investing an equal dollar amount in index stocks
D) investing in an equal amount of shares in each of the index stocks

Question 62

An implication of the efficient market hypothesis is that ________.

A) high-beta stocks are consistently overpriced
B) low-beta stocks are consistently overpriced
C) nonzero alphas will quickly disappear
D) growth stocks are better buys than value stocks

Question 63

Which of the following is not a concept related to explaining abnormal excess stock returns?

A) January effect
B) neglected-firm effect
C) P/E effect
D) preferred stock effect

Question 64

Insiders are able to profitably trade and earn abnormal returns prior to the announcement of positive news. This is a violation of which form of efficiency?

A) weak-form efficiency
B) semistrong-form efficiency
C) strong-form efficiency
D) technical analysis

Question 65

Value stocks may provide investors with better returns than growth stocks if:
I) Value stocks are out of favor with investors.
II) Prices of growth stocks include premiums for overly optimistic growth levels.
III) Value stocks are likely to generate positive-earnings surprises.

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

Question 66

A technical analyst is most likely to be affiliated with which investment philosophy?

A) active management
B) buy and hold
C) passive investment
D) index funds

Question 67

In an efficient market and for an investor who believes in a passive approach to investing, what is the primary duty of a portfolio manager?

A) accounting for results
B) diversification
C) identifying undervalued stocks
D) no need for a portfolio manager

Question 68

Which of the following is not a topic related to the debate over market efficiency?

A) IPO results
B) lucky event issue
C) magnitude issue
D) selection bias

Question 69

The tendency of poorly performing stocks and well-performing stocks in one period to continue their performance into the next period is called the ________.

A) fad effect
B) martingale effect
C) momentum effect
D) reversal effect

Question 70

The lack of adequate trading volume in stock that may ultimately lead to its ability to produce excess returns is referred to as the ________.

A) January effect
B) liquidity effect
C) neglected-firm effect
D) P/E effect

Question 71

Evidence by Blake, Elton, and Gruber indicates that, on average, actively managed bond funds ________.

A) outperform passive fixed-income indexes
B) underperform passive fixed-income indexes by a wide margin
C) perform as well as passive fixed-income indexes
D) underperform passive fixed-income indexes by an amount equal to fund expenses

Question 72

Which of the following would violate the efficient market hypothesis?

A) Intel has consistently generated large profits for years.
B) Prices for stocks before stock splits show, on average, consistently positive abnormal returns.
C) Investors earn abnormal returns months after a firm announces surprise earnings.
D) High-earnings growth stocks fail to generate higher returns for investors than do low earnings growth stocks.

Question 73

Someone who invests in the Vanguard Index 500 mutual fund could most accurately be described as using which approach?

A) Active management
B) Arbitrage
C) Fundamental analysis
D) Passive investment

Question 74

The four-factor model used to construct performance benchmarks for mutual funds uses the three Fama and French factors and one additional factor related to ________.

A) the tenure of the fund manager
B) momentum
C) fees
D) the age of the fund manager

Question 75

The semistrong-form of the efficient market hypothesis implies that ________ generate abnormal returns and ________ generate abnormal returns.

A) technical analysis cannot; fundamental analysis can
B) technical analysis can; fundamental analysis can
C) technical analysis can; fundamental analysis cannot
D) technical analysis cannot; fundamental analysis cannot

Question 76

Value stocks usually exhibit ________ price-to-book ratios and ________ price-to-earnings ratios.

A) low; low
B) low; high
C) high; low
D) high; high

Question 77

Which Fidelity Magellan portfolio manager is often referenced as an exception to the general conclusion of efficient markets?

A) Jeff Vinik
B) Peter Lynch
C) Robert Stansky
D) William Hayes

Question 78

A day trade with an average stock holding period of under 8 minutes might be most closely associated with which trading philosophy?

A) EMH
B) fundamental analysis
C) strong-form market efficiency
D) technical analysis

Question 79

Growth stocks usually exhibit ________ price-to-book ratios and ________ price-to-earnings ratios.

A) low; low
B) low; high
C) high; low
D) high; high

Question 80

Which of the following stock price observations would appear to contradict the weak form of the efficient market hypothesis?

A) The average rate of return is significantly greater than zero.
B) The correlation between the market return one week and the return the following week is zero.
C) You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.
D) You could have consistently made superior returns by forecasting future earnings performance with your new Crystal Ball forecast methodology.