FIN 501 – FINAL EXAM QUESTIONS AND 100%
CORRECT ANSWERS
Bond rating
Letter grades that designate investment quality and are assigned to a bond issue by rating
agencies. Best-know rating agencies are Moody's, standard & poor's and fitch.
Random walk Hypothesis
The theory that stock price movements are unpredictable, so there's no way to know where prices
are headed.
Efficient market hypothesis (EMH)
Basic theory of the behavior of efficient markets, in which there are large number of
knowledgeable investors who react quickly to new information, causing securities prices to
adjust quickly and accurately.
Market anomalies
Irregularities or deviations from the behaviour one would expect in an efficient market. Four
effects: Calendar effect, small-firm effect, post earning announcement drift (or momentum), and
value effect.
Weak form (EMH)
A form of the EMH. Holding that past data on stock prices are no use in predicting future prices.
Prices follow random walk.
Semi-strong form (EMH)
A form of the EMH. Holding that abnormally large profits cannot be consistently earned using
publicly available information. Stock prices will adjust to news before you can trade the stock.
Strong form (EMH)
Form of the EMH that holds that there is no information, public or private, that allows investors
to consistently earn abnormal profits. Insider trading.
Arbitrage
A transaction in which an investor simultaneously buys and sells identical assets at different
prices to earn an instant, risk-free profit.
Calendar effect
A form of market anomalies. Stock returns may be closely tied to the time of the year or time of
the week.
January effect
, Tendency for small-cap stocks to outperform large stocks by an unusually wide margin.
Small-firm effect
A form of market anomalies. Small firms tend to earn positive abnormal returns of as much as
5% to 6% per year.
Post earnings announcement drift (or momentum):
A form of market anomalies. Another market anomaly has to do with how stock prices react to
earnings announcements. Stock prices that are gone up will keep going up and vice versa.
Value effect
A form of market anomalies. Best way to make money in the market is to buy stocks that have
relatively low prices relative to some measure of fundamental value such as book value or
earnings.
Behavioral finance
The body of research into the role that emotions and other subjective factors play in investment
decisions. Some behaviour factors are: overconfidence, self-attribution bias, loss aversion,
representativeness, narrow framing, belief perseverance, anchoring and familiarity bias.
Overconfidence
The tendency to overestimate one's ability to perform a particular task.
Self-attribution bias
The tendency to overestimate the role that one's intelligence or skill plays in brining about a
favourable investment result and to underestimate the role of chance in that result.
Loss aversion
A situation in which the desire to avoid losses is so great that investors who are otherwise risk-
averse will exhibit risk-seeking behavior in an attempt to avoid a loss.
Representativeness
Cognitive biases that occur because people have difficult thinking about randomness in
outcomes.
Narrowing framing
Analyzing an investment problem in isolation or in a particularly narrow context rather than
looking at all aspects of the problem.
Belief Perseverance
The tendency to ignore or discount evidence contrary to one's existing belief.
Anchoring
CORRECT ANSWERS
Bond rating
Letter grades that designate investment quality and are assigned to a bond issue by rating
agencies. Best-know rating agencies are Moody's, standard & poor's and fitch.
Random walk Hypothesis
The theory that stock price movements are unpredictable, so there's no way to know where prices
are headed.
Efficient market hypothesis (EMH)
Basic theory of the behavior of efficient markets, in which there are large number of
knowledgeable investors who react quickly to new information, causing securities prices to
adjust quickly and accurately.
Market anomalies
Irregularities or deviations from the behaviour one would expect in an efficient market. Four
effects: Calendar effect, small-firm effect, post earning announcement drift (or momentum), and
value effect.
Weak form (EMH)
A form of the EMH. Holding that past data on stock prices are no use in predicting future prices.
Prices follow random walk.
Semi-strong form (EMH)
A form of the EMH. Holding that abnormally large profits cannot be consistently earned using
publicly available information. Stock prices will adjust to news before you can trade the stock.
Strong form (EMH)
Form of the EMH that holds that there is no information, public or private, that allows investors
to consistently earn abnormal profits. Insider trading.
Arbitrage
A transaction in which an investor simultaneously buys and sells identical assets at different
prices to earn an instant, risk-free profit.
Calendar effect
A form of market anomalies. Stock returns may be closely tied to the time of the year or time of
the week.
January effect
, Tendency for small-cap stocks to outperform large stocks by an unusually wide margin.
Small-firm effect
A form of market anomalies. Small firms tend to earn positive abnormal returns of as much as
5% to 6% per year.
Post earnings announcement drift (or momentum):
A form of market anomalies. Another market anomaly has to do with how stock prices react to
earnings announcements. Stock prices that are gone up will keep going up and vice versa.
Value effect
A form of market anomalies. Best way to make money in the market is to buy stocks that have
relatively low prices relative to some measure of fundamental value such as book value or
earnings.
Behavioral finance
The body of research into the role that emotions and other subjective factors play in investment
decisions. Some behaviour factors are: overconfidence, self-attribution bias, loss aversion,
representativeness, narrow framing, belief perseverance, anchoring and familiarity bias.
Overconfidence
The tendency to overestimate one's ability to perform a particular task.
Self-attribution bias
The tendency to overestimate the role that one's intelligence or skill plays in brining about a
favourable investment result and to underestimate the role of chance in that result.
Loss aversion
A situation in which the desire to avoid losses is so great that investors who are otherwise risk-
averse will exhibit risk-seeking behavior in an attempt to avoid a loss.
Representativeness
Cognitive biases that occur because people have difficult thinking about randomness in
outcomes.
Narrowing framing
Analyzing an investment problem in isolation or in a particularly narrow context rather than
looking at all aspects of the problem.
Belief Perseverance
The tendency to ignore or discount evidence contrary to one's existing belief.
Anchoring
