Documente Academic
Documente Profesional
Documente Cultură
Chapter 13
Efficient Markets and Behavioral Finance
2. A large firm is receiving a loan guarantee from the government. Because of the guarantee,
the firm is able to borrow $50 million for five years at 8% interest rate per year instead of
10% per year. Calculate the value of the guarantee to the firm. (Ignore taxes.)
A. +$53.79 million
B. +$3.79 million
C. -$3.79 million
D. None of the above
3. If the capital markets are efficient, then the sale or purchase of any security at the
prevailing market price is:
A. Always a positive NPV transaction
B. Generally a zero NPV transaction
C. Is always a negative NPV transaction
D. None of the above
13-1
Chapter 13 - Efficient Markets and Behavioral Finance
4. Financing decisions differ from investment decisions for which of the following reasons?
I) You cannot use NPV to evaluate financing decisions
II) The market for financial assets is more active
III) It is easier to find financing decisions with positive NPV than to find investment decisions
with positive NPV
A. I only
B. II only
C. III only
D. I and III only
13-2
Chapter 13 - Efficient Markets and Behavioral Finance
7. The statement that stock prices follow a random walk implies that:
I) Successive price changes are independent of each other
II) Successive price changes are positively related
III) Successive price changes are negatively related
IV) The autocorrelation coefficient is either +1 or -1
A. I only
B. II and III only
C. IV only
D. III only
8. A random walk process consists of the toss of a fair coin at the end of each day. If the
outcome is heads stock price increases by 1.25% and if the outcome is tails the stock price
decreases by 0.75%. What is the drift of such a process?
A. +1.25%
B. -0.75%
C. +0.25%
D. None of the above
9. The statement that stock prices follow a random walk implies that:
I) The correlation coefficient between successive price changes (auto correlation) is not
significantly different from zero.
II) Successive price changes are positively related.
III) Successive price changes are negatively related.
IV) The autocorrelation coefficient is positive.
A. I only
B. II only
C. II and III only
D. IV only
10. Stock price cycles or patterns self-destruct as soon as investors recognize them through:
A. stock market regulation by the Securities and Exchange Commission (SEC)
B. price fixing by the specialists on New York Stock Exchange
C. trading by the investors
D. none of the above
13-3
Chapter 13 - Efficient Markets and Behavioral Finance
13. Which of the following statement(s) is/are true if the efficient market hypothesis holds?
I) It implies perfect forecasting ability
II) It implies market is irrational
III) It implies that prices follow a particular pattern
IV) It implies that prices reflect all available information
A. I only
B. II only
C. I and III only
D. IV only
13-4
Chapter 13 - Efficient Markets and Behavioral Finance
14. Strong form market efficiency states that the market incorporates all information in the
stock price. Strong form efficiency implies that:
I) An investor can only earn risk-free rates of return
II) An investor can always rely on technical analysis
III) An insider or corporate officer can not outperform the market by trading on the inside
information
A. I only
B. II only
C. III only
D. I, II, and III
13-5
Chapter 13 - Efficient Markets and Behavioral Finance
13-6
Chapter 13 - Efficient Markets and Behavioral Finance
21. If the markets are efficient, which of the following investors should have above normal
return on assets over time?
A. Those who choose their stocks by throwing darts at a list of stocks found in the financial
pages of a newspaper.
B. Analysts who spend considerable time evaluating the best stocks to buy.
C. Mutual fund managers who manage other people's money for a living.
D. None of the above
23. The semi-strong form of efficiency deals with the following type of information:
A. insider information
B. publicly available information
C. privileged information
D. all of the above
24. The semi-strong form of has been tested by measuring how rapidly security prices react
various news items like:
I) earnings announcements
II) dividend announcements
III) news of takeovers
IV) macroeconomic information
A. I and II only
B. I, II and III only
C. IV only
D. I, II, III and IV
13-7
Chapter 13 - Efficient Markets and Behavioral Finance
26. In order to test the efficient-market hypothesis in the weak form, researchers have used the
following methods except:
A. Estimation of the serial correlation (autocorrelation) for securities and markets
B. Measurement of the profitability of trading rules used by technical analysts
C. Measurement of how rapidly security prices adjust to different news items
D. All of the above are methods used for testing weak-form market efficiency
28. In order to test the efficient-market hypothesis in the semi-strong form, researchers have
used (the):
A. Estimation of the serial correlation (autocorrelation) for securities and markets
B. Measurement of the performance of mutual fund managers over the years
C. Measurement of how rapidly security prices adjust to different news items
D. All of the above
29. Analysis of past monthly movements in Wal-Mart's stock price has produced the
following estimates: α = -0.45% and β = 0. 5. If the market index subsequently rises by 5%
one month and Wal-Mart's stock price rises by 3%, what is the abnormal change in Wal-
Mart's stock price?
A. -0.95%
B. +0.95%
C. +0.05%
D. None of the above
13-8
Chapter 13 - Efficient Markets and Behavioral Finance
30. Analysis of past monthly movements in IBM's stock price produces the following
estimates: α = 2. 5% and β = 1. 6. If the market index subsequently rises by 12% in one
month and IBM's stock price increases by 20%, what is the abnormal change in IBM's stock
price?
A. +1.7%
B. +8%
C. -1.7%
D. None of the above
31. If the abnormal return for a stock during the first week is +5% and during the second
week is +3%, what is the abnormal return for the two-week period?
A. 5%
B. 3%
C. 8.15%
D. None of the above
33. In order to test the strong form of market efficiency, researchers have:
I) examined the recommendations of professional security analysts
II) performance of mutual funds
III) performance of pension funds
A. I only
B. I and II only
C. I, II, and III only
D. II and III only
13-9
Chapter 13 - Efficient Markets and Behavioral Finance
34. Which of the following observations would provide evidence against the strong form of
efficient market theory?
I) Mutual fund managers do not on average make superior returns
II) In any year approximately 50% of all pension funds outperform the market
III) Managers who trade in their own firm's stocks make superior returns
A. I only
B. II only
C. III only
D. I and II only
35. A lawyer works for a firm that advises corporate firms planning to sue other corporations
for antitrust damages. He finds that he can "beat the market" by short selling the stock of the
firm that will be sued. This finding is in violation of the:
A. Weak form market efficiency
B. Semi-strong form market efficiency
C. Strong form market efficiency
D. None of the above
37. The following are anomalies associated with market efficiency except:
I) the small-firm effect
II) the earnings announcement puzzle
III) the new-issue puzzle
IV) trading rules based on patterns
A. I only
B. I and II only
C. I, II, and III only
D. IV only
13-10
Chapter 13 - Efficient Markets and Behavioral Finance
38. The annual expected dividend on the S&P index was about 154.6. If the dividend is
expected to grow at a steady rate of 8% a year and the required annual rate of return is 10%,
what is the value of the index?
A. 1193
B. 1700
C. 7730
D. None of the above
41. Investors are particularly averse to the possibility of even a very small loss and need a
high return to compensate for it. Such a concept is related to what theory?
A. Market efficiency theory
B. Random walk theory
C. Convergence trading
D. Prospect theory
13-11
Chapter 13 - Efficient Markets and Behavioral Finance
42. Which theory offers an explanation for the crash of a stock market one day and its
rebound the next?
A. Market efficiency theory
B. Random walk theory
C. Convergence trading
D. Prospect theory
43. For a corporation, financing decisions are harder to reverse than investment decisions.
True False
44. If capital markets are efficient, then the purchase or sale of any security at the prevailing
market price is never a positive-NPV transaction.
True False
47. The weak form of efficient market theory implies that technical analysis is valuable.
True False
48. When a firm announces a dividend change or publishes its latest earnings, the major part
of the price adjustment takes place within a few minutes of the announcement.
True False
13-12
Chapter 13 - Efficient Markets and Behavioral Finance
50. The evidence against market efficiency are called puzzles or anomalies.
True False
51. Behavioral finance deals with the idea that individual investors have built-in biases and
misconceptions that can drive prices away from fair values.
True False
52. In an efficient market, investors will not pay others what they can do equally well
themselves.
True False
53. Behavioral finance and technical analysis are basically the same theory.
True False
54. A majority of research supports the theory that past stock movements can predict future
asset prices.
True False
13-13
Chapter 13 - Efficient Markets and Behavioral Finance
55. State the important differences between investment decisions and financing decisions.
56. Briefly explain why, in a competitive securities market, successive price changes are
random.
57. List the three forms of market efficiency and explain the basis for it.
13-14
Chapter 13 - Efficient Markets and Behavioral Finance
59. State the weak form of market efficiency and its implications.
60. State the semi-strong form of market efficiency and its implications.
62. Briefly discuss some of the important findings of behavioral finance studies.
13-15
Chapter 13 - Efficient Markets and Behavioral Finance
64. How does the random walk theory explain market crashes?
13-16
Chapter 13 - Efficient Markets and Behavioral Finance
Type: Medium
2. A large firm is receiving a loan guarantee from the government. Because of the guarantee,
the firm is able to borrow $50 million for five years at 8% interest rate per year instead of
10% per year. Calculate the value of the guarantee to the firm. (Ignore taxes.)
A. +$53.79 million
B. +$3.79 million
C. -$3.79 million
D. None of the above
Type: Medium
13-17
Chapter 13 - Efficient Markets and Behavioral Finance
3. If the capital markets are efficient, then the sale or purchase of any security at the
prevailing market price is:
A. Always a positive NPV transaction
B. Generally a zero NPV transaction
C. Is always a negative NPV transaction
D. None of the above
Type: Medium
4. Financing decisions differ from investment decisions for which of the following reasons?
I) You cannot use NPV to evaluate financing decisions
II) The market for financial assets is more active
III) It is easier to find financing decisions with positive NPV than to find investment decisions
with positive NPV
A. I only
B. II only
C. III only
D. I and III only
Type: Easy
Type: Easy
13-18
Chapter 13 - Efficient Markets and Behavioral Finance
Type: Easy
7. The statement that stock prices follow a random walk implies that:
I) Successive price changes are independent of each other
II) Successive price changes are positively related
III) Successive price changes are negatively related
IV) The autocorrelation coefficient is either +1 or -1
A. I only
B. II and III only
C. IV only
D. III only
Type: Medium
8. A random walk process consists of the toss of a fair coin at the end of each day. If the
outcome is heads stock price increases by 1.25% and if the outcome is tails the stock price
decreases by 0.75%. What is the drift of such a process?
A. +1.25%
B. -0.75%
C. +0.25%
D. None of the above
Type: Medium
13-19
Chapter 13 - Efficient Markets and Behavioral Finance
9. The statement that stock prices follow a random walk implies that:
I) The correlation coefficient between successive price changes (auto correlation) is not
significantly different from zero.
II) Successive price changes are positively related.
III) Successive price changes are negatively related.
IV) The autocorrelation coefficient is positive.
A. I only
B. II only
C. II and III only
D. IV only
Type: Medium
10. Stock price cycles or patterns self-destruct as soon as investors recognize them through:
A. stock market regulation by the Securities and Exchange Commission (SEC)
B. price fixing by the specialists on New York Stock Exchange
C. trading by the investors
D. none of the above
Type: Medium
Type: Medium
13-20
Chapter 13 - Efficient Markets and Behavioral Finance
Type: Easy
13. Which of the following statement(s) is/are true if the efficient market hypothesis holds?
I) It implies perfect forecasting ability
II) It implies market is irrational
III) It implies that prices follow a particular pattern
IV) It implies that prices reflect all available information
A. I only
B. II only
C. I and III only
D. IV only
Type: Medium
14. Strong form market efficiency states that the market incorporates all information in the
stock price. Strong form efficiency implies that:
I) An investor can only earn risk-free rates of return
II) An investor can always rely on technical analysis
III) An insider or corporate officer can not outperform the market by trading on the inside
information
A. I only
B. II only
C. III only
D. I, II, and III
Type: Medium
13-21
Chapter 13 - Efficient Markets and Behavioral Finance
Type: Medium
Type: Easy
Type: Medium
13-22
Chapter 13 - Efficient Markets and Behavioral Finance
Type: Medium
Type: Easy
Type: Easy
21. If the markets are efficient, which of the following investors should have above normal
return on assets over time?
A. Those who choose their stocks by throwing darts at a list of stocks found in the financial
pages of a newspaper.
B. Analysts who spend considerable time evaluating the best stocks to buy.
C. Mutual fund managers who manage other people's money for a living.
D. None of the above
Type: Difficult
13-23
Chapter 13 - Efficient Markets and Behavioral Finance
Type: Medium
23. The semi-strong form of efficiency deals with the following type of information:
A. insider information
B. publicly available information
C. privileged information
D. all of the above
Type: Medium
24. The semi-strong form of has been tested by measuring how rapidly security prices react
various news items like:
I) earnings announcements
II) dividend announcements
III) news of takeovers
IV) macroeconomic information
A. I and II only
B. I, II and III only
C. IV only
D. I, II, III and IV
Type: Difficult
Type: Medium
13-24
Chapter 13 - Efficient Markets and Behavioral Finance
26. In order to test the efficient-market hypothesis in the weak form, researchers have used the
following methods except:
A. Estimation of the serial correlation (autocorrelation) for securities and markets
B. Measurement of the profitability of trading rules used by technical analysts
C. Measurement of how rapidly security prices adjust to different news items
D. All of the above are methods used for testing weak-form market efficiency
Type: Medium
Type: Medium
28. In order to test the efficient-market hypothesis in the semi-strong form, researchers have
used (the):
A. Estimation of the serial correlation (autocorrelation) for securities and markets
B. Measurement of the performance of mutual fund managers over the years
C. Measurement of how rapidly security prices adjust to different news items
D. All of the above
Type: Medium
13-25
Chapter 13 - Efficient Markets and Behavioral Finance
29. Analysis of past monthly movements in Wal-Mart's stock price has produced the
following estimates: α = -0.45% and β = 0. 5. If the market index subsequently rises by 5%
one month and Wal-Mart's stock price rises by 3%, what is the abnormal change in Wal-
Mart's stock price?
A. -0.95%
B. +0.95%
C. +0.05%
D. None of the above
Type: Medium
30. Analysis of past monthly movements in IBM's stock price produces the following
estimates: α = 2. 5% and β = 1. 6. If the market index subsequently rises by 12% in one
month and IBM's stock price increases by 20%, what is the abnormal change in IBM's stock
price?
A. +1.7%
B. +8%
C. -1.7%
D. None of the above
Type: Medium
31. If the abnormal return for a stock during the first week is +5% and during the second
week is +3%, what is the abnormal return for the two-week period?
A. 5%
B. 3%
C. 8.15%
D. None of the above
Type: Medium
13-26
Chapter 13 - Efficient Markets and Behavioral Finance
Type: Difficult
33. In order to test the strong form of market efficiency, researchers have:
I) examined the recommendations of professional security analysts
II) performance of mutual funds
III) performance of pension funds
A. I only
B. I and II only
C. I, II, and III only
D. II and III only
Type: Medium
34. Which of the following observations would provide evidence against the strong form of
efficient market theory?
I) Mutual fund managers do not on average make superior returns
II) In any year approximately 50% of all pension funds outperform the market
III) Managers who trade in their own firm's stocks make superior returns
A. I only
B. II only
C. III only
D. I and II only
Type: Medium
13-27
Chapter 13 - Efficient Markets and Behavioral Finance
35. A lawyer works for a firm that advises corporate firms planning to sue other corporations
for antitrust damages. He finds that he can "beat the market" by short selling the stock of the
firm that will be sued. This finding is in violation of the:
A. Weak form market efficiency
B. Semi-strong form market efficiency
C. Strong form market efficiency
D. None of the above
Type: Medium
Type: Medium
37. The following are anomalies associated with market efficiency except:
I) the small-firm effect
II) the earnings announcement puzzle
III) the new-issue puzzle
IV) trading rules based on patterns
A. I only
B. I and II only
C. I, II, and III only
D. IV only
Type: Difficult
13-28
Chapter 13 - Efficient Markets and Behavioral Finance
38. The annual expected dividend on the S&P index was about 154.6. If the dividend is
expected to grow at a steady rate of 8% a year and the required annual rate of return is 10%,
what is the value of the index?
A. 1193
B. 1700
C. 7730
D. None of the above
Type: Medium
Type: Medium
Type: Easy
13-29
Chapter 13 - Efficient Markets and Behavioral Finance
41. Investors are particularly averse to the possibility of even a very small loss and need a
high return to compensate for it. Such a concept is related to what theory?
A. Market efficiency theory
B. Random walk theory
C. Convergence trading
D. Prospect theory
Type: Easy
42. Which theory offers an explanation for the crash of a stock market one day and its
rebound the next?
A. Market efficiency theory
B. Random walk theory
C. Convergence trading
D. Prospect theory
Type: Easy
43. For a corporation, financing decisions are harder to reverse than investment decisions.
FALSE
Type: Medium
44. If capital markets are efficient, then the purchase or sale of any security at the prevailing
market price is never a positive-NPV transaction.
TRUE
Type: Medium
13-30
Chapter 13 - Efficient Markets and Behavioral Finance
Type: Medium
Type: Medium
47. The weak form of efficient market theory implies that technical analysis is valuable.
FALSE
Type: Medium
48. When a firm announces a dividend change or publishes its latest earnings, the major part
of the price adjustment takes place within a few minutes of the announcement.
TRUE
Type: Medium
Type: Easy
50. The evidence against market efficiency are called puzzles or anomalies.
TRUE
Type: Medium
13-31
Chapter 13 - Efficient Markets and Behavioral Finance
51. Behavioral finance deals with the idea that individual investors have built-in biases and
misconceptions that can drive prices away from fair values.
TRUE
Type: Medium
52. In an efficient market, investors will not pay others what they can do equally well
themselves.
TRUE
Type: Medium
53. Behavioral finance and technical analysis are basically the same theory.
FALSE
Type: Medium
54. A majority of research supports the theory that past stock movements can predict future
asset prices.
FALSE
Type: Medium
13-32
Chapter 13 - Efficient Markets and Behavioral Finance
55. State the important differences between investment decisions and financing decisions.
Generally, investment decisions have positive NPVs, while financing decisions have zero
NPV. Mostly, investment decisions are irreversible while financing decisions are reversible.
Investment decisions are made in factor markets while financing decisions are made in
financial markets.
Type: Easy
56. Briefly explain why, in a competitive securities market, successive price changes are
random.
In a competitive market, prices reflect all available information. The only reason prices
change is because of new information. By definition new information arrives randomly.
Therefore security prices change randomly.
Type: Difficult
57. List the three forms of market efficiency and explain the basis for it.
• Weak-form efficiency
• Semi-strong form efficiency
• Strong form efficiency
These distinctions are based on the level of information reflected in the security prices. Weak-
form efficiency deals with historical prices. Semi-strong form deals with publicly available
information that also includes historical information. Lastly, strong-form which includes all
information.
Type: Easy
Security prices reflect all the information that is available to the investors.
Type: Medium
13-33
Chapter 13 - Efficient Markets and Behavioral Finance
59. State the weak form of market efficiency and its implications.
Security prices reflect the information contained in the record of past prices. This implies that
prices will follow a random walk. It is impossible to make consistently superior profits by
studying past returns.
Type: Medium
60. State the semi-strong form of market efficiency and its implications.
Security prices reflect all publicly available information. If markets are efficient in this sense,
then prices will adjust immediately to public announcements.
Type: Medium
Puzzles and anomalies are abnormal behavior of stocks that apparently contradict the efficient
market hypothesis. There are quite a few of them. For example, stocks of small firms have
provided abnormally high returns compared to stocks of large firms.
Type: Difficult
13-34
Chapter 13 - Efficient Markets and Behavioral Finance
62. Briefly discuss some of the important findings of behavioral finance studies.
Behavioral finance studies have focused on three important areas: (1) limits to arbitrage, (2)
attitudes toward risk, and (3) beliefs about probabilities.
Arbitrage is defined as a strategy that exploits market inefficiency and generates superior
returns if and when the prices return to efficient market prices or equilibrium prices. If
arbitrage is not powerful enough to drive all prices to equilibrium levels, it will result in
mispricing. This is caused by investors' attitude towards risk and the way the investors assess
probabilities. This has led to the development of "prospect theory." Most investors are either
too conservative or overconfident. In other words, investors are not 100% rational 100% of
the time. Thus behavioral finance provides new interpretations of some long-standing puzzles
and anomalies.
Type: Medium
Type: Medium
64. How does the random walk theory explain market crashes?
Random walk theory relies upon the concept of a normal or lognormal distribution pattern for
stocks. This requires that the stock price gains and losses reflect a normal distribution. For this
to occur, there must, on rare occasion, be large movements in stock prices in either direction.
Thus, a large drop in stock prices must occur for the movement to truly be random.
Type: Medium
13-35