FIN 218:Chapter 6

1) According to the efficient market hypothesis, the current price of a financial security

A) is the discounted net present value of future interest payments.  

B) is determined by the highest successful bidder.

C) fully reflects all available relevant information.

D) is a result of none of the above.

Answer: C) fully reflects all available relevant information.

2) New information reveals that a stock's price will be $150 in one year.  If the stock pays no dividends, and the required return is 10%, what does the efficient market hypothesis indicate the price will be today?

A) $130.33

B) $136.36

C) $142.59

D) $145.00

Answer: B) $136.36

3) Another way to state the efficient market condition is that in an efficient market,

A) unexploited profit opportunities will be quickly eliminated.

B) unexploited profit opportunities will never exist.

C) arbitrageurs guarantee that unexploited profit opportunities never exist.

D) both A and C of the above occur.

Answer: A) unexploited profit opportunities will be quickly eliminated.

4) Jared recognized that a stock was underpriced since the firm’s expected cash flows were much higher than most investors realized and not fully reflected in the stock’s price. What is Jared doing if he buys the stock based on his expectations? 

A) Arbitrage

B) Pure arbitrage

C) Riskless investing

D) Speculating

Answer: D) Speculating

5) Pure arbitrage occurs when an investor

A) buys and holds an asset until it rises in price.

B) simultaneously buys and sells an asset with no risk.

C) sells an asset and earns a capital gain.

D) buys a stock and sells a bond on the same company.

Answer: B) simultaneously buys and sells an asset with no risk.

6) Arbitrageurs take advantage of

A) efficient markets.

B) other investors.

C) unexploited profit opportunities.

D) exploited profit opportunities.

Answer: C) unexploited profit opportunities.

7) A situation in which the price of an asset differs from its fundamental market value is called

A) an unexploited profit opportunity.

B) a bubble.

C) a correction.

D) a mean reversion.

Answer: B) a bubble.

8) Studies of mutual fund performance indicate that mutual funds that outperformed the market in one time period

A) usually beat the market in the next time period.

B) usually beat the market in the next two subsequent time periods.

C) usually beat the market in the next three subsequent time periods.

D) usually do not beat the market in the next time period.

Answer: D) usually do not beat the market in the next time period.

9) The efficient market hypothesis suggests that allocating your funds in the financial markets on the advice of a financial analyst

A) will certainly mean higher returns than if you had made selections by throwing darts at the financial page.

B) will always mean lower returns than if you had made selections by throwing darts at the financial page.

C) is not likely to prove superior to a strategy of making selections by throwing darts at the financial page.

D) is good for the economy.

Answer: C) is not likely to prove superior to a strategy of making selections by throwing darts at the financial page.

10) Raj Rajaratnam, a successful investor in the 2000s who consistently beat the market, was able to outperform the market on a consistent basis, indicating that

A) securities markets are not efficient.

B) unexploited profit opportunities were abundant.

C) investors can outperform the market with inside information.

D) only B and C of the above.

Answer: D) only B and C of the above.

11) To say that stock prices follow a "random walk" is to argue that

A) stock prices rise, then fall.

B) stock prices rise, then fall in a predictable fashion.

C) stock prices tend to follow trends.

D) stock prices are, for all practical purposes, unpredictable.

Answer: D) stock prices are, for all practical purposes, unpredictable.

12) Tests used to rate the performance of rules developed in technical analysis conclude that

A) technical analysis outperforms the overall market.

B) technical analysis far outperforms the overall market, suggesting that stockbrokers provide valuable services.

C) technical analysis does not outperform the overall market.

D) technical analysis does not outperform the overall market, suggesting that stockbrokers do not provide services of any value.

Answer: C) technical analysis does not outperform the overall market.

13) Which of the following types of information will most likely enable the exploitation of a profit opportunity?

A) Financial analysts' published recommendations

B) Technical analysis

C) Hot tips from a stockbroker

D) Insider information

Answer: D) Insider information

14 The advantage of a "buy and hold strategy" is that

A) net profits will tend to be higher because there will be fewer brokerage commissions.

B) losses will eventually be eliminated.

C) the longer a stock is held, the higher its price will be.

D) only B and C of the above are true.

Answer: A) net profits will tend to be higher because there will be fewer brokerage commissions.

15) The efficient market hypothesis suggests that

A) investors should not try to outguess the market by constantly buying and selling securities.

B) investors do better on average if they adopt a "buy and hold" strategy.

C) buying into a mutual fund is a sensible strategy for a small investor.

D) all of the above are sensible strategies.

E) only A and B of the above are sensible strategies.

Answer: D) all of the above are sensible strategies.

16) Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is

A) clearly inconsistent with the efficient market hypothesis.

B) consistent with the efficient market hypothesis if the earnings were not as high as anticipated.

C) consistent with the efficient market hypothesis if the earnings were not as low as anticipated.

D) the result of none of the above.

Answer: B) consistent with the efficient market hypothesis if the earnings were not as high as anticipated.

17) According to the January effect, stock prices

A) experience an abnormal price rise from December to January.

B) experience an abnormal price decline from December to January.

C) follow a random walk during January.

D) set the pattern for the entire year in January.

Answer: A) experience an abnormal price rise from December to January.

18) The small-firm effect refers to the observation that small firms' stocks

A) follow a random walk but large firms' stocks do not.

B) have earned abnormally low returns given their greater risk.

C) have earned abnormally high returns even taking into account their greater risk.

D) sell for lower prices than large firms' stocks.

Answer: C) have earned abnormally high returns even taking into account their greater risk.

19) Some investors use past stock price data in an attempt to identify price trends and cycles they can use to develop trading rules. What technique are they using?

A) Random walk

B) Technical analysis

C) Fundamental analysis

D) Buy-and-hold

Answer: B) Technical analysis

20) When a market bubble occurs,

A) prices of assets rise well above their fundamental values.

B) a "thin layer" of trading masks true market movements.

C) market fundamentals and actual security prices converge.

D) prices of assets fluctuate rapidly above and below market fundamentals.

Answer: A) prices of assets rise well above their fundamental values.