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CAS Exam 9 > BKM Chapter 11 > Flashcards

BKM Chapter 11 Flashcards

(52 cards)

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1
Q

Efficient market hypothesis (EMH)

BKM - 11

A

stock prices reflect all available information at a given point in time

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2
Q

Cause of stock price changes under EMH

BKM - 11

A

release of new information

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3
Q

Main consequence of EMH

BKM - 11

A

stock prices should follow a random walk (e.g. random & unpredictable)

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4
Q

Support for EMH

BKM - 11

A

competition b/w investment firms (to identify & exploit mispricing) leads to investors immediately bidding up or forcing down prices

> > suggests stock prices reflect nearly all available information

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5
Q

Difference between an efficient market and an efficient portfolio

(BKM - 11)

A

efficient market = information rapidly reflected in stock prices

efficient portfolio = highest expected return for a given level of risk

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6
Q

Forms of the EMH (3)

BKM - 11

A
  1. weak-form
  2. semistrong-form
  3. strong-form
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7
Q

Difference between forms of the EMH

BKM - 11

A

meaning of “all available information”

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8
Q

Weak-form EMH

BKM - 11

A

stock prices reflect all information that can be derived from historical data

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9
Q

Implication of the weak-form EMH

BKM - 11

A

trend analysis is not worthwhile

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10
Q

Types of data considered in weak-form EMH (3)

BKM - 11

A
  1. past stock prices
  2. trade volume
  3. short interest
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11
Q

Semistrong-form EMH

BKM - 11

A

stock prices reflect all publicly available information related to a firm’s prospects

*implies weak-form EMH

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12
Q

Types of data considered in semistrong-form EMH (6)

BKM - 11

A
  1. product lines
  2. quality of management
  3. balance sheet composition
  4. patents held
  5. earnings forecasts
  6. accounting practices
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13
Q

Strong-form EMH

BKM - 11

A

stock prices reflect all information relevant to a firm, including information only available to company insiders

*implies semistrong- and weak-form EMH

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14
Q

Common aspect of all forms of EMH

BKM - 11

A

prices should reflect available information

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15
Q

Technical analysis

BKM - 11

A

search for recurrent and predictable patterns in stock prices

*only works if stock prices are slow to respond to market forces of supply and demand

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16
Q

Technical analysis & efficient markets

BKM - 11

A

if markets are truly efficient, technical analysis will not work (b/c stock prices already reflect all available information)

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17
Q

Resistance levels in technical analysis

BKM - 11

A

values at which it is difficult for stock prices to rise above/fall below (driven by market psychology)

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18
Q

Self-destructing nature of price patterns

BKM - 11

A

once a useful price pattern is discovered, it is soon invalidated once it is exploited by many traders

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19
Q

Fundamental analysis

BKM - 11

A

using a firm’s earnings and dividend prospects + expectations of future interest rates to determine stock prices

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20
Q

Buy decisions in fundamental analysis

BKM - 11

A

if PV(future payments) > current stock price, then buy

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21
Q

Fundamental analysis & efficient markets

BKM - 11

Study These Flashcards
A

under EMH, fundamental analysis will not work since it relies on publicly available information and it is unlikely for evaluations to be significantly different b/w competing firms

22
Q

Critical element of success for firms in fundamental analysis

(BKM - 11)

Study These Flashcards
A

superior firm analysis relative to other firms (e.g. more accurate projections)

23
Q

Are small investors better off using active or passive portfolio management?

(BKM - 11)

Study These Flashcards
A

passive strategy

24
Q

Advantage of using index funds in a passive strategy

BKM - 11

Study These Flashcards
A

minimizes trading costs/management fees

25
Reasons portfolio management is still necessary in an efficient market (3) (BKM - 11)
1. portfolio must be well-diversified to eliminate firm-specific risk (select stocks that provide strong diversification) 2. optimal securities depend on the tax bracket of the investor (preferences for low-yield, tax-exempt bonds to minimize taxes) 3. must consider the risk profile of the individual investor (e.g. age or other sources of income)
26
Event study | BKM - 11
method to measure the impact of an event/release of new information on stock prices
27
Steps in an event study (2) | BKM - 11
1. find a benchmark return to represent what the stock price would have been in the absence of the event 2. calculate the abnormal return due to the event
28
Possible benchmark returns for an event study (3) | BKM - 11
1. broad market index (e.g. S&P 500) 2. narrow broad index down to firms of similar size, beta, etc. 3. use an asset pricing model to estimate an expected ROR (e.g. CAPM)
29
Estimating alpha and beta with event studies | BKM - 11
should be estimated using data sufficiently separated in time from the event so they are not impacted by event-period abnormal performance
30
Impact of information leakage on an event study | BKM - 11
flawed event stud because it does not recognize the change in prices ahead of the event caused by leakage
31
Cumulative abnormal return (CAR) | BKM - 11
sum of all abnormal returns over the period where the market is responding to new information (captures the impact of the event + information leakage)
32
Common uses for event studies (2) | BKM - 11
used: 1. by the SEC to assess violation of insider trading or other securities laws 2. in fraud cases to assess damages
33
Issues that make it challenging to determine if markets are truly efficient (3) (BKM - 11)
1. magnitude issue 2. selection bias issue 3. lucky event issue
34
Magnitude issue in determining if markets are efficient | BKM - 11
small increases in performance are difficult to detect against market fluctuations
35
Selection bias issue in determining if markets are efficient (BKM - 11)
more likely to observe failed techniques because investors who can consistently beat the market would not publicize their techniques
36
Lucky event issue in determining if markets are efficient | BKM - 11
luck of an individual investor winning more or less frequently than would be implied by the average results
37
Tests of weak-form EMH & conclusions (2) | BKM - 11
1. patterns in stock returns - short-term momentum (representing market over-reaction) followed by long-term reversals (representing correction of past errors) 2. predictors of broad market returns - more likely predictors such as dividend yield are proxies for changes in market risk premium (alternative interpretation to #1 could be that market risk premiums are changing over time)
38
Serial correlation of stock returns | BKM - 11
measures correlation of consecutive return periods positive serial correlation: positive returns tend to follow positive returns
39
Market anomalies | BKM - 11
easily accessible statistics that seem to predict abnormal risk-adjusted returns
40
Tests of semistrong-form EMH | BKM - 11
studies of efficient market anomalies
41
Disadvantages of evaluating risk-adjusted returns | BKM - 11
actually evaluating 2 things: 1. the EMH 2. the risk adjustment procedure used
42
Market anomalies associated with semistrong-form EMH (5) | BKM - 11
1. small-firm effect 2. neglected firm effect 3. liquidity effect 4. book-to-market ratios 5. post-earnings-announcement price drift
43
Small firm effect market anomaly | BKM - 11
smaller firms (= low market capitalization) produce higher returns than larger firms even after risk adjustment
44
Neglected firm effect market anomaly & explanation | BKM - 11
smaller firms ignored by investment firms have higher returns >> explanation: lack of information can be seen as a form of risk premium
45
Liquidity effect market anomaly & explanation | BKM - 11
small/neglected firms tend to have less liquid stocks >> explanation: lack of liquidity can be a form of risk premium
46
Book-to-market effect market anomaly & potential explanations (2) (BKM - 11)
firms with high book-to-market ratios have higher returns >> explanations: 1. high book-to-market firms are relatively under-priced 2. book-to-market is a proxy for a risk factor impacting market returns
47
Post-earnings-announcement price drift market anomaly | BKM - 11
abnormal returns continue to rise/fall gradually after the announcement (which should not happen in an efficient market)
48
Strong-form tests of EMH (3) | BKM - 11
1. whether outsiders can profit following insiders' trades 2. market anomalies & data mining 3. market bubbles
49
Different interpretations for market anomalies (2) | BKM - 11
1. effects are related to risk premiums rather than market inefficiencies (e.g. proxies for risk factors) 2. market inefficiencies: investment analysts extrapolate past performance leading to over/under pricing and prices eventually self-correct
50
Argument that market anomalies are related to data mining | BKM - 11
false patterns appear to show predictive power that isn't really there
51
Possible explanations for stock price increases following changes in market analyst recommendations (2) (BKM - 11)
1. analysts have unique insights and are revealing new information when upgrading a stock 2. demand increases because of the upgrade (stock price change is driven by demand not new information)
52
Better indicator of skill in managing funds compared to alphas & rationale (BKM - 11)
increase in amount of funds under management - skilled mutual fund managers attract new funds and the cost of managing those funds drives alphas to 0

CAS Exam 9 (26 decks)

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