Equity Investments. 14 question(s) in this unit's pool
(2 above the exam). Free up to ten a day; the coach picks which ones based on what you have
already answered and when each is next due.
Pick an answer, say how sure you are, then reveal. Every wrong choice gets its own
explanation. Questions you have already answered correctly and confidently stay out of the way until they
are due for review again.
Question 1Exam level
According to the weak form of the efficient market hypothesis, which of the following strategies would most likely NOT be expected to consistently earn abnormal returns?
How sure are you?
Correct: A. Weak-form efficiency states that current prices fully reflect all past trading information, including price and volume history. A moving-average crossover signal is a technical strategy built entirely from past price and volume data, so it cannot generate consistent abnormal returns under weak-form efficiency.
B. Buying ahead of earnings announcements trades on information not yet public. That challenges semi-strong form, not weak form, since weak form only concerns past price/volume data.
C. Trading on insider information challenges strong-form efficiency, the strictest form. Weak form makes no claim about private information.
Unit: market-efficiency
Question 2Exam level
A portfolio manager discovers that stocks with high earnings surprises consistently outperform the market for 6 months following the announcement. If this finding is statistically robust, it most likely challenges which form of market efficiency?
How sure are you?
Correct: A. Post-earnings announcement drift (PEAD) is a semi-strong form anomaly. Earnings announcements are public information. If prices do not fully and immediately adjust to this public information, it violates semi-strong efficiency (which holds that all publicly available information is already priced in). It does not challenge weak-form (which only concerns past price data) nor strong-form (which concerns private/inside information).
B. You might be tempted to think that past price data is also relevant here, thus including weak form, but PEAD specifically relates to public information not being fully reflected in prices immediately, which is a semi-strong form issue, not a weak form one.
C. Choosing C might tempt you if you think that insider information is involved, but strong-form efficiency pertains to private or inside information not being exploited, whereas the earnings surprises are public information that semi-strong form efficiency should account for.
Unit: market-efficiency
Question 3Exam level
A research analyst finds that stock returns are significantly higher in January than in other months of the year, even after adjusting for risk. This finding is most consistent with which of the following?
How sure are you?
Correct: B. The January effect is a calendar anomaly. A pattern in publicly available data (month of year) that predicts returns. Its persistence would challenge semi-strong efficiency because month-of-year is a publicly known variable, and if it predicts returns, prices are not fully reflecting all public information. Option A is partially correct but incomplete. Option B contradicts the finding.
A. Option A is partially correct but incomplete.
C. You might be tempted to think that higher January returns indicate a consistent opportunity for alpha, but fundamental analysis relies on company-specific insights rather than calendar patterns, making choice C inconsistent with the observed calendar anomaly.
Unit: market-efficiency
Question 4Harder
Under the strong form of market efficiency, which of the following trading strategies would most likely be expected to consistently earn abnormal returns?
How sure are you?
Correct: A. Strong-form efficiency holds that ALL information, including private/insider information, is already reflected in prices. Therefore, no strategy, not even insider trading, can earn consistent abnormal returns. This is the extreme form and the empirical evidence actually REJECTS strong-form efficiency (studies show corporate insiders and specialists do earn abnormal returns), but by definition, the strong form says no strategy can consistently work.
B. You might think that proprietary models offer an edge over public information, but under strong-form efficiency, even fundamental analysis with unique models cannot consistently earn abnormal returns because all information, including that used in proprietary models, is already priced in.
C. You might be tempted to think that combining both fundamental and technical analysis could exploit market inefficiencies, but under strong-form market efficiency, all information is already priced in, making both approaches ineffective in earning abnormal returns consistently, thus violating the principle that no strategy can outperform in a strongly efficient market.
Unit: market-efficiency
Question 5Exam level
Which of the following pieces of evidence would most likely most strongly SUPPORT semi-strong form market efficiency?
How sure are you?
Correct: A. Semi-strong efficiency predicts that prices adjust rapidly and without systematic bias to all publicly available information. An earnings announcement is the classic public information event. If prices adjust immediately and completely, leaving no profitable trading opportunity after the announcement, this directly supports semi-strong efficiency. Option A contradicts semi-strong (analyst reports are public). Option C contradicts strong-form.
B. Choosing B might seem logical if you think that higher returns for insiders indicate market efficiency, but this actually supports weak-form efficiency being violated, as semi-strong form efficiency implies that all public information, not private information, is already reflected in stock prices.
C. Choosing C might seem logical if you think that momentum investing can persist, but this contradicts semi-strong form efficiency, which posits that all public information is already reflected in stock prices, leaving no room for consistent outperformance based on recent price movements.
Unit: market-efficiency
Question 6Harder
A fund manager claims to have generated consistent alpha by buying small-capitalization stocks and rebalancing quarterly. His track record spans 15 years with statistically significant outperformance. A CFA candidate evaluating this claim under the EMH framework should most likely FIRST consider:
How sure are you?
Correct: A. The size effect (small caps outperforming) is a well-documented anomaly. However, the CFA curriculum teaches candidates to first evaluate whether apparent anomalies have risk-based explanations before concluding market inefficiency. Small-cap stocks have higher liquidity risk, higher distress risk, and higher beta in some specifications. The premium may compensate for these risks rather than represent true alpha from inefficiency. This is the first-order analytical step the CFA tests.
B. Choosing B might tempt you if you assume any outperformance claim requires a conduct check, but evaluating whether outperformance stems from risk premiums aligns with EMH principles, not with ethical standards reviews.
C. Choosing C might tempt you because passive management often involves buying and holding a diversified index, but the question focuses on evaluating the risk-adjusted returns under the EMH framework, not on management style. You should first consider whether the outperformance is due to risk premiums, as per the EMH, rather than assessing the alignment with passive management principles.
Unit: market-efficiency
Question 7Exam level
The Random Walk Hypothesis is most likely most directly associated with which form of market efficiency?
How sure are you?
Correct: B. The Random Walk Hypothesis states that successive price changes are independent. Future price changes cannot be predicted from past price changes. This directly corresponds to weak-form efficiency, which holds that all past trading information (prices, volume) is already reflected in current prices. If prices followed predictable patterns based on past data, technical analysis would work. Which the weak form says it cannot.
A. You might sometimes associate Random Walk with 'all information is random' and choose D. But Random Walk specifically concerns past price data predictability. The definition of weak-form. Semi-strong and strong forms make additional claims beyond price randomness.
C. Choosing C might seem plausible if you think all forms of market efficiency equally reject the idea of predictable price patterns, but this overlooks the specific focus of weak-form efficiency on past price and volume data, which is directly challenged by the Random Walk Hypothesis.
Unit: market-efficiency
Question 8Harder
An investor consistently earns positive abnormal returns by trading immediately after corporate earnings announcements are released to the public. This behavior most likely indicates:
How sure are you?
Correct: B. Trading immediately after a PUBLIC earnings announcement and earning consistent abnormal returns means the market is not fully incorporating publicly available information into prices. A violation of semi-strong efficiency. The information is public (no ethics violation), so this rules out Option A. Earnings announcements are not past price data, so Option B (weak-form) is incorrect.
A. Option B (weak-form) is incorrect.
C. Choosing C might seem logical if you think that positive abnormal returns indicate all information, including insider information, is already priced in, but this confuses strong-form efficiency, which includes private information, with the actual scenario of public information not being fully reflected, which is a violation of semi-strong form efficiency.
Unit: market-efficiency
Question 9Exam level
Which of the following is the MOST accurate description of the CFA Institute's official position on market efficiency?
How sure are you?
Correct: B. The CFA curriculum adopts a nuanced position: markets are reasonably efficient, meaning prices generally reflect available information, but temporary mispricings can occur. The curriculum does not endorse perfect efficiency (which the evidence rejects) nor does it endorse markets as consistently beatable (which would support active management universally). The official position is that efficiency is a matter of degree and varies across markets and time periods.
A. Choosing A might be tempting if you believe in the strong form of the efficient market hypothesis, but this answer violates the CFA Institute's nuanced stance on market efficiency, which acknowledges that while markets are generally efficient, they are not perfect, and consistent outperformance is difficult due to temporary mispricings.
C. Choosing C might seem logical if you think emerging markets, due to their transparency and regulatory frameworks, are more efficient than the often complex and opaque developed markets, but the CFA Institute's stance is that efficiency is a spectrum and applies to both types of markets, albeit to varying degrees, which contradicts the binary efficiency claim in C.
Unit: market-efficiency
Question 10Exam level
A technical analyst identifies that a specific stock chart pattern has correctly predicted a 15% upside move in a particular stock on 22 of the last 25 occurrences over 10 years. If this pattern is real and statistically significant, it most likely provides evidence against:
How sure are you?
Correct: B. Technical analysis patterns use only past price and volume data. Exactly the information set that weak-form efficiency claims is already reflected in prices. If a chart pattern predicts future returns, past price data contains predictive information that the market has not yet incorporated. A direct violation of weak-form efficiency. Since weak form is violated, there is no need to invoke semi-strong or strong form.
A. Choosing A might tempt you because strong-form efficiency involves all information, not just past prices, but this pattern relies solely on historical price data, directly challenging weak-form efficiency, not the broader scope of strong-form efficiency.
C. You might be tempted by choice C if you think that semi-strong and strong form efficiency are more relevant because they involve more information sets, but this overlooks that technical analysis specifically relies on historical price data, which directly contradicts weak-form efficiency, not the broader information sets of semi-strong and strong forms.
Unit: market-efficiency
Question 11Harder
Studies of insider trading. Specifically, purchases by corporate officers and directors using material nonpublic information. Have consistently shown abnormal returns. This evidence most directly:
How sure are you?
Correct: A. Strong-form efficiency holds that even private/insider information is already incorporated into prices, meaning insiders cannot earn abnormal returns. Evidence showing insiders DO earn abnormal returns directly refutes strong-form efficiency. This evidence is CONSISTENT with semi-strong form. Semi-strong only requires that public information be reflected, and private information remaining valuable does not contradict that. So the answer is B: strong-form refuted, semi-strong consistent.
B. Choosing B might seem logical if you think that any abnormal returns indicate market inefficiency, but semi-strong form efficiency only requires that public information is reflected in stock prices, not private information, so insider trading profits do not refute semi-strong form efficiency.
C. You might be tempted to think that abnormal returns indicate random price movements, but the Random Walk Hypothesis suggests that past prices cannot predict future prices, which contradicts the idea of consistent abnormal returns from insider trading; this evidence actually shows predictability based on nonpublic information, not randomness.
Unit: market-efficiency
Question 12Harder
The value anomaly. Finding that stocks with low price-to-book ratios earn higher long-run returns. Is best categorized as, most likely:
How sure are you?
Correct: A. The price-to-book ratio is calculated from publicly available financial statements and market prices. Information accessible to all market participants. If buying low P/B stocks consistently earns abnormal returns, it means publicly available information (the P/B ratio) is not fully reflected in prices, which violates semi-strong efficiency.
B. You might be thinking that identifying low P/B stocks requires special data access, but this confuses strong-form efficiency, which involves inside information, with semi-strong efficiency, which includes all public information like P/B ratios.
C. You might be tempted to think that low P/B stocks simply carry more risk, but the value anomaly persists even after accounting for systematic risk, which contradicts the idea that it is just about higher risk; this anomaly suggests that publicly available information like P/B is not fully priced in, aligning with a semi-strong form market inefficiency.
Unit: market-efficiency
Question 13Above the exam
A researcher finds that stocks with high past 12-month returns continue to outperform over the following 3-6 months (momentum), a pattern that persists even after accounting for transaction costs, and is not explained by the stocks' exposure to any commonly used risk factor. Combining the definitions of the three forms of market efficiency, this finding is most likely evidence against:
How sure are you?
Correct: A. Momentum is defined using purely historical price/return data (past 12-month returns predicting future returns), which is exactly the information set the WEAK form of market efficiency claims is already fully reflected in prices. A persistent, cost-net-of-transaction-costs, risk-unexplained momentum effect is evidence AGAINST weak-form efficiency specifically, since it shows that past price patterns alone can predict future abnormal returns.
B. The strong form of market efficiency is about whether prices reflect ALL information, including private/insider information; momentum uses only PUBLICLY AVAILABLE past price data, which is squarely the weak-form information set, not a strong-form question.
C. While it is true that weak-form efficiency is logically the most basic level (and its failure does raise questions about the stronger forms too, since they build on similar assumptions about price behavior), the finding as described most directly and specifically targets weak-form efficiency; describing it as evidence against 'both' specific forms named here overstates what a pure price-pattern anomaly directly tests.
Unit: market-efficiency
Question 14Above the exam
A mutual fund manager delivers statistically significant outperformance over 10 years, but careful analysis shows this reflects survivorship bias in the manager's reported track record (many similar funds that underperformed were closed and excluded from the sample) combined with the manager taking on significantly higher systematic risk than the benchmark. Combining these two issues with the concept of risk-adjusted, bias-free performance evaluation, an analyst should most likely conclude that the manager's TRUE, properly evaluated skill is:
How sure are you?
Correct: B. Survivorship bias means the visible sample of long-surviving funds/managers overstates average performance, since the worse performers were removed from the sample over time. Separately, failing to risk-adjust for a manager who took on more systematic risk than the benchmark means some of the raw outperformance simply compensates for that extra risk, not genuine skill. Combining both corrections (removing the survivorship inflation AND properly risk-adjusting), the manager's true outperformance is very likely much smaller than the raw, unadjusted track record suggests.
A. Raw, statistically significant outperformance in a track record that suffers from BOTH survivorship bias and unadjusted risk-taking cannot be taken at face value; both issues specifically work to inflate the APPARENT skill shown in the raw numbers.
C. The existence of survivorship bias and unadjusted risk does not make performance evaluation meaningless; it means analysts must correct for these specific, well-understood biases (using survivorship-bias-free databases and risk-adjusted measures), not abandon evaluation altogether.