Investments Canadian Canadian 8th Edition Bodie Test Bank

Investments Canadian Canadian 8th
Edition Bodie Test Bank

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09
Student: _______________________________________________________________________________________
1. If you believe in the ________ form of the EMH, you believe that stock prices reflect all relevant
information including historical stock prices and current public information about the firm, but not
information that is available only to insiders.
A. semistrong
B. strong
C. weak
D. a, b, and c
E. none of these
2. When Maurice Kendall examined the patterns of stock returns in 1953, he concluded that the stock
market was __________. Now, these random price movements are believed to be _________.
A. inefficient; the effect of a wellfunctioning market

B. efficient; the effect of an inefficient market
C. inefficient; the effect of an inefficient market
D. efficient; the effect of a wellfunctioning market
E. irrational; even more irrational than before
3. The stock market follows a
A. nonrandom walk.
B. submartingale.
C. predictable pattern that can be exploited.
D. nonrandom walk and predictable pattern that can be exploited.
E. submartingale and predictable pattern that can be exploited.
4. A hybrid strategy is one where the investor
A. uses both fundamental and technical analysis to select stocks.

B. selects the stocks of companies that specialize in alternative fuels.
C. selects some activelymanaged mutual funds on their own and uses an investment advisor to select
other activelymanaged funds.
D. maintains a passive core and augments the position with an actively managed portfolio.
E. None of these are correct.
5. The difference between a random walk and a submartingale is the expected price change in a random
walk is ______, and the expected price change for a submartingale is ______.
A. positive; zero
B. positive; positive
C. positive; negative
D. zero; positive
E. zero; zero
6. Proponents of the EMH typically advocate
A. an active trading strategy.

B. investing in an index fund.
C. a passive investment strategy.
D. a and b
E. b and c
A. buying individual stocks on margin and trading frequently.

B. investing in hedge funds.
D. buying individual stocks on margin and trading frequently and investing in hedge funds.
E. investing in hedge funds and a passive investment strategy.
8. If you believe in the _______ form of the EMH, you believe that stock prices reflect all information
that can be derived by examining market trading data such as the history of past stock prices, trading
volume or short interest.
A. semistrong
B. strong
C. weak
D. all of these
E. none of these
9. If you believe in the _________ form of the EMH, you believe that stock prices reflect all available
information, including information that is available only to insiders.
A. semistrong
B. strong
C. weak
D. all of these
E. none of these
10. If you believe in the reversal effect, you should
A. buy bonds in this period if you held stocks in the last period
B. buy stocks in this period if you held bonds in the last period
C. buy stocks this period that performed poorly last period
D. go short
E. c and d
11. __________ focus more on past price movements of a firm's stock than on the underlying
determinants of future profitability.
A. Credit analysts
B. Fundamental analysts
C. Systems analysts
D. Technical analysts
E. Specialists
12. ___________ the return on a stock beyond what would be predicted from market movements alone.
A. An excess economic return is

B. An economic return is
C. An abnormal return is
D. a and b
E. a and c
13. The debate over whether markets are efficient will probably never be resolved because of ________.
A. the lucky event issue

B. the magnitude issue
C. the selection bias issue
D. all of these
E. none of these
14. A common strategy for passive management is ____________.
A. creating an index fund

B. creating a small firm fund
C. creating an investment club
D. a and c
E. b and c
15. Arbel (1985) found that
A. the January effect was highest for neglected firms.

B. the booktomarket value ratio effect was highest in January.
C. the liquidity effect was highest for small firms.
D. the neglected firm effect was independent of the small firm effect.
E. small firms had higher booktomarket value ratios.
16. Researchers have found that most of the small firm effect occurs
A. during the spring months.

B. during the summer months.
C. in December.
D. in January.
E. randomly.
17. Basu (1977, 1983) found that firms with low P/E ratios
A. earned higher average returns than firms with high P/E ratios.
B. earned the same average returns as firms with high P/E ratios.
C. earned lower average returns than firms with high P/E ratios.
D. had higher dividend yields that firms with high P/E ratios.
E. none of these.
18. Basu (1977, 1983) found that firms with high P/E ratios.
A. earned higher average returns than firms with low P/E ratios.
B. earned the same average returns as firms with low P/E ratios.
C. earned lower average returns than firms with low P/E ratios.
D. had higher dividend yields than firms with low P/E ratios.
19. Jaffe (1974) found that stock prices _______ after insiders intensively bought shares while a later
study by Seyhun (1986) found _________
A. decreased; buying on insider trading did not yield abnormal returns.

B. decreased; buying on insider trading produced significant abnormal returns.
C. increased; buying on insider trading did not yield abnormal returns.
D. increased; buying on insider trading produced significant abnormal returns.
E. remained stable; buying on insider trading produced significant abnormal returns.
20. Banz (1981) found that, on average, the riskadjusted returns of small firms
A. were higher than the riskadjusted returns of large firms.

B. were the same as the riskadjusted returns of large firms.
C. were lower than the riskadjusted returns of large firms.
D. were unrelated to the riskadjusted returns of large firms.
E. were negative.
21. Banz (1981) found that, on average, the riskadjusted returns of large firms
A. were higher than the riskadjusted returns of small firms.

B. were the same as the riskadjusted returns of small firms.
C. were lower than the riskadjusted returns of small firms.
D. were unrelated to the riskadjusted returns of small firms.
E. were negative.
22. Proponents of the EMH think technical analysts
A. should focus on relative strength.

B. should focus on resistance levels.
C. should focus on support levels.
D. should focus on financial statements.
E. are wasting their time.
23. Studies of positive earnings surprises have shown that there is
A. a positive abnormal return on the day positive earnings surprises are announced.
B. a positive drift in the stock price on the days following the earnings surprise announcement.
C. a negative drift in the stock price on the days following the earnings surprise announcement.
D. both a and b are true.
E. both a and c are true.
24. Studies of negative earnings surprises have shown that there is
A. a negative abnormal return on the day that negative earnings surprises are announced.
D. a negative abnormal return on the day that negative earnings surprises are announced and a positive
drift in the stock price on the days following the earnings surprise announcement.
E. a negative abnormal return on the day that negative earnings surprises are announced and a negative
25. Studies of stock price reactions to news are called
A. reaction studies.
B. event studies.
C. drift studies.
D. reaction studies and event studies.
E. event studies and drift studies.
26. On November 22, 2012 the stock price of WalMart was $69.50 and the retailer stock index was
600.30. On November 25, 2012 the stock price of WalMart was $40.25 and the retailer stock index
was 605.20. Consider the ratio of WalMart to the retailer index at November 22 and November 25.
WalMart is _______ the retail industry and technical analysts who follow relative strength would
advise _______ the stock.
A. outperforming; buying
B. outperforming; selling
C. underperforming; buying
D. underperforming; selling
E. equally performing; neither buying nor selling
27. Work by Amihud and Mendelson (1986, 1991)
A. argues that investors will demand a rate of return premium to invest in less liquid stocks.
B. may help explain the small firm effect.
C. may be related to the neglected firm effect.
D. b and c
E. a, b, and c
28. Fama and French (1992) found that the stocks of firms within the highest decile of market/book
ratios had average monthly returns of _______ while the stocks of firms within the lowest decile of
market/book ratios had average monthly returns of
A. greater than 1%, greater than 1%

B. greater than 1%, less than 1%
C. less than 1%, greater than 1%
D. less than 1%, less than 1%
E. less than 0.5%, greater than 0.5%
29. Empirical research by DeBondt and Thaler (1985), and Chopra, Lakonishok and Ritter (1992)
A. found that poorly stocks that performed poorly in one period experienced sizable reversals in the
subsequent period.
B. found that stocks that performed poorly in one period experienced poor performance in the
subsequent period.
C. found that stocks that performed poorly in one period experienced neither better nor worse
performance than other stocks in the subsequent period.
D. did not try to test the reversal effect.
E. reinforces the EMH.
30. A market decline of 23% on a day when there is no significant macroeconomic event ______
consistent with the EMH because ________.
A. would be, because it was a clear response to macroeconomic news

B. would be, because it was not a clear response to macroeconomic news
C. would not be, because it was a clear response to macroeconomic news
D. would not be, because it was not a clear response to macroeconomic news
E. We cannot tell based on the information given
31. In an efficient market, __________.
A. security prices react quickly to new information.

B. security prices are seldom far above or below their justified levels.
C. security analysts will not enable investors to realize superior returns consistently.
D. one cannot make money.
E. a, b, and c
32. The weak form of the efficient market hypothesis asserts that
A. stock prices do not rapidly adjust to new information contained in past prices or past data.
B. future changes in stock prices cannot be predicted from past prices.
C. technicians cannot expect to outperform the market.
D. a and b
E. b and c
33. A finding that _________ would provide evidence against the semistrong form of the efficient
market theory.
A. low P/E stocks tend to have positive abnormal returns

B. trend analysis is worthless in determining stock prices
C. one can consistently outperform the market by adopting the contrarian approach exemplified by the
reversals phenomenon
D. a and b
E. a and c
34. The weak form of the efficient market hypothesis contradicts
A. technical analysis, but supports fundamental analysis as valid.

B. fundamental analysis, but supports technical analysis as valid.
C. both fundamental analysis and technical analysis.
D. technical analysis, but is silent on the possibility of successful fundamental analysis.
E. none of these.
35. Two basic assumptions of technical analysis are that security prices adjust
A. rapidly to new information and market prices are determined by the interaction of supply and
demand.
B. rapidly to new information and liquidity is provided by security dealers.
C. gradually to new information and market prices are determined by the interaction of supply and
demand.
D. gradually to new information and liquidity is provided by security dealers.
E. rapidly to information and to the actions of insiders.
36. Cumulative abnormal returns (CAR)
A. are used in event studies.

B. are better measures of security returns due to firmspecific events than are abnormal returns (AR).
C. are cumulated over the period prior to the firmspecific event.
D. a and b.
E. a and c.
37. Studies of mutual fund performance
A. indicate that one should not randomly select a mutual fund.

B. indicate that historical performance is not necessarily indicative of future performance.
C. indicate that the professional management of the fund insures above market returns.
D. a and b.
E. b and c.
38. The likelihood of an investment newsletter's successfully predicting the direction of the market for
three consecutive years by chance should be
A. between 50% and 70%.

B. between 25% and 50%.
C. between 10% and 25%.
D. less than 10%.
E. greater than 70%.
39. In an efficient market the correlation coefficient between stock returns for two nonoverlapping time
periods should be
A. positive and large.

B. positive and small.
C. zero.
D. negative and small.
E. negative and large.
40. The weather report says that a devastating and unexpected freeze is expected to hit Florida tonight,
during the peak of the citrus harvest. In an efficient market one would expect the price of Florida
Orange's stock to
A. drop immediately.
B. remain unchanged.
C. increase immediately.
D. gradually decline for the next several weeks.
E. gradually increase for the next several weeks.
41. Matthews Corporation has a beta of 1.2. The annualized market return yesterday was 13%, and the
riskfree rate is currently 5%. You observe that Matthews had an annualized return yesterday of 17%.
Assuming that markets are efficient, this suggests that
A. bad news about Matthews was announced yesterday.

B. good news about Matthews was announced yesterday.
C. no news about Matthews was announced yesterday.
D. interest rates rose yesterday.
E. interest rates fell yesterday.
42. Nicholas Manufacturing just announced yesterday that its 4thquarter earnings will be 10% higher
than last year's 4th quarter. You observe that Nicholas had an abnormal return of 1.2% yesterday.
This suggests that
A. the market is not efficient.

B. Nicholas' stock will probably rise in value tomorrow.
C. investors expected the earnings increase to be larger than what was actually announced.
D. investors expected the earnings increase to be smaller than what was actually announced.
E. earnings are expected to decrease next quarter.
43. When Maurice Kendall first examined stock price patterns in 1953, he found that
A. certain patterns tended to repeat within the business cycle.

B. there were no predictable patterns in stock prices.
C. stocks whose prices had increased consistently for one week tended to have a net decrease the
following week.
D. stocks whose prices had increased consistently for one week tended to have a net increase the
following week.
E. the direction of change in stock prices was unpredictable, but the amount of change followed a
distinct pattern.
44. If stock prices follow a random walk
A. it implies that investors are irrational.

B. it means that the market cannot be efficient.
C. price levels are random.
D. price changes are random.
E. price movements are predictable.
45. The main difference between the three forms of market efficiency is that
A. the definition of efficiency differs.

B. the definition of excess return differs.
C. the definition of prices differs.
D. the definition of information differs.
E. they were discovered by different people.
46. Chartists practice
A. technical analysis.
B. fundamental analysis.
C. regression analysis.
D. insider analysis.
E. psychoanalysis.
47. Which of the following are used by fundamental analysts to determine proper stock prices?
I) trendlines
II) earnings
III) dividend prospects
IV) expectations of future interest rates
V) resistance levels
A. I, IV, and V
B. I, II, and III
C. II, III, and IV
D. II, IV, and V
E. All of the items are used by fundamental analysts.
48. According to proponents of the efficient market hypothesis, the best strategy for a small investor with
a portfolio worth $40,000 is probably to
A. perform fundamental analysis.

B. exploit market anomalies.
C. invest in Treasury securities.
D. invest in derivative securities.
E. invest in mutual funds.
49. Which of the following are investment superstars who have consistently shown superior
performance?
I) Warren Buffet
II) Phoebe Buffet
III) Peter Lynch
IV) Merrill Lynch
V) Jimmy Buffet
A. I, III, and IV
B. II, III, and IV
C. I and III
D. III and IV
E. I, III, IV, and V
50. Google has a beta of 1.0. The annualized market return yesterday was 11%, and the riskfree rate is
currently 5%. You observe that Google had an annualized return yesterday of 14%. Assuming that
markets are efficient, this suggests that
A. bad news about Google was announced yesterday.

B. good news about Google was announced yesterday.
C. no news about Google was announced yesterday.
51. Music Doctors has a beta of 2.25. The annualized market return yesterday was 12%, and the riskfree
rate is currently 4%. You observe that Music Doctors had an annualized return yesterday of 15%.
A. bad news about Music Doctors was announced yesterday.

B. good news about Music Doctors was announced yesterday.
C. no news about Music Doctors was announced yesterday.
52. QQAG has a beta of 1.7. The annualized market return yesterday was 13%, and the riskfree rate is
currently 3%. You observe that QQAG had an annualized return yesterday of 20%. Assuming that
A. bad news about QQAG was announced yesterday.

B. good news about QQAG was announced yesterday.
C. no significant news about QQAG was announced yesterday.
53. QQAG just announced yesterday that its fourth quarter earnings will be 35% higher than last year's
fourth quarter. You observe that QQAG had an abnormal return of 1.7% yesterday. This suggests
that

B. QQAG stock will probably rise in value tomorrow.
54. LJP Corporation just announced yesterday that it would undertake an international joint venture. You
observe that LJP had an abnormal return of 3% yesterday. This suggests that

B. LJP stock will probably rise in value again tomorrow.
C. investors view the international joint venture as bad news.
D. investors view the international joint venture as good news.
55. The Food and Drug Administration (FDA) just announced yesterday that they would approve a new
cancerfighting drug from King. You observe that King had an abnormal return of 0% yesterday.
This suggests that

B. King stock will probably rise in value tomorrow.
C. King stock will probably fall in value tomorrow.
D. the approval was already anticipated by the market.
56. Your professor finds a stocktrading rule that generates excess riskadjusted returns. Instead of
publishing the results, she keeps the trading rule to herself. This is most closely associated with
________.
1. regret avoidance
2. selection bias
3. framing
4. insider trading
5. None of these is correct.
6. Answer: B
57. At freshman orientation, 1,500 students are asked to flip a coin 20 times. One student is crowned the
winner (tossed 20 heads). This is most closely associated with
A. regret avoidance.
B. selection bias.
C. overconfidence.
D. the lucky event issue.
A. sell bonds in this period if you held stocks in the last period.
B. sell stocks in this period if you held bonds in the last period.
C. sell stocks this period that performed well last period.
D. go long.
E. sell stocks this period that performed well last period and go long
59. Discuss the various forms of market efficiency. Include in your discussion the information sets
involved in each form and the relationships across information sets and across forms of market
efficiency. Also discuss the implications for the various forms of market efficiency for the various
types of securities' analysts.
60. What is an event study? It is a test of what form of market efficiency? Discuss the process of
conducting an event study, including the best variable(s) to observe as tests of market efficiency.
61. Discuss the small firm effect, the neglected firm effect, and the January effect, the tax effect and how
the four effects may be related.
62. Why might the degree of market efficiency differ across various markets? State three reasons why
this might occur and explain each reason briefly.
63. With regard to market efficiency, what is meant by the term "anomaly"? Give three examples of
market anomalies and explain why each is considered to be an anomaly.
09 KEY
1. If you believe in the ________ form of the EMH, you believe that stock prices reflect all relevant
information including historical stock prices and current public information about the firm, but not
information that is available only to insiders.
A. semistrong
B. strong
C. weak
D. a, b, and c
E. none of these
The semistrong form of EMH maintains that stock prices immediately reflect all historical and current
public information, but not inside information
Accessibility: Keyboard Navigation
Bodie Chapter 09 #1
Difficulty: Basic
2. When Maurice Kendall examined the patterns of stock returns in 1953, he concluded that the stock
market was __________. Now, these random price movements are believed to be _________.
A. inefficient; the effect of a wellfunctioning market

B. efficient; the effect of an inefficient market
C. inefficient; the effect of an inefficient market
D. efficient; the effect of a wellfunctioning market
E. irrational; even more irrational than before
Random price changes were originally thought to be driven by irrationality. Now, financial economists
believe random price changes occur because markets are informationally efficient.
Bodie Chapter 09 #2
Difficulty: Basic
3. The stock market follows a
A. nonrandom walk.
B. submartingale.
C. predictable pattern that can be exploited.
D. nonrandom walk and predictable pattern that can be exploited.
E. submartingale and predictable pattern that can be exploited.
The stock market follows a submartingale.

Bodie Chapter 09 #3
Difficulty: Basic
4. A hybrid strategy is one where the investor
A. uses both fundamental and technical analysis to select stocks.

B. selects the stocks of companies that specialize in alternative fuels.
C. selects some activelymanaged mutual funds on their own and uses an investment advisor to select
other activelymanaged funds.
D. maintains a passive core and augments the position with an actively managed portfolio.
E. None of these are correct.
A hybrid strategy is one where the investor maintains a passive core and augments the position with an
actively managed portfolio.
Bodie Chapter 09 #4
Difficulty: Basic
5. The difference between a random walk and a submartingale is the expected price change in a random
walk is ______, and the expected price change for a submartingale is ______.
A. positive; zero
B. positive; positive
C. positive; negative
D. zero; positive
E. zero; zero
A random walk has an expected price change of zero, and a submartingale has a positive expected price
change.
Bodie Chapter 09 #5
Difficulty: Basic
A. an active trading strategy.

B. investing in an index fund.
D. a and b
E. b and c
Believers of market efficiency advocate passive investment strategies, and investment in an index fund is
one of the most practical passive investment strategies, especially for small investors.
Bodie Chapter 09 #6
Difficulty: Basic
A. buying individual stocks on margin and trading frequently.

B. investing in hedge funds.
D. buying individual stocks on margin and trading frequently and investing in hedge funds.
E. investing in hedge funds and a passive investment strategy.
Believers of market efficiency advocate passive investment strategies that makes no attempt to outsmart
the market.
Bodie Chapter 09 #7
Difficulty: Basic
8. If you believe in the _______ form of the EMH, you believe that stock prices reflect all information
that can be derived by examining market trading data such as the history of past stock prices, trading
volume or short interest.
A. semistrong
B. strong
C. weak
D. all of these
E. none of these
The information described above is market data, which is the data set for the weak form of market
efficiency.
Bodie Chapter 09 #8
Difficulty: Basic
9. If you believe in the _________ form of the EMH, you believe that stock prices reflect all available
information, including information that is available only to insiders.
A. semistrong
B. strong
C. weak
D. all of these
E. none of these
The strong form of the EMH includes all public and private information.
Bodie Chapter 09 #9
Difficulty: Basic
A. buy bonds in this period if you held stocks in the last period
B. buy stocks in this period if you held bonds in the last period
C. buy stocks this period that performed poorly last period
D. go short
E. c and d
The reversal effect states that stocks that do well in one period tend to perform poorly in the subsequent
period, and vice versa.
Bodie Chapter 09 #10
Difficulty: Basic
11. __________ focus more on past price movements of a firm's stock than on the underlying
determinants of future profitability.
A. Credit analysts
B. Fundamental analysts
C. Systems analysts
D. Technical analysts
E. Specialists
Technicians attempt to predict future stock prices based on historical stock prices.
Difficulty: Basic
12. ___________ the return on a stock beyond what would be predicted from market movements alone.
A. An excess economic return is

B. An economic return is
C. An abnormal return is
D. a and b
E. a and c
An economic return is the expected return, based on the perceived level of risk and market factors. When
returns exceed these levels, the returns are called abnormal or excess economic returns.
Difficulty: Basic
13. The debate over whether markets are efficient will probably never be resolved because of ________.
A. the lucky event issue

B. the magnitude issue
C. the selection bias issue
D. all of these
E. none of these
Factors a, b, and c all exist make rigid testing of market efficiency difficult or impossible.
Difficulty: Basic
14. A common strategy for passive management is ____________.
A. creating an index fund

B. creating a small firm fund
C. creating an investment club
D. a and c
E. b and c
The index fund is, by definition, passively managed. The other investment alternatives may or may not
be managed passively.
Difficulty: Basic
15. Arbel (1985) found that
A. the January effect was highest for neglected firms.

B. the booktomarket value ratio effect was highest in January.
C. the liquidity effect was highest for small firms.
D. the neglected firm effect was independent of the small firm effect.
E. small firms had higher booktomarket value ratios.
Arbel divided firms into highly researched, moderately researched, and neglected groups based on the
number of institutions holding the stock.
Difficulty: Moderate
16. Researchers have found that most of the small firm effect occurs
A. during the spring months.

B. during the summer months.
C. in December.
D. in January.
E. randomly.
Much of the socalled small firm effect simply may be the taxeffect as investors sell stocks on which
they have losses in December and reinvest the funds in January. As small firms are especially volatile,
these actions affect small firms in a more dramatic fashion.
17. Basu (1977, 1983) found that firms with low P/E ratios
A. earned higher average returns than firms with high P/E ratios.
B. earned the same average returns as firms with high P/E ratios.
C. earned lower average returns than firms with high P/E ratios.
D. had higher dividend yields that firms with high P/E ratios.
E. none of these.
Firms with high P/E ratios already have an inflated price relative to earnings and thus tend to have lower
returns than low P/E ratio stocks. However, the P/E ratio may capture risk not fully impounded in market
betas so this may represent an appropriate risk adjustment rather than a market anomaly.
18. Basu (1977, 1983) found that firms with high P/E ratios.
A. earned higher average returns than firms with low P/E ratios.
B. earned the same average returns as firms with low P/E ratios.
C. earned lower average returns than firms with low P/E ratios.
D. had higher dividend yields than firms with low P/E ratios.
Firms with high P/E ratios already have an inflated price relative to earnings and thus tend to have lower
returns than low P/E ratio stocks. However, the P/E ratio may capture risk not fully impounded in market
betas, so this may represent an appropriate risk adjustment rather than a market anomaly.
19. Jaffe (1974) found that stock prices _______ after insiders intensively bought shares while a later
study by Seyhun (1986) found _________
A. decreased; buying on insider trading did not yield abnormal returns.

B. decreased; buying on insider trading produced significant abnormal returns.
C. increased; buying on insider trading did not yield abnormal returns.
D. increased; buying on insider trading produced significant abnormal returns.
E. remained stable; buying on insider trading produced significant abnormal returns.
Insider trading may signal private information, but after adjusting for transaction costs no abnormal
returns were generated.
20. Banz (1981) found that, on average, the riskadjusted returns of small firms
A. were higher than the riskadjusted returns of large firms.

B. were the same as the riskadjusted returns of large firms.
C. were lower than the riskadjusted returns of large firms.
D. were unrelated to the riskadjusted returns of large firms.
E. were negative.
Banz found a to be true; although subsequent studies have attempted to explain the small firm effect as
the January effect, the neglected firm effect, etc.
21. Banz (1981) found that, on average, the riskadjusted returns of large firms
A. were higher than the riskadjusted returns of small firms.

B. were the same as the riskadjusted returns of small firms.
C. were lower than the riskadjusted returns of small firms.
D. were unrelated to the riskadjusted returns of small firms.
E. were negative.
Banz found the riskadjusted returns of large firms were lower than the riskadjusted returns of small
firms, although subsequent studies have attempted to explain the small firm effect as the January effect,
the neglected firm effect, etc.
22. Proponents of the EMH think technical analysts
A. should focus on relative strength.

B. should focus on resistance levels.
C. should focus on support levels.
D. should focus on financial statements.
E. are wasting their time.
Technical analysts attempt to predict future stock prices from historic stock prices; proponents of EMH
believe that stock price changes are random variables.
23. Studies of positive earnings surprises have shown that there is
A. a positive abnormal return on the day positive earnings surprises are announced.
D. both a and b are true.
E. both a and c are true.
The market appears to adjust to earnings information gradually, resulting in a sustained period of
abnormal returns.
24. Studies of negative earnings surprises have shown that there is
A. a negative abnormal return on the day that negative earnings surprises are announced.
D. a negative abnormal return on the day that negative earnings surprises are announced and a positive
E. a negative abnormal return on the day that negative earnings surprises are announced and a negative
The market appears to adjust to earnings information gradually, resulting in a sustained period of
abnormal returns.
25. Studies of stock price reactions to news are called
A. reaction studies.
B. event studies.
C. drift studies.
D. reaction studies and event studies.
E. event studies and drift studies.
An event study describes a technique of empirical financial research that enables an observer to to assess
the impact of a particular event on a firm's stock price. Studies of stock price reactions to news are called
event studies.
26. On November 22, 2012 the stock price of WalMart was $69.50 and the retailer stock index was
600.30. On November 25, 2012 the stock price of WalMart was $40.25 and the retailer stock index
was 605.20. Consider the ratio of WalMart to the retailer index at November 22 and November 25.
WalMart is _______ the retail industry and technical analysts who follow relative strength would
advise _______ the stock.
A. outperforming; buying
B. outperforming; selling
C. underperforming; buying
D. underperforming; selling
E. equally performing; neither buying nor selling
Nov 22: $39.50/600.30 = 0.0658;

Nov 25: $40.25/605.20 = 0.0665;
Thus, WalMart's relative strength is improving and technicians using this technique would recommend
buying.
27. Work by Amihud and Mendelson (1986, 1991)
A. argues that investors will demand a rate of return premium to invest in less liquid stocks.
B. may help explain the small firm effect.
C. may be related to the neglected firm effect.
D. b and c
E. a, b, and c
Lack of liquidity may affect the returns of small and neglected firms; however the theory does not
explain why the abnormal returns are concentrated in January.
28. Fama and French (1992) found that the stocks of firms within the highest decile of market/book
ratios had average monthly returns of _______ while the stocks of firms within the lowest decile of
market/book ratios had average monthly returns of
A. greater than 1%, greater than 1%

B. greater than 1%, less than 1%
C. less than 1%, greater than 1%
D. less than 1%, less than 1%
E. less than 0.5%, greater than 0.5%
This finding suggests either that low markettobook ratio firms are relatively underpriced, or that the
markettobook ratio is serving as a proxy for a risk factor that affects expected equilibrium returns.
29. Empirical research by DeBondt and Thaler (1985), and Chopra, Lakonishok and Ritter (1992)
A. found that poorly stocks that performed poorly in one period experienced sizable reversals in the
subsequent period.
B. found that stocks that performed poorly in one period experienced poor performance in the
subsequent period.
C. found that stocks that performed poorly in one period experienced neither better nor worse
performance than other stocks in the subsequent period.
D. did not try to test the reversal effect.
E. reinforces the EMH.
The observed reversal effect is a result of overreaction, which is difficult to explain if markets are
efficient. However, a subsequent study showing that if portfolios are formed by grouping based on past
performance in periods ending in midyear rather than in December, the reversal effect is substantially
diminished. In addition, this effect is most pronounced in low priced stocks, where small spreads have
large impacts; the liquidity effect may also be a factor. The riskadjusted return of this contrarian strategy
is not statistically significantly different from zero.
30. A market decline of 23% on a day when there is no significant macroeconomic event ______
consistent with the EMH because ________.
A. would be, because it was a clear response to macroeconomic news

B. would be, because it was not a clear response to macroeconomic news
C. would not be, because it was a clear response to macroeconomic news
D. would not be, because it was not a clear response to macroeconomic news
E. We cannot tell based on the information given
This happened on October 19, 1987. Although this specific event is not mentioned in this edition of the
book, it is an example of something that would be considered a violation of the EMH.
31. In an efficient market, __________.
A. security prices react quickly to new information.

B. security prices are seldom far above or below their justified levels.
C. security analysts will not enable investors to realize superior returns consistently.
D. one cannot make money.
E. a, b, and c
a, b, and c are true; however, even in an efficient market one should be able to earn the appropriate risk
adjusted rate of return.
Difficulty: Basic
32. The weak form of the efficient market hypothesis asserts that
A. stock prices do not rapidly adjust to new information contained in past prices or past data.
B. future changes in stock prices cannot be predicted from past prices.
C. technicians cannot expect to outperform the market.
D. a and b
E. b and c
According to the weak form of the EMH b and c holds true. But this form also asserts that stock prices
adjust rapidly to new information.
Difficulty: Basic
33. A finding that _________ would provide evidence against the semistrong form of the efficient
market theory.
A. low P/E stocks tend to have positive abnormal returns

B. trend analysis is worthless in determining stock prices
C. one can consistently outperform the market by adopting the contrarian approach exemplified by the
reversals phenomenon
D. a and b
E. a and c
Both a and c are inconsistent with the semistrong form of the EMH.
34. The weak form of the efficient market hypothesis contradicts
A. technical analysis, but supports fundamental analysis as valid.

B. fundamental analysis, but supports technical analysis as valid.
C. both fundamental analysis and technical analysis.
D. technical analysis, but is silent on the possibility of successful fundamental analysis.
E. none of these.
The process of fundamental analysis makes the market more efficient, and thus the work of the
fundamentalist more difficult. The data set for the weak form of the EMH is market data, which is the
only data used exclusively by technicians. Fundamentalists use all public information.
35. Two basic assumptions of technical analysis are that security prices adjust
A. rapidly to new information and market prices are determined by the interaction of supply and
demand.
B. rapidly to new information and liquidity is provided by security dealers.
C. gradually to new information and market prices are determined by the interaction of supply and
demand.
D. gradually to new information and liquidity is provided by security dealers.
E. rapidly to information and to the actions of insiders.
Technicians follow market dataprice changes and volume of trading (as indicator of supply and
demand) believing that they can identify price trends as security prices adjust gradually.
36. Cumulative abnormal returns (CAR)
A. are used in event studies.

B. are better measures of security returns due to firmspecific events than are abnormal returns (AR).
C. are cumulated over the period prior to the firmspecific event.
D. a and b.
E. a and c.
As leakage of information occurs, the accumulated abnormal returns which are abnormal returns summed
over the period of interest (around the event date), are better measures of the effect of firmspecific
events.
37. Studies of mutual fund performance
A. indicate that one should not randomly select a mutual fund.

B. indicate that historical performance is not necessarily indicative of future performance.
C. indicate that the professional management of the fund insures above market returns.
D. a and b.
E. b and c.
Studies show that all funds do not outperform the market and that historical performance is not
necessarily an indicator of future performance.
Difficulty: Basic
38. The likelihood of an investment newsletter's successfully predicting the direction of the market for
three consecutive years by chance should be
A. between 50% and 70%.

B. between 25% and 50%.
C. between 10% and 25%.
D. less than 10%.
E. greater than 70%.
The probability of successful prediction for 3 consecutive years is 23, or 12.5%.

39. In an efficient market the correlation coefficient between stock returns for two nonoverlapping time
periods should be
A. positive and large.

B. positive and small.
C. zero.
D. negative and small.
E. negative and large.
In an efficient market there should be no serial correlation between returns from nonoverlapping
periods.
40. The weather report says that a devastating and unexpected freeze is expected to hit Florida tonight,
during the peak of the citrus harvest. In an efficient market one would expect the price of Florida
Orange's stock to
A. drop immediately.
B. remain unchanged.
C. increase immediately.
D. gradually decline for the next several weeks.
E. gradually increase for the next several weeks.
In an efficient market the price of the stock should drop immediately when the bad news is announced. If
later news changes the perceived impact to Florida Orange, the price may once again adjust quickly to
the new information. A gradual change is a violation of the EMH.
41. Matthews Corporation has a beta of 1.2. The annualized market return yesterday was 13%, and the
riskfree rate is currently 5%. You observe that Matthews had an annualized return yesterday of 17%.
A. bad news about Matthews was announced yesterday.

B. good news about Matthews was announced yesterday.
C. no news about Matthews was announced yesterday.
AR = 17% (5% + 1.2 (8%)) = + 2.4%. A positive abnormal return suggests that there was firmspecific
good news.
42. Nicholas Manufacturing just announced yesterday that its 4thquarter earnings will be 10% higher
than last year's 4th quarter. You observe that Nicholas had an abnormal return of 1.2% yesterday.
This suggests that

B. Nicholas' stock will probably rise in value tomorrow.
Anticipated earnings changes are impounded into a security's price as soon as expectations are formed.
Therefore a negative market response indicates that the earnings surprise was negative, that is, the
increase was less than anticipated.
43. When Maurice Kendall first examined stock price patterns in 1953, he found that
A. certain patterns tended to repeat within the business cycle.

B. there were no predictable patterns in stock prices.
C. stocks whose prices had increased consistently for one week tended to have a net decrease the
following week.
D. stocks whose prices had increased consistently for one week tended to have a net increase the
following week.
E. the direction of change in stock prices was unpredictable, but the amount of change followed a
distinct pattern.
The first studies in this area were made possible by the development of computer technology. Kendall's
study was the first to indicate that markets were efficient.
Difficulty: Basic
44. If stock prices follow a random walk
A. it implies that investors are irrational.

B. it means that the market cannot be efficient.
C. price levels are random.
D. price changes are random.
E. price movements are predictable.
A random walk means that the changes in prices are random and independent.
Difficulty: Basic
45. The main difference between the three forms of market efficiency is that
A. the definition of efficiency differs.

B. the definition of excess return differs.
C. the definition of prices differs.
D. the definition of information differs.
E. they were discovered by different people.
The main difference is that weak form encompasses historical data, semistrong form encompasses
historical data and current public information, and strong form encompasses historical data, current
public information, and inside information. All of the other definitions remain the same.
46. Chartists practice
A. technical analysis.
B. fundamental analysis.
C. regression analysis.
D. insider analysis.
E. psychoanalysis.
Chartist is another name for a technical analyst.

Difficulty: Basic
47. Which of the following are used by fundamental analysts to determine proper stock prices?
I) trendlines
II) earnings
III) dividend prospects
IV) expectations of future interest rates
V) resistance levels
A. I, IV, and V
B. I, II, and III
C. II, III, and IV
D. II, IV, and V
E. All of the items are used by fundamental analysts.
Analysts look at fundamental factors such as earnings, dividend prospects, expectation of future interest
rates, and risk of the firm. The information is used to determine the present value of future cash flows to
stockholders. Technical analysts use trendlines and resistance levels.
48. According to proponents of the efficient market hypothesis, the best strategy for a small investor with
a portfolio worth $40,000 is probably to
A. perform fundamental analysis.

B. exploit market anomalies.
C. invest in Treasury securities.
D. invest in derivative securities.
E. invest in mutual funds.
Individual investors tend to have relatively small portfolios and are usually unable to realize economies
of size. The best strategy is to pool funds with other small investors and allow professional managers to
invest the funds.
49. Which of the following are investment superstars who have consistently shown superior
performance?
I) Warren Buffet
II) Phoebe Buffet
III) Peter Lynch
IV) Merrill Lynch
V) Jimmy Buffet
A. I, III, and IV
B. II, III, and IV
C. I and III
D. III and IV
E. I, III, IV, and V
Warren Buffet manages Berkshire Hathaway and Peter Lynch managed Fidelity's Magellan Fund.
Phoebe Buffet is a character on NBC's "Friends" and Jimmy Buffet is "Wasting Away in Margaritaville".
Merrill Lynch isn't a person.
50. Google has a beta of 1.0. The annualized market return yesterday was 11%, and the riskfree rate is
currently 5%. You observe that Google had an annualized return yesterday of 14%. Assuming that
A. bad news about Google was announced yesterday.

B. good news about Google was announced yesterday.
C. no news about Google was announced yesterday.
AR = 14% (5% + 1.0 (6%)) = + 3.0%. A positive abnormal return suggests that there was firmspecific
good news.
51. Music Doctors has a beta of 2.25. The annualized market return yesterday was 12%, and the riskfree
rate is currently 4%. You observe that Music Doctors had an annualized return yesterday of 15%.
A. bad news about Music Doctors was announced yesterday.

B. good news about Music Doctors was announced yesterday.
C. no news about Music Doctors was announced yesterday.
AR = 15% (4% + 2.25 (8%)) = 7.0%. A negative abnormal return suggests that there was firmspecific
bad news.
52. QQAG has a beta of 1.7. The annualized market return yesterday was 13%, and the riskfree rate is
currently 3%. You observe that QQAG had an annualized return yesterday of 20%. Assuming that
A. bad news about QQAG was announced yesterday.

B. good news about QQAG was announced yesterday.
C. no significant news about QQAG was announced yesterday.
AR = 20% (3% + 1.7 (10%)) = 0.0%. A positive abnormal return suggests that there was firmspecific
good news and a negative abnormal return suggests that there was firmspecific bad news.
53. QQAG just announced yesterday that its fourth quarter earnings will be 35% higher than last year's
fourth quarter. You observe that QQAG had an abnormal return of 1.7% yesterday. This suggests
that

B. QQAG stock will probably rise in value tomorrow.
Anticipated earnings changes are impounded into a security's price as soon as expectations are formed.
Therefore a negative market response indicates that the earnings surprise was negative, that is, the
increase was less than anticipated.
54. LJP Corporation just announced yesterday that it would undertake an international joint venture. You
observe that LJP had an abnormal return of 3% yesterday. This suggests that

B. LJP stock will probably rise in value again tomorrow.
C. investors view the international joint venture as bad news.
D. investors view the international joint venture as good news.
The positive abnormal return suggests that investors view the international joint venture as good news.
55. The Food and Drug Administration (FDA) just announced yesterday that they would approve a new
cancerfighting drug from King. You observe that King had an abnormal return of 0% yesterday.
This suggests that

B. King stock will probably rise in value tomorrow.
C. King stock will probably fall in value tomorrow.
D. the approval was already anticipated by the market.
The approval was already anticipated by the market.

56. Your professor finds a stocktrading rule that generates excess riskadjusted returns. Instead of
publishing the results, she keeps the trading rule to herself. This is most closely associated with
________.
1. regret avoidance
2. selection bias
3. framing
4. insider trading
5. None of these is correct.
6. Answer: B
57. At freshman orientation, 1,500 students are asked to flip a coin 20 times. One student is crowned the
winner (tossed 20 heads). This is most closely associated with
A. regret avoidance.
B. selection bias.
C. overconfidence.
D. the lucky event issue.
This is an example of the lucky event issue.

A. sell bonds in this period if you held stocks in the last period.
B. sell stocks in this period if you held bonds in the last period.
C. sell stocks this period that performed well last period.
D. go long.
E. sell stocks this period that performed well last period and go long
The reversal effect states that stocks that do well in one period tend to perform poorly in the subsequent
period, and vice versa.
Difficulty: Basic
59. Discuss the various forms of market efficiency. Include in your discussion the information sets
involved in each form and the relationships across information sets and across forms of market
efficiency. Also discuss the implications for the various forms of market efficiency for the various
types of securities' analysts.
The weak form of the efficient markets hypothesis (EMH) states that stock prices immediately reflect
market data. Market data refers to stock prices and trading volume. Technicians attempt to predict future
stock prices based on historic stock price movements. Thus, if the weak form of the EMH holds, the
work of the technician is of no value.
The semistrong form of the EMH states that stock prices include all public information. This public
information includes market data and all other publicly available information, such as financial
statements, and all information reported in the press relevant to the firm. Thus, market information is a
subset of all public information. As a result, if the semistrong form of the EMH holds, the weak form
must hold also. If the semistrong form holds, then the fundamentalist, who attempts to identify
undervalued securities by analyzing public information is unlikely to do so consistently over time. In
fact, the work of the fundamentalist may make the markets even more efficient! The strong form of the
EMH states that all information (public and private) is immediately reflected in stock prices. Public
information is a subset of all information, thus if the strong form of the EMH holds, the semistrong form
must hold also. The strong form of EMH states that even with inside (legal or illegal) information, one
cannot expect to outperform the market consistently over time.
Studies have shown the weak form to hold, when transactions costs are considered. Studies have shown
the semistrong form to hold in general, although some anomalies have been observed. Studies have
shown that some insiders (specialists, major shareholders, major corporate officers) do outperform the
market.
Feedback: The purpose of this question is to assure that the student understands the interrelationships
across different forms of the EMH, across the information sets, and the implications of each form for
different types of analysts.
60. What is an event study? It is a test of what form of market efficiency? Discuss the process of
conducting an event study, including the best variable(s) to observe as tests of market efficiency.
A event study is an empirical test which allows the researcher to assess the impact of a particular event
on a firm's stock price. To do so, one often uses the index model and estimates et, the residual term which
measures the firmspecific component of the stock's return. This variable is the difference between the
return the stock would ordinarily earn for a given level of market performance and the actual rate of
return on the stock. This measure is often referred to as the abnormal return of the stock. However, it is
very difficult to identify the exact point in time that an event becomes public information; thus, the better
measure is the cumulative abnormal return, which is the sum of abnormal returns over a period of time (a
window around the event date). This technique may be used to study the effect of any public event on a
firm's stock price; thus, this technique is a test of the semistrong form of the EMH.
Feedback: The rationale for this question is to ascertain if the student understands the methodology most
commonly used as a test of the semistrong form of market efficiency.
61. Discuss the small firm effect, the neglected firm effect, and the January effect, the tax effect and how
the four effects may be related.
Studies have shown that small firms earn a riskadjusted rate of return greater than that of larger firms.
Additional studies have shown that firms that are not followed by analysts (neglected firms) also have a
riskadjusted return greater than that of larger firms. However, the neglected firms tend to be small firms;
thus, the neglected firm effect may be a manifestation of the small firm effect. Finally, studies have
shown that returns in January tend to be higher than in other months of the year. This effect has been
shown to persist consistently over the years. However, the January effect may be the tax effect, as
investors may have sold stocks with losses in December for tax purposes and reinvested in January.
Small firms (and neglected firms) would tend to be more affected by this increased buying than larger
firms, as small firms tend to sell for lower prices.
Feedback: The purpose of this question is to reinforce the interrelationships, that "effects" may not
always be independent and thus readily identifiable. Also these effects are widely discussed in the
financial press, and the January effect appears to be quite persistent.
62. Why might the degree of market efficiency differ across various markets? State three reasons why
this might occur and explain each reason briefly.
1. Market efficiency depends on information being essentially free and costless to market participants. In
the U.S. markets this is the case to a large extent. The U.S. markets are well developed and professional
analysts often follow securities. Information is available on television, in the press, and on the internet.
The opposite may be true in other markets, such as those of developing countries, where there are fewer
or no analysts and few market participants with these resources. 2. Accounting disclosure requirements
are different across markets. In the U.S. firms must meet SEC requirements to be publicly traded. In
other countries the requirements may be different or nonexistent. This has implications about the ease
with which analysts can evaluate the company to determine its proper value. 3. Markets for "neglected"
stocks may be less efficient than markets for stocks that are heavily followed by analysts. If analysts feel
that it is not worthwhile to give their attention to particular stocks then ample information about these
stocks will not be readily available to investors.
Feedback: This question leads the student to look at some of the fundamental reasons for market
efficiency and why there may be differences among markets with regard to the reasons. Alternative
answers are possible.
63. With regard to market efficiency, what is meant by the term "anomaly"? Give three examples of
market anomalies and explain why each is considered to be an anomaly.
Anomalies are patterns that should not exist if the market is truly efficient. Investors might be able to
make abnormal profits by exploiting the anomalies, which doesn't make sense in an efficient market.
Possible examples include, but are not limited to, the following.
• the smallfirm effectaverage annual returns are consistently higher for smallfirm portfolios, even
when adjusted for risk by using the CAPM.
• the January effectthe smallfirm effect occurs virtually entirely in January.
• the neglectedfirm effectsmall firms tend to be ignored by large institutional traders and stock analysts.
This lack of monitoring makes them riskier and they earn higher riskadjusted returns. The January effect
is largest for neglected firms.
• the liquidity effectinvestors demand a return premium to invest in lessliquid stocks. This is related to
the smallfirm effect and the neglectedfirm effect. These stocks tend to earn high riskadjusted rates of
return.
• booktomarket ratiosfirms with the higher booktomarketvalue ratios have higher riskadjusted
returns, suggesting that they are underpriced. When combined with the firmsize factor, this ratio
explained returns better than systematic risk as measured by beta.
• the reversal effectstocks that have performed best in the recent past seem to underperform the rest of
the market in the following periods, and vice versa. Other studies indicated that this effect might be an
illusion. These studies used portfolios formed midyear rather than in December and considered the
liquidity effect.
Investors should not be able to earn excess returns by taking advantage of any of these. The market
should adjust prices to their proper levels. But these things have been documented to occur repeatedly.
Feedback: This question tests whether the student grasps the basic concept of anomalies and allows some
choice in explaining some of them.
09 Summary
Category # of Questions
Accessibility: Keyboard Navigation 58
Bodie Chapter 09 63
Difficulty: Basic 21
Difficulty: Moderate 42

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A. inefficient; the effect of a well­functioning market

3. The stock market follows a

4. A hybrid strategy is one where the investor

A. uses both fundamental and technical analysis to select stocks.

A. an active trading strategy.

7. Proponents of the EMH typically advocate

A. buying individual stocks on margin and trading frequently.

10. If you believe in the reversal effect, you should

A. An excess economic return is

A. the lucky event issue

14. A common strategy for passive management is ____________.

A. creating an index fund

15. Arbel (1985) found that

A. the January effect was highest for neglected firms.

A. during the spring months.

A. decreased; buying on insider trading did not yield abnormal returns.

A. were higher than the risk­adjusted returns of large firms.

A. were higher than the risk­adjusted returns of small firms.

22. Proponents of the EMH think technical analysts

A. should focus on relative strength.

23. Studies of positive earnings surprises have shown that there is

25. Studies of stock price reactions to news are called

27. Work by Amihud and Mendelson (1986, 1991)

A. greater than 1%, greater than 1%

A. would be, because it was a clear response to macroeconomic news

31. In an efficient market, __________.

A. security prices react quickly to new information.

A. low P/E stocks tend to have positive abnormal returns

A. technical analysis, but supports fundamental analysis as valid.

36. Cumulative abnormal returns (CAR)

A. are used in event studies.

37. Studies of mutual fund performance

A. indicate that one should not randomly select a mutual fund.

A. between 50% and 70%.

A. positive and large.

A. bad news about Matthews was announced yesterday.

A. the market is not efficient.

A. certain patterns tended to repeat within the business cycle.

44. If stock prices follow a random walk

A. it implies that investors are irrational.

A. the definition of efficiency differs.

46. Chartists practice

A. perform fundamental analysis.

A. bad news about Google was announced yesterday.

A. bad news about Music Doctors was announced yesterday.

A. bad news about QQAG was announced yesterday.

A. the market is not efficient.

A. the market is not efficient.

A. the market is not efficient.

A. inefficient; the effect of a well­functioning market

3. The stock market follows a

The stock market follows a submartingale.

A. uses both fundamental and technical analysis to select stocks.

6. Proponents of the EMH typically advocate

A. an active trading strategy.

A. buying individual stocks on margin and trading frequently.

A. An excess economic return is

A. the lucky event issue

14. A common strategy for passive management is ____________.

A. creating an index fund

15. Arbel (1985) found that

A. the January effect was highest for neglected firms.

A. inefficient; the effect of a wellfunctioning market

A. were higher than the riskadjusted returns of large firms.

A. were higher than the riskadjusted returns of small firms.

A. inefficient; the effect of a wellfunctioning market

A. were higher than the riskadjusted returns of large firms.

A. were higher than the riskadjusted returns of small firms.