Chapter 7: Stock Price Behavior
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Questions and Answers

What is the primary reason for the ban on profiting from non-public information in the U.S. stock markets?

  • To increase stock prices
  • To allow insiders to trade freely
  • To protect corporate profits
  • To ensure fairness and trust in the markets (correct)

    • Which of the following describes an informed trader?

  • An investor who speculates without any information
  • An investor who uses non-public information to trade
  • An investor who is an insider in a corporation
  • An investor who trades based on public information and analysis (correct)

    • What is required for company insiders to legally trade stocks of their own company?

  • They can use any information without restriction
  • They must gain permission from the company's board
  • They must comply with SEC reporting rules (correct)
  • They must not report their trades to anyone

    • Which statement is true regarding illegal insider trading?

    <p>It involves material non-public information that affects stock price</p> Signup and view all the answers

    What distinguishes legal insider trading from illegal insider trading?

    <p>Legal insider trading is based on public information and reported accordingly</p> Signup and view all the answers

    Who is considered an 'insider' for the purpose of identifying illegal insider trading?

    <p>Someone with material non-public information</p> Signup and view all the answers

    Which source is NOT considered a common information source for informed traders?

    <p>Company insider leaks</p> Signup and view all the answers

    What action can lead to charges of insider trading?

    <p>Acting on non-public information to make a profit</p> Signup and view all the answers

    What do researchers suggest about the predictability of future stock returns based on past returns?

    <p>Future returns have a degree of predictability from past returns.</p> Signup and view all the answers

    What impact do trading costs have on attempts to build a profitable trading system based on past stock returns?

    <p>They negate potential gains.</p> Signup and view all the answers

    How do stock price movements behave in terms of predictability?

    <p>They are entirely random and unpredictable.</p> Signup and view all the answers

    What does the efficient market hypothesis (EMH) imply regarding stock prices and publicly available information?

    <p>Stock prices reflect publicly available information fully.</p> Signup and view all the answers

    What does the pattern of stock price changes resemble under the concept of a random walk?

    <p>Stock prices fluctuate randomly, reflecting equal chances of increase or decrease.</p> Signup and view all the answers

    In which way can stock prices adjust to unexpected news according to the efficient market reaction?

    <p>Prices instantaneously adjust to incorporate new information.</p> Signup and view all the answers

    What is a common misconception about stock market price predictability?

    <p>Most individuals believe stock prices can be easily predicted.</p> Signup and view all the answers

    Which statement correctly describes the relationship between historical price movements and future stock performance?

    <p>Past stock movements do not ensure future performance.</p> Signup and view all the answers

    What is the primary assertion of the efficient markets hypothesis (EMH)?

    <p>Major financial markets incorporate all relevant information at any given time.</p> Signup and view all the answers

    What does a delayed reaction in stock prices imply?

    <p>The price partially adjusts to the new information.</p> Signup and view all the answers

    What does 'beating the market' refer to?

    <p>Consistently earning a positive abnormal return above other investments with similar risk.</p> Signup and view all the answers

    What is the primary focus of researchers conducting event studies?

    <p>Studying the size and adjustment process of stock price reactions.</p> Signup and view all the answers

    Which of the following is a finding regarding professional money managers and market performance?

    <p>They often find it difficult to outperform the market.</p> Signup and view all the answers

    Which of the following describes an abnormal return?

    <p>Return in excess of that earned by other investments with similar risk.</p> Signup and view all the answers

    Following the recall of Complete MoisturePlus Multi Purpose Solution, how much did EYE shares drop by on May 29, 2007?

    <p>$5.83</p> Signup and view all the answers

    What type of infection was linked to the contact lens solution by the CDC?

    <p>Acanthamoeba keratitis</p> Signup and view all the answers

    What is one implication of market efficiency on individual investors?

    <p>Luck plays a significant role in investment success.</p> Signup and view all the answers

    How did Advanced Medical Optics respond to the link found by the CDC regarding their product?

    <p>They voluntarily recalled the product.</p> Signup and view all the answers

    Which phenomenon is mentioned as a potentially misleading occurrence in market performance?

    <p>Market bubbles and crashes.</p> Signup and view all the answers

    What must researchers account for when analyzing effects of news on stock prices?

    <p>Overall market news.</p> Signup and view all the answers

    What is a critical question raised about investors in the discussion of market efficiency?

    <p>Is it possible to consistently 'beat the market'?</p> Signup and view all the answers

    What is likely a common misconception about stock price adjustments?

    <p>All stock prices adjust immediately to new information.</p> Signup and view all the answers

    According to market efficiency principles, which statement is likely true?

    <p>All available information is processed by market participants immediately.</p> Signup and view all the answers

    What was the main reason the executives believed for the occurrences of AK infections?

    <p>Poor hygiene practices by users.</p> Signup and view all the answers

    What is the role of a tipper in illegal insider trading?

    <p>The person who purposely divulges material non-public information.</p> Signup and view all the answers

    Which statement accurately describes the difficulty faced by the SEC in prosecuting insider trading?

    <p>Proving that a trader knowingly used insider information is complex.</p> Signup and view all the answers

    What initiated Martha Stewart's illegal insider trading case?

    <p>Knowledge about an FDA rejection of a drug related to ImClone.</p> Signup and view all the answers

    What happened to the price of ImClone shares after the FDA rejection was announced?

    <p>It fell sharply after the announcement was made public.</p> Signup and view all the answers

    Which was a key factor in the SEC's case against Martha Stewart?

    <p>The timing of her stock sale before the public announcement.</p> Signup and view all the answers

    What must the SEC demonstrate about a trader in cases of insider trading?

    <p>That they were aware of the insider information before trading.</p> Signup and view all the answers

    What plea did Martha Stewart enter during her indictment?

    <p>Not guilty.</p> Signup and view all the answers

    When did Martha Stewart's trial begin?

    <p>January 2004.</p> Signup and view all the answers

    What characterizes a bubble in the financial context?

    <p>Market prices far exceeding rational analysis</p> Signup and view all the answers

    Which effect is characterized by daily returns from the last day of a month and the following three days of the next month?

    <p>Turn-of-the-Month effect</p> Signup and view all the answers

    During which period was the difference between 'Turn-of-the-Year' returns and 'Rest of the Days' returns the most significant?

    <p>1962-1990</p> Signup and view all the answers

    What is associated with a crash in the market?

    <p>Significant and sudden drop in market values</p> Signup and view all the answers

    Which event is considered the Crash of 1987?

    <p>DJIA experiencing a 22.6% drop on October 19, 1987</p> Signup and view all the answers

    What typically occurs after a bubble pops?

    <p>Investors are left with assets that plummet in value</p> Signup and view all the answers

    How long do bubbles typically take to form?

    <p>Weeks, months or even years</p> Signup and view all the answers

    What notable event happened on October 16, 1987?

    <p>DJIA fell by more than 100 points in one day for the first time</p> Signup and view all the answers

    What was the outcome of Martha Stewart's securities fraud charge?

    <p>The charge was dismissed.</p> Signup and view all the answers

    What was the minimum sentence that Judge Cedarbaum could impose on Martha Stewart?

    <p>Five months in prison</p> Signup and view all the answers

    What do researchers find about the predictability of short-term stock price movements?

    <p>They are difficult to predict with any accuracy.</p> Signup and view all the answers

    What implication does market efficiency have on the roles of professional money managers?

    <p>Their role is diminished due to fair pricing of securities.</p> Signup and view all the answers

    What charge was Martha Stewart convicted of?

    <p>Obstructing justice</p> Signup and view all the answers

    What is one of the problems that make testing market efficiency difficult?

    <p>The data snooping problem</p> Signup and view all the answers

    Which of the following is NOT a reason why testing market efficiency is challenging?

    <p>The regulation problem</p> Signup and view all the answers

    What was the maximum fine that could be imposed on Martha Stewart by federal rules?

    <p>A fine of $30,000</p> Signup and view all the answers

    What differentiates informed trading from insider trading?

    <p>Informed trading is always legal.</p> Signup and view all the answers

    What requirement must company insiders fulfill to legally trade their company's stock?

    <p>They need to report their trades to the SEC.</p> Signup and view all the answers

    What constitutes illegal insider trading?

    <p>Trading based on material non-public information.</p> Signup and view all the answers

    What characterizes the 'Turn-of-the-Month' effect?

    <p>Daily returns from the last day of any month and the following three days exceed returns from other days.</p> Signup and view all the answers

    Which of the following actions is not considered informed trading?

    <p>Buying stocks based on rumors from unverified sources.</p> Signup and view all the answers

    During which time period was the 'Turn-of-the-Year' effect most pronounced?

    <p>1962-1990</p> Signup and view all the answers

    What is a consequence of illegal insider trading for the markets?

    <p>It undermines investor trust in stock markets.</p> Signup and view all the answers

    What does the SEC's role in insider trading include?

    <p>To enforce laws against illegal trading activities.</p> Signup and view all the answers

    What is a common consequence of a market bubble popping?

    <p>Investors facing rapid depreciation in asset values.</p> Signup and view all the answers

    What distinguishes a market crash from a bubble?

    <p>A crash coincides with sharp declines in market values, not gradual rises.</p> Signup and view all the answers

    Who can be classified as an 'insider' under insider trading laws?

    <p>Persons possessing material non-public information.</p> Signup and view all the answers

    What event is recognized as the beginning of the Crash of 1987?

    <p>October 16, 1987, marked a significant point drop in DJIA.</p> Signup and view all the answers

    What investment strategy offers an advantage against professional money managers?

    <p>Holding a broad-based market index</p> Signup and view all the answers

    Which circumstance would not classify as legal insider trading?

    <p>An employee trading based on speculated information.</p> Signup and view all the answers

    What is indicated by the low and stable percentage of professional money managers beating the Vanguard 500 Index Fund over a 10-year investment period?

    <p>Few managers achieve better long-term results than the index</p> Signup and view all the answers

    What effect is generally evident in the stock market across various time periods?

    <p>The 'Turn-of-the-Month' effect is evident in all analyzed periods.</p> Signup and view all the answers

    In how many years between 1989 and 2018 did more than half of managed equity funds beat the Vanguard 500 Index Fund for a year?

    <p>12 years</p> Signup and view all the answers

    What best describes a significant feature of a market crash?

    <p>It often occurs suddenly and lasts less than a week.</p> Signup and view all the answers

    What is a typical result of a stock market bubble forming?

    <p>Market prices soar significantly above rational valuation levels.</p> Signup and view all the answers

    What is a significant feature of the Vanguard 500 Index Fund?

    <p>It tracks the performance of the S&amp;P 500 Index</p> Signup and view all the answers

    What does the variation in the performance of actively managed equity funds compared to the Vanguard 500 Index Fund suggest?

    <p>There are substantial differences in year-to-year performance</p> Signup and view all the answers

    What conclusion can be drawn from the percentage of managed equity funds beating the Vanguard 500 Index Fund over 10-year periods?

    <p>Persistent outperformance by funds is unlikely over a decade</p> Signup and view all the answers

    Which mutual fund is specifically mentioned as an example of a broad-based market index fund?

    <p>Vanguard 500 Index Fund</p> Signup and view all the answers

    What does the term 'market index' refer to in the context of investing?

    <p>A construct used to track a specific group of stocks</p> Signup and view all the answers

    What opportunity does Starbucks offer to its employees regarding company stock?

    <p>Employees can purchase company stock at a discount.</p> Signup and view all the answers

    Which phenomenon describes the tendency for Mondays to have negative average returns?

    <p>Day-of-the-Week Effect</p> Signup and view all the answers

    What is a characteristic of many market anomalies?

    <p>They frequently diminish once discovered.</p> Signup and view all the answers

    What does the January effect predominantly relate to?

    <p>Large returns of small-cap stocks specifically in January.</p> Signup and view all the answers

    The Turn-of-the-Year Effect studies returns during which time frame?

    <p>The last month of the year and the first month of the next.</p> Signup and view all the answers

    Which time periods show a stronger Day-of-the-Week Effect according to the information provided?

    <p>1950–1980</p> Signup and view all the answers

    What is one reason why market anomalies are difficult to exploit for profit?

    <p>Transaction costs often render them unprofitable.</p> Signup and view all the answers

    What does the analysis of small-cap stock returns in January examine?

    <p>Returns across the entire month of January.</p> Signup and view all the answers

    Which of the following concepts best describes the efficient markets hypothesis (EMH)?

    <p>Markets reflect all relevant information at any given time.</p> Signup and view all the answers

    What is the primary implication of market efficiency for professional money managers?

    <p>They struggle to outperform the market consistently.</p> Signup and view all the answers

    What does 'beating the market' generally mean in investment terms?

    <p>Achieving consistent, positive abnormal returns over time.</p> Signup and view all the answers

    Which of the following best characterizes stock market anomalies?

    <p>They are inconsistencies that challenge the notion of market efficiency.</p> Signup and view all the answers

    Which of the following statements reflects the challenge faced by investors regarding market efficiency?

    <p>Consistently beating the market may not be realistically achievable.</p> Signup and view all the answers

    What role do economic forces play in market efficiency?

    <p>They facilitate the rational use of information by investors.</p> Signup and view all the answers

    Which of the following phenomena is noted as an intriguing market occurrence?

    <p>The Amazing January Effect</p> Signup and view all the answers

    Which of the following statements about stock price behavior is likely true?

    <p>Stock prices can reflect all information only in highly efficient markets.</p> Signup and view all the answers

    What is the implication of rational investors in a market context?

    <p>They do not overvalue or undervalue financial assets.</p> Signup and view all the answers

    Under what condition is a market categorized as weak-form efficient?

    <p>Past price and volume figures are ineffective.</p> Signup and view all the answers

    What primarily drives market efficiency according to the content?

    <p>Investment competition and profit motivation.</p> Signup and view all the answers

    What does a strong-form efficient market indicate?

    <p>Even inside information is ineffective for gaining an edge.</p> Signup and view all the answers

    What might occur if collective irrationality does not balance out?

    <p>Market dynamics shift significantly toward one group.</p> Signup and view all the answers

    What is typically a minimal performance enhancement worth to a large fund?

    <p>20 basis points equating to $30 million.</p> Signup and view all the answers

    What is a common misconception about old information in the context of market efficiency?

    <p>Old information is always predictive of future prices.</p> Signup and view all the answers

    What characterizes irrational investors in a market setting?

    <p>They have different beliefs leading to diversified effects.</p> Signup and view all the answers

    What does delayed reaction in stock prices indicate?

    <p>Prices partially adjust to new information.</p> Signup and view all the answers

    How did Advanced Medical Optics respond to the CDC's findings regarding their contact lens solution?

    <p>They ordered a recall of the product.</p> Signup and view all the answers

    Which of the following best describes overreaction and correction in stock price behavior?

    <p>Prices over-adjust and then settle to an appropriate level.</p> Signup and view all the answers

    What is a primary focus of event studies in the context of stock prices?

    <p>Examining the adjustment process to news announcements.</p> Signup and view all the answers

    What must researchers consider when analyzing the effects of news on stock prices?

    <p>The overall market news and its impact.</p> Signup and view all the answers

    What was the opening price of Advanced Medical Optics shares on May 29, 2007?

    <p>$34.37</p> Signup and view all the answers

    What type of method do researchers use to measure the impact of new information on stock prices?

    <p>Event Study Method.</p> Signup and view all the answers

    Which infection was linked to Advanced Medical Optics' contact lens solution by the CDC?

    <p>Acanthamoeba keratitis.</p> Signup and view all the answers

    What distinguishes informed trading from insider trading?

    <p>Informed trading is based on public information, while insider trading is based on non-public information.</p> Signup and view all the answers

    Which of the following is necessary for trades made by company insiders to be considered legal?

    <p>They must comply with SEC reporting rules.</p> Signup and view all the answers

    What could be considered as material non-public information for an insider?

    <p>Upcoming company mergers not yet announced.</p> Signup and view all the answers

    What is a potential consequence if investors were allowed to trade based on non-public information?

    <p>Greater volatility and diminished fair competition.</p> Signup and view all the answers

    Which of the following statements accurately describes legal insider trading?

    <p>Legal insider trading requires public disclosure of trades.</p> Signup and view all the answers

    What defines an 'insider' in the context of illegal trading?

    <p>An individual with material non-public information.</p> Signup and view all the answers

    Why is the ban on profiting from non-public information considered necessary for stock market integrity?

    <p>It promotes equal access to information among all investors.</p> Signup and view all the answers

    What is the role of the SEC in relation to insider trading?

    <p>To enforce laws and regulations regarding securities trading.</p> Signup and view all the answers

    What percentage of the time did half of the professionally managed funds outperform the Vanguard 500 Index Fund?

    <p>More than 50%</p> Signup and view all the answers

    What key issue is raised regarding mutual fund managers in the context of efficient markets?

    <p>They struggle to beat a broad market index despite available resources.</p> Signup and view all the answers

    What is a primary role of a portfolio manager in an efficient market?

    <p>Constructing a portfolio based on individual investor needs.</p> Signup and view all the answers

    What does survivorship bias refer to in the context of professional money managers?

    <p>The exclusion of poorly performing funds from performance data.</p> Signup and view all the answers

    Which factors influence the choice of an optimal portfolio for an investor?

    <p>Investor's age, tax bracket, and risk aversion.</p> Signup and view all the answers

    What implication does the ability to beat the market have for individual investors?

    <p>It indicates that individual investors are at a disadvantage to professionals.</p> Signup and view all the answers

    Why is the performance of professional money managers considered troubling?

    <p>They have access to more resources than their counterparts but underperform.</p> Signup and view all the answers

    During which investment period was most data on money managers' performance analyzed?

    <p>A combination of different rolling periods.</p> Signup and view all the answers

    What characterizes the 'Turn-of-the-Month' effect in stock market returns?

    <p>Returns from the last day of the month and the first day of the next month.</p> Signup and view all the answers

    Which statement best explains the nature of investment bubbles?

    <p>Bubbles occur when market prices rise significantly above normal valuations.</p> Signup and view all the answers

    What is the typical duration of a market crash?

    <p>Days, generally lasting less than a week.</p> Signup and view all the answers

    During which period was the 'Turn-of-the-Year' effect notably observed?

    <p>1962-1990</p> Signup and view all the answers

    What was the impact of the 'Turn-of-the-Month' effect on stock returns?

    <p>Returns exceeded those of the 'Rest of the Days.'</p> Signup and view all the answers

    What defines a market crash in contrast to a bubble?

    <p>Crashes represent sudden drops often following a bubble.</p> Signup and view all the answers

    Which event marked a significant drop in the DJIA on October 19, 1987?

    <p>DJIA plummeted 508.32 points.</p> Signup and view all the answers

    How are the effects of a market crash characterized after the initial plunge?

    <p>The aftermath can last for many years.</p> Signup and view all the answers

    What happens when the S&P 500 index falls 13% before 3:25 p.m.?

    <p>Level 2 circuit breakers kick in, halting trading for 15 minutes.</p> Signup and view all the answers

    Which of the following best describes the market conditions before the Asian Crash?

    <p>A booming bull market that contributed to investor optimism.</p> Signup and view all the answers

    What was a key issue that contributed to the failures of many DotComs during the bubble?

    <p>Lack of solid business models.</p> Signup and view all the answers

    What characteristic defines Level 3 circuit breakers?

    <p>Kicks in if the S&amp;P 500 index falls by 20% at any time during the day.</p> Signup and view all the answers

    How did the Crash of 1987 affect market infrastructure?

    <p>It prompted the adoption of circuit breakers to manage trading volumes.</p> Signup and view all the answers

    What triggered strong investor interest in the 'new economy' during the mid-1990s?

    <p>The rising use of the Internet and its growth potential.</p> Signup and view all the answers

    How do investors typically react to market crashes, such as the Crash of 1929 and the Asian Crash?

    <p>They become overly cautious, often leading to a prolonged bear market.</p> Signup and view all the answers

    Which of the following describes the typical response of trading halts during a significant market decline?

    <p>Trading may be halted for a brief period based on the level of circuit breaker triggered.</p> Signup and view all the answers

    What occurs when irrational investors in a market have different beliefs?

    <p>They effectively cancel each other's effects.</p> Signup and view all the answers

    Why is it difficult to earn an excess return in a perfectly rational market?

    <p>Rational investors do not systematically misprice assets.</p> Signup and view all the answers

    In a weak-form efficient market, which investment strategy is least effective?

    <p>Using past price data to forecast prices.</p> Signup and view all the answers

    What drives the competition that leads to market efficiency?

    <p>The profit motive and potential performance enhancement.</p> Signup and view all the answers

    What characterizes a strong-form efficient market?

    <p>Even inside information offers no advantage in beating the market.</p> Signup and view all the answers

    What might happen if collective irrationality does not balance out in the market?

    <p>It can lead to consistent market inefficiencies.</p> Signup and view all the answers

    What is a key implication of market efficiency regarding old information?

    <p>Old information is irrelevant in the context of investment decisions.</p> Signup and view all the answers

    What does the profit potential in an efficient market create incentives for?

    <p>Investors to actively seek and utilize relevant information.</p> Signup and view all the answers

    What is the formula for calculating abnormal return?

    <p>Abnormal return = Observed return − Expected return</p> Signup and view all the answers

    How is the expected return typically calculated?

    <p>Using a market index or historical average return</p> Signup and view all the answers

    What value is assigned to the day of the news announcement in the abnormal returns calculation?

    <p>0</p> Signup and view all the answers

    What was the maximum fine imposed on Martha Stewart by Judge Cedarbaum?

    <p>$30,000</p> Signup and view all the answers

    What do cumulative abnormal returns (CAR) indicate after an announcement?

    <p>The overall reaction of the market to the announcement</p> Signup and view all the answers

    Which type of crime was Martha Stewart convicted of?

    <p>Obstructing justice</p> Signup and view all the answers

    What implication does market efficiency suggest regarding the role of professional money managers?

    <p>They have little to no impact.</p> Signup and view all the answers

    What pattern is expected according to the Efficient Market Hypothesis (EMH) in the context of cumulative abnormal returns?

    <p>A band of returns, a sharp break, and another band</p> Signup and view all the answers

    What is a reason that makes testing market efficiency challenging?

    <p>The data snooping problem</p> Signup and view all the answers

    What does it mean if a market is strong-form efficient?

    <p>All information, private and public, is reflected in stock prices</p> Signup and view all the answers

    What is typically the time frame for accumulating abnormal returns in event studies?

    <p>60 or 80 days</p> Signup and view all the answers

    How did the market react to new information according to general findings about market efficiency?

    <p>Quickly and sharply</p> Signup and view all the answers

    What is the significance of observing a sharp downward movement in cumulative abnormal returns after an announcement?

    <p>There was a negative reaction to the announcement</p> Signup and view all the answers

    What is a consequence of market efficiency on security selection?

    <p>It becomes less important.</p> Signup and view all the answers

    What was the fine imposed on Peter Bacanovic, Martha Stewart's broker?

    <p>$4,000</p> Signup and view all the answers

    Who is the person that discloses material non-public information in an illegal insider trading scenario?

    <p>The tipper</p> Signup and view all the answers

    What is the challenge faced by the SEC in proving insider trading cases?

    <p>Difficulty in tracking insider information flows</p> Signup and view all the answers

    What must the SEC prove regarding the trader's awareness in insider trading cases?

    <p>The trader knew the broker had non-public information</p> Signup and view all the answers

    What was the significant information that Martha Stewart was allegedly tipped off about?

    <p>Rejection of a cancer drug by the FDA</p> Signup and view all the answers

    What action did Martha Stewart take on December 27, 2001, regarding her shares in ImClone?

    <p>She sold her shares</p> Signup and view all the answers

    What triggered Martha Stewart's stop-loss order on her ImClone shares?

    <p>$60 per share</p> Signup and view all the answers

    What was the closing price of ImClone shares the Monday after the FDA rejection news was made public?

    <p>$46 per share</p> Signup and view all the answers

    What was Martha Stewart's plea during her indictment in June 2003?

    <p>Not guilty</p> Signup and view all the answers

    What is a characteristic of informed trading?

    <p>Utilizing publicly available information and analysis</p> Signup and view all the answers

    Which action distinguishes legal insider trading from illegal insider trading?

    <p>Trades must be reported to the SEC</p> Signup and view all the answers

    What constitutes an 'insider' in the context of illegal insider trading?

    <p>Individuals with material non-public information</p> Signup and view all the answers

    Which of the following best describes the need for a ban on profits from non-public information?

    <p>To prevent loss of investor trust in markets</p> Signup and view all the answers

    What is a common misconception about insider trading?

    <p>All insider trading is illegal</p> Signup and view all the answers

    Which activities are considered illegal insider trading?

    <p>Selling stocks prior to a corporate earnings announcement</p> Signup and view all the answers

    Why are SEC regulations critical to insider trading practices?

    <p>They provide transparency and trust in market activities</p> Signup and view all the answers

    What defines the 'Turn of the Month Days'?

    <p>Daily returns from the last day of any month and the following three days</p> Signup and view all the answers

    What was significant about the Crash of 1987 regarding the DJIA?

    <p>It was the first instance where the DJIA fell by more than 100 points in a day.</p> Signup and view all the answers

    Which period demonstrated the greatest difference between 'Turn-of-the-Year' returns and 'Rest of the Days' returns?

    <p>1962-1990</p> Signup and view all the answers

    How long do market crashes typically last?

    <p>Less than a week</p> Signup and view all the answers

    Which statement best describes the characteristics of a bubble?

    <p>It represents a significant rise in prices far above rational valuation.</p> Signup and view all the answers

    What is a common feature of the 'Turn-of-the-Month' effect?

    <p>It consistently appears in all observed time periods.</p> Signup and view all the answers

    During which event did the DJIA lose about 22.6% of its value on a single day?

    <p>Black Monday</p> Signup and view all the answers

    What is the primary connection between bubbles and crashes in the stock market?

    <p>Crashes are often the sudden aftermath of an inflated bubble.</p> Signup and view all the answers

    Which statement accurately describes the Constant Perpetual Growth Model?

    <p>It assumes a constant rate of growth indefinitely.</p> Signup and view all the answers

    What is a major limitation of the Two-Stage Dividend Growth Model?

    <p>It is used exclusively for companies that pay dividends.</p> Signup and view all the answers

    Which aspect of the Residual Income Model (RIM) is crucial for its calculation?

    <p>The economic value added, which is the difference between actual and required earnings.</p> Signup and view all the answers

    What challenge do analysts face when estimating parameters in the models discussed?

    <p>Difficulty in accurately estimating the required rate of return.</p> Signup and view all the answers

    What does the Clean Surplus Relationship (CSR) suggest about a company's financial activities?

    <p>Changes in book value are directly related to earnings minus dividends.</p> Signup and view all the answers

    What is the formula used for valuing a stock under the constant growth rate model when the growth rate does not equal the discount rate?

    <p>$D_0(1 + g) / (k - g)$</p> Signup and view all the answers

    If the current dividend is $10, the growth rate is 10%, and the discount rate is 8%, what is the estimated value of the stock?

    <p>$243.86</p> Signup and view all the answers

    Under the constant perpetual growth model, what condition must be satisfied for the formula $P_0 = D_1 / (k - g)$ to be valid?

    <p>g must be less than k</p> Signup and view all the answers

    What is the primary purpose of using historical average growth rates in estimating future dividend growth?

    <p>To estimate the growth rate in dividends</p> Signup and view all the answers

    If a company offers a dividend of $3.78 with a growth rate of 2% and a discount rate of 5%, what would be the value of the stock using the constant perpetual growth model?

    <p>$128.52</p> Signup and view all the answers

    Which of the following components is not part of the Dividend Discount Model (DDM) for estimating stock values?

    <p>The company's earnings</p> Signup and view all the answers

    What happens to the estimated stock value when the growth rate approaches the discount rate in the DDM?

    <p>The stock value becomes undefined</p> Signup and view all the answers

    In the constant growth rate model, what signifies that dividends will grow at a constant rate?

    <p>Stable historical growth trends</p> Signup and view all the answers

    Which of the following factors can cause a company to have negative earnings while still maintaining positive cash flows?

    <p>Depreciation counted as an expense</p> Signup and view all the answers

    In the formula for Free Cash Flow (FCF), what does the term 'Capital Spending' refer to?

    <p>Expenses related to asset purchases</p> Signup and view all the answers

    What differentiates the Dividend Discount Model (DDM) from the Free Cash Flow (FCF) model in terms of value calculation?

    <p>DDM focuses on equity only, while FCF accounts for the entire firm</p> Signup and view all the answers

    Which of the following statements is true regarding asset betas?

    <p>Asset betas are concerned with industry-wide risk assessment</p> Signup and view all the answers

    What effect does depreciation have on reported earnings?

    <p>It reduces reported earnings</p> Signup and view all the answers

    When can a company report positive EBIT while still having negative Free Cash Flow?

    <p>When capital expenditures are significantly high</p> Signup and view all the answers

    How do cash flows differ from net income in the context of companies with different depreciation methods?

    <p>Net income differences reflect profitability, while cash flows remain unchanged</p> Signup and view all the answers

    Which component is not included in the calculation of Free Cash Flow (FCF)?

    <p>Interest expenses</p> Signup and view all the answers

    What is the estimated CAPM discount rate for CVS based on the given rates?

    <p>10.21%</p> Signup and view all the answers

    How is the retention ratio for CVS calculated?

    <p>1 - $2.00/$3.04</p> Signup and view all the answers

    What is CVS's sustainable growth rate derived from the retention ratio and ROE?

    <p>2.98%</p> Signup and view all the answers

    Which valuation method produces the highest estimated stock price for CVS?

    <p>FCF, with historical growth rate</p> Signup and view all the answers

    What is the value obtained from the Dividend Discount Model (DDM) using analyst forecasted growth rate?

    <p>$54.37</p> Signup and view all the answers

    Which two-stage model price estimate is listed for CVS?

    <p>$32.83</p> Signup and view all the answers

    What percentage is the retention ratio calculated for CVS?

    <p>0.342</p> Signup and view all the answers

    What insight is provided regarding the range of share values estimated by various models?

    <p>Wide discrepancies in model outputs are common.</p> Signup and view all the answers

    What is the primary result of converting reported equity betas into asset betas?

    <p>It adjusts for the company's debt levels.</p> Signup and view all the answers

    If a firm has no debt, what is the relationship between equity beta and asset beta?

    <p>Equity beta equals asset beta.</p> Signup and view all the answers

    Which input is NOT required to calculate the value of a firm using the FCF approach?

    <p>Market share</p> Signup and view all the answers

    What formula is used to calculate the proper discount rate for Landon Air?

    <p>$k = risk-free rate + (market risk premium × equity beta)$</p> Signup and view all the answers

    What is the effect of a high P/E ratio on a company’s stock classification?

    <p>It denotes a growth stock.</p> Signup and view all the answers

    What does the conversion of asset beta to equity beta account for when a company has debt?

    <p>The fixed interest expenses related to debt.</p> Signup and view all the answers

    In the example provided, what is Landon Air's estimated asset beta based on its equity beta and leverage?

    <p>0.912</p> Signup and view all the answers

    What does the earnings yield represent in relation to the P/E ratio?

    <p>It is the inverse of the P/E ratio.</p> Signup and view all the answers

    What is the primary focus of the Dividend Discount Model (DDM)?

    <p>Calculating the present value of all future dividend payments</p> Signup and view all the answers

    Which of the following is NOT one of the four categories commonly used to assess the economic value of common stocks?

    <p>Price-to-earnings analysis</p> Signup and view all the answers

    In the equation of the Dividend Discount Model, what does 'k' represent?

    <p>The required rate of return on the investment</p> Signup and view all the answers

    What is the basic purpose of fundamental analysis in stock valuation?

    <p>To evaluate a company’s accounting statements and financial information</p> Signup and view all the answers

    Which statement accurately reflects a common risk faced when using the Dividend Discount Model?

    <p>Future dividends may not occur as expected</p> Signup and view all the answers

    What does the term 'undervalued stocks' mean in the context of stock analysis?

    <p>Stocks priced lower than their intrinsic value</p> Signup and view all the answers

    In the context of stock valuation methods, what is the Free Cash Flow model primarily based on?

    <p>Expected cash flows generated by the company</p> Signup and view all the answers

    Which valuation method incorporates growth rates into the expected future dividend payments?

    <p>Two-stage dividend growth model</p> Signup and view all the answers

    Study Notes

    Chapter 7: Stock Price Behavior and Market Efficiency

    • A market is the combined behavior of thousands of people responding to information, misinformation, and whim.

    • "If you want to know what's happening in the market, ask the market." - Japanese proverb

    • The efficient markets hypothesis (EMH) is a theory stating that major financial markets reflect all relevant information at a given time.

    • Market efficiency research examines the relationship between stock prices and available information, the important question is: is it possible for investors to "beat the market?"

    • Prediction of the efficient market hypothesis: if a market is efficient, it is not possible to consistently "beat the market."

    • Abnormal return on an investment is the return in excess of that earned by other investments with the same risk.

    • "Beating the market" means consistently earning a positive abnormal return.

    • Investors use their information rationally, not systematically overvaluing or undervaluing financial assets.

    • If every investor makes perfectly rational investment decisions, earning an excess return is difficult.

    • There are independent deviations from rationality.

    • Irrationality cancels out; the important issue is that irrational investors have differing beliefs; arbitrage exists.

    • A weak-form efficient market uses past prices and volume as no use in beating the market and so technical analysis is of little use.

    • A semistrong-form efficient market uses publicly available information, fundamental analysis is of little use in this form.

    • A strong-form efficient market uses information of any kind (public or private) and "inside information" is of little use.

    • The driving force toward market efficiency is simply competition and the profit motive.

    • Even a relatively small performance enhancement can be worth a tremendous amount (when multiplied by the dollar involved).

    • Profit potential creates incentives to unearth relevant information and use it.

    • This question is surprisingly difficult to answer clearly.

    • Researchers have used sophisticated techniques to test whether past stock-price movements help predict future stock-price movements.

    • Future returns are partly predictable by past returns.

    • Trading costs swamp attempts to build profitable trading systems built on past returns.

    • No matter how often a particular stock price path has related to subsequent stock-price changes in the past, there is no assurance that this relationship will occur again in the future.

    • Stock prices change when traders buy and sell shares based on their view of the future stock prospects.

    • Unexpected new announcements influence the prospects for the stock.

    • Prices could adjust to unexpected news in three basic ways:

      • Efficient market reaction: The price instantaneously adjusts to the new information.
      • Delayed reaction: The price partially adjusts to the new information.
      • Overreaction and correction: The price over-adjusts to the new information but eventually falls to the appropriate price

    • Researchers have examined the effects of many types of news announcements on stock prices in the intent to learn more about the adjustment process itself and the size of the stock price reaction

    • To test the effects of new information on stock prices, researchers use something called an event study.

    • Executives of Advanced Medical Optics, Inc. (EYE), voluntarily recalled a contact lens solution due to a link between the solution and a rare cornea infection called acanthamoeba keratitis (AK).

    • In the U.S., it's illegal to make profits from non-public information to protect investor trust in markets; the SEC enforces the laws.

    • An insider is someone who has material non-public information.

    • When an illegal insider trade occurs, there is a tipper (divulges material non-public information) and a tippee (knowingly uses it to profit); It is difficult for the SEC to prove a trader is truly a tippee (Information flows are difficult to track; sometimes people are accused of insider trading but merely "overheard" conversations).

    • The SEC believed that Martha Stewart sold ImClone shares after being told of the bad news, in advance of this news's public release.

    • In June 2003, Ms. Stewart and her stock broker, Peter Bacanovic, were indicted; they both pled not guilty.

    • Ms. Stewart's trial began in January 2004. Days before the deliberations, Judge Miriam Cedarbaum dismissed the most serious charge of securities fraud, although Ms. Stewart was convicted on four counts of obstructing justice.

    • Judge Cedarbaum fined Ms. Stewart $30,000 and sentenced her to five months in prison, two years of probation, and five months of home confinement.

    • Financial markets are the most extensively documented human endeavors, with colossal amounts of financial market data collected and reported every day.

    • Market efficiency is difficult to test for four basic reasons: the risk-adjustment problem, the relevant information problem, the dumb luck problem, and the data snooping problem.

    • Short-term stock price and market movements are difficult to predict with accuracy.

    • The market quickly reacts to new information; studies show little evidence that such reactions can be profitably exploited.

    • If a stock market can be beaten, the way to do it is not obvious.

    • Security selection becomes less important because securities are fairly priced.

    • A small role is left for professional money managers when the market is efficient.

    • Timing the market makes little sense.

    • The role of a portfolio manager is to build a portfolio to meet the specific needs of individual investors, often emphasizing a well-diversified portfolio.

    • Tax brackets, risk aversion, age, and employer can influence portfolio choices.

    • Market anomalies generally do not involve large sums of money in the overall market.

    • They're often fleeting and disappear quickly; difficult to use as a trading strategy because of transaction costs.

    • The day-of-the-week effect refers to Mondays' tendency to have a negative average return.

    • The January effect shows small-cap stocks having heightened returns in January.

    • The turn-of-the-year and turn-of-the-month effects exhibit similar patterns of returns (turn-of-month returns exceed "rest of the days" returns).

    • A bubble is when prices soar beyond normal analysis, eventually popping.

    • Crashes are significant and sudden market drops, often linked to bubbles resulting in plummeting asset values.

    • Crashes are typically under a week but have lasting financial aftermath that can stretch on for years.

    • The crash of 1929 is an example of a significant crash and the crash of 1987 was a similar example of a dramatic crash.

    • The Asian crash of 1990 resulted in a long bear market following.

    • The "Dot-Com" bubble and crash are another example of a crash; the crash of October 2008 is a possible example of a significant, market-moving crash.

    • Circuit breakers are used to avoid market crashes and are designed to halt trading when the S&P 500 index experiences an excessive drop.

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    Related Documents

    Chapter 7 Stock Price Behavior and Market Efficiency PDF
    Chapter 6 Common Stock Valuation PDF

    Description

    Explore the concepts of market efficiency and stock price behavior in this quiz based on Chapter 7. Delve into theories like the efficient markets hypothesis and understand how investors respond to information. Can you grasp the dynamics of market predictions and the possibility of beating the market?

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