Chapter 6Are Financial Markets Efficient?nMultiple Choice Questions1.How expectations are formed is important because expectations influence(a)the demand for assets.(b)bond prices.(c)the risk structure of interest rates.(d)the term structure of interest rates.(e)all of the above.Answer:E2.According to the efficient market hypothesis, the current price of a financial security(a)is the discounted net present value of future interest payments.(b)is determined by the highest successful bidder.(c)fully reflects all available relevant information.(d)is a result of none of the above.Answer:C3.The efficient market hypothesis(a)is based on the assumption that prices of securities fully reflect all available information.(b)holds that the expected return on a security equals the equilibrium return.(c)both (a) and (b).(d)neither (a) nor (b).Answer:C4.If the optimal forecast of the return on a security exceeds the equilibrium return, then(a)the market is inefficient.(b)an unexploited profit opportunity exists.(c)the market is in equilibrium.(d)only (a) and (b) of the above are true.(e)only (b) and (c) of the above are true.Answer:D5.According to the efficient market hypothesis(a)one cannot expect to earn an abnormally high return by purchasing a security.(b)information in newspapers and in the published reports of financial analysts is already reflected in market prices.(c)unexploited profit opportunities abound, thereby explaining why so many people get rich by trading securities.(d)all of the above are true.(e)only (a) and (b) of the above are true.Answer:E6.Another way to state the efficient market condition is that in an efficient market,(a)unexploited profit opportunities will be quickly eliminated.(b)unexploited profit opportunities will never exist.(c)arbitrageurs guarantee that unexploited profit opportunities never exist.(d)both (a) and (c) of the above occur.Answer:A7.Another way to state the efficient market hypothesis is that in an efficient market,(a)unexploited profit opportunities will never exist as market participants, such as arbitrageurs, ensure that they are instantaneously dissipated.(b)unexploited profit opportunities will not exist for long, as market participants will act quickly to eliminate them.(c)every financial market participant must be well informed about securities.(d)only (a) and (c) of the above.Answer:B8.A situation in which the price of an asset differs from its fundamental market value is called(a)an unexploited profit opportunity.(b)a bubble.(c)a correction.(d)a mean reversion.Answer:B9.A situation in which the price of an asset differs from its fundamental market value(a)indicates that unexploited profit opportunities exist.(b)indicates that unexploited profit opportunities do not exist.(c)need not indicate that unexploited profit opportunities exist.(d)indicates that the efficient market hypothesis is fundamentally flawed.Answer:C10.Studies of mutual fund performance indicate that mutual funds that outperformed the market in one time period(a)usually beat the market in the next time period.(b)usually beat the market in the next two subsequent time periods.(c)usually beat the market in the next three subsequent time periods.(d)usually do not beat the market in the next time period.Answer:D11.The efficient market hypothesis suggests that allocating your funds in the financial markets on the advice of a financial analyst(a)will certainly mean higher returns than if you had made selections by throwing darts at the financial page.(b)will always mean lower returns than if you had made selections by throwing darts at the financial page.(c)is not likely to prove superior to a strategy of making selections by throwing darts at the financial page.(d)is good for the economy.Answer:C12.Ivan Boesky, the most successful of the so-called arbs in the 1980s, was able to outperform the market on a consistent basis, indicating that(a)securities markets are not efficient.(b)unexploited profit opportunities were abundant.(c)investors can outperform the market with inside information.(d)only (b) and (c) of the above.Answer:D13.To say that stock prices follow a “random walk” is to argue that(a)stock prices rise, then fall.(b)stock prices rise, then fall in a predictable fashion.(c)stock prices tend to follow trends.(d)stock prices are, for all practical purposes, unpredictable.Answer:D14.To say that stock prices follow a “random walk” is to argue that(a)stock prices rise, then fall, then rise again.(b)stock prices rise, then fall in a predictable fashion.(c)stock prices tend to follow trends.(d)stock prices cannot be predicted based on past trends.Answer:D15.Rules used to predict movements in stock prices based on past patterns are, accor