Investment Exam 3

According to the Efficient Market Hypothesis (EMH), stock prices:

Fully reflect all available information

The random walk theory implies that:

Stock price changes are independent and unpredictable.

In a weak-form efficient market, prices reflect:

All past trading information, such as prices and volumes.

The semi-strong form of EMH suggests that:

Prices reflect all past and all publicly available information.

The strong form of EMH asserts that:

All relevant information, public and private, is reflected in prices

If markets are semi-strong-form efficient, which strategy is most appropriate?

Passive index investing.

The 'momentum effect' in weak-form tests refers to:

The continuation of abnormal stock performance over short horizons

The 'reversal effect' implies that:

Stocks performing well in the past tend to underperform in the future.

Which of the following is an implication of the EMH for portfolio management?

Passive investing is consistent with market efficiency.

The P/E effect is an example of:

A semi-strong-form anomaly.

The small-firm effect refers to

Small firms earning higher average risk-adjusted returns

The neglected-firm effect suggests that:

Stocks of less-followed firms can generate abnormal returns.

The book-to-market effect indicates that:

High book-to-market stocks generate abnormal returns.

The post-earnings-announcement drift suggests that:

Prices slowly adjust to earnings announcements over time.

According to EMH, which of the following should NOT yield consistent abnormal returns?

Technical analysis.

The 'magnitude issue' implies that

Even small inefficiencies may not be economically exploitable.

According to the selection bias issue

Investors only publish successful strategies.

Speculative bubbles challenge market efficiency because:

They cause prices to deviate from intrinsic values for extended periods.

Studies by Fama and French interpret anomalies as:

Evidence of risk premia rather than inefficiency.

Evidence from mutual fund performance suggests that:

Persistence in fund performance is largely due to luck and costs.

What are the implications of weak-form efficiency for investors?

Technical analysis cannot consistently generate abnormal profits.

What are the implications of semi-strong efficiency for investors?

Fundamental analysis cannot consistently generate abnormal profits.

What are the implications of strong-form efficiency for investors?

Even insider trading cannot generate consistent abnormal profits.

What is technical analysis?

The study of past stock prices and trading volume to identify future price patterns or trends

Why does EMH imply that technical analysis is useless?

Because all information from past prices is already reflected in current prices

What is fundamental analysis?

The study of a firm's financial data, management, and industry to estimate its intrinsic value and compare it to market price.

Why does EMH imply that most fundamental analysis fails?

Because public information is already reflected in stock prices, so only unique or superior insights can yield profits

What investment strategy does EMH support for most investors?

A passive investment strategy, such as buy-and-hold or index fund investing.

What is passive portfolio management?

Holding a diversified portfolio that mirrors a market index, without frequent trading or attempts to beat the market.

What is an index fund?

A fund designed to replicate the performance of a market index like the S&P 500.

What is an exchange-traded fund (ETF)?

A portfolio of securities that tracks an index and trades on an exchange like a stock

What is the magnitude effect

Small market inefficiencies are difficult to detect due to overall market volatility.

What is selection bias in EMH testing?

Only successful studies showing inefficiencies are reported, while failed attempts are not.

What is the lucky event issue?

Some investors may appear successful simply due to chance, not skill.

What is serial correlation testing?

Measuring whether past returns predict future returns; used to test weak-form efficiency.

What does positive short-term serial correlation suggest?

Momentum — that short-term returns are positively related

What does negative long-term serial correlation suggest?

The "fads hypothesis" — markets overreact short-term, then correct long-term.

What is the P/E effect?

Stocks with low price-to-earnings ratios tend to offer higher risk-adjusted returns.

What is the size effect?

Small-cap stocks have historically earned higher abnormal returns than large-cap stocks.

What is the neglected-firm effect?

Lesser-known or less-followed firms tend to earn higher returns

What is the book-to-market effect?

Firms with high book-to-market ratios (value stocks) tend to outperform those with low ratios (growth stocks).

What is post-earnings announcement drift?

The tendency for stock prices to continue moving in the direction of an earnings surprise for some time after the announcement.

What does research say about insider trading and EMH?

Following insider trades does not reliably yield profits after accounting for transaction costs.

What does evidence say about mutual fund managers' performance?

Most mutual fund managers do not consistently outperform the market, especially after fees.

What is the implication of EMH for small investors?

They are better off investing in low-cost index funds or ETFs rather than trying to beat the market.

Two types of market professionals:

a stock market analyst and a mutual fund manager

When market interest rates rise, bond prices:

Fall

Which of the following bonds has the greatest interest rate risk?

10-year bond

A bond with a coupon rate greater than its yield to maturity sells at a:

Premium

The yield spread between corporate bonds and Treasury bonds primarily reflects:

Default risk premium

The yield to maturity assumes that:

Coupons are reinvested at the YTM rate

Which of the following is true about a callable bond?

It benefits the issuer when rates fall

A bond rated below BBB by S&P is considered:

Speculative

The difference between the promised yield and the expected yield of a bond is primarily due to:

Default risk

A $1,000 par bond’s YTM is 6% and its coupon rate is 5%. How will its price change over time if YTM remains constant?

Rise overtime

A bond is priced at $1,200 with 7% coupon and YTM = 5%. What is its duration behavior relative to a 5-year 5% coupon bond?

Lower

Selling at a discount

Coupon rate < YTM

Selling at a Premium

Coupon Rate > YTM

Selling on Par

Coupon Rate = YTM