The Efficient Market Hypothesis Flashcards
What is true about stock prices?
a) They follow a systematic pattern
b) To a close approximation they seem to follow a random walk.
c) Only new information will move stock prices, this information is usually positive.
b) To a close approximation they seem to follow a random walk.
Only new information will move stock prices, but this information is equally likely to be good or bad news.
Market participants distinguish among three forms of the efficient market hypothesis.
The ______ form, which generally is acknowledged to be extreme, asserts that all information, including insider information, is reflected in prices.
The _______ form asserts that all information to be derived from past trading data already is reflected in stock prices.
The ________ form claims that all publicly available information is already reflected.
a) Efficient
b) Semi-strong
c) Weak
d) strong
The (d) strong form, which generally is acknowledged to be extreme, asserts that all information, including insider information, is reflected in prices.
The (c) weak form asserts that all information to be derived from past trading data already is reflected in stock prices.
The (b) semi strong form claims that all publicly available information is already reflected.
True or false
Proponents of the efficient market hypothesis often advocate active as opposed to passive investment strategies
False
Proponents of the efficient market hypothesis often advocate PASSIVE as opposed to ACTIVE investment strategies.
The policy of passive investors is to buy and hold a broad-based market index. They expend resources neither on market research nor on frequent purchase and sale of stocks. Passive strategies may be tailored to meet individual investor requirements.
Which of the following describe technical analysis?
a) Focuses on the determinants of the underlying value of the firm, such as current profitability and growth prospects.
b) Passive strategies
c) Active portfolio management
d) Focuses on stock price patterns and on proxies for buy or sell pressure in the market.
d) Focuses on stock price patterns and on proxies for buy or sell pressure in the market.
Technical analysis is essentially the search for recurrent and predictable patterns in stock prices. Whatever the fundamental reason for a change in stock price, if the stock price responds slowly enough, the analysis will be able to identify a trend that can be exploited during the adjustment period.
Which of the following describe fundamental analysis?
a) Focuses on the determinants of the underlying value of the firm, such as current profitability and growth prospects.
b) Passive strategies
c) Active portfolio management
d) Focuses on stock price patterns and on proxies for buy or sell pressure in the market.
a) Focuses on the determinants of the underlying value of the firm, such as current profitability and growth prospects.
Fundamental analysis uses earnings and dividend prospects of the firm, expectations of future interest rates and risk evaluation of the firm to determine proper stock prices. Ultimately, it represents an attempt to determine the PV of all the payments a stockholder will receive from each share of stock.
Both technical and fundamental analysis are based on public information, therefore, neither should generate excess profits if markets are operating efficiently.
How is abnormal return computed?
Abnormal return = Actual return -Expected return given the return on a market index
Why should information that could be used to predict stock performance already be reflected in stock prices?
As soon as there is any information indicating that a stock is underpriced, and therefore offers a profit opportunity, investors flock to buy the stock and immediately bid up its price to a fair level, where only ordinary rates (=return commensurate with risk of stock) of return can be expected. At those levels one cannot expect abnormal returns.
What does the efficient market hypothesis (EMH) reflect?
a) All information is reflected in the stock price
b) Selected information is reflected in the stock price
c) All available information is reflected in the stock price
d) No information is reflected in the stock price
c) All available information is reflected in the stock price
What is true about resistance and support levels?
a) Terms describing price levels
b) These levels are believed to be determined by market psychology.
c) Above these there are difficult for stock prices to rise and below these there are unlikely for stocks to fall.
d) All of the above
d) All of the above
What does proponents of the EMH advocate?
a) Active management
b) Passive investment strategy
Why?
b) Passive investment strategy
They believe active management is largely wastes effort and unlikely to justify the expenses incurred. They advocate a passive investment strategy that makes no attempt to outsmart the market. Because EMH indicates that stock prices are at fair levels, given all available information, it makes no sense to buy and sell securities frequently, due to large trading costs without increasing expected performance.
Which of the following describe event studies?
a) Focuses on the determinants of the underlying value of the firm, such as current profitability and growth prospects.
b) A technique of empirical financial research that enables an observer to assess the impact of a particular event on a firm’s stock price.
c) Active portfolio management
d) Focuses on stock price patterns and on proxies for buy or sell pressure in the market.
b) A technique of empirical financial research that enables an observer to assess the impact of a particular event on a firm’s stock price.
It quantifies the relationship between dividend changes and stock returns.
Which of the following describe the magnitude issue?
a) Under the hypothesis that any stock is fairly priced, given all available information, any bet on a stock is simply a coin toss. Equal likelihood of winning or losing the bet. However, if many investors using a variety of schemes make fair bets, statistically speaking, some of those investors will be lucky and win a great majority of the bets.
b) Annual standard deviation of S&P500 is 20%. Hence a 0,1% annual contribution to a portfolio performance would be swamped by the volatility of the market. A small increase in performance will be hard to detect among all the fluctuations in the index.
c) When you discover a profitable investment scheme you have two options, publish in The Wall Street Journal, or keep it a secret. Only investors who don’t are able to create abnormal returns will report their techniques. Opponents of EMH will therefore always be able to use evidence that various techniques do not provide investment rewards as proof that the techniques that do work simply are not being reported to the public.
b) Annual standard deviation of S&P500 is 20%. Hence a 0,1% annual contribution to a portfolio performance would be swamped by the volatility of the market. A small increase in performance will be hard to detect among all the fluctuations in the index.
Which of the following describe the selection bias issue?
a) Under the hypothesis that any stock is fairly priced, given all available information, any bet on a stock is simply a coin toss. Equal likelihood of winning or losing the bet. However, if many investors using a variety of schemes make fair bets, statistically speaking, some of those investors will be lucky and win a great majority of the bets.
b) Annual standard deviation of S&P500 is 20%. Hence a 0,1% annual contribution to a portfolio performance would be swamped by the volatility of the market. A small increase in performance will be hard to detect among all the fluctuations in the index.
c) When you discover a profitable investment scheme you have two options, publish in The Wall Street Journal, or keep it a secret. Only investors who don’t are able to create abnormal returns will report their techniques. Opponents of EMH will therefore always be able to use evidence that various techniques do not provide investment rewards as proof that the techniques that do work simply are not being reported to the public.
c) When you discover a profitable investment scheme you have two options, publish in The Wall Street Journal, or keep it a secret. Only investors who don’t are able to create abnormal returns will report their techniques. Opponents of EMH will therefore always be able to use evidence that various techniques do not provide investment rewards as proof that the techniques that do work simply are not being reported to the public.
Which of the following describe the lucky event issue?
a) Under the hypothesis that any stock is fairly priced, given all available information, any bet on a stock is simply a coin toss. Equal likelihood of winning or losing the bet. However, if many investors using a variety of schemes make fair bets, statistically speaking, some of those investors will be lucky and win a great majority of the bets.
b) Annual standard deviation of S&P500 is 20%. Hence a 0,1% annual contribution to a portfolio performance would be swamped by the volatility of the market. A small increase in performance will be hard to detect among all the fluctuations in the index.
c) When you discover a profitable investment scheme you have two options, publish in The Wall Street Journal, or keep it a secret. Only investors who don’t are able to create abnormal returns will report their techniques. Opponents of EMH will therefore always be able to use evidence that various techniques do not provide investment rewards as proof that the techniques that do work simply are not being reported to the public.
a) Under the hypothesis that any stock is fairly priced, given all available information, any bet on a stock is simply a coin toss. Equal likelihood of winning or losing the bet. However, if many investors using a variety of schemes make fair bets, statistically speaking, some of those investors will be lucky and win a great majority of the bets.
Several studies have documented the ability of easily observed variables to predict market return – variation in the market risk premium.
Match studies and people.
a) The return on the aggregate stock market tends to be higher when the dividend/ price ratio, the dividend yield, is high.
b) The earnings yield can predict market returns.
c) Bond market data such as the spread between yields on high- and low-grade corporate bonds also help predict broad market returns.
i) Keim and Stambaugh.
ii) Fama and French.
iii) Campbell and Shiller.
a) - ii)
b) - iii)
c) - i)