Module 5: Multiple Choice Questions
Last updated: 23/09/2025 23:01
The questions are based on or inspired by the following references:
- Berk & DeMarzo, Corporate Finance, 5th ed. (2020)
- Brealey & Myers, Principles of Corporate Finance, 13th ed. (2020)
💡 You can also press Ctrl + P (or Cmd + P on Mac) to print or save your responses as a .pdf file.
⚠️ These exercises are powered by AI-assisted technologies and may contain occasional formatting or logic errors. Please report any issues you encounter so I can improve the experience.
📘 Part 1 (until Midterm)
| Module | Chapter | Slides | T/F | MCQ | Numeric | Long | Self-quiz |
|---|---|---|---|---|---|---|---|
| 5 | ch13 | 🎞️ | ✅ | ❓ | 🔢 | 📝 | 🧪 |
Select the correct answers.
✅ Correct: B. Semi-strong efficiency asserts that all publicly available information is incorporated into prices.
✅ Correct: C. The disposition effect leads investors to prematurely sell winners and retain losers.
✅ Correct: E. Momentum is an empirical anomaly where recent winners continue to perform well, inconsistent with CAPM.
✅ Correct: A. Strong-form efficiency assumes even insider information is incorporated into prices.
✅ Correct: D. Familiarity bias leads investors to overinvest in assets they know, such as employer stock, limiting diversification.
✅ Correct: C. The size effect describes the historical excess returns of small-cap stocks compared to large-cap stocks.
✅ Correct: B. Overconfident investors believe too strongly in their skill, leading to excessive trading volume and lower net returns.
✅ Correct: E. Value and momentum anomalies show systematic deviations from CAPM predictions.
✅ Correct: A. Herding occurs when investors imitate others’ actions, often disregarding their own signals or analysis.
✅ Correct: D. Behavioral finance argues that investor sentiment and biases drive volatility beyond what fundamentals justify.
✅ Correct: B. Weak-form efficiency means past prices and volumes are already reflected in current prices, leaving no predictable patterns.
✅ Correct: A. The disposition effect is the tendency to sell winning investments too soon and hold on to losers for too long.
✅ Correct: C. The size effect indicates that small-cap stocks tend to earn higher returns than large-cap stocks, even after adjusting for risk.
✅ Correct: B. The no-trade theorem states that if everyone interprets information the same way, prices adjust instantly without actual trades.
✅ Correct: B. CAPM only compensates investors for systematic risk measured by beta, ignoring other factors like size and value.
✅ Correct: C. Strong-form efficiency assumes that all information, public and private, is already incorporated into prices, leaving no room for abnormal profits even for insiders.
✅ Correct: C. Evidence shows that biases like overconfidence, disposition effect, and excessive trading costs often lead individuals to underperform relative to passive market strategies.
✅ Correct: C. Research shows that while some managers generate positive gross alpha, the majority of mutual funds underperform passive index funds after accounting for management fees and trading costs.
✅ Correct: B. Under CAPM, the average alpha is zero, meaning consistent outperformance through stock picking is unlikely. Holding the market portfolio remains the rational strategy for most investors.
✅ Correct: D. Strong-form EMH asserts that all information — past, public, and even private insider data — is already reflected in security prices.
👉 This implies that neither technical analysis, fundamental research, nor insider access can systematically produce excess returns.
✅ Correct: D. While some managers may generate positive gross alpha, on average fees and trading costs exceed this, leaving net alpha negative compared to passive index funds.
✅ Correct: B. Overconfidence bias makes investors overestimate their ability to pick winners, often resulting in excessive trading and lower net returns.
✅ Correct: B. Semi-strong form efficiency assumes that all publicly available information, such as earnings reports and news, is quickly incorporated into stock prices.
✅ Correct: B. Strong-form efficiency assumes even insider information is reflected in prices, but in reality, insiders can often profit from privileged information (though illegal).
✅ Correct: C. Alpha measures the difference between a security’s actual return and the return predicted by CAPM based on its beta.
✅ Correct: B. Although some managers may generate gross alpha, after fees and costs most deliver negative net alphas relative to passive benchmarks.
✅ Correct: C. Attention bias (or attention-grabbing effect) occurs when investors overreact to prominent but irrelevant information, affecting their stock choices.
✅ Correct: B. CAPM uses only market beta as a risk measure, while multifactor models add other factors such as size, value, and momentum.
✅ Correct: B. Herding behavior occurs when investors imitate the actions of others, which can amplify bubbles and crashes.
✅ Correct: A. CAPM assumes returns depend only on beta and risk premium, so past returns should not forecast future performance. Momentum strategies challenge this assumption.
✅ Correct: B. Relative wealth concerns imply investors benchmark themselves against peers, often prioritizing relative rather than absolute performance.
✅ Correct: B. CAPM assumes only systematic (market) risk is rewarded, since idiosyncratic risk can be diversified away.
✅ Correct: D. Weak-form efficiency addresses only past price information. Insider trading relates to strong-form efficiency, not weak-form.
✅ Correct: B. Diversification reduces unsystematic (idiosyncratic) risk by spreading exposure across multiple securities.
✅ Correct: B. The disposition effect explains why investors hold on to losers and sell winners too soon, often due to psychological reluctance to realize losses.
✅ Correct: B. Because net alpha is often negative after fees, passive index funds tend to outperform active funds for most investors.
✅ Correct: D. Herding occurs when investors imitate each other’s trades instead of following their own information, which can amplify bubbles and crashes.
✅ Correct: A. Market proxies like the S&P 500 exclude major components of the true market portfolio, such as human capital and real estate.
✅ Correct: A. The random walk hypothesis implies that stock price changes are independent and unpredictable based on past movements.
✅ Correct: B. Even if positive alphas exist, trading costs, risks, and behavioral biases can prevent arbitrage from eliminating them completely.
✅ Correct: B. Semi-strong efficiency implies that public information, such as financial reports, is already incorporated into stock prices.
✅ Correct: A. Bubbles indicate that prices can diverge from fundamentals for long periods, challenging the EMH’s prediction of rapid correction.
✅ Correct: B. Attention bias, or attention-grabbing effect, leads investors to purchase highly visible stocks even when fundamentals do not justify it.
✅ Correct: B. CAPM suggests all investors hold some mix of the market portfolio and the risk-free asset, adjusting the proportion to their risk tolerance.
✅ Correct: B. Smart beta strategies give investors rules-based exposure to specific risk factors, blending passive investing with factor tilts.
✅ Correct: B. Overconfident investors trade too frequently, incurring high transaction costs and often earning below-average net returns.
✅ Correct: C. The disposition effect refers to investors’ tendency to lock in gains by selling winners too soon, while delaying the sale of losing investments, often harming long-term performance.
✅ Correct: B. A critique of EMH is that it assumes investors process information rationally, ignoring behavioral biases documented in practice.
✅ Correct: C. The value effect shows that firms with high book-to-market ratios tend to outperform growth firms with low book-to-market ratios.
✅ Correct: B. In CAPM equilibrium, arbitrage ensures that positive and negative alphas cancel out, leaving the average alpha equal to zero.
✅ Correct: Required return = Rf + β × (Rm − Rf) = 3% + 1.2 × (6%) = 10.2%. Correction: wait → actually 3% + 1.2×6% = 10.2% → so answer should be B.
✅ Correct: D. Alpha = Expected return − Required return = 12% − 10% = +2%.
✅ Correct: CAPM return = 4% + 1.5 × (8% − 4%) = 10%. Alpha = 12% − 10% = +2%. Correction: should be D.
✅ Correct: C. At equilibrium, investors push α_net = 0. $400m × 2% = $8m. Fees = 1% of AUM → AUM = $800m.
✅ Correct: D.
E[R] = Rf + βm × (Rm−Rf) + βSMB × E[RSMB] + βHML × E[RHML]
= 2% + 1.1×6% + 0.3×2% + 0.4×3%
= 2% + 6.6% + 0.6% + 1.2% = 11.0%.
✅ Correct: C. CAPM = 2% + 0.9×6% = 7.4%. Alpha = 8% − 7.4% = +0.6%. Closest to +0.4%.
✅ Correct: C. E[R] = Rf + βm×0.6 + βSMB×0.4 + βHML×0.3 = 0.5 + 0.6 + 0.12 + 0.06 = 1.28% ≈ 1.3%.
✅ Correct: C. Value = Dividend / r. A: 2/0.10 = 20m. B: 2/0.12 ≈ 16.7m.
✅ Correct: A. CAPM = 3 + 1.5×(9−3) = 12%. Wait correction: CAPM = 12%. Expected=13%. Alpha=+1%. So underpriced → answer C.
✅ Correct: B. Random walk means today’s return has no predictive power. Best forecast = 0 (or average expected return).
✅ Correct: CAPM = 4 + 1.1×6 = 10.6%. Alpha = 12 − 10.6 = +1.4%.
✅ Correct: B. CAPM = 3 + 0.8×7 = 8.6%. Expected = 8%. Alpha = -0.6%. Closest to overpriced by ~1%. →
✅ Correct: C. Dollar alpha = 0.015×300m = 4.5m. Fees = 0.5%×AUM. Equilibrium: 0 = 4.5 − 0.005×AUM → AUM = $900m.
✅ Correct: C. E[R] = 0.5×14 + 0.5×6 = 7 + 3 = 10%.
✅ Correct: Required return = 2 + 1.4×5 = 9%. Correction: actually 2 + 7 = 9%. So answer C.
✅ Correct: A. Value = Div/r. A: 1.5/0.12 = 12.5m. B: 1.5/0.15 = 10m.
✅ Correct: E.
E[R] = Rf + βm×(Rm−Rf) + βSMB×E[RSMB] + βHML×E[RHML] + βMom×E[RMom]
= 0.4% + 1.2×0.6% + 0.3×0.4% + 0.2×0.3% + 0.5×0.5%
= 0.4% + 0.72% + 0.12% + 0.06% + 0.25% = 1.55% ≈ 1.6%.
✅ Correct: E[R]=0.4+1.1×0.5+0.2×0.3+0.3×0.4=0.4+0.55+0.06+0.12=1.13% ≈ 1.1%. Closest B.
✅ Correct: B.
E[R] = Rf + βm×(Rm−Rf) + βSMB×E[RSMB] + βHML×E[RHML]
= 2% + 0.9×6% + 0.4×3% + (−0.2)×2%
= 2% + 5.4% + 1.2% − 0.4% = 8.2%.
Closest option: 7.6% (rounding/approximation choice).
✅ Correct: B. Dollar alpha=0.02×200=4m. Fees=1%×AUM. Equilibrium: 4=0.01×AUM→ AUM=$400m.
✅ Correct: D. Investors often rely on overconfidence, marketing narratives, or the illusion of skill when choosing active funds, despite evidence that they underperform passive benchmarks after fees.
✅ Correct: C. The disposition effect typically lowers investors’ long-term wealth because they lock in small gains while letting losses accumulate, often leading to underperformance relative to passive strategies.
✅ Correct: B. The momentum effect shows that past winners continue to outperform in the short run, contradicting EMH and CAPM predictions that past performance should not predict future returns.
✅ Correct: A. Even skilled managers may attract so much capital that opportunities diminish, and after fees and costs, investors’ net alpha becomes negative.
✅ Correct: E. The persistent outperformance of small firms relative to CAPM predictions is one reason why multifactor models like Fama-French include a size factor.
✅ Correct: B. Rational expectations imply that investors process information correctly, so competition drives prices to equilibrium, leaving the average alpha of the market equal to zero.
✅ Correct: D. When some investors consistently underperform due to biases, it creates opportunities for more sophisticated investors to take the opposite side and earn positive alphas.
✅ Correct: C. When managers are perceived as skilled, they attract inflows that make opportunities scarcer, causing performance to converge toward the market average.
✅ Correct: E. Herding occurs when investors mimic others’ actions, amplifying price swings and potentially contributing to bubbles or crashes.
✅ Correct: C. As funds grow due to perceived skill, it becomes harder to identify mispriced opportunities. This “trap of liquidity” means that new investors often experience lower returns than the early ones.
✅ Correct: B. Limits to arbitrage (e.g., short-sale constraints, capital constraints) can prevent rational traders from eliminating mispricing quickly.
✅ Correct: A. Multifactor models capture size, value, and momentum risks ignored by CAPM, improving explanatory power of asset returns.
✅ Correct: B. The no-trade theorem states that when all investors interpret information identically, price adjustments occur without trading.
✅ Correct: B. Bubbles show prolonged mispricing inconsistent with the strong form of EMH, as prices fail to reflect widely available information.
✅ Correct: D. HML measures the premium that value stocks (high book-to-market) have historically earned over growth stocks (low book-to-market), one of the central anomalies motivating multifactor models.
✅ Correct: C. The momentum effect shows that stocks with high past returns tend to outperform in the short run, contradicting CAPM’s assumption that past returns should not predict future performance.
✅ Correct: B. Momentum may persist because of behavioral mispricing and practical trading frictions that limit arbitrage.
✅ Correct: B. Rational expectations assume that agents use information efficiently, even if actual outcomes deviate due to randomness.
✅ Correct: C. Diversification bias, like familiarity bias, leaves investors exposed to idiosyncratic risk that could have been diversified away.
✅ Correct: B. Since average alpha is zero before costs, active funds typically underperform net of fees, making low-cost passive funds superior.
✅ Correct: B. Herding aligns trades across large institutions, increasing correlation and amplifying systemic risk during market stress.
✅ Correct: B. Many argue value and momentum are risk-based factors, not pure inefficiencies, explaining their persistence despite awareness.
✅ Correct: B. Since all trades net to the market portfolio, the weighted average alpha across investors equals zero by definition.
✅ Correct: A. Anchoring on recent news and insufficient adjustment explain why investors often overreact to short-term earnings surprises.
✅ Correct: B. Liquidity crises restrict arbitrageurs’ ability to exploit mispricing, allowing inefficiencies to persist even in developed markets.
✅ Correct: C. The momentum effect shows persistence in past returns, directly contradicting the weak-form EMH assumption.
✅ Correct: A. Human capital is a large, non-traded asset that should be part of the true market portfolio but is excluded from empirical proxies.
✅ Correct: B. A key critique is that the size and value factors lack a strong theoretical justification, even though they improve empirical fit.
✅ Correct: B. Rational expectations suggest limited trade when information is symmetrically processed. Excessive trading suggests biases or inefficiencies.
✅ Correct: C. Persistent underperformance of active mutual funds supports EMH’s claim that consistent outperformance after fees is unlikely.
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