Question Investor Behavior and Capital Market Efficiency

29 Jun Question Investor Behavior and Capital Market Efficiency

Question
Investor Behavior and Capital Market Efficiency

MULTIPLE CHOICE QUESTIONS

13.1 Competition and Capital Markets

Use the following information to answer the question(s) below.

Assume that the CAPM is a good description of stock price returns. The market expected return is 8% with 12% volatility and the risk-free rate is 3%. New news arrives that does not change any of these numbers, but it does change the expected returns of the following stocks:

Stock

Expected

Return

Volatility

Beta

Taggart Transcontinental

8%

28%

1.2

Rearden Metal

13%

40%

1.7

Wyatt Oil

7%

20%

0.8

Nielson Motors

10%

32%

1.3

1) The expected alpha for Taggart Transcontinental is closest to:

A) -3.00%

B) -1.00%

C) 1.00%

D) 3.00%

2) The expected alpha for Wyatt Oil is closest to:

A) -3.00%

B) -1.00%

C) 0.00%

D) 3.00%

3) Which of the following stocks represent buying opportunities?

1. Taggart Transcontinental

2. Rearden Metal

3. Wyatt Oil

4. Nielson Motors

A) 1 only

B) 1 & 2 only

C) 2 & 3 only

D) 2 & 4 only

4) Which of the following stocks represent selling opportunities?

1. Taggart Transcontinental

2. Rearden Metal

3. Wyatt Oil

4. Nielson Motors

A) 1 only

B) 1 & 2 only

C) 2 & 3 only

D) 2 & 4 only

5) A stock’s alpha is defined as the stock’s:

A) expected return minus its required return.

B) expected return minus its actual return.

C) nominal return minus its required return.

D) required return minus its actual return.

13.2 Information and Rational Expectations

1) When all investors correctly interpret and use their own information, as well as information that can be inferred from market prices or the trades of others, they are said to have

A) sensation seeking expectations.

B) positive expectations.

C) rational expectations.

D) confident expectations.

2) The CAPM does not require investors have homogeneous expectations, but rather that they have

A) rational biases.

B) no biases.

C) heterogenous expectations.

D) rational expectations.

13.3 The Behavior of Individual Investors

1) Investors that suffer from a familiarity bias

A) prefer not to invest in companies they are familiar with.

B) favor investments in companies they are familiar with.

C) invest in the same stocks that their friends or family recommend.

D) tend to overestimate the precision of their knowledge.

2) The tendency of uninformed individuals to overestimate the precision of their knowledge is known as

A) overconfidence bias.

B) herd behavior.

C) familiarity bias.

D) disposition bias.

3) If investors have relative wealth concerns, they care most about

A) the return on their portfolio relative to their overall current wealth.

B) the performance of their portfolio relative to that of their peers.

C) their current portfolio performance relative to their past portfolio performance.

D) the performance of their current wealth relative to their past wealth.

4) An individual’s desire for intense risk-taking experiences is known as

A) phenomenon seeking.

B) herd seeking.

C) sensation seeking.

D) rational expectations seeking.

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5) Which of the following is not true regarding individual investor behavior.

A) Individual investors fail to diversify their portfolios adequately.

B) A vast majority of individual investors hold fewer than 10 stocks in their portfolio.

C) Employees tend to overinvest in their company’s own stock.

D) Individual investors’ portfolios consistently outperform the market averages.

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13.4 Systematic Trading Biases

Use the following information to answer the question(s) below.

Consider the price paths of the following stocks over a six-month period:

Stock

January

February

March

April

May

June

Taggart Transcontinental

$15

$18

$21

$18

$20

$24

Rearden Metal

$30

$22

$16

$24

$30

$36

Wyatt Oil

$20

$21

$23

$24

$26

$26

Nielson Motors

$20

$17

$14

$12

$14

$12

None of these stocks pay dividends.

1) Assume that you are an investor with the disposition effect and you bought each of these stocks in January. Suppose that it is currently the end of March, which stocks are you most inclined to sell?

1. Taggart Transcontinental

2. Rearden Metal

3. Wyatt Oil

4. Nielson Motors

A) 1 only

B) 1 & 3 only

C) 2 only

D) 2 & 4 only

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2) Assume that you are an investor with the disposition effect and you bought each of these stocks in January. Suppose that it is currently the end of March, which stocks are you most inclined to hold?

1. Taggart Transcontinental

2. Rearden Metal

3. Wyatt Oil

4. Nielson Motors

A) 1 only

B) 1 & 3 only

C) 2 only

D) 2 & 4 only

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3) Assume that you are an investor with the disposition effect and you bought each of these stocks in January. Suppose that it is currently the end of June, which stocks are you most inclined to sell?

1. Taggart Transcontinental

2. Rearden Metal

3. Wyatt Oil

4. Nielson Motors

A) 1 only

B) 1 & 3 only

C) 2 only

D) 1, 2 & 3 only

4) Assume that you are an investor with the disposition effect and you bought each of these stocks in January. Suppose that it is currently the end of June, which stocks are you most inclined to hold?

1. Taggart Transcontinental

2. Rearden Metal

3. Wyatt Oil

4. Nielson Motors

A) 1 only

B) 4 only

C) 1 & 3 only

D) 2 & 4 only

5) If investors believe that others have superior information which they can take advantage of by copying their trades, this can lead to

A) an informational cascade effect.

B) a disposition effect.

C) a sensation seeking effect.

D) an overconfidence bias.

6) The tendency to hang on to losers and sell winners is known as the

A) cascade effect.

B) disposition effect.

C) overconfidence bias.

D) systematic behavior bias.

7) When investors imitate each other’s actions, this is known as ________ behavior.

A) pack

B) flock

C) herd

D) shepherd

13.5 The Efficiency of the Market Portfolio

Use the following information to answer the question(s) below.

Assume that the economy has three types of people. 20% are fad followers, 75% are passive investors, and 5% are informed traders. The portfolio consisting of all informed traders has a beta of 1.4 and an expected return of 16%. The market has an expected return of 10% and the risk-free rate is 4%.

1) The alpha for the informed investors is closest to:

A) -2.4%

B) -0.9%

C) 0.0%

D) 3.6%

2) The alpha for the passive investors is closest to:

A) -2.4%

B) -0.9%

C) 0.0%

D) 3.6%

3) The expected return for the fad follower’s portfolio is closest to:

A) 11.5%

B) 12.4%

C) 13.6%

D) 16.0%

+.

Use the following information to answer the question(s) below.

John Galt is a mutual fund manager at Atlas Asset Management. He can generate an alpha of 2% a year up to $500 million of invested capital. After that amount his skills are spread too thin, so he cannot add value and his alpha is zero for all investments over $500 million. Atlas Asset Management charges a fee of 0.80% on the total amount of money under management. Assume that there are always investors looking for positive alpha investments and no investor would invest in a fund with a negative alpha. Assume that the fund is in equilibrium, meaning that no investor either takes out money or wishes to invest new money into the fund.

4) The expected return for the fad follower’s portfolio is closest to: