TBChap 011

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.
A. semistrong
B. strong
C. weak
D. All of the options
E. None of the options
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 _________.
A. inefficient; the effect of a well-functioning market
B. efficient; the effect of an inefficient market
C. inefficient; the effect of an inefficient market
D. efficient; the effect of a well-functioning market
E. irrational; even more irrational than before
11-1
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
3. The stock market follows a
A. nonrandom walk.
B. submartingale.
C. predictable pattern that can be exploited.
D. nonrandom walk and predictable pattern that can be exploited.
E. submartingale and predictable pattern that can be exploited.
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.
C. selects some actively managed mutual funds on their own and uses an investment advisor to
select other actively managed funds.
D. maintains a passive core and augments the position with an actively managed portfolio.
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
B. positive; positive
C. positive; negative
D. zero; positive
E. zero; zero
11-2
6. Proponents of the EMH typically advocate
A. an active trading strategy.
B. investing in an index fund.
C. a passive investment strategy.
D. an active trading strategy and investing in an index fund.
E. investing in an index fund and a passive investment strategy.
A. buying individual stocks on margin and trading frequently.
B. investing in hedge funds.
D. buying individual stocks on margin and trading frequently and investing in hedge funds.
E. investing in hedge funds and a passive investment strategy.
8. If you believe in the _______ form of the EMH, you believe that stock prices only 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
C. weak
11-3
9. 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
B. strong
C. weak
10. If you believe in the reversal effect, you should
A. buy bonds in this period if you held stocks in the last period.
B. buy stocks in this period if you held bonds in the last period.
C. buy stocks this period that performed poorly last period.
D. go short.
E. buy stocks this period that performed poorly last period and go short.
11. __________ focus more on past price movements of a firm's stock than on the underlying
determinants of future profitability.
A. Credit analysts
B. Fundamental analysts
C. Systems analysts
D. Technical analysts
11-4
12. _________ above which it is difficult for the market to rise.
A. A book value is a value
B. A resistance level is a value
C. A support level is a value
D. A book value and a resistance level are values
E. A book value and a support level are values
13. _________ below which it is difficult for the market to fall.
A. An intrinsic value is a value
D. An intrinsic value and a resistance level are values
E. A resistance level and a support level are values
14. ___________ the return on a stock beyond what would be predicted from market movements alone.
A. An irrational return is
B. An economic return is
C. An abnormal return is
D. None of the options
E. All of the options
11-5
15. The debate over whether markets are efficient will probably never be resolved because of
A. the lucky event issue.
B. the magnitude issue.
C. the selection bias issue.
16. A common strategy for passive management is
A. creating an index fund.
B. creating a small firm fund.
C. creating an investment club.
D. creating an index fund and creating an investment club.
E. creating a small firm fund and creating an investment club.
17. Arbel (1985) found that
A. theJanuary effect was highest for neglected firms.
B. the book-to-market value ratio effect was highest in January.
C. the liquidity effect was highest for small firms.
D. the neglected firm effect was independent of the small firm effect.
E. small firms had higher book-to-market value ratios.
11-6
18. Researchers have found that most of the small firm effect occurs
A. during the spring months.
B. during the summer months.
C. in December.
D. in January.
E. randomly.
19. Basu (1977, 1983) found that firms with low P/E ratios
A. earned higher average returns than firms with high P/E ratios.
B. earned the same average returns as firms with high P/E ratios.
C. earned lower average returns than firms with high P/E ratios.
D. had higher dividend yields than firms with high P/E ratios.
20. Basu (1977, 1983) found that firms with high P/E ratios
A. earned higher average returns than firms with low P/E ratios.
B. earned the same average returns as firms with low P/E ratios.
C. earned lower average returns than firms with low P/E ratios.
D. had higher dividend yields than firms with low P/E ratios.
11-7
21. Jaffe (1974) found that stock prices _________ after insiders intensively bought shares.
A. decreased
B. did not change
C. increased
D. became extremely volatile
E. became much less volatile
22. Jaffe (1974) found that stock prices _________ after insiders intensively sold shares.
A. decreased
B. did not change
C. increased
D. became extremely volatile
E. became much less volatile
23. Banz (1981) found that, on average, the risk-adjusted returns of small firms
A. were higher than the risk-adjusted returns of large firms.
B. were the same as the risk-adjusted returns of large firms.
C. were lower than the risk-adjusted returns of large firms.
D. were unrelated to the risk-adjusted returns of large firms.
E. were negative.
11-8
24. Banz (1981) found that, on average, the risk-adjusted returns of large firms
A. were higher than the risk-adjusted returns of small firms.
B. were the same as the risk-adjusted returns of small firms.
C. were lower than the risk-adjusted returns of small firms.
D. were unrelated to the risk-adjusted returns of small firms.
E. were negative.
25. Proponents of the EMH think technical analysts
A. should focus on relative strength.
B. should focus on resistance levels.
C. should focus on support levels.
D. should focus on financial statements.
E. are wasting their time.
26. 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 announcement.
C. a negative drift in the stock price on the days following the earnings surprise announcement.
D. a positive abnormal return on the day positive earnings surprises are announced and a positive
drift in the stock price on the days following the earnings surprise announcement.
E. a positive abnormal return on the day positive earnings surprises are announced and a negative
drift in the stock price on the days following the earnings surprise announcement.
11-9
27. Studies of negative earnings surprises have shown that there is
A. a negative abnormal return on the day that negative earnings surprises are announced.
C. a negative drift in the stock price on the days following the earnings surprise announcement.
D. 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.
E. 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.
28. Studies of stock price reactions to news are called
A. reaction studies.
B. event studies.
C. drift studies.
D. reaction studies and event studies.
E. event studies and drift studies.
11-10
29. On November 22, 2012, the stock price of WalMart was $69.50 and the retailer stock index was
600.30. On November 25, 2012, the stock price of WalMart was $70.25 and the retailer stock index
was 605.20. Consider the ratio of WalMart to the retailer index on November 22 and November
25. WalMartis _______ the retail industry, and technical analysts who follow relative strength would
advise _______ the stock.
A. outperforming, buying
B. outperforming, selling
C. underperforming, buying
D. underperforming, selling
E. equally performing, neither buying nor selling
30. 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.
C. may be related to the neglected firm effect.
D. may help explain the small firm effect and may be related to the neglected firm effect.
11-11
31. Fama and French (1992) found that the stocks of firms within the highest decile of book-to-market
ratios had average monthly returns of _______, while the stocks of firms within the lowest decile of
book-to-market ratios had average monthly returns of ________.
A. greater than 1%; greater than 1%
B. greater than 1%; less than 1%
C. less than 1%; greater than 1%
D. less than 1%; less than 1%
E. less than 0.5%; greater than 0.5%
32. 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
C. would not be; it was a clear response to macroeconomic news
D. would not be; it was not a clear response to macroeconomic news
33. In an efficient market,
A. security prices react quickly to new information.
B. security prices are seldom far above or below their justified levels.
C. security analysis will not enable investors to realize superior returns consistently.
D. one cannot make money.
E. security prices react quickly to new information, security prices are seldom far above or below
their justified levels, and security analysis will not enable investors to realize superior returns
consistently.
11-12
34. 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.
C. technicians cannot expect to outperform the market.
D. stock prices do not rapidly adjust to new information contained in past prices or past data and
future changes in stock prices cannot be predicted from past prices.
E. future changes in stock prices cannot be predicted from past prices and technicians cannot
expect to outperform the market.
35. 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.
C. demand for a stock to increase substantially.
D. demand for a stock to decrease substantially.
E. price of a stock to fall.
11-13
36. 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
C. one can consistently outperform the market by adopting the contrarian approach exemplified
by the reversals phenomenon
D. low P/E stocks tend to have positive abnormal returns and trend analysis is worthless in
determining stock prices
E. low P/E stocks tend to have positive abnormal returns and one can consistently outperform the
market by adopting the contrarian approach exemplified by the reversals phenomenon
37. The weak form of the efficient market hypothesis contradicts
A. technical analysis, but supports fundamental analysis as valid.
B. fundamental analysis, but supports technical analysis as valid.
C. both fundamental analysis and technical analysis.
D. technical analysis, but is silent on the possibility of successful fundamental analysis.
38. 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.
B. rapidly to new information and liquidity is provided by security dealers.
C. gradually to new information and market prices are determined by the interaction of supply and
demand.
D. gradually to new information and liquidity is provided by security dealers.
E. rapidly to information and to the actions of insiders.
11-14
39. Cumulative abnormal returns (CAR)
A. are used in event studies.
B. are better measures of security returns due to firm-specific events than are abnormal returns
(AR).
C. are cumulated over the period prior to the firm-specific event.
D. are used in event studies and are better measures of security returns due to firm-specific events
than are abnormal returns (AR).
E. are used in event studies and are cumulated over the period prior to the firm-specific event.
40. Studies of mutual fund performance
A. indicate that one should not randomly select a mutual fund.
B. indicate that historical performance is not necessarily indicative of future performance.
C. indicate that the professional management of the fund insures above market returns.
D. indicate that one should not randomly select a mutual fund and indicate that historical
performance is not necessarily indicative of future performance.
E. indicate that historical performance is not necessarily indicative of future performance and
indicate that the professional management of the fund insures above market returns.
41. 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%.
B. between 25% and 50%.
C. between 10% and 25%.
D. less than 10%.
E. greater than 70%.
11-15
42. In an efficient market the correlation coefficient between stock returns for two nonoverlapping
time periods should be
A. positive and large.
B. positive and small.
C. zero.
D. negative and small.
E. negative and large.
43. 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
A. drop immediately.
B. remain unchanged.
C. increase immediately.
D. gradually decline for the next several weeks.
E. gradually increase for the next several weeks.
44. 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
A. bad news about Matthews was announced yesterday.
B. good news about Matthews was announced yesterday.
C. no news about Matthews was announced yesterday.
D. interest rates rose yesterday.
E. interest rates fell yesterday.
11-16
45. 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
A. the market is not efficient.
B. Nicholas' stock will probably rise in value tomorrow.
C. investors expected the earnings increase to be larger than what was actually announced.
D. investors expected the earnings increase to be smaller than what was actually announced.
E. earnings are expected to decrease next quarter.
46. When Maurice Kendall first examined stock price patterns in 1953, he found that
A. certain patterns tended to repeat within the business cycle.
B. there were no predictable patterns in stock prices.
C. stocks whose prices had increased consistently for one week tended to have a net decrease the
following week.
D. stocks whose prices had increased consistently for one week tended to have a net increase the
following week.
E. the direction of change in stock prices was unpredictable, but the amount of change followed a
distinct pattern.
47. If stock prices follow a random walk
A. it implies that investors are irrational.
B. it means that the market cannot be efficient.
C. price levels are not random.
D. price changes are random.
E. price movements are predictable.
11-17
48. The main difference between the three forms of market efficiency is that
A. the definition of efficiency differs.
B. the definition of excess return differs.
C. thedefinition of prices differs.
D. the definition of information differs.
E. they were discovered by different people.
49. Chartists practice
A. technical analysis.
B. fundamental analysis.
C. regression analysis.
D. insideranalysis.
E. psychoanalysis.
50. 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
A. I, IV, and V
B. I, II, and III
C. II, III, and IV
D. II, IV, and V
E. All of the items are used by fundamental analysts.
11-18
51. Which of the following are used by technical analysts to determine proper stock prices?
I) Trendlines
II) Earnings
A. I and V
B. I, II, and III
C. II, III, and IV
D. II, IV, and V
52. According to proponents of the efficient market hypothesis, the best strategy for a small investor
with a portfolio worth $40,000 is probably to
A. perform fundamental analysis.
B. exploit market anomalies.
C. invest in Treasury securities.
D. invest in derivative securities.
E. invest in mutual funds.
11-19
53. Which of the following are investment superstars who have consistently shown superior
performance?
I) Warren Buffet
II) Phoebe Buffet
III) Peter Lynch
IV) Merrill Lynch
V) Jimmy Buffet
A. I, III, and IV
B. II, III, and IV
C. I and III
D. III and IV
E. I, III, IV, and V
54. Google has a beta of 1.0. The annualized market return yesterday was 11%, and the risk-free rate is
currently 5%. You observe that Google had an annualized return yesterday of 14%. Assuming that
markets are efficient, this suggests that
A. bad news about Google was announced yesterday.
B. good news about Google was announced yesterday.
C. no news about Google was announced yesterday.
11-20
55. 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
A. bad news about Music Doctors was announced yesterday.
B. good news about Music Doctors was announced yesterday.
C. no news about Music Doctors was announced yesterday.
D. interestrates rose yesterday.
56. QQAG has a beta of 1.7. The annualized market return yesterday was 13%, and the risk-free rate is
currently 3%. You observe that QQAG had an annualized return yesterday of 20%. Assuming that
markets are efficient, this suggests that
A. bad news about QQAG was announced yesterday.
B. good news about QQAG was announced yesterday.
C. no significant news about QQAG was announced yesterday.
11-21
57. QQAG just announced yesterday that its fourth quarter earnings will be 35% higher than last year's
fourth quarter. You observe that QQAG had an abnormal return of -1.7% yesterday. This suggests
that
B. QQAG stock will probably rise in value tomorrow.
58. LJP Corporation just announced yesterday that it would undertake an international joint venture.
You observe that LJP had an abnormal return of 3% yesterday. This suggests that
B. LJP stock will probably rise in value again tomorrow.
C. investors view the international joint venture as bad news.
D. investors view the international joint venture as good news.
59. 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
A. themarket is not efficient.
B. Music Doctors stock will probably rise in value tomorrow.
C. investors expected the sales increase to be larger than what was actually announced.
D. investors expected the sales increase to be smaller than what was actually announced.
11-22
60. The Food and Drug Administration (FDA) just announced yesterday that they would approve a
new cancer-fighting drug from King. You observe that King had an abnormal return of 0%
yesterday. This suggests that
B. King stock will probably rise in value tomorrow.
C. King stock will probably fall in value tomorrow.
D. the approval was already anticipated by the market.
61. 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
A. regret avoidance.
B. selection bias.
C. framing.
D. insider trading.
62. 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
B. selection bias.
C. overconfidence.
D. the lucky event issue.
11-23
63. Sehun (1986) finds that the practice of monitoring insider trade disclosures, and trading on that
information, would be
A. extremely profitable for long-term traders.
B. extremely profitable for short-term traders.
C. marginally profitable for long-term traders.
D. marginally profitable for short-term traders.
E. not sufficiently profitable to cover trading costs.
A. sellbonds in this period if you held stocks in the last period.
B. sell stocks in this period if you held bonds in the last period.
C. sell stocks this period that performed well last period.
D. go long.
E. sell stocks this period that performed well last period and go long.
65. Patell and Woflson (1984) report that most of the stock price response to corporate dividend or
earnings announcements occurs within ____________ of the announcement.
A. 10 minutes
B. 45 minutes
C. 2 hours
D. 4 hours
E. 2 trading days
11-24
66. Del Guerico and Reuter (2013) report that the average underperformance of actively managed
mutual funds is driven largely by
A. sector mutual funds.
B. index funds.
C. direct sold funds.
D. brokersold funds.
E. bank sold mutual funds.
Short Answer Questions
67. Discuss the various forms of market efficiency. Include in your discussion the information sets
involved in each form and the relationships across information sets and across forms of market
efficiency. Also discuss the implications for the various forms of market efficiency for the various
types of securities' analysts.
11-25
68. What is an event study? It is a test of what form of market efficiency? Discuss the process of
conducting an event study, including the best variable(s) to observe as tests of market efficiency.
69. Discuss the small firm effect, the neglected firm effect, and the January effect, the tax effect and
how the four effects may be related.
70. Why might the degree of market efficiency differ across various markets? State three reasons why
this might occur, and explain each reason briefly.
11-26
71. With regard to market efficiency, what is meant by the term "anomaly"? Give three examples of
market anomalies and explain why each is considered to be an anomaly.
11-27
Chapter 11 The Efficient Market Hypothesis Answer Key
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.
A. semistrong
B. strong
C. weak
The semistrong form of the EMH maintains that stock prices immediately reflect all historical
and current public information, but not inside information.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
Topic: Efficient Market Hypothesis
11-28
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 _________.
A. inefficient; the effect of a well-functioning market
B. efficient; the effect of an inefficient market
C. inefficient; the effect of an inefficient market
D. efficient; the effect of a well-functioning market
E. 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.
AACSB: Analytic
Blooms: Understand
Difficulty: Basic
3. The stock market follows a
A. nonrandom walk.
B. submartingale.
C. predictable pattern that can be exploited.
D. nonrandom walk and predictable pattern that can be exploited.
E. submartingale and predictable pattern that can be exploited.
The stock market follows a submartingale.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
11-29
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.
C. selects some actively managed mutual funds on their own and uses an investment advisor
to select other actively managed funds.
D. maintains a passive core and augments the position with an actively managed portfolio.
A hybrid strategy is one where the investor maintains a passive core and augments the position
with an actively managed portfolio.
AACSB: Analytic
Blooms: Understand
Difficulty: Basic
Topic: Implications of the EMH
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
B. positive; positive
C. positive; negative
D. zero; positive
E. zero; zero
A random walk has an expected price change of zero, and a submartingale has a positive
expected price change.
AACSB: Analytic
Blooms: Understand
11-30
Difficulty: Basic
A. an active trading strategy.
B. investing in an index fund.
D. an active trading strategy and investing in an index fund.
E. investing in an index fund and a passive investment strategy.
Believers of market efficiency advocate passive investment strategies, and an investment in an
index fund is one of the most practical passive investment strategies, especially for small
investors.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
11-31
A. buying individual stocks on margin and trading frequently.
B. investing in hedge funds.
C. apassive investment strategy.
D. buying individual stocks on margin and trading frequently and investing in hedge funds.
E. investing in hedge funds and a passive investment strategy.
Believers of market efficiency advocate passive investment strategies, and an investment in an

index fund is one of the most practical passive investment strategies, especially for small
investors.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
11-32
8. If you believe in the _______ form of the EMH, you believe that stock prices only 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
C. weak
The information described above is market data, which is the data set for the weak form of
market efficiency. The semistrong form includes the above plus all other public information. The
strong form includes all public and private information.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
9. 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
B. strong
C. weak
The strong form includes all public and private information.
AACSB: Analytic
11-33
Blooms: Remember
Difficulty: Basic
A. buy bonds in this period if you held stocks in the last period.
B. buy stocks in this period if you held bonds in the last period.
C. buy stocks this period that performed poorly last period.
D. go short.
E. buy stocks this period that performed poorly last period and go short.
The reversal effect states that stocks that do well in one period tend to perform poorly in the
subsequent period, and vice versa.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
11. __________ focus more on past price movements of a firm's stock than on the underlying
determinants of future profitability.
A. Credit analysts
B. Fundamental analysts
C. Systems analysts
D. Technical analysts
Technicians attempt to predict future stock prices based on historical stock prices.
AACSB: Analytic
Blooms: Remember
11-34
Difficulty: Basic
12. _________ above which it is difficult for the market to rise.
A. A book value is a value
D. A book value and a resistance level are values
E. A book value and a support level are values
When stock prices have remained stable for a long period, these prices are termed resistance
levels; technicians believe it is difficult for the stock prices to penetrate these resistance levels.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
13. _________ below which it is difficult for the market to fall.
A. An intrinsic value is a value
D. An intrinsic value and a resistance level are values
E. 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.
AACSB: Analytic
11-35
Blooms: Remember
Difficulty: Basic
14. ___________ the return on a stock beyond what would be predicted from market movements
alone.
A. An irrational return is
B. An economic return is
C. An abnormal return is
D. None of the options
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.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
Topic: Event Studies
11-36
15. The debate over whether markets are efficient will probably never be resolved because of
A. the lucky event issue.
B. The magnitude issue.
C. the selection bias issue.
All of the options make rigid testing of market efficiency difficult or impossible.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
Topic: Efficient Markets
16. A common strategy for passive management is
A. creating an index fund.
B. creating a small firm fund.
C. creating an investment club.
D. creating an index fund and creating an investment club.
E. 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.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
11-37
17. Arbel (1985) found that
A. the January effect was highest for neglected firms.
B. the book-to-market value ratio effect was highest in January.
C. the liquidity effect was highest for small firms.
D. the neglected firm effect was independent of the small firm effect.
E. small firms had higher book-to-market value ratios.
Arbel divided firms into highly researched, moderately researched, and neglected groups based
on the number of institutions holding the stock.
AACSB: Analytic
Blooms: Remember
Difficulty: Intermediate
11-38
18. Researchers have found that most of the small firm effect occurs
A. during the spring months.
B. during the summer months.
C. in December.
D. in January.
E. randomly.
Much of the so-called small firm effect simply may be the tax effect as investors sell stocks on
which they have losses in December and reinvest the funds in January. As small firms are
especially volatile, these actions affect small firms in a more dramatic fashion.
25. Proponents of the EMH think technical analysts
A. should focus on relative strength.
B. should focus on resistance levels.
C. should focus on support levels.
D. should focus on financial statements.
E. are wasting their time.
Technical analysts attempt to predict future stock prices from historic stock prices; proponents
of EMH believe that stock price changes are random variables.
AACSB: Analytic
Blooms: Remember
11-39
26. Studies of positive earnings surprises have shown that there is
A. a positive abnormal return on the day positive earnings surprises are announced.
B. apositive drift in the stock price on the days following the earnings surprise announcement.
C. a negative drift in the stock price on the days following the earnings surprise
announcement.
D. a positive abnormal return on the day positive earnings surprises are announced and a
positive drift in the stock price on the days following the earnings surprise announcement.
E. a positive abnormal return on the day positive earnings surprises are announced and a
negative 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.
AACSB: Analytic
Blooms: Understand
11-40
27. Studies of negative earnings surprises have shown that there is
A. a negative abnormal return on the day that negative earnings surprises are announced.
C. a negative drift in the stock price on the days following the earnings surprise
announcement.
D. 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.
E. 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.
The market appears to adjust to earnings information gradually, resulting in a sustained period
of abnormal returns.
AACSB: Analytic
Blooms: Understand
28. Studies of stock price reactions to news are called
A. reaction studies.
B. event studies.
C. drift studies.
D. reaction studies and event studies.
E. event studies and drift studies.
Studies of stock price reactions to news are called event studies.
AACSB: Analytic
11-41
Blooms: Understand
29. On November 22, 2012, the stock price of WalMart was $69.50 and the retailer stock index was
600.30. On November 25, 2012, the stock price of WalMart was $70.25 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.
A. outperforming, buying
B. outperforming, selling
C. underperforming, buying
D. underperforming, selling
E. equally performing, neither buying nor selling
11/22: $69.50/600.30 = 0.1158; 11/25: $70.25/605.20 = 0.1161; Thus, WalMart's relative strength is
improving, and technicians using this technique would recommend buying.
AACSB: Analytic
Blooms: Understand
AACSB: Analytic
Blooms: Understand
11-42
\
32. 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
C. would not be; it was a clear response to macroeconomic news
D. would not be; it was not a clear response to macroeconomic news
This happened on October 19, 1987. Although this specific event is not mentioned in this edition
of the book, it is an example of something that would be considered a violation of the EMH.
AACSB: Analytic
Blooms: Understand
11-43
33. In an efficient market,
A. security prices react quickly to new information.
B. securityprices are seldom far above or below their justified levels.
C. security analysis will not enable investors to realize superior returns consistently.
D. one cannot make money.
E. security prices react quickly to new information, security prices are seldom far above or
below their justified levels, and security analysis will not enable investors to realize superior
returns consistently.
Security prices react quickly to new information, security prices are seldom far above or below
their justified levels, and security analysis will not enable investors to realize superior returns
consistently; however, even in an efficient market one should be able to earn the appropriate
risk-adjusted rate of return.
AACSB: Analytic
Blooms: Understand
Difficulty: Basic
11-44
34. 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.
C. technicians cannot expect to outperform the market.
D. stock prices do not rapidly adjust to new information contained in past prices or past data
and future changes in stock prices cannot be predicted from past prices.
E. future changes in stock prices cannot be predicted from past prices and technicians cannot
expect to outperform the market.
The weak form of the efficient market hypothesis asserts that future changes in stock prices
cannot be predicted from past prices; therefore, technicians cannot expect to outperform the
market.
AACSB: Analytic
Blooms: Understand
Difficulty: Basic
35. 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.
C. demand for a stock to increase substantially.
D. demand for a stock to decrease substantially.
E. price of a stock to fall.
A support level is considered to be a level below that the price of the stock is unlikely to fall and
is believed to be determined by market psychology.
AACSB: Analytic
11-45
Blooms: Remember
Difficulty: Basic
36. 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
C. one can consistently outperform the market by adopting the contrarian approach
exemplified by the reversals phenomenon
D. low P/E stocks tend to have positive abnormal returns and trend analysis is worthless in
determining stock prices
E. low P/E stocks tend to have positive abnormal returns and one can consistently outperform
the market by adopting the contrarian approach exemplified by the reversals phenomenon
Both low P/E stocks tend to have positive abnormal returns and one can consistently
outperform the market by adopting the contrarian approach exemplified by the reversals
phenomenon are inconsistent with the semistrong form of the EMH.
AACSB: Analytic
Blooms: Understand
11-46
37. The weak form of the efficient market hypothesis contradicts
A. technical analysis, but supports fundamental analysis as valid.
B. fundamental analysis, but supports technical analysis as valid.
C. both fundamental analysis and technical analysis.
D. technical analysis, but is silent on the possibility of successful fundamental analysis.
The weak form of the efficient market hypothesis contradicts technical analysis, but is silent on
the possibility of successful fundamental analysis.
AACSB: Analytic
Blooms: Understand
38. 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.
B. rapidly to new information and liquidity is provided by security dealers.
C. gradually to new information and market prices are determined by the interaction of supply
and demand.
D. gradually to new information and liquidity is provided by security dealers.
E. rapidly to information and to the actions of insiders.
Technicians follow market data such as price changes and volume of trading (as indicator of
supply and demand) believing that they can identify price trends as security prices adjust
gradually.
AACSB: Analytic
Blooms: Understand
11-47
39. Cumulative abnormal returns (CAR)
A. are used in event studies.
B. are better measures of security returns due to firm-specific events than are abnormal
returns (AR).
C. are cumulated over the period prior to the firm-specific event.
D. are used in event studies and are better measures of security returns due to firm-specific
events than are abnormal returns (AR).
E. 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.
AACSB: Analytic
Blooms: Remember
11-48
40. Studies of mutual fund performance
A. indicate that one should not randomly select a mutual fund.
B. indicatethat historical performance is not necessarily indicative of future performance.
C. indicate that the professional management of the fund insures above market returns.
D. indicate that one should not randomly select a mutual fund and indicate that historical
performance is not necessarily indicative of future performance.
E. indicate that historical performance is not necessarily indicative of future performance 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.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
Topic: Mutual Fund/Analyst Performance
41. 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%.
B. between 25% and 50%.
C. between 10% and 25%.
D. less than 10%.
E. greater than 70%.
The probability of successful prediction for three consecutive years is 12.5%.
AACSB: Analytic
Blooms: Understand
11-49
42. In an efficient market the correlation coefficient between stock returns for two nonoverlapping
time periods should be
A. positive and large.
B. positive and small.
C. zero.
D. negative and small.
E. negative and large.
In an efficient market there should be no serial correlation between returns from

nonoverlapping periods.
AACSB: Analytic
Blooms: Understand
11-50
43. 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
A. drop immediately.
B. remain unchanged.
C. increase immediately.
D. gradually decline for the next several weeks.
E. 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.
AACSB: Analytic
Blooms: Apply
11-51
44. 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
A. bad news about Matthews was announced yesterday.
B. good news about Matthews was announced yesterday.
C. no news about Matthews was announced yesterday.
AR = 17% - (5% + 1.2 (8%)) = +2.4%. A positive abnormal return suggests that there was firm-
specific good news.
AACSB: Analytic
Blooms: Apply
11-52
45. 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
B. Nicholas' stock will probably rise in value tomorrow.
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.
AACSB: Analytic
Blooms: Apply
11-53
46. When Maurice Kendall first examined stock price patterns in 1953, he found that
A. certain patterns tended to repeat within the business cycle.
B. there were no predictable patterns in stock prices.
C. stocks whose prices had increased consistently for one week tended to have a net decrease
the following week.
D. stocks whose prices had increased consistently for one week tended to have a net increase
the following week.
E. thedirection 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.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
47. If stock prices follow a random walk
A. it implies that investors are irrational.
B. it means that the market cannot be efficient.
C. price levels are not random.
D. price changes are random.
E. price movements are predictable.
A random walk means that the changes in prices are random and independent.
AACSB: Analytic
Blooms: Remember
11-54
Difficulty: Basic
48. The main difference between the three forms of market efficiency is that
A. the definition of efficiency differs.
B. the definition of excess return differs.
C. the definition of prices differs.
D. the definition of information differs.
E. 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.
AACSB: Analytic
Blooms: Apply
11-55
49. Chartists practice
A. technical analysis.
B. fundamental analysis.
C. regression analysis.
D. insider analysis.
E. psychoanalysis.
Chartist is another name for a technical analyst.
AACSB: Analytic
Blooms: Understand
Difficulty: Basic
11-56
50. Which of the following are used by fundamental analysts to determine proper stock prices?
I) Trendlines
II) Earnings
A. I, IV, and V
B. I, II, and III
C. II, III, and IV
D. II, IV, and V
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.
AACSB: Analytic
Blooms: Understand
11-57
51. Which of the following are used by technical analysts to determine proper stock prices?
I) Trendlines
II) Earnings
A. I and V
B. I, II, and III
C. II, III, and IV
D. II, IV, and V
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.
AACSB: Analytic
Blooms: Understand
11-58
52. According to proponents of the efficient market hypothesis, the best strategy for a small
investor with a portfolio worth $40,000 is probably to
A. perform fundamental analysis.
B. exploit market anomalies.
C. invest in Treasury securities.
D. invest in derivative securities.
E. invest in mutual 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.
AACSB: Analytic
Blooms: Apply
11-59
53. Which of the following are investment superstars who have consistently shown superior
performance?
I) Warren Buffet
II) Phoebe Buffet
III) Peter Lynch
IV) Merrill Lynch

V) Jimmy Buffet
A. I, III, and IV
B. II, III, and IV
C. I and III
D. III and IV
E. I, III, IV, and V
Warren Buffet manages Berkshire Hathaway and Peter Lynch managed Fidelity's Magellan
Fund. Phoebe Buffet is a character on NBC's "Friends" and Jimmy Buffet is "Wasting Away in
Margaritaville." Merrill Lynch isn't a person.
AACSB: Analytic
Blooms: Remember
11-60
54. Google has a beta of 1.0. The annualized market return yesterday was 11%, and the risk-free
rate is currently 5%. You observe that Google had an annualized return yesterday of 14%.
Assuming that markets are efficient, this suggests that
A. bad news about Google was announced yesterday.
B. good news about Google was announced yesterday.
C. no news about Google was announced yesterday.
AR = 14% - (5% + 1.0 (6%)) = +3.0%. A positive abnormal return suggests that there was firm-
specific good news.
AACSB: Analytic
Blooms: Apply
11-61
55. 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
A. bad news about Music Doctors was announced yesterday.
B. good news about Music Doctors was announced yesterday.
C. no news about Music Doctors was announced yesterday.
AR = 15% - (4% + 2.25 (8%)) = -7.0%. A negative abnormal return suggests that there was firm-
specific bad news.
AACSB: Analytic
Blooms: Apply
11-62
56. QQAG has a beta of 1.7. The annualized market return yesterday was 13%, and the risk-free rate
is currently 3%. You observe that QQAG had an annualized return yesterday of 20%. Assuming
that markets are efficient, this suggests that
A. bad news about QQAG was announced yesterday.
B. good news about QQAG was announced yesterday.
C. no significant news about QQAG was announced 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.
AACSB: Analytic
Blooms: Apply
11-63
57. QQAG just announced yesterday that its fourth quarter earnings will be 35% higher than last
year's fourth quarter. You observe that QQAG had an abnormal return of -1.7% yesterday. This
suggests that
B. QQAG stock will probably rise in value tomorrow.
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.
AACSB: Analytic
Blooms: Apply
11-64
58. LJP Corporation just announced yesterday that it would undertake an international joint
venture. You observe that LJP had an abnormal return of 3% yesterday. This suggests that
B. LJP stock will probably rise in value again tomorrow.
C. investors view the international joint venture as bad news.
D. investors view the international joint venture as good news.
The positive abnormal return suggests that investors view the international joint venture as
good news.
AACSB: Analytic
Blooms: Apply
59. 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
B. Music Doctors stock will probably rise in value tomorrow.
C. investors expected the sales increase to be larger than what was actually announced.
D. investors expected the sales increase to be smaller than what was actually announced.
The negative abnormal return suggests that investors expected the sales increase to be larger
than what was actually announced.
AACSB: Analytic
11-65
Blooms: Apply
60. The Food and Drug Administration (FDA) just announced yesterday that they would approve a
new cancer-fighting drug from King. You observe that King had an abnormal return of 0%
yesterday. This suggests that
A. themarket is not efficient.
B. King stock will probably rise in value tomorrow.
C. King stock will probably fall in value tomorrow.
D. the approval was already anticipated by the market.
The approval was already anticipated by the market.
AACSB: Analytic
Blooms: Apply
61. 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
B. selection bias.
C. framing.
D. insider trading.
This is an example of selection bias.
AACSB: Analytic
Blooms: Apply
11-66
62. 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
B. selection bias.
C. overconfidence.
D. the lucky event issue.
This is an example of the lucky event issue.
AACSB: Analytic
Blooms: Apply
63. Sehun (1986) finds that the practice of monitoring insider trade disclosures, and trading on that
information, would be
A. extremely profitable for long-term traders.
B. extremely profitable for short-term traders.
C. marginally profitable for long-term traders.
D. marginally profitable for short-term traders.
E. 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.
AACSB: Analytic
11-67
Blooms: Apply
A. sell bonds in this period if you held stocks in the last period.
B. sell stocks in this period if you held bonds in the last period.
C. sell stocks this period that performed well last period.
D. go long.
E. 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.
AACSB: Analytic
Blooms: Apply
Difficulty: Basic
11-68
65. Patell and Woflson (1984) report that most of the stock price response to corporate dividend or
earnings announcements occurs within ____________ of the announcement.
A. 10 minutes
B. 45 minutes
C. 2 hours
D. 4 hours
E. 2 trading days
The correct answer is 10 minutes.
AACSB: Analytic
Blooms: Remember
66. Del Guerico and Reuter (2013) report that the average underperformance of actively managed
mutual funds is driven largely by
A. sector mutual funds.
B. index funds.
C. direct sold funds.
D. broker sold funds.
E. bank sold mutual funds.
AACSB: Analytic
Blooms: Remember
Topic: Mutual Fund and Analyst Performance
11-69
Short Answer Questions
11-70
67. Discuss the various forms of market efficiency. Include in your discussion the information sets
involved in each form and the relationships across information sets and across forms of market
efficiency. Also discuss the implications for the various forms of market efficiency for the various
types of securities' analysts.
The weak form of the efficient markets hypothesis (EMH) states that stock prices immediately
reflect market data. Market data refers to stock prices and trading volume. Technicians attempt
to predict future stock prices based on historic stock price movements. Thus, if the weak form
of the EMH holds, the work of the technician is of no value.
The semistrong form of the EMH states that stock prices include all public information. This
public information includes market data and all other publicly available information, such as
financial statements, and all information reported in the press relevant to the firm. Thus, market
information is a subset of all public information. As a result, if the semistrong form of the EMH
holds, the weak form must hold also. If the semistrong form holds, then the fundamentalist,
who attempts to identify undervalued securities by analyzing public information, is unlikely to
do so consistently over time. In fact, the work of the fundamentalist may make the markets
even more efficient!
The strong form of the EMH states that all information (public and private) is immediately
reflected in stock prices. Public information is a subset of all information; thus if the strong form
of the EMH holds, the semistrong form must hold also. The strong form of EMH states that
even with inside (legal or illegal) information, one cannot expect to outperform the market
consistently over time.

Studies have shown the weak form to hold when transactions costs are considered. Studies
have shown the semistrong form to hold in general, although some anomalies have been
observed. Studies have shown that some insiders (specialists, major shareholders, major
corporate officers) do outperform the market.
Feedback: The purpose of this question is to assure that the student understands the
interrelationships across different forms of the EMH, across the information sets, and the
implications of each form for different types of analysts.
11-71
AACSB: Reflective Thinking
Blooms: Analyze
68. What is an event study? It is a test of what form of market efficiency? Discuss the process of
conducting an event study, including the best variable(s) to observe as tests of market
efficiency.
A event study is an empirical test which allows the researcher to assess the impact of a
particular event on a firm's stock price. To do so, one often uses the index model and estimates
et, the residual term which measures the firm-specific component of the stock's return. This
variable is the difference between the return the stock would ordinarily earn for a given level of
market performance and the actual rate of return on the stock. This measure is often referred
to as the abnormal return of the stock. However, it is very difficult to identify the exact point in
time that an event becomes public information; thus, the better measure is the cumulative
abnormal return, which is the sum of abnormal returns over a period of time (a window around
the event date).

This technique may be used to study the effect of any public event on a firm's stock price; thus,
this technique is a test of the semistrong form of the EMH.
Feedback: The rationale for this question is to ascertain if the student understands the
methodology most commonly used as a test of the semistrong form of market efficiency.

Blooms: Analyze
Difficulty: Challenge
11-72
69. Discuss the small firm effect, the neglected firm effect, and the January effect, the tax effect and
how the four effects may be related.
Studies have shown that small firms earn a risk-adjusted rate of return greater than that of
larger firms. Additional studies have shown that firms that are not followed by analysts
(neglected firms) also have a risk-adjusted return greater than that of larger firms. However, the
neglected firms tend to be small firms; thus, the neglected firm effect may be a manifestation of
the small firm effect. Finally, studies have shown that returns in January tend to be higher than
in other months of the year. This effect has been shown to persist consistently over the years.
However, the January effect may be the tax effect, as investors may have sold stocks with losses
in December for tax purposes and reinvested in January. Small firms (and neglected firms)
would tend to be more affected by this increased buying than larger firms, as small firms tend
to sell for lower prices.
Feedback: The purpose of this question is to reinforce the interrelationships, that "effects" may
not always be independent and thus readily identifiable. In addition, these effects are widely
discussed in the financial press, and the January effect appears to be quite persistent.

Blooms: Analyze
11-73
70. Why might the degree of market efficiency differ across various markets? State three reasons
why this might occur, and explain each reason briefly.
(1) Market efficiency depends on information being essentially free and costless to market
participants. In the U.S. this is the case to a large extent. The U.S. markets are well developed,
and professional analysts often follow securities. Information is available on television, in the
press, and on the Internet. The opposite may be true in other markets, such as those of
developing countries, where there are fewer or no analysts and few market participants with
these resources. (2) Accounting disclosure requirements are different across markets. In the U.S.
firms must meet SEC requirements to be publicly traded. In other countries the requirements
may be different or nonexistent. This has implications about the ease with which analysts can
evaluate the company to determine its proper value. (3) Markets for "neglected" stocks may be
less efficient than markets for stocks that are heavily followed by analysts. If analysts feel that it
is not worthwhile to give their attention to particular stocks, then ample information about
these stocks will not be readily available to investors.
Feedback: This question leads the student to look at some of the fundamental reasons for
market efficiency and why there may be differences among markets with regard to the reasons.
Alternative answers are possible.

Blooms: Analyze
11-74
71. With regard to market efficiency, what is meant by the term "anomaly"? Give three examples of
market anomalies and explain why each is considered to be an anomaly.
Anomalies are patterns that should not exist if the market is truly efficient. Investors might be
able to make abnormal profits by exploiting the anomalies, which doesn't make sense in an
efficient market.
Possible examples include, but are not limited to, the following:
The small firm effect—average annual returns are consistently higher for small-firm portfolios,
even when adjusted for risk by using the CAPM.
The January effect—the small firm effect occurs virtually entirely in January.
The neglected firm effect—small firms tend to be ignored by large institutional traders and
stock analysts. This lack of monitoring makes them riskier and they earn higher risk-adjusted
returns. The January effect is largest for neglected firms.
The liquidity effect—investors demand a return premium to invest in less-liquid stocks. This is
related to the small firm effect and the neglected firm effect. These stocks tend to earn high
risk-adjusted rates of return.
Book-to-market ratios—firms with the higher book-to-market-value ratios have higher risk-
adjusted returns, suggesting that they are underpriced. When combined with the firm-size
factor, this ratio explained returns better than systematic risk as measured by beta.
The reversal effect—stocks that have performed best in the recent past seem to underperform
the rest of the market in the following periods, and vice versa. Other studies indicated that this
effect might be an illusion. These studies used portfolios formed mid-year rather than in
December and considered the liquidity effect.

Investors should not be able to earn excess returns by taking advantage of any of these. The
market should adjust prices to their proper levels. But these things have been documented to
occur repeatedly.
Feedback: This question tests whether the student grasps the basic concept of anomalies and
allows some choice in explaining some of them.
11-75
Blooms: Analyze
11-76

TBChap 011

Caricato da

Informazioni sul documento

Titolo originale

Copyright

Formati disponibili

Condividi questo documento

Condividi o incorpora il documento

Opzioni di condivisione

Hai trovato utile questo documento?

Questo contenuto è inappropriato?

Copyright:

Formati disponibili

TBChap 011

Caricato da

Copyright:

Formati disponibili

Chapter 11

The Efficient Market Hypothesis

Multiple Choice Questions

information that is available only to insiders.

D. All of the options

E. None of the options

A. inefficient; the effect of a well-functioning market

B. efficient; the effect of an inefficient market

C. inefficient; the effect of an inefficient market

D. efficient; the effect of a well-functioning market

E. irrational; even more irrational than before

C. predictable pattern that can be exploited.

D. nonrandom walk and predictable pattern that can be exploited.

E. submartingale and predictable pattern that can be exploited.

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.

select other actively managed funds.

A. an active trading strategy.

B. investing in an index fund.

C. a passive investment strategy.

D. an active trading strategy and investing in an index fund.

E. investing in an index fund and a passive investment strategy.

7. Proponents of the EMH typically advocate

A. buying individual stocks on margin and trading frequently.

B. investing in hedge funds.

C. a passive investment strategy.

E. investing in hedge funds and a passive investment strategy.

prices, trading volume or short interest.

D. All of the options

E. None of the options

information, including information that is available only to insiders.

D. All of the options

E. None of the options

10. If you believe in the reversal effect, you should

C. buy stocks this period that performed poorly last period.

determinants of future profitability.

A. A book value is a value

B. A resistance level is a value

C. A support level is a value

D. A book value and a resistance level are values

E. A book value and a support level are values

13. _________ below which it is difficult for the market to fall.

A. An intrinsic value is a value

B. A resistance level is a value

C. A support level is a value

D. An intrinsic value and a resistance level are values

E. A resistance level and a support level are values

D. None of the options

E. All of the options

A. the lucky event issue.

B. the magnitude issue.

C. the selection bias issue.

D. All of the options

E. None of the options

16. A common strategy for passive management is

A. creating an index fund.

B. creating a small firm fund.

C. creating an investment club.

D. creating an index fund and creating an investment club.

E. creating a small firm fund and creating an investment club.

17. Arbel (1985) found that

A. theJanuary effect was highest for neglected firms.