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Multiple Choice Questions
1. Which of the following beliefs would not preclude charting as a method of portfolio
management?
A. The market is strong-form efficient.
B. The market is semistrong-form efficient.
C. The market is weak-form efficient.
D. Stock prices follow recurring patterns.
Answer: D. Stock prices follow recurring patterns.
2. In a 1953 study of stock prices, Maurice Kendall found that ________.
A. there were no predictable patterns in stock prices
B. stock prices exhibited strong serial autocorrelation
C. day-to-day stock prices followed consistent trends
D. fundamental analysis could be used to generate abnormal returns
Answer: A. there were no predictable patterns in stock prices
3. The weak form of the EMH states that ________ must be reflected in the current stock
price.
A. all past information, including security price and volume data
B. all publicly available information
C. all information, including inside information
D. all costless information
Answer: A. all past information, including security price and volume data
4. The semistrong form of the EMH states that ________ must be reflected in the current
stock price.
A. all security price and volume data
B. all publicly available information
C. all information, including inside information
D. all costless information
Answer: B. all publicly available information
5. The strong form of the EMH states that ________ must be reflected in the current stock
price.
A. all security price and volume data
B. all publicly available information
C. all information, including inside information
D. all costless information
Answer: C. all information, including inside information
6. Random price movements indicate ________.
A. irrational markets
B. that prices cannot equal fundamental values
C. that technical analysis to uncover trends can be quite useful
D. that markets are functioning efficiently
Answer: D. that markets are functioning efficiently
7. When the market risk premium rises, stock prices will ________.
A. rise
B. fall
C. recover
D. have excess volatility
Answer: B. fall
8. The small-firm-in-January effect is strongest ________.
A. early in the month
B. in the middle of the month
C. late in the month
D. in even-numbered years
Answer: A. early in the month
9. Evidence suggests that there may be _______ momentum and ________ reversal patterns
in stock price behavior.
A. short-run; short-run
B. long-run; long-run
C. long-run; short-run
D. short-run; long run
Answer: D. short-run; long run
10. Proponents of the EMH typically advocate __________.
A. a conservative investment strategy
B. a liberal investment strategy
C. a passive investment strategy
D. an aggressive investment strategy
Answer: C. a passive investment strategy
11. Stock prices that are stable over time _______.
A. indicate that prices are useful indicators of true economic value
B. indicate that the market is not incorporating new information into current stock prices
C. ensure that an economy allocates its resources efficiently
D. indicates that returns follow a random-walk process
Answer: B. indicate that the market is not incorporating new information into current stock
prices
12. The tendency when the ______ performing stocks in one period are the best performers in
the next and the current ________ performers are lagging the market later is called the
reversal effect.
A. worst; best
B. worst; worst
C. best; worst
D. best; best
Answer: A. worst; best
13. Which of the following is not a method employed by followers of technical analysis?
A. Charting
B. Relative strength analysis
C. Earnings forecasting
D. Trading around support and resistance levels
Answer: C. Earnings forecasting
14. Which of the following is not a method employed by fundamental analysts?
A. Analyzing the Fed's next interest rate move
B. Relative strength analysis
C. Earnings forecasting
D. Estimating the economic growth rate
Answer: B. Relative strength analysis
15. The primary objective of fundamental analysis is to identify __________.
A. well-run firms
B. poorly run firms
C. mispriced stocks
D. high P/E stocks
Answer: C. mispriced stocks
16. If you believe in the __________ form of the EMH, you believe that stock prices reflect
all publicly available information but not information that is available only to insiders.
A. semistrong
B. strong
C. weak
D. perfect
Answer: A. semistrong
17. If you believe in the __________ form of the EMH, you believe that stock prices reflect
all relevant information, including information that is available only to insiders.
A. semistrong
B. strong
C. weak
D. perfect
Answer: B. strong
18. Most of the stock price response to a corporate earnings or dividend announcement occurs
within ________________.
A. about 30 seconds
B. about 10 minutes
C. 6 months
D. 2 years
Answer: B. about 10 minutes
19. __________ is the return on a stock beyond what would be predicted from market
movements alone.
A. A normal return
B. A subliminal return
C. An abnormal return
D. None of these options
Answer: C. An abnormal return
20. 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,
but you do not believe stock prices reflect all publicly available and inside information. You
are a proponent of the ____________ form of the EMH.
A. semistrong
B. strong
C. weak
D. perfect
Answer: C. weak
21. You are an investment manager who is currently managing assets worth $6 billion. You
believe that active management of your fund could generate an additional one-tenth of 1%
return on the portfolio. If you want to make sure your active strategy adds value, how much
can you spend on security analysis?
A. $12,000,000
B. $6,000,000
C. $3,000,000
D. $0
Answer: B. $6,000,000
(.001)($6 billion) = $6,000,000
22. A mutual fund that attempts to hold quantities of shares in proportion to their
representation in the market is called a __________ fund.
A. stock
B. index
C. hedge
D. money market
Answer: B. index
23. Choosing stocks by searching for predictable patterns in stock prices is called ________.
A. fundamental analysis
B. technical analysis
C. index management
D. random-walk investing
Answer: B. technical analysis
24. Which of the following is not an issue that is central to the debate regarding market
efficiency?
A. The magnitude issue
B. The tax-loss selling issue
C. The lucky event issue
D. The selection bias issue
Answer: B. The tax-loss selling issue
25. Most people would readily agree that the stock market is not _________.
A. weak-form efficient
B. semistrong-form efficient
C. strong-form efficient
D. efficient at all
Answer: C. strong-form efficient
26. Small firms have tended to earn abnormal returns primarily in __________.
A. the month of January
B. the month July
C. the trough of the business cycle
D. the peak of the business cycle
Answer: A. the month of January
27. Fama and French have suggested that many market anomalies can be explained as
manifestations of ____________.
A. regulatory effects
B. high trading costs
C. information asymmetry
D. varying risk premiums
Answer: D. varying risk premiums
28. 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. are wasting their time
Answer: D. are wasting their time
29. Evidence supporting semistrong-form market efficiency suggests that investors should
_________________________.
A. rely on technical analysis to select securities
B. rely on fundamental analysis to select securities
C. use a passive trading strategy such as purchasing an index fund or an ETF
D. select securities by throwing darts at the financial pages of the newspaper
Answer: C. use a passive trading strategy such as purchasing an index fund or an ETF
30. "Buy a stock if its price moves up by 2% more than the Dow Average" is an example of a
_________________.
A. trading rule
B. market anomaly
C. fundamental approach
D. passive trading strategy
Answer: A. trading rule
31. Jaffe found that stock prices __________ after insiders intensively bought shares and
__________ after insiders intensively sold shares.
A. decreased; decreased
B. decreased; increased
C. increased; decreased
D. increased; increased
Answer: C. increased; decreased
32. In a 1988 study, Fama and French found that the return on the aggregate stock market was
__________ when the dividend yield was higher.
A. higher
B. lower
C. unaffected
D. more skewed
Answer: A. higher
33. In their 2010 study, Fama and French used a four-factor model to analyze excess returns
on equity mutual funds. They found that the funds ______.
A. had negative alphas before fees were considered.
B. had positive alphas after fees were considered.
C. had negative alphas after fees were considered.
D. had negative alphas before fees were considered and had negative alphas after fees were
considered.
Answer: C. had negative alphas after fees were considered.
34. Joe bought a stock at $57 per share. The price promptly fell to $55. Joe held on to the
stock until it again reached $57, and then he sold it once he had eliminated his loss. If other
investors do the same to establish a trading pattern, this would contradict _______.
A. the strong-form EMH
B. the weak-form EMH
C. technical analysis
D. the semistrong-form EMH
Answer: B. the weak-form EMH
35. According to 1968 research by Ball and Brown, securities markets fully adjust to earnings
announcements _______.
A. instantly
B. in 1 day
C. in 1 week
D. gradually over time
Answer: D. gradually over time
36. When stock returns exhibit positive serial correlation, this means that __________ returns
tend to follow ___________ returns.
A. positive; positive
B. positive; negative
C. negative; positive
D. positive; zero
Answer: A. positive; positive
37. Basu 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
Answer: C. earned lower average returns than firms with low P/E ratios
38. Fundamental analysis is likely to yield best results for _______.
A. NYSE stocks
B. neglected stocks
C. stocks that are frequently in the news
D. fast-growing companies
Answer: B. neglected stocks
39. You are looking to invest in one of three stocks. All other things being equal, Stock A has
high expected earnings growth, stock B has only modest expected earnings growth, and stock
C is expected to generate poor earnings growth. According to LaPorta's 1996 study, which
stock is likely to generate the greatest alpha for you?
A. Stock A
B. Stock B
C. Stock C
D. The answer cannot be determined from the information given.
Answer: C. Stock C
40. You believe that you can earn 2% more on your portfolio if you engage in full-time stock
research. However, the additional trading costs and tax liability from active management will
cost you about .5%. You have an $800,000 stock portfolio. What is the most you can afford to
spend on your research?
A. $4,000
B. $8,000
C. $12,000
D. $16,000
Answer: C. $12,000
(.02 - .005)($800,000) = $12,000
41. Even if the markets are efficient, professional portfolio management is still important
because it provides investors with:
I. Low-cost diversification
II. A portfolio with a specified risk level
III. Better risk-adjusted returns than an index
A. I only
B. I and II only
C. II and III only
D. I, II, and III
Answer: B. I and II only
42. Banz found that, on average, the risk-adjusted returns of small firms __________.
A. were higher than the risk-adjusted returns of large firms
B. were the same as the risk-adjusted returns of large firms
C. were lower than the risk-adjusted returns of large firms
D. were negative
Answer: A. were higher than the risk-adjusted returns of large firms
43. If the U.S. capital markets are not informationally efficient, ______.
A. the markets cannot be allocationally efficient
B. systematic risk does not matter
C. no type of analysis can be used to generate abnormal returns
D. returns must follow a random walk
Answer: A. the markets cannot be allocationally efficient
44. "Active investment management may at times generate additional returns of about .1%.
However, the standard deviation of the typical well-diversified portfolio is about 20%, so it is
very difficult to statistically identify any increase in performance." Even if true, this statement
is an example of the _________ problem in deciding how efficient the markets are.
A. magnitude
B. selection bias
C. lucky event
D. allocation
Answer: A. magnitude
45. DeBondt and Thaler (1985) found that the poorest-performing stocks in one time period
experienced __________ performance in the following period and that the best-performing
stocks in one time period experienced __________ performance in the following time period.
A. good; good
B. good; poor
C. poor; good
D. poor; poor
Answer: B. good; poor
46. J. M. Keyes put all his money in one stock, and the stock doubled in value in a matter of
months. He did this three times in a row with three different stocks. J. M. got his picture on
the front page of the Wall Street Journal. However, the paper never mentioned the thousands
of investors who made similar bets on other stocks and lost most of their money. This is an
example of the ________ problem in deciding how efficient the markets are.
A. magnitude
B. selection bias
C. lucky event
D. small firm
Answer: C. lucky event
47. Most tests of semistrong efficiency are _________.
A. designed to test whether inside information can be used to generate abnormal returns
B. based on technical trading rules
C. unable to generate any evidence of market anomalies
D. joint tests of market efficiency and the risk-adjustment measure
Answer: D. joint tests of market efficiency and the risk-adjustment measure
48. The _________ effect may explain much of the small-firm anomaly.
I. January
II. neglected
III. liquidity
A. I only
B. II only
C. II and III only
D. I, II, and III
Answer: D. I, II, and III
49. The effect of liquidity on stock returns might be related to:
I. The small-firm effect
II The book-to-market effect
III The neglected-firm effect
IV. The P/E effect
A. I and II only
B. I and III only
C. II and IV only
D. I, II, and III only
Answer: B. I and III only
50. The broadest information set is included in the _____.
A. weak-form efficiency argument
B. semistrong-form efficiency argument
C. strong-form efficiency argument
D. technical analysis trading method
Answer: C. strong-form efficiency argument
51. The Fama and French evidence that high book-to-market firms outperform low book-tomarket firms even after adjusting for beta means that _________.
A. high book-to-market firms are underpriced or the book-to-market ratio is a proxy for a
unique risk factor
B. low book-to-market firms are underpriced or the book-to-market ratio is a proxy for a
systematic risk factor
C. either high book-to-market firms are underpriced or the book-to-market ratio is a proxy for
a systematic risk factor
D. high book-to-market firms have more post-earnings drift
Answer: C. either high book-to-market firms are underpriced or the book-to-market ratio is a
proxy for a systematic risk factor
52. According to results by Seyhun, __________.
A. investors cannot usually earn abnormal returns by following inside trades after knowledge
of the trades are made public
B. investors can usually earn abnormal returns by following inside trades after knowledge of
the trades are made public
C. investors cannot earn abnormal returns by following inside trades before knowledge of the
trades are made public
D. investors cannot earn abnormal returns by trading before insiders
Answer: A. investors cannot usually earn abnormal returns by following inside trades after
knowledge of the trades are made public
53. If the daily returns on the stock market are normally distributed with a mean of .05% and
a standard deviation of 1%, the probability that the stock market would have a return of -23%
or worse on one particular day (as it did on Black Monday) is approximately __________.
A. .0%
B. .1%
C. 1%
D. 10%
Answer: A. .0%
Prob = 1 - N[(-.2300 - .0005)/.01] ≈ 0
54. According to the semistrong form of the efficient markets hypothesis, ____________.
A. stock prices do not rapidly adjust to new information
B. future changes in stock prices cannot be predicted from any information that is publicly
available
C. corporate insiders should have no better investment performance than other investors even
if allowed to trade freely
D. arbitrage between futures and cash markets should not produce extraordinary profits
Answer: B. future changes in stock prices cannot be predicted from any information that is
publicly available
55. The term random walk is used in investments to refer to ______________.
A. stock price changes that are random but predictable
B. stock prices that respond slowly to both old and new information
C. stock price changes that are random and unpredictable
D. stock prices changes that follow the pattern of past price changes
Answer: C. stock price changes that are random and unpredictable
56. Among the important characteristics of market efficiency is (are) that:
I. There are no arbitrage opportunities.
II. Security prices react quickly to new information.
III. Active trading strategies will not consistently outperform passive strategies.
A. I only
B. II only
C. I and III only
D. I, II, and III
Answer: D. I, II, and III
57. Stock market analysts have tended to be ___________ in their recommendations to
investors.
A. slightly overly optimistic
B. overwhelmingly optimistic
C. slightly overly pessimistic
D. overwhelmingly pessimistic
Answer: B. overwhelmingly optimistic
58. Assume that a company announces unexpectedly high earnings in a particular quarter. In
an efficient market one might expect _____________.
A. an abnormal price change immediately after the announcement
B. an abnormal price increase before the announcement
C. an abnormal price decrease after the announcement
D. no abnormal price change before or after the announcement
Answer: A. an abnormal price change immediately after the announcement
59. Market anomaly refers to _______.
A. an exogenous shock to the market that is sharp but not persistent
B. a price or volume event that is inconsistent with historical price or volume trends
C. a trading or pricing structure that interferes with efficient buying and selling of securities
D. price behavior that differs from the behavior predicted by the efficient market hypothesis
Answer: D. price behavior that differs from the behavior predicted by the efficient market
hypothesis
60. Which of the following contradicts the proposition that the stock market is weakly
efficient?
A. Over 25% of mutual funds outperform the market on average.
B. Insiders earn abnormal trading profits.
C. Every January, the stock market earns above-normal returns.
D. Applications of technical trading rules fail to earn abnormal returns.
Answer: C. Every January, the stock market earns above-normal returns.
61. Which of the following would violate the efficient market hypothesis?
A. Intel has consistently generated large profits for years.
B. Prices for stocks before stock splits show, on average, consistently positive abnormal
returns.
C. Investors earn abnormal returns months after a firm announces surprise earnings.
D. High-earnings growth stocks fail to generate higher returns for investors than do low
earnings growth stocks.
Answer: C. Investors earn abnormal returns months after a firm announces surprise earnings.
62. Which of the following stock price observations would appear to contradict the weak form
of the efficient market hypothesis?
A. The average rate of return is significantly greater than zero.
B. The correlation between the market return one week and the return the following week is
zero.
C. You could have consistently made superior returns by buying stock after a 10% rise in
price and selling after a 10% fall.
D. You could have consistently made superior returns by forecasting future earnings
performance with your new Crystal Ball forecast methodology.
Answer: C. You could have consistently made superior returns by buying stock after a 10%
rise in price and selling after a 10% fall.
63. The semistrong form of the efficient market hypothesis implies that ____________
generate abnormal returns and ____________ generate abnormal returns.
A. technical analysis cannot; fundamental analysis can
B. technical analysis can; fundamental analysis can
C. technical analysis can; fundamental analysis cannot
D. technical analysis cannot; fundamental analysis cannot
Answer: D. technical analysis cannot; fundamental analysis cannot
64. An implication of the efficient market hypothesis is that __________.
A. high-beta stocks are consistently overpriced
B. low-beta stocks are consistently overpriced
C. nonzero alphas will quickly disappear
D. growth stocks are better buys than value stocks
Answer: C. nonzero alphas will quickly disappear
65. One type of passive portfolio management is ________.
A. investing in a well-diversified portfolio without attempting to search out mispriced
securities
B. investing in a well-diversified portfolio while only seeking out passively mispriced
securities
C. investing an equal dollar amount in index stocks
D. investing in an equal amount of shares in each of the index stocks
Answer: A. investing in a well-diversified portfolio without attempting to search out
mispriced securities
66. The four-factor model used to construct performance benchmarks for mutual funds uses
the three Fama and French factors and one additional factor related to _________.
A. the tenure of the fund manager
B. momentum
C. fees
D. the age of the fund manager
Answer: B. momentum
67. Value stocks may provide investors with better returns than growth stocks if:
I. Value stocks are out of favor with investors.
II. Prices of growth stocks include premiums for overly optimistic growth levels.
III. Value stocks are likely to generate positive-earnings surprises.
A. I only
B. II only
C. I and III only
D. I, II, and III
Answer: D. I, II, and III
68. Value stocks usually exhibit ______ price-to-book ratios and ______ price-to-earnings
ratios.
A. low; low
B. low; high
C. high; low
D. high; high
Answer: A. low; low
69. Growth stocks usually exhibit ______ price-to-book ratios and ______ price-to-earnings
ratios.
A. low; low
B. low; high
C. high; low
D. high; high
Answer: D. high; high
70. A day trade with an average stock holding period of under 8 minutes might be most
closely associated with which trading philosophy?
A. EMH
B. Fundamental analysis
C. Strong-form market efficiency
D. Technical analysis
Answer: D. Technical analysis
71. A technical analyst is most likely to be affiliated with which investment philosophy?
A. Active management
B. Buy and hold
C. Passive investment
D. Index funds
Answer: A. Active management
72. Someone who invests in the Vanguard Index 500 mutual fund could most accurately be
described as using which approach?
A. Active management
B. Arbitrage
C. Fundamental analysis
D. Passive investment
Answer: D. Passive investment
73. Evidence by Blake, Elton, and Gruber indicates that, on average, actively managed bond
funds ______.
A. outperform passive fixed-income indexes
B. underperform passive fixed-income indexes by a wide margin
C. perform as well as passive fixed-income indexes
D. underperform passive fixed-income indexes by an amount equal to fund expenses
Answer: D. underperform passive fixed-income indexes by an amount equal to fund expenses
74. Insiders are able to profitably trade and earn abnormal returns prior to the announcement
of positive news. This is a violation of which form of efficiency?
A. Weak-form efficiency
B. Semistrong-form efficiency
C. Strong-form efficiency
D. Technical analysis
Answer: C. Strong-form efficiency
75. In an efficient market and for an investor who believes in a passive approach to investing,
what is the primary duty of a portfolio manager?
A. Accounting for results
B. Diversification
C. Identifying undervalued stocks
D. No need for a portfolio manager
Answer: B. Diversification
76. Which of the following is not a topic related to the debate over market efficiency?
A. IPO results
B. Lucky event issue
C. Magnitude issue
D. Selection bias
Answer: A. IPO results
77. Which Fidelity Magellan portfolio manager is often referenced as an exception to the
general conclusion of efficient markets?
A. Jeff Vinik
B. Peter Lynch
C. Robert Stansky
D. William Hayes
Answer: B. Peter Lynch
78. The tendency of poorly performing stocks and well-performing stocks in one period to
continue their performance into the next period is called the ________________.
A. fad effect
B. martingale effect
C. momentum effect
D. reversal effect
Answer: C. momentum effect
79. Which of the following is not a concept related to explaining abnormal excess stock
returns?
A. January effect
B. Neglected-firm effect
C. P/E effect
D. Preferred stock effect
Answer: D. Preferred stock effect
80. The lack of adequate trading volume in stock that may ultimately lead to its ability to
produce excess returns is referred to as the ____________________.
A. January effect
B. liquidity effect
C. neglected-firm effect
D. P/E effect
Answer: B. liquidity effect
81. Fundamental analysis determines that the price of a firm's stock is too low, given its
intrinsic value. The information used in the analysis is available to all market participants, yet
the price does not seem to react. The stock does not trade on a major exchange. What concept
might explain the ability to produce excess returns on this stock?
A. January effect
B. Neglected-firm effect
C. P/E effect
D. Reversal effect
Answer: B. Neglected-firm effect
82. When testing mutual fund performance over time, one must be careful of ___________,
which means that a certain percentage of poorer-performing funds fail over time, making the
performance of remaining funds seem more consistent over time.
A. survivorship bias
B. lucky event bias
C. magnitude bias
D. mean reversion bias
Answer: A. survivorship bias
83. Most evidence indicates that U.S. stock markets are _______________________.
A. reasonably weak-form and semistrong-form efficient
B. strong-form efficient
C. reasonably weak-form but not semistrong- or strong-form efficient
D. neither weak-, semistrong-, nor strong-form efficient
Answer: A. reasonably weak-form and semistrong-form efficient
84. Which of the following statements is (are) correct?
A. If a market is weak-form efficient, it is also semistrong- and strong-form efficient.
B. If a market is semistrong-form efficient, it is also strong-form efficient.
C. If a market is strong-form efficient, it is also semistrong- but not weak-form efficient.
D. If a market is strong-form efficient, it is also semistrong- and weak-form efficient.
Answer: D. If a market is strong-form efficient, it is also semistrong- and weak-form efficient.
85. According to Markowitz and other proponents of modern portfolio theory, which of the
following activities would not be expected to produce any benefits?
A. Diversifying
B. Investing in Treasury bills
C. Investing in stocks of utility companies
D. Engaging in active portfolio management to enhance returns
Answer: D. Engaging in active portfolio management to enhance returns
86. According to results by Seyhun, the main reason that investors cannot earn excess returns
by following inside trades after they become public is that ______________.
A. the information isn't available for at least 2 weeks
B. transaction costs offset abnormal returns
C. the SEC late-disclosure rule doesn't apply to insiders
D. insiders don't have to disclose their trades
Answer: B. transaction costs offset abnormal returns
Test Bank for Essentials of Investments
Zvi Bodie, Alex Kane, Alan Marcus
9780078034695, 9789389957877, 9781264140251, 9781260316148, 9780073382401, 9780078034695, 9781260013924, 9780077835422
