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1. In an efficient market, the price of a security will _____.

a. always rise immediately upon the release of new information

b. be slow to react for a period of time after new information is released allowing time for that information to be

reviewed and analyzed by market participants

c. react immediately to new information with no further price adjustments related to that information

d. rise sharply when new information is first released and then decline to a new stable level by the following day

e. slowly be incorporated into market prices as the market gains confidence in the information


2. Which one of the following statements concerning market efficiency is correct?

a. A firm will generally receive a fair price when it sells shares of stock.

b. If a market is efficient, arbitrage opportunities should be common.

c. In a strong-form efficient market, some market participants will have an informational advantage over others.

d. Information will gradually be reflected in a stock’s price to avoid any sudden change in the price of the stock.

e. Real asset markets are more efficient than financial markets.


3. According to the efficient market hypothesis, financial markets fluctuate because they _____.

a. are inefficient

b. slowly react to new information

c. are continually reacting to new information

d. offer tremendous arbitrage opportunities

e. only reflect historical information


4. The U.S. Securities and Exchange Commission periodically charges individuals for insider trading and claims those

individuals have made unfair profits. This suggests that financial markets are at best _____ form efficient.

a. perfect

b. semi-strong

c. semi-weak

d. strong

e. weak


5. In practice, individuals that continually monitor financial markets seeking mispriced securities _____.

a. are never able to find a security that is temporarily mispriced

b. are usually successful in identifying mispriced securities using historical price patterns as their basis of evaluation

c. are usually successful using only public information as their basis of evaluation

d. tend to make substantial profits if they are trading on a daily basis

e. tend to make the markets more efficient


6. An investor discovers that for a certain group of stocks, large positive price changes are always followed by large

negative price changes. This finding is a violation of the (Note: Identify only the most relevant violation.)

a. perfect market conditions

b. semi-strong form of the efficient market hypothesis

c. semi-weak form of the efficient market hypothesis

d. strong form of the efficient market hypothesis

e. weak form of the efficient market hypothesis


7. A lawyer advises firms planning to sue other firms for antitrust damages. He finds that he can "beat the market" by

trading on the inside information acquired through his legal activities. This finding is in violation of

(Note: Identify only the most relevant violation.)

a. weak form market efficiency

b. semi-strong form market efficiency

c. strong form market efficiency

d. More than one of the above

e. None of the above


8. The Carhart study cited in Chapter 11 of the text found that most mutual funds had _____.

a. higher returns than the benchmark portfolio after expenses

b. lower returns than the benchmark portfolio before expenses

c. roughly the same returns as the benchmark portfolio after expenses

d. lower returns than benchmark portfolios after expenses and about the same returns before expenses

e. None of the above


PIM 842 Make-up Quiz 3 – 20 total points continued

MM capital structure problem (12 points total) - Assume a MM no-tax world (TC = 0) ala the text’s Chapter 13.



An investment costs $20,000 and is expected to produce EBIT of $10,000 (in cash) forever. The market’s required return

on similar-risk assets is rA = 10 percent. You are evaluating the consequences of issuing yourself $5,000 in perpetual debt

at the market rate of rD = 5% and 10 shares at a par value of $1,000 per share. In this case, the $20,000 investment would

be financed with $5,000 in debt and $15,000 in equity. (Hint: For a perpetuity, V = CF/r.)


a. (2 points) Complete the missing fields in the income statement below:

Earnings (as cash flow) before interest & taxes $10,000

Less: Interest

Earnings before taxes

Less: Taxes (TC = 0) $0

Earnings (as cash flow)

Cash flow to both debt and equity

b. (2 point) What is the value of the firm (VL) according to MM’s Proposition I?

c. (2 point) What is the equity required return (rE) according to MM’s Proposition II?

d. (2 point) Find the market value of debt by discounting interest payments to debt at the cost of debt?

e. (2 point) Find the equity market value by discounting earnings (cash flows to equity) at the equity required return?

f. (2 point) What is the weighted average cost of capital rWACC?

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