LOS c, (Part 3): Explain the rationale for investing in index funds.

Q1. Which of the following statements regarding index funds is least accurate?

A)   One disadvantage of index funds is that they do not provide access to international securities.

B)   One advantage of index funds is that they allow for diversification that is typically not available to the average individual investor due to a lack of resources.

C)   One might conclude from the efficient market literature that an investor should mimic the market's performance and minimize costs by buying index funds.

Q2. Given that markets are efficient, which of the following is least likely to cause an actively managed mutual fund to underperform an index fund?

A)   Inferior stock selection.

B)   Taxes.

C)   Management expenses.

Q3. Assuming that markets are efficient, which of the following statements is FALSE?

A)   Investors should not trade often.

B)   Investors should buy and hold passively managed index funds.

C)   Markets will not be volatile.

Q4. Which of the following is NOT a rationale for investing in index funds?

A)   Minimize risk.

B)   Active mutual fund managers underperform index funds.

C)   Efficient financial markets.

LOS c, (Part 3): Explain the rationale for investing in index funds.fficeffice" />

Q1. Which of the following statements regarding index funds is least accurate?

A)   One disadvantage of index funds is that they do not provide access to international securities.

B)   One advantage of index funds is that they allow for diversification that is typically not available to the average individual investor due to a lack of resources.

C)   One might conclude from the efficient market literature that an investor should mimic the market's performance and minimize costs by buying index funds.

Correct answer is A)

An advantage of index funds is that they do offer international diversification via international index funds.

Q2. Given that markets are efficient, which of the following is least likely to cause an actively managed mutual fund to underperform an index fund?

A)   Inferior stock selection.

B)   Taxes.

C)   Management expenses.

Correct answer is A)

Inferior stock selection would not be a reason because, in an efficient market, all securities are priced perfectly. Therefore, there are no undervalued or overvalued securities. Since all securities are perfectly priced, the investor should select a strategy that minimizes taxes, transactions costs, and management expenses.

Q3. Assuming that markets are efficient, which of the following statements is FALSE?

A)   Investors should not trade often.

B)   Investors should buy and hold passively managed index funds.

C)   Markets will not be volatile.

Correct answer is C)

If markets are efficient, prices are correct. Therefore, the best investment strategy is one that chooses a market index and then minimizes investment expenses, such as transaction costs. Markets may still be volatile if important news is arriving to the market, at which time the market will react to the news, perhaps with great volatility until the news is digested.

Q4. Which of the following is NOT a rationale for investing in index funds?

A)   Minimize risk.

B)   Active mutual fund managers underperform index funds.

C)   Efficient financial markets.

Correct answer is A)

The minimization of risk is not a rationale for investing in index funds.

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