Chapter 11 Study Notes

Chapter 11 Study Notes
Chapter 11 [Old exam conceptual questions]

1- Suppose you purchase a stock expecting the price to rise in the coming year. After one year,
your stock has actually decreased in value, due primarily to adverse information released
during the year. Which of the following describes this result?
A) This is not a violation of market efficiency.
B) This is a violation of weak form efficiency.
C) This is a violation of semi-strong form efficiency.
D) This is a violation of strong form efficiency.
E) This is a violation of all forms of market efficiency.
2- You discover you can make above normal returns if you buy oil-company stocks just before
noon on any given trading day and then sell them immediately before the market closes
that same day. Which of the following describes this event?
A) This would not be a violation of market efficiency.
B) This would be a violation of weak form efficiency.
C) This would be a violation of semi-strong form efficiency.
D) This would be a violation of strong form efficiency.
E) This would be a violation of all forms of market efficiency.
3- While eating in an exclusive restaurant in New York City, you overhear two executives
negotiating a merger. When you check the news about the two companies after lunch
you find there is no public information about any merger. Thus, you buy shares of stock
in both firms and make a killing when the merger is announced publicly two days later.
This is a violation of ______________ market efficiency.
A) weak form
B) semi-weak form
C) semi-strong form
D) strong form
E) TSX stock
4- Last year you purchased a stock at $21.63 a share. Today you sold your shares at $23.01 after
receiving your quarterly dividend. The total return on this stock consists of:
A) A capital gain only.
B) A capital loss only.
C) A capital gain and a dividend yield.
D) A capital loss and a dividend yield.
E) A dividend yield and a risk-free rate of return.
5- Which of the following statements is (are) true concerning risk and return?
I. To accept higher levels of risk, investors must be paid a higher risk premium.
II. Small-company stocks offer a higher return and less risk than large-company stocks.
III. The risk-free rate of return is based on the long-term government bond rate.
IV. The higher the standard deviation, the less predictable the rate of return in any one
year.
A) I only
B) II only
C) III and IV only
D) I and II only
E) I and IV only
6- If capital markets are efficient, then ________________________.

A) there is no reason to believe that prices are too high or too low
B) it is possible to make abnormal returns from publicly available information
C) prices will adjust slowly when reacting to new information
D) it is not possible to make money in the stock market
E) historical price trends will give you a good idea of where prices are headed in the
future
7- Which of the following are considered to be market anomalies:

I The January effect.
II The World Cup effect
III The Super Bowl effect
IV The market crash of March 29th 1996.
A) I only
B) III and IV only
C) I and III only
D) II and III only
E) II, III, and IV only
8- An asset's return on investment has two components, one of which is ____________, which
reflects the cash you receive directly while you own the investment.
A) the capital gain
B) the income component
C) your reward for bearing risk
D) your total dollar return
E) your gross return on that investment
9- Which of the following statements about historical security returns is/are true?
I. Stocks of small companies have higher average returns than those of larger
companies.
II. Risky securities have higher average returns than riskless securities.
III. Long bonds have higher average yields than Treasury bills.
IV. Historical information about capital markets is useful for drawing conclusions
about the relationship between risk and return.
A) I and III only
B) I, II, and III only
C) III and IV only
D) I and II only
E) I, II, III, and IV
10- IBM announces that earnings per share for the current quarter are $1.25; this figure is barely
half of what investors and analysts expected. In an efficient market, the price of IBM
stock will
A) change immediately to reflect changes in investor expectations
B) gradually fall over several days as investors assimilate the new information
C) first fall, reflecting investors' surprise; then rise back somewhat as investors
assimilate the new information
D) probably not change at all
E) fall only if there is additional unfavourable news about IBM announced at the same
time
11- The nominal rate of return on large-company stocks consists of a:

A) Risk-free rate of return plus an inflation adjustment.
B) Real rate of return plus the Treasury bill rate of return.
C) Risk premium plus the Treasury bill rate of return.
D) Risk-free rate of return plus a bond premium.
E) none of the above.
Chapter 11 [Old exam Problems]

1- A stock produced total returns of 9.78%, 13.61%, 1.19%, and -4.90% over the past four
years, respectively. Based on this information what range of returns would you expect to
see in the 95% confidence interval but not in the 68% confidence interval? (use 5 decimal
points when calculating variance and standard deviation)
Solution:
E(R) = µ = [9.78% + 13.61% + 1.19% + (-4.9%)]/4 = 19.68%/4 = 4.92%
σ² = (1/3) [(0.0978 – 0.0492)² + (0.1361 – 0.0492)² + (0.0119 – 0.0492)² + (-0.049 – 0.0492)²]
= (1/3) [(0.0486)² + (0.0869)² + (-0.0373)² + (-0.0982)²]
= (1/3) [(0.00236) + (0.00755) + (0.00139) + (0.00964)]
= 0.02094/3 = 0.00698
σ = 0.08355 = 8.35%
Range of returns:
(µ - 2 σ) → (µ - σ) and (µ + σ) → (µ + 2 σ)
[4.92% - 2 (8.35%)] → [4.92% - 8.35%] and [4.92% + 8.35%] → [4.92% + 2 (8.35%)]
[4.92% - 16.7%] → -3.43% and 13.27% → [4.92% + 16.7%]
-11.78% → -3.43% and 13.27% → 21.62%

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Chapter 11 Study Notes

Chapter 11 [Old exam conceptual questions]

6- If capital markets are efficient, then ________________________.

7- Which of the following are considered to be market anomalies:

11- The nominal rate of return on large-company stocks consists of a:

Chapter 11 [Old exam Problems]

[4.92% - 16.7%] → -3.43% and 13.27% → [4.92% + 16.7%]

-11.78% → -3.43% and 13.27% → 21.62%

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