Ch. 13: Efficient Markets & Behavioural Finance

Question 1

One key difference between financing decisions and investment decisions is different degree of reversibility. Explain what this means

Answer 1

Reversibility refers to the ease of reversing a decision. With investment decisions, it is more difficult and expensive to abandon a project, but with financing decisions, it is easier to reconstruct the capital structure if necessary

Question 2

What is meant by an efficient market?

A) a market where current prices reflect all information available to the public/ investors
B) prices rapidly impounded new information and only change when new information emerges
C) a market where it is difficult to make consistently superior returns
D) in an efficient market, investors can only expect a return that compensates for time-value of money and borne risk

Answer 2

All are true

Question 3

Which of the following statements are correct about the weak-form efficiency?

A) Current prices reflect all the information that can be derived from historical market trading data
B) historical data can be obtained at virtually no costs
C) Historical data reflected in prices incl. past prices, trading volume and short interest
D) Prices reflect all publicly available information

Answer 3

All are true except D

D) prices reflect all publicly available information in the semi-strong form of efficiency

Question 4

When prices reflect all publicly available information such as historical market trading data, accounting reports, earnings forecasts, announcements, etc.

This is a description of ____-___ of efficiency

Answer 4

Semistrong-form of efficiency

Question 5

When prices reflect all relevant information, even non-public such as insider information, this is a case of ____-_____ of efficiency

Answer 5

Strong-form of efficiency

Question 6

Behavioural finance is part of the explanation to why markets may indicate lack of full efficiency. More specifically, individual investor’s irrationality may cause market prices to deviate from fair value.´

True/ False

Answer 6

True

Question 7

Psychologists have observed that, when making risky decisions,
people are particularly loath to incur losses. It seems that investors do not focus solely
on the current value of their holdings, but look back at whether their investments are
showing a profit or a loss.

This phenomenon is termed ____ _____

Answer 7

Prospect theory

Question 8

Under the belief that markets are efficient, following lessons hold (Select all correct)
A) markets have no memory
B) market prices are trustworthy
C) read the entrails
D) the “do-it-yourself” alternative
E) high-minus-low book to market value
F) Seen one stock, seen them all

Answer 8

A) markets have no memory
B) market prices are trustworthy
C) read the entrails
D) the “do-it-yourself” alternative
F) Seen one stock, seen them all

Question 9

Under the belief that markets are efficient, it holds that markets have no memory. This means that an investor should not buy or sell shares based on apparent trends or cycles in returns

True/ False

Answer 9

True

Question 10

Under the belief that markets are efficient, it holds that one can trust market prices. This means that there is no reason to think that the CFO has superior information, and that market prices simply reflect all available information

True/ False

Answer 10

True

Question 11

What is the objective of financing decisions?

Answer 11

To find positive NPV financing opportunities