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Chapter 11 - The Efficient Market Hypothesis

Chapter 11

The Efficient Market Hypothesis

Multiple Choice Questions

1. If you believe in the

_

_______

f

orm of the EMH, you believe that stock prices reflect all

releva nt in formati on in clud ing historical stock prices and curre nt public in formati on about the

firm, but not information that is available only to insiders.

A.

Semistro ng

2.

Whe n Maurice Ken dall exam ined the patter ns of stock retur ns in 1953 he con cluded that

the

stock market was __________

. Now, these ran dom price moveme nts are believed to be

A.

in efficie nt; the effect of a well-fu nctio ning market

3.

The stock market follows a

_________ .

B.

Submartingale

4.

A hybrid strategy is one where the investor

D.

mai ntai ns a passive core and augme nts the positi on with an actively man aged portfolio.

5.

The differe nee betwee n a ran dom walk and a submart in gale is the expected price cha nge

in a

ran dom walk is

_

____

and the expected price cha nge for a submart in gale is

_____

.

D.

zero; positive

6.6. The differe nee betwee n a ran dom walk and a submart in gale is the expected price cha

nge in a ran dom walk is and the expected price cha nge for a submart in gale is _____

.

D.

zero; positive

7.

Prop onents of the EMH typically advocate

B.

inv esti ng in an in dex fund.

C.

a passive inv estme nt strategy.

E.

B and C

8.

Prop onents of the EMH typically advocate

C.

a passive inv estme nt strategy.

9.

If you believe in the ______

form of the EMH, you believe that stock prices reflect all

in formati on that can be derived by exam ining market trad ing data such as the history of past

stock prices, tradi ng volume or short in terest.

C.

Weak

10. If you believe in the

________ form of the EMH, you believe that stock prices reflect all

available information, including information that is available only to insiders.

B.

strong

11. If you believe in the reversal effect, you should

C.

buy stocks this period that performed poorly last period.

12. ________

focus more on past price moveme nts of a firm's stock tha n on the un derly ing

determi nants of future profitability.

D.

Tech ni cal an alysts

13. ________

above which it is difficult for the market to rise.

B.

Resista nee level is a value

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Chapter 11 - The Efficient Market Hypothesis

14. ________ below which it is difficult for the market to fall.

C.

Support level is a value

15. __________ the return on a stock bey ond what would be predicted from market

moveme nts alone.

A.

An excess econo mic retur n is

C. An abno rmal return is

E.

A and C

16. The debate over whether markets are efficie nt will probably n ever be resolved because of

A.

the lucky eve nt issue.

B.

the magn itude issue.

C.

the selecti on bias issue.

D.

all of the above.

17. A com mon strategy for passive management is

___________ .

A

creating an index fund

18. Arbel (1985) found that

A

the January effect was highest for neglected firms.

19. Researchers have found that most of the small firm effect occurs

D.

in Janu ary.

20.

Basu (1977, 1983) found that firms with low P/E ratios

A

earned higher average returns than firms with high P/E ratios.

21.

Jaffe (1974) found that stock prices

_

________

after in siders inten sively bought shares.

C.

in creased

22.

Banz (1981) found that, on average, the risk-adjusted returns of small firms

A

were higher than the risk- adjusted returns of large firms.

23.

Proponents of the EMH think technical analysts

E.

are wasti ng their time.

24.

Studies of positive earnings surprises have show n that there is

A.

a positive abnormal return on the day positive earnings surprises are announced.

B.

a positive drift in the stock price on the days follow ing the earnings surprise announ ceme nt.

D.

both A and B are true.

25.

Studies of n egative earnings surprises have show n that there is

A.

a negative abnormal return on the day negative earnings surprises are announced.

B.

a positive drift in the stock price on the days follow ing the earnings surprise announ ceme nt.

D.

both A and B are true.

26.

Studies of stock price reacti ons to n ews are called

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Chapter 11 - The Efficient Market Hypothesis

B.

eve nt studies.

27.

On November 22, 2005 the stock price of Walmart was $$39.50 and the retailer stock index

was 600.30. On November 25, 2005 the stock price of Walmart was $$40.25 and the retailer stock

in dex was 605.20. Con sider the ratio of Walmart to the retailer in dex on November 22 and

November 25. Walmart is

_

_________ the retail in dustry and tech ni cal an alysts who follow

relative stre ngth would advise

______ the stock.

A

outperforming, buying

28.

Work by Amihud and Mendelson (1986,1991)

A.

argues that in vestors will dema nd a rate of return premium to inv est in less liquid stocks.

B.

may help explain the small firm effect.

C.

may be related to the n eglected firm effect.

E.

A, B, and C

.

29.

Fama and French (1992) found that the stocks of firms within the highest decile of

market/book ratios had average mon thly returns of ______

while the stocks of firms within the

lowest decile of market/book ratios had average mon thly returns of

_______

.

C.

less than 1%, greater than 1%

30.

A market decli ne of 23% on a day whe n there is no sig nifica nt macroec ono mic eve nt

_____ con siste nt with the EMH because

_______ .

D.

would not be, it was not a clear response to macroeconomic news.

31.

In an efficie nt market, _________ .

A.

security prices react quickly to new in formatio n

B.

security prices are seldom far above or below their justified levels

C.

security an alysts will not en able in vestors to realize superior returns con siste ntly

E.

A, B, and C

32.

The weak form of the efficie nt market hypothesis asserts that

B.

future cha nges in stock prices cannot be predicted from past prices.

C.

tech nicians cannot expect to outperform the market.

E.

B and C

33.

A support level is the price range at which a technical analyst would expect the

C.

dema nd for a stock to in crease substa ntially.

34.

A finding that

________ would provide evide nee aga inst the semistro ng form of the

efficient market theory.

A.

low P/E stocks tend to have positive abnormal returns

C.

one can con siste ntly outperform the market by adopti ng the con traria n approach

exemplified by the reversals phe nomenon

巳

A and C

35.

The weak form of the efficie nt market hypothesis con tradicts

D.

tech ni cal an alysis, but is sile nt on the possibility of successful fun dame ntal an alysis.

36.

Two basic assumpti ons of tech ni cal an alysis are that security prices adjust

C.

gradually to new in formatio n and market prices are determ ined by the in teractio n of supply

and dema nd.

37.

Cumulative abn ormal returns (CAR)

A.

are used in eve nt studies.

B.

are better measures of security returns due to firm- specific eve nts tha n are abno rmal

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Chapter 11 - The Efficient Market Hypothesis

returns (AR).

D.

A and B.

38.

Studies of mutual fund performa nee

A.

in dicate that one should not ran domly select a mutual fund.

B.

i ndicate that historical performa nee is not n ecessarily in dicative of future performa nee.

D.

A and B.

39.

The likelihood of an inv estme nt n ewsletter's successfully predict ing the direct ion of the

market for three con secutive years by cha nee should be

C.

between 10% and 25%.

40.

I n an efficie nt market the correlati on coefficie nt betwee n stock returns for two

non-o verlapp ing time periods should be

C.

zero.

41.

The weather report says that a devastat ing and un expected freeze is expected to hit Florida

toni ght, duri ng the peak of the citrus harvest. I n an efficie nt market one would expect the price

of Florida Oran ge's stock to

A

drop immediately.

42.

Matthews Corporation has a beta of 1.2. The annualized market return yesterday was 13%,

and the risk-free rate is currently 5%. You observe that Matthews had an annualized return

yesterday of 17%. Assu ming that markets are efficie nt, this suggests that

B.

good news about Matthews was announced yesterday.

43.

Nicholas Manu facturi ng just announ ced yesterday that its F quarter earnings will be 10%

higher than last year's

4

quarter. You observe that Nicholas had an abnormal return of -1.2%

yesterday. This suggests that

C.

in vestors expected the earnings in crease to be larger tha n what was actually announ ced.

44.

When Maurice Ken dall first exam ined stock price patter ns in 1953, he found that

B.

there were no predictable patter ns in stock prices.

45.

If stock prices follow a ran dom walk

D.

price changes are random.

46.

The main differe nee betwee n the three forms of market efficie ncy is that

D.

the definition of information differs.

47.

Chartists practice

A

technical analysis.

48.

Which of the followi ng are used by fun dame ntal an alysts to determ ine proper stock

prices?

I) tren dli nes

II)

earnings

III)

divide nd prospects

IV) expectati ons of future in terest rates

V)

resista nee levels

C.

II, III, and IV

49.

Accord ing to prop onents of the efficie nt market hypothesis, the best strategy for a small in

vestor with a portfolio worth $$40,000 is probably to

E.

inv est in mutual fun ds.

50.

Which of the followi ng are inv estme nt superstars who have con siste ntly show n superior

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