Question

1. You go to your regular appointment with your financial advisor Mr. Dayan. You complain about the recent news in the Wall Street Journal that a member of Congress used information in a classified briefing to make profitable investment decisions. You argue that investors are able to earn abnormal returns tracking firm fundamentals such as earnings announcements, and that you are sympathetic to that. However, the Congress member’s ability of profiting from the briefing is unacceptable. Mr. Dayan disagrees with you vehemently. He believes that no investor can earn superior returns without taking risk even if they analyze firm fundamentals. Furthermore, Mr. Dayan thinks that the profits of the Congress member must have been a coincidence and cannot possibly be due to his informational advantage. Based on this information, which of the following statements is correct regarding your and Mr. Dayan’s views on market efficiency?

A) You believe that markets are at least semi strong form efficient, while Mr. Dayan believes they are at best weak form efficient.

B) Mr. Dayan and you agree that markets are strong form efficient.

C) You believe that markets are at least semi strong form efficient, while Mr. Dayan believes they are at best weak form efficient.

D) Mr. Dayan and you agree that markets are at best weak form efficient.

E) You believe that markets are at best weak form efficient, while Mr. Dayan believes they are strong form efficient.

2. Which of the following statements is not correct regarding market fluctuations and efficient market hypothesis?

A) Fundamental analysis does not lead to abnormal returns in a semi strong efficient financial market.

B) If investment strategies based on fundamental analysis earn abnormal returns, one can rule out that weak form efficiency holds.

C) In a financial market where insiders obtain superior returns due to private information, markets are at best semi strong efficient.

D) If investment strategies based on technical analysis earn abnormal returns, then markets are not even weak form efficient.

E) The Securities and Exchange Commission works on preventing insider trading, because their goal is a strong form efficient market.

Answer 1

As per you: markets are weak form efficient, as your hypothesis is that abnormal extra returns can be made from information that not available in the public immediately.

As per Mr. Dayan: markets are strong form efficient, that any information available in public/private domain is already factored in the price of the asset & any abnormal extra profit is sheer luck

1. Option E is correct as per the above logic

2. Option B is incorrect. In weak form efficient markets, fundamental analysis can be applied to generate abnormal returns.