5.3 market efficiency Flashcards
Market value
the price at which an asset currently trades.
intrinsic value (or fundamental value)
the theoretical value of an asset that would be calculated by investors if they possessed (and accurately processed) all relevant information.
Intrinsic value cannot be known with certainty, it can only be estimated.
An asset is described as mispriced if it is trading at a market value that
deviates from its intrinsic value
A market anomaly
a change in a security’s price that cannot be attributed to new information.
Anomalies may be observed for brief periods in an efficient market. However, for a market to be considered inefficient, anomalies must persist over long periods.
Fundamental analysts assume that markets are:
a) weak-form inefficient.
b) semi-strong-form efficient.
c) semi-strong-form inefficient.
c) semi-strong-form inefficient.
If a market is weak-form efficient but semi-strong-form inefficient, then which of the following types of portfolio management is most likely to produce abnormal returns?
a) Passive portfolio management.
b) Active portfolio management based on technical analysis.
c) Active portfolio management based on fundamental analysis.
c) Active portfolio management based on fundamental analysis.
If a researcher conducting empirical tests of a trading strategy using time series of returns finds statistically significant abnormal returns, then the researcher has most likely found:
a) a market anomaly.
b) evidence of market inefficiency.
c) a strategy to produce future abnormal returns.
a) a market anomaly.
Researchers have found that value stocks have consistently outperformed growth stocks. An investor wishing to exploit the value effect should purchase the stock of companies with above-average:
a) dividend yields.
b) market-to-book ratios.
c) price-to-earnings ratios.
a) dividend yields.
Higher than average dividend yield is a characteristic of a value stock, along with low price-to-earnings and low market-to-book ratios.
Growth stocks are characterized by low dividend yields and high price-to-earnings and high market-to-book ratios.
Which of the following market anomalies is inconsistent with weak-form market efficiency?
a) Earnings surprise.
b) Momentum pattern.
c) Closed-end fund discount.
b) Momentum pattern.
Trading based on historical momentum indicates that price patterns exist and can be exploited by using historical price information
A momentum trading strategy that produces abnormal returns contradicts the weak form of the efficient market hypothesis, which states that investors cannot earn abnormal returns on the basis of past trends in prices.
With respect to efficient markets, a company whose share price changes gradually after the public release of its annual report most likely indicates that the market where the company trades is:
a) semi-strong-form efficient.
b) subject to behavioral biases.
c) receiving additional information about the company.
c) receiving additional information about the company.
If markets are efficient, the information from the annual report is reflected in the stock prices; therefore, the gradual changes must be from the release of additional information.
With respect to rational and irrational investment decisions, the efficient market hypothesis requires:
a) only that the market is rational.
b) that all investors make rational decisions.
c) that some investors make irrational decision
a) only that the market is rational.
The efficient market hypothesis and asset-pricing models only require that the market is rational. Behavioral finance is used to explain some of the market anomalies as irrational decisions.
Observed overreactions in markets can be explained by an investor’s degree of:
a) risk aversion.
b) loss aversion.
c) confidence in the market.
b) loss aversion.
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).
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:
a_ leptokurtic.
b) symmetrical.
c) asymmetrical.
a_ leptokurtic.
The behavioral bias in which investors tend to avoid realizing losses but rather seek to realize gains is best described as:
a) mental accounting.
b) the gambler’s fallacy.
c) the disposition effect.
c) the disposition effect.
