Market Efficiency and Stock Price Impact Quiz

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Questions and Answers

What can the price of a security be thought of as?

The minimum value of expected future cash flows

The present value of all the cash flows tied to that security (correct)

The average value of expected future cash flows

The maximum value of expected future cash flows

What are the expectations about cash flows based on?

Speculative forecasts

Currently available information (correct)

Random fluctuations

Historical data

What is the overarching discussion topic for this lecture?

How to manipulate stock prices

The psychology of investors

What information is (already) incorporated into expectations (correct)

The history of stock markets

What are the broad implications of identifying information not fully incorporated into current prices?

Potential for trading on this information Signup and view all the answers

According to the efficient markets hypothesis (EMH), what can't consistently predict future price changes?

Past and current information Signup and view all the answers

What does Burton Malkiel's 'A Random Walk Down Wall Street' suggest about stock picks?

A blindfolded monkey's stock picks perform as well as experts' Signup and view all the answers

What do weak form EMH tests show about predictive power?

Some evidence of predictive power in past price movements Signup and view all the answers

What do semi-strong form EMH tests look for?

Market anomalies related to publicly available information Signup and view all the answers

What do anomalies in the context of market efficiency include?

P/E effect, small firm effect, neglected firm effect, liquidity, and value versus growth stocks Signup and view all the answers

Which market reactions align with semi-strong form efficiency?

Stock market reactions to announcements of dividend changes, earnings, and mergers Signup and view all the answers

What does strong form efficiency evidence include?

Run-up in short interest prior to fraud revelation and price increases before merger announcements Signup and view all the answers

What does evidence against strong form efficiency include?

Insider information earning abnormally good returns and strong price reactions to important announcements Signup and view all the answers

What do price increases of target firms' stock prices before acquisition announcements indicate?

Market inefficiency Signup and view all the answers

According to strong-form market efficiency, what should happen to stock prices when announcements of previously private information are made?

Stock prices should not react to the announcements Signup and view all the answers

What did the cumulative returns around Terremark's M&A announcement indicate about strong-form market efficiency?

Prices can't be completely strong-form efficient Signup and view all the answers

What are the different forms of market efficiency mentioned in the text?

Weak form, semistrong form, and strong form Signup and view all the answers

What is the mechanism that leads to efficient prices in the market?

Competition for profits Signup and view all the answers

According to the text, how quickly can market reactions to information occur?

Within minutes Signup and view all the answers

How are stock price changes often described in relation to market efficiency?

A 'random walk with drift' Signup and view all the answers

What does an efficient market imply about future price changes in relation to past information?

Future price changes are independent from today’s price changes Signup and view all the answers

What does the text suggest about the efficiency of different markets and securities?

Some markets and securities' prices are likely more efficient than others Signup and view all the answers

According to the concept of weak-form market efficiency, what type of information is already reflected in stock prices?

Historical price and volume data Signup and view all the answers

In the context of market efficiency, what does 'semistrong form' refer to?

Incorporation of all publicly available information Signup and view all the answers

What is the main factor that ensures efficient prices in the market, according to the text?

Competition for profits Signup and view all the answers

In the context of market efficiency, what does 'weak form' refer to?

Incorporation of all historical price and volume data Signup and view all the answers

What do price run-ups before the official announcement date potentially indicate?

Leaked private information Signup and view all the answers

What is a key characteristic of the market, as evidenced by the potential for earning abnormal returns with inside information?

Not strong form efficient Signup and view all the answers

What do portfolios of best and worst performing stocks often exhibit over 3-12 month periods?

Momentum Signup and view all the answers

What do historical examples of bubbles in valuation make difficult to recognize?

Rational, unbiased assessments of intrinsic value Signup and view all the answers

What do small, neglected, and less transparent firms exhibit evidence of in relation to information affecting prices?

Slower reaction to information Signup and view all the answers

What can portfolio managers and personal wealth advisors add value by achieving?

Diversified positions Signup and view all the answers

What do evidence against strong form efficiency include?

Limits to attention Signup and view all the answers

What is a characteristic of anomalies in the context of market efficiency?

GameStop Twitter vs Tweeter Signup and view all the answers

What percentage of trades in S&P 500-listed stocks took place between 3:30 and the 4 p.m. closing bell?

One in six Signup and view all the answers

What do small companies exhibit evidence of in relation to information affecting prices?

19.3% of trades in the final 30 minutes Signup and view all the answers

What can portfolio managers and personal wealth advisors add value by dealing with in relation to investment decisions?

Tax considerations Signup and view all the answers

What is generally not strong form efficient, according to the text?

The market Signup and view all the answers

What does the Efficient Market Hypothesis (EMH) state?

Security prices are efficient and reflect available information, making it difficult to predict future price changes using current information. Signup and view all the answers

What does weak-form market efficiency suggest?

Past public trading information, like price trends and volume, is already reflected in the price, making technical analysis ineffective. Signup and view all the answers

What does the current stock price reflect, according to the text?

Investors' opinions on current management talent, fraud fears, and expectations of how M&A activity might affect future cash flows. Signup and view all the answers

What does semistrong-form market efficiency posit?

All public information is already reflected in the price, making both technical and fundamental analysis ineffective. Signup and view all the answers

What did Verizon's intent to acquire Terremark for $19.00 per share cause?

Terremark's share price to jump from $14.05 to $18.92 per share, and Savvis' share price to jump from $26.57 to $30.26. Signup and view all the answers

What are analysts' predictions about Crocs in early 2023 reflecting?

The use of fundamental analysis. Signup and view all the answers

What does the current stock price incorporate, according to the text?

Public information, and the speed at which information affects prices varies, posing challenges for predicting future price changes. Signup and view all the answers

Study Notes

Understanding Market Efficiency and Price Reactions

Strong-form market efficiency implies all public and private information is already reflected in the price, and there should not be price reactions to announcements of previously private information.
Cumulative returns around M&A announcement show Terremark's stock price surged when Verizon announced its intent to acquire it, indicating prices can't be completely strong-form efficient.
Forms of market efficiency include weak form, semistrong form, and strong form, each reflecting different levels of information incorporation in market prices.
Competition for profits is the mechanism that leads to efficient prices, ensuring that prices reflect a comprehensive information set.
The speed at which information affects price varies, with studies suggesting market reactions can occur within minutes.
Stock price changes are often described as a "random walk with drift," implying that future price changes are independent of past prices if markets are efficient.
Efficient markets imply that future price changes are independent from today’s price changes, as past information is already impounded in the price today.
Some markets and securities' prices are likely more efficient than others, suggesting that the best profit opportunities might be in less efficient markets or assets.

Efficiency of Financial Markets and Anomalies

Day 0 marks the public announcement date, and price run-ups before the official announcement may indicate leaked private information.
The market is generally not strong form efficient, evidenced by the potential for earning abnormal returns with inside information and stock reactions to announcements.
The market is generally semi-strong efficient, with occasional examples of misvaluation and valuable opportunities for lucky/sophisticated investors.
Portfolios of best and worst performing stocks often exhibit momentum over 3-12 month periods, and prices react dramatically to news announcements.
Some investors earn incredible returns over time, and those with inside information appear to earn abnormally good returns in some studies.
Evidence includes limits to attention, repeated news announcements, high news days, bubbles, and hard-to-explain price changes and market reactions.
Historical examples of bubbles in valuation include the Tulip bubble, South Sea bubble, Railway bubble, US stock market in the 1920s, Japanese stock and assets in the 1980s, Dot-com bubble, and Housing bubble.
Bubbles make it difficult to recognize rational, unbiased assessments of intrinsic value, and most bubbles only become obvious in retrospect.
Examples of anomalies include GameStop Twitter vs Tweeter, Graco Inc vs Graco Children’s Product Inc, Nest Labs vs NEST, and Castle Convertible Fund.
One in six trades in S&P 500-listed stocks took place between 3:30 and the 4 p.m. closing bell, and for shares of smaller companies, 19.3% of trades were in the final 30 minutes.
Small, neglected, and less transparent firms exhibit evidence of information affecting prices in a slower manner, suggesting profitable investments in alternative and non-liquid asset classes.
Portfolio managers and personal wealth advisors can add value by achieving diversified positions, making strategic asset allocation choices, dealing with tax considerations, and relating retirement considerations with investment decisions.

Impact of Management Changes, Fraud, and M&A on Stock Prices

Autozone announced a long-time employee as the next CEO, causing a more than 12% stock drop, while S&P500 went up 0.5% on the same day.
Best Buy's announcement of an outsider as the new CEO led to an over 8% stock price drop, while S&P500 went up 0.19% on the same day.
Symantec's announcement of a new CEO resulted in a 13% stock price rise, while S&P500 went down 0.04% on the same day.
Healthsouth's $1.3 billion fraud announcement caused the stock price to almost completely collapse.
Verizon's intent to acquire Terremark for $19.00 per share caused Terremark's share price to jump from $14.05 to $18.92 per share, and Savvis' share price to jump from $26.57 to $30.26.
The current stock price reflects investors' opinions on current management talent, fraud fears, and expectations of how M&A activity might affect future cash flows.
Efficient Market Hypothesis (EMH) states that security prices are efficient and reflect available information, making it difficult to predict future price changes using current information.
Weak-form market efficiency suggests that past public trading information, like price trends and volume, is already reflected in the price, making technical analysis ineffective.
Semistrong-form market efficiency posits that all public information is already reflected in the price, making both technical and fundamental analysis ineffective.
Fundamental analysis uses earnings, dividends, interest rates, and risk evaluation to determine stock prices, aiming to calculate the present value of all future stockholder payments.
Analysts' predictions about Crocs in early 2023 ranged from $75-$175 per share, reflecting the use of fundamental analysis.
The current stock price incorporates public information, and the speed at which information affects prices varies, posing challenges for predicting future price changes.

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Description

Test your knowledge of market efficiency, anomalies, and the impact of management changes, fraud, and M&A on stock prices with this quiz. Explore concepts such as market efficiency forms, price reactions to announcements, historical bubbles, and the Efficient Market Hypothesis. Sharpen your understanding of fundamental analysis, momentum in stock prices, and the influence of management changes and fraud on stock prices.