Chapter 9 Market Efficiency and Behavioral Finance

11) Four "decision traps " identified by behavioral finance are A) overconfidence, representativeness, loss aversion, narrow framing B) lack of confidence, representativeness, overreaction, narrow framing C) overconfidence, representativeness, loss aversion, comprehensive framing D) overconfidence, unfamiliarity bias, loss aversion. narrow framing

A

11) Which of the following activities would be most useful in an efficient market. A) buying and holding a diversified portfolio B) searching for patterns in charts based on stock price movements C) analyzing financial ratios based on accounting data D) buying only securities that have performed well in the recent past

A

13) The weak form of the efficient market theory contends that A) past price performance is useless in predicting future price movements. B) past performance can help determine the general direction of future price movements. C) any publicly available information is useless in predicting future price movements. D) price movements are not random but follow a general trend over a period of time.

A

14) The tendency to hold onto losing stocks in the hope that they will recoup is called A) loss aversion. B) representativeness. C) narrow framing. D) biased self-attribution.

A

15) Which one of the following combinations best signals a strong market? I. a greater number of advancing stocks than declining stocks II. a greater number of declining stocks than advancing stocks III. a greater volume in rising stocks than in declining stocks IV. a greater volume in declining stocks than in advancing stocks A) I and III B) I and IV C) II and III D) II and IV

A

17) People tend to A) ignore information that contradicts their current beliefs. B) overestimate the effects of random chance. C) be underconfident in their judgment of investments. D) look at the entire situation when analyzing an individual security.

A

18) The odd-lot trading theory advocates that small investors A) tend to buy high and sell low. B) react in a manner which generally forecasts the future direction of the market. C) are the first to react to market changes. D) tend to be the first to speculate on a bull market.

A

22) Chartists advocate that A) history repeats itself. B) patterns appear that are very clear and distinctive. C) formations are less important than the direction of the latest price movement. D) a breakout below a support line is a buy signal.

A

7) A type of mutual fund with particular appeal to investors who accept the efficient market hypothesis is A) index fund. B) asset allocation fund. C) growth opportunities fund. D) emerging markets fund.

A

7) Behavioral finance would explain many market anomalies to A) the influence of human emotions and biases on securities markets. B) random price movements that only appear to have a rational explanation. C) poorly understood aspects of market efficiency. D) illegal manipulation of securities prices.

A

7) Even after adjusting for risk, ________ firms earn have, over long periods of time, earned higher returns than ________ firms. A) small, large B) large, small C) new, old D) old, new

A

8) The random walk hypothesis A) implies that security analysis is unable to predict future market behavior. B) suggests that random patterns appear but only over long periods of time. C) has been disproved based on recent computer simulations. D) accounts for market anomalies such as calendar effects.

A

10) The theory behind the mutual fund cash ratio is A) mutual fund managers hold high levels of cash when they are optimistic about market conditions. B) when mutual fund managers hold high levels of cash, they must eventually buy stocks with it. C) when mutual fund managers hold low levels of cash they are pessimistic about market conditions. D) when market conditions are favorable, shareholders remit more cash than the managers can invest.

B

10) Which of the following is true? A) Historically, high P/E or growth stocks have outperformed low P/E or value stocks. B) Historically, low P/E or value stocks have outperformed high P/E or growth stocks. C) After adjusting for risk, high P/E or growth stocks and low P/E or value stocks have performed about the same over time. D) the P/E effect is limited to U.S. stocks.

B

10) Which one of the following best describes the term "efficient market"? A) The commissions on large transactions are smaller than the commissions on small transactions. B) New information is quickly reflected in security prices. C) Little time and effort are spent on marketing securities to the public. D) The cost of receiving, processing, executing, and reporting securities orders is small.

B

15) Which of the following characteristics are referred to as representativeness? I. hesitating to sell stocks at a loss II. basing conclusions on small samples III. underestimating the effects of random chance IV. underestimating the level of risk in an investment A) I and IV only B) II and III only C) I, II and III only D) I, II, III and IV only

B

20) Investors who obsessively monitor their last few stock purchases while paying little attention to the rest of their portfolio are exhibiting the tendency known as A) overconfidence. B) narrow framing. C) loss aversion. D) representativeness.

B

21) Which of the following accurately reflect appropriate investment guidelines? I. Always invest in last years best performing mutual fund. II. Trade frequently to increase your investment returns. III. Sell losing stocks unless you are willing to buy them at the current price. IV. Take corrective action when so indicated. A) I and II only B) III and IV only C) I, III and IV only D) I, II, III and IV

B

22) Which of the following statements correctly present recommendations based on behavioral finance? I. Don't hesitate to sell a losing stock. II. Trade frequently. III. Chase performance. IV. Be humble and open-minded. A) I and II only B) I and IV only C) II and III only D) III and IV only

B

5) Followers of the random walk hypothesis believe that A) security analysis is the best tool to utilize when investing in the stock market. B) the price movements of stocks are unpredictable, and therefore security analysis will not help to predict future market behavior. C) that traders can earn higher than normal returns by exploiting market anomalies such as the small-firm effect. D) support levels and resistance lines, when combined with basic chart formations, yield both buy and sell signals.

B

6) The anomaly known as post-earnings announcement drift or momentum describes the tendency of stock prices to rise or fall for several ________ after unexpectedly good or bad earnings announcements. A) months B) weeks C) days D) hours

B

6) Which one of the following statements concerning the random walk hypothesis is correct? A) Stock price movements are predictable but only over short periods of time. B) Random price movements support the weak form efficient market hypothesis. C) Stock prices in general follow repetitive patterns but the actions of individual investors are random in nature. D) Random price movements indicate that investors can earn abnormal profits on a routine basis.

B

8) In an efficient market, prices appear to move randomly because A) investors do not process new information correctly. B) only new information affects stock prices. C) insider trading has an unpredictable effect on stock prices. D) the number of investors who can forecast prices correctly is too small to have any effect.

B

9) There is evidence to support the contention that company insiders A) cannot earn abnormal profits because they are not permitted to trade shares in their company's stock without a one-month advance notice to the SEC. B) can profit in a manner that counters the strong form of the efficient market hypothesis. C) generally earn a profit equal to that of public investors. D) have no distinct advantage when trading shares of their company's stock.

B

10) Investor overconfidence leads to A) too little trading. B) an overestimation of risk. C) overly optimistic predictions. D) narrow framing.

C

12) Followers of the efficient market hypothesis believe that A) very few investors actually analyze or evaluate stocks before they make a purchase decision. B) the needed information to assess the market is available only to corporate insiders. C) investors react quickly and accurately to new information. D) individual traders can have a significant impact on the price of a security.

C

12) Which one of the following statements is correct? A) The weekend effect states that security prices tend to rise between Friday afternoon and Monday morning. B) The market responds immediately to reflect the information contained in quarterly earnings reports. C) Low P/E stocks tend to outperform high P/E stocks on a risk-adjusted basis. D) The market fully anticipates the information contained in an earnings announcement prior to the actual announcement.

C

13) The most important lesson investors can learn from behavioral finance is A) to understand psychological factors influencing long-term price movement. B) to have the humility to let professionals manage their investments. C) how to avoid letting their emotions and biases affect their investment decisions. D) to have confidence in their instincts and first impressions.

C

14) Based on the semi-strong form of the efficient market theory, an investor reacting immediately to a news flash on the television generally A) can make an abnormal profit. B) is guaranteed to make a reasonable profit. C) is too late to make an exceptional profit. D) will suffer a loss.

C

16) Which of the following are common but dysfunctional investor behaviors? I. overinvesting in companies with familiar names II. dividing their funds equally among available choices, even if several of the choices serve the same purpose IV. hastily disposing of stocks that have dropped in price in order to take advantage of tax breaks IV. exaggerating the role of luck and randomness in investment success or failure A) I and IV only B) II and III only C) I, II and III only D) I, II, III and IV only

C

18) The tendency of investors to take greater risks after a large loss and fewer risks after a large gain can be attributed to A) overconfidence. B) the "house money" effect. C) loss aversion. D) representativeness.

C

5) One of the calendar effect market anomalies indicates that ________ in value during January. A) large cap stocks tend to decline B) equities in general tend to decline C) small cap stocks tend to increase D) equities in general tend to increase

C

8) The tendency of small firms to have higher returns than large firms , even after adjusting for risk, may be attributable to A) representativeness. B) overconfidence. C) familiarity bias. D) loss aversion.

C

8) Which one of the following relative strength values would most indicate that a stock is oversold? A) 120 B) 80 C) 20 D) -20

C

9) The new highs-new lows indicator is based on prices over the past A) week. B) 90 days. C) 52 weeks. D) calendar year.

C

11) Market anomalies are caused by A) investors' efforts to avoid or postpone taxes. B) different levels of risk. C) statistical quirks. D) some poorly understood combination of factors.

D

12) The tendency of investors to blame others for their failures and take personal credit for their successes is referred to as A) loss aversion. B) representativeness. C) narrow framing. D) self-attribution bias.

D

15) The strong form of the efficient market hypothesis contends that A) a select few institutional investors can earn abnormal profits. B) abnormal profits are randomly distributed. C) no one can consistently earn a profit. D) no one can consistently earn abnormal profits.

D

19) Investors who buy mutual funds that have had large gains over the last few years are exhibiting a tendency known as A) overconfidence. B) narrow framing. C) loss aversion. D) representativeness.

D

23) Evidence suggests that the price of a stock continues to move up or down for a period of A) a decade or more. B) 3 to 5 years. C) 1 to 3 years. D) 6 to 12 months.

D

6) An efficient market reflects A) only historical information. B) only the information related to events that have already occurred. C) all publicly known information related to past events and announced future events. D) all information including predictions about future information.

D

9) The efficient market hypothesis rests on which of the following assumptions? I. Information is widely available to all investors almost simultaneously. II. Investors react quickly to new information. III. Investors correctly interpret all available information. IV. Events which affect the market occur randomly. A) I and II only B) I, II and III only C) I, III and IV only D) I, II, III and IV

D