CHAPTER 10
EFFICIENT CAPITAL MARKETS
TRUE/FALSE QUESTIONS
(t) 1 Prices in efficient capital markets fully reflect all available information and rapidly adjust to new information.
(t) 2 An efficient market requires a large number of
participants
who
independent
profit-maximizing
analyze and value curities and act upon this
valuation.
(t) 3 In an efficient market, prevailing curity prices should be an unbiad reflection of all current
information.
(f) 4 Even though markets are efficient, the expected
returns for a curity may not always reflect its
risk.
(t) 5 Random walk hypothesis contends that changes in
occur
randomly.
stock
prices
(f) 6 If the efficient market hypothesis is true, price
and
biad.
independent
changes
are
(t) 7 The major factor that differentiates the three forms of the efficient market hypothesis is the t
of information being considered in each ca.
(t) 8 The weak-form of the efficient market hypothesis contends that stock prices fully reflect all
information.
curity-market
(f) 9 A runs test is ud to test the weak-form efficient
market hypothesis by checking for correlations that
persist longer than one would expect for a random
ries.
(f) 10 Tests of filter trading rules were quite successful
when the investigator assumed very small filters
commissions.
and
considered
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MULTIPLE CHOICE QUESTIONS
(d) 1 Escalation bias refers to the situation where
a) Investors have a propensity to ll winners too
soon and hang on to lors too long.
b) Investors ignore bad news and overemphasize
good news.
c) Investors tend to follow the herd.
d) Investors put more money into a failure rather
than into a success.
e) Investors are all noi traders.
(b) 2 Confirmation bias refers to the situation where
a) Investors have a propensity to ll winners too
soon and hang on to lors too long.
b) Investors ignore bad news and overemphasize
good news.
c) Investors tend to follow the herd.
d) Investors put more money into a failure rather
than into a success.
e) Investors are all noi traders.
(a) 3 According to prospect theory
a) Investors have a propensity to ll winners too
soon and hang on to lors too long.
b) Investors ignore bad news and overemphasize
good news.
c) Investors tend to follow the herd.
d) Investors put more money into a failure rather
than into a success.
e) Investors are all noi traders.
(b) 4 Behavioral finance differs from the standard model of
finance becau behavioral finance
a) Precludes the impact of investor psychology.
b) Includes the impact of investor psychology.
c) Accepts the Efficient Markets Hypothesis.
d) Rejects the idea of market anomalies.
e) none of the above.
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(b) 5 Studies of the relationship between P/E ratios and
stock returns have found that
a) Low P/E stocks of large cap stocks outperformed
low P/E stocks of small cap stocks.
b) Low P/E stocks of small cap stocks outperformed
high P/E stocks of large cap stocks.
c) High P/E stocks of large cap stocks
outperformed low P/E stocks of small cap
stocks.
d) High P/E stocks of large cap stocks
outperformed high P/E stocks of small cap
stocks.
e) none of the above.
(d) 6 The January anomaly refers to the phenomenon where
stock prices
a) Decline in December.
b) Decline in January.
c) Ri in January.
d) Decline in December and ri in January.
e) Ri in December and decline in January.
(a) 7 Rearchers have found a positive relationship between
default spread and stock returns in the long run
becau a large default spread implies
a) a high risk premium and higher expected
returns.
b) a high risk premium and lower expected returns.
c) a low risk premium and higher expected returns.
d) a low risk premium and lower expected returns.
e) none of the above.
(e) 8 The results of return prediction studies have found
a) Limited success predicting short-horizon
returns.
b) Limited success predicting long-horizon
returns.
c) Good success predicting long-horizon returns.
d) a) and b).
e) a) and c).
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(c) 9 In tests of the mistrong-form efficient market
hypothesis, an adjustment for market effects is carried
by
a) Calculating the historical return.
b) Calculating the market rate of return.
c) Calculating the abnormal rate of return.
d) Calculating the cross-ctional return.
e) None of the above.
(b) 10 In an event study the objective is to
a) Whether it is possible to predict stock prices.
b) How fast stock prices adjust to news.
c) Examine the cross-ctional distributions of
returns.
d) Conduct a time ries analysis of returns.
e) Determine normal P/E ratios.
(d) 11 In order to confirm the weak-form efficient market
hypothesis you could develop trading rules that
consider,
a) Advance-decline ratios.
b) Short sales.
c) Specialist activities.
d) Any of the above.
e) None of the above.
(e) 12 In order to confirm the weak-form efficient market
hypothesis, an examination of stock price runs over
time would reveal that stock price changes over time
were
a) Highly positively correlated.
b) Moderately positively correlated.
c) Highly negatively correlated.
d) Moderately negatively correlated.
e) None of the above.
(c) 13 According to the strong-form efficient market
hypothesis, stock prices fully reflect
a) All curity market information only.
b) All public information only.
c) All public and private information only.
d) All of the above.
e) None of the above.
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(e) 14 According to the mistrong-form efficient market
hypothesis, which of the following types of information
are fully reflected in stock prices?
a) Rates of return, trading volume, and news about
the economy.
b) Dividend and earnings announcements.
c) Rates of return, trading volume, and block
trades.
d) Earnings announcements and rates of return.
e) All of the above.
(c) 15 According to the weak-form efficient market hypothesis,
which of the following types of information are fully
reflected in stock prices?
a) Rates of return, trading volume, and news about
the economy.
b) Dividend and earnings announcements.
c) Rates of return, trading volume, and block
trades.
d) Earnings announcements and rates of return.
e) All of the above.
(b) 16 Which of the following is not an assumption of an
efficient market?
a) The prence of a large number of profit maxi-
mizing participants concerned with the analysis
and valuation of curities.
b) There exists a small group of investors who
have monopolistic access to certain sources of very important information.
c) New information randomly comes to the market.
d) Investors adjust curity prices rapidly to
reflect information.
e) The curity prices that prevail at any point
in time should be an unbiad reflection of all currently available information.
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