Fundamentals of Investments, 8e (Jordan)
Chapter 7 Stock Price Behavior and Market Efficiency
1) Which one of the following states that investors cannot consistently earn positive excess
returns?
A) market return hypothesis
B) current market hypothesis
C) efficient market hypothesis
D) risk-return theory
E) excess theory
2) Security A and Security B have similar risks. However, Security A has a higher rate of return
than Security B. The return on Security A minus the return on Security B is referred to as which
one of the following?
A) market return
B) abnormal return
C) deviated return
D) excess return
E) real return
3) Which one of the following terms is used to describe a stock price that moves over time
creating no discernible pattern?
A) deviated pattern
B) dispersed flow
C) efficient movement
D) overreaction and correction
E) random walk
4) Which one of the following is a research method used to study the effects news has on stock
prices?
A) polarization
B) market analysis
C) event study
D) news theory
E) reaction hypothesis
5) Which one of the following returns is computed as the observed return minus the expected
return?
A) visible
B) distinct
C) abnormal
D) subjective
E) efficient
6) Which type of trader is defined as one who decides to trade securities based on publicly
available information and analysis?
A) public
B) informed
C) normal
D) inside
E) block
7) Which one of the following terms best describes the information you know about a company
that will have a significant effect on the price of the company’s stock once that information is
released?
A) material public information
B) public information
C) abnormal information
D) private, non-material information
E) material non-public information
8) The day-of-the-week effect is defined as the tendency for which day of the week to have a
negative average rate of return?
A) Monday
B) Tuesday
C) Wednesday
D) Thursday
E) Friday
9) Which one of the following correctly identifies the phenomenon that states that one month has
the greatest tendency for small stocks to earn large returns?
A) January effect
B) March effect
C) September effect
D) October effect
E) December effect
10) Which one of the following terms is used to describe a market situation where prices are
much higher than either fundamental or rational analysis would tend to support?
A) bear market
B) cloud
C) inversion
D) bubble
E) crash aversion
11) Which one of the following terms is used to describe a sudden and significant collapse in
market prices?
A) dive
B) recession
C) crash
D) adjustment
E) rebound
12) Which one of the following terms is used to identify the NYSE rules which slow or stop
trading when the DJIA declines by more than a specified amount during a trading session?
A) order flows
B) market timers
C) crash helmets
D) circuit breakers
E) trade barriers
13) Which one of the following is required for a trader to earn excess profits?
A) excessive trading
B) excessive research
C) market inefficiency
D) highly volatile market state
E) relatively stable market state
14) Stocks A, B, and C have identical risks. Stock A earns an annual return of 9.9 percent as
compared to 9.6 percent returns on stocks B and C. Given this, you can correctly assume that:
A) Stock A is overpriced.
B) the market return is 9.75 percent.
C) Stock A represents the smallest-sized firm.
D) Stock A has a positive excess return.
E) Stocks B and C represent firms that are in the process of merging.
15) In an efficient market, stocks with similar risks will:
A) have the same market price.
B) pay similar dividends.
C) yield the market rate of return.
D) produce abnormal returns.
E) have similar rates of return.
16) Which one of the following will automatically occur if all investors are rational?
A) All stock prices will be equal.
B) Equivalent risk assets will have equal expected rates of return.
C) All investors will earn the market rate of return.
D) All investors will earn the same rate of return.
E) The riskier an asset, the higher its market price will be.
17) Efficient markets tend to exist:
A) only when all investors are rational.
B) anytime market volume exceeds the average trading volume.
C) only when market volatility is low.
D) when rational arbitrage traders dominate irrational traders.
E) when arbitrage trading is prohibited.
18) Independent deviations from rationality:
A) only exist when the overall market is overvalued.
B) prevent the markets from ever being efficient.
C) can create an efficient market.
D) are the actions taken by rational arbitrage traders.
E) do not exist in an efficient market.
19) The term “independent deviations from rationality” implies that:
A) irrational investors are absent from an efficient market.
B) arbitrage traders act independent of each other.
C) markets must be inefficient.
D) irrational investors behave differently from one another.
E) arbitrage traders act together to offset the actions of rational investors.
20) Arbitrage traders:
A) tend to be well-capitalized.
B) tend to be irrational investors.
C) are dominated by irrational investors in an efficient market.
D) lower the efficiency level of a market.
E) sell only relatively inexpensive stocks.
21) You are the chief financial officer of Davidson Industries. On multiple occasions, you have
engaged in insider trading but have never been able to earn any abnormal returns. Which form of
market efficiency most likely exists given your situation?
A) mild-form
B) weak-form
C) historical-form
D) semi-strong form
E) strong-form
22) Which one of the following best describes the type(s) of information included in a strong-
form efficient market?
A) historical
B) historical and public
C) private and public
D) current and public
E) historical and private
23) If the financial markets were regulated such that the markets maintained strong-form
efficiency, then:
A) insider trading laws would be unnecessary.
B) all investors would earn equivalent rates of return.
C) risk premiums would vanish.
D) all investors would become arbitrage traders.
E) securities would tend to be continually underpriced.
24) Which of the following are ineffective strategies for producing excess returns if the market is
semistrong-form efficient?
I. graphing past prices searching for patterns
II. watching the daily market movements
III. studying the latest analyst’s reports
IV. analyzing a firm’s financial statements
A) I and III only
B) I and IV only
C) I, II, and III only
D) II, III, and IV only
E) I, II, III, and IV
25) You analyze a firm’s financial statements and invest based upon the results of this analysis.
Which form of market efficiency must exist if you are able to earn excess profits on these
investments?
A) weak-form
B) historical-form
C) semi-strong form
D) full-form
E) mild-form
26) Ann uses two approaches to trading stocks. First, she trades on what she believes is a
repetitive pattern as seen in Dotson Co’s historical prices. Secondly, she analyzes the financial
statements of The Allen Co. to compute changes in the return on equity as a predictor of future
stock prices for that firm. She trades based on both strategies. Ann earns excess profits on her
return on equity strategy but not on her historical prices strategy. This suggests that the market is
at least ________ efficient but less than ________ efficient.
A) weak-form; mild-form
B) mild-form; semistrong-form
C) weak-form; semistrong-form
D) semistrong-form; full-form
E) semistrong-form; strong-form
27) If the market is semistrong-form efficient, then which one of the following statements is
true?
A) Neither technical nor fundamental analysis leads to abnormal profits.
B) Technical analysts have the ability to earn excess profits but fundamental analysts cannot.
C) Fundamental analysts can earn excess profits but technical analysts cannot.
D) Both technical and fundamental analysts earn excess profits based on their research.
E) No answer can be determined as the form of market efficiency is unrelated to abnormal, or
excess returns.
28) Which form of market efficiency exists if the market is efficient only in regard to historical
information?
A) mild-form
B) weak-form
C) historical-form
D) semistrong-form
E) strong-form
29) Which of the following will lead to excess profits in a semistrong-form efficient market?
I. private financial information
II. historical price trends
III. financial analysts reports
IV. unreleased merger plans
A) I only
B) I and IV only
C) II and III only
D) I, II, and III only
E) I, III, and IV only
30) Research on semistrong-form efficient markets indicates which one of the following is
correct?
A) Identifying a stock with repetitive price movements is generally the best method of active
investing.
B) Future returns on large company stocks tend to closely follow past pricing patterns.
C) Buying and holding a broad market index is one of the best investment strategies.
D) Predicting future stock prices is relatively easy for academic researchers.
E) Trading costs have little, if any, impact on investment returns.
31) If you believe that stock market prices follow a random walk, then:
A) historical price information provides no benefit in predicting future prices.
B) there is no financial benefit from investing in the stock market.
C) having inside information will not lead to excess profits.
D) studying past price movements will lead to excess profits.
E) you also believe the market is strong-form efficient.
32) Two weeks ago Acme Electronics announced that it had developed a new chip design which
was being considered by major companies for use in future smart phone development. At the
close of trading the day before the announcement, Acme common stock closed at $20. On the
day following the announcement, Acme closed at $21. Two days after the announcement the
stock closed at $22.50. Four days after the announcement the stock traded at $23. Last week,
Acme stock traded at $26, a level it has maintained since then. This is an example of a(n):
A) over-reaction and correction.
B) underpricing.
C) delayed reaction.
D) pre-activity action.
E) efficient market reaction.
33) Dover Lumber announced last week that its unpopular CEO had resigned. In response to this
announcement, the firm’s stock price increased from $17 a share to $23 a share. The following
day the price declined to $21 a share and has remained constant at that level. This is an example
of a(n):
A) over-reaction and correction.
B) underpricing.
C) delayed reaction.
D) pre-activity action.
E) efficient market reaction.
34) Last week, Newtown Plastics announced that it had developed a new plastic container that is
stronger and more durable, yet easier to recycle. In response to this announcement, the firm’s
stock price rose from $21 a share to a high of $27 a share and has remained at that level. This is
an example of a(n):
A) over-reaction and correction.
B) post-activity reaction.
C) delayed reaction.
D) pre-activity action.
E) efficient market reaction.
35) Which one of the following involves the study of a firm’s stock price for the few days
surrounding a news announcement?
A) web survey
B) market analysis
C) event study
D) auditing review
E) trend study
36) Which one of the following would best reveal how stock prices react when competitive firms
merge?
A) financial analysis
B) field testing
C) risk analysis
D) event study
E) market survey
37) In an efficient market, daily abnormal returns:
A) are very volatile.
B) reflect news within the past week.
C) reflect news since the prior trading day.
D) remain constant.
E) do not exist.
38) How should cumulative abnormal returns react in an efficient market?
A) relatively constant, sharp break, relatively constant
B) relatively constant with no breaks
C) steadily increasing
D) steadily decreasing
E) remain constant at zero
39) Which of the following sources of information are used by informed traders?
I. financial statements
II. inside information
III. internet reports
IV. analysts reports
A) I and IV only
B) II and III only
C) III and IV only
D) I, III, and IV only
E) I, II, III, and IV
40) Which one of the following statements is correct?
A) Company insiders are not permitted to trade their employer’s securities.
B) Only tippers can be accused of illegal insider trading.
C) Tippees are permitted to trade securities based on information they know is private.
D) Trading on private information which you just happen to overhear is legal.
E) Any trading based on information known to be private is illegal.
41) Tom is an engineer for Talbot Tech and has just discovered a revolutionary method for
strengthening metals. He knows this knowledge will add value to Talbot Tech’s stock. Tom
happens to mention this discovery and its value to his neighbor, Fred. Fred can be charged with
insider trading if he:
A) continues to hold the Talbot Tech shares of stock he already owns.
B) shares this information with another neighbor.
C) sells his shares in Talbot Tech immediately after the news of the discovery is announced.
D) provides this information to a friend who will trade the stock and split the profits with him.
E) buys shares in Talbot Tech immediately after the news is announced and then shortly
thereafter sells the shares at a profit.
42) Which one of the following is most apt to be considered insider trading?
A) Amy overhears Mary say she is being promoted to accounts payables manager and then she
purchases shares in Mary’s employer.
B) Jennifer compiles the financial statements and knows that net income for the latest quarter is
significantly below analyst’s forecasts but continues to hold shares of her employer’s stock.
C) Kathy is an outside auditor and has found what she believes are significant accounting
irregularities in a company’s financial reports but owns no shares in the firm.
D) Lee buys stock in Winter’s Wear after he overhears a conversation between the firm’s
president and vice-president concerning a proposed acquisition.
E) Jeff buys shares of stock in his employer’s firm through the company retirement plan on a
regular monthly basis.