Question 1

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

D contradicts the efficient market hypothesis, which states that all publicly available information is already reflected in stock prices and it's impossible to consistently earn a higher rate of return by using undisclosed information. A, B, and C are all correct statements in finance.

Question 2

In the 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 1990s, Fed Chair Alan Greenspan...

Question 3

Suppose that interest rates unexpectedly rise and that FineLine Corporation announces that revenues from last quarter were down but not as much as the public had anticipated they would be down. According to the efficient markets hypothesis, which of the these things make the price of FineLine Corporation Stock fall?
A) both the interest rate rising and the revenue announcement
B) neither the interest rate rising nor the revenue announcement
C) only the interest rate rising
D) only the revenue announcement

Accepted Answer

According to the efficient markets hypothesis, all currently available information is already reflected in the stock price. Therefore, the revenue announcement would not have a significant impact on the stock price since it was not as much of a surprise as anticipated. However, the unexpected rise in interest rates could cause investors to reassess the value of the stock, leading to a decrease in price.

Question 4

An index fund
A) holds only stocks and bonds that are indexed to inflation.
B) holds all the stocks in a given stock index.
C) guarantees a return that follows the index of leading economic indicators.
D) typically has a lower return than a managed fund.

Accepted Answer

An index fund holds all the stocks in a given stock index, such as the S&P 500 or Nasdaq, and seeks to replicate the performance of that index. This provides broad market exposure and typically has lower fees and expenses compared to managed funds. However, there is no guarantee of a specific return.

Question 5

According to the efficient markets hypothesis, which of the following would increase the price of stock in the Simpson Corporation?
A) Simpson announces, just as everyone had expected, that it has hired a new highly respected CEO.
B) Simpson announces that its profits were low, but not as low as the market had expected.
C) Analysis by a column in a business weekly indicates that Simpson is overvalued.
D) All of the above would increase the price.

Accepted Answer

The answer of According to the efficient markets hypothesis, which...

Question 6

Fundamental analysis determines the value of a stock based on
A) dividends.
B) the expected final sale price.
C) the ability of the corporation to earn profits.
D) All of the above are correct.

Accepted Answer

Fundamental analysis determines the value of a stock by examining factors such as dividends, the ability of the corporation to earn profits, and the expected final sale price. Therefore, all of the above options are correct.

Question 7

Fundamental analysis shows that stock in Johnson's Lumber Company has a price that is less than its present value.
A) This stock is overvalued; you should consider adding it to your portfolio.
B) This stock is overvalued; you shouldn't consider adding it to your portfolio.
C) This stock is undervalued; you should consider adding it to your portfolio.
D) This stock is undervalued; you shouldn't consider adding it to your portfolio.

Accepted Answer

Fundamental analysis indicating that the stock price is lower than its present value suggests that the stock is undervalued. Therefore, it would be wise to consider adding it to one's portfolio.

Question 8

Fundamental analysis shows that stock in Widgets-R-Us has a present value that is lower than its price.
A) This stock is overvalued; you should consider adding it to your portfolio.
B) This stock is overvalued; you shouldn't consider adding it to your portfolio.
C) This stock is undervalued; you should consider adding it to your portfolio.
D) This stock is undervalued; you shouldn't consider adding it to your portfolio.

Accepted Answer

When fundamental analysis shows that the present value of a stock is lower than its price, it means that the stock is overvalued. Therefore, it is not a good choice to add it to your portfolio.

Question 9

If stock prices follow a random walk, it means
A) long periods of declining prices are followed by long periods of rising prices.
B) the greater the number of consecutive days of price declines, the greater the probability prices will increase the following day.
C) stock prices are unrelated to random events that shock the economy.
D) stock prices are just as likely to rise as to fall at any given time.

Accepted Answer

If stock prices follow a random walk, it means that they are unpredictable and there is no way to accurately forecast whether prices will rise or fall. Therefore, stock prices are just as likely to rise as they are to fall at any given time.

Question 10

Which of the following is correct?
A) Managed funds typically have a higher return than indexed funds. This tends to refute the efficient market hypothesis.
B) Managed funds typically have a higher return than indexed funds. This tends to support the efficient market hypothesis.
C) Index funds typically have a higher rate of return than managed funds. This tends to refute the efficient market hypothesis.
D) Index funds typically have a higher rate of return than managed funds. This tends to support the efficient market hypothesis.

Accepted Answer

This statement is mostly true. According to the efficient market hypothesis, which suggests that it is impossible to consistently outperform the market over the long term, actively managed funds should not be able to achieve higher returns than passively managed index funds. Empirical evidence has shown that over the long term, index funds typically outperform actively managed funds due to their lower fees and broad diversification. Therefore, D is the correct answer as it supports the efficient market hypothesis.

Question 11

According to the efficient market hypothesis, which of the following statements is not correct?
A) Stock market prices tend to rise today if they rose yesterday.
B) As judged by the typical person in the market, all stocks are fairly valued all the time.
C) At the market price, the number of shares being offered for sale matches the number of shares people want to buy.
D) All of the above statements are incorrect.

Accepted Answer

The answer of According to the efficient market hypothesis, which...

Question 12

Fundamental analysis shows that Quadrangle Company is fairly valued. Then Quadrangle Company unexpectedly improves its production techniques and unexpectedly hires a new CEO away from another very successful competitor. Suppose this has no effect on the price of the stock of Quadrangle 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

Improvements in production techniques and hiring a successful CEO are positive developments that should increase the company's value. If the stock price remains unchanged despite these improvements, fundamental analysis would likely show the company is undervalued. The fact that the stock price did not adjust to reflect this new, positive information suggests the market is not efficiently incorporating all available information, which contradicts the efficient markets hypothesis.

Question 13

Fundamental analysis shows that stock in Stainless Appliance Company has a present value below its price.
A) This stock is overvalued; you should consider adding it to your portfolio.
B) This stock is overvalued; you shouldn't consider adding it to your portfolio.
C) This stock is undervalued; you should consider adding it to your portfolio.
D) This stock is undervalued; you shouldn't consider adding it to your portfolio.

Accepted Answer

Since the present value of the stock is below its price, this indicates that the stock is overvalued. Therefore, the best choice is to not consider adding it to your portfolio, as it may not provide a good return on investment.

Question 14

Some people claim that stocks follow a random walk. What does this mean?
A) The price of stock one day is about what it was on the previous day.
B) Changes in stock prices cannot be predicted from available information.
C) Stock prices are not determined by market fundamentals such as supply and demand.
D) Prices of stocks of different firms in the same industry show no or little tendency to move together.

Accepted Answer

If stocks follow a random walk, it means that changes in stock prices cannot be predicted from available information. The movement of the stock price is believed to be random and unpredictable, making it difficult to make informed investment decisions based on information and analysis. This theory suggests that past movements and performance are not indicators of future movements and performance.

Question 15

Which of the following is not consistent with the efficient market hypothesis?
A) Stock prices should follow a random walk.
B) Index funds should typically outperform highly managed funds.
C) News has no effect on stock prices.
D) There is little point in spending many hours studying the business pages looking for undervalued stocks.

Accepted Answer

The efficient market hypothesis suggests that all publicly available information is already reflected in stock prices, meaning that news should have an effect on stock prices. The other choices are consistent with the efficient market hypothesis: A) stock prices should follow a random walk because they reflect all available information, B) index funds should typically outperform highly managed funds because highly managed funds have higher fees and may not beat the market after accounting for fees, and D) there is little point in spending many hours studying the business pages looking for undervalued stocks because all publicly available information is already incorporated into stock prices.

Question 16

If the efficient market hypothesis is correct, then
A) index funds should typically beat managed funds, and usually do.
B) index fund should typically beat managed funds, but usually do not.
C) mutual funds should typically beat index funds, and usually do.
D) mutual funds should typically beat index funds, but usually do not.

Accepted Answer

The efficient market hypothesis states that all publicly available information is already reflected in a security's price, making it impossible for investors to consistently earn abnormal returns. Therefore, if this hypothesis is correct, actively managed funds should not be able to consistently beat their respective benchmarks, which are usually index funds. Studies have shown that index funds typically outperform actively managed funds, supporting the notion that the efficient market hypothesis is correct.

Question 17

The efficient markets hypothesis says that
A) only individual investors can make money in the stock market.
B) it should be easy to find stocks whose price differs from their fundamental value.
C) stock prices follow a random walk.
D) All of the above are correct.

Accepted Answer

The efficient markets hypothesis states that stock prices follow a random walk and that it should be difficult to find mispriced stocks that differ from their fundamental value. It does not suggest that individual investors cannot make money in the stock market, but rather that it is unlikely to consistently outperform the market due to the efficiency of market pricing. Therefore, option C is the best choice.

Question 18

According to the efficient markets hypothesis, worse-than-expected news about a corporation will
A) have no effect on its stock price.
B) raise the price of the stock.
C) lower the price of the stock.
D) change the price of the stock in a random direction.

Accepted Answer

The efficient markets hypothesis suggests that all relevant information is already reflected in a stock's price, meaning that any negative news about a corporation will lead to a decrease in its stock price. Therefore, choice C is the best answer.

Question 19

If stock prices follow a random walk, then stock investors can make large profits by
A) buying stocks whose prices have been falling for several days.
B) buying stocks whose prices have been rising for several days.
C) performing fundamental analysis of stocks using data contained in annual reports.
D) using inside information.

Accepted Answer

If stock prices follow a random walk, then it means that they are unpredictable and there is no consistent pattern that can be used for investment purposes. Therefore, the only way an investor can make large profits is by using inside information (which is illegal and unethical).

Question 20

In the 1990s, Fed Chairperson Alan Greenspan questioned whether the stock market
A) boom at that time reflected "irrational exuberance."
B) decline at that time reflected "irrational funk."
C) boom at that time reflected "rational exuberance."
D) decline at that time reflected "rational funk."

Accepted Answer

In 1996, Fed Chairperson Alan Greenspan commented on the stock market's rapid rise and questioned whether it was being driven by "irrational exuberance," suggesting that investors may have been getting ahead of themselves in their optimism.

Quiz 27: The Basic Tools of Finance

Which of the following is not correct?

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

An index fund

According to the efficient markets hypothesis, which of the following would increase the price of stock in the Simpson Corporation?

Fundamental analysis determines the value of a stock based on

Fundamental analysis shows that stock in Johnson's Lumber Company has a price that is less than its present value.

Fundamental analysis shows that stock in Widgets-R-Us has a present value that is lower than its price.

If stock prices follow a random walk, it means

Which of the following is correct?

According to the efficient market hypothesis, which of the following statements is not correct?

Fundamental analysis shows that Quadrangle Company is fairly valued. Then Quadrangle Company unexpectedly improves its production techniques and unexpectedly hires a new CEO away from another very successful competitor. Suppose this has no effect on the price of the stock of Quadrangle Company.

Fundamental analysis shows that stock in Stainless Appliance Company has a present value below its price.

Some people claim that stocks follow a random walk. What does this mean?

Which of the following is not consistent with the efficient market hypothesis?

If the efficient market hypothesis is correct, then

The efficient markets hypothesis says that

According to the efficient markets hypothesis, worse-than-expected news about a corporation will

If stock prices follow a random walk, then stock investors can make large profits by

In the 1990s, Fed Chairperson Alan Greenspan questioned whether the stock market