finance 340 chapter 8

Which of the following most appears to contradict the proposition that the stock market is weakly efficient?

Every January, the stock market earns abnormal returns. This is a predictable pattern of returns, which should not occur if the stock market is weakly efficient.

Which of the following statements are true if the efficient market hypothesis holds?

It implies that prices reflect all available information

In an efficient market, professional portfolio management can offer all of the following benefits:

Low-cost record keeping. A targeted risk level. Low-cost diversification.

Suppose you find that prices of stocks before large dividend increases show on average consistently positive abnormal returns. Is this a violation of the EMH?

No, this is not a violation of the EMH. This empirical tendency does not provide investors with a tool that will enable them to earn abnormal returns; in other words, it does not suggest that investors are failing to use all available information. An investor could not use this phenomenon to choose undervalued stocks today. The phenomenon instead reflects the fact that dividends occur as a response to good performance. After the fact, the stocks that happen to have performed the best will pay higher dividends, but this does not imply that you can identify the best performers early enough to earn abnormal returns.

Suppose that, after conducting an analysis of past stock prices, you come up with the following observations. Which would appear to contradict the weak form of the efficient market hypothesis?

One could have made superior returns by buying stock after a 10% rise in price and selling after a 10% fall

Which version of the efficient market hypothesis focuses on the most inclusive set of information?

Strong-form

Which of the following observations would provide evidence against the semistrong form of the efficient market theory?

The P/E ratio is public information so this observation would provide evidence against the semi-strong form of the efficient market theory. Low P/E stocks tend to have positive abnormal returns.

You know that firm XYZ is very poorly run. On a scale of 1 (worst) to 10 (best), you would give it a score of 3. The market consensus evaluation is that the management score is only 2. Should you buy or sell the stock?

You should buy the stock. The firm's management is not as bad as everyone else believes it to be, therefore, the firm is undervalued by the market. You are less pessimistic about the firm's prospects than the beliefs built into the stock price.

The semistrong form of the EMH states that ________ must be reflected in the current stock price.

all publicly available information

Basu found that firms with high P/E ratios __________.

earned lower average returns than firms with low P/E ratios

DeBondt and Thaler (1985) found that the poorest-performing stocks in one time period experienced __________ performance in the following period and that the best-performing stocks in one time period experienced __________ performance in the following time period.

good; poor

According to 1968 research by Ball and Brown, securities markets fully adjust to earnings announcements _______.

gradually over time

Growth stocks usually exhibit ______ price-to-book ratios and ______ price-to-earnings ratios.

high; high

Value stocks usually exhibit ______ price-to-book ratios and ______ price-to-earnings ratios.

low; low

The primary objective of fundamental analysis is to identify __________.

mispriced stocks

Fundamental analysis is likely to yield best results for _______.

neglected stocks

Someone who invests in the Vanguard Index 500 mutual fund could most accurately be described as using which approach?

passive investment

f you believe in the __________ form of the EMH, you believe that stock prices reflect all relevant information, including information that is available only to insiders.

strong

Choosing stocks by searching for predictable patterns in stock prices is called ________.

technical analysis

Small firms have tended to earn abnormal returns primarily in __________.

the month of january

Evidence supporting semistrong-form market efficiency suggests that investors should _________________________.

use a passive trading strategy such as purchasing an index fund or an ETFs

Fama and French have suggested that many market anomalies can be explained as manifestations of ____________.

varying risk premiums