Corporate finance Chapter 13

ALLGO announced at Time t that it was acquiring DoLittle Industries. There were no other announcements affecting these firms. ALLGO's stock had daily returns of -.2, +.1, -.5, -.1, +.1 for Time t - 2 to Time t + 2, respectively. The daily returns on the market were -.1, +.2, +.1, -.2, and +.2 for Time t - 2 to Time t + 2, respectively. What is the cumulative abnormal return for these five days?

-.8

The higher returns from value stocks could be due to

1. Biases in commercial databases 2. Differences in risk

Implications of the efficient market hypothesis (EMH)

1. Investors should expect a normal rate of return 2. Securities sellers will receive a fair price that reflects the present value of the security

According to EMH

1. Investors should expect only a normal return 2. Stock prices adjust to new information before the typical investor has time to trade on them 3. New information is immediately reflected in stock prices

Impact of fraud on security prices

1. It will distort prices in the short-run 2. Security prices will likely revert to equilibrium once the fraud is discovered

Earnings surprises occur when earnings are

1. Lower than expected 2. Higher than expected

Mutual Funds Popularity Reasons

1. Serving as a custodian of keeping record of all the stocks, 2. Large number of stocks (well-diversified portfolio)

Which one of the following statements is correct concerning market efficiency?

A firm will generally receive a fair price when it sells shares of stock in an efficient market.

A real world example that does not support market efficiency is called a

Anomaly

A positive coefficient of serial correlation of a particular stock indicates a tendency towards ________, which means that a higher-than-average return today is likely to be followed by higher-than -average returns in the future

Continuation

Serial Correlation

Correlation between the current return on a security and the return on the security same security in the future

Efficient markets require which one of these?

Countervailing irrationalities

Event studies

Examine the effect of an event or set of events on the value of a company or group of companies

Which of these are arguments that support the position that the efficient market hypothesis fails in actual application?

I. Arbitrage may involve too much risk to offset irrational behaviour II. Investors may be irrational III. Irrationalities are contervailing IV. Irrationality may be related across investors I, II, and IV only

Which of these help prevent arbitrage from totally correcting market mispricings?

I. Trading costs II. Market domination by rational professionals III. Number of amateur investors IV. Near-term risk I, III, and IV only

An efficient market is one that fully reflects all available

Information

Keim s research presents evidence that the difference in performance between small capitalization stocks and large capitalization stocks is largest in the month of:

January.

Representativeness

Judging the likelihood of things in terms of how well they seem to represent, or match, particular prototypes; may lead one to ignore other relevant information.

The efficient market hypothesis supports which one of these statements?

Market prices do not reflect the underlying value of securities. Managers can profitably speculate in foreign currency. Financial managers can time stock and bond sales. Managers cannot boost stock prices through creative accounting. Market prices are uncaused. Ans: Managers cannot boost stock prices through creative accounting.

What does weak form efficiency imply?

Past price movement is unrelated to the movement of future prices.

Weak form efficiency

Prices reflect all past market information such as price and volume. The least you should know about an asset is what has been traded (volume) and historical price/returns

Which one of these terms is used to describe a market where investors draw conclusions from insufficient data?

Representativeness

Internet stock bubble in the 1990's can be explained by

Representatives, overreaction

Which one of these would generally be considered the most rational action for a tax-paying investor?

Selling their losing and holding their winning securities

The U.S. Securities and Exchange Commission periodically charges individuals for insider trading and claims those individuals have made unfair profits. Based on this fact, you would tend to argue that the financial markets are at best _____ form efficient.

Semistrong

Insider trading does not offer any advantages if the financial markets are:

Strong Form Efficient

Arbitrage is more risky than it appears at first glance

True

On average, all mutual funds ________ the market by approximately _______ percent per year

Under perform, 2

In examining the issue of whether the choice of accounting methods affects stock prices, studies have found that:

a firm can affect its stock price if it either withholds information or provides incorrect information.

Market prices can be efficiently priced if

a number of interested traders use the publicly available information.

Based on the efficient market hypothesis, a stock's abnormal return at Time t is an indicator of:

a release of information at Time t.

The abnormal return in an event study is described as the:

actual return on a security minus the market rate of return on the same date

In an efficient market, the price of a security will:

be slow to react for the first few hours after new information is released allowing time for that information to be reviewed and analyzed.

The principle that investors might be too slow in adjusting their beliefs to new information is referred to as:

conservatism.

Stock prices fluctuate daily. In relation to the efficient market hypothesis, these fluctuations are:

consistent with the semistrong form because new information arrives daily.

The cause of the October 19, 1987 stock market crash:

has yet to be determined.

If the financial markets are efficient, then investors should expect their investments in those markets to:

have zero net present values.

Serial correlation:

involves only one security.

The efficient market hypothesis says that on average managers will:

not be able to earn an excess return

Sam, an avid day trader, has noticed that a particular stock has increased in value in each of the last three trading days. Given this trend, he believes the stock price will increase over the next two trading days. This is an example of:

representativeness.

The hypothesis that market prices reflect all publicly available information is called _____ form efficiency.

semistrong

Individuals that continually monitor the financial markets seeking mispriced securities:

tend to make the markets more efficient.