7.4 The Efficient Market Hypothesis: Rational Expectations in

1) The theory of rational expectations, when applied to financial markets, is known as

• A) monetarism.

• B) the efficient markets hypothesis.

• C) the theory of strict liability.

• D) the theory of impossibility.

2) According to the efficient markets hypothesis, the current price of a financial security

• A) is the discounted net present value of future interest payments.

• B) is determined by the highest successful bidder.

• C) fully reflects all available relevant information.

• D) is a result of none of the above.

3) If the optimal forecast of the return on a security exceeds the equilibrium return, then

• A) the market is inefficient.

• B) no unexploited profit opportunities exist.

• C) the market is in equilibrium

• D) the market is myopic

4) Another way to state the efficient markets condition is: in an efficient market,

• A) unexploited profit opportunities will be quickly eliminated.

• B) unexploited profit opportunities will never exist.

• C) arbitragers guarantee that unexploited profit opportunities never exist

• D) every financial market participant must be well informed about securities

5) ________ occurs when market participants observe returns on a security that are larger than what is justified by the characteristics of that security and take action to quickly eliminate the unexploited profit opportunity.

• A) Arbitrage

• B) Mediation

• C) Asset capitalization

• D) Market intercession

6) The efficient markets hypothesis suggests that if an unexploited profit opportunity arises in an efficient market,

• A) it will tend to go unnoticed for some time.

• B) it will be quickly eliminated.

• C) financial analysts are your best source of this information.

• D) prices will reflect the unexploited profit opportunity

7) Financial markets quickly eliminate unexploited profit opportunities through changes in

• A) dividend payments.

• B) tax laws.

• C) asset prices.

• D) monetary policy.

8) The elimination of unexploited profit opportunities requires that ________ market participants be well informed.

• A) all

• B) a few

• C) zero

• D) many

9) If in an efficient market all prices are correct and reflect market fundamentals, which of the following is a false statement?

• A) A stock that has done poorly in the past is more likely to do well in the future.

• B) One investment is as good as any other because the securities' prices are correct.

• C) A security's price reflects all available information about the intrinsic value of the security

• D) Security prices can be used by managers to assess their cost of capital accurately

10) According to the efficient markets hypothesis, purchasing the reports of financial analysts

• A) is likely to increase one's returns by an average of 10%.

• B) is likely to increase one's returns by about 3 to 5%.

• C) is not likely to be an effective strategy for increasing financial returns.

• D) is likely to increase one's returns by an average of about 2 to 3%