LOS c, (Part 2): Explain the implications of stock market efficiency for the portfolio management process and the role of the portfolio manager.

Q1. Under the efficient market hypothesis (EMH), the major effort of the portfolio manager should be to:

A)   achieve complete diversification of the portfolio.

B)   minimize systematic risk in the portfolio.

C)   stay the course by following a strict buy and hold strategy.

Q2. Which of the following statements about the assumptions of efficient capital markets and the conclusion of the efficient market hypothesis is least accurate?

A)   If markets are efficient, investors should not trade often.

B)   Tests of market efficiency have found no strategy that produces excess returns above the market after accounting for transaction costs.

C)   In testing for semistrong-form market efficiency, researchers typically adjust for the stock's risk.

Q3. In a perfectly efficient market, portfolio managers should do all of the following EXCEPT:

A)   monitor their client's needs and circumstances.

B)   quantify their risk and return needs within the bounds of the client's liquidity, income, time horizon, legal, and regulatory constraints.

C)   diversify to eliminate systematic risk.

Q4. An implication of the weak-form efficient market hypothesis (EMH) is:

A)   that there should be no relationship between past price changes and future price changes.

B)   insider information is of no value for obtaining excess abnormal returns.

C)   that technical analysts can make excess returns on filter rules but not runs rules.

LOS c, (Part 2): Explain the implications of stock market efficiency for the portfolio management process and the role of the portfolio manager.fficeffice" />

Q1. Under the efficient market hypothesis (EMH), the major effort of the portfolio manager should be to:

A)   achieve complete diversification of the portfolio.

B)   minimize systematic risk in the portfolio.

C)   stay the course by following a strict buy and hold strategy.

Correct answer is A)        

In an efficient market, portfolio managers must create and maintain the appropriate mix of assets to meet their client’s needs. The portfolio should be diversified to eliminate unsystematic risk. The appropriate systematic risk will depend on the clients risk tolerance and return requirement. Over time the needs of the client and environment will justify changes to the portfolio. The manager should also try to minimize transaction costs and at least try to match the performance of a benchmark.

Q2. Which of the following statements about the assumptions of efficient capital markets and the conclusion of the efficient market hypothesis is least accurate?

A)   If markets are efficient, investors should not trade often.

B)   Tests of market efficiency have found no strategy that produces excess returns above the market after accounting for transaction costs.

C)   In testing for semistrong-form market efficiency, researchers typically adjust for the stock's risk.

Correct answer is B)

Several strategies have been shown to produce abnormal returns (returns above the market after adjusting for risk). Small firms and firms with low price to earnings (P/E) ratios and high book-to-market values have all been found to produce positive abnormal returns.

Q3. In a perfectly efficient market, portfolio managers should do all of the following EXCEPT:

A)   monitor their client's needs and circumstances.

B)   quantify their risk and return needs within the bounds of the client's liquidity, income, time horizon, legal, and regulatory constraints.

C)   diversify to eliminate systematic risk.

Correct answer is C)

Portfolio mangers cannot eliminate systematic risk (i.e., market risk) thru the use of diversification. Portfolio managers should try to eliminate unsystematic portfolio risk.

Q4. An implication of the weak-form efficient market hypothesis (EMH) is:

A)   that there should be no relationship between past price changes and future price changes.

B)   insider information is of no value for obtaining excess abnormal returns.

C)   that technical analysts can make excess returns on filter rules but not runs rules.

Correct answer is A)

The implication of the weak-form EMH is that there should be no relationship between past price changes and future price changes. Results of runs tests and filter tests suggest that excess returns are not possible. Tests related to insider or private information are related to the strong-form EMH.

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