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Portfolios 502: The Efficient Market Theory

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1.
In an efficient market, only new information about a security can change its price.
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True. According to the theory, prices react to new information.
2.
According to the efficient market theory, mutual funds will underperform the market by the amount of their transaction and management costs.
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True. Since index funds match the market, the only thing reducing their performance is their costs.
3.
What findings threw the efficient market theory into question?
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That stocks that are unpopular tend to outperform. Fama and French found that buying stocks that have performed poorly during the past few years led to superior returns over the next few years. In other words, a contrarian investment strategy can lead to better results than a strategy of buying popular stocks.
4.
In an efficient market, _______.
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All of the above. These are all essential if a market is to be efficient.
5.
Small-cap and large-cap stocks are examples of sub-asset categories.
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True. They are sub-categories of stocks, and they are described by their capitalizations.