Chapter 13

45) When a firm announces a dividend change, or publishes its latest earnings, the major part of any price adjustment usually takes place within a few minutes of the announcement. (T/F)

True

46) The collections of evidence against market efficiency are referred to as "puzzles" or anomalies. (T/F)

True

47) Behavioral finance deals with the idea that individual investors have built-in biases and misconceptions that can drive prices away from fair values. (T/F)

True

48) In an efficient market, investors will not pay others what they can do equally well themselves. (T/F)

True

1) A small business received a five-year $1,000,000 loan at a subsidized rate of 3 percent per year. The firm will pay 3 percent annual interest payment each year and the principal at the end of five years. If market interest rates on similar loans are 6 percent per year, what is the NPV of the loan? (Ignore taxes.) A) +$126,371 B) +$348,369 C) −$501,595 D) −$137,391

A) +$126,371 NPV = +1,000,000 − [((30,000/1.06) + ... + (30,000/(1.06^5)) + (1,000,000/(1.06^5))] = 126,371.

11) Which of the following is a statement of weak-form efficiency? I) If markets are efficient in the weak form, then it is impossible to make consistently superior profits by using trading rules based on past returns. II) If markets are efficient in the weak form, then prices will adjust immediately to public information. III) If markets are efficient in the weak form, then prices reflect all information. A) I only B) II only C) II and III only D) III only

A) I only

16) Which of the following is a statement of semistrong form efficiency? I) Stock prices will adjust immediately to public information. II) Stock prices reflect all information. III) Stock prices will adjust to newly published information after a long time delay. A) I only B) II only C) II and III only D) III only

A) I only

7) The statement that stock prices follow a random walk implies that I) successive price changes are independent of each other; II) successive price changes are positively related; III) successive price changes are negatively related; IV) the autocorrelation coefficient is either +1.0 or −1.0 A) I only B) II and III only C) IV only D) III only

A) I only

9) The statement that stock prices follow a random walk implies that I) the correlation coefficient between successive price changes (auto correlation) is not significantly different from zero; II) successive price changes are positively related; III) successive price changes are negatively related; IV) the autocorrelation coefficient is positive A) I only B) II only C) II and III only D) IV only

A) I only

27) For most stocks, a scatter plot chart of stock returns versus past stock returns will appear as A) a shotgun pattern centered close to the origin. B) a random pattern mostly concentrated in the top-right and lower-left quadrants. C) a random pattern mostly concentrated in the upper-left and upper-right quadrants. D) None of the options.

A) a shotgun pattern centered close to the origin.

34) Strong-form efficiency implies that mutual fund managers should A) buy the index that maximizes diversification and minimizes the cost of managing portfolios. B) actively seek underperforming stocks and buy them. C) generally earn superior returns each year. D) attempt to earn superior returns by using technical analysis.

A) buy the index that maximizes diversification and minimizes the cost of managing portfolios.

22) One important implication of the efficient markets hypothesis is that most investors A) should avoid active trading. B) can benefit by purchasing high-beta stocks. C) should trade actively to help ensure the highest overall gain in their portfolios. D) should hold IPO stock issues for the long term.

A) should avoid active trading.

2) A large firm received a loan guarantee from the government. Due to the guarantee, the firm can borrow $50 million for five years at 8 percent interest rate per year instead of 10 percent per year. Calculate the value of the guarantee to the firm. (Ignore taxes.) A) +$53.79 million B) +$3.79 million C) −$3.79 million D) $3.99 million

B) +$3.79 million NPV = +50 − [(4/1.1) + . . . + (4/(1.1^5)) + (50/(1.1^5)] = +3.79.

29) Analysis of past monthly movements in Wal-Mart's stock price has produced the following estimates: α = −0.45 percent and β = 0.5. If the market index subsequently rises by 5 percent while Wal-Mart's stock price rises by 3 percent, what is the abnormal change in Wal-Mart's stock price? A) −0.45 percent B) +0.95 percent C) +0.05 percent D) +2.50 percent

B) +0.95 percent Expected change: −0.45 + 0. 5(+5) = 2.05; Abnormal return = 3 − 2.05 = +0.95%.

18) Predictable cycles in stock price movements I) tend to persist for a long time; II) tend to self-destruct as soon as investors recognize them; III) never appear, since stock returns change randomly A) I only B) II only C) III only D) I, II, and III

B) II only

4) Financing decisions differ from investment decisions for which of the following reasons? I) you cannot use NPV to evaluate financing decisions; II) markets for financial assets are more active than for real assets; III) it is easier to find financing decisions with positive NPV than to find investment decisions with positive NPV A) I only B) II only C) III only D) I and III only

B) II only

3) If capital markets are efficient, then the sale or purchase of any security at the prevailing market price is generally A) a positive-NPV transaction. B) a zero-NPV transaction. C) a negative-NPV transaction. D) No general trend exists for such transactions.

B) a zero-NPV transaction.

23) The semistrong form of efficiency focuses on the economic ineffectiveness of the following type of information: A) insider information. B) publicly available information. C) privileged information. D) only information provided by the SEC.

B) publicly available information.

25) An abnormal stock return is calculated as the A) return on the stock minus the expected stock return. B) return on the stock minus the return on the market. C) return on the stock for the current period minus the return on the stock for the previous period. D) return on the stock minus the return on a comparable firm.

B) return on the stock minus the return on the market.

8) A random walk process for a single stock consists of the toss of a fair coin at the end of each day. If the outcome is heads, the stock price increases by 1.25 percent. If the outcome is tails, the stock price decreases by 0.75 percent. What is the drift of such a process? A) +1.25 percent B) −0.75 percent C) +0.25 percent D) +2 percent

C) +0.25 percent Drift = (0.5)(1.25%) + (0.5)(−0.75%) = +0.25%.

31) If the abnormal return for a stock during the first week is +5 percent and +3 percent during the second week, what is the abnormal return for the two-week period? A) 5 percent B) 3 percent C) 8.15 percent D) 8 percent

C) 8.15 percent Abnormal return = (1.05)(1.03) − 1 = 8.15%.

15) If the weak form of market efficiency holds, then I) technical analysis is useless; II) stock prices reflect all information contained in past prices; III) stock price returns follow a random walk A) I only B) I and II only C) I, II, and III D) I and III only

C) I, II, and III

5) Financing decisions differ from investment decisions because I) financing decisions are easier to reverse; II) markets for financial assets are generally more competitive than real asset markets; III) generally, financing decisions have NPVs very close to zero A) I only B) I and II only C) I, II, and III D) II and III only

C) I, II, and III

14) Strong-form market efficiency states that the market incorporates all information into stock prices. Strong-form efficiency implies that I) an investor can only earn risk-free rates of return; II) an investor can always rely on technical analysis; III) professional investors cannot consistently outperform the market; A) I only B) II only C) III only D) I, II, and III

C) III only

32) Which of the following observations would provide evidence against the strong form of efficient market theory? I) Mutual fund managers do not on average make superior returns. II) In any year approximately 50% of all pension funds outperform the market. III) Managers who trade in their own firm's stocks make superior returns. A) I only B) II only C) III only D) I and II only

C) III only

20) Weak-form efficiency implies that past stock returns A) form patterns that tend to repeat. B) are major inputs to investors for forming trading strategies. C) do not help to predict future returns. D) are difficult to explain.

C) do not help to predict future returns.

19) Informational efficiency in financial markets results in stock prices being A) higher. B) lower. C) fairer. D) easier to predict.

C) fairer.

26) In order to test the weak form of the efficient-market hypothesis, researchers have used the following methods except A) estimation of the serial correlation (autocorrelation) for securities and markets. B) measurement of the profitability of trading rules used by technical analysts. C) measurement of how rapidly security prices adjust to different news items. D) All of the options are methods used for testing weak-form market efficiency.

C) measurement of how rapidly security prices adjust to different news items.

28) In order to test the semistrong form of the efficient-market hypothesis, researchers have mostly relied on the A) estimation of the serial correlation coefficients (autocorrelations) for securities and markets. B) measurement of the performance of technical trading strategies over the years. C) measurement of how rapidly security prices adjust to different news items. D) All of the options.

C) measurement of how rapidly security prices adjust to different news items.

33) Suppose that a lawyer works for a firm that advises corporate firms planning to sue other corporations for antitrust damages. He finds that he can "beat the market" by short selling the stock of firms that will be sued. This hypothetical finding would violate A) the weak-form hypothesis of market efficiency. B) the semistrong form hypothesis of market efficiency. C) the strong-form hypothesis of market efficiency. D) none of the hypotheses of market efficiency.

C) the strong-form hypothesis of market efficiency.

10) Stock price cycles or patterns tend to self-destruct as soon as investors recognize them through A) stock market regulation by the Securities and Exchange Commission (SEC). B) price fixing by the specialists on the New York Stock Exchange. C) trading by investors. D) the actions of corporate treasurers.

C) trading by investors.

30) Analysis of past monthly movements in IBM's stock price produces the following estimates: α = 2.5 percent and β = 1.6. If the market index subsequently rises by 12 percent in one month and IBM's stock price increases by 20 percent, what is the abnormal change in IBM's stock price? A) +1.7 percent B) +8 percent C) −1.7 percent D) +2.5 percent

C) −1.7 percent Expected change = 2.5 + 1.6(12) = 21.7; Abnormal change = 20 − 21.7 = −1.7%.

17) If the efficient market hypothesis holds, investors should expect I) to receive a fair price for their security II) to earn a normal rate of return on their investments III) to be able to pick stocks that will outperform the market A) I only B) II only C) III only D) I and II only

D) I and II only

35) The various lessons of market efficiency are I) markets have no memory; II) trust market prices; III) read the entrails; IV) the do-it yourself alternative; V) seen one stock, seen them all A) I and II only B) I, II, III, and IV only C) I, and V only D) I, II, III, IV, and V

D) I, II, III, IV, and V

24) The semistrong form of the efficient markets hypothesis has been tested by measuring how rapidly security prices react to various news items like I) earnings announcements; II) dividend announcements; III) news of takeovers; IV) macroeconomic information A) I and II only B) I, II, and III only C) IV only D) I, II, III, and IV

D) I, II, III, and IV

12) The different forms of market efficiency are I) weak form; II) semistrong form; III) strong form A) I only B) I and II only C) I and III only D) I, II, and III

D) I, II, and III

6) Generally, a firm is able to find positive-NPV opportunities among its I) financing decisions; II) capital investment decisions; III) short-term borrowing decisions A) I only B) I and III only C) III only D) II only

D) II only

13) Which of the following statements is (are) true if the strong-form efficient market hypothesis holds? I) Analysts can easily forecast stock price changes. II) Financial markets are irrational. III) Stock returns follow a particular pattern. IV) Stock prices reflect all available information. A) I only B) II only C) I and III only D) IV only

D) IV only

36) The study of behavioral finance has best helped explain which of the following investor behaviors? A) Investors are often unable to short-sell unfavorable stocks. B) Investors often create undiversified portfolios. C) Investors tend to sell their losing stocks and retain stocks that have capital gains. D) Investors are generally too slow to update their beliefs in the face of new evidence.

D) Investors are generally too slow to update their beliefs in the face of new evidence.

21) If markets are efficient, which of the following investors should achieve superior returns over time? A) Investors who choose stocks by throwing darts at a list of stocks in the financial pages of a newspaper B) Analysts who spend considerable time evaluating the best stocks to buy C) Mutual fund managers who manage other people's money for a living D) None of these options.

D) None of these options.

37) Investors are particularly averse to the possibility of even a very small loss and need a high return to compensate for it. Such a concept is related to which theory? A) Market efficiency theory B) Random walk theory C) Convergence trading D) Prospect theory

D) Prospect theory

41) If capital markets are completely efficient, then the purchase or sale of any security at the prevailing market price is never a positive-NPV transaction. (T/F)

True

40) For a corporation, financing decisions are typically harder to reverse than investment decisions. (T/F)

False

42) In an efficient market, information is costless. (T/F)

False

44) The weak form of efficient market theory implies that technical analysis is valuable. (T/F)

False

49) Behavioral finance and technical analysis are basically the same theory. (T/F)

False

50) A majority of research supports the theory that past stock movements can predict future asset prices. (T/F)

False

43) In a completely competitive market, security prices follow a random walk. (T/F)

True

39) If a stock's returns follow a random walk pattern, then one should expect to calculate a statistically insignificant autocorrelation coefficient, calculated between each successive day's stock returns. (T/F)

True

38) If stock returns follow a random walk pattern, then knowing the history of stock returns is not useful for predicting future stock returns. (T/F)

True