Market Efficiency: R47

Consider the following statements: Statement 1: In efficient capital markets, prices only adjust to reflect new information that comes to the market. Statement 2: In efficient capital markets, the time taken by security prices to reflect new information is long enough for traders to earn profits with little risk. Which of the following is most likely? Only one statement is correct. Both statements are incorrect. Both statements are correct.

Answer: A Only Statement 1 is correct. In efficient capital markets, the time frame required for security prices to reflect any new information is very short.

If a security's market price is greater than its intrinsic value, the investor should most likely: Buy the security as it is undervalued. Sell the security as it is overvalued. Buy the security as it is fairly valued.

Answer: B If a security's market price is greater than its intrinsic value, it is overvalued and the investor should sell it.

Under which of the following efficient market hypotheses is an investor least likely to earn consistent abnormal returns based on financial analysis? Weak form only Strong form and semi-strong form only Weak form and semi-strong form only

Answer: B Semi-strong form EMH asserts that investors cannot earn abnormal risk-adjusted returns if their investment decisions are based on important information after it has been made public. Strong-form EMH encompasses semi-strong form EMH.

The phenomena that people ignore their own preferences and follow other people's investment decisions is referred to as: Herding. Gambler's fallacy. Information cascade.

Answer: C Herding is clustered trading that may or may not be based on information. Gambler's fallacy is a behavioral theory which suggests that recent outcomes affect investors' estimates of future probabilities.

Increasing the cost of borrowing shares most likely: Enhances market efficiency. Has no impact on market efficiency. Hinders market efficiency.

Answer: C Higher cost of borrowing shares limits short selling, which impedes market efficiency.

In an efficient market, overestimating a security's risk will lead to an intrinsic value that is most likely: Equal to the market price. Greater than the market price. Lower than the market price.

Answer: C Overestimating a security's risk will lead to a higher discount rate which, in turn, will cause the intrinsic value estimate to be lower than the market price.

Under which of the following efficient market hypotheses is a company director least likely to earn abnormal returns consistently? Weak form and semi-strong form only Semi-strong form and strong form only Strong form only

Answer: C Strong-form EMH asserts that no one can consistently achieve abnormal risk-adjusted returns.

Observed overreactions in markets can be explained by an investor's degree of: risk aversion. loss aversion. confidence in the market.

B is correct. Behavioral theories of loss aversion can explain observed overreaction in markets, such that investors dislike losses more than comparable gains (i.e., risk is not symmetrical).

The intrinsic value of an undervalued asset is: less than the asset's market value. greater than the asset's market value. the value at which the asset can currently be bought or sold.

B is correct. The intrinsic value of an undervalued asset is greater than the market value of the asset, where the market value is the transaction price at which an asset can be currently bought or sold.

The market value of an undervalued asset is: greater than the asset's intrinsic value. the value at which the asset can currently be bought or sold. equal to the present value of all the asset's expected cash flows.

B is correct. The market value is the transaction price at which an asset can be currently bought or sold.

Like traditional finance models, the behavioral theory of loss aversion assumes that investors dislike risk; however, the dislike of risk in behavioral theory is assumed to be: leptokurtic. symmetrical. asymmetrical.

C is correct. Behavioral theories of loss aversion allow for the possibility that the dislike for risk is not symmetrical, which allows for loss aversion to explain observed overreaction in markets such that investors dislike losses more than they like comparable gains.