Week 3 Quiz: Ch. 6-7

The efficient market hypothesis suggests that: a) investors should purchase no-load mutual funds, which have low management fees. b) investors can use the advice of technical analysts to outperform the market. c) investors let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy. d) only investors should purchase no-load mutual funds, which have low management fees and investors can use the advice of technical analysts to outperform the market are sensible strategies.

a) investors should purchase no-load mutual funds, which have low management fees.

The elimination of a riskless profit opportunity in a market is called

arbitrage

That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries: a) have been afforded special government treatment, since used car dealers do not provide information that is valued by b) consumers of used cars. are able to prevent potential competitors from free-riding off the information that they provide. c) have failed to solve adverse selection problems in this market because "lemons" continue to be traded. d) do all of these.

are able to prevent potential competitors from free-riding off the information that they provide.

Which of the following best explains the recent decline in the role of financial intermediaries? Private production and sale of information Government regulation to increase information Improvements in information technology None of these can explain the recent decline

Improvements in information technology

Which of the following is an insight from behavioral finance? The price of securities fully reflects all available information. Investor overconfidence leads to high trading volumes. The optimal forecast of a security's return equals the security's equilibrium return. Investment advisers cannot consistently beat the market.

Investor overconfidence leads to high trading volumes.

Which of the following does not weaken the efficient markets hypothesis? Mean reversion Success of buy-and-hold strategy January effect Excessive volatility

Success of buy-and-hold strategy

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

a bubble

An audit certifies that

a firm abides by standard accounting principles.

Rules used to predict movements in stock prices based on past patterns are, according to the efficient markets theory,

a waste of time.

Evidence that stock prices sometimes fall when a firm announces good news contradicts the efficient market hypothesis.

False

Another way to state the efficient market hypothesis is that in an efficient market, a) unexploited profit opportunities will never exist as market participants, such as arbitrageurs, ensure that they are instantaneously dissipated. b) unexploited profit opportunities will not exist for long, as market participants will act quickly to eliminate them. c) every financial market participant must be well informed about securities. d) only unexploited profit opportunities will never exist as market participants, such as arbitrageurs, ensure that they are instantaneously dissipated and every financial market participant must be well informed about securities.

b) unexploited profit opportunities will not exist for long, as market participants will act quickly to eliminate them.

With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? a) Direct finance is used in less than 5% of the external financing of American businesses. b) Only large, well-established corporations have access to securities markets to finance their activities. c) Loans from banks and other financial intermediaries in the United States provide five times more financing of corporate activities than do stock markets. d) All of these. e) Only Direct finance is used in less than 5% of the external financing of American businesses and Only large, well-established corporations have access to securities markets to finance their activities.

d) all of these

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

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

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 these are sensible strategies. e) only investors should not try to outguess the market by constantly buying and selling securities and investors do better on average if they adopt a "buy and hold" strategy are sensible strategies.

d) All of these are sensible strategies.

The free-rider problem: a) occurs when people who do not pay for information take advantage of the information other people have to pay for. b) suggests that the private sale of information will only be a partial solution to the lemons problem. c) prevents the private market from producing enough information to eliminate all the asymmetric information that leads to adverse selection. d) All of these.

d) All of these.

Important implications of the efficient market hypothesis include which of the following? a) Future changes in stock prices should, for all practical purposes, be unpredictable. b) Stock prices will respond to announcements only when the information in these announcements is new. c) Sometimes a stock price declines when good news is announced. d) All of these. e) Only Future changes in stock prices should, for all practical purposes, be unpredictable and Stock prices will respond to announcements only when the information in these announcements is new.

d) all of these

The problem of adverse selection helps to explain: a) why banks prefer to make loans secured by collateral. b) why banks have a comparative advantage in raising funds for American businesses. c) why borrowers are willing to offer collateral to secure their promises to repay loans. d) All of these. e) only why banks prefer to make loans secured by collateral and why banks have a comparative advantage in raising funds for American businesses.

d) all of these

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: securities markets are not efficient. unexploited profit opportunities were abundant. investors can outperform the market with inside information. only unexploited profit opportunities were abundant and investors can outperform the market with inside information.

investors can outperform the market with inside information.

Net worth

is the difference between assets and liabilities.

Liquidity services are services that

make it easier for customers to conduct transactions.

Of the following sources of external finance for American nonfinancial businesses, the most important is: loans from banks. stocks. bonds and commercial paper. nonbank loans.

non-bank loans

Evidence against market efficiency does not include: the small-firm effect. technical analysis. excessive volatility. mean reversion.

technical analysis

The authors' analysis of adverse selection indicates that financial intermediaries

overcome free-rider problems by holding nontraded loans.

(I) In the United States, nonbank loans are the most important source of external funds for nonfinancial businesses. (II) In Germany and Japan, issuing stocks and bonds is the most important source of external for nonfinancial businesses.

(I) is true, (II) false.

The efficient market hypothesis applies to

A) both the stock market and the foreign exchange market.

Evidence in favor of market efficiency includes: performance of investment analysts and mutual funds. whether stock prices reflect publicly available information. the random-walk behavior of stock prices. All of these.

All of these

Which of the following is empirical evidence indicating that the efficient market hypothesis may not always be generally applicable? Small-firm effect January effect Market overreaction All of these

All of these

In the U.S. stock market, arbitrageurs are typically able to eliminate (profit from) unexploited profit opportunities by engaging in pure arbitrage.

False

Financial intermediaries (banks in particular) have the ability to avoid the free-rider problem as long as they primarily: a) make private loans. b) acquire a diversified portfolio of stocks. c) buy junk bonds. d) do a balanced combination of make private loans and acquire a diversified portfolio of stocks.

a) make private loans

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 losses will eventually be eliminated and the longer a stock is held, the higher its price will be are true

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

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 unexploited profit opportunities will be quickly eliminated and arbitrageurs guarantee that unexploited profit opportunities never exist occur.

a) unexploited profit opportunities will be quickly eliminated

The problem of adverse selection helps to explain A) why firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets. B) why collateral is an important feature of consumer, but not business, debt contracts. C) why direct finance is more important than indirect finance as a source of business finance. D) why lenders refuse loans to individuals with high net worth.

a) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets.

How expectations are formed is important because expectations influence the demand for assets. bond prices. the risk structure of interest rates. the term structure of interest rates. All of these.

all of these

Which of the following is not an implication of the strong view of market efficiency in an efficient market? a) One investment is as good as any other because the securities' prices are correct. b) Security prices will reflect all relevant information about a securities price: past, present, and future. c) A security's price reflects all available information about the intrinsic value of the security. d) Security prices can be used by managers of both financial and non-financial firms to assess their cost of capital (cost of financing their investments) accurately.

b) Security prices will reflect all relevant information about a securities price: past, present, and future.

The efficient market hypothesis a) is based on the assumption that prices of securities fully reflect all available information. b) holds that the expected return on a security equals the equilibrium return. c) both is based on the assumption that prices of securities fully reflect all available information and holds that the expected return on a security equals the equilibrium return. d) neither is based on the assumption that prices of securities fully reflect all available information nor holds that the expected return on a security equals the equilibrium return.

c) both is based on the assumption that prices of securities fully reflect all available information and holds that the expected return on a security equals the equilibrium return.

A bank: a) has the ability to profit from the information it produces. b) avoids the free-rider problem by primarily making private loans rather than by purchasing securities that are traded in the open market. c) becomes an expert in determining good firms from bad firms. d) All of these.

d) All of these.

That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries: a) provide information that is valued by consumers of used cars. b) are able to prevent others from free-riding off the information that they provide. c) can profit by becoming experts in determining whether an automobile is a good car or a lemon. d) do all of these.

d) do all of these.

If the optimal forecast of the return on a security exceeds the equilibrium return, then: a) the market is inefficient. b) an unexploited profit opportunity exists. c) the market is in equilibrium. d) only the market is inefficient and an unexploited profit opportunity exists are true. e) only an unexploited profit opportunity exists and the market is in equilibrium are true.

d) only the market is inefficient and an unexploited profit opportunity exists are true.

With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? a) Marketable securities account for a larger share of external business financing in the United States than in most other countries. b) Since 1970, less than 5% of newly issued corporate bonds and commercial paper have been sold directly to American households. c) The stock market accounted for the largest share of the financing of American businesses in the 1970-2000 period. d) All of these. e) Only Marketable securities account for a larger share of external business financing in the United States than in most other countries and Since 1970, less than 5% of newly issued corporate bonds and commercial paper have been sold directly to American households.

e) Only Marketable securities account for a larger share of external business financing in the United States than in most other countries and Since 1970, less than 5% of newly issued corporate bonds and commercial paper have been sold directly to American households.

Because information is scarce, a) equity contracts are used much more frequently to raise capital than are debt contracts. b) monitoring managers gives rise to costly state verification. c) government regulations, such as standard accounting principles, can help reduce moral hazard. d) All of these are true. e) only monitoring managers gives rise to costly state verification and government regulations, such as standard accounting principles, can help reduce moral hazard are true.

e) only monitoring managers gives rise to costly state verification and government regulations, such as standard accounting principles, can help reduce moral hazard are true.

According to the efficient market hypothesis: a) one cannot expect to earn an abnormally high return by purchasing a security. b) information in newspapers and in the published reports of financial analysts is already reflected in market prices. c) unexploited profit opportunities abound, thereby explaining why so many people get rich by trading securities. d) All of these are true. e) only one cannot expect to earn an abnormally high return by purchasing a security and information in newspapers and in the published reports of financial analysts is already reflected in market prices are true.

e) only one cannot expect to earn an abnormally high return by purchasing a security and information in newspapers and in the published reports of financial analysts is already reflected in market prices are true.

Moral hazard is a problem associated with debt and equity contracts arising from: a) the borrower's incentive to undertake highly risky investments. b) the owners' inability to ensure that managers will act in the owners' interest. c) the difficulty lenders have in sorting out good credit risks from bad credit risks. d) All of these. e) only the borrower's incentive to undertake highly risky investments and the owners' inability to ensure that managers will act in the owners' interest.

e) only the borrower's incentive to undertake highly risky investments and the owners' inability to ensure that managers will act in the owners' interest.

According to the January effect, stock prices

experience an abnormal price rise from December to January.

The ________ problem occurs when people who do not pay for information take advantage of the information that other people have paid for.

free-rider

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

fully reflects all available information

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

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

Which of the following types of information will most likely enable the exploitation of a profit opportunity? Financial analysts' published recommendations Technical analysis Hot tips from a stockbroker Insider information

insider information

Because of the adverse selection problem, A) good credit risks are more likely to seek loans causing lenders to make a disproportionate amount of loans to good credit risks. B) lenders may refuse loans to individuals with high net worth, because of their greater proclivity to ʺskip town.ʺ C) lenders are reluctant to make loans that are not secured by collateral. D) all of these

lenders are reluctant to make loans that are not secured by collateral.

Financial intermediaries (banks in particular) have the ability to avoid the free-rider problem as long as they primarily

make private loans.

According to the strong view of the efficient markets hypothesis, security prices reflect ________ and so financial markets are efficient.

market fundamentals

Items that have a direct impact on future income streams of the securities are also known as

market fundamentals

A situation in which the price of an asset differs from its fundamental market value

need not indicate that unexploited profit opportunities exist.

The authors' analysis of adverse selection indicates that financial intermediaries in general, and banks in particular (because they hold a large fraction of nontraded loans), a) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than direct finance. b) play a greater role in moving funds to corporations than do securities markets as a result of their ability to overcome the free-rider problem. c) provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations, which rely to a greater extent on the new issues market for funds. d) All of these. e) only have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than direct finance and play a greater role in moving funds to corporations than do securities markets as a result of their ability to overcome the free-rider problem.

only have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than direct finance and play a greater role in moving funds to corporations than do securities markets as a result of their ability to overcome the free-rider problem.

The efficient markets hypothesis is weakened by evidence that: a) stock prices tend to follow a random walk. b) stock prices are more volatile than fluctuations in their fundamental values can explain. c) technical analysis does not outperform the overall market. d) an investment adviser's past success or failure at picking stocks does not predict his or her future performance.

stock prices are more volatile than fluctuations in their fundamental values can explain.

Of the following sources of external finance for American nonfinancial businesses, the least important is: loans from banks. stocks. bonds and commercial paper. nonbank loans.

stocks

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

technical analysis does not outperform the overall market.

A key finding of the economic analysis of financial structure is that

the existence of the free-rider problem for traded securities helps to explain why banks play a predominant role in financing the activities of businesses.

When an accounting firm conducts on independent audit, the accounting firms certify that

the firm is adhering to standard accounting principles and disclosing accurate information about sales, assets, and earnings.