Exercises on EMH

1. 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) A, B, and C E) none of the above

Answer: A Difficulty: Easy Rationale: The semistrong form of EMH maintains that stock prices immediately reflect all historical and current public information, but not inside information.

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

Answer: E Difficulty: Easy Rationale: 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.

3. If you believe in the _______ form of the EMH, you believe that stock prices 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) all of the above E) none of the above

Answer: C Difficulty: Easy Rationale: 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.

4. 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) all of the above E) none of the above

Answer: B Difficulty: Easy Rationale: The strong form includes all public and private information.

5.__________ focus more on past price movements of a firm's stock than on the underlying determinants of future profitability. A) Credit analysts B) Fundamental analysts C) Systems analysts D) Technical analysts E) All of the above

Answer: D Difficulty: Easy Rationale: Technicians attempt to predict future stock prices based on historical stock prices.

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6. Proponents of the EMH think technical analysts A) should focus on relative strength. B) should focus on resistance levels. C) should focus on support levels. D) should focus on financial statements. E) are wasting their time.

Answer: E Difficulty: Moderate Rationale: Technical analysts attempt to predict future stock prices from historic stock prices; proponents of EMH believe that stock price changes are random variables.

7. In an efficient market, __________. A) security prices react quickly to new information B) security prices are seldom far above or below their justified levels C) security analysts will not enable investors to realize superior returns consistently D) one cannot make money E) A, B, and C

Answer: E Difficulty: Easy Rationale: A, B, and C are true; however, even in an efficient market one should be able to earn the appropriate risk-adjusted rate of return.

8. The weak form of the efficient market hypothesis asserts that A) stock prices do not rapidly adjust to new information contained in past prices or past data. B) future changes in stock prices cannot be predicted from past prices. C) technicians cannot expect to outperform the market. D) A and B E) B and C

Answer: E Difficulty: Easy Rationale: Stock prices do adjust rapidly to new information.

9. 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.

Answer: D Difficulty: Moderate Rationale: The main difference is that weak form encompasses 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.

10. According to proponents of the efficient market hypothesis, the best strategy for a small investor with a portfolio worth $40,000 is probably to A) perform fundamental analysis. B) exploit market anomalies. C) invest in Treasury securities. D) invest in derivative securities. E) invest in mutual funds.

Answer: E Difficulty: Moderate Rationale: Individual investors tend to have relatively small portfolios and are usually unable to realize economies of size. The best strategy is to pool funds with other small investors and allow professional managers to invest the funds.

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