Problem 11-2
A successful firm like Microsoft has consistently generated large profits for years. Is this a violation of the EMH?
Yes
No
Problem 11-9
Which of the following most appears to contradict the proposition that the stock market is weakly efficient?
Over 25% of mutual funds outperform the market on average.
Insiders earn abnormal trading profits.
Problem 11-10
Which of the following sources of market inefficiency would be most easily exploited?
A stock price drops suddenly due to a large sale by an institution.
Problem 11-11
Suppose that, after conducting an analysis of past stock prices, you come up with the following observations. Which would
appear to contradict the weak form of the efficient market hypothesis?
The average rate of return is significantly greater than zero.
The correlation between the return during a given week and the return during the following week is zero.
Answer:
Problem 11-12
Which of the following statements are true if the efficient market hypothesis holds?
It implies that future events can be forecast with perfect accuracy.
It implies that prices reflect all available information.
It implies that security prices change for no discernible reason.
It implies that prices do not fluctuate.
Answer:
Problem 11-14
Which of the following would be a viable way to earn abnormally high trading profits if markets are semistrong-form
efficient?
Buy shares in companies with low P/E ratios.
Buy shares in companies with recent above-average price changes.
Buy shares in companies with recent below-average price changes.
Buy shares in companies for which you have advance knowledge of an improvement in the management team.
Answer:
a. Consistent
Problem 11-17
Which of the following phenomena would be either consistent with or a violation of the efficient market hypothesis?
a. Nearly half of all professionally managed mutual funds are able to outperform the S&P 500 in a typical year.
Consistent
Inconsistent
b. Money managers that outperform the market (on a risk-adjusted basis) in one year are likely to outperform in the following year.
Consistent
Inconsistent
e. Stocks that perform well in one week perform poorly in the following week.
Consistent
Inconsistent
Equation Format
rF = 0.1% + 1.1rM
Mkt Ndx F actual
rM = 7.1 7
rF7.91
rA7
Abnormal Change = -0.91
Problem 11-18
An index model regression applied to past monthly returns in Ford’s stock price produces the following estimates, which are
believed to be stable over time:
rF= 0.10% + 1.1rM
If the market index subsequently rises by 8% and Ford’s stock price rises by 7%, what is the abnormal change in Ford’s stock price?
(Negative value should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 1 decimal
place. Omit the “%” sign in your response.)
0.055
Format
Apex: rA = 0.2% + 1.2rM
Input: 0.004 1.5
Bpex: rB = –0.1% + 0.8rM
Bpex 0.0262
rM = 0.034
Answers:
Problem 11-20
In a recent closely contested lawsuit, Apex sued Bpex for patent infringement. The jury came back today with its decision. Th e rate of
return on Apex was rA= 3.1%. The rate of return on Bpex was only rB = 2.5%. The market today responded to very encouraging news
about the unemployment rate, and rM= 3%. The historical relationship between returns on these stocks and the market portfolio has
been estimated from index model regressions as:
Predicted Returns
Apex %
Bpex %
b. Which company do you think won the lawsuit?
Apex: rA = 0.0944
Bpex: rB = 0.0194
Predicted Returns
Answer:
Problem 11-24
You know that firm XYZ is very poorly run. On a scale of 1 (worst) to 10 (best), you would give it a score of 3. The
market consensus evaluation is that the management score is only 2. Should you buy or sell the stock?
Buy
Sell