Question

1) While eating dinner at a high-end restaurant, you start to listen to two famous executives talking about starting a merger. After you eat, you look at the news and see that story about the merger has not been made public quite yet. You get on the phone with your personal broker and purchase stocks in both companies, as much as you are able to afford. Then, two days later, when the merger is made public, the stock prices go up exponentially and you make massive money. The fact that you were able to use inside information to make a huge profit directly contradicts which form of market efficiency?

a. Weak form

b. Semi-strong form

c. Strong form

d. Medium form

e. The question is not appropriate, because the market is not at all efficient, and is getting less efficient every year.

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2) The data in regards to two stocks is shown below:

-----------------------------------------------------------------Returns for---------

State of Economy -  Probability --------------- Stock A --- Stock B -----

Boom ------------------- 30% -------------------------100% -------20%

Normal ------------------40% --------------------------15% ---------15%

Recession --------------30%-------------------------( -70%)------- 10%

Which of the following statements regarding Stocks A and B is true? [Note: you do not need to calculate standard deviation; you merely need to look at the figures to see which stock has a higher deviation.]

a. Stock A has a higher expected return than Stock B, but Stock A is more risky because it has a lower standard deviation.

b. Stock A has the same expected return as Stock B, but Stock A is more risky because it has a higher standard deviation.

c. Stock B has the same expected return as Stock A, but Stock B is more risky because it has a higher standard deviation.

d. Stock B has a higher expected return than Stock A, but Stock B is less risky because it has a lower standard deviation.

e. Both stocks have the same expected returns and the same standard deviations.

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3) Which of the following is NOT true regarding beta (the beta coefficient)?

a. It is a measure of systematic risk, which cannot be diversified away.

b. A stock with a beta of .5 generally is considered to be less risky than a stock with beta of 2.

c. A stock with a beta of 3 historically moves three times as far as the overall market.

d. A beta of one indicates an investment is totally risk free.

e. A negative beta means that a stock price has reacted in an opposite direction to the overall market.
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4) Assume the following information is available: Return on ABC, 30-year, corporate bonds is 8%. The bonds are regularly traded and very liquid. The current and expected inflation rate is 3% Return on U.S. Treasury Bill is 4% Return on 30-year U.S. Treasury Bond is 6% Which of the following statements is correct?

a. The real risk-free rate is approximately 2%

b. The return on the U.S. Treasury bond includes an interest-rate risk premium of 4%

c. The return on the corporate bond includes a default risk premium of 3%

d. The return on the corporate bond includes a liquidity risk premium of 2%

e. The return on the corporate bond includes a default risk premium of 2%

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5) Fort his question, let's assume that Treasury Bills currently yield 4.5% and the market risk premium is 4% (i.e. expected market return is 8.5%). If the common stock of Hughley Corp. has a beta of 1.42, which of the following statements is true?

a. Hughley’s cost of equity financing (from common stock) is 4.8%

b. Hughley’s after-tax cost of equity financing (from common stock) is 6.6%.

c. Hughley’s stock is not as volatile as the overall market.

d. Hughley’s cost of equity financing (from common stock) is 10.2%

e. None of the above statements is true

Answer 1

Question 1) ans: C) strong form

The strong form of market efficiency hypothesis states that all kinds of information related to the stock (public as well those which are not public) are incorporated into the current stock prices and hence investors can never make any profits regardless of any information they get.

In the given question, since it was possible to earn profits on my investment by taking advantage of an inside information that was not publicly known, the strong form of market efficiency does not hold good in this case.