Question 1

The efficient markets hypothesis implies that
A) Above-market returns cannot be expected by an investor
B) Stock prices follow a random walk
C) Regular intramonthly patterns in stock prices cannot persist
D) All of the above

Accepted Answer

The efficient markets hypothesis (EMH) suggests that all available information is already reflected in stock prices, making it impossible to consistently achieve above-market returns (A), leading to stock prices moving in what appears to be a random walk because new information is unpredictable (B), and preventing regular patterns, such as intramonthly patterns, from persisting because they would be quickly acted upon and eliminated by market participants (C).

Question 2

Investors build a portfolio of multiple securities to
A) Improve the returns on their investments
B) Avoid the consequences of inflation
C) Lower the risk on the funds that they have invested
D) Save more

Accepted Answer

Investors build a portfolio of multiple securities primarily to diversify their investments, which helps in lowering the overall risk. Diversification reduces the impact of poor performance of any single security on the entire portfolio.

Question 3

When the price of a financial asset embodies all available information bearing on its value, this reflects
A) The Fisher effect
B) The term premium hypothesis
C) The efficient markets hypothesis
D) None of the above

Accepted Answer

The efficient markets hypothesis posits that asset prices fully reflect all available information, meaning that it is impossible to consistently achieve higher returns on a risk-adjusted basis than the market average by using this information.

Question 4

A reason to hold a portfolio of S&P 500 shares is
A) Such a portfolio achieves close to optimal gains from equity diversification
B) Such a portfolio has returns that approach market returns
C) Such a portfolio can be easily acquired through mutual funds
D) All of the above

Accepted Answer

Holding a portfolio of S&P 500 shares achieves close to optimal gains from equity diversification, has returns that approach market returns, and can be easily acquired through mutual funds, making all of the provided options correct.

Question 5

An investor considering a security for a portfolio will regard as important
A) The security's return
B) The security's risk measured as the variability of its returns
C) The correlation of its returns with the returns of other securities in the portfolio
D) All of the above

Accepted Answer

All of the options listed are important factors for an investor to consider when evaluating a security for inclusion in a portfolio. The return of the security indicates the potential profit, the risk measured as the variability of its returns provides insight into the security's stability, and the correlation of its returns with other securities in the portfolio helps in understanding how the security will contribute to the portfolio's overall risk and return profile.

Question 6

A security with the following beta would be the most attractive candidate for a portfolio (everything else the same)
A) 1.0
B) 0.5
C) 0.0
D) There would be no difference

Accepted Answer

A security with a beta of 0.0 would be the most attractive candidate for a portfolio because it has the lowest risk.

Question 7

Under the efficient markets hypothesis
A) Stock prices follow a random walk
B) All relevant information bearing on a stock's value is embedded in its price
C) Careful picking of stocks cannot be expected to provided better-than-market returns
D) All of the above

Accepted Answer

The efficient markets hypothesis posits that stock prices fully reflect all available information, which leads to the conclusions that prices follow a random walk, all relevant information is embedded in stock prices, and that careful stock picking cannot consistently yield better-than-market returns.

Question 8

Adding foreign stocks to a portfolio
A) Is always a bad idea
B) Is always a good idea
C) Is a good idea if the returns on these stocks are weakly correlated with the returns on the rest of the portfolio
D) Is a good idea if the returns on these stocks are highly correlated with the returns on the rest of the portfolio

Accepted Answer

Adding foreign stocks to a portfolio can be beneficial if their returns are weakly correlated with the returns on the rest of the portfolio. This can help in diversifying the portfolio, potentially reducing risk and improving the overall return.

Question 9

Home-country bias refers to
A) Investors forgoing full diversification benefits from investing abroad
B) Investors not seeking good returns on domestic investments
C) Favoring domestic bonds over other investments
D) Unwillingness to use foreign investment advisers

Accepted Answer

Home-country bias is the tendency of investors to favor investments from their own country over those from abroad, leading to a portfolio that is not as diversified as it could be. This can result in forgoing the full benefits of diversification, which include potentially higher returns and reduced risk through exposure to a variety of global markets.

Question 10

An efficient portfolio is
A) One selected by a certified portfolio adviser
B) An exchange-traded fund
C) A portfolio for which higher returns can be achieved only by accepting more risk
D) A portfolio of equally weighted domestic and foreign assets

Accepted Answer

An efficient portfolio is one where higher returns can only be achieved by taking on more risk, according to the principles of modern portfolio theory. This concept is central to the efficient frontier, which illustrates the best possible return for a given level of risk.

Question 11

In the pricing of a financial asset
A) The greater the asset's beta (?), the smaller will be compensation for risk
B) The smaller the asset's beta (?), the smaller will be compensation for risk
C) Compensation for risk will be at a maximum when the asset's beta (?) is equal to zero
D) There is no relationship between an asset's beta (?) and compensation for risk

Accepted Answer

The asset's beta measures its volatility relative to the market. A smaller beta indicates less volatility and thus, typically, less compensation for risk is required by investors.

Question 12

An asset bubble
A) Contradicts a strict version of the efficient markets hypothesis
B) Means that the price of an asset exceeds that implied by economic fundamentals
C) Can be explained by rational behavior
D) All of the above

Accepted Answer

Asset bubbles contradict the efficient markets hypothesis by suggesting that prices can deviate significantly from true values based on fundamentals. They imply that the price of an asset exceeds what is justified by economic fundamentals, and various theories, including those based on rational behavior, have been proposed to explain their occurrence.

Quiz 6: Principles of Portfolio Selection and Efficient Markets

The efficient markets hypothesis implies that

Investors build a portfolio of multiple securities to

When the price of a financial asset embodies all available information bearing on its value, this reflects

A reason to hold a portfolio of S&P 500 shares is

An investor considering a security for a portfolio will regard as important

A security with the following beta would be the most attractive candidate for a portfolio (everything else the same)

Under the efficient markets hypothesis

Adding foreign stocks to a portfolio

Home-country bias refers to

An efficient portfolio is

In the pricing of a financial asset

An asset bubble