Corporate Finance: Core Principles & Apps, 5e (Ross)
Chapter 13 Efficient Capital Markets and Behavioral Challenges
1) Efficient markets require which one of these?
A) Dart thrower investors
B) Only rational investors
C) Overly optimistic amateur investors
D) Countervailing irrationalities
E) Investors adhering to the conservatism principle
2) Markets tend to be efficient when
A) arbitrage is unlawful.
B) amateurs dominate the market.
C) all investors are required to be rational.
D) professional arbitrage exceeds amateur speculation.
E) prices adjust to new information slowly.
3) In an efficient market, the price of a security will
A) react immediately to new information with no further price adjustments related to that
information.
B) react to new information over a 2-day period after which time no further price adjustments
related to that information will occur.
C) rise sharply when new information is first released and then decline to a new stable level by the
following day.
D) always rise immediately upon the release of new information with no further price adjustments
related to that information.
E) be slow to react for the first few hours after new information is released allowing time for that
information to be reviewed and analyzed.
4) The efficient market hypothesis says that, on average, professional investors will
A) tend to earn below average rates of returns.
B) earn a normal rate of return.
C) outperform investors with inside information.
D) tend to outperform most market participants.
E) earn the same rate of return over time regardless of the risk assumed.
5) If the financial markets are efficient, then investors should expect their investments in those
markets to
A) have zero net present values.
B) earn extraordinary returns on a routine basis.
C) generally have positive net present values.
D) produce arbitrage opportunities on a routine basis.
E) produce negative returns on a routine basis.
6) Which one of the following statements is correct concerning market efficiency?
A) New information will gradually be reflected in a stock’s price to avoid any sudden change in the
price of the stock in an efficient market.
B) In an efficient market, some market participants will have an advantage over others.
C) If a market is efficient, arbitrage opportunities should be common.
D) Real asset markets are more efficient than financial markets.
E) A firm will generally receive a fair price when it sells shares of stock in an efficient market.
7) If the market is fully efficient, then an announcement by a firm of a new product with a high net
present value will cause the market price of that firm’s stock to
A) remain constant.
B) rise gradually over the next few days.
C) decline gradually over the next few days.
D) immediately increase to a new level equivalent to the increased value of the firm.
E) immediately decline to a new level equivalent to the decreased value of the firm.
8) Weak form efficiency is best defined as a market where current prices are based on
A) totally rational decisions.
B) historical prices.
C) information known to any person or organization.
D) all publicly available information.
E) irrational decisions by amateur investors.
9) The hypothesis that market prices reflect all publicly available information is called ________
form efficiency.
A) open
B) strong
C) semistrong
D) weak
E) stable
10) The hypothesis that market prices reflect all available information of every kind is called
________ form efficiency.
A) stable
B) weak
C) semistrong
D) strong
E) open
11) Insider trading does not offer any advantages if the financial markets are
A) inefficient.
B) semiweak form efficient.
C) semistrong form efficient.
D) strong form efficient.
E) weak form efficient.
12) If you live in a remote area with limited access to the news but do a lot of historical research on
firms, you would prefer that the financial markets be ________ form efficient so you can have an
advantage in the marketplace.
A) strong
B) semiweak
C) semistrong
D) perfect
E) weak
13) Your best friend works in the finance office of the Delta Corporation. You are aware that this
friend trades Delta stock based on information he overhears in the office. You know that this
information is not known to the general public. Your friend continually brags to you about the
profits he earns trading Delta stock. Based on this information, you would tend to argue that the
financial markets are at best ________ form efficient.
A) weak
B) semistrong
C) semiweak
D) strong
E) perfect
14) The U.S. Securities and Exchange Commission periodically charges individuals for insider
trading and claims those individuals have made unfair profits. Based on this fact, you would tend
to argue that the financial markets are at best ________ form efficient.
A) weak
B) semiweak
C) semistrong
D) perfect
E) strong
15) Which of the following tend to reinforce the argument that the financial markets are efficient?
I. Information spreads rapidly in today’s world.
II. There is tremendous competition in the financial markets.
III. Market prices continually fluctuate.
IV. Market prices react suddenly to unexpected news announcements.
A) I and III only
B) II and IV only
C) I, II, and III only
D) II, III, and IV only
E) I, II, III, and IV
16) Stock prices fluctuate daily. In relation to the efficient market hypothesis, these fluctuations
are
A) inconsistent with the semistrong form of efficiency because prices should be stable.
B) inconsistent with all forms of market efficiency.
C) consistent with the semistrong form because new information arrives daily.
D) consistent with the strong form because prices and information are controlled by insiders.
E) consistent with all forms of market efficiency provided the prices do fluctuate on a daily basis.
17) What does weak form efficiency imply?
A) Portfolio diversification is ineffective as all prices are interrelated.
B) Past price movement is unrelated to the movement of future prices.
C) Abnormal returns will disappear within a trading day.
D) Price patterns that existed in the past will reappear in the future.
E) Investors cannot earn abnormal profits based on any publicly available information.
18) The efficient market hypothesis implies that
A) all investments should earn the same average rate of return over time.
B) any investment should earn a normal return commensurate with the investment’s risk.
C) efficient markets will tend to have fixed prices from one day to the next.
D) stock prices are only efficient when all investors review their portfolios on a daily basis.
E) investors must be disinterested in their investments for the markets to be efficient.
19) Which one of these is an indicator that a market is efficient?
A) Positive serial correlation coefficients equal to or greater than 1
B) Lack of daily price movement
C) Lack of any adjustment for degree of risk
D) Repetitive price patterns
E) Normal rates of return
20) Based on the efficient market hypothesis, a stock’s abnormal return at Time t is an indicator of
A) semistrong form inefficiency.
B) cumulative market expectations.
C) a release of new information at Time t.
D) conservatism.
E) weak form inefficiency.
21) Given the vast resources available to mutual fund managers, these managers on average have
generally
A) outperformed the overall market on a risk-adjusted basis.
B) eliminated excess profits for arbitrageurs.
C) beat broad-based indexes.
D) proved the market to be strong form efficient.
E) underperformed the market on a risk-adjusted basis.
22) Market prices can be efficiently priced if
A) brokerage commissions are zero.
B) a number of interested traders use the publicly available information.
C) securities always offer a positive rate of return to investors.
D) the prices are guaranteed by the U.S. Securities and Exchange Commission.
E) taxes are irrelevant.
23) Serial correlation
A) indicates a reversal in the direction of returns when the coefficient is positive.
B) involves the relationship of one stock’s returns over various time periods.
C) indicates a tendency toward reversal when its coefficient is positive.
D) measures the cumulative difference between the returns on two similar securities.
E) measures the current relationship between the returns on two securities.
24) Serial correlation
A) tends to prove that markets are totally inefficient.
B) supports weak form efficiency.
C) coefficients tend to range between 0.75 and 1.
D) is best used to identify insider trading.
E) best indicates that markets are semi-strong form efficient.
25) Which one of these serial coefficient values is most consistent with weak form market
efficiency?
A) –1
B) –0.5
C) 0
D) +0.5
E) +1
26) Which one of these serial correlation values is the strongest indicator of price continuation?
A) –0.5
B) –0.25
C) 0
D) +0.25
E) +0.5
27) The abnormal return in an event study is described as the
A) actual return on a security minus the market rate of return on the same date.
B) total return earned by a security on the date of an announcement affecting that security.
C) total return earned on a security for the 7-day period commencing 3 days prior to an
announcement affecting that security.
D) change in market value of a security on the day of an announcement affecting that security.
E) any change in the market price of a security that exceeds 5 percent over a 7-day period.
28) If markets are strong-form efficient, then event studies should show that new information
affects a related stock’s price
A) for a single day.
B) only when the new information relates to a dividend payment.
C) over a range of days with the overreactions exactly offsetting the underreactions.
D) only if the information is company specific.
E) by a very minimal amount, if any.
29) If semistrong, or strong, form efficiency exists, then, on average, investors are probably best
served by
A) investing based solely on a stock’s past performance.
B) avoiding all mutual funds.
C) avoiding the stock market altogether.
D) investing in index funds rather than in actively managed mutual funds.
E) randomly purchasing stocks by just throwing darts.
30) Individuals that continually monitor the financial markets seeking mispriced securities
A) tend to make substantial profits on a daily basis.
B) tend to make the markets more efficient.
C) are never able to find a security that is temporarily mispriced.
D) are always quite successful using only well-known public information as their basis of
evaluation.
E) are always quite successful using only historical price information as their basis of evaluation.
31) Which one of these terms is used to describe a principle where investors draw conclusions
from insufficient data?
A) Representativeness
B) Synergy
C) Conservatism
D) Arbitrage
E) Independent deviations from rationality
32) Sam, an avid day trader, has noticed that a particular stock has increased in value in each of the
last three trading days. Given this trend, he believes the stock price will increase over the next two
trading days. This is an example of
A) a timing decision.
B) irrational exuberance.
C) representativeness.
D) conservatism.
E) arbitrage.
33) Which one of these would generally be considered the most rational action for a tax-paying
investor?
A) Trading frequently
B) Selling their losing and holding their winning securities
C) Throwing darts to select their portfolio holdings
D) Holding a less than fully diversified portfolio of securities
E) Ignoring taxes when making investment decisions
34) The principle that investors slowly adjust their beliefs to new information is referred to as
A) conservatism.
B) stockholder disinterest.
C) reversal.
D) insider trading.
E) continuation.
35) If behavioral finance holds, this implies
A) all investors are irrational some of the time.
B) all investors are irrational all the time.
C) some investors are irrational some of the time.
D) some investors are irrational all of the time.
E) all investors are rational all of the time.
36) Which one of these statements is correct?
A) Irrationality may be related across investors.
B) Arbitrage is risk-free.
C) Irrationality always cancels out among a group of investors.
D) Investors are always rational.
E) Arbitrage eliminates all market inefficiencies.
37) Donald Keim’s research presents evidence that the difference in performance between small
capitalization stocks and large capitalization stocks is largest in the month of
A) January.
B) April.
C) May.
D) August.
E) October.
38) Even though no final conclusion is currently warranted, a number of research papers, including
those of Fama and French, have argued that
A) there is no noticeable difference in the returns of growth versus value stocks.
B) growth stocks outperform value stocks.
C) stocks with high book-value-to-stock-price ratios outperform stocks with low ratios.
D) no observable differences in returns can be associated with varying price-earnings ratios.
E) stocks with low earnings-to-price ratios outperform stocks with high ratios.
39) Researchers have found that over long periods of time
A) the difference between the returns on large company and small company stocks is due solely to
the difference in their risks.
B) strong form market efficiency exists, without argument.
C) large company stocks tend to outperform small company stocks.
D) arbitrage has no effect on market efficiency.
E) value stocks may outperform growth stocks on a risk-adjusted basis but no firm conclusion can
be drawn.
40) The cause of the October 19, 1987 stock market crash
A) is related to actions taken on that date by the Federal Reserve Bank.
B) has been identified as the result of major internet company announcements on the prior day.
C) resulted from losses in international markets.
D) has yet to be determined.
E) was the result of regulatory changes that were implemented that morning.
41) Research has found that investors tend to react to earnings surprises
A) slowly, which illustrates conservatism.
B) immediately and fully on the day the information becomes public.
C) quickly and efficiently.
D) in the same manner whether they are positive or negative surprises.
E) always in a negative manner as they do not like any surprises.
42) Market efficiency
A) or the lack thereof, is highly controversial.
B) has been proven to exist only during times when earnings surprises are minimal.
C) has been proven to be strong form efficient for all publicly traded markets.
D) advocates that market prices are correct with both perfect foresight and hindsight.
E) as a hypothesis has been disproven in its entirety.
43) Representativeness, according to financial economists, leads to
A) overreactions in stock returns.
B) abnormal long-term profits.
C) stock price under reactions to new information.
D) stable stock returns over both short and long periods of time.
E) strong form efficient financial markets.
44) In examining the issue of whether the choice of accounting methods affects stock prices,
studies have found that
A) the decision between LIFO and FIFO for inventory accounting can significantly affect stock
prices.
B) a firm can affect its stock price if it either withholds information or provides incorrect
information.
C) accounting changes that increase accounting earnings also increase stock prices.
D) switching depreciation methods can significantly affect stock prices.
E) the choice between the percentage-of-completion or the completed-contract method for
construction projects affect stock prices.
45) Choices between various accounting methods should not affect stock prices if
A) and only if the financial markets are strong form efficient.
B) the financial market is weak form efficient and the investors are at least somewhat rational.
C) the markets have recently experienced the bursting of a market bubble.
D) companies consistently select the most conservative of the allowable methods.
E) markets are at least semistrong form efficient and firms provide sufficient information so
investors can analyze those choices.
46) The research done by Ikenberry, Lakonishok, and Vermaelen supports the argument that
mangers:
A) effectively time IPOs but not SEOs.
B) cannot effectively time IPOs.
C) cannot effectively time either stock sales or repurchases.
D) effectively time stock repurchases.
E) can effectively time stock sales but not repurchases.
47) Which one of these is a finding of Ritter’s study of initial public offerings (IPOs)?
A) Firms with either IPOs or SEPs tend to outperform their control groups for the 5-year period
following the issue of the new securities.
B) IPOs are generally incorrectly priced at issuance because over the next 5 years the IPO firm’s
abnormal returns exceeded 6 percent on average.
C) The annual returns for IPO firms during the 5-year period following an IPO are about 2 percent
lower than their control group.
D) Comparable IPO and non-IPO firms had similar returns for the 5-year period following an IPO.
E) IPO firms tend to lose 10 percent or more of their market value in the 2 years following their
IPO.
48) Managers are probably best qualified to predict when
A) currency exchange rates are most favorable.
B) a firm they wish to acquire is most undervalued.
C) market interest rates are at their lowest point.
D) interest rates are peaking.
E) their company’s stock is overvalued.
49) The efficient market hypothesis says that
A) market prices reflect underlying asset values.
B) individual investors should not participate in the financial markets.
C) investors should expect to earn abnormal profits.
D) financial managers can accurately time stock and bond sales.
E) creative accounting can be used to inflate stock prices.
50) ALLGO announced at Time t that it was acquiring DoLittle Industries. There were no other
announcements affecting these firms. ALLGO’s stock had daily returns of +0.1, +0, −0.5, −0.2,
+0.1 for Timet − 2 to Timet + 2, respectively. The daily returns on the market were −0.1, +0.2,
+0.3, −0.2, and +0.2 for Timet − 2 to Timet + 2, respectively. What is the cumulative abnormal
return for these 5 days?
A) −0.7
B) −0.9
C) −0.5
D) −0.8
E) −0.3
51) Franklin Mills announced at Time t that it just sold its worst performing division. There were
no other announcements affecting the firm. The firm’s stock had daily returns of −0.2, +0.1, +0.4,
−0.1, +0.2 for Timet − 2 to Timet + 2, respectively. The daily returns on the market were −0.1,
+0.2, +0.3, −0.2, and +0.2 for Timet − 2 to Timet + 2, respectively. What is the cumulative
abnormal return for these 5 days?
A) 0.3
B) 0.8
C) 1.1
D) 0.5
E) 0.6
52) Southern Goods announced at Time t that it was replacing its CEO. There were no other
announcements affecting the firm. The stock had daily returns of 0.1, +0.2, −0.8, −0.3, +0.5 for
Timet − 2 to Timet + 2, respectively. The daily returns on the market were 0.1, +0.2, −0.4, −0.2,
and +0.2 for Timet − 2 to Timet + 2, respectively. What is the cumulative abnormal return for these
5 days?
A) 0.1
B) 0.3
C) −0.2
D) −0.1
E) −0.3