Question 1

The efficient markets hypothesis implies that
A) building a portfolio based on a published list of the "most respected" companies is likely to produce a better-than-average return.
B) if a stock rose in price last year,it is likely to rise in price this year.
C) managed mutual funds should generally outperform indexed mutual funds.
D) None of the above are correct.

Accepted Answer

The efficient markets hypothesis suggests that all available information about a security is already reflected in its price, making it impossible to consistently outperform the market through either stock picking or market timing strategies. Therefore, choices A, B, and C are unlikely to be correct according to this theory.

Question 2

The possibility of speculative bubbles in the stock market arises in part because
A) stock prices may not depend at all on psychological factors.
B) fundamental analysis may be the correct way to evaluate the value of stocks.
C) future streams of dividend payments are very hard to estimate.
D) the value of shares of stock depends not only on the future stream of dividend payments but also on the price at which the stock will be sold.

Accepted Answer

The answer of The possibility of speculative bubbles in the...

Question 3

In the late 1990s,Fed Chairperson Alan Greenspan believed that the market was
A) overvalued,but stock prices continued to rise through mid 2002.
B) overvalued,and stock prices fell by mid 2002.
C) undervalued,but stock prices continued to fall into mid 2002.
D) undervalued,but stock prices continued to rise even into mid 2002.

Accepted Answer

Alan Greenspan famously warned of "irrational exuberance" in the stock market in the late 1990s, suggesting he believed it was overvalued. The dot-com bubble burst in the early 2000s, leading to a decline in stock prices by mid-2002.

Question 4

The value of a stock is based on the
A) present values of the dividend stream and final price.So,the value of a stock rises when interest rates rise.
B) present values of the dividend stream and final price.So,the value of a stock falls when interest rates rise.
C) future values of the dividend stream and final price.So,the value of a stock rises when interest rates rises.
D) future values of the dividend stream and final price.So,the value of a stock falls when interest rates rise.

Accepted Answer

The value of a stock is based on the present values of the dividend stream and final price. When interest rates rise, the present value of future dividends decreases, which reduces the value of the stock. Therefore, the value of a stock falls when interest rates rise.

Question 5

In the late 1990s,Fed Chair Alan Greenspan believed that the market was
A) undervalued,and evidence later showed that this was clearly correct.
B) undervalued,but whether it was remains debatable.
C) overvalued,and evidence later showed that this was clearly correct.
D) overvalued,but whether it was remains debatable.

Accepted Answer

The answer of In the late 1990s,Fed Chair Alan Greenspan...

Question 6

Which of the following is not correct?
A) There is a greater reduction in risk by increasing the number of stocks in a portfolio from 1 to 10,than by increasing it from 100 to 120 stocks.
B) The historical rate of return on stocks has been about 5 percentage points higher than the historical rate of return on bonds.
C) Stock in an industry that is very sensitive to economic conditions is likely to have a higher average return than stock in an industry that is not so sensitive to economic conditions.
D) If you had information about a corporation that no one else had,you could earn a very high rate of return.This contradicts the efficient market hypothesis.

Accepted Answer

The efficient market hypothesis suggests that all relevant information is already reflected in a stock's price, so it is not possible to earn a high rate of return based on private information. Therefore, choice D contradicts this concept and is not correct. Choices A, B, and C are all correct statements.

Question 7

Diversification
A) increases the likely fluctuation in a portfolio's return.Thus,the likely standard deviation of the portfolio's return is higher.
B) increases the likely fluctuation in a portfolio's return.Thus,the likely standard deviation of the portfolio's return is lower.
C) reduces the likely fluctuation in a portfolio's return.Thus,the likely standard deviation of the portfolio's return is higher.
D) reduces the likely fluctuation in a portfolio's return.Thus,the likely standard deviation of the portfolio's return is lower.

Accepted Answer

Diversification reduces the risk of a portfolio by investing in a variety of assets that are not correlated with each other. This reduces the likely fluctuation in the portfolio's return, resulting in a lower standard deviation of the portfolio's return. Therefore, the correct option is D.

Question 8

A soup manufacturer unexpectedly announces that it has hired a new manager.It is widely believed that this manager will raise the profitability of the corporation.At the same time interest rates unexpectedly rise.Which of the above would tend to make the price of the stock rise?
A) the announcement and the rise in interest rates
B) the announcement but not the rise in interest rates
C) the rise in interest rates,but not the announcement
D) neither the announcement nor the rise in interest rates

Accepted Answer

The announcement of a new manager expected to raise profitability would be seen as positive news for the company and would likely result in an increase in the price of the stock. The rise in interest rates, however, would typically have a negative effect on stocks as it makes borrowing more expensive and can slow down economic growth. Therefore, the announcement of the new manager would outweigh the negative impact of the rise in interest rates, resulting in a likely rise in the price of the stock.

Question 9

The efficient markets hypothesis says that beating the market consistently is
A) impossible.Many studies find that beating the market is,at best,extremely difficult.
B) impossible.Many studies find that beating the market is relatively easy.
C) relatively easy.Many studies find that beating the market is,at best,extremely difficult.
D) relatively easy.Many studies find that beating the market is relatively easy.

Accepted Answer

The efficient markets hypothesis asserts that all market participants have access to the same information and that asset prices always reflect this information. Therefore, any attempt to outperform the market consistently based on this information is futile. Many studies have found the evidence to support this theory, making option A the correct answer.

Question 10

Fundamental analysis shows that Green Leaf Tea Company is fairly valued.Then Green Leaf Tea Company unexpectedly improves its production techniques and unexpectedly hires a new CEO away from another very successful tea producer.Suppose this has no effect on the price of the stock of Green Leaf Tea Company.
A) Fundamental analysis would now show the corporation is overvalued.The fact that the price was unchanged is consistent with the efficient markets hypothesis.
B) Fundamental analysis would now show the corporation is overvalued.The fact that the price was unchanged is not consistent with the efficient markets hypothesis.
C) Fundamental analysis would now show the corporation is undervalued.The fact that the price was unchanged is consistent with the efficient markets hypothesis.
D) Fundamental analysis would now show the corporation is undervalued.The fact that the price was unchanged is not consistent with the efficient markets hypothesis.

Accepted Answer

Fundamental analysis would show the company is undervalued because the improvements should increase the company's value. The efficient markets hypothesis suggests that stock prices reflect all available information, so if the price remains unchanged despite positive news, it indicates the market is not fully efficient.

Question 11

In 2005,the Wall Street Journal reported that researchers in an interdisciplinary field called neuroeconomics had concluded a study that suggests that
A) biology plays no role in economic decision-making.
B) psychotherapy directed at improving economic decision-making can produce beneficial results.
C) people who are very emotional may make better financial decisions than other people.
D) people with certain kinds of brain disorders may make better financial decisions than other people.

Accepted Answer

The study in neuroeconomics suggested that people with certain brain disorders might make better financial decisions, as these disorders can affect emotional responses and risk assessment.

Question 12

The efficient markets hypothesis implies
A) that all stocks are fairly valued all the time and that no stock is a better buy than any other.
B) that all stocks are fairly valued all the time,but that some stocks may be better buys than other.
C) that some stocks may be better buys than others and stock experts can determine which ones.
D) that no stock is efficiently valued.

Accepted Answer

The efficient markets hypothesis suggests that markets are highly efficient and all stocks are fairly valued all the time, and therefore, no stock is a better buy than any other. It implies that any new information relevant to a stock will be quickly reflected in its price, making it impossible to consistently beat the market on a risk-adjusted basis.

Question 13

If you are convinced that stock prices are impossible to predict from available information,then you probably also believe that
A) the efficient markets hypothesis is not a correct hypothesis.
B) the stock market is informationally efficient.
C) the stock market is informationally inefficient.
D) there is no reason to establish a diversified portfolio of stocks.

Accepted Answer

If stock prices are impossible to predict from available information, then it follows that the market is informationally efficient, since all available information is already reflected in current stock prices according to the efficient markets hypothesis. Therefore, choice B is the correct answer. Choice A is incorrect because it implies that the efficient markets hypothesis is incorrect, which contradicts the assumption that stock prices are impossible to predict. Choice C is also incorrect because it suggests that the market is informationally inefficient, which contradicts the efficient markets hypothesis. Choice D is incorrect because even if stock prices are impossible to predict, it is still important to establish a diversified portfolio to manage risk.

Question 14

Whenever the price of an asset rises above what appears to be its fundamental value,the market is said to be experiencing
A) a conjectural mistake.
B) a fundamental mishap.
C) a speculative bubble.
D) a neuroeconomic flaw.

Accepted Answer

When the price of an asset rises above its fundamental value, it is said to have entered the speculative bubble phase. This means that the asset is being valued higher than what it is actually worth due to speculative investor behavior, rather than its underlying fundamental value. This can lead to a market crash when the bubble eventually bursts. The other options do not accurately describe this phenomenon.

Question 15

Suppose that an increased risk of mortgage defaults lowers the expected profitability of banks.Then we would expect to see
A) the demand for bank stocks rise which would raise the prices of bank stocks.
B) the demand for bank stocks rise which would reduce the prices of bank stocks.
C) the demand for bank stocks fall which would raise the prices of bank stocks.
D) the demand for bank stocks fall which would reduce the prices of bank stocks.

Accepted Answer

An increased risk of mortgage defaults lowers the expected profitability of banks, which means there is a higher likelihood of losses. This would lead to a decrease in demand for bank stocks as investors become less willing to invest in a potentially riskier asset. As demand falls, prices would also fall. Therefore, the correct answer is D.

Question 16

Which of the following is correct concerning stock market irrationality?
A) Bubbles could arise,in part,because the price that people pay for stock depends on what they think someone else will pay for it in the future.
B) Economists almost all agree that the evidence for stock market irrationality is convincing and the departures from rational pricing are important.
C) Some evidence for the existence of market irrationality is that informed and presumably rational managers of mutual funds generally beat the market.
D) All of the above are correct.

Accepted Answer

Bubbles in the stock market can arise due to people's expectations of future prices, which may not always be rational.

Answer: C 
 The fact that supposedly rational and informed mutual fund managers consistently beat the market suggests there may be irrationality in the stock market.

Therefore, the correct answer is A and C. Option B is incorrect as it states that almost all economists agree on the evidence for stock market irrationality, which is not entirely true.

Quiz 27: The Basic Tools of Finance

The efficient markets hypothesis implies that

The possibility of speculative bubbles in the stock market arises in part because

In the late 1990s,Fed Chairperson Alan Greenspan believed that the market was

The value of a stock is based on the

In the late 1990s,Fed Chair Alan Greenspan believed that the market was

Which of the following is not correct?

Diversification

A soup manufacturer unexpectedly announces that it has hired a new manager.It is widely believed that this manager will raise the profitability of the corporation.At the same time interest rates unexpectedly rise.Which of the above would tend to make the price of the stock rise?

The efficient markets hypothesis says that beating the market consistently is

In 2005,the Wall Street Journal reported that researchers in an interdisciplinary field called neuroeconomics had concluded a study that suggests that

The efficient markets hypothesis implies

If you are convinced that stock prices are impossible to predict from available information,then you probably also believe that

Whenever the price of an asset rises above what appears to be its fundamental value,the market is said to be experiencing

Suppose that an increased risk of mortgage defaults lowers the expected profitability of banks.Then we would expect to see

Which of the following is correct concerning stock market irrationality?