ch 9

Question 1

What is Modern Portfolio Theory (MPT) based on

Answer 1

the logic that all investors are risk-averse.

Question 2

What do EMH (effective market hypothesis) opponents respond with?

Answer 2

1) risk and 2) luck

Question 3

What three factors lead to market efficiency?

Answer 3

investor rationality, independent deviations from rationality, arbitrage

Question 4

What does “Rational” mean?

Answer 4

that investors do not systematically overvalue or undervalue financial assets in light of the information they possess.

Question 5

What are the three forms of market efficiency?

Answer 5

Strong-form set, semistrong-form set, weak-form set

Question 6

Weak Form of market Efficiency

Answer 6

efficiency states that information reflected in past prices and volume figures is of no value in beating the market

Question 7

If you believe the market is weak form efficient then what is of no use?

Answer 7

technical analysis- all past price volume data are worked into a stock’s price

Question 8

Semi-strong of market efficiency

Answer 8

states that publicly available information of any and all kinds is of no use in beating the market.

Question 9

If you believe the market is semi-strong form efficient then what is of no use?

Answer 9

then fundamental analysis (studying past price and volume data & studying earnings and growth forecasts) is useless.

Question 9

Strong form of market efficiency

Answer 9

states that no information of any kind, public or private is useful in beating the market.

Question 10

If you believe the market is strong form efficient then what is of no use?

Answer 10

ignoring the issue of legality, possessing non-public inside information is useless when it comes to beating the market.

Question 11

Insider

Answer 11

anyone who possesses material nonpublic information

Question 12

Market anomalies

Answer 12

predictable abnormal returns and can be interpreted as known deviations of efficiency.

Question 13

What does it mean to beat the market?

Answer 13

Investor earns an excess return against a benchmark with equal risk.

Question 14

Technical Analysis

Answer 14

using the historical market activity of a security to predict future price movement

Question 15

Day-Trading

Answer 15

the rapid buying and selling of securities to make quick profits but have all open orders closed out by the day’s market close

Question 16

Fundamental Analysis

Answer 16

an investment evaluation method that using public info in an attempt to measure a security’s intrinsic value

Question 17

Event study

Answer 17

a statistical method of assessing the impact of an event on a stock’s price

Question 18

What form of efficiency do most professionals agree the market is not?

Answer 18

Strong form efficient. The debate is weather the market is weak form or semi-strong.

Question 19

What are the three inherent difficulties in measuring market efficiency?

Answer 19

1- the measure used for risk
2- dumb luck
2- data dredging

Question 20

What are some of the anomalies to market efficiency?

Answer 20

-earnings announcement anomaly
-the day of the week anomaly
-the January effect
-the size effect
-price-to-earnings anomaly
most are too

Question 21

Earnings announcement anomaly

Answer 21

According to EMH, prices should then adjust very quickly to the earnings “surprise”.

However, some research shows it takes days for the market price to adjust fully.

Question 22

The day of the week

Answer 22

Market appears to be better on Friday and the worst on Mondays

Question 23

The January Effect

Answer 23

January is frequently the best-preforming month for small-cap stocks, especially those who underperformed in the month of December

More specifically – the “small stock in January especially around the turn of the year for losers effect” – or SSIJEATTOTYFLE.

This one is partially understood:
Tax loss selling
Institutional investors

Question 24

Size effect

Answer 24

Small-capitalization stocks tend to provide investors with a greater risk-adjusted return than mid-cap and large-cap stocks.

This abnormal risk-adjusted return takes into consideration the fact that small-cap stocks are naturally more volatile than larger firms, and investors should be compensated for taking on the additional risk.

What some studies have found is that investors are compensated more than they should be for the risk taken in a small-cap stock.

Question 25

Price-to-earnings anomaly

Answer 25

The P/E ratio is widely followed by investors and used in stock valuation.

Research shows that, on average, stocks with relatively low P/E ratios outperform those with relatively high P/E ratios.

According to EMH, the P/E is publicly available and should already be worked into the stocks price; nevertheless, some research shows that buying low P/E stocks is a positive investment strategy

Question 26

The Fama and French three factor model

Answer 26

Expanded on the capital asset pricing model/ The model looks at:
1- market risk (measured by beta)
2- company size (smaller companies tend to outperform)
3- P/E (Lower P/E firms tend to outperform)

Basically this model states that portfolios that are heavy in small-cap and/or vale stocks provide greater risk-addjusted returans than other portfolios along the efficient frontier

Question 27

Capital Asset pricing model

Answer 27

Model that describes the relationship between systematic risk and expected return