15) In an efficient market with rational expectations, the actual price of an asset
A) will equal its expected price.
B) will often be below its expected price.
C) will often be above its expected price.
D) equals its expected price plus a random error term.
16) The efficient markets hypothesis
A) assumes that market participants form their expectations adaptively.
B) applies rational expectations to the pricing of assets.
C) applies to the stock market, but not to the bond market.
D) indicates that the stock market is efficient, but not rational.
17) According to the efficient markets hypothesis,
A) the equilibrium price of an asset equals the optimal forecast of fundamental value based on
available information.
B) the actual and expected prices of an asset will be equal.
C) the actual price of an asset reflects only information on past returns on the asset.
D) the expected price of an asset incorporates only information on past returns on the asset.
18) According to the Efficient Markets Hypothesis, prices of securities
A) change infrequently.
B) change frequently to reflect news about changes in the fundamental values of the securities.
C) change frequently as evaluations of existing information about the securities change.
D) are not allowed, under federal securities laws, to change more frequently than once a month.
19) Under the efficient markets hypothesis, what would be the price per share of a company
whose current dividend is $10.00 and whose dividends are expected to grow by 3% per year
(assume the risk-adjusted interest rate is 10%)?
A) $74.62
B) $79.23
C) $142.86
D) $147.14
20) According to the efficient markets hypothesis,
A) common stock prices should be constant.
B) the price of a corporation’s stock is likely to fluctuate substantially in response to news about
changes in the company’s short-term prospects.
C) the price of a corporation’s stock will fluctuate significantly only in response to news about
changes in the company’s long-term prospects.
D) price fluctuations in common stock are a response to fads and are only infrequently the result
of changes in the expected profitability of the companies involved.
21) According to the efficient markets hypothesis, who is most likely to benefit from frequently
moving funds from one asset to another?
A) your broker
B) small investors
C) big investors
D) only those who consistently beat the market
22) Under the efficient markets hypothesis, for news about a company’s prospects to have a large
impact on the price of the company’s stock the news must
A) have an impact on the company’s profitability in the short term.
B) have an impact on the company’s profitability in the long term.
C) significantly increase the likelihood that the company will go bankrupt.
D) significantly reduce the liquidity of the company’s stock.
23) An implication of the efficient markets hypothesis is that
A) only sophisticated investors will be able to earn above-normal profits from financial
investments.
B) above-normal profits are available only to major traders.
C) above-normal profits will be eliminated in the trading process.
D) unless he or she acts recklessly, the average investor should be able to make above-normal
profits.
24) Above-normal returns on stock investments can be expected by investors who
A) possess insider information.
B) are wealthy enough to hold the stock of many different companies in their portfolios.
C) are risk seeking.
D) concentrate their investments in one or two stocks.
25) One implication of the efficient markets hypothesis is that investors should
A) concentrate their investments in just a few well-chosen assets.
B) hold a diversified portfolio of assets.
C) buy stocks rather than bonds.
D) buy bonds rather than stocks.
26) An investor will generally find that hiring an investment firm to actively manage his or her
portfolio will
A) result in a higher return than would be received from an index mutual fund.
B) be less expensive than simply placing money in an index mutual fund.
C) result in a higher return, but will be more expensive than placing money in an index mutual
fund.
D) result in about the same return, but be more expensive than placing money in an index mutual
fund.
27) In comparing actively managed mutual funds with those funds that simply buy and hold a
large market portfolio (index funds), we would expect that
A) the actively managed funds provide a higher return than the index funds.
B) the index funds provide a higher return after expenses than the actively managed funds.
C) actively managed funds and index funds provide the same returns.
D) index funds provide a lower return than actively managed funds only if taxes are taken into
consideration.
28) “Tips” published in leading commercial or financial publications are unlikely to lead to
profitable trades because
A) only wealthy individuals can buy stocks in the volume necessary to take advantage of tips.
B) whatever is gained by trading on the basis of tips will be taxed away by the government.
C) the news will already be reflected in the market prices of the assets.
D) the news contained in the tips is usually inaccurate.
29) According to the efficient markets hypothesis, the difference between today’s price for a
share of stock and tomorrow’s price is
A) predictable given currently available information.
B) equal to today’s price minus yesterday’s price.
C) unforecastable.
D) zero.
30) Suppose Exxon-Mobil announces that its profits in the third quarter of 2011 were $40 billion.
This will cause the price of Exxon-Mobil stock to
A) rise.
B) fall.
C) remain unchanged.
D) rise, fall, or remain unchanged depending on the expectations of market participants before
the announcement.
31) Suppose that Google announces that its profits for the third quarter of 2011 were $1.6 billion.
As a result of this announcement the price of Google’s stock declines. The best explanation of
this is
A) market participants expected Google’s profits to be greater than $1.6 billion for the third
quarter.
B) market participants expected Google’s profits to be less than $1.6 billion for the third quarter.
C) the stock market is not an efficient market.
D) market participants have adaptive expectations.
32) Suppose Apple announces that its earnings for the fourth quarter of 2011 rose to $2 billion.
As a result of this announcement the price of Apple’s stock does not change. The best
explanation of this is
A) market participants were expecting Apple’s earnings to be greater than $2 billion.
B) market participants expected Apple’s earnings to be $2 billion.
C) market participants expected Apple’s earnings to be less than $2 billion.
D) market participants have adaptive expectations.
33) The efficient markets hypothesis predicts that an investor
A) will not be able consistently to earn above-normal profits from buying or selling stocks.
B) will be able consistently to earn above-normal profits from buying or selling stocks so long as
he or she makes use of rational expectations.
C) will be able consistently to earn above-normal profits from buying or selling stocks so long as
he makes us of adaptive expectations.
D) will be able consistently to earn above-normal profits so long as stock prices in general are
rising.
34) According to the efficient markets hypothesis, who should earn the highest risk-adjusted
return on stocks?
A) a financial expert who can devote considerable time to research
B) the average investor who doesn’t do too much research
C) someone throwing darts at possible stock picks
D) all of the above should earn the same average return
35) What is the difference between adaptive expectations and rational expectations?
36) What should affect the fundamental value of a stock according to the efficient markets
hypothesis?
6.4 Actual Efficiency in Financial Markets
1) In the context of the evaluation of the efficient markets hypothesis, pricing anomalies refer to
A) the existence of trading strategies that appear to have offered above-normal returns.
B) the gap between actual and expected prices.
C) the spread between the price at which a broker will purchase stock from an investor and the
price at which the broker will sell stock to an investor.
D) the difficulty in practice of computing stock prices on the basis of expectations of future
dividends.
2) The economist known for his early empirical work supporting the efficient markets hypothesis
is
A) Milton Friedman.
B) John Muth.
C) Eugene Fama.
D) Glenn Hubbard.
3) Suppose that research shows that by buying stocks issued by companies whose names begin
with the letter G investors can earn above-normal returns in even-numbered years. From the
perspective of the efficient markets hypothesis,
A) this is further evidence that the hypothesis is correct.
B) this would be considered a pricing anomaly.
C) investors must have insider information on these companies.
D) purchasers of these stocks must have been noise traders.
4) The small-firm effect
A) shows that investments in the stocks of small firms would have earned a below-normal return
during the period beginning in the mid-1920s.
B) may be the result of the low liquidity and high information costs of small-firm stock.
C) was stronger during the 1980s than in previous decades.
D) is the tendency for stocks of large firms to outperform those of small firms.
5) The January effect
A) largely disappeared after receiving attention in the 1980s.
B) refers to the gap between futures prices and the prices of the underlying securities that occurs
each January.
C) was stronger during the 1980s than during previous decades.
D) is the observation that stocks tend to be sold off in January.
6) Mean reversion refers to the tendency for
A) futures prices to revert to the prices of the underlying securities.
B) the long-run mean return on stocks to equal the long-run mean return on bonds.
C) stocks with high returns today to experience low returns in the future and for stocks with low
returns today to experience high returns in the future.
D) financial analysts whose stock picks have earned above-normal returns in the past to be
unable to pick stocks that will perform as well in the future.
7) Momentum investing can be described as
A) consistent with the efficient markets hypothesis.
B) similar to mean reversion.
C) follow the picks of investors who have been successful in the past.
D) the trend is your friend.
8) Excess volatility refers to
A) the unwillingness of financial analysts to consistently recommend the same stocks.
B) the greater volatility of futures prices compared to the volatility of prices of the underlying
assets.
C) the tendency for stocks with high rates of returns also to have quite variable returns.
D) the larger movements in market prices of stock than in their fundamental values.
9) How can the Gordon Growth model help explain the major decline in stock indexes during
2007-2009?
A) There was an increase in the required return on equities and a decrease in the expected growth
rate of dividends.
B) There was a decrease in the required return on equities and a decrease in the expected growth
rate of dividends.
C) There was an increase in the required return on equities and an increase in the expected
growth rate of dividends.
D) There was a decrease in the required return on equities and a decrease in the expected growth
rate of dividends.
10) The efficient markets hypothesis implies that stock investments should have the same
expected return after adjusting for
A) risk.
B) information costs.
C) liquidity.
D) all of the above.
11) How would proponents of the efficient markets hypothesis use the Gordon-Growth model to
explain the movement of stock prices during the Financial Crisis of 2007-2009?
6.5 Behavioral Finance
1) Noise traders
A) pursue trading strategies based on inflated view of their ability to understand the significance
of a piece of news.
B) make use of inside information.
C) reduce the amount of risk in the market.
D) help to ensure that asset prices reflect the fundamental values of the securities being traded.
2) Behavioral economics can best be described as
A) the study of situations in which people’s choices do not appear to be economically rational.
B) the study of human economic behavior.
C) the basis for efficient markets.
D) the study of how the economy affects human behavior.
3) Which of the following is an example of behavior that is not rational?
A) buying stocks after stock prices have declined
B) buying stocks after stock prices have risen
C) a significantly higher enrollment in 401K plans if people are automatically enrolled rather
than having the option of signing up on their own
D) enrollment in 401K plans during a bear market
4) Noise traders involves investors who
A) overreact to good and bad news.
B) strictly follow the efficient markets hypothesis.
C) filter out the noise involved in following their stocks.
D) ignore new information about stocks.
5) Noise traders
A) tend to lose money on stock trades, but help to stabilize the market.
B) tend to make higher returns than do “buy-and-hold” investors.
C) create additional risk in the market by increasing price fluctuations.
D) trade only when they have inside information.
6) A bubble occurs when
A) the price of a stock is above its fundamental value.
B) inside information is used to make profits from trading a company’s stock.
C) a company reports profits that are significantly above or below the expectations of financial
analysts.
D) the futures price is greater than the price of the underlying asset.
7) The “greater fool” theory assumes that
A) markets are efficient.
B) bubbles cannot exist in well-organized markets.
C) it makes sense for an investor to buy an asset as long as there is someone else to buy it later
for a higher price.
D) bond market returns are always above stock market returns.
8) Herd behavior can best be described as
A) the large number of investors involved in the stock market.
B) how large participation in financial markets increase market efficiency.
C) informed investors can outperform relatively uninformed investors.
D) relatively uninformed investors follow the behavior of other investors instead of consider
fundamentals.
9) All of the following are possible consequences of noise traders EXCEPT
A) increased volatility in the financial market.
B) asset prices differing from fundamental values.
C) herd behavior contributing to speculative bubbles.
D) reduced volatility of asset prices.
10) Given the financial market bubbles since the late 1990s, most economists think
A) asset prices always equal their fundamental value.
B) investors can consistently outperform the market.
C) it is unlikely that investors can earn above normal profits in the long run by following trading
strategies.
D) there is no such thing as a fundamental value of an asset.
11) Shouldn’t better informed investors be able to profit from the deviations from pricing
efficiency caused by noise traders?
12) Explain how a bubble can develop in the market for an asset.