Lecture 7

Question 1

Efficient market hypothesis states

Answer 1

Any information that could be used to predict the stock performance should already be reflected in the stock price

Question 2

Increases/ decreases in stock prices due to

Answer 2

New information (unpredictable)

Question 3

Random walk

Answer 3

Stock price changes should be random and unpredictable

Question 4

If stock prices are predictable

Answer 4

Stock markets are inefficient

Question 5

Weak form EMH

Answer 5

Stock prices reflect all past information that can be derived by examining market trading data

Question 6

Trend analysis in weak form EMH

Answer 6

Pointless > any relevant information regarding the future performance will already be reflected

Question 7

Semi-strong EMH

Answer 7

All publicly available information regarding the prospects of a firm must be reflected in the stock price

Question 8

Strong form EMH

Answer 8

Stock prices reflect all information relevant to the firm, even if only available to insiders

Question 9

Technical analysis =

Answer 9

Search for recurrent and predictable patterns in stock prices

Question 10

Fundamental analysis =

Answer 10

Uses earnings and dividend prospects, expectations of future interest rates and risk evaluation to determine proper stock prices

Question 11

If the present discounted value of payments stockholder received exceeds stock price

Answer 11

Purchase stock

Question 12

EMH predicts that the majority of fundamental analysis is

Answer 12

Doomed to fail > if analysts use the same publicly available info, little different between their analysis

Question 13

Investor’s trick =

Answer 13

To find firms that are better than other’s estimate/ not as bad as the stock price suggests

Question 14

Mututal funds benefit from

Answer 14

Economies of scale

Question 15

Active management according to EMH

Answer 15

Largely wasted effort

Question 16

EMH advocates

Answer 16

The passive investment strategy > because stock prices are at fair levels, makes no sense to buy and sell frequently and incur large brokerage fees

Question 17

Index funds

Answer 17

Designed to replicate the performance of a broad based index of stocks

Question 18

Firm specific risk can be eliminated through

Answer 18

Diversification

Question 19

Tax considerations (3)

Answer 19

• Tax brackets of investors impacts their preference
• Capital gains are taxed less heavily than dividends
• Investment opportunities can be sensitive to tax benefits eg real estate

Question 20

Role of portfolio manager in efficient market =

Answer 20

To tailor portfolio to investors’ needs instead of beating the market

Question 21

Deviations from efficiency may

Answer 21

Offer profit opportunity for better informed traders

Question 22

Disadvantage of deviations from efficiency

Answer 22

Can result in large costs > inefficient resource allocation

Question 23

If inefficient capital markets (2)

Answer 23

• Investment opportunities may be foregone

- Overpriced securities may be able to obtain capital too cheaply

Question 24

Event studies =

Answer 24

Assess the impact of an event on the firm’s stock price using empirical financial research

Question 25

Can measure the impact of an event by

Answer 25

Estimating the abnormal return of a stock at the moment the information about the event becomes known to the market

Question 26

Leakage information

Answer 26

Occurs when information regarding an event is released to a small group of investors before public release

Question 27

Leakage information skews

Answer 27

Abnormal returns on announcement date > therefore cumulative abnormal return better indicator

Question 28

Are markets efficient? > The magnitude issue

Answer 28

Against large fluctuations in the market, small increases in the performance can be hard to detect

Question 29

Are markets efficient? > The selection bias issue

Answer 29

Investors are unlikely to share successful techniques with others

Question 30

Are markets efficient? > the lucky event issue

Answer 30

Only tend to hear about the large wins, not the corresponding losses

Question 31

Weak-form tests (5)

Answer 31

- Returns over the short horizon - Returns over the long horizon - Fama & French - Campbell & Shiller - Kiem & Stambaugh

Question 32

Fama & French

Answer 32

Aggregate returns are higher with higher dividend ratios

Question 33

Campbell & Shiller

Answer 33

Earnings yield can predict market returns

Question 34

Kiem & Stamburgh

Answer 34

Bond spreads can predict market returns

Question 35

Semi-strong tests (5)

Answer 35

- PE effect - Small firm effect - Neglected firm effect - Book-to-market ratios - Post-earnings announcement price drift

Question 36

Strong form tests (2)

Answer 36

- Insider trading studies by Jaffe | - SEC requires all insiders to register trading activity