Investment I Chapter 11

The weak form of the efficient market hypothesis asserts that

future changes in stock prices cannot be predicted from past prices and techinicians cannot be expected to outperform the market

Matthews Corporation has a beta of 1.2. The annualized market return yesterday was 13%, and the risk-free rate is currently 5%. You observe that Matthews had an annualized return yesterday of 17%. Assuming that markets are efficient, this suggests that

good news about matthews was announced yesterday abnormal return = 17 - (5 + 1.2*8) = +-2.4% positive abnormal return suggests good news

Two basic assumptions of technical analysis are that security prices adjust

gradually to new information and market prices are determined by the interaction of supply and demand technicians follow data on prices believing that they can find price trends as security prices adjust gradually

Fama and French (1992) found that the stocks of firms within the highest decile of book-to-market ratios had average monthly returns of _______, while the stocks of firms within the lowest decile of book-to-market ratios had average monthly returns of ________.

greater than 1%, less than 1%

Researchers have found that most of the small firm effect occurs

in January

Jaffe (1974) found that stock prices _________ after insiders intensively bought shares.

increased insider trading may signal insider information

Studies of mutual fund performance

indicate that one should not randomly select a mutual fund and that historical performance is not indicative of future performance

When Maurice Kendall examined the patterns of stock returns in 1953, he concluded that the stock market was __________. Now, these random price movements are believed to be _________.

inefficient; the effect of a well-functioning market

According to proponents of the efficient market hypothesis, the best strategy for a small investor with a portfolio worth $40,000 is probably to

invest in mutual funds

Proponents of the EMH typically advocate

investing in an index fund and a passive investment strategy an index fund is one of the most practical passive investment strategies, especially for small investors

Nicholas Manufacturing just announced yesterday that its fourth quarter earnings will be 10% higher than last year's fourth quarter. Nicholas had an abnormal return of -1.2% yesterday. This suggests that

investors expected the earnings increase to be larger than what was actually announced a negative market response suggests that the earnings surprise was negative

LJP Corporation just announced yesterday that it would undertake an international joint venture. You observe that LJP had an abnormal return of 3% yesterday. This suggests that

investors view it as good news

A finding that _________ would provide evidence against the semistrong form of the efficient market theory.

low P/E stocks tend to have positive abnormal returns and one consistently outperform the market by adopting the contrarian approach exemplified by the reversals phenomenon

A hybrid strategy is one where the investor

maintains a passive core and augments the position with an actively managed portfolio

Sehun (1986) finds that the practice of monitoring insider trade disclosures, and trading on that information, would be

not sufficiently profitable to cover trading costs

On November 22, 2012, the stock price of WalMart was $69.50 and the retailer stock index was 600.30. On November 25, 2012, the stock price of WalMart was $70.25 and the retailer stock index was 605.20. Consider the ratio of WalMart to the retailer index on November 22 and November 25. WalMart is _______ the retail industry, and technical analysts who follow relative strength would advise _______ the stock.

outperforming, buying 69.50/600.30 = 0.1158 70.25/605.20 = 0.1161 there is an increase

Proponents of the EMH typically advocate

passive investment strategy

what is anomaly?

patterns that should not occur is the market is efficient: small firm effect, january effect

If stock prices follow a random walk

price changes are random and independent

In an efficient market,

security prices react quickly to new info, security prices are seldom far above or below their justified levels, and security analysis will not allow investors to realize superior returns consistently

Your professor finds a stock-trading rule that generates excess risk-adjusted returns. Instead of publishing the results, she keeps the trading rule to herself. This is most closely associated with

selection bias

If you believe in the reversal effect, you should

sell stocks this period that performed well last period

If you believe in the ________ form of the EMH, you believe that stock prices reflect all relevant information including historical stock prices and current public information about the firm, but not information that is available only to insiders.

semistrong stock prices reflect all publicly available and historical info, but not insider info

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

strong

The stock market follows a

submartingale

Chartists practice

technical analysis

The weak form of the efficient market hypothesis contradicts

technical analysis, but is silent on the possibility of successful fundamental analysis

__________ focus more on past price movements of a firm's stock than on the underlying determinants of future profitability.

technical analysts technicians attempt to predict future stock prices based on past stock prices

what is an event study?

test that allows the researcher to assess the impact of an event on a stock price. it is a test of the semistrong form of the EMH

Arbel (1985) found that

the January effect was highest for neglected firms arbel divided firms into highly researched, moderately researched, and neglected groups based on the number of institutions holding the stock

The Food and Drug Administration (FDA) just announced yesterday that they would approve a new cancer-fighting drug from King. You observe that King had an abnormal return of 0% yesterday. This suggests that

the approval was already approved by the market

The main difference between the three forms of market efficiency is that

the definition of information differs

At freshman orientation, 1,500 students are asked to flip a coin 20 times. One student is crowned the winner (tossed 20 heads). This is most closely associated with

the lucky event issue

The debate over whether markets are efficient will probably never be resolved because of

the lucky event, magnitude, and selection bias issues these make rigid testing of market efficiency impossible

When Maurice Kendall first examined stock price patterns in 1953, he found that

there were no predictable patterns in stock prices

Which of the following are used by technical analysts to determine proper stock prices?

trendlines and resistance levels

If you believe in the _______ form of the EMH, you believe that stock prices only reflect all information that can be derived by examining market trading data such as the history of past stock prices, trading volume or short interest.

weak the info above is considered market data, which is what weak EMH is.

Banz (1981) found that, on average, the risk-adjusted returns of small firms

were higher than the risk-adjusted returns of large firms

Banz (1981) found that, on average, the risk-adjusted returns of large firms

were lower than the risk-adjusted returns of small firms

A market decline of 23% on a day when there is no significant macroeconomic event ______ consistent with the EMH because ________.

would not be; it was not a clear response to macroeconomic news

In an efficient market the correlation coefficient between stock returns for two non overlapping time periods should be

zero

The difference between a random walk and a submartingale is the expected price change in a random walk is ______, and the expected price change for a submartingale is ______.

zero, positive

Patell and Woflson (1984) report that most of the stock price response to corporate dividend or earnings announcements occurs within ____________ of the announcement.

10 minutes

Studies of negative earnings surprises have shown that there is

a negative abnormal return on the day that negative earnings surprises are announced and a positive drift in the stock price on the days following the earnings surprise announcement.

Studies of positive earnings surprises have shown that there is

a positive abnormal return on the day positive earnings surprises are announced and a positive drift in the stock price on the days following the announcement. the market seems to adjust to earnings info gradually, resulting in a sustained period of abnormal gains

_________ above which it is difficult for the market to rise.

a resistance value is a value when stock prices have remained stagnant for a while, technicians believe it is difficult for the stock prices to penetrate that price. that price becomes the resistance value

_________ below which it is difficult for the market to fall.

a support value

___________ the return on a stock beyond what would be predicted from market movements alone.

an abnormal return is the economic return is the expected level of return based on risk and market factors. when returns exceed this, the returns are called abnormal returns

Cumulative abnormal returns (CAR)

are used in event studies and are better measures of security returns due to firm-specific events than are abnormal returns

Proponents of the EMH think technical analysts

are wasting their time technical analysts attempt to predict future stock prices, whereas proponents of the EMH think stock price changes are random variables

The likelihood of an investment newsletter's successfully predicting the direction of the market for three consecutive years by chance should be

between 10 and 25 percent

Del Guerico and Reuter (2013) report that the average underperformance of actively managed mutual funds is driven largely by

broker sold funds

If you believe in the reversal effect, you should

buy stocks this period that performed poorly last period the reversal effects states that stocks that perform well in this period do badly in the next period, and vice versa

A common strategy for passive management is

creating an index fund by definition, an index fund is passively managed. other options may or not be passively managed.

Jaffe (1974) found that stock prices _________ after insiders intensively sold shares.

decreased

A support level is the price range at which a technical analyst would expect the

demand for a stock to increase substantially

The weather report says that a devastating and unexpected freeze is expected to hit Florida tonight, during the peak of the citrus harvest. In an efficient market one would expect the price of Florida Orange's stock to

drop immediately a gradual change in info is a violated of the EMH

Basu (1977, 1983) found that firms with low P/E ratios

earned higher average returns than firms with high P/E ratios

Basu (1977, 1983) found that firms with high P/E ratios

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

Which of the following are used by fundamental analysts to determine proper stock prices?

earnings, dividend prospects, expectations of future interest rates

Studies of stock price reactions to news are called

event studies