Question 1

A phenomenon closely related to market overreaction is

Accepted Answer

Excessive volatility is closely related to market overreaction because it refers to the tendency of asset prices to fluctuate more widely than is warranted by changes in fundamentals, often as a result of investor overreaction to news or events.

Question 2

If a mutual fund outperforms the market in one period,evidence suggests that this fund is

Accepted Answer

Mutual funds that outperform the market in one period may have had a good investment strategy or just got lucky. However, this does not necessarily mean that they will consistently outperform the market in subsequent periods. Most mutual funds tend to revert to the mean and underperform the market over the long term, so it is not a reliable indication of future performance.

Question 3

Tests used to rate the performance of rules developed in technical analysis conclude that technical analysis

Accepted Answer

Tests used to rate the performance of rules developed in technical analysis show that technical analysis does not outperform the overall market.

Question 4

Evidence in support of the efficient markets hypothesis includes

Accepted Answer

The efficient markets hypothesis states that all available information is immediately reflected in the price of a security, making it impossible for investors to consistently outperform the market through technical analysis or other means of predicting price movements. The fact that technical analysis has been unsuccessful in consistently beating the market supports the efficient markets hypothesis.

B, C, and D are not evidence in support of the efficient markets hypothesis. The small-firm effect (B) suggests that small-cap companies tend to have higher returns than large-cap companies, which contradicts the efficient markets hypothesis. The January effect (C) refers to the tendency for stocks to have higher returns in January, which some argue is due to the lag time in incorporating tax information into stock prices, not consistent with the instantaneous information incorporation of the efficient markets hypothesis. Excessive volatility (D) can occur in any market condition, including those that are efficient, and does not necessarily imply that prices are not reflective of all available information.

Question 5

Loss aversion can explain why very little ________ actually takes place in the securities market.

Accepted Answer

Loss aversion refers to the psychological bias of individuals to feel the pain of a loss more acutely than the pleasure of an equal gain. This bias can make individuals hesitant to engage in activities that involve potential losses, such as short-selling in the securities market, where the potential for loss is unlimited. As a result, very little short selling actually takes place in the securities market due to loss aversion.

Question 6

________ and ________ may provide an explanation for stock market bubbles.

Accepted Answer

Overconfidence can lead individuals to overvalue certain stocks or investments, while social contagion can spread this irrational exuberance to others in the market, creating a bubble.

Question 7

Investors tend to trade on their beliefs rather than on pure facts. This statement might explain why securities markets have ________ that the efficient market hypothesis does not predict.

Accepted Answer

The efficient market hypothesis (EMH) predicts that all available information is immediately reflected in a stock's price, leading to minimal trading volume. However, if investors are trading based on their beliefs rather than pure facts, they may engage in more trading activity, leading to a larger trading volume than predicted by the EMH.

Question 8

To say that stock prices follow a "random walk" is to argue that stock prices

Accepted Answer

The concept of a "random walk" in the context of stock prices suggests that they cannot be predicted based on past trends. The movements of stock prices are believed to be somewhat unpredictable and random, making it difficult to reliably forecast future price changes.

Question 9

The small-firm effect refers to the

Accepted Answer

The small-firm effect refers to the abnormal high returns earned by small firms. This effect is inconsistent with the efficient market hypothesis and has been observed in many studies.

Question 10

The efficient markets hypothesis predicts that stock prices follow a "random walk." The implication of this hypothesis for investing in stocks is

Accepted Answer

The efficient markets hypothesis suggests that it is difficult to consistently outperform the market by timing trades or selecting individual stocks. Therefore, a "buy and hold strategy" of holding a diversified portfolio of stocks may be the most effective approach, especially considering that frequent trading can lead to higher transaction costs and taxes.

Question 11

When a corporation announces a major decline in earnings,the stock price may initially decline significantly and then rise back to normal levels over the next few weeks. This impact is called

Accepted Answer

The described phenomenon is known as market overreaction, where investors tend to overreact to news about a company's financial performance, causing a temporary swing in the stock price. As the market digests the news and investors adjust their expectations, the stock price may eventually settle back to more reasonable levels. The January effect refers to a seasonal pattern in stock returns, while mean reversion and the small-firm effect are other market phenomena that do not accurately describe the scenario described in the question.

Question 12

Which of the following accurately summarize the empirical evidence about technical analysis?

Accepted Answer

Empirical evidence suggests that technical analysts, on average, do not outperform the market, indicating that their performance is similar to other forms of financial analysis. This aligns with the efficient market hypothesis, which posits that all known information is already reflected in stock prices, making it difficult to achieve consistent above-market returns through technical analysis or other methods.

Question 13

The number and availability of discount brokers has grown rapidly since the mid-1970s. The efficient markets hypothesis predicts that people who use discount brokers

Accepted Answer

The efficient markets hypothesis suggests that it is difficult to consistently outperform the market, regardless of whether one uses a discount or full-service broker. However, using a discount broker can save on brokerage commissions, allowing investors to earn about the same returns as those who use full-service brokers but with lower expenses, resulting in a higher net return.

Question 14

Studies of mutual fund performance indicate that mutual funds that outperformed the market in one time period usually

Accepted Answer

Studies have shown that there is little persistence in mutual fund performance, meaning that a fund that outperforms the market in one time period is not likely to outperform the market in the next time period. Therefore, D is the correct answer as it states that mutual funds do not beat the market in the next time period.

Question 15

Mean reversion refers to the fact that

Accepted Answer

Mean reversion refers to the tendency of stocks that have had low returns in the past to have higher returns in the future, and vice versa. This is based on the belief that stock prices will eventually move back towards their average or "mean" over time.

Question 16

The January effect refers to the fact that

Accepted Answer

The January effect refers to the historical phenomenon of stock prices experiencing abnormal increases in January, possibly due to tax-related factors or investors buying back stocks after selling them for tax-loss harvesting purposes at the end of the previous year. This effect is not related to stock market crashes or the performance of football teams.

Question 17

When Happy Feet Corporation announces that their fourth quarter earnings are up 10%,their stock price falls. This is consistent with the efficient markets hypothesis

Accepted Answer

According to the efficient markets hypothesis, stock prices reflect all available information and react immediately to any new information. In this case, even though Happy Feet Corporation's earnings are up, if they are not as high as expected by investors, the stock price may still fall. This is because the market has already priced in higher earnings expectations and may now adjust accordingly.

Question 18

Rules used to predict movements in stock prices based on past patterns are,according to the efficient markets hypothesis

Accepted Answer

According to the efficient markets hypothesis, stock prices reflect all available information and are therefore unpredictable based on past patterns. As a result, rules used to predict movements in stock prices based on past patterns are a waste of time.

Question 19

Excessive volatility refers to the fact that

Accepted Answer

Excessive volatility refers to when stock prices fluctuate more than is justified by dividend fluctuations. This can occur due to a variety of factors, such as market speculation or emotional trading behavior, and can lead to increased uncertainty and risk for investors.

Question 20

Psychologists have found that people tend to be ________ in their own judgments.

Accepted Answer

Research has shown that people tend to be overconfident in their own judgments, meaning they have more confidence in the accuracy of their beliefs and predictions than is warranted by the evidence. This overconfidence can lead to errors in decision-making and can cause people to be too quick to dismiss alternative viewpoints.

Quiz 7: The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis