Question 1

Which form of efficient market asserts that asset prices fully reflect all information, which includes both public and private information?

Accepted Answer

Strong-form efficient market hypothesis asserts that asset prices fully reflect all information, both public and private (or insider information), meaning that no one can consistently achieve higher returns.

Question 2

Evidence supports that the U.S. market is what form of market efficiency?

Accepted Answer

The U.S. market is considered both weak-form and semi-strong form efficient. This means that all past trading information (weak-form) and all publicly available information (semi-strong form) are already reflected in stock prices, making it difficult to achieve consistently higher returns. However, it is not considered strong-form efficient, as not all information, including insider information, is reflected in stock prices.

Question 3

Evidence supports that the U.S. market is what form of market efficiency?

Accepted Answer

The U.S. market is considered both weak-form and semi-strong form efficient. This means that all past trading information (weak-form) and all publicly available information (semi-strong form) are already reflected in stock prices. However, it is not considered strong-form efficient, as not all information, including insider information, is reflected in stock prices.

Question 4

A market that is weak form efficient is not consistent with abnormal returns from:

Accepted Answer

In a weak form efficient market, all past trading information is already reflected in stock prices, meaning that technical analysis, which relies on historical price and volume data, would not yield consistent abnormal returns. Insider trading could still lead to abnormal returns as it involves non-public information, and financial analysis could also potentially yield abnormal returns as it involves evaluating a company's financial health and prospects, which might not be fully reflected in stock prices.

Question 5

A market that is semi-strong form efficient is consistent with the idea that there are abnormal returns from:

Accepted Answer

In a semi-strong form efficient market, all publicly available information is already reflected in stock prices, making it impossible to achieve abnormal returns through financial or technical analysis. However, insider trading can still lead to abnormal returns because it involves access to non-public, material information.

Question 6

Which of the following is not a cognitive bias that occurs in financial management?

Accepted Answer

Random walk is a theory suggesting that stock market prices evolve according to a random walk and thus cannot be predicted, rather than a cognitive bias, which is a systematic pattern of deviation from norm or rationality in judgment. Cognitive biases like framing, anchoring, loss aversion, and overconfidence affect decision-making processes, including in financial contexts.

Question 7

Suppose a company provides a press release that states that earnings are higher than last year, ignoring the fact that the earnings last year were the lowest in a decade. What cognitive bias is the company using in the way it created its press release?

Accepted Answer

Framing bias is at play here because the company is presenting information in a way that manipulates perception, emphasizing the positive aspect of higher earnings compared to last year without considering the context of those earnings being the lowest in a decade.

Question 8

Suppose companies recently went through a credit squeeze, in which companies had difficulty obtaining credit, no matter how credit worthy the company. If a company's financial managers are keeping more cash on hand than typical, despite forecasts for an improving economy, this is possibly a result of:

Accepted Answer

Anchoring refers to the tendency to rely too heavily on the first piece of information seen (in this case, the recent experience of a credit squeeze) when making decisions. Financial managers may be anchoring on the recent difficulty in obtaining credit and thus are keeping more cash on hand as a precaution, despite positive economic forecasts.

Question 9

A college student who looks at the spending of money from loans differently from the spending of scholarships, differently from the spending of money from parents, and differently from money earned would be exhibiting what cognitive bias?

Accepted Answer

Mental accounting refers to the tendency of individuals to categorize and treat money differently based on its source or intended use, which is exactly what the college student is doing by viewing money from loans, scholarships, parents, and earnings differently.

Question 10

An insurance premium is required by a risk-averse person to enter into a risky situation.

Accepted Answer

The answer of An insurance premium is required by a...

Question 11

The existence of insurance markets indicates how risk aversion creates a demand to remove risk.

Accepted Answer

Insurance markets exist because individuals and businesses are generally risk-averse; they prefer to pay a premium to transfer the risk of financial losses to an insurance company rather than facing the uncertainty of these losses on their own. This demand for risk mitigation is what drives the existence and growth of insurance markets.

Question 12

The existence of insurance markets indicates how risk aversion generates risk premiums required to induce people to bear risk.

Accepted Answer

The answer of The existence of insurance markets indicates how...

Question 13

Portfolios composed of the risk-free rate and the tangent portfolio that offer the highest expected rate of return for any given level of risk are best described as super-tangent portfolios.

Accepted Answer

Portfolios composed of the risk-free rate and the tangent portfolio that offer the highest expected rate of return for any given level of risk are best described as lying on the Capital Market Line (CML), not as "super-tangent portfolios." The tangent portfolio itself is the optimal risky portfolio that is tangent to the efficient frontier, and when combined with the risk-free asset, it forms the basis of the CML.

Question 14

Buying stock on margin is an example of a short position.

Accepted Answer

The answer of Buying stock on margin is an example...

Question 15

The standard deviation of a risk-free asset is 1.

Accepted Answer

The standard deviation of a risk-free asset is 0 because it has no volatility; its returns are certain.

Question 16

The market portfolio is observable.

Accepted Answer

The market portfolio, in theory, includes all available assets in the world, making it practically impossible to observe or replicate in reality due to the vast and diverse nature of global investments.

Question 17

The risk measurement associated with the capital market line (CML) is beta.

Accepted Answer

The risk measurement associated with the Capital Market Line (CML) is total risk, which is represented by the standard deviation of returns, not beta. Beta is used in the context of the Security Market Line (SML) to measure systematic risk.

Question 18

All rational and risk averse investors will seek to be on the capital market line (CML).

Accepted Answer

Rational and risk-averse investors aim for the highest return for a given level of risk, which is represented by the Capital Market Line (CML) in the Capital Asset Pricing Model (CAPM). The CML shows the optimal portfolio of risky assets, offering the best possible risk-return combinations.

Question 19

The CML must always be upward sloping.

Accepted Answer

The Capital Market Line (CML) represents portfolios that optimally combine risk and return, assuming all investors can lend and borrow at the risk-free rate. It is upward sloping because it reflects the trade-off between expected return and risk (measured as standard deviation), indicating that higher expected returns come with higher risk.

Question 20

If the expected return on a diversified portfolio lies below the CML, an investor should not buy the stock.

Accepted Answer

The Capital Market Line (CML) represents portfolios that optimally combine risk and return. If a portfolio's return is below the CML, it is not providing adequate return for its level of risk, indicating inefficiency.

Quiz 9: Asset Pricing

Which form of efficient market asserts that asset prices fully reflect all information, which includes both public and private information?

Evidence supports that the U.S. market is what form of market efficiency?

Evidence supports that the U.S. market is what form of market efficiency?

A market that is weak form efficient is not consistent with abnormal returns from:

A market that is semi-strong form efficient is consistent with the idea that there are abnormal returns from:

Which of the following is not a cognitive bias that occurs in financial management?

Suppose a company provides a press release that states that earnings are higher than last year, ignoring the fact that the earnings last year were the lowest in a decade. What cognitive bias is the company using in the way it created its press release?

A college student who looks at the spending of money from loans differently from the spending of scholarships, differently from the spending of money from parents, and differently from money earned would be exhibiting what cognitive bias?

An insurance premium is required by a risk-averse person to enter into a risky situation.

The existence of insurance markets indicates how risk aversion creates a demand to remove risk.

The existence of insurance markets indicates how risk aversion generates risk premiums required to induce people to bear risk.

Portfolios composed of the risk-free rate and the tangent portfolio that offer the highest expected rate of return for any given level of risk are best described as super-tangent portfolios.

Buying stock on margin is an example of a short position.

The standard deviation of a risk-free asset is 1.

The market portfolio is observable.

The risk measurement associated with the capital market line (CML) is beta.

All rational and risk averse investors will seek to be on the capital market line (CML).

The CML must always be upward sloping.

If the expected return on a diversified portfolio lies below the CML, an investor should not buy the stock.