Chapter 11 The Efficient Market Hypothesis 237 Multiple Choice Questions 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 the above Answer: A Difficulty: Easy Rationale: The semistrong form of EMH maintains that stock prices immediately reflect all historical and current public information, but not inside information. 2. 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 Answer: E Difficulty: Easy Rationale: Believers of market efficiency advocate passive investment strategies, and an investment in an index fund is one of the most practical passive investment strategies, especially for small investors. 3. 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 the above E) none of the above Answer: C Difficulty: Easy Rationale: The information described above is market data, which is the data set for the weak form of market efficiency. The semistrong form includes the above plus all other public information. The strong form includes all public and private information. Chapter 11 The Efficient Market Hypothesis 238 4. 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 the above E) none of the above Answer: B Difficulty: Easy Rationale: The strong form includes all public and private information. 5. 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 Answer: C Difficulty: Easy Rationale: The reversal effect states that stocks that do well in one period tend to perform poorly in the subsequent period, and vice versa. 6. _ focus more on past price movements of a firms stock than on the underlying determinants of future profitability. A) Credit analysts B) Fundamental analysts C) Systems analysts D) Technical analysts E) All of the above Answer: D Difficulty: Easy Rationale: Technicians attempt to predict future stock prices based on historical stock prices. Chapter 11 The Efficient Market Hypothesis 239 7. _ above which it is difficult for the market to rise. A) Book value is a value B) Resistance level is a value C) Support level is a value D) A and B E) A and C Answer: B Difficulty: Easy Rationale: When stock prices have remained stable for a long period, these prices are termed resistance levels; technicians believe it is difficult for the stock prices to penetrate these resistance levels. 8. _ 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 Answer: E Difficulty: Easy Rationale: 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. 9. 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 the above. E) none of the above. Answer: D Difficulty: Easy Rationale: Factors A, B, and C all exist make rigid testing of market efficiency difficult or impossible. Chapter 11 The Efficient Market Hypothesis 240 10. 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 Answer: A Difficulty: Easy Rationale: The index fund is, by definition, passively managed. The other investment alternatives may or may not be managed passively. 11. Arbel (1985) found that A) the January effect was highest for neglected firms. B) the book-to-market 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 book-to-market value ratios. Answer: A Difficulty: Moderate Rationale: Arbel divided firms into highly researched, moderately researched, and neglected groups based on the number of institutions holding t