Module 38.1: Market Efficiency Flashcards

1
Q

What is an informationally efficient capital market?

A

is one in which the current price of a security fully, quickly, and rationally reflects all available information about the security.

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2
Q

What strategy should investors use in a perfectly efficient market?

A

passive investment strategy, because active investment management strategies will underperform due to transactions costs and management fees.

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3
Q

What is the difference between market value and intrinsic value or fundamental value?

A

fundamental value is the value that a rational investor with full knowledge about the asset would willingly pay.

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4
Q

How does the number of market participants effect efficiency?

A

larger number of investors, analysts, and traders the more efficient

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5
Q

how does availability of information effect efficiency?

A

more information the more efficient, in emerging markets, the availability of information is lower, and consequently market prices are relatively less efficient.

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6
Q

How does impediments to trading arbitrage improve efficiency?

A

impediments to arbitrage such as transaction costs and lack of indormation will limit arbitrage activity and allow some price inefficiencies.

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7
Q

how does transaction and information costs effect market efficiency?

A

to the extent the costs of trading are higher than expected profit, the market prices will be inefficient.

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8
Q

What is weak form market efficiency?

A

states that current security prices fully reflect all currently available security market data. a trader cannot achieve risk positive returns on average by using technical analysis.

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9
Q

what is semi-strong form market efficiency?

A

security prices rapidly adjust without bias to arival of new public information. cannot achieve positive risk adjusted returns by using fundamental analysis.

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10
Q

what is strong form market efficiency?

A

security prices fully reflect all information from both public and private sources. no investor can achieve positive abnormal returns.

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11
Q

What is technical analysis?

A

seeks to earn positive returns by using historical price and volume data.

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12
Q

What is fundamental analysis?

A

based on public information such as earnings, dividends, and various accounting ratios and estimates.

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13
Q

How can an investor test a semi-strong form market?

A

event study - examines the abnormal returns before and after the release of new information that affects a firms intrinsic value.

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14
Q

What is the strategy applied to semi-strong efficiency?

A

a passive investment strategy. portfolio managers can add value by establishing and implementing portfolio risk and return onjectives and tax management.

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15
Q

What are calendar anomalies?

A

finding that during the first five days of january, stock returns, epecially for small furms are significantly higher than they are the rest of the year.

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16
Q

What is tax-loss selling and window dressing?

A

tax-loss selling - sell losiing positions in december to realize losses for tax purposes

window dressing - sell risky stocks in december to remove them from their year-end statements. will be repurchased in January.

17
Q

What is the overreaction and momentum effect?

A

overreaction - firms with poor stock returns over the previous three or five years have better subsequent returns than firms that had high stock returns over the prior period.

Momentum - high short term reutrns are followed by continued high returns.

18
Q

What is the size effect?

A

refers to initial findings that small cap stocks outperform large cap stocks.

19
Q

What is the value effect?

A

finding that value stocks (higher dividend yields) have outperformed growth stocks.

20
Q

What is the closed-end investment fund effect?

A

when a fund trades at a different price than NAV. caused by management fees, taxes, and future capital gains.

21
Q

What is an earnings surprise?

A

portion of earnings not expected by the market.

22
Q

What is the initial public offerings effect on market effiicency?

A

IPOs are typically underpriced

23
Q

What is behavioral finance?

A

examines the actual decision making process of investors. conclusion that investors are not the rational utility-maximizing decision makers with complete information that traditional finance assumes they are.

24
Q

What are three biases and behaviors that are considered evidence of irrational behavior?

A

1) Loss aversion - tendency of investors to be more risk averse when faced with potential losses
2) investor overconfidence - overestimate their abilities to analyze security information
3) herding - investors act on same side of the market.

25
Q

what is an information cascade?

A

results when investors mimic the decisions of others.