LOS d: Explain why a mispricing may persist and why valid anomalies may not be profitable.

Q1. The reasons why a mispricing can persist all relate to the idea that:

A)   the size of the available profit is too small.

B)   taxes and other transactions costs make exploiting the anomaly prohibitive.

C)   an anomaly cannot be quickly exploited by traders or arbitrageurs.

Q2. Which of the following statements concerning the persistence of pricing anomalies is least likely to be correct?

A)   If the shares of an IPO cannot be shorted, mispricing may be difficult to exploit.

B)   Small profit opportunities are difficult to exploit in the absence of derivative securities.

C)   Arbitrageurs may exploit opportunities down to the point where the remaining mispricing is approximately equal to transactions costs.

Q3. Which of the following statements concerning the persistence of pricing anomalies is least likely to be correct?

A)   The capital required to exploit an anomaly is often not available.

B)   When there is no theoretical explanation, an anomaly is difficult to exploit.

C)   A lack of liquidity may cause transactions costs to exceed the profit potential of the anomaly.

LOS d: Explain why a mispricing may persist and why valid anomalies may not be profitable.fficeffice" />

Q1. The reasons why a mispricing can persist all relate to the idea that:

A)   the size of the available profit is too small.

B)   taxes and other transactions costs make exploiting the anomaly prohibitive.

C)   an anomaly cannot be quickly exploited by traders or arbitrageurs.

Correct answer is C)

The fundamental reason that mispricing and anomalies can persist is that traders and arbitrageurs are not able to exploit the situation. The other items are possible reasons why traders and arbitrageurs are not able to act.

Q2. Which of the following statements concerning the persistence of pricing anomalies is least likely to be correct?

A)   If the shares of an IPO cannot be shorted, mispricing may be difficult to exploit.

B)   Small profit opportunities are difficult to exploit in the absence of derivative securities.

C)   Arbitrageurs may exploit opportunities down to the point where the remaining mispricing is approximately equal to transactions costs.

Correct answer is B)        

The size of the profit opportunity is likely to be more important than the absence of derivative securities. Thus, this statement is the least likely to be correct from those given for the persistence of mispricing.

Q3. Which of the following statements concerning the persistence of pricing anomalies is least likely to be correct?

A)   The capital required to exploit an anomaly is often not available.

B)   When there is no theoretical explanation, an anomaly is difficult to exploit.

C)   A lack of liquidity may cause transactions costs to exceed the profit potential of the anomaly.

Correct answer is A)

If an anomaly exists and is exploitable, the lack of capital is not a likely explanation for its persistence. The other statements both reflect valid rationales for why mispricing can persist.

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