Question 1

An abnormal return is calculated as:

A) expected return less risk-free rate
B) expected return less market return
C) actual return less market return
D) actual return less expected return

Accepted Answer

The expected rate of return on a share may be compared with the actual rate of return on a share,and differences are then termed excess or abnormal returns.That is,the residual returns are abnormal when compared with prior expectations.

Question 2

Lakonishok,Shleifer and Vishny (1994)provide arguments why fund managers will avoid:

A) value shares
B) growth shares
C) glamorous shares
D) all of these choices

Accepted Answer

Lakonishok,Shleifer and Vishny (1994)mount a number of arguments as to why fund managers will avoid value stocks.First,fund managers are typically assessed on short-term performance,and hence they must select short-term winners.Second,by the very nature of benchmarking and performance comparisons,there is an incentive for fund managers to structure portfolios that are not too different from the market index.However,market indices are biased towards large firms,which tend to be growth,not value,shares.Third,if the fund underperforms the market,then the fund manager needs to point to reasons other than his or her skill for the underperformance.Hence,funds tend to invest in large companies that at least appear secure and not stray too far from the major shares in the market index.Fourth,growth shares tend also to be glamour shares that have substantial public profiles.If a fund manager chooses not to invest in a glamour share and take a position at odds to the competition,then there is potential embarrassment if the glamour shares perform well.These reasons are all plausible,but we have no evidence.

Question 3

Loyalists believe that the long-term patterns in returns are induced by institutional and/or research method problems such that the patterns are artificial and therefore not exploitable.Examples are:

A) changes in risk that are not accounted for when estimating abnormal returns
B) differences in firm size
C) problems in correctly estimating beta risk over different return intervals
D) all of these choices

Accepted Answer

Loyalists believe that the long-term patterns in returns are induced by institutional and/or research method problems such that the patterns are artificial and therefore not exploitable.Examples are changes in risk that are not accounted for when estimating abnormal returns (Chan 1988,Jones 1993,Ball and Kothari 1989);differences in firm size,which drive the differential returns (Zarowin 1989,1990);problems in correctly estimating beta risk over different return intervals (Ball,Kothari and Shanken 1995);problems in estimating returns because of microstructure effects,particularly among the losers,which tend to be low-priced shares (Ball,Kothari and Shanken 1995);and problems in the benchmark return (Easton 1995).Each of these reasons appears to be capable of partially explaining the apparent overreaction.

Question 4

An unbiased reaction is one where there is ___ to the arrival of new information.

A) a slight overreaction
B) a slight underreaction
C) a strong overreaction
D) no overreaction

Accepted Answer

An unbiased reaction is one where there is no underreaction or overreaction to the arrival of new information.If the market underreacts to the value of new information,then the market price will fall below fundamental value.Profits can be earned by buying the undervalued security.Conversely,if the market overreacts,then profits can be earned by selling or taking a short position in the overvalued security.An underreaction or overreaction is a biased reaction,and is inconsistent with an efficient price reaction.

Question 5

Trading on the NYSE is halted for one hour if the Dow Jones Index falls by:

A) 150 points
B) 200 points
C) 250 points
D) 400 points

Accepted Answer

Circuit breakers are activated if the Dow Jones Index falls by 250 points from its previous close,and trading is halted for one hour.If the index falls another 150 points,then trading is halted for two hours (NYSE Rules 80A and 80B).

Question 6

Event study tests generally focus on the price reaction to

A) publicly released information
B) private information
C) past information
D) none of the above

Accepted Answer

Event study tests generally focus on the price reaction to publicly released information.This information includes financial reports,press releases,stock exchange announcements,capital structure changes and takeover announcements.These studies typically examine the short-term price reaction,and are concerned with issues such as the speed of the reaction and the degree of underreaction or overreaction.

Question 7

The hypothesis that argues that there is a downward price pressure at the end of the tax year on shares that have experienced recent price declines as investors attempt to sell in order to realise capital losses is the:

A) tax-loss selling hypothesis
B) tax on capital gains hypothesis
C) price rebound hypothesis
D) share price declines hypothesis

Accepted Answer

The tax-loss selling hypothesis has been put forward as an explanation of the seasonality in the size premium in the USA and extended to other monthly seasonal in other markets,such as July in Australia.The hypothesis that argues that there is a downward price pressure at the end of the tax year on shares that have experienced recent price declines as investors attempt to sell in order to realize the capital loss.

Question 8

The production of _____ is more likely to be greater during trading periods.

A) private information
B) public information
C) private and public information
D) neither private nor public information

Accepted Answer

Information that affects prices can be separated into two categories: public and private information.Public information becomes known at the same time that it affects prices.However,private information only affects prices through trading.The production of both types of information is likely to be greater during trading periods.Furthermore,the benefits of producing private information are likely to be higher during trading hours,as the information can be acted on quickly and conveniently.However,there will still be some information (both public and private)produced over non-trading periods.When the market is closed,this information cannot be acted upon.

Question 9

Growth shares are those firms that are expected to grow at a faster rate than:

A) value shares
B) speculative shares
C) glamorous shares
D) the market

Accepted Answer

Growth shares have low book-to-market ratios while value shares have high book-to-market ratios.Firms coming off a low profit base but undertaking expansion through growth opportunities will have a relatively low book value,as the firm will have a relatively low value of historical assets in place.However,the market value will be higher,as it incorporates some of the future value arising from the growth opportunities.Thus,the book-to-market ratio of growth shares is low.In contrast,value shares are those with a relatively high value of assets in place.These firms are generally viewed by the market as having low growth opportunities,and hence their market price is relatively low,being closer to book value.Therefore,value shares have a high book-to-market ratio.Hence,growth shares are those firms that are expected to grow at a faster rate than the market.

Question 10

The presence of negative correlation over long horizons is consistent with:

A) buil market
B) bear market
C) mean reversion
D) price overreaction

Accepted Answer

The presence of negative correlation over long horizons is consistent with mean reversion.That is,over time,prices tend to revert back to an average or mean value.

Question 11

Which of the following strategies will be profitable if the market overreacts?

A) selling an undervalued security
B) buying an overvalued security
C) selling an overvalued security
D none of these choices

Accepted Answer

An unbiased reaction is one where there is no underreaction or overreaction to the arrival of new information.If the market underreacts to the value of new information,then the market price will fall below fundamental value.Profits can be earned by buying the undervalued security.Conversely,if the market overreacts,then profits can be earned by selling or taking a short position in the overvalued security.An underreaction or overreaction is a biased reaction,and is inconsistent with an efficient price reaction.

Question 12

Loyalists believe that the long-term patterns in returns are induced by:

A) the private investor
B) institutional problems
C) government policy
D) none of these choices

Accepted Answer

Loyalists believe that the long-term patterns in returns are induced by institutional and/or research method problems such that the patterns are artificial and therefore not exploitable.Examples are changes in risk that are not accounted for when estimating abnormal returns (Chan 1988,Jones 1993,Ball and Kothari 1989);differences in firm size,which drive the differential returns (Zarowin 1989,1990);problems in correctly estimating beta risk over different return intervals (Ball,Kothari and Shanken 1995);problems in estimating returns because of microstructure effects,particularly among the losers,which tend to be low-priced shares (Ball,Kothari and Shanken 1995);and problems in the benchmark return (Easton 1995).Each of these reasons appears to be capable of partially explaining the apparent overreaction.

Question 13

According to the semi-strong form efficient: ____________.
A)stock prices do not rapidly adjust to new information
B)future changes in stock prices cannot be predicted from any information that is publicly available
C)corporate insiders should have no better investment performance than other investors even if allowed to trade freely
D)arbitrage between futures and cash markets should not produce extraordinary profits

Accepted Answer

Semi-strong form efficiency is used to describe the market when prices fully reflect public information.

Question 14

Banz (1981)has evidenced a trading strategy in the USA that can earn risk-adjusted profits of around 20% by taking:

A) long positions in a portfolio of large firms and short positions in a portfolio of small firms
B) short positions in a portfolio of large firms and long positions in a portfolio of small firms
C) short positions in a portfolio of small firms and long positions in a portfolio of large firms
D) long positions in a portfolio of small firms and short positions in a portfolio of large firms

Accepted Answer

Banz (1981)presents evidence that a trading strategy of taking long positions in a portfolio of small firms and short positions in a portfolio of large firms can earn risk-adjusted profits of around 20% per annum in the USA.

Question 15

Transaction costs of taking a short position exceed those of a long position by:

A) About 40 \% 
B) About 15\%
C) About 2-3\%
D) About  4-5 \%

Accepted Answer

Transaction costs of taking a short position exceed those of a long position by 2-3%.

Question 16

The more profitable IPO investments seem to be those:

A) associated with established companies
B) of a relatively large size
C) issued in a cold market
D) all of these choices

Accepted Answer

IPOs represent a puzzling phenomenon.On average,IPOs apparently give rise to quick profits,but they do not appear to represent a profitable long-run investment.The more profitable IPO investments appear to be those associated with established companies,of a relatively large size,and issued in a cold market.

Question 17

Prospect theory provides an explanation for why individuals tend to

A) hold on to their investments for too long
B) sell their investments too quickly
C) sell their investments under value
D) none of these choices

Accepted Answer

These loss-averse investors prefer to hold a risky,loss-making asset where they believe that there is a chance of recovering the loss in the future,rather than selling the asset immediately and cutting their losses.This helps to understand why individuals might hold poor investments for too long.Prospect theory provides an explanation for why individuals tend to sell their investments too quickly.

Question 18

Bowman and Buchanan (1995)argue that there are two sets of forces at work that operate as impediments to the acceptance of efficient markets.These are:

A) market structure forces and behavioural forces
B) market structure forces and industry structure forces
C) market structure forces and international market structure forces
D) none of these choices

Accepted Answer

Bowman and Buchanan (1995)argue that there are two sets of forces at work that operate as impediments to the acceptance of efficient markets.These are market structure forces and behavioural forces.

Question 19

By using the Consumer Price Index (CPI)as an economic indicator,it can be argued that it has a:

A) significant negative relationship between share prices and unanticipated inflation
B) significant positive relationship between share prices and anticipated inflation
C) significant positive relationship between consumer goods prices and anticipated inflation
D) insignificant negative relationship between share prices and anticipated inflation

Accepted Answer

Announcements of inflation,such as the Consumer Price Index (CPI)appear to be one economic indicator that carries a signal to the market.It is hypothesised that a significant negative relationship exists between share prices and unanticipated inflation.

Question 20

Short-term profits are expected to be greatest by forming a position on/in _________ and closing it in ____________.

A) the first day of the week, the last day of the week
B) early December, late January
C) late December, mid January
D) mid June, early July

Accepted Answer

Short-term profits are expected to be greatest by forming a position in late December and closing it in mid January.

Quiz 10: Concepts and Applications of Market Efficiency