Finance Ch12 non-math ?s

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Efficient financial markets fluctuate continuously because:

. the markets are continually reacting to new information.

Which one of the following statements best defines the efficient market hypothesis?

All securities in an efficient market are zero net present value investments.

Shawn earned an average return of 14.6 percent on his investments over the past 20 years while the S&P 500, a measure of the overall market, only returned an average of 13.9 percent. Explain how this can occur if the stock market is efficient.

An investor can purchase securities that have a higher level of risk than the overall market. In an efficient market, these securities will earn a higher return over the long-term as compensation for the assumption of the increased risk. This is the first lesson of the capital markets: There is a reward for bearing risk.

Which of the following statements are true based on the historical record for 1926-2007?

Bonds are generally a safer investment than are stocks.

Which one of the following statements is correct concerning market efficiency? A. Real asset markets are more efficient than financial markets. B. If a market is efficient, arbitrage opportunities should be common. C. In an efficient market, some market participants will have an advantage over others. D. A firm will generally receive a fair price when it issues new shares of stock. E. New information will gradually be reflected in a stock's price to avoid any sudden change in the price of the stock.

D. A firm will generally receive a fair price when it issues new shares of stock

Which of the following statements related to market efficiency tend to be supported by current evidence? I. Markets tend to respond quickly to new information. II. It is difficult for investors to earn abnormal returns. III. Short-run prices are difficult to predict accurately based on public information. IV. Markets are most likely weak form efficient.

I. Markets tend to respond quickly to new information. II. It is difficult for investors to earn abnormal returns. III. Short-run prices are difficult to predict accurately based on public information.

Which one of the following statements concerning U.S. Treasury bills is correct for the period 1926- 2007?

The annual rate of return was always positive

Which one of the following best defines the variance of an investment's annual returns over a number of years?

The average squared difference between the actual returns and the arithmetic average return.

How can an investor lose money on a stock while making money on a bond investment if there is a reward for bearing risk? Aren't stocks riskier than bonds?

There is a reward for bearing risk over the long-term. However, the nature of risk implies the returns on a high risk security will be more volatile than the returns on a low risk security. Thus, stocks can produce lower returns in the short run. It is the acceptance of this risk that justifies the potential long-term reward.

Which one of the following categories of securities had the lowest average risk premium for the period 1926-2007?

U.S. Treasury bills

You want to invest in an index fund which directly correlates to the overall U.S. stock market. How can you determine if the market risk premium you are expecting to earn is reasonable for the long-term?

You could compare your expectation to the historical market risk premium for the United States, as well as other industrialized countries, realizing of course, that the future will not be exactly like the past. Nevertheless, this should indicate whether or not your expectation is at least reasonable.

Assume that the market prices of the securities that trade in a particular market fairly reflect the available information related to those securities. Which one of the following terms best defines that market?

efficient capital market

If the variability of the returns on large-company stocks were to increase over the long-term, you would expect which of the following to occur as a result?

increase in the risk premium & increase in the 68 percent probability range of the frequency distribution of returns

. To convince investors to accept greater volatility, you must:

increase the risk premium.

According to theory, studying historical stock price movements to identify mispriced stocks:

is ineffective even when the market is only weak form efficient.

As long as the inflation rate is positive, the real rate of return on a security will be ____ the nominal rate of return.

less than

Individuals who continually monitor the financial markets seeking mispriced securities make the markets increasingly _________

make the markets increasingly more efficient.

Which one of the following is defined by its mean and its standard deviation?

normal distribution

Which of the following correspond to a wide frequency distribution?

relatively high standard deviation & relatively large risk premium

The excess return is computed as the:

return on a risky security minus the risk-free rate.

Last year, T-bills returned 2 percent while your investment in large-company stocks earned an average of 5 percent. Which one of the following terms refers to the difference between these two rates of return?

risk premium

Which one of the following categories of securities had the highest average return for the period 1926-2007?

small company stocks

Which one of the following is a correct ranking of securities based on their volatility over the period of 1926-2007? Rank from highest to lowest.

small company stocks, long-term corporate bonds, intermediate-term government bonds

Which one of the following categories of securities has had the most volatile returns over the period 1926-2007?

small-company stocks

The U.S. Securities and Exchange Commission periodically charges individuals with insider trading and claims those individuals have made unfair profits. Given this, you would be most apt to argue that the markets are less than _____ form efficient.

strong

Inside information has the least value when financial markets are

strong form efficient.

The real rate of return on a stock is approximately equal to the nominal rate of return, minus _____

the inflation rate.

Standard deviation is a measure of which one of the following?

volatility

50. If you excel in analyzing the future outlook of firms, you would prefer the financial markets be ____ form efficient so that you can have an advantage in the marketplace.

weak

The average annual return on small-company stocks was about _____ percent greater than the average annual return on large-company stocks over the period 1926-2007.

5

Which two of the following are the most likely reasons why a stock price might not react at all on the day that new information related to the stock issuer is released? I. insiders knew the information prior to the announcement II. investors need time to digest the information prior to reacting III. the information has no bearing on the value of the firm IV. the information was anticipated

III. the information has no bearing on the value of the firm IV. the information was anticipated

Which one of the following is most indicative of a totally efficient stock market? A. extraordinary returns earned on a routine basis B. positive net present values on stock investments over the long-term C. zero net present values for all stock investments D. arbitrage opportunities which develop on a routine basis E. realizing negative returns on a routine basis

. zero net present values for all stock investments

What is the probability that small-company stocks will produce an annual return that is more than one standard deviation below the average?

16 percent

What are the two primary lessons learned from capital market history? Use historical information to justify that these lessons are correct.

First, there is a reward for bearing risk, and second, the greater the risk, the greater the potential reward. As evidence, students should provide a brief discussion of the historical rates of return and the related standard deviations of the various asset classes discussed in the text.

The historical record for the period 1926-2007 supports which one of the following statements?

It is possible for small-company stocks to more than double in value in any one given year.

Which one of the following statements is correct based on the historical record for the period 1926-2007? A. The standard deviation of returns for small-company stocks was double that of large-company stocks. B. U.S. Treasury bills had a zero standard deviation of returns because they are considered to be risk-free. C. Long-term government bonds had a lower return but a higher standard deviation on average than did long-term corporate bonds. D. Inflation was less volatile than the returns on U.S. Treasury bills. E. Long-term government bonds underperformed intermediate-term government bonds.

Long-term government bonds had a lower return but a higher standard deviation on average than did long-term corporate bonds

Which one of the following statements is correct? A. The greater the volatility of returns, the greater the risk premium. B. The lower the volatility of returns, the greater the risk premium. C. The lower the average return, the greater the risk premium. D. The risk premium is unrelated to the average rate of return. E. The risk premium is not affected by the volatility of returns.

The greater the volatility of returns, the greater the risk premium

Which one of the following was the least volatile over the period of 1926-2007?

U.S. Treasury bills

Which one of the following statements correctly applies to the period 1926-2007? A. Large-company stocks earned a higher average risk premium than did small-company stocks. B. Intermediate-term government bonds had a higher average return than long-term corporate bonds. C. Large-company stocks had an average annual return of 14.7 percent. D. Inflation averaged 2.6 percent for the period. E. U.S. Treasury bills had a positive average real rate of return.

U.S. Treasury bills had a positive average real rate of return.

Assume that you invest in a portfolio of large-company stocks. Further assume that the portfolio will earn a rate of return similar to the average return on large-company stocks for the period 1926-2007. What rate of return should you expect to earn?

between 10 and 12.5 percent

What was the average rate of inflation over the period of 1926-2007?

between 3.0 and 3.5 percent

Which one of the following earned the highest risk premium over the period 1926-2007?

small-company stocks

hree forms of market efficiency.

weak: all historical information semistrong: all public and historical information strong:all private, public and historical information


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