Chapter 08 – Stocks, Stock Markets, and Market Efficiency
61. The theory of efficient markets implies:
D. The chartists are in fact correct that there are patterns in stock prices.
62. The theory of efficient markets means
D. A professional fund manager who beats the market average one year should be expected to
not beat the market average the next year.
63. The theory of efficient markets:
A. Rules out high returns due to chance.
Chapter 08 – Stocks, Stock Markets, and Market Efficiency
64. The notion that stock prices reflect all current available information:
D. Makes it easier to predict the movements in the price of a stock.
65. People who claim to have the ability to accurately predict the future prices of stocks:
D. Are always psychologists.
66. Consider a game that involves the tossing of a fair coin. The winner is the individual who
calls the outcome correctly, the loser obviously called the wrong outcome. The theory of
efficient markets would say:
D. Outcomes of events that require luck cannot be evaluated.
Chapter 08 – Stocks, Stock Markets, and Market Efficiency
67. In the first calendar quarter a company reports that it expects profits to rise in the fourth
quarter. The theory of efficient markets says we should expect the price of the company’s
stock to:
A. Rise in the fourth quarter when the higher profits are actually seen.
68. According to the theory of efficient markets:
A. Investors use rules of thumb to make choices about which stocks to buy and sell.
69. According to the theory of efficient markets, mutual fund managers may be expected to
earn above-average returns if they:
D. Have learned from investing in the same stocks repeatedly.
Chapter 08 – Stocks, Stock Markets, and Market Efficiency
70. Under what circumstances are stocks less risky than bonds?
D. When the economy goes into a period of economic recession.
71. Stocks appear to present risk, yet many people have substantial parts of their wealth
invested in them. This behavior could be explained by:
A. People are irrational in their investment behavior, only focusing on positive outcomes.
72. Professor Jeremy Siegel, of the University of Pennsylvania, did research showing that:
D. Bonds really are less risky to hold over the long term.
Chapter 08 – Stocks, Stock Markets, and Market Efficiency
73. Professor Jeremy Siegel, of the University of Pennsylvania, conducted research that
D. Investors should only own stocks for short periods of time to maximize returns.
74. Mutual funds are characterized by the fact that the all:
A. Have the same management fee set by regulation.
75. Management fees for mutual funds are:
A. Fixed by regulation.
Chapter 08 – Stocks, Stock Markets, and Market Efficiency
76. Management fees for mutual funds are:
D. Usually a percentage of the return achieved by fund managers.
77. Index funds are often preferred to mutual funds because:
A. They offer greater diversification.
78. When stock prices reflect fundamental values:
D. The overall level of the stock market should move higher.
Chapter 08 – Stocks, Stock Markets, and Market Efficiency
79. The fact that returns from the stock market are less volatile over long-periods of time
suggests that:
D. Stock market bubbles have become more common.
80. Stock market bubbles are:
D. Those periods of time when the overall level of the stock market is rising at a slow rate
reflecting market fundamentals.
81. Stock market bubbles can lead to all of the following except:
D. Gaps between actual stock prices and those warranted by the fundamentals.
Chapter 08 – Stocks, Stock Markets, and Market Efficiency
82. Which of the following could cause a stock market bubble?
A. Changes in the real interest rate
83. Why are stock market bubbles costly for the economy?
A. They imply that the actual stock price is equal to the fundamental value of the stock.
84. Companies whose stocks increase the most during a stock market bubble will:
85. The stock market bubble of the late 1990’s and early 2000:
D. Was an example that not all bubbles burst.
Chapter 08 – Stocks, Stock Markets, and Market Efficiency
86. Stock market bubbles impact consumers by:
D. Resulting in less investment in home ownership and more into stocks.
87. Some good did come from the Internet bubble of the late 1990s. One good thing was that:
D. The theory of efficient markets doesn’t always hold and consistently better-than-market
returns are achievable.
Short Answer Questions
88. Explain why being a residual claimant can increase the risk from owning stocks.
Chapter 08 – Stocks, Stock Markets, and Market Efficiency
89. Does the concept of limited liability make owning stocks more or less attractive? Explain.
90. Explain why the willingness to purchase stocks is influenced heavily by shareholders’
legal rights.
91. Why isn’t the actual level of an index, for example the Dow Jones Industrial Average,
very useful on its own?
Chapter 08 – Stocks, Stock Markets, and Market Efficiency
92. You have a price-weighted index made up of two stocks, A and B. The price of A equals
$30 and the price of B equals $70. What is the current value of this index? Also, what will be
the percentage change in the index resulting from a 10 % increase only in the price of A? A
10% increase only in the price of B?
93. Why does the Dow Jones Industrial Average have a value over 10,000 when the 30 stocks
that make up the index all have values less than $200 per share?
94. The Standard & Poor’s 500 Index differs from the DJIA in at least two major respects.
What are the two major differences?
Chapter 08 – Stocks, Stock Markets, and Market Efficiency
95. You have a value-weighted index made up of two companies. One company, we will call
A, has a stock price of $25 per share and there are 10,000 shares outstanding. The other
company, we will call B, has a stock price of $100 per share and has 1000 shares outstanding.
What will be the percentage change in the index from a 10% increase in the share price of
company A? What will be the percentage change in the index from a 10% increase in the
share price of company B?
96. Compare/contrast the Nasdaq Composite Index with the Dow Jones Industrial Average.
97. Why must caution be employed in comparing stock indexes across countries?
98. Briefly explain the different focus of valuing stocks taken by behavioralists, chartists, and
those who focus on Pnext year.
99. Many small companies currently pay no dividends to their shareholders. Based on the
dividend discount model, how is it possible for these stocks to sell for a positive price?
100. What price would an individual be willing to pay today for a stock he/she expects can be
sold for $200 one year from now, if the individual has a discount rate of 6% (.06) and the
stock pays an annual dividend of $7.50?