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Equity Investments【Reading 49】Sample

An efficient capital market:
A)
fully reflects all of the information currently available about a given security, excluding risk.
B)
fully reflects all of the information currently available about a given security, including risk.
C)
does not fully reflect all of the information currently available about a given security, including risk.



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

The implication of efficient capital markets and a lack of superior analysts have led to the introduction of:
A)
balanced funds.
B)
index funds.
C)
futures options.



An index fund is designed to duplicate the composition of a specific index series or market segment. There is a strong argument suggesting that portfolio managers cannot beat the market after fees, therefore an index fund should be used to try to match the market.

TOP

In an informationally efficient market:
A)
buying and holding a broad market portfolio is the preferred investment strategy.
B)
the conditions exist for active investment strategies to achieve superior risk-adjusted returns.
C)
share prices adjust rapidly when companies announce results in line with expectations.



If financial markets are informationally efficient, active investment strategies cannot consistently achieve risk-adjusted returns superior to holding a passively managed index portfolio. In addition, a passive investment strategy has lower transactions costs than an active management strategy. Share prices should not adjust when a company announces results in line with expectations in an informationally efficient market, because the market price already reflects the expected results.

TOP

Hume Inc. announces fourth quarter earnings per share of $1.20, which is 15% higher than last year. Hume’s earnings are equal to the consensus analyst forecast for the quarter. Assuming markets are efficient, the announcement will most likely cause the price of Hume’s stock to:
A)
decrease.
B)
remain the same.
C)
increase.



An efficient capital market would price Hume’s stock based on the expectation for earnings per share. Since actual earnings equal expected earnings, the stock price should not change as a result of the announcement.

TOP

Which of the following would be inconsistent with an efficient market?
A)
Stock prices adjust rapidly to new information.
B)
Price adjustments are biased.
C)
Price changes are independent.



Market efficiency assumes that investors adjust their estimates of security prices rapidly to reflect their unbiased interpretation of the new information. New information arrives randomly and independently. Therefore, price changes are independent.

TOP

A market’s efficiency is most likely to negatively affected by:
A)
substantial analyst coverage of the exchange listed companies
B)
a high amount of trading activity.
C)
a ban on short selling.



Research supports the conclusion that short selling helps to prevent market prices from becoming overvalued, while limiting short selling has the opposite effect. More analyst coverage and more liquidity contribute to market efficiency.

TOP

An increase in which of the following factors would most likely improve a market’s efficiency?
A)
Restrictions on short selling.
B)
Number of participants.
C)
Bid-ask spreads.



As the number of market participants increases, the speed at which markets adjust to new information is likely to increase. Restrictions on short selling limit the ability of arbitrage to correct pricing anomalies. High bid-ask spreads increase transaction costs and decrease efficiency.

TOP

The measure of an asset’s value that can most likely be determined without estimation is its:
A)
intrinsic value.
B)
fundamental value.
C)
market value.



The current price of a traded asset is its market value. An asset’s intrinsic or fundamental value is the price a rational investor with complete information about the asset would pay for it.

TOP

A stock is said to be undervalued if its market price is:
A)
greater than its intrinsic value.
B)
less than its intrinsic value.
C)
less than its book value.



A security with a market price less than its intrinsic value is undervalued.

TOP

Which of the following is NOT an assumption behind efficient capital markets?
A)
Market participants correctly adjust prices to reflect new information.
B)
Return expectations implicitly include risk.
C)
New information occurs randomly, and the timing of announcements is independent of one another.



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.

TOP

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