Chapter 11 – The Efficient Market Hypothesis
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Chapter 11
The Efficient Market Hypothesis
Multiple Choice Questions
1. If you believe in the ________ form of the EMH, you believe that stock prices reflect all
relevant information including historical stock prices and current public information about the
firm, but not information that is available only to insiders.
D. A, B, and C
E. none of the above
Difficulty: Easy
2. When Maurice Kendall examined the patterns of stock returns in 1953 he concluded that
the stock market was __________. Now, these random price movements are believed to be
_________.
D. efficient; the effect of a well-functioning market
E. irrational; even more irrational than before
Difficulty: Easy
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3. The stock market follows a __________.
D. A and C
E. B and C
Difficulty: Easy
4. A hybrid strategy is one where the investor
A. uses both fundamental and technical analysis to select stocks.
B. selects the stocks of companies that specialize in alternative fuels.
Difficulty: Easy
5. The difference between a random walk and a submartingale is the expected price change in
a random walk is ______ and the expected price change for a submartingale is ______.
A. positive; zero
Difficulty: Easy
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6. The difference between a random walk and a submartingale is the expected price change in
a random walk is ______ and the expected price change for a submartingale is ______.
A. negative; zero
Difficulty: Easy
7. Proponents of the EMH typically advocate
A. an active trading strategy.
B. investing in an index fund.
Difficulty: Easy
8. Proponents of the EMH typically advocate
A. buying individual stocks on margin and trading frequently.
B. investing in hedge funds.
Difficulty: Easy
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9. If you believe in the _______ form of the EMH, you believe that stock prices reflect all
information that can be derived by examining market trading data such as the history of past
stock prices, trading volume or short interest.
A. semistrong
B. strong
Difficulty: Easy
10. If you believe in the _________ form of the EMH, you believe that stock prices reflect all
available information, including information that is available only to insiders.
A. semistrong
Difficulty: Easy
11. If you believe in the reversal effect, you should
A. buy bonds in this period if you held stocks in the last period.
Difficulty: Easy
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12. __________ focus more on past price movements of a firm’s stock than on the underlying
determinants of future profitability.
A. Credit analysts
Difficulty: Easy
13. _________ above which it is difficult for the market to rise.
A. Book value is a value
Difficulty: Easy
14. _________ below which it is difficult for the market to fall.
A. Intrinsic value is a value
B. Resistance level is a value
Difficulty: Easy
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15. ___________ the return on a stock beyond what would be predicted from market
movements alone.
A. An excess economic return is
B. An economic return is
Difficulty: Easy
16. The debate over whether markets are efficient will probably never be resolved because of
________.
A. the lucky event issue.
B. the magnitude issue.
Difficulty: Easy
17. A common strategy for passive management is ____________.
D. A and C
E. B and C
Difficulty: Easy
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18. Arbel (1985) found that
D. the neglected firm effect was independent of the small firm effect.
E. small firms had higher book-to-market value ratios.
Difficulty: Moderate
19. Researchers have found that most of the small firm effect occurs
A. during the spring months.
Difficulty: Moderate
20. Basu (1977, 1983) found that firms with low P/E ratios
D. had higher dividend yields than firms with high P/E ratios.
E. none of the above.
Difficulty: Moderate
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21. Jaffe (1974) found that stock prices _________ after insiders intensively bought shares.
A. decreased
B. did not change
Difficulty: Moderate
22. Banz (1981) found that, on average, the risk-adjusted returns of small firms
D. were unrelated to the risk-adjusted returns of large firms.
E. were negative.
Difficulty: Moderate
23. Proponents of the EMH think technical analysts
A. should focus on relative strength.
B. should focus on resistance levels.
Difficulty: Moderate
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24. Studies of positive earnings surprises have shown that there is
A. a positive abnormal return on the day positive earnings surprises are announced.
B. a positive drift in the stock price on the days following the earnings surprise
Difficulty: Moderate
25. Studies of negative earnings surprises have shown that there is
A. a negative abnormal return on the day negative earnings surprises are announced.
B. a positive drift in the stock price on the days following the earnings surprise
Difficulty: Moderate
26. Studies of stock price reactions to news are called
A. reaction studies.
Difficulty: Moderate
Chapter 11 – The Efficient Market Hypothesis
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27. On November 22, 2005 the stock price of Walmart was $39.50 and the retailer stock index
was 600.30. On November 25, 2005 the stock price of Walmart was $40.25 and the retailer
stock index was 605.20. Consider the ratio of Walmart to the retailer index on November 22
and November 25. Walmart is _______ the retail industry and technical analysts who follow
relative strength would advise _______ the stock.
D. underperforming, selling
E. equally performing, neither buying nor selling
Difficulty: Moderate
28. Work by Amihud and Mendelson (1986,1991)
A. argues that investors will demand a rate of return premium to invest in less liquid stocks.
B. may help explain the small firm effect.
Difficulty: Moderate
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29. Fama and French (1992) found that the stocks of firms within the highest decile of
market/book ratios had average monthly returns of _______ while the stocks of firms within
the lowest decile of market/book ratios had average monthly returns of ________.
A. greater than 1%, greater than 1%
B. greater than 1%, less than 1%
Difficulty: Moderate
30. A market decline of 23% on a day when there is no significant macroeconomic event
______ consistent with the EMH because ________.
A. would be, it was a clear response to macroeconomic news.
B. would be, it was not a clear response to macroeconomic news.
Difficulty: Moderate
Chapter 11 – The Efficient Market Hypothesis
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31. In an efficient market, __________.
A. security prices react quickly to new information
B. security prices are seldom far above or below their justified levels
Difficulty: Easy
32. The weak form of the efficient market hypothesis asserts that
A. stock prices do not rapidly adjust to new information contained in past prices or past data.
B. future changes in stock prices cannot be predicted from past prices.
Difficulty: Easy
33. A support level is the price range at which a technical analyst would expect the
A. supply of a stock to increase dramatically.
B. supply of a stock to decrease substantially.
Difficulty: Easy
Chapter 11 – The Efficient Market Hypothesis
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34. A finding that _________ would provide evidence against the semistrong form of the
efficient market theory.
A. low P/E stocks tend to have positive abnormal returns
B. trend analysis is worthless in determining stock prices
Difficulty: Moderate
35. The weak form of the efficient market hypothesis contradicts
A. technical analysis, but supports fundamental analysis as valid.
Difficulty: Moderate
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36. Two basic assumptions of technical analysis are that security prices adjust
A. rapidly to new information and market prices are determined by the interaction of supply
and demand.
Difficulty: Moderate
37. Cumulative abnormal returns (CAR)
A. are used in event studies.
Difficulty: Moderate
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38. Studies of mutual fund performance
A. indicate that one should not randomly select a mutual fund.
Difficulty: Easy
39. The likelihood of an investment newsletter’s successfully predicting the direction of the
market for three consecutive years by chance should be
A. between 50% and 70%.
Difficulty: Moderate
40. In an efficient market the correlation coefficient between stock returns for two non-
overlapping time periods should be
A. positive and large.
Difficulty: Moderate