The Efficient Market Hypothesis

Chapter 08 - The Efficient Market Hypothesis Chapter 08 The Efficient Market Hypothesis Multiple Choice Questions 1. Which of the following beliefs would not preclude charting as a method of portfolio management? A. The market is strong form efficient. B. The market is semi-strong form efficient. C. The market is weak form efficient. D. Stock prices follow recurring patterns. Bodie - Chapter 08 #1 Difficulty: Medium 2. In a 1953 study of stock prices, Maurice Kendall found that ________. A. there were no predictable patterns in stock prices B. stock prices exhibited strong serial autocorrelation C. day to day stock prices followed consistent trends D. fundamental analysis could be used to generate abnormal returns Bodie - Chapter 08 #2 Difficulty: Easy 3. The weak form of the EMH states that ________ must be reflected in the current stock price. A. all past information including security price and volume data B. all publicly available information C. all information including inside information D. all costless information Bodie - Chapter 08 #3 Difficulty: Easy 1 Chapter 08 - The Efficient Market Hypothesis 4. The semi-strong form of the EMH states that ________ must be reflected in the current stock price. A. all security price and volume data B. all publicly available information C. all information including inside information D. all costless information Bodie - Chapter 08 #4 Difficulty: Easy 5. The strong form of the EMH states that ________ must be reflected in the current stock price. A. all security price and volume data B. all publicly available information C. all information including inside information D. all costless information Bodie - Chapter 08 #5 Difficulty: Easy 6. Random price movements indicate ________. A. irrational markets B. that prices cannot equal fundamental values C. that technical analysis to uncover trends can be quite useful D. that markets are functioning efficiently Bodie - Chapter 08 #6 Difficulty: Medium 7. When the market risk premium rises, stock prices will ________. A. rise B. fall C. recover D. have excess volatility Bodie - Chapter 08 #7 Difficulty: Medium 2 Chapter 08 - The Efficient Market Hypothesis 8. The small firm in January effect is strongest ________. A. early in the month B. in the middle of the month C. late in the month D. in even numbered years Bodie - Chapter 08 #8 Difficulty: Medium 9. Evidence suggests that there may be _______ momentum and ________ reversal patterns in stock price behavior. A. short-run, short-run B. long-run, long-run C. long-run, short-run D. short-run, long run Bodie - Chapter 08 #9 Difficulty: Medium 10. Proponents of the EMH typically advocate __________. A. a conservative investment strategy B. a liberal investment strategy C. a passive investment strategy D. an aggressive investment strategy Bodie - Chapter 08 #10 Difficulty: Easy 11. Stock prices that are stable over time _______. A. indicate that prices are useful indicators of true economic value B. indicate that the market is not incorporating new information into current stock prices C. ensure that an economy allocates its resources efficiently D. indicates that returns follow a random walk process Bodie - Chapter 08 #11 Difficulty: Hard 3 Chapter 08 - The Efficient Market Hypothesis 12. The tendency when the ______ performing stocks in one period are the best performers in the next and the current ________ performers are lagging the market later is called the reversal effect. A. worst, best B. worst, worst C. best, worst D. best, best Bodie - Chapter 08 #12 Difficulty: Medium 13. Which of the following is not a method employed by followers of technical analysis? A. Charting B. Relative strength analysis C. Earnings forecasting D. Trading around support and resistance levels Bodie - Chapter 08 #13 Difficulty: Easy 14. Which of the following is not a method employed by fundamental analysts? A. Analyzing the Fed's next interest rate move B. Relative strength analysis C. Earnings forecasting D. Estimating the economic growth rate Bodie - Chapter 08 #14 Difficulty: Easy 15. The primary objective of fundamental analysis is to identify __________. A. well run firms B. poorly run firms C. mis-priced stocks D. high P/E stocks Bodie - Chapter 08 #15 Difficulty: Easy 4 Chapter 08 - The Efficient Market Hypothesis 16. If you believe in the __________ form of the EMH, you believe that stock prices reflect all publicly available information but not information that is available only to insiders. A. semi-strong B. strong C. weak D. perfect Bodie - Chapter 08 #16 Difficulty: Easy 17. If you believe in the __________ form of the EMH, you believe that stock prices reflect all relevant information including information that is available only to insiders. A. semi-strong B. strong C. weak D. perfect Bodie - Chapter 08 #17 Difficulty: Easy 18. Most of the stock price response to a corporate earnings or dividend announcement occurs within ________________. A. about 30 seconds B. about 10 minutes C. 6 months D. 2 years Bodie - Chapter 08 #18 Difficulty: Medium 5 Chapter 08 - The Efficient Market Hypothesis 19. __________ is the return on a stock beyond what would be predicted from market movements alone. A. A normal return B. A subliminal return C. An abnormal return D. An excess return Bodie - Chapter 08 #19 Difficulty: Easy 20. You believe that stock prices reflect all information that can be derived by examining market trading data such as the history of past stock prices, trading volume or short interest but you do not believe stock prices reflect all publicly available or inside information. You are a proponent of ____________. A. semi-strong B. strong C. weak D. perfect Bodie - Chapter 08 #20 Difficulty: Easy 21. You are an investment manager who is currently managing assets worth $6 billion. You believe that active management of your fund could generate between an additional one tenth of 1% return on the portfolio. If you want to make sure your active strategy adds value, how much can you spend on security analysis? A. $12,000,000 B. $6,000,000 C. $3,000,000 D. $0 (0.001)($6 billion) = $6,000,000 Bodie - Chapter 08 #21 Difficulty: Easy 6 Chapter 08 - The Efficient Market Hypothesis 22. A mutual fund which attempts to hold quantities of shares in proportion to their representation in the market is called a __________ fund. A. stock B. index C. hedge D. money market Bodie - Chapter 08 #22 Difficulty: Easy 23. Choosing stocks by searching for predictable patterns in stock prices is called ________. A. fundamental analysis B. technical analysis C. index management D. random walk investing Bodie - Chapter 08 #23 Difficulty: Easy 24. Which of the following is not an issue that is central to the debate regarding market efficiency? A. The magnitude issue B. The tax loss selling issue C. The lucky event issue D. The selection bias issue Bodie - Chapter 08 #24 Difficulty: Easy 25. Most people would readily agree that the stock market is not _________. A. weak form efficient B. semi-strong form efficient C. strong form efficient D. efficient at all Bodie - Chapter 08 #25 Difficulty: Easy 7 Chapter 08 - The Efficient Market Hypothesis 26. Small firms have tended to earn abnormal returns primarily in __________. A. the month of January B. the month July C. the trough of the business cycle D. the peak of the business cycle Bodie - Chapter 08 #26 Difficulty: Easy 27. Fama and French have suggested that many market anomalies can be explained as manifestations of ____________. A. regulatory effects B. high trading costs C. information asymmetry D. varying risk premiums Bodie - Chapter 08 #27 Difficulty: Medium 28. Proponents of the EMH think technical analysts __________. A. should focus on relative strength B. should focus on resistance levels C. should focus on support levels D. are wasting their time Bodie - Chapter 08 #28 Difficulty: Easy 29. Evidence supporting semi-strong form market efficiency suggests that investors should _________________________. A. rely on technical analysis to select securities B. rely on fundamental analysis to select securities C. use a passive trading strategy such as purchasing an index fund or an ETF D. select securities by throwing darts at the financial pages of the newspaper Bodie - Chapter 08 #29 Difficulty: Easy 8 Chapter 08 - The Efficient Market Hypothesis 30. "Buy a stock if its price moves up by 2% more than the Dow Average," is an example of a _________________. A. filter rule B. market anomaly C. fundamental approach D. passive trading strategy Bodie - Chapter 08 #30 Difficulty: Easy 31. Jaffee found that stock prices __________ after insiders intensively bought shares and __________ after insiders intensively sold shares. A. decreased, decreased B. decreased, increased C. increased, decreased D. increased, increased Bodie - Chapter 08 #31 Difficulty: Medium 32. In a recent study, Fama and French found that the return on the aggregate stock market was __________ when the dividend yield was higher. A. higher B. lower C. unaffected D. more skewed Bodie - Chapter 08 #32 Difficulty: Medium 9 Chapter 08 - The Efficient Market Hypothesis 33. Fama and French (1991) and Reinganum (1988) found that firms with __________ market/book ratios had higher stock returns. A. high B. low C. medium D. paired Bodie - Chapter 08 #33 Difficulty: Medium 34. Joe bought a stock at $57 per share. The price promptly fell to $55. Joe held on to the stock until it again reached $57 and then he sold once he had eliminated his loss. If other investors do the same to establish a trading pattern this would contradict _______. A. the strong-form EMH B. the weak-form EMH C. technical analysis D. the semistrong-form EMH Bodie - Chapter 08 #34 Difficulty: Medium 35. According to recent research securities markets fully adjust to earnings announcements _______. A. instantly B. in 1 day C. in 1 week D. gradually over time Bodie - Chapter 08 #35 Difficulty: Medium 10 Chapter 08 - The Efficient Market Hypothesis 36. When stock returns exhibit positive serial correlation, this means that __________ returns tend to follow ___________ returns. A. positive; positive B. positive; negative C. negative; positive D. positive; zero Bodie - Chapter 08 #36 Difficulty: Easy 37. Basu found that firms with high P/E ratios __________. A. earned higher average returns than firms with low P/E ratios B. earned the same average returns as firms with low P/E ratios C. earned lower average returns than firms with low P/E ratios D. had higher dividend yields than firms with low P/E ratios Bodie - Chapter 08 #37 Difficulty: Medium 38. Fundamental analysis is likely to yield best results for _______. A. NYSE stocks B. neglected stocks C. stocks that are frequently in the news D. fast growing companies Bodie - Chapter 08 #38 Difficulty: Medium 39. You are looking to invest in one of three stocks. Stock A has high expected earnings growth, Stock B has only modest expected earnings growth and Stock C is expected to generate poor earnings growth. Which stock is likely to generate the greatest alpha for you? A. Stock A B. Stock B C. Stock C D. You cannot tell from the information given Bodie - Chapter 08 #39 Difficulty: Medium 11 Chapter 08 - The Efficient Market Hypothesis 40. You believe that you can earn 2% more on your portfolio if you engage in full time stock research. However, the additional trading costs and tax liability from active management will cost you about 0.5%. You have a $800,000 stock portfolio. What is the most you can afford to spend on your research? A. $4,000 B. $8,000 C. $12,000 D. $16,000 (0.02 - 0.005)($800,000) = $12,000 Bodie - Chapter 08 #40 Difficulty: Medium 41. Even if the markets are efficient, professional portfolio management is still important because it provides investors with _________. I. low cost diversification II. provides a portfolio with a specified risk level III. provides better risk adjusted returns than an index A. I only B. I and II only C. II and III only D. I, II and III Bodie - Chapter 08 #41 Difficulty: Medium 42. Banz found that, on average, the risk-adjusted returns of small firms __________. A. was higher than the risk-adjusted returns of large firms B. was the same as the risk-adjusted returns of large firms C. was lower than the risk-adjusted returns of large firms D. was negative Bodie - Chapter 08 #42 Difficulty: Medium 12 Chapter 08 - The Efficient Market Hypothesis 43. If the U.S. capital markets are not informationally efficient ______. A. the markets cannot be allocationally efficient B. then systematic risk does not matter C. then no type of analysis can be used to generate abnormal returns D. then returns must follow a random walk Bodie - Chapter 08 #43 Difficulty: Medium 44. "Active investment management may generate additional returns at times of about 0.1%. However, the standard deviation of the typical well diversified portfolio is about 20%, so it is very difficult to statistically identify any increase in performance." Even if true, this statement is an example of the _________ problem in deciding how efficient the markets are. A. magnitude B. selection bias C. lucky event D. allocation Bodie - Chapter 08 #44 Difficulty: Medium 45. DeBondt and Thaler (1985) found that the poorest performing stocks in one time period experienced __________ performance in the following period and the best performing stocks in one time period experienced __________ performance in the following time period. A. good, good B. good, poor C. poor, good D. poor, poor Bodie - Chapter 08 #45 Difficulty: Medium 13 Chapter 08 - The Efficient Market Hypothesis 46. J.M. Keyes put all his money in one stock and the stock doubled in value in a matter of months. He did this three times in a row with three different stocks. J.M. got his picture on the front page of the Wall Street Journal. However the paper never mentioned the thousands of investors who made similar bets on other stocks and lost most of their money. This is an example of the ________ problem in deciding how efficient the markets are. A. magnitude B. selection bias C. lucky event D. small firm Bodie - Chapter 08 #46 Difficulty: Medium 47. Most tests of semi-strong efficiency are _________. A. designed to test whether inside information can be used to generate abnormal returns B. based on technical trading rules C. unable to generate any evidence of market anomalies D. joint tests of market efficiency and the risk adjustment measure Bodie - Chapter 08 #47 Difficulty: Medium 48. The _________ effect may explain much of the small firm anomaly. I. January effect II. neglected effect III. liquidity effect A. I only B. II only C. II and III only D. I, II and III Bodie - Chapter 08 #48 Difficulty: Medium 14 Chapter 08 - The Efficient Market Hypothesis 49. Studies show that the bid-ask spread for the least liquid stocks may be as high as ______. A. 3% B. 5% C. 9% D. 12% Bodie - Chapter 08 #49 Difficulty: Hard 50. The broadest information set is included in the A. weak form efficiency argument B. semi-strong form efficiency argument C. strong form efficiency argument D. technical analysis trading method Bodie - Chapter 08 #50 Difficulty: Easy 51. The Fama and French evidence that high book to market firms outperform low book to market firms even after adjusting for beta means _________. A. high book to market firms are underpriced B. low book to market firms are underpriced C. either high book to market firms are underpriced or the book to market ratio is a proxy for a systematic risk factor D. high book to market firms have more post earnings drift Bodie - Chapter 08 #51 Difficulty: Medium 15 Chapter 08 - The Efficient Market Hypothesis 52. According to results by Seyhun __________. A. investors cannot usually earn abnormal returns by following inside trades after knowledge of the trades are made public B. investors can usually earn abnormal returns by following inside trades after knowledge of the trades are made public C. investors cannot earn abnormal returns by following inside trades before knowledge of the trades are made public D. investors cannot earn abnormal returns by trading before insiders Bodie - Chapter 08 #52 Difficulty: Hard 53. If the daily returns on the stock market are normally distributed with a mean of 0.05% and a standard deviation of 1.00%, the probability that the stock market would have a return of 23.00% or worse on one particular day (as it did on Black Monday) is approximately __________. A. 0.0% B. 0.1% C. 1.0% D. 10.0% Prob = 1 - N{(.2300 - .0005)/.01}  0 Bodie - Chapter 08 #53 Difficulty: Medium 54. According to the semi-strong form of the efficient markets hypothesis ____________. 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 Bodie - Chapter 08 #54 Difficulty: Easy 16 Chapter 08 - The Efficient Market Hypothesis 55. The term random walk is used in investments to refer to ______________. A. stock price changes that are random but predictable B. stock prices that respond slowly to both old and new information C. stock price changes that are random and unpredictable D. stock prices changes that follow the pattern of past price changes Bodie - Chapter 08 #55 Difficulty: Easy 56. Important characteristic(s) of market efficiency is that _________________. I. there are no arbitrage opportunities II. security prices react quickly to new information III. active trading strategies will not consistently outperform passive strategies A. I only B. II only C. I and III only D. I, II and III Bodie - Chapter 08 #56 Difficulty: Easy 57. Stock market analysts have tended to be ___________ in their recommendations to investors. A. slightly overly optimistic B. overwhelmingly optimistic C. slightly overly pessimistic D. overwhelmingly pessimistic Bodie - Chapter 08 #57 Difficulty: Medium 17 Chapter 08 - The Efficient Market Hypothesis 58. Assume that a company announces unexpectedly high earnings in a particular quarter. In an efficient market one might expect _____________. A. an abnormal price change immediately following the announcement B. an abnormal price increase before the announcement C. an abnormal price decrease after the announcement D. no abnormal price change before or after the announcement Bodie - Chapter 08 #58 Difficulty: Easy 59. A market anomaly refers to _______. A. an exogenous shock to the market that is sharp but not persistent B. a price or volume event that is inconsistent with historical price or volume trends C. a trading or pricing structure that interferes with efficient buying and selling of securities D. price behavior that differs from the behavior predicted by the efficient market hypothesis Bodie - Chapter 08 #59 Difficulty: Medium 60. Which of the following contradicts the proposition that the stock market is weakly efficient? A. Over 25% of mutual funds outperform the market on average. B. Insiders earn abnormal trading profits. C. Every January, the stock market earns above normal returns. D. Applications of technical trading rules fail to earn abnormal returns. Bodie - Chapter 08 #60 Difficulty: Medium 18 Chapter 08 - The Efficient Market Hypothesis 61. Which of the following would violate the efficient market hypothesis? A. Intel has consistently generated large profits for years. B. Prices for stocks before stock splits show on average consistently positive abnormal returns. C. Earning abnormal returns after a firm announces surprise earnings. D. High earnings growth stocks fail to generate higher returns for investors than low earnings growth stocks. Bodie - Chapter 08 #61 Difficulty: Medium 62. Which of the following stock price observations would appear to contradict the weak form of the efficient market hypothesis? A. The average rate of return is significantly greater than zero. B. The correlation between the market return one week and the return the following week is zero. C. You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall. D. You could have consistently made superior returns by forecasting future earnings performance with your new Crystal Ball forecast methodology. Bodie - Chapter 08 #62 Difficulty: Medium 63. The semi-strong form of the efficient market hypothesis implies that ____________ generate abnormal returns and ____________ generate abnormal returns. A. Technical analysis cannot; fundamental analysis can B. Technical analysis can; fundamental analysis can C. Technical analysis can; fundamental analysis cannot D. Technical analysis cannot; fundamental analysis cannot Bodie - Chapter 08 #63 Difficulty: Medium 19 Chapter 08 - The Efficient Market Hypothesis 64. An implication of the efficient market hypothesis is that __________. A. high beta stocks are consistently overpriced B. low beta stocks are consistently overpriced C. nonzero alphas will quickly disappear D. growth stocks are better buys than value stocks Bodie - Chapter 08 #64 Difficulty: Medium 65. Fundamental indexing refers to ________. A. investing in index stocks in proportion to the stock's fundamental value B. investing in index stocks in proportion to the stock's market value C. investing an equal dollar amount in index stocks D. investing in an equal amount shares in each of the index stocks Bodie - Chapter 08 #65 Difficulty: Medium 66. Tests of mutual fund performance indicate that funds with ______________ tend to have poorer performance. A. more funds in the family B. higher expense and turnover ratios C. lower management fees D. larger asset size Bodie - Chapter 08 #66 Difficulty: Easy 20 Chapter 08 - The Efficient Market Hypothesis 67. Value stocks may provide investors with better returns than growth stocks if _______. I. value stocks are out of favor with investors II. prices of growth stocks include premiums for overly optimistic growth levels III. value stocks are likely to generate positive earnings surprises. A. I only B. II only C. I and III only D. I, II and III Bodie - Chapter 08 #67 Difficulty: Medium 68. Value stocks usually exhibit ___ price-to-book ratios and ___ price-to-earnings ratios. A. low, low B. low, high C. high, low D. high, high Bodie - Chapter 08 #68 Difficulty: Medium 69. Growth stocks usually exhibit ___ price-to-book ratios and ___ price-to-earnings ratios. A. low, low B. low, high C. high, low D. high, high Bodie - Chapter 08 #69 Difficulty: Medium 21 Chapter 08 - The Efficient Market Hypothesis 70. A day trade with an average stock holding period of under 8 minutes might be most closely associated with which trading philosophy? A. EMH B. Fundamental analysis C. Strong form market efficiency D. Technical analysis Bodie - Chapter 08 #70 Difficulty: Easy 71. A technical analyst is most likely to be affiliated with which investment philosophy? A. Active management B. Buy and hold C. Passive investment D. Index funds Bodie - Chapter 08 #71 Difficulty: Easy 72. Someone who invests in the Vanguard Index 500 mutual fund could most accurately be described as using what approach? A. Active management B. Arbitrage C. Fundamental analysis D. Passive investment Bodie - Chapter 08 #72 Difficulty: Easy 73. Evidence by Blake, Elton and Gruber indicates that on average actively managed bond funds A. outperform passive fixed-income indexes __________. B. under perform passive fixed-income indexes by a wide margin C. perform as well as passive fixed-income indexes D. under perform passive fixed-income indexes by an amount equal to fund expenses Bodie - Chapter 08 #73 Difficulty: Medium 22 Chapter 08 - The Efficient Market Hypothesis 74. Insiders are able to profitably trade and earn abnormal returns prior to the announcement of positive news. This is a violation of which form of efficiency? A. Weak form efficiency B. Semi-strong form efficiency C. Strong form efficiency D. Technical analysis Bodie - Chapter 08 #74 Difficulty: Medium 75. In an efficient market and for an investor that believes in a passive approach to investing, what is the primary duty of a portfolio manager? A. Accounting for results B. Diversification C. Identifying undervalued stocks D. No need for a portfolio manager Bodie - Chapter 08 #75 Difficulty: Medium 76. Which of the following is not a topic related to the debate over market efficiency? A. IPO results B. Lucky event issue C. Magnitude issue D. Selection bias Bodie - Chapter 08 #76 Difficulty: Medium 77. Which Fidelity Magellan portfolio manager is often referenced as an exception to the general conclusion of efficient markets? A. Jeff Vinik B. Peter Lynch C. Robert Stansky D. William Hayes Bodie - Chapter 08 #77 Difficulty: Medium 23 Chapter 08 - The Efficient Market Hypothesis 78. The tendency of poorly performing stocks and well performing stocks in one period to continue their performance into the next period is called the ________________. A. fad effect B. martingale effect C. momentum effect D. reversal effect Bodie - Chapter 08 #78 Difficulty: Medium 79. Which of the following is not a concept related to explaining abnormal excess stock returns? A. January effect B. Neglected firm effect C. P/E effect D. Preferred stock effect Bodie - Chapter 08 #79 Difficulty: Easy 80. The lack of adequate trading volume in stock that may ultimately lead to its ability to produce excess returns is referred to as the ____________________. A. January effect B. liquidity effect C. neglected firm effect D. P/E effect Bodie - Chapter 08 #80 Difficulty: Easy 24 Chapter 08 - The Efficient Market Hypothesis 81. Fundamental analysis determines that the price of a firm's stock is too low, given its intrinsic value. The information used in the analysis is available to all market participants, yet the price does not seem to react. The stock does not trade on a major exchange. What concept might explain the ability to produce excess returns on this stock? A. January effect B. Neglected firm effect C. P/E effect D. Reversal effect Bodie - Chapter 08 #81 Difficulty: Medium 82. When testing mutual fund performance over time one must be careful of ___________, which means that a certain percentage of poorer performing funds fail over time which makes the performance of remaining funds seem more consistent over time. A. survivorship bias B. lucky event bias C. magnitude bias D. mean reversion bias Bodie - Chapter 08 #82 Difficulty: Medium 83. Most evidence indicates that U.S. stock markets are _______________________. A. reasonably weak form and semi-strong form efficient B. strong form efficient C. reasonably weak form but not semi- or strong form efficient D. neither weak form, semi- or strong form efficient Bodie - Chapter 08 #83 Difficulty: Medium 25 Chapter 08 - The Efficient Market Hypothesis 84. Which of the following statements is/are correct? A. If a market is weak form efficient it is also semi- and strong form efficient B. If a market is semi-strong efficient it is also strong form efficient C. If a market is strong form efficient it is also semi-strong but not weak form efficient D. If a market is strong form efficient it is also semi- and weak form efficient Bodie - Chapter 08 #84 Difficulty: Medium 85. According to Markowitz and other proponents of modern portfolio theory which of the following activities would not be expected to produce any benefits? A. Diversification B. Investing in Treasury bills C. Investing in stocks of utility companies D. Engaging in active portfolio management to enhance returns Bodie - Chapter 08 #85 Difficulty: Easy 86. According to results by Seyhun the main reason why investors cannot earn excess returns by following inside trades after they become public is ______________. A. risk premium B. transaction costs C. the SEC late disclosure rule D. the stock reversal effect Bodie - Chapter 08 #86 Difficulty: Hard 26