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Essentials of Investments, 11e (Bodie)
Chapter 8 The Efficient Market Hypothesis
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 semistrong-form efficient.
C) The market is weak-form efficient.
D) Stock prices follow recurring patterns.
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
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
4) The semistrong 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
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
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
7) When the market risk premium rises, stock prices will ________.
A) rise
B) fall
C) recover
D) have excess volatility
8) The small-firm effect is strongest in which month?
A) January
B) June
C) July
D) December
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
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
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
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
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
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
15) The primary objective of fundamental analysis is to identify ________.
A) well-run firms
B) poorly run firms
C) mispriced stocks
D) high P/E stocks
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) semistrong
B) strong
C) weak
D) perfect
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) semistrong
B) strong
C) weak
D) perfect
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
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) None of these options
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 and inside information. You are a proponent
of the ________ form of the EMH.
A) semistrong
B) strong
C) weak
D) perfect
21) You are an investment manager who is currently managing assets worth $6 billion. You
believe that active management of your fund could generate 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
22) A mutual fund that attempts to hold quantities of shares in proportion to their representation
in the market is called an ________ fund.
A) stock
B) index
C) hedge
D) money market
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
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
25) Most people would readily agree that the stock market is not ________.
A) weak-form efficient
B) semistrong-form efficient
C) strong-form efficient
D) efficient at all
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
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
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
29) Evidence supporting semistrong-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
30) "Buy a stock if its price moves up by 2% more than the Dow Average" is an example of a
________.
A) trading rule
B) market anomaly
C) fundamental approach
D) passive trading strategy
31) Jaffe 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
32) In a 1988 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
33) In their 2010 study, Fama and French used a four-factor model to analyze excess returns on
equity mutual funds. They found that the funds ________.
A) had negative alphas before fees were considered
B) had positive alphas after fees were considered
C) had negative alphas after fees were considered
D) had negative alphas before fees were considered and had negative alphas after fees were
considered
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 it 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
35) According to 1968 research by Ball and Brown, securities markets fully adjust to earnings
announcements ________.
A) instantly
B) in 1 day
C) in 1 week
D) gradually over time
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
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
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
39) You are looking to invest in one of three stocks. All other things being equal, 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. According to LaPorta's 1996 study, which stock is
likely to generate the greatest alpha for you?
A) Stock A
B) Stock B
C) Stock C
D) The answer cannot be determined from the information given.
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 .5%. You have an $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
41) Even if the markets are efficient, professional portfolio management is still important
because it provides investors with:
I. Low-cost diversification
II. A portfolio with a specified risk level
III. 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
42) Banz found that, on average, the risk-adjusted returns of small firms ________.
A) were higher than the risk-adjusted returns of large firms
B) were the same as the risk-adjusted returns of large firms
C) were lower than the risk-adjusted returns of large firms
D) were negative
43) If the U.S. capital markets are not informationally efficient, ________.
A) the markets cannot be allocationally efficient
B) systematic risk does not matter
C) no type of analysis can be used to generate abnormal returns
D) returns must follow a random walk
44) "Active investment management may at times generate additional returns of about .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
45) DeBondt and Thaler (1985) found that the poorest-performing stocks in one time period
experienced ________ performance in the following period and that 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
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
47) Most tests of semistrong 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
48) The ________ effect may explain much of the small-firm anomaly.
I. January
II. neglected
III. liquidity
A) I only
B) II only
C) II and III only
D) I, II, and III
