Question 1

In an efficient market,

Accepted Answer

In an efficient market, prices of securities quickly adjust to new information, ensuring they are always close to their true value, making it impossible for investors to consistently achieve higher returns through security analysis. This concept is encapsulated in choice E, which combines A, B, and C, all of which are characteristics of an efficient market.

Question 2

On November 22, the stock price of Coca Cola was $69.50, and the retailer stock index was 600.30. On November 25, the stock price of Coca Cola was $70.25, and the retailer stock index was 605.20. Consider the ratio of Coca Cola to the retailer index on November 22 and November 25. Coca Cola is _______ the retail industry, and technical analysts who follow relative strength would advise _______ the stock.

Accepted Answer

Explanation: To determine if Coca Cola is outperforming or underperforming the retail industry, we calculate the ratio of Coca Cola's stock price to the retailer index for both dates. On November 22, the ratio is $ \frac{69.50}{600.30} $, and on November 25, the ratio is $ \frac{70.25}{605.20} $. The increase in this ratio indicates that Coca Cola's stock price increased more, in relative terms, than the retailer index, suggesting that Coca Cola is outperforming the retail industry. Technical analysts who follow relative strength would see this as a positive sign and would likely advise buying the stock.

Question 3

Studies of positive earnings surprises have shown that there is

Accepted Answer

Studies have shown that when companies announce positive earnings surprises, not only do their stock prices typically experience a positive abnormal return on the day of the announcement, but there is also a tendency for the stock price to continue drifting upwards in the days following the announcement. This phenomenon is known as the post-earnings announcement drift (PEAD).

Question 4

A finding that _________ would provide evidence against the semistrong form of the efficient-market theory.

Accepted Answer

The answer of A finding that _________ would provide evidence...

Question 5

A market decline of 23% on a day when there is no significant macroeconomic event ______ consistent with the EMH because ________.

Accepted Answer

According to the Efficient Market Hypothesis (EMH), market prices reflect all available information. A significant market decline without any macroeconomic news suggests that the market is not efficiently processing information, which is inconsistent with EMH.

Question 6

Two basic assumptions of technical analysis are that security prices adjust

Accepted Answer

Technical analysis assumes that security prices adjust gradually to new information and that market prices are determined by the interaction of supply and demand.

Question 7

Cumulative abnormal returns (CAR)

Accepted Answer

Cumulative abnormal returns (CAR) are used in event studies and are better measures of security returns due to firm-specific events than are abnormal returns (AR).

Question 8

Studies of stock price reactions to news are called

Accepted Answer

Event studies analyze how stock prices react to specific events, such as earnings announcements or regulatory changes, to assess the impact of these events on stock value.

Question 9

The weather report says that a devastating and unexpected freeze is expected to hit Florida tonight during the peak of the citrus harvest. In an efficient market, one would expect the price of Florida Orange's stock to

Accepted Answer

In an efficient market, all available information is immediately incorporated into stock prices. Therefore, the expectation of a devastating freeze, which would likely damage the citrus harvest and negatively impact Florida Orange's business, would cause the stock price to drop immediately as investors react to the news.

Question 10

Studies of negative earnings surprises have shown that there is

Accepted Answer

Studies have shown that when companies announce earnings that are below expectations (negative earnings surprises), there is typically a negative abnormal return on the announcement day. This means the stock price drops more than what would be expected based on market movements alone. Following the announcement, the stock price tends to continue to drift lower, indicating a negative drift in the days after the announcement. This reflects the market's adjustment to the new, lower-than-expected earnings information.

Question 11

Proponents of the EMH think technical analysts

Accepted Answer

Proponents of the Efficient Market Hypothesis (EMH) believe that all available information is already reflected in stock prices, making it impossible to consistently achieve higher returns through technical analysis or any form of market timing. Therefore, they think technical analysts are wasting their time.

Question 12

Work by Amihud and Mendelson (1986, 1991)

Accepted Answer

Amihud and Mendelson's work suggests that investors require a higher return for investing in less liquid stocks, which can help explain both the small firm effect (where smaller firms often have less liquidity and thus higher expected returns) and the neglected firm effect (where less followed or less popular firms, often smaller and less liquid, also demand higher returns).

Question 13

The likelihood of an investment newsletter's successfully predicting the direction of the market for three consecutive years by chance should be

Accepted Answer

The answer of The likelihood of an investment newsletter's successfully...

Question 14

The weak form of the efficient-market hypothesis contradicts

Accepted Answer

The answer of The weak form of the efficient-market hypothesis...

Question 15

A support level is the price range at which a technical analyst would expect the

Accepted Answer

A support level is typically where demand increases, preventing the stock price from decreasing further.

Question 16

Studies of mutual-fund performance

Accepted Answer

Studies of mutual-fund performance generally show that randomly selecting a mutual fund is not advisable because past performance does not guarantee future results. Additionally, while professional management aims for above-market returns, there's no assurance of achieving this, making option D the most comprehensive and accurate choice without implying guaranteed above-market returns.

Question 17

The weak form of the efficient-market hypothesis asserts that

Accepted Answer

The weak form of the efficient-market hypothesis suggests that all past trading information is already reflected in stock prices, meaning that analyzing past price movements (technical analysis) will not provide an investor with an advantage. Therefore, future stock price movements cannot be predicted based on past prices, and technicians (those who rely on technical analysis) cannot consistently outperform the market.

Question 18

In an efficient market the correlation coefficient between stock returns for two nonoverlapping time periods should be

Accepted Answer

In an efficient market, prices fully reflect all available information at any point in time, meaning that past prices or returns cannot predict future prices or returns. Therefore, the correlation coefficient between stock returns for two nonoverlapping time periods should be zero, indicating no linear relationship.

Question 19

Banz (1981) found that, on average, the risk-adjusted returns of large firms

Accepted Answer

Banz (1981) discovered that small firms, on average, had higher risk-adjusted returns than large firms, a phenomenon known as the "small firm effect."

Question 20

Fama and French (1992) found that the stocks of firms within the highest decile of book-to-market ratios had an average annual return of _______, while the stocks of firms within the lowest decile of book-to-market ratios had an average annual return of ________.

Accepted Answer

Fama and French (1992) found that stocks of firms with the highest decile of book-to-market ratios (indicating they are potentially undervalued) had higher average annual returns (17.2%) compared to those in the lowest decile (indicating they are potentially overvalued) with an average annual return of 11.1%. This supports the value effect, where higher book-to-market ratios are associated with higher future returns.

Quiz 11: The Efficient Market Hypothesis