# Review Sheet

1. Explain the Apples and Arbitrage Story from Lecture 8 that explained in class.
2. Why is Arbitrage the key to having efficient markets?
3. What does efficient markets mean?
4. Why can you not consistently beat the market if markets are efficient?
5. “By looking for arbitrage opportunities you eliminate the arbitrage opportunities”. What does this statement mean?
6. Why will the price be right if you have efficient markets?
7. Why will there be no free lunch if you have efficient markets?
8. What is the empirical evidence for no free lunch?
9. What is the empirical evidence for the price is right?
10. Explain the Royal Dutch Shell example.
11. Explain the Palm 3 Com example.
12. Explain the “Limits to Arbitrage” explanation for why the price may not right.
13. Explain the Herding argument for why the price may not be right.
14. Explain how penalty kicks in soccer are an example of herding.
15. We know that prices are sometimes wrong in the market. This would suggest that we can beat the market buying while prices are too low and selling when prices are too high. If this is the case, why then do so many money managers still not beat the market?
16. What happened to Jeff Vinik?
17. Why did the efficient markets hypothesis collapse?
18. What are the consequences of teaching students that markets are efficient when they are likely not?
19. Explain the Keynesian beauty contest and how it applies to stock valuation.
20. Let’s play the following game: Guess a number from 0 to 100 with the goal of making your guess as close as possible to two-thirds of the average guess of those participating in the contest. Now let’s assume, everyone in the game is completely rational. What number will everyone choose? Why? Explain.
21. What is the difference between precipitating and amplifying mechanisms in terms of the causes of a bubble? Explain
22. Explain what happened at the experiment done on students at Cal-Tech?
23. Analysts on Wall-Street became increasing optimistic by 1999. How is this an example of herding?
24. Explain how overconfidence causes a feedback loop that causes bubbles.
25. Explain what is meant by “drives out people who predicted the market would go down but were wrong”
26. Explain the graph in Lecture 9 that shows “Public Sentiment about Stocks and 10-year annual returns”.
27. The standard measure of whether homes are overvalued is the ratio of median home prices to median household incomes. Figures from the Harvard Joint Center for Housing Studies show that between 1980 and the late 1990’s this ratio stayed pretty steady at 3.0. What happened to this ratio nationwide by 2006? What happened to this ratio in L.A. and San Francisco by 2006?
28. How would you explain a financial bubble to someone who does not understand finance?

Last Updated on February 11, 2019

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