Finance Chapter 12

Strong Form Efficient Market

A market is strong form efficient if traders cannot generate an abnormal return from any public or private information. A strong form efficient market is also semi strong and weak form efficient. Strong form efficient markets serve as a benchmark for ultimate market efficiency: prices are always priced correctly for their value. Strong form efficient markets do not exist, because private insider information can undoubtedly be used to generate abnormal returns Traders would love strong form efficient markets if they existed because they would never be purchasing mispriced investments

Semi-Strong Form Efficient Market

A semi strong form efficient market is one where no one can use all public information- including SEC reporting, in order to generate abnormal returns. If a market is semi- strong form efficient, it is also weak form efficient In Finance 300, we assume that markets are reasonably semi strong efficient assumes that prices fully reflect all publicly available information

Equity Premium Puzzle

Anyone who knows a little bit of finance knows that to assume more risk, an investor must have a larger return.

13. Which form(s) of market efficiency supports the idea that market prices reflect all public but not all private information? Select one or more correct answers. A. weak form B. semi-strong form C. strong form D. both weak and semi-strong forms E. weak form but not strong form F. None of the above is correct.

B

Which of the following categories of securities had the second most volatile returns since the 1920s? Select thesingle best answer. A. U.S. Treasury bills B. large-company stocks C. long-term corporate bonds D. intermediate-term government bonds E. long-term government bonds F. None of the above is correct.

B

Which of the following statements are correct for the period since the 1920s? A. The standard deviation of the returns on large-company stocks exceeded the standard deviation of the returns on small-company stocks. B. The frequency distribution of the returns on large-company stocks is wider than the frequency distribution of the returns on long-term corporate bonds. C. The average annual rate of inflation exceeded the average annual return on U.S. Treasury bills. D. The standard deviation of the returns on U.S. Treasury bills was zero percent. E. The average U.S. Treasury bill rate exceeded inflation, which was compensation for waiting. F. None of the above is correct.

B, E

The normal distribution is so useful in analyzing security returns because A. we frequently deal with finite data sets B. it allows investors to assign probabilities to events C. 95 percent of all observations fall within two standard deviations of the mean D. the distribution of security returns varies so much from a normal distribution E. it can be entirely described by its mean and standard deviation F. None of the above correctly completes the sentence

B,E

If the stock market is efficient, then which of the following statements are true? Select one or more correct answers. A. Stock prices slowly adjust to reflect new information diffusing through the economy over days. B. Stock prices over-react immediately to the new information, then adjust to proper levels over time. C. Stock prices instantaneously adjust to reflect new information. D. Then, on average, it will be difficult to earn profits from mispriced stocks. E. Retail investors should avoid the market because they will regularly be taken advantage of by professionals. F. None of these statements is true.

C, D

Which of the following categories produced the lowest average annual rate of return based on the historical record for the period since the 1920s? Select the single best answer. A. long-term corporate bonds B. large-company stocks C. long-term government bonds D. intermediate-term government bonds E. small-company stocks F. None of the above is correct.

D

Which of the following statements are true? A. Capital market efficiency is attributable largely to the lack of competition among market participants for information. B. Investors should not count capital gains as part of total returns until the security is sold since the capital gain is really only a paper gain up to that point. C. Your classmate just made $10,000 in a single day by trading in the stock market. It is reasonable to conclude, therefore, that the efficient market hypothesis cannot be true. D. From capital market history, the greater the risk, the greater the compensation for inflation. E. The equity premium puzzle concerns the large additional risk premium of small-company stocks above large company stocks. F. None of the choices is true

F: None of the above are true

Fundamental Analysis

Fundamental analysis uses all public information to forecast a businesses' future cash flows, and then discounts them back to find the true value of the stock. If a market is semi strong form efficient, fundamental analysis will not generate a positive alpha

Technical Analysis

Technical analysis compares historical data to lead trading strategy. It usually uses short and long run moving averages of cost and volume data in order to generate abnormal returns. Technical analysis is pointless if the market for a particular asset is weak form efficient, because public data such as price and volume data cannot be used to generate abnormal returns

arithmetic average

The average that we know and love when we begin to think of returns in terms of their average, the arithmetic average is the mean of the distribution found by simply adding all of the returns and dividing by tghe number of returns observed. The arithmetic average is the one that minimizes error. Half of the values will be above it and half of them will be below it.

Equity Premium Puzzle

The compensation to move from fixed income to stocks is abnormally large. Stocks are much more volatile, so why is the return so much larger?

Momentum

The concept of momentum is an important exception of the weak form efficient equity markets. The strategy of going long recent winners and shorting recent losers generates small positive abnormal returns, which goes against the weak form efficient market

geometric average

The geometric average is the rate that relates the present vale to the future value. A stock may have lots of different fluctuations in a year, but the geometric average is the one that moves the PV to the FV.

Alpha

The measure of investment performance above and beyond the risk of the investor, indicating an abnormal return

Shortselling

When you think that a company stock is going to

Weak form efficient

weak form efficient markets are those where investors cannot receive abnormal returns by using public market information like cost and volume. Assuming a market is weak form efficient, technical analysis is useless An important exception to the weak form efficient market hypothesis is the concept of Momentum Advocates of the weak form efficiency believe that stock prices fully reflect all past market data, and so this data cannot be used to gain an informational advantage