NISM Series XXI-B · Unit 8 of 12 · about 6% of the paper
Market efficiency and behavioural finance: NISM Series XXI-B notes and practice questions
How efficient markets are, anomalies, and the biases that affect investors.
What to know in Unit 8
- Forms of efficiency.
- Anomalies.
- Biases.
Key terms, examples and exam traps
Efficient market hypothesis
Under the efficient market hypothesis, prices reflect available information, making it hard to earn excess returns consistently.
Example. A manager finds it hard to beat the index after costs.
Exam trap. This statement is false: Prices never reflect any information.
Weak form
Weak form efficiency says current prices reflect all past price data, so technical analysis cannot earn excess returns.
Example. Chart patterns give no edge in a weak form market.
Exam trap. This statement is false: Weak form efficiency says insider information is already in the price.
Semi-strong form
Semi-strong efficiency says prices reflect all public information, so fundamental analysis of public data cannot earn excess returns.
Example. Published results are priced in quickly.
Exam trap. This statement is false: Semi-strong efficiency includes private information.
Strong form
Strong form efficiency says prices reflect all information, public and private, so even insiders cannot earn excess returns.
Example. Even insider information gives no advantage.
Exam trap. This statement is false: Strong form efficiency covers only past prices.
Random walk
A random walk means price changes are unpredictable because new information arrives randomly.
Example. Tomorrow's price change cannot be forecast from today's.
Exam trap. This statement is false: A random walk means prices follow a fixed pattern.
Market anomalies
Anomalies, such as size and value effects, are patterns that appear to contradict market efficiency.
Example. Small stocks have earned more than large over long periods.
Exam trap. This statement is false: Anomalies prove that markets are perfectly efficient.
Overconfidence
Overconfidence is overestimating one's own skill and information, which can lead to excess trading.
Example. An investor trades often, sure of her views.
Exam trap. This statement is false: Overconfidence leads to under-trading.
Loss aversion
Loss aversion is the tendency to feel losses more strongly than equal gains, which can lead to holding losers.
Example. An investor refuses to sell a falling stock.
Exam trap. This statement is false: Loss aversion makes investors sell losers quickly.
Herding
Herding is following the crowd rather than one's own analysis, which can feed bubbles.
Example. Investors rush into a hot sector.
Exam trap. This statement is false: Herding is independent analysis.
Anchoring
Anchoring is holding on to an initial reference, such as a purchase price, when making later decisions.
Example. An investor waits for the price to return to her cost.
Exam trap. This statement is false: Anchoring updates views fully on new data.
6 practice questions
Read each question and choose your answer before opening the free mock, which shows the correct answer and the reason.
Q1. Which term is described here? Overconfidence is overestimating one's own skill and information, which can lead to excess trading.
- Counterparty risk
- Alpha
- Expense ratio
- Overconfidence
Q2. Which statement best describes “Loss aversion”?
- Herding is following the crowd rather than one's own analysis, which can feed bubbles.
- The SML plots expected return against beta, and securities above the line are undervalued.
- Trading on unpublished price-sensitive information is prohibited, and managers must have policies to prevent misuse.
- Loss aversion is the tendency to feel losses more strongly than equal gains, which can lead to holding losers.
Q3. Which term is described here? Anchoring is holding on to an initial reference, such as a purchase price, when making later decisions.
- Anchoring
- Yield curve
- Non-discretionary service
- Efficient market hypothesis
Q4. Which statement best describes “Semi-strong form”?
- The expected return of a portfolio is the weighted average of the expected returns of its assets.
- Concentration risk arises when a large part of the portfolio is in a few securities or sectors.
- Semi-strong efficiency says prices reflect all public information, so fundamental analysis of public data cannot earn excess returns.
- Systematic risk affects the whole market and cannot be diversified, while unsystematic risk is specific to a company or sector and can be.
Q5. Which statement best describes “Weak form”?
- Weak form efficiency says current prices reflect all past price data, so technical analysis cannot earn excess returns.
- The market portfolio contains all risky assets in proportion to their market value and is the tangency portfolio in the theory.
- Growth investing seeks firms with high earnings growth, while value investing seeks stocks trading below their estimated worth.
- A portfolio manager may charge a fee that is fixed, return-based or a mix of both, but cannot charge an upfront fee directly or indirectly from clients.
Q6. Which term is described here? Under the efficient market hypothesis, prices reflect available information, making it hard to earn excess returns consistently.
- Risk-averse investor
- Efficient market hypothesis
- Growth and value styles
- CPPI
Frequently asked questions
How much of NISM Series XXI-B comes from Unit 8?
Unit 8 (Market efficiency and behavioural finance) usually carries about 6% of the questions. The whole exam has 120 questions and the pass mark is 60%.
What should I study in NISM Series XXI-B Unit 8?
Forms of efficiency. Anomalies. Biases.
Are these NISM Series XXI-B practice questions free?
Yes. Take the full free mocks to see the correct answer and the reason for every question.
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