BKM 11

Question 1

Random walk

Answer 1

Stock price changes should be random and unpredictable

Question 2

Efficient market hypothesis

Answer 2

The notion that stocks already reflect all available information

Question 3

Weak-form hypothesis

Answer 3

Stock prices already reflect all information that can be derived by examining market trading data such as history of past prices, trading volume, or short interest.
Trend analysis is fruitless.

Question 4

Semistrong-form hypothesis

Answer 4

All publicly available information regarding the prospects of a firm must be already reflected in a stock’s price

Question 5

Strong-form hypothesis

Answer 5

Stock prices reflect all information relevant to the firm, even including information available only to company insiders.
Quite an extreme

Question 6

Technical analysis

Answer 6

Search for recurrent and predictable patterns in stock prices

Question 7

Resistance/support levels

Answer 7

Above which it is difficult for stock prices to rise, or below which it is unlikely for them to fall
Believed to be determined by market psychology

Question 8

EMH and technical analysis

Answer 8

EMH implies technical analysis is without merit

Question 9

Fundamental analysis

Answer 9

Uses earnings and dividend prospects of the firm, expectations of future interest rates, and risk evaluation of the firm to determine proper stock prices

Question 10

EMH and fundamental analysis

Answer 10

Most fundamental analysis is doomed to failure

Question 11

Passive investment strategy

Answer 11

Makes no attempt to outsmart the market; proponents of EMH prefer this strategy as other efforts are wasted

Question 12

Index fund

Answer 12

Fund designed to replicate performance of a broad-based index of stocks

Question 13

Role for portfolio management in efficient market

Answer 13

Tailor portfolio to investor needs depending on factors such as age, tax bracket, aversion, etc.

Question 14

Event study

Answer 14

Technique of empirical financial research that enables observers to assess the impact of a particular event on a firm’s stock price

Question 15

Abnormal return (definition)

Answer 15

Difference between actual stock return and a benchmark

Question 16

Abnormal return (formula)

Answer 16

e(t) = r(t) - a + br(M(t))

a = average rate of return with zero market return

Question 17

Cumulative abnormal return

Answer 17

Sum of all abnormal returns over a given time period; event studies could be complicated due to leakage of information

Question 18

SEC and availability of information

Answer 18

Dramatic increase in value with announcement date indicates these are indeed news to the market, not already reflected in the price

Question 19

Three factors the imply EMH does not hold

Answer 19

Magnitude Issue
Selection Bias Issue
Lucky Event Issue

Question 20

Magnitude issue

Answer 20

Small percentage increase could be large $-wise based on size of portfolio

Question 21

Selection bias issue

Answer 21

Only investors who find an investment scheme that does not generate abnormal returns will report findings

Question 22

Lucky event issue

Answer 22

Any bet on a stock is a coin toss, given EMH

Ex: Coin-flipper with 75% heads

Question 23

Weak-form tests

Answer 23

Patterns in stock returns

Question 24

Serial correlation

Answer 24

Tendency for stock returns to be related to past returns; positive over short horizons

Question 25

Momentum effect

Answer 25

Good or bad recent performance of particular stocks continues over time; evidence of short- to intermediate-horizon price momentum in both aggregate and cross-sectional

Question 26

Tests of long-horizon returns

Answer 26

Suggestions of pronounced negative long-term serial correlation in the performance of the aggregate market

Question 27

Fads hypothesis

Answer 27

Stock market may overreact to relevant news

Question 28

Reversal effect

Answer 28

Losers rebound and winners fade back

Stock market overreacts to relevant news

Question 29

Market anomalies

Answer 29

P/E effect
Small firm in January effect
Neglected firm effect
Liquidity effects
Book-to-Market ratios
Post-earnings announcement price drift

Question 30

P/E effect

Answer 30

Low price-earnings ratio stocks have provided higher returns than high P/E portfolios;
Low P/E = higher expected returns, so returns are not properly adjusted for risk

Question 31

Small-firm-in-January effect

Answer 31

Smaller-firm portfolios tend to be riskier;
Even when adjusted for risk (CAPM), still a consistent premium;
Concentrated in first 2 weeks of January

Question 32

Neglected-firm effect

Answer 32

Information about smaller firms is less available; neglected firms might be expected to earn higher returns as compensation for risk associated with limited information

Question 33

Liquidity effect

Answer 33

Small and less-analyzed stocks are less liquid; investors demand liquidity premium to invest in such stocks

Question 34

Book-to-Market ratios

Answer 34

Ratio of book value of firm’s equity to market value of firm’s ratio; book-to-market ratio might serve as a proxy for a risk factor

Question 35

Post-earnings announcement drift

Answer 35

Market adjusts to information only gradually, resulting in sustained period of abnormal returns

Question 36

Insider transactions

Answer 36

To no avail; abnormal returns not of sufficient magnitude to overcome transaction costs