Question

​​​​​Select the best answer for each of the following unrelated items. Answer each of these items in your examination booklet by giving the number of your choice. For example, if the best answer for item (a) is (1), write (a)(1) in your examination booklet. If more than one answer is given for an item, that item will not be marked. Incorrect answers will be marked as zero. Marks will not be awarded for explanations.

1. Which of the following is an example of finer information in the context of information production by firm managers?
   1. Additional line items in financial statements
   2. Future-oriented financial information incorporated in management discussion and analyses
   3. A “clean” audit report by a large established auditing firm
   4. Information that, if released, will adversely affect the firm’s future cash flows

2. According to the theoretical literature on disclosure and its determinants, the presence or absence of “externalities” play an important role. The literature states that the presence of externalities can cause firms to under-produce information. Which of the following statements describes “externalities” in the context of information production?
   1. When information that is disclosed is not used in the financial statements
   2. When the costs or benefits of disclosure are not borne by the producer of the information
   3. When information that is disclosed is not used for internal planning purposes
   4. When information produced has economic consequences

3. Which of the following statements describes the public interest theory of regulation?
   1. The regulator is motivated to maximize social welfare through regulation.
   2. The regulator is motivated to maximize his or her own utility.
   3. The regulator is democratically elected.
   4. The regulator is appointed by elected individuals.

4. One way investors can lower risk for a given expected return is to adopt a strategy of portfolio diversification of securities. How does this reduce portfolio risk?
   1. Systematic risk in the portfolio is reduced as the number of firms included in the portfolio increases.
   2. The number of firms in the portfolio is reduced to reduce the risk of the portfolio.
   3. Security returns across securities are not perfectly correlated.          4) All securities in the portfolio have the same risk.

5. The principle of diversification leads to an important risk measure (beta) in the theory of investment. Which statement about beta is correct?

1. Beta is used as a proxy for the firm-specific risk of a security.
2. Beta is a measure of the systematic risk of a security.
3. Beta measures the covariance of the price of a security and changes in the market value of the investor’s portfolio.
4. By definition, the beta of the market portfolio is zero.

6. Which of the following correctly represents “noise” in an information system?
   1. When prior probability is the same as posterior probability
   2. When prices do not react to earnings announcements
   3. When diagonal probabilities are large
   4. When off-diagonal probabilities are small

7. Which of the following indicates an efficient securities market in the semi-strong form?
   1. The prices of securities traded on that market at all times reflect all information that is publicly and privately known about those securities.
   2. The prices of securities traded on that market at all times reflect substantially all the information that is publicly known about those securities.
   3. The prices of securities traded on that market at most times reflect most information that is publicly known about those securities.
   4. The prices of securities traded on that market at all times reflect all information that is publicly known about those securities.

8. By introducing the concept of noise traders (or liquidity traders), the efficient securities market theory was extended to reconcile the concept of efficiency with the usefulness of financial accounting information. With noise traders, security prices are which of the following?
   1. Uninformative
   2. Fully informative
   3. Only partly informative
   4. Random

1. In 1970, Akerlof examined information asymmetry in the used car market. He argued that buyers do not have the information required to distinguish between “lemons” and good cars. Which of the following statements is correct?
   1. Buyers will lower the price they are willing to pay for any used car.
   2. Buyers will pay a lower price for lemons than for good quality used cars.
   3. Buyers will raise the price they are willing to pay for any used car. 4) Owners of lemons will withdraw from the used car market.

Answer 1

(a)(2) Future-oriented financial information incorporated in management discussion and analyses.

(b)(4) When information produced has economic consequences.

(c)(1) The regulator is motivated to maximize social welfare through regulation.

(d)(1) Systematic risk in the portfolio is reduced as the number of firms included in the portfolio increases.

(e)(2) Beta is a measure of the systematic risk of a security.

(f)(4) When off-diagonal probabilities are small.

(g)(4) The prices of securities traded on that market at all times reflect all information that is publicly known about those securities.

(h)(4) Random.

(i)(2). Buyers will pay a lower price for lemons than for good quality used cars.