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Chapter 14 - Efficient Capital Markets and Behavioral Challenges

56. In the five years after the offering, ___ underperform matched control groups. A. initial public offerings B. seasoned equity offerings C. bond offerings D. A and B E. A, B, and C

Difficulty level: Medium

Topic: STOCK MARKET PERFORMANCE Type: CONCEPTS

57. In the three years prior to a forced departure of management, stock prices, adjusted for market performance, on average will: A. decline about 20%. B. decline about 40%. C. decline about 60%. D. remain stable.

E. increase about 20%.

Difficulty level: Medium

Topic: STOCK PERFORMANCE Type: CONCEPTS

Essay Questions

58. Define the three forms of market efficiency.

The student should present a straightforward discussion of weak (all past prices are in the current price), semistrong form (all public information is in the current price), and strong form (all information is in the current price) market efficiency.

Topic: EFFICIENT MARKETS Type: ESSAYS

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Chapter 14 - Efficient Capital Markets and Behavioral Challenges

59. Explain why it is that in an efficient market, investments have an expected NPV of zero. In an efficient market, prices are \too low. Thus, on average, investments in that market will yield a zero NPV. Investors get exactly what they pay for when they buy a security in an efficient market and firms get exactly what their stocks and bonds are worth when they sell them.

Topic: EFFICIENT MARKETS Type: ESSAYS

60. Do you think the lessons from capital market history will hold for each year in the future? That is, as an example, if you buy small stocks will your investment always outperform U.S. Treasury bonds?

The student should realize that we are working with averages, so they should not expect riskier assets to always outperform less risky assets. The student should explain somewhere in their answer that this gets to the heart of what risk is. That is, the reason you expect to earn a higher return over the long haul is that your variability in price from year to year can be significant.

Topic: EFFICIENT MARKETS Type: ESSAYS

61. Suppose your cousin invests in the stock market and doubles her money in a single year while the market, on average, earned a return of only about 15%. Is your cousin's performance a violation of market efficiency?

No, market efficiency does not preclude investors from \possible to earn higher returns than the market at times. However, if your cousin is able to do so consistently, then there would certainly be some doubt cast upon market efficiency.

Topic: MARKET EFFICIENCY Type: ESSAYS

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Chapter 14 - Efficient Capital Markets and Behavioral Challenges

62. Why should a financial decision maker such as a corporate treasurer or CFO be concerned with market efficiency?

Good answers to this question might indicate that market efficiency is a necessary condition for the \economically meaningful number, seeking to maximize it is silly. Similarly, students should recognize that there is a very strong link between managerial decisions and the value of the firm, as reflected in security prices. Finally, as a preview of the cost of capital discussion in later chapters, instructors might point out that market efficiency ensures that the required returns on new securities will be directly related to the risk-return profile of the firm and, therefore, to managerial actions.

Topic: MARKET EFFICIENCY Type: ESSAYS

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