The likelihood of an investment newsletter's successfully predicting the direction of the market for three consecutive years by chance should be

41. The likelihood of an investment newsletter's successfully predicting the direction of the market for three consecutive years by chance should be
A. between 50% and 70%.
B. between 25% and 50%.
C. between 10% and 25%.
D. less than 10%.
E. greater than 70%.

The probability of successful prediction for 3 consecutive years is 12.5%.

AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Mutual Fund/Analyst Performance
 

42. In an efficient market the correlation coefficient between stock returns for two non-overlapping time periods should be
A. positive and large.
B. positive and small.
C. zero.
D. negative and small.
E. negative and large.

In an efficient market there should be no serial correlation between returns from non-overlapping periods.

AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Efficient Market Hypothesis
 

43. The weather report says that a devastating and unexpected freeze is expected to hit Florida tonight, during the peak of the citrus harvest. In an efficient market one would expect the price of Florida Orange's stock to
A. drop immediately.
B. remain unchanged.
C. increase immediately.
D. gradually decline for the next several weeks.
E. gradually increase for the next several weeks.

In an efficient market the price of the stock should drop immediately when the bad news is announced. If later news changes the perceived impact to Florida Orange, the price may once again adjust quickly to the new information. A gradual change is a violation of the EMH.

AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: Event Studies
 

44. Matthews Corporation has a beta of 1.2. The annualized market return yesterday was 13%, and the risk-free rate is currently 5%. You observe that Matthews had an annualized return yesterday of 17%. Assuming that markets are efficient, this suggests that
A. bad news about Matthews was announced yesterday.
B. good news about Matthews was announced yesterday.
C. no news about Matthews was announced yesterday.
D. interest rates rose yesterday.
E. interest rates fell yesterday.

AR = 17% − (5% + 1.2 (8%)) = +2.4%. A positive abnormal return suggests that there was firm-specific good news.

AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: Event Studies
 

45. Nicholas Manufacturing just announced yesterday that its fourth quarter earnings will be 10% higher than last year's fourth quarter. You observe that Nicholas had an abnormal return of −1.2% yesterday. This suggests that
A. the market is not efficient.
B. Nicholas' stock will probably rise in value tomorrow.
C. investors expected the earnings increase to be larger than what was actually announced.
D. investors expected the earnings increase to be smaller than what was actually announced.
E. earnings are expected to decrease next quarter.

Anticipated earnings changes are impounded into a security's price as soon as expectations are formed. Therefore a negative market response indicates that the earnings surprise was negative, that is, the increase was less than anticipated.

AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: Event Studies
 

46. When Maurice Kendall first examined stock price patterns in 1953, he found that
A. certain patterns tended to repeat within the business cycle.
B. there were no predictable patterns in stock prices.
C. stocks whose prices had increased consistently for one week tended to have a net decrease the following week.
D. stocks whose prices had increased consistently for one week tended to have a net increase the following week.
E. the direction of change in stock prices was unpredictable, but the amount of change followed a distinct pattern.

The first studies in this area were made possible by the development of computer technology. Kendall's study was the first to indicate that markets were efficient.

AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Implications of the EMH
 

47. If stock prices follow a random walk
A. it implies that investors are irrational.
B. it means that the market cannot be efficient.
C. price levels are not random.
D. price changes are random.
E. price movements are predictable.

A random walk means that the changes in prices are random and independent.

AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Efficient Market Hypothesis
 

48. The main difference between the three forms of market efficiency is that
A. the definition of efficiency differs.
B. the definition of excess return differs.
C. the definition of prices differs.
D. the definition of information differs.
E. they were discovered by different people.

The main difference is that weak form encompasses only historical data, semistrong form encompasses historical data and current public information, and strong form encompasses historical data, current public information, and inside information. All of the other definitions remain the same.

AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: Efficient Market Hypothesis
 

49. Chartists practice
A. technical analysis.
B. fundamental analysis.
C. regression analysis.
D. insider analysis.
E. psychoanalysis.

Chartist is another name for a technical analyst.

AACSB: Analytic
Bloom's: Understand
Difficulty: Basic
Topic: Implications of the EMH
 

50. Which of the following are used by fundamental analysts to determine proper stock prices?
I) trendlines
II) earnings
III) dividend prospects
IV) expectations of future interest rates
V) resistance levels
A. I, IV, and V
B. I, II, and III
C. II, III, and IV
D. II, IV, and V
E. All five items are used by fundamental analysts.

Fundamental analysts look at factors such as earnings, dividend prospects, expectation of future interest rates, and risk of the firm. The information is used to determine the present value of future cash flows to stockholders. Technical analysts use trendlines and resistance levels.

AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Implications of the EMH