Chapter 11

3. Award: 10.00 points Problems? Adjust credit for all students. Which of the following sources of market inefficiency would be most easily exploited? 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. Explanation: Acute market inefficiencies are temporary in nature and are more easily exploited than chronic inefficiencies. A temporary drop in a stock price due to a large sale would be more easily exploited than the chronic inefficiencies mentioned in the other responses. Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 11:The Efficient Market Hypothesis > Chapter 11 Problems - Algorithmic & Static References

6. Award: 10.00 points Problems? Adjust credit for all students. Which of the following would be a viable way to earn abnormally high trading profits if markets are semistrong-form efficient? 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 for which you have advance knowledge of an improvement in the management team. Explanation: In a semistrong-form efficient market, it is not possible to earn abnormally high profits by trading on publicly available information. Information about P/E ratios and recent price changes is publicly known. On the other hand, an investor who has advance knowledge of management improvements could earn abnormally high trading profits (unless the market is also strong-form efficient). Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 11:The Efficient Market Hypothesis > Chapter 11 Problems - Algorithmic & Static References

9. Award: 10.00 points Problems? Adjust credit for all students. In a recent closely contested lawsuit, Apex sued Bpex for patent infringement. The jury came back today with its decision. The rate of return on Apex was r A = 3.1% . The rate of return on Bpex was only r B = 2.5% . The market today responded to very encouraging news about the unemployment rate, and r M = 3% . The historical relationship between returns on these stocks and the market portfolio has been estimated from index model regressions as: Apex: r A = 0.2% + 1.4 r M Bpex: r B = −0.1% + 0.6 r M Required: a. What is the predicted returns for Apex & Bpex? b. Which company do you think won the lawsuit?  Required A Required B  Complete this question by entering your answers in the tabs below. What is the predicted returns for Apex & Bpex? Note: Do not round intermediate calculations. Round your answers to 1 decimal place. Required A Required B Predicted Returns Apex 4.4 % Bpex 1.7 % Explanation: a. Given market performance, predicted returns on the two stocks would be: Apex: 0.2% + (1.4 × 3%) = 4.4% Bpex: −0.1% + (0.6 × 3%) = 1.7% b. Apex underperformed this prediction; Bpex outperformed the prediction. We conclude that Bpex won the lawsuit. Worksheet Difficulty: 2 Intermediate Source: Investments (Bodie, 13e, ISBN 1266836322) > Chapter 11:The Efficient Market Hypothesis > Chapter 11 Problems - Algorithmic & Static References

1. Award: 10.00 points 2. Award: 10.00 points 3. Award: 10.00 points 4. Award: 10.00 points 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. semistrong strong weak All of the options are correct. None of the options are correct. The semistrong form of the EMH maintains that stock prices immediately reflect all historical and current public information, but not inside information. References Multiple Choice Difficulty: 1 Basic 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 __________. inefficient; the effect of a well-functioning market efficient; the effect of an inefficient market inefficient; the effect of an inefficient market efficient; the effect of a well-functioning market irrational; even more irrational than before Random price changes were originally thought to be driven by irrationality. Now, financial economists believe random price changes occur because markets are informationally efficient. References Multiple Choice Difficulty: 1 Basic The stock market follows a: nonrandom walk. submartingale. predictable pattern that can be exploited. nonrandom walk and predictable pattern that can be exploited. submartingale and predictable pattern that can be exploited. The stock market follows a submartingale. References Multiple Choice Difficulty: 1 Basic A hybrid strategy is one where the investor: uses both fundamental and technical analysis to select stocks. selects the stocks of companies that specialize in alternative fuels. selects some actively-managed mutual funds on their own and uses an investment advisor to select other actively-managed funds. maintains a passive core and augments the position with an actively-managed portfolio. None of the options are correct. A hybrid strategy is one where the investor maintains a passive core and augments the position with an actively managed portfolio. References Multiple Choice Difficulty: 1 Basic                        

13. Award: 10.00 points 14. Award: 10.00 points 15. Award: 10.00 points 16. Award: 10.00 points _________ below which it is difficult for the market to fall. An intrinsic value is a value A resistance level is a value A support level is a value An intrinsic value and a resistance level are values A resistance level and a support level are values When stock prices have remained stable for a long period, these prices are termed support levels; technicians believe it is difficult for the stock prices to penetrate these support levels. References Multiple Choice Difficulty: 1 Basic ___________ the return on a stock beyond what would be predicted from market movements alone. An irrational return is An economic return is An abnormal return is None of the options are correct. All of the options are correct. An economic return is the expected return based on the perceived level of risk and market factors. When returns exceed these levels, the returns are called abnormal returns. References Multiple Choice Difficulty: 1 Basic The debate over whether markets are efficient will probably never be resolved because of: the lucky event issue. the magnitude issue. the selection bias issue. All of the options are correct. None of the options are correct. All of the options make rigid testing of market efficiency difficult or impossible. References Multiple Choice Difficulty: 1 Basic A common strategy for passive management is: creating an index fund. creating a small firm fund. creating an investment club. creating an index fund and creating an investment club. creating a small firm fund and creating an investment club. The index fund is, by definition, passively managed. The other investment alternatives may or may not be managed passively. References Multiple Choice Difficulty: 1 Basic                        

25. Award: 10.00 points 26. Award: 10.00 points 27. Award: 10.00 points 28. Award: 10.00 points Studies of negative earnings surprises have shown that there is a negative abnormal return on the day that negative earnings surprises are announced. a positive drift in the stock price on the days following the earnings surprise announcement. a negative drift in the stock price on the days following the earnings surprise announcement. a negative abnormal return on the day that negative earnings surprises are announced and a negative drift in the stock price on the days following the earnings surprise announcement. a negative abnormal return on the day that negative earnings surprises are announced and a positive drift in the stock price on the days following the earnings surprise announcement. The market appears to adjust to earnings information gradually, resulting in a sustained period of abnormal returns. References Multiple Choice Difficulty: 2 Intermediate Studies of stock price reactions to news are called: reaction studies. event studies. drift studies. reaction studies and event studies. event studies and drift studies. Studies of stock price reactions to news are called event studies. References Multiple Choice Difficulty: 2 Intermediate On November 22, the stock price of Coca Cola was $69.50, and the retailer stock index was 600.30. On November 25, the stock price of Coca Cola was $70.25, and the retailer stock index was 605.20. Consider the ratio of Coca Cola to the retailer index on November 22 and November 25. Coca Cola is _______ the retail industry, and technical analysts who follow relative strength would advise _______ the stock. outperforming; buying outperforming; selling underperforming; buying underperforming; selling equally performing; neither buying nor selling 11/22: $69.50 ÷ 600.30 = 0.1158; 11/25: $70.25 ÷ 605.20 = 0.1161; Thus, Coca Cola's relative strength is improving, and technicians using this technique would recommend buying. References Multiple Choice Difficulty: 2 Intermediate Work by Amihud and Mendelson (1986, 1991): argues that investors will demand a rate of return premium to invest in less liquid stocks. may help explain the small firm effect. may be related to the neglected firm effect. may help explain the small firm effect and may be related to the neglected firm effect. All of the options are correct. Lack of liquidity may affect the returns of small and neglected firms; however the theory does not explain why the abnormal returns are concentrated in January. References Multiple Choice Difficulty: 2 Intermediate                        

37. Award: 10.00 points 38. Award: 10.00 points 39. Award: 10.00 points 40. Award: 10.00 points Cumulative abnormal returns (CAR): are used in event studies, only. are better measures of security returns due to firm-specific events than are abnormal returns (AR), only. are cumulated over the period prior to the firm-specific event, only. are used in event studies and are better measures of security returns due to firm-specific events than are abnormal returns (AR). are used in event studies and are cumulated over the period prior to the firm-specific event. As leakage of information occurs, the accumulated abnormal returns that are abnormal returns summed over the period of interest (around the event date) are better measures of the effect of firm-specific events. References Multiple Choice Difficulty: 2 Intermediate Studies of mutual-fund performance: indicate that one should not randomly select a mutual fund. indicate that historical performance is not necessarily indicative of future performance. indicate that the professional management of the fund insures above market returns. indicate that one should not randomly select a mutual fund and indicate that historical performance is not necessarily indicative of future performance. indicate that one should not randomly select a mutual fund and indicate that the professional management of the fund insures above market returns. Studies show that, in general, funds do not outperform the market and that historical performance is not necessarily an indicator of future performance. References Multiple Choice Difficulty: 1 Basic The likelihood of an investment newsletter's successfully predicting the direction of the market for three consecutive years by chance should be: between 50% and 70%. between 25% and 50%. between 10% and 25%. less than 10%. greater than 70%. The probability of successful prediction for three consecutive years is 12.5%. References Multiple Choice Difficulty: 2 Intermediate In an efficient market the correlation coefficient between stock returns for two nonoverlapping time periods should be: positive and large. positive and small. zero. negative and small. negative and large. In an efficient market there should be no serial correlation between returns from nonoverlapping periods. References Multiple Choice Difficulty: 2 Intermediate                        

41. Award: 10.00 points 42. Award: 10.00 points 43. Award: 10.00 points 44. Award: 10.00 points The weather report says that a devastating and unexpected freeze is expected to hit Florida tonight during the peak of the citrus harvest. In an efficient market, one would expect the price of Florida Orange's stock to: drop immediately. unable to determine. increase immediately. gradually decline for the next several weeks. gradually increase for the next several weeks. In an efficient market the price of the stock should drop immediately when the bad news is announced. If later news changes the perceived impact to Florida Orange, the price may once again adjust quickly to the new information. A gradual change is a violation of the EMH. References Multiple Choice Difficulty: 2 Intermediate Matthews Corporation has a beta of 1.2. The annualized market return yesterday was 13%, and the risk-free rate is currently 5%. You observe that Matthews had an annualized return yesterday of 17%. Assuming that markets are efficient, this suggests that: bad news about Matthews was announced yesterday. good news about Matthews was announced yesterday. no news about Matthews was announced yesterday. interest rates rose yesterday. interest rates fell yesterday. AR = 17% − (5% + 1.2 × 8%) = +2.4%. A positive abnormal return suggests that there was firm-specific good news. References Multiple Choice Difficulty: 2 Intermediate Nicholas Manufacturing just announced yesterday that its fourth quarter earnings will be 10% higher than last year's fourth quarter. Nicholas had an abnormal return of 1.2% yesterday. This suggests that: the market is not efficient. Nicholas' stock will probably rise in value tomorrow. investors expected the earnings increase to be larger than what was actually announced. investors expected the earnings increase to be smaller than what was actually announced. earnings are expected to decrease next quarter. Anticipated earnings changes are impounded into a security's price as soon as expectations are formed. Therefore a negative market response indicates that the earnings surprise was negative, that is, the increase was less than anticipated. References Multiple Choice Difficulty: 2 Intermediate When Maurice Kendall first examined stock price patterns in 1953, he found that: certain patterns tended to repeat within the business cycle. there were no predictable patterns in stock prices. stocks whose prices had increased consistently for one week tended to have a net decrease the following week. stocks whose prices had increased consistently for one week tended to have a net increase the following week. the direction of change in stock prices was unpredictable, but the amount of change followed a distinct pattern. The first studies in this area were made possible by the development of computer technology. Kendall's study was the first to indicate that markets were efficient. References Multiple Choice Difficulty: 1 Basic                        

45. Award: 10.00 points 46. Award: 10.00 points 47. Award: 10.00 points 48. Award: 10.00 points If stock prices follow a random walk,: it implies that investors are irrational. it means that the market cannot be efficient. price levels are not random. price changes are random. price movements are predictable. A random walk means that the changes in prices are random and independent. References Multiple Choice Difficulty: 1 Basic The main difference between the three forms of market efficiency is that: the definition of efficiency differs. the definition of excess return differs. the definition of prices differs. the definition of information differs. they were discovered by different people. The main difference is that weak form encompasses only historical data, semistrong form encompasses historical data and current public information, and strong form encompasses historical data, current public information, and inside information. All of the other definitions remain the same. References Multiple Choice Difficulty: 2 Intermediate Chartists practice: technical analysis. fundamental analysis. regression analysis. insider analysis. psychoanalysis. Chartist is another name for a technical analyst. References Multiple Choice Difficulty: 1 Basic Which of the following are used by fundamental analysts to determine proper stock prices? I. Trendlines II. Earnings III. Dividend prospects IV. Expectations of future interest rates V. Resistance levels I, IV, and V I, II, and III II, III, and IV II, IV, and V All of the items are used by fundamental analysts. Fundamental analysts look at factors such as earnings, dividend prospects, expectation of future interest rates, and risk of the firm. The information is used to determine the present value of future cash flows to stockholders. Technical analysts use trendlines and resistance levels. References Multiple Choice Difficulty: 2 Intermediate                        

49. Award: 10.00 points 50. Award: 10.00 points 51. Award: 10.00 points Which of the following are used by technical analysts to determine proper stock prices? I. Trendlines II. Earnings III. Dividend prospects IV. Expectations of future interest rates V. Resistance levels I and V I, II, and III II, III, and IV II, IV, and V All of the items are used by fundamental analysts. Fundamental analysts look at factors such as earnings, dividend prospects, expectation of future interest rates, and risk of the firm. The information is used to determine the present value of future cash flows to stockholders. Technical analysts use trendlines and resistance levels. References Multiple Choice Difficulty: 2 Intermediate According to proponents of the efficient-market hypothesis, the best strategy for a small investor with a portfolio worth $40,000 is probably to: perform fundamental analysis. exploit market anomalies. invest in Treasury securities. invest in derivative securities. invest in index funds. Individual investors tend to have relatively small portfolios and are usually unable to realize economies of size. The best strategy is to pool funds with other small investors and allow professional managers to invest the funds. References Multiple Choice Difficulty: 2 Intermediate Which of the following are investment superstars who have consistently shown superior performance? I. Warren Buffet II. Burton Malkiel III. Peter Lynch IV. Merrill Lynch V. Jimmy Buffet I, III, and IV II, III, and IV I and III III and IV I, III, IV, and V Warren Buffet manages Berkshire Hathaway and Peter Lynch managed Fidelity's Magellan Fund. Burton Malkiel, author of A Random Walk Down Wall Street , advocates passive investment strategies for the average investor. Jimmy Buffet is "Wasting Away in Margaritaville." Merrill Lynch is not a person. References Multiple Choice Difficulty: 2 Intermediate                  

52. Award: 10.00 points 53. Award: 10.00 points 54. Award: 10.00 points 55. Award: 10.00 points Boeing has a beta of 1.0. The annualized market return yesterday was 11%, and the risk-free rate is currently 5%. You observe that Boeing had an annualized return yesterday of 14%. Assuming that markets are efficient, this suggests that: bad news about Boeing was announced yesterday. good news about Boeing was announced yesterday. no news about Boeing was announced yesterday. interest rates rose yesterday. interest rates fell yesterday. AR = 14% − (5% + 1.0 × 6%) = 3.0%. A positive abnormal return suggests that there was firm-specific good news. References Multiple Choice Difficulty: 2 Intermediate Music Doctors has a beta of 2.25. The annualized market return yesterday was 12%, and the risk-free rate is currently 4%. You observe that Music Doctors had an annualized return yesterday of 15%. Assuming that markets are efficient, this suggests that: bad news about Music Doctors was announced yesterday. good news about Music Doctors was announced yesterday. no news about Music Doctors was announced yesterday. interest rates rose yesterday. interest rates fell yesterday. AR = 15% − (4% + 2.25 × 8%) = − 7.0%. A negative abnormal return suggests that there was firm-specific bad news. References Multiple Choice Difficulty: 2 Intermediate XRCO has a beta of 1.7. The annualized market return yesterday was 13%, and the risk-free rate is currently 3%. You observe that XRCO had an annualized return yesterday of 20%. Assuming that markets are efficient, this suggests that: bad news about XRCO was announced yesterday. good news about XRCO was announced yesterday. no significant news about XRCO was announced yesterday. interest rates rose yesterday. interest rates fell yesterday. AR = 20% − (3% + 1.7 × 10%) = 0.0%. A positive abnormal return suggests that there was firm-specific good news and a negative abnormal return suggests that there was firm-specific bad news. References Multiple Choice Difficulty: 2 Intermediate XRCO just announced yesterday that its fourth quarter earnings will be 35% higher than last year's fourth quarter. You observe that XRCO had an abnormal return of − 1.7% yesterday. This suggests that: the market is not efficient. XRCO stock will probably rise in value tomorrow. investors expected the earnings increase to be larger than what was actually announced. investors expected the earnings increase to be smaller than what was actually announced. earnings are expected to decrease next quarter. Anticipated earnings changes are impounded into a security's price as soon as expectations are formed. Therefore, a negative market response indicates that the earnings surprise was negative; that is, the increase was less than anticipated. References Multiple Choice Difficulty: 2 Intermediate                        

56. Award: 10.00 points 57. Award: 10.00 points 58. Award: 10.00 points 59. Award: 10.00 points KWM Corporation just announced yesterday that it would undertake an international joint venture. You observe that KWM had an abnormal return of 3% yesterday. This suggests that: the market is not efficient. KWM stock will probably rise in value again tomorrow. investors view the international joint venture as bad news. investors view the international joint venture as good news. earnings are expected to decrease next quarter. The positive abnormal return suggests that investors view the international joint venture as good news. References Multiple Choice Difficulty: 2 Intermediate Music Doctors just announced yesterday that its first quarter sales were 35% higher than last year's first quarter. You observe that Music Doctors had an abnormal return of − 2% yesterday. This suggests that: the market is not efficient. Music Doctors stock will probably rise in value tomorrow. investors expected the sales increase to be larger than what was actually announced. investors expected the sales increase to be smaller than what was actually announced. earnings are expected to decrease next quarter. The negative abnormal return suggests that investors expected the sales increase to be larger than what was actually announced. References Multiple Choice Difficulty: 2 Intermediate The Food and Drug Administration (FDA) just announced yesterday that they would approve a new cancer-fighting drug from Queen. You observe that Queen had an abnormal return of 0% yesterday. This suggests that: the market is not efficient. Queen stock will probably rise in value tomorrow. Queen stock will probably fall in value tomorrow. the approval was already anticipated by the market. None of the options are correct. The approval was already anticipated by the market. References Multiple Choice Difficulty: 2 Intermediate Your professor finds a stock-trading rule that generates excess risk-adjusted returns. Instead of publishing the results, she keeps the trading rule to herself. This is most closely associated with: regret avoidance. selection bias. framing. insider trading. None of the options are correct. This is an example of selection bias. References Multiple Choice Difficulty: 2 Intermediate                        

60. Award: 10.00 points 61. Award: 10.00 points 62. Award: 10.00 points 63. Award: 10.00 points At freshman orientation, 1,500 students are asked to flip a coin 20 times. One student is crowned the winner (tossed 20 heads). This is most closely associated with: regret avoidance. selection bias. overconfidence. the lucky event issue. None of the options are correct. This is an example of the lucky event issue. References Multiple Choice Difficulty: 2 Intermediate Seyhun (1986) finds that the practice of monitoring insider trade disclosures, and trading on that information, would be: extremely profitable for long-term traders. extremely profitable for short-term traders. marginally profitable for long-term traders. marginally profitable for short-term traders. not sufficiently profitable to cover trading costs. The practice of monitoring insider trade disclosures, and trading on that information, would be not sufficiently profitable to cover trading costs. References Multiple Choice Difficulty: 2 Intermediate If you believe in the reversal effect, you should: sell bonds in this period if you held stocks in the last period. sell stocks in this period if you held bonds in the last period. sell stocks this period that performed well last period. go long. sell stocks this period that performed well last period and go long. The reversal effect states that stocks that do well in one period tend to perform poorly in the subsequent period, and vice versa. References Multiple Choice Difficulty: 1 Basic Patell and Woflson (1984) report that most of the stock-price response to corporate dividend or earnings announcements occurs within _____________ of the announcement. 10 minutes 45 minutes 2 hours 4 hours 2 trading days The correct answer is 10 minutes. References Multiple Choice Difficulty: 2 Intermediate                        

64. Award: 10.00 points 65. Award: 10.00 points 66. Award: 10.00 points 67. Award: 10.00 points Del Guerico and Reuter (2014) report that the average underperformance of actively-managed mutual funds is driven largely by: sector mutual funds. index funds. direct-sold funds. broker-sold funds. bank-sold mutual funds. References Multiple Choice Difficulty: 2 Intermediate Expert firms must maintain detailed records of conversations in the event authorities decide to investigate _____________. tax evasion insider trading excess profits FDA violations SEC violations Expert firms now maintain detailed records of which experts have talk to whom, when those conversations took place, and what was discussed. These records can be released to authorities in the event of an insider trading investigation. References Multiple Choice Difficulty: 2 Intermediate Billy Bean and his success chronicled in Moneyball by Michael Lewis illustrates that teams were_____________. mispricing the value of players paying too much for players hampered by the salary cap able to win using statistical analysis None of the options are correct. He begins with the observation that baseball players at the turn of the century were systematically “mispriced” by team management and scouts. References Multiple Choice Difficulty: 2 Intermediate Using finance terminology, Billy Bean discovered a better estimate of _____________. intrinsic value inflation market efficiency discount rates None of the options are correct. He figured out how to best evaluate players’ “intrinsic value” by finder better gauges of value. References Multiple Choice Difficulty: 2 Intermediate                        

68. Award: 10.00 points 69. Award: 10.00 points What factor of fundamental analysis has been found to have a negative impact on returns over a 3-12 month time horizon? intrinsic value inflation volatility discount rates None of the options are correct. While the CAPM predicts that idiosyncratic volatility should not be related to stock returns, it appears that at intermediate horizons of 3-12 months, volatility is negatively associated with returns. References Multiple Choice Difficulty: 2 Intermediate What term measures the positive result of market inefficiency? CAPM beta volatility alpha None of the options are correct. The CAPM model has an additional term, alpha, to describe the returns in excess of the expected. References Multiple Choice Difficulty: 1 Basic            