Question

1) Suppose a manager earns a positive alpha for a year of investing. Efficient market hypothesis explains this as:

A. the manager got lucky.

B. the manager took high risk.

C. both (A) and (B) are true.

D. none of the above

2) Suppose a manager earns a positive alpha for a year of investing. Efficient market hypothesis explains this as:

A. the manager got lucky.

B. the model of risk which produced the result was flawed or incomplete.

C. both (A) and (B) are possible.

D. none of the above

3) If the stock market is semi-strong form efficient, then:

A. it’s possible for technical analysis to beat the market consistently, but not fundamental analysis

B. it’s possible for fundamental analysis to beat the market consistently, but not technical analysis

C. it’s possible for both technical analysis and fundamental analysis to beat the market consistently

D. it’s not possible for technical analysis or fundamental analysis to beat the market consistently

4) Which of following would violate the efficient market hypothesis?

A. evidence shows that individual investors are often irrational in their decision making

B. evidence shows that stock investors earn higher returns on average than bond investors

C. Both A) and B)

D. None of the above

5) Limits to arbitrage:

A. include costs of trading

B. include model risk

C. both (A) and (B) are correct

D. none of the above

6) Limits to arbitrage:

A. include forecasting errors

B. include regret avoidance

C. both (A) and (B) are correct

D. none of the above

7) Research shows that investors commonly make the following mistake:

A. overestimate the likelihood of rare events

B. continue to hold profitable investments longer than they should

C. both (A) and (B)

D. none of the above

8) Research shows that investors commonly make the following mistake:

A. sell profitable investments sooner than they should

B. continue to hold losing investments longer than they should

C. both (A) and (B)

D. none of the above

Answer 1

1) The answer is C - both (A) and (B) are true.

A. the manager got lucky.

B. the manager took high risk.

The term Alpha predominantly refers to the performance of the market. How well the stocks are being performed in the market. This term is generally used in all the instruments like bonds, securities, etc..

Efficient market hypothesis states that standard earning in the market is impossible unless we the manger took high risk on the stock. Since the market is performed on the demand and supply sentiments , no one knows about the price movement of the stock unless we have an insider information. Manager should take the higher risk investment for the positive returns and also the luck that manger to got to earn the positive alpha consistently.

2. The answer is C - both (A) and (B) are possible.

A. the manager got lucky.

B. the model of risk which produced the result was flawed or incomplete.

In order to have the consistent return on investment the manger must got lucky enough to get the returns positively.  

If the model of risk is incomplete and also the luck comes by your then the way for consistent return is possible. The model of risk here states that in which way the portfolio's are diversified in order to reduce the risk and by luck all the diversified portfolios are performed in luck then there is a chance of positive alpha returns.

3. The answer is D: - it’s not possible for both technical analysis and fundamental analysis to beat the market consistently

Stock market are driven by the sentiments of the buyers and sellers. But what makes the stock to go up or down in fully on the technical analysis and fundamental analysis. However most of the retail traders can only have the access to determine the price movement of the stock and only with the fundamental analysis we can able to determine the strength of the company. But in stock market even if know both the market will always fluctuate. There will not be any consistent growth in the market , market will fell down for 2-3 days and again it will climb up, but no way possible for the market to always be in green trend since it is driven sentiment factor of buyer and sellers.

4 The answer is C -  Both A) and B)

A. evidence shows that individual investors are often irrational in their decision making

B. evidence shows that stock investors earn higher returns on average than bond investors

As being an individual investors we do not know about the full outskirts of the market. Individual investors are always irrational in decision making since we are not sure about the exact price movement of the market. Neither technical nor fundamental analysis will able to predict the market and as an individual investors we will not have that much information in hand and will always make irrational decision.

Its being a fact that stock investors earns more than bond investors but also we should know that how consistently the stock investor is being earned. Maybe for a month he can be consistent but not all investors make consistent returns compared to the bond investors. Bond investors have the constant returns if the market is performing well or not they get their constant returns.

5 - The answer is C - both (A) and (B) are correct

A. include costs of trading

B. include model risk

In layman term Arbitrage means buying and selling of any securities in two different markets. Arbitrage always includes the cost of trading and the model risk. It always have an unanticipated amount of losses. Also, the cost for arbitraging is also high since it has to done in two different markets and also high amount of risk is involved.

6 - The answer is C - both (A) and (B) are correct.

A. include forecasting errors

B. include regret avoidance

  Arbitrage is the process where we buy and sell in two different martes assuming that the prices will go up either in any of the markets. We forecast that the market will go up but in return the market goes down then it causes us a huge loss in the market. Always better to avoid arbitrage as the amount of risk involved is unanticipated.

7 - The answer is C -  both (A) and (B)

A. overestimate the likelihood of rare events

B. continue to hold profitable investments longer than they should

Likelihood rare events are more rare where the investors tend to think that they something will happen in the stock or the market where my portfolio will give me n number of returns and they likely to hold forever.

Investors always make a mistake where they continue to hold the profitable investment more than they actually should hold. This will make the investment return less because the stock price will always be on the upper hand and it will come to the red side as well, so as an investor we should be emotionally controlled and should sell the stock at one level.

8 - The answer is C - both (A) and (B)

A. sell profitable investments sooner than they should

B. continue to hold losing investments longer than they should

Being an investor we should know when to sell the stock , see the range bound of the stock and the upper circuit as well. This will help to determine whether the stock have the ability to move upwards the market. If so hold the stock and do not sell it sooner.

Some of the investors still hold the losing investment stock assuming the one day or other the price will go up. In this case the investor should know his/her risk ratio in order to hold the stock. If the investor can able to take care of their risk they can hold the stock and also the matter of strength that company has. If the company has good strength in the market then they can hold the stock for longer term and it will give you a capitalized return.