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Pragyani S Maharjan

Accounting 507 Text Chapter 4 Research Methodology
1. What are the steps in the Scientific Method of Inquiry?
Ans: The steps in the Scientific Method of Inquiry are as follows:

Identify and state the problem to be studied.

2. State the hypotheses to be tested.
3. Collect the data that seem necessary for testing the hypotheses.
4. Analyze and evaluate the data in relation to the hypotheses.
5. Draw a tentative conclusion.
2. Must they be followed in order?
Ans: We can follow them in order but there is considerable back-and-forth movement
between the steps.
3. Do you agree/disagree?
Ans: Scientific method of inquiry is helpful in some ways but there are sometimes when
scientific method can fail. For instance, if the hypothesis-testing process fails to eliminate
most of the personal and cultural biases of the community of investigators, false
hypotheses can survive the testing process and then be accepted as correct descriptions of
the way the world works.
4. How do we know that accounting information is important to resource providers?
Ans: Resource providers are those people who have a claim on the assets of any company. They
can be owners or creditors. Owners use accounting information for analyzing the viability and
profitability of their investment and determining any future course of action. Creditors need
accounting information for determining the credit worthiness of any organization.
5. What are the specific needs of those who may buy, hold, or sell?
Ans: Those people who have to take buy, hold, or sell decisions have to rely on financial reports,
quarterly earnings reports to analyze the financial condition of their company.
6. What is fundamental analysis?
Ans: A fundamental analysis is an attempt to identify individual securities that are mispriced by
reviewing all available financial information.

7. What financial information may be used by security analyst?

Ans: Security analyst use published financial statements and quarterly earnings reports to
comment on the companys performance and make buy-hold-sell recommendations.
8. What other information may they use?
Ans: They may use the information contained in the Management Discussion and Analysis
section of the annual report, particularly those sections containing forward-looking information
and the companys plans.

9. What is the efficient market hypothesis (EMH)?

Ans: The efficient-market hypothesis (EMH) states that asset prices fully reflect all
available information. A direct implication is that it is impossible to "beat the market"
consistently on a risk-adjusted basis since markets prices should only react to news, and
news by definition is random.

10. How does it fit with fundamental analysis?

Ans: There are three common forms in which the efficient-market hypothesis is commonly
statedweak-form efficiency, semi-strong-form efficiency and strong-form efficiency. In
weak-form efficiency, future prices cannot be predicted by analyzing prices from the past.
Excess returns cannot be earned in the long run by using investment strategies based on
historical share prices or other historical data nor from the Technical analysis though some
forms of fundamental analysis may still help to provide excess returns.

11. What is a random walk?

Ans: Random walk is a term used to characterize a price series where all subsequent price
changes represent random departures from previous prices. The logic of the random walk idea is
that if the flow of information is unimpeded and information is immediately reflected in stock
prices, then tomorrows price change will react only to tomorrows news and will be independent
of the price changes today

12. What information is incorporated into stock price under the weak form of the EMH?
Ans: Under the weak form of the EMH, the historical price of a stock provides an unbiased
estimate of its future price. This hypothesis assumes that the rates of return on the market should
be independent; past rates of return have no effect on future rates. Given this assumption, rules
such as the ones traders use to buy or sell a stock, are invalid.
13. What information is incorporated into stock price under the semi-strong form of the
Ans: Under the semi-strong form of the EMH, all publicly available information, including past
stock prices, is assumed to be important in determining securities prices. In other words, if this
form of the EMH is correct, no investor can make an excess return by use of publicly available
information because this information has already been considered by the marketplace in
establishing securities prices.
This hypothesis assumes that stocks adjust quickly to absorb new information. The semi-strong
form EMH also incorporates the weak-form hypothesis. Given the assumption that stock prices
reflect all new available information and investors purchase stocks after this information is
released, an investor cannot benefit over and above the market by trading on new information.

14. What information is incorporated into stock price under the strong form of the EMH?
Ans: The strong-form EMH implies that the market is efficient: it reflects all information
both public and private, building and incorporating the weak-form EMH and the semistrong form EMH. Given the assumption that stock prices reflect all information (public
as well as private) no investor would be able to profit above the average investor even if
he was given new information.
15. What is a Ponzi scheme? Chain letter?
Ans: A Ponzi scheme is a fraudulent investment operation where the operator, an
individual or organization, pays returns to its investors from new capital paid to the
operators by new investors, rather than from profit earned by the operator.
A typical chain letter consists of a message that attempts to convince the recipient to
make a number of copies of the letter and then pass them on to as many recipients as

16. What caused the housing bubble?

Ans: The collapse of the housing market a few years ago was caused by predatory lending
practices on people who couldnt really afford to buy a house, coupled with shady investment
instruments from the world of high finance. In addition to that, the real problem may be an
optimism from virtually everyone in the housing industry that home prices would continue to go
up forever. Some market strategist also believes that EMH is responsible for the housing crisis.
17. Does the EMH mean that no one can make money in the market?
Ans: No. EMH does not mean having no uncertainty about the future or one cannot make money
but this hypothesis i.e. market efficiency is a simplification of the world which may not always
hold true, and that the market is practically efficient for investment purposes for most
More questions?
18. What roles do regulators play in efficient markets?
Ans: They regulate and oversee the financial markets and companies.
19. What is prospect theory?
Ans: Prospect theory is a theory about how people make choices between different options or
20. What role should behavioral issues play in setting accounting standards?

21. Do people (investors) behave rationally?

Ans: No. Investors are not always rational. They are often driven by emotion and
cognitive psychology.
22. How should we treat dividends v. capital gains?

23. Should a purchase today be driven by past purchase price?

No a purchase today should not be driven by past purchase price because the market is
always fluctuating and fixed price is never guaranteed.
24. Should a person buy Apple? IBM? Exxon/Mobile?
Ans: Apple because their market capitalization is comparatively high in compared to
25. What is bounded rationality?
Ans: Bounded rationality is the idea that in decision-making, rationality of individuals is
limited by the information they have, the cognitive limitations of their minds, and the
finite amount of time they have to make a decision.
26. Who sets stock prices?
Ans: In the broad sense, stock prices are based on investors' expectations of the future
value of a company; its future earning power. But the actual selling price, at any given
moment, is that at which investors are willing to buy and sell the stock. The price is not
set by anyone.
27. What is the effect of risk averse?
Ans: If an investor becomes risk averse, he or she will stay away from adding high-risk
stocks or investments to their portfolio and in turn will often lose out on higher rates of
28. What is unsystematic risk?
Ans: Unsystematic risk is the portion of a companys particular risk that can be diversified away.
29. What is systematic risk?
Ans: Systematic risk is the non-diversifiable portion that is related to overall movements in the
stock market and is consequently unavoidable.
30. What is the advantage of a portfolio?

Ans: Portfolio helps to reduce unsystematic risk. Investors can eliminate the risk associated with
acquiring a particular companys common stock by purchasing diversified portfolios.