Chapter 11 The Efficient Market Hypothesis Answer Key
Multiple Choice Questions

If you believe in the ________ form of the EMH, you believe that stock prices reflect all relevant information including historical stock prices and current public information about the firm, but not information that is available only to insiders.
A.semistrong
B. strong
C. weak
D. semistrong, strong, and weak
E. hard

The semistrong form of the EMH maintains that stock prices immediately reflect all historical and current public information, but not inside information.

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

When Maurice Kendall examined the patterns of stock returns in 1953 he concluded that the stock market was __________. Now, these random price movements are believed to be _________.
A.inefficient; the effect of a well-functioning market
B. efficient; the effect of an inefficient market
C. inefficient; the effect of an inefficient market
D. efficient; the effect of a well-functioning market
E. irrational; even more irrational than before

Random price changes were originally thought to be driven by irrationality. Now, financial economists believe random price changes occur because markets are informationally efficient.

AACSB: Analytic
Bloom’s: Understand
Difficulty: Basic
Topic: Efficient Market Hypothesis

The stock market follows a __________.
A.random walk
B. submartingale
C. predictable pattern that can be exploited
D. random walk and a predictable pattern that can be exploited
E. submartingale and a predictable pattern that can be exploited

The stock market follows a submartingale.

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

A hybrid strategy is one where the investor
A.uses both fundamental and technical analysis to select stocks.
B. selects the stocks of companies that specialize in alternative fuels.
C. selects some actively-managed mutual funds on their own and uses an investment advisor to select other actively-managed funds.
D. maintains a passive core and augments the position with an actively managed portfolio.
E. None of these are correct.

A hybrid strategy is one where the investor maintains a passive core and augments the position with an actively managed portfolio.

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

The difference between a random walk and a submartingale is the expected price change in a random walk is ______ and the expected price change for a submartingale is ______.
A.positive; zero
B. positive; positive
C. positive; negative
D. zero; positive
E. zero; zero

A random walk has an expected price change of zero and a submartingale has a positive expected price change.

AACSB: Analytic
Bloom’s: Understand
Difficulty: Basic
Topic: Efficient Market Hypothesis

Proponents of the EMH typically advocate
A.an active trading strategy.
B. investing in an index fund.
C. a passive investment strategy.
D. an active trading strategy and investing in an index fund
E. investing in an index fund and a passive investment strategy

Believers of market efficiency advocate passive investment strategies, and an investment in an index fund is one of the most practical passive investment strategies, especially for small investors.

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

Proponents of the EMH typically advocate
A.buying individual stocks on margin and trading frequently.
B. investing in hedge funds.
C. a passive investment strategy.
D. buying individual stocks on margin and trading frequently and investing in hedge funds
E. investing in hedge funds and a passive investment strategy

Believers of market efficiency advocate passive investment strategies, and an investment in an index fund is one of the most practical passive investment strategies, especially for small investors.

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

If you believe in the _______ form of the EMH, you believe that stock prices only reflect all information that can be derived by examining market trading data such as the history of past stock prices, trading volume or short interest.
A.semistrong
B. strong
C. weak
D. semistrong, strong, and weak
E. None of these are correct.

The information described above is market data, which is the data set for the weak form of market efficiency. The semistrong form includes the above plus all other public information. The strong form includes all public and private information.

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

If you believe in the _________ form of the EMH, you believe that stock prices reflect all available information, including information that is available only to insiders.
A.semistrong
B. strong
C. weak
D. semistrong, strong, and weak
E. None of these are correct.

The strong form includes all public and private information.

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

If you believe in the reversal effect, you should
A.buy bonds in this period if you held stocks in the last period.
B. buy stocks in this period if you held bonds in the last period.
C. buy stocks this period that performed poorly last period.
D. go short.
E. both buy stocks this period that performed poorly last period and go short

The reversal effect states that stocks that do well in one period tend to perform poorly in the subsequent period, and vice versa.

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