Function of Financial Markets

7.4 The Efficient Market Hypothesis: Rational Expectations in Financial Markets

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 lowest successful bidder.
C) fully reflects all available relevant information.
D) is a result of none of the above.

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

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

A) dividend payments.
B) tax laws.
C) asset prices.
D) monetary policy.

10) When we describe stock prices as following a random walk, we mean that future changes in stock prices are

A) unpredictable.
B) increasing.
C) decreasing.
D) constant.

11) The efficient markets hypothesis implies that future changes in exchange rates should for all practical purposes be

A) unpredictable.
B) set by each country.
C) increasing.
D) pegged to a standard such as the U.S. dollar or the Euro.

12) 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%.

16) You read a story in the newspaper announcing the proposed merger of Dell Computer and Gateway. The merger is expected to greatly increase Gateway's profitability. If you decide to invest in Gateway stock, you can expect to earn

A) above average returns since you will share in the higher profits.
B) above average returns since your stock price will definitely appreciate as higher profits are earned.
C) below average returns since computer makers have low profit rates.
D) a normal return since stock prices adjust to reflect expected changes in profitability almost immediately.

17) The efficient markets hypothesis indicates that investors

A) can use the advice of technical analysts to outperform the market.
B) do better on average if they adopt a "buy and hold" strategy.
C) let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy.
D) do better if they purchase loaded mutual funds.