LOS a, (Part 1): Define an efficient capital market.

Q1. If a firm announces an unexpectedly large cash dividend, the efficient market hypothesis (EMH) would predict which of the following price changes at the announcement?

A)   An abnormal price change to occur at the time of the announcement.

B)   No price change.

C)   An abnormal price change to occur before the announcement.

Q2. Which of the following is NOT an assumption behind efficient capital markets?

A)   Return expectations implicitly include risk.

B)   New information occurs randomly, and the timing of announcements is independent of one another.

C)   Market participants correctly adjust prices to reflect new information.

Q3. An efficient capital market:

A)   fully reflects all of the information currently available about a given security, excluding risk.

B)   does not fully reflect all of the information currently available about a given security, including risk.

C)   fully reflects all of the information currently available about a given security, including risk.

Q4. Classifying a capital market as efficient is least likely to imply that:

A)   stock prices adjust swiftly to new information.

B)   corporate insider’s investment performance will consistently exceed the performance of other investors.

C)   stock price changes are random and unpredictable.

Q5. Which one of the following is least likely an assumption of efficient capital markets?

A)   Risk is included in the pricing of the security.

B)   Market participants correctly adjust prices when new information is received.

C)   There are a large number of participants that analyze and value securities independently of one another.

LOS a, (Part 1): Define an efficient capital market. fficeffice" />

Q1. If a firm announces an unexpectedly large cash dividend, the efficient market hypothesis (EMH) would predict which of the following price changes at the announcement?

A)   An abnormal price change to occur at the time of the announcement.

B)   No price change.

C)   An abnormal price change to occur before the announcement.

Correct answer is A)

Market efficiency assumes investors adjust their estimate of security prices rapidly to reflect their interpretation of the new information received. Market efficiency also assumes that new information comes to market randomly and is available to all investors at the same time. Therefore, the price should not be reflected prior to the announcement.

Q2. Which of the following is NOT an assumption behind efficient capital markets?

A)   Return expectations implicitly include risk.

B)   New information occurs randomly, and the timing of announcements is independent of one another.

C)   Market participants correctly adjust prices to reflect new information.

Correct answer is C)

The set of assumptions that imply an efficient capital market includes:

§   There exists a large number of profit-maximizing market participants.

§   New information occurs randomly.

§   Market participants adjust their price expectations rapidly (but not necessarily correctly).

§   Return expectations implicitly include risk.

Q3. An efficient capital market:

A)   fully reflects all of the information currently available about a given security, excluding risk.

B)   does not fully reflect all of the information currently available about a given security, including risk.

C)   fully reflects all of the information currently available about a given security, including risk.

Correct answer is C)

An efficient capital market fully reflects all of the information currently available about a given security, including risk.

Q4. Classifying a capital market as efficient is least likely to imply that:

A)   stock prices adjust swiftly to new information.

B)   corporate insider’s investment performance will consistently exceed the performance of other investors.

C)   stock price changes are random and unpredictable.

Correct answer is B)

In efficient markets, stock prices reflect all available information. Therefore, insiders have no advantage.

Q5. Which one of the following is least likely an assumption of efficient capital markets?

A)   Risk is included in the pricing of the security.

B)   Market participants correctly adjust prices when new information is received.

C)   There are a large number of participants that analyze and value securities independently of one another.

Correct answer is B)

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