Fundamentals of Investing, 11e (Gitman/Joehnk/Smart)
Chapter 9 Market Efficiency, Behavioral Finance, and Technical Analysis
1) In an efficient market, the only means of achieving high returns is to invest in high-risk
securities.
2) In an efficient market, fundamental analysis still provides value to an investor.
3) If stock prices move randomly, charting and technical analysis are useful investment tools.
4) Recent academic studies in behavioral finance confirm that markets are even more efficient
than previously believed.
5) The efficient market hypothesis means that trades can be executed quickly, easily, and
inexpensively.
6) Advocates of the weak-form efficient market hypothesis claim that past price movements are
the best predictors of future price movements.
7) Available evidence does not support the strong form of the efficient market hypothesis.
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8) Even if the semi-strong form of the efficient market hypothesis is true, trading on illegal
insider information may lead to abnormal profits.
9) The market reaction to quarterly earnings announcements tends to support the strong form of
the efficient market hypothesis.
10) The random walk hypothesis
A) implies that security analysis is unable to predict future market behavior.
B) suggests that random patterns appear but only over long periods of time.
C) has been disproved based on recent computer simulations.
D) supports the notion that random price movements are indicative of inefficient markets.
11) Followers of the random walk hypothesis believe that
A) security analysis is the best tool to utilize when investing in the stock market.
B) the price movements of stocks are unpredictable, and therefore security analysis will not help
to predict future market behavior.
C) the price movements of stocks follow a “flag” formation such that charting prices can help an
investor better time his or her security purchases.
D) support levels and resistance lines, when combined with basic chart formations, yield both
buy and sell signals.
12) Which one of the following statements concerning the random walk hypothesis is correct?
A) Stock price movements are predictable but only over short periods of time.
B) Random price movements support the weak form efficient market hypothesis.
C) Stock prices in general follow repetitive patterns but the actions of individual investors are
random in nature.
D) Random price movements indicate that investors can earn abnormal profits on a routine basis.
13) An efficient market reflects
A) only historical information.
B) only the information related to events that have already occurred.
C) all publicly known information related to past events and announced future events.
D) all information including predictions about future information.
14) A type of mutual fund with particular appeal to investors who accept the efficient market
hypothesis is
A) index fund.
B) asset allocation fund.
C) growth opportunities fund.
D) emerging markets fund.
15) In an efficient market, prices appear to move randomly because
A) investors do not process new information correctly.
B) only new information affects stock prices.
C) insider trading has an unpredictable effect on stock prices.
D) the number of investors who can forecast prices correctly is too small to have any effect.
16) The efficient market hypothesis rests on which of the following assumptions?
I. Information is widely available to all investors almost simultaneously.
II. Investors react quickly to new information.
III. Accounting information accurately portray a company’s economic situation.
IV. Events which affect the market occur randomly.
A) I and II only
B) I, II and III only
C) I, III and IV only
D) I, II, III and IV
17) Which one of the following best describes the term “efficient market”?
A) The commissions on large transactions are smaller than the commissions on small
transactions.
B) New information is quickly reflected in security prices.
C) Little time and effort are spent on marketing securities to the public.
D) The cost of receiving, processing, executing, and reporting securities orders is small.
18) Which of the following activities would be most useful in an efficient market.
A) Buying and holding a diversified portfolio.
B) Searching for patterns in charts based on stock price movements.
C) Analyzing financial ratios based on accounting data.
D) Buying only securities that have performed well in the recent past.
19) Followers of the efficient market hypothesis believe that
A) very few investors actually analyze or evaluate stocks before they make a purchase decision.
B) the needed information to assess the market is available only to corporate insiders.
C) investors react quickly and accurately to new information.
D) individual traders can have a significant impact on the price of a security.
20) The weak form of the efficient market theory contends that
A) past price performance is useless in predicting future price movements.
B) past performance can help determine the general direction of future price movements.
C) any publicly available information is useless in predicting future price movements.
D) price movements are not random but follow a general trend over a period of time.
21) Based on the semi-strong form of the efficient market theory, an investor reacting
immediately to a news flash on the television generally
A) can make an abnormal profit.
B) is guaranteed to make a reasonable profit.
C) is too late to make an exceptional profit.
D) will suffer a loss.
22) The strong form of the efficient market hypothesis contends that
A) a select few institutional investors can earn abnormal profits.
B) abnormal profits are randomly distributed.
C) no one can consistently earn a profit.
D) no one can consistently earn abnormal profits.
23) There is evidence to support the contention that company insiders
A) cannot earn abnormal profits because they are not permitted to trade shares in their company’s
stock without a one-month advance notice to the SEC.
B) can profit in a manner that counters the strong form of the efficient market hypothesis.
C) generally earn a profit equal to that of public investors.
D) have no distinct advantage when trading shares of their company’s stock.
24) Security markets have been described as random walks and efficient markets. What does
each of these terms mean and how do they relate to the stock market? What makes a market
efficient and what are the consequences of efficiency for fundamental and technical analysis?
1) Behavioral finance suggests that investors react to new information in an efficient manner
such that security prices accurately reflect the new information.
2) Fund managers tend to have too little confidence in their abilities leading them to be
excessively cautious.
3) Individuals tend to invest in mutual funds that have recently been performing well.
4) Analysts tend to issue similar recommendations on individual securities.
5) Self attribution bias causes investors to attribute their successes to skill and failures to chance.
6) There is strong evidence that investors who trade frequently outperform the market.
7) Some behavioral characteristics cause investors to realize lower investment returns.
8) Investor overconfidence leads to
A) too little trading.
B) an overestimation of risk.
C) overly optimistic predictions.
D) narrow framing.
9) The tendency of investors to blame others for their failures and take personal credit for their
successes is referred to as
A) loss aversion.
B) representativeness.
C) narrow framing.
D) biased self-attribution.
10) The tendency to hold onto losing stocks in the hope that they will recoup is called
A) loss aversion.
B) representativeness.
C) narrow framing.
D) biased self-attribution.
11) Which of the following characteristics are referred to as representativeness?
I. hesitating to sell stocks at a loss
II. basing conclusions on small samples
III. underestimating the effects of random chance
IV. underestimating the level of risk in an investment
A) I and IV only
B) II and III only
C) I, II, and III only
D) I, II, III and IV only
12) People tend to
A) ignore information that contradicts their current beliefs.
B) overestimate the effects of random chance.
C) be underconfident in their judgment of investments.
D) look at the entire situation when analyzing an individual security.
13) The tendency of investors to take greater risks after a large loss and fewer risks after a large
gain can be attributed to
A) overconfidence.
B) the “house money” effect.
C) loss aversion.
D) representativeness.
14) Investors who buy mutual funds that have had large gains over the last few years are
exhibiting a tendency known as
A) overconfidence.
B) narrow framing.
C) loss aversion.
D) representativeness.
15) Investors who obsessively monitor their last few stock purchases while paying little attention
to the rest of their portfolio are exhibiting the tendency known as
A) overconfidence.
B) narrow framing.
C) loss aversion.
D) representativeness.
16) Which of the following accurately reflect appropriate investment guidelines?
I. always invest in last year’s best performing mutual fund
II. trade frequently to increase your investment returns
III. sell losing stocks unless you are willing to buy them at the current price
IV. take corrective action when so indicated
A) I and II only
B) III and IV only
C) I, III and IV only
D) I, II, III and IV
17) Which of the following statements correctly present recommendations based on behavioral
finance?
I. Don’t hesitate to sell a losing stock.
II. Trade frequently.
III. Chase performance.
IV. Be humble and open-minded.
A) I and II only
B) I and IV only
C) II and III only
D) III and IV only
18) Evidence suggests that the price of a stock continues to move up or down for a period of
A) a decade or more.
B) 3 to 5 years.
C) 1 to 3 years.
D) 6 to 12 months.
19) Market bubbles such as the technology bubble of the 1990’s and the housing bubble of 2004–
2007 are best explained by
A) the efficient market hypothesis.
B) behavioral finance and economics.
C) rational expectations theory.
D) anomaly theory.
20) What are some of the more important disagreements between the efficient market hypothesis
and the findings of behavioral finance.
1) Historically higher returns on the stocks of small companies can be completely explained by
their higher risk.
2) Investors skilled in exploiting behavioral errors and market anomalies can consistently
outperform the market by a wide margin.
3) Evidence suggests that growth stocks tend to outperform value stocks.
4) Stocks of small companies have a historical tendency to do especially well in the month of
January.
5) One of the calendar effect market anomalies indicates that ________ in value during January.
A) large cap stocks tend to decline
B) equities in general tend to decline
C) small cap stocks tend to increase
D) equities in general tend to increase
6) The anomaly known as post-earnings announcement drift or momentum describes the
tendency of stock prices to rise or fall for several ________ after unexpectedly good or bad
earnings announcements.
A) months
B) weeks
C) days
D) hours
7) Even after adjusting for risk,________ firms earn have, over long periods of time, earned
higher returns than ________ firms.
A) small, large
B) large, small
C) new, old
D) old, new
8) Which of the following is true.
A) Historically, high P/E or growth stocks have outperformed low P/E or value stocks.
B) Historically, low P/E or value stocks have outperformed high P/E or growth stocks.
C) After adjusting for risk, high P/E or growth stocks and low P/E or value stocks have
performed about the same over time.
D) the P/E effect is limited to U.S. stocks.
9) Market anomalies are caused by
A) investors’ efforts to avoid or postpone taxes.
B) different levels of risk.
C) statistical quirks.
D) some poorly understood combination of factors.
10) Which one of the following statements is correct?
A) The weekend effect states that security prices tend to rise between Friday afternoon and
Monday morning.
B) The market responds immediately to reflect the information contained in quarterly earnings
reports.
C) Low P/E stocks tend to outperform high P/E stocks on a risk-adjusted basis.
D) The market fully anticipates the information contained in an earnings announcement prior to
the actual announcement.
1) A principal objective of technical analysis is trying to determine when to invest.
2) Investors should never combine fundamental analysis and technical analysis.
3) Resources for technical analysis are readily available on the internet.
4) For technical analysts, the forces of supply and demand have an important effect on the prices
of securities.