FMT tutorial 5

Rational expectations are:

• always correct.

• based only on past information.

• identical to optimal forecasts using all information.

• identical to optimal forecasts using all available information.

An implication of rational expectation is that

• Changes in how a variable moves over time will not affect the way expectations are formed.

• Forecast errors of expectations will, on the average, be zero.

• Some error can be forecast.

• Forecast error will always be zero

People and firms make optimal forecasts based upon all available information because:

• Forecasting error is costly.

• Optimal forecasting errors are zero.

• Optimal forecasting errors are small.

• All forecasting errors are small

The efficient market hypothesis states that

• prices of securities in financial markets reflect only past price information on that and similar securities.

• prices of securities in financial markets reflect all available information.

• prices of securities in financial markets reflect only monetary policy changes.

• prices of securities in financial markets reflect only past price information on that security

The expected rate of return (RET^e) on a security is:

•   (Pet+1 – Pt+1 + C)/Pt+1

•   (Pet+1 – Pt + C)/Pt

• (Pet+1 – Pt + C)/Pt+1

• (Pet+1 – Pt+1 + C)/Pt

Based upon unexploited profit opportunities, if RET^OF > RET*, then:

• people will buy the security, increasing its price, and reducing RET*.

• people will buy the security, increasing its price, and reducing RET^OF.

• people will not buy the security, lowering its price, and reducing RET*.

•   people will not buy the security, lowering its price, and reducing RETOF.

A random walk describes movements of a variable:

• whose future changes cannot be predicted.

• whose future changes can only be predicted with past information.

• whose future changes can be predicted based upon money supply changes.

• whose future changes can be perfectly predicted.

Technical analysis:

 

• generates buy/sell rules that usually outperform the markets as a whole.

• is the study of past stock price data in search of patterns.

• exploits the idea that stocks follow a random walk.

• examines the role of unexpected events in determining stock prices

Which of the following is not part of the evidence against market efficiency?

• Stocks with high returns now tend to have high returns in the future.

• Markets overreact to news and announcements.

• The January effect.

• The small firm effect.

Stock prices respond to announcements and news only when:

• the announcements are well-known anyway before the official release of the announcement.

• the announcements are about predictable events.

• the announcements are new and unexpected.

• the announcements are made early in the day.