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Money, Banking, and Financial Markets Practice Test: The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis
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The efficient market hypothesis (EMH) is a financial economics theory that states that asset prices reflect all available information. The EMH also states that stocks always trade at their fair value on exchanges, which means that it is impossible to outperform the market through expert stock selection or market timing. The EMH is a cornerstone of modern financial theory, but it is highly controversial and often disputed. For example, investors such as Warren Buffett have consistently beaten the market over long periods.  The rational expectations hypothesis, also known as the... Show more
Money, Banking, and Financial Markets Practice Test: The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis
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25 Questions

1. Rational expectations forecast errors will on average be ________ and therefore ________ be predicted ahead of time.
2. Using the one-period valuation model, assuming a year-end dividend of $0.11, an expected sales price of $110, and a required rate of return of 10%, the current price of the stock would be
3. The efficient markets hypothesis suggests that if an unexploited profit opportunity arises in an efficient market,
4. Using the Gordon growth model, a stockʹs price will increase if
5. ________ occurs when market participants observe returns on a security that are larger than what is justified by the characteristics of that security and take action to quickly eliminate the unexploited profit opportunity.
6. The efficient markets hypothesis suggests that investors
7. The theory of rational expectations, when applied to financial markets, is known as
8. The view that expectations change relatively slowly over time in response to new information is known in economics as
9. ________ means people are more unhappy when they suffer losses than they are happy when they achieve gains.
10. In the Gordon growth model, a decrease in the required rate of return on equity
11. The elimination of unexploited profit opportunities requires that ________ market participants be well informed.
12. The small-firm effect refers to the
13. If expectations are formed adaptively, then people
14. Which of the following accurately summarize the empirical evidence about technical analysis?
15. To say that stock prices follow a ʺrandom walkʺ is to argue that stock prices
16. According to rational expectations theory, forecast errors of expectations
17. One of the assumptions of the Gordon Growth Model is that dividends will continue growing at________ rate.
18. If a mutual fund outperforms the market in one period, evidence suggests that this fund is
19. If market participants notice that a variable behaves differently now than in the past, then, according to rational expectations theory, we can expect market participants to
20. A stockʹs price will fall if there is
21. Loss aversion can explain why very little ________ actually takes place in the securities market.
22. Studies of mutual fund performance indicate that mutual funds that outperformed the market in one time period usually
23. The number and availability of discount brokers has grown rapidly since the mid -1970s. The efficient markets hypothesis predicts that people who use discount brokers
24. Financial markets quickly eliminate unexploited profit opportunities through changes in
25. In a rational bubble, investors can have ________ expectations that a bubble is occurring but continue to hold the asset anyway.

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