Chapter 11 Quiz Questions

An index model regression applied to past monthly returns of Tesla's stock price produces the estimate below. Assume that estimates are to be stable over time: rF = .13% + 1.24rM If the market index rises by 15% and Tesla's stock price rises by 37%, what is the abnormal change in Tesla's stock price?

.13% + (1.24* 15%) = 18.73% Tesla's actual return was 37%, so the abnormal return is 18.27%

Q: What is the Cumulative Abnormal Return and what does it capture?

A: CAR is the sum of all abnormal returns over a time period, and it captures the reaction of a firm's stock price to new information

In a market that is declared efficient what is the role of portfolio management? Diversification Appropriate risk level Tax considerations All of the above None of the above

All of the above

The strong-form version of the efficient market hypothesis assumes which of the following? A. All public information is reflected in the stock price of a company B. Stock prices reflect all relevant information including insider information C. The strong-form version implies that there is no point to trend analysis D. All public and relevant information is considered in a firm's stock price

B. Stock prices reflect all relevant information including insider information

_________focuses on stock price patterns and on proxies for buy or sell pressure in the market. _______ focuses on determinants as earnings and dividend prospects, expectations for future interest rates, and risk evaluation of the firm. Investors always use one OR the other methodologies, never in conjunction. T/F? A.) Technical Analysis; Fundamental Analysis; True B.) Technical Analysis; Fundamental Analysis; False C.) Fundamental Analysis; Technical Analysis; True D.) Fundamental Analysis; Technical Analysis; False

B.) Technical Analysis; Fundamental Analysis; False

Which of the following is not true about the reversal effect? A. It means that losers rebound and winners fade back B. The effect suggests that the stock market overreacts to relevant news C. This should imply that a contrarian investment strategy would be profitable D. All of the above are true

D. All of the above are true

Why would an asset show positive serial correlation over a short horizon and a negative serial correlation over a long horizon?

Fads may give rise to short term serial correlation in which the stock market overreacts to certain news about a stock. Overtime, the overreaction will correct itself and may show negative serial correlation in the long run.

The Efficient Market Hypothesis advocates for a passive style of investment. What would happen to market efficiency if everyone chose passive over active styles of investment strategies? why is an active strategy more feasible for large institutions?

If everyone decided to go with the passive investment strategy, markets would quickly become much more inefficient. The efficiency in the market is maintained by a large number of investors monitoring the market which allows for passive investor's to piggy back of their efforts while choosing to invest in assets such as index funds. The reason this works is because large investment institutions have the funds necessary to conduct the analysis necessary for an active strategy. Furthermore, a billion dollar fund would receive a large benefit from a 1% alpha, while an single investor with a couple thousand dollars would not be compensated enough for his efforts with a mere 1% alpha. All this and more works together to allow passive investors and active investors to thrive.

If stock prices are predictable, this would indicate an inefficient market. Why might this be true?

If the market is efficient then stock prices should reflect all available information. The ability to predict prices would indicate that all available information is not already reflected in the stock prices and therefore the market is inefficient. A stock price in an efficient market would already have the predictable information reflected in the stock price.

What implications does EMH have on market analysis? Consider the forms of EMH.

Implications of EMH say that technical analysis is pointless as tech analysis involves looking for trends and patterns of how a stock has moved. However because markets are efficient and all trends and information on a stock's performance is available to everyone, prices will be driven to current market price. Fundamental Analysis also is pointless as the semi strong form of EMH implies that all public info such as company financials and prices are available to everyone. Therefore no one investor will have better information than what others possess, so prices will be reflective of this information. Active portfolio management is discouraged by EMH lovers as they say there is no point to attempting to beat the market when all information that could possibly exist reflects current prices. Passive strategies are encouraged.

What is the relationship between prices reflecting all available information and NPV?

NPV should be equal to zero if prices reflect all available information (that is market is efficient). Hence, no need calculating NPV to uncover mispriced securities in an efficient market.

Q: Why does passive management work?

Passive management is only possible because there is active management. Without active management markets would not be very efficient and then would not allow passive management to be the best strategy. Active managers are the ones who process and use all available information to make sure prices reflect all available information, i.e. markets efficient.

What is the Price-Earnings (P/E) Effect?

Portfolios with low P/E ratios have provided higher returns than portfolios with high P/E ratios.

A stock analyst is studying stock charts looking for patterns to exploit. She is commonly looking at what she calls resistance levels and support levels. She is demonstrating a strategy known as: Fundamental analysis Momentum effect Technical analysis Index fund

Technical Analysis

Q : What is the difference between Technical Analysis and Fundamental Analysis ?

Technical Analysis is using prices and volume information to predict future prices. Success depends on a sluggish response of stock prices to supply-and-demand factors. Weak-form efficiency. Fundamental Analysis is using economic and accounting information to predict stock prices. Seek firms that are mispriced. Find poorly run firms that are not as bad as the market thinks. Semi-strong form efficiency.

After controlling for size and book-to-market effects, beta has no power to explain average security returns. True/False.

True

Based on the efficient market hypothesis, and certain factors such as the unpredictable nature of the market, it is suggested that a passive portfolio will outperform an active portfolio the majority of the time. (True/False)

True

Please describe the information available in the three Forms of the Efficient Market Hypothesis (EMH).

Weak: Hypothesis asserts that stock prices already reflect all information that can be derived by examining market trading data such as the history of past prices, trading volume, or short interest. Semi-strong: Hypothesis states that all publicly available information regarding the prospects of a firm must be reflected already in the stock price. Such information includes, in addition to past prices, fundamental data on the firm's product line, quality of management, balance sheet composition, patents held, earnings forecasts, and accounting practices. Strong: Version of the efficient market hypothesis states that stock prices reflect all information relevant to the firm, even including information available only to company insiders