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The Basic Tools of Finance 6721
25. If stock prices follow a random walk, then stock investors can make large profits by
a. buying stocks whose prices have been falling for several days.
b. buying stocks whose prices have been rising for several days.
c. performing fundamental analysis of stocks using data contained in annual reports.
d. using inside information.
26. The efficient markets hypothesis says that
a. only individual investors can make money in the stock market.
b. it should be easy to find stocks whose price differs from their fundamental value.
c. stock prices follow a random walk.
d. All of the above are correct.
27.
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28. According to the efficient market hypothesis, which of the following statements is not
correct?
a. Stock market prices tend to rise today if they rose yesterday.
b. As judged by the typical person in the market, all stocks are fairly valued all the time.
c. At the market price, the number of shares being offered for sale matches the number
of shares people want to buy.
d. All of the above statements are incorrect.
29. According to the efficient markets hypothesis, worse-than-expected news about a
corporation will
a. have no effect on its stock price.
b. raise the price of the stock.
c. lower the price of the stock.
d. change the price of the stock in a random direction.
The Basic Tools of Finance 6723
30. An index fund
a. holds only stocks and bonds that are indexed to inflation.
b. holds all the stocks in a given stock index.
c. guarantees a return that follows the index of leading economic indicators.
d. typically has a lower return than a managed fund.
31. If the efficient market hypothesis is correct, then
a. index funds should typically beat managed funds, and usually do.
b. index fund should typically beat managed funds, but usually do not.
c. mutual funds should typically beat index funds, and usually do.
d. mutual funds should typically beat index funds, but usually do not.
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32. Which of the following is correct?
a. Managed funds typically have a higher return than indexed funds. This tends to refute
the efficient market hypothesis.
b. Managed funds typically have a higher return than indexed funds. This tends to support
the efficient market hypothesis.
c. Index funds typically have a higher rate of return than managed funds. This tends to
refute the efficient market hypothesis.
d. Index funds typically have a higher rate of return than managed funds. This tends to
support the efficient market hypothesis.
33. Which of the following is not consistent with the efficient market hypothesis?
a. Stock prices should follow a random walk.
b. Index funds should typically outperform highly managed funds.
c. News has no effect on stock prices.
d. There is little point in spending many hours studying the business pages looking for
undervalued stocks.
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34. According to the efficient markets hypothesis, which of the following would increase the
price of stock in the Simpson Corporation?
a. Simpson announces, just as everyone had expected, that it has hired a new highly
respected CEO.
b. Simpson announces that its profits were low, but not as low as the market had
expected.
c. Analysis by a column in a business weekly indicates that Simpson is overvalued.
d. All of the above would increase the price.
35. Suppose that interest rates unexpectedly rise and that FineLine Corporation announces
that revenues from last quarter were down but not as much as the public had anticipated
they would be down. According to the efficient markets hypothesis, which of the these
things make the price of FineLine Corporation Stock fall?
a. both the interest rate rising and the revenue announcement
b. neither the interest rate rising nor the revenue announcement
c. only the interest rate rising
d. only the revenue announcement
6726 The Basic Tools of Finance
36. Fundamental analysis shows that Quadrangle Company is fairly valued. Then Quadrangle
Company unexpectedly improves its production techniques and unexpectedly hires a new
CEO away from another very successful competitor. Suppose this has no effect on the
price of the stock of Quadrangle Company.
a. Fundamental analysis would now show the corporation is overvalued. The fact that the
price was unchanged is consistent with the efficient markets hypothesis.
b. Fundamental analysis would now show the corporation is overvalued. The fact that the
price was unchanged is not consistent with the efficient markets hypothesis.
c. Fundamental analysis would now show the corporation is undervalued. The fact that
the price was unchanged is consistent with the efficient markets hypothesis.
d. Fundamental analysis would now show the corporation is undervalued. The fact that
the price was unchanged is not consistent with the efficient markets hypothesis.
37. In the 1990s, Fed Chairperson Alan Greenspan questioned whether the stock market
a. boom at that time reflected “irrational exuberance.”
b. decline at that time reflected “irrational funk.”
c. boom at that time reflected “rational exuberance.”
d. decline at that time reflected “rational funk.”
The Basic Tools of Finance 6727
38. In the 1990s, Fed Chair Alan Greenspan believed that the market was
a. undervalued, and evidence later showed that this was clearly correct.
b. undervalued, but whether it was remains debatable.
c. overvalued, and evidence later showed that this was clearly correct.
d. overvalued, but whether it was remains debatable.
39. Which of the following is not correct?
a. There is a greater reduction in risk by increasing the number of stocks in a portfolio
from 1 to 10, than by increasing it from 100 to 120 stocks.
b. The historical rate of return on stocks has been about 5 percentage points higher than
the historical rate of return on bonds.
c. Stock in an industry that is very sensitive to economic conditions is likely to have a
higher average return than stock in an industry that is not so sensitive to economic
conditions.
d. If you had information about a corporation that no one else had, you could earn a very
high rate of return. This contradicts the efficient market hypothesis.
6728 The Basic Tools of Finance
40. Which of the following is correct concerning stock market irrationality?
a. Bubbles could arise, in part, because the price that people pay for stock depends on
what they think someone else will pay for it in the future.
b. Economists almost all agree that the evidence for stock market irrationality is
convincing and the departures from rational pricing are important.
c. Some evidence for the existence of market irrationality is that informed and
presumably rational managers of mutual funds generally beat the market.
d. All of the above are correct.
41. Whenever the price of an asset rises above what appears to be its fundamental value, the
market is said to be experiencing a
a. conjectural mistake.
b. fundamental mishap.
c. speculative bubble.
d. temporary inefficiency.
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42. Which of the following terms is used to describe a situation in which the price of an asset
rises above what appears to be its fundamental value?
a. “random walk”
b. “random bubble”
c. “speculative bubble”
d. “speculative hedge”
43. An asset market is said to experience a speculative bubble when
a. the price of the asset rises above what appears to be its fundamental value.
b. the price of the asset appears to follow a random walk.
c. the market cannot establish an equilibrium price for the asset.
d. the asset is a natural resource and its supply is manipulated by foreign nations and
foreign firms.
6730 The Basic Tools of Finance
44. The possibility of speculative bubbles in the stock market arises in part because
a. stock prices may not depend at all on psychological factors.
b. fundamental analysis may be the correct way to evaluate the value of stocks.
c. future streams of dividend payments are very hard to estimate.
d. the value of shares of stock depends not only on the future stream of dividend
payments but also on the price at which the stock will be sold.
45. If asset markets are driven by the “animal spirits” of investors, then
a. those markets reflect rational behavior.
b. those markets reflect irrational behavior.
c. the efficient markets hypothesis is correct.
d. the stock market exhibits informational efficiency.
The Basic Tools of Finance 6731
46. Diversification
a. increases the likely fluctuation in a portfolio’s return. Thus, the likely standard deviation
of the portfolio’s return is higher.
b. increases the likely fluctuation in a portfolio’s return. Thus, the likely standard deviation
of the portfolio’s return is lower.
c. reduces the likely fluctuation in a portfolio’s return. Thus, the likely standard deviation
of the portfolio’s return is higher.
d. reduces the likely fluctuation in a portfolio’s return. Thus, the likely standard deviation
of the portfolio’s return is lower.
47. The value of a stock is based on the
a. present values of the dividend stream and final price. As a result, the value of a stock
rises when interest rates rise.
b. present values of the dividend stream and final price. As a result, the value of a stock
falls when interest rates rise.
c. future values of the dividend stream and final price. As a result, the value of a stock
rises when interest rates rises.
d. future values of the dividend stream and final price. As a result, the value of a stock
falls when interest rates rise.
6732 The Basic Tools of Finance
48. Suppose that an increased risk of mortgage defaults lowers the expected profitability of
banks. Then we would expect to see
a. the demand for bank stocks rise which would raise the prices of bank stocks.
b. the demand for bank stocks rise which would reduce the prices of bank stocks.
c. the demand for bank stocks fall which would raise the prices of bank stocks.
d. the demand for bank stocks fall which would reduce the prices of bank stocks.
49. An automobile manufacturer unexpectedly announces that it has hired a new chief
executive officer. It is widely believed that the presence of this individual will raise the
profitability of the corporation. At the same time interest rates unexpectedly rise. Which
of the above would tend to make the price of the stock rise?
a. the announcement and the rise in interest rates
b. the announcement but not the rise in interest rates
c. the rise in interest rates, but not the announcement
d. neither the announcement nor the rise in interest rates
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50. The efficient markets hypothesis implies
a. that all stocks are fairly valued all the time and that no stock is a better buy than any
other.
b. that all stocks are fairly valued all the time, but that some stocks may be better buys
than other.
c. that some stocks may be better buys than others and stock experts can determine
which ones.
d. that no stock is efficiently valued.
51. The efficient markets hypothesis implies that
a. building a portfolio based on a published list of the “most respected” companies is
likely to produce a better- than-average return.
b. if a stock rose in price last year, it is likely to rise in price this year.
c. managed mutual funds should generally outperform indexed mutual funds.
d. None of the above are correct.
6734 The Basic Tools of Finance
52. The efficient markets hypothesis says that beating the market consistently is
a. impossible. Many studies find that beating the market is, at best, extremely difficult.
b. impossible. Many studies find that beating the market is relatively easy.
c. relatively easy. Many studies find that beating the market is, at best, extremely difficult.
d. relatively easy. Many studies find that beating the market is relatively easy.
53. If you are convinced that stock prices are impossible to predict from available information,
then you probably also believe that
a. the efficient markets hypothesis is not a correct hypothesis.
b. the stock market is informationally efficient.
c. the stock market is informationally inefficient.
d. there is no reason to establish a diversified portfolio of stocks.
The Basic Tools of Finance 6735
54. A person who believes strongly in the use of fundamental analysis to choose a portfolio
of stocks
a. has a better chance of outperforming the market if stock prices follow a random walk
than if they do not follow a random walk.
b. almost always chooses to hold index funds in his or her portfolio rather than actively-
managed funds.
c. is spending his or her time wisely if the efficient markets hypothesis is correct.
d. is interested in the likely ability of a corporation to pay dividends in the future.
55. Which of the following methods of picking stocks is not consistent with fundamental
analysis?
a. doing research such as thoroughly reading and analyzing companies’ annual reports
b. choosing mutual funds that are managed by individuals with good reputations
c. viewing individual stock prices as unpredictable
d. relying upon the advice of Wall Street analysts
6736 The Basic Tools of Finance
56. The available evidence indicates that
a. about one-half of all managers of active mutual funds consistently outperform index
funds.
b. outperforming the market on a consistent basis is extremely difficult to do.
c. there is little truth to the notion that there is a trade-off between risk and return.
d. there is little truth to the efficient markets hypothesis.
57. The word “efficient” in the term “efficient markets hypothesis” refers to the idea that
a. fundamental analysis is an efficient way to go about choosing which stocks to buy or
sell.
b. stock prices move upward and downward “efficiently,” rather than following a
“random walk.”
c. the stock market is “informationally efficient.”
d. companies employ officers and managers who are well-qualified to perform their jobs.
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58. A pharmaceutical company unexpectedly announces that it just developed an important
new drug. This news should
a. raise the price of the corporation's stock; if it does not the stock is overvalued.
b. raise the price of the corporation's stock; if it does not the stock is undervalued.
c. reduce the price of the corporation's stock; if it does not the stock is overvalued.
d. reduce the price of the corporation's stock; if it does not the stock is undervalued.
59. If your research leads you to believe that the present value of a stock’s dividend stream
and future price is less than
its price then you believe the stock is
a. overvalued so you should consider buying it.
b. overvalued so you should not consider buying it.
c. undervalued so you should consider buying it.
d. undervalued so you should not consider buying it.
6738 The Basic Tools of Finance
60. If unexpected news raised people’s expectations of a corporation’s future dividends and
price, then before the price changes this corporation’s stock would be
a. overvalued, so its price would rise.
b. overvalued, so its price would fall.
c. undervalued, so its price would rise.
d. undervalued, so its price would fall.
61. If more people think a corporation’s stock is overvalued than think it is undervalued then
there is a
a. surplus, so its price will rise.
b. surplus, so its price will fall.
c. shortage, so its price will rise.
d. shortage, so its price will fall.
The Basic Tools of Finance 6739
62. According to the efficient market hypothesis
a. changes in the prices of stocks are predictable. Evidence shows that managed funds
typically do better than indexed funds.
b. changes in the prices of stocks are predictable. Evidence shows that indexed funds
typically do better than managed funds.
c. changes in the prices of stocks are not predictable. Evidence shows that managed
funds typically do better than indexed funds.
d. changes in the prices of stocks are not predictable. Evidence shows that indexed funds
typically do better than managed funds.
63. During a financial crisis the possibility of bank failures rose. An increase in the likelihood
of a bank failing shifts demand for its stock
a. right, so the price rises.
b. right, so the price falls.
c. left, so the price rises.
d. left, so the price falls.
6740 The Basic Tools of Finance
64. After the 1982 recession, the U.S. and world economies entered into a long period
a. of high unemployment rates.
b. high inflation rates.
c. that has become known as the “Great Moderation.”
d. that has become known as the “Great Recession.”
65. Writing in the Wall Street Journal in 2009, economist Jeremy Siegel argued that, in the
years leading up to the financial crisis of 2008–2009,
a. financial firms acted in too risky a fashion.
b. the Federal Reserve’s efforts to rein in the risky behavior of certain financial firms
were inadequate.
c. falling house prices “crashed the banks and the economy.”
d. All of the above are correct.
