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Many managers of mutual funds proclaim that they have been able to gen

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Many managers of mutual funds proclaim that they have been able to gen  [#permalink]

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New post Updated on: 04 Oct 2018, 23:02
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Many managers of mutual funds proclaim that they have been able to generate consistently higher rates of return on their investments than the general stock market by buying shares of undervalued companies. Classical economic theory, however, proposes the "efficient capital markets hypothesis", which proposes that stock prices accurately reflect the value of the underlying investments, incorporating all information available to the public. if the efficient capital markets hypothesis is correct, then it should be expected that_____________.


(A) mutual fund managers, in order to compete with each other, will bid up the prices of certain stocks beyond their true values

(B) mutual fund managers use insider information, an illegal practice, to generate higher rates of return than the general stock market

(C) stock price will rise over time

(D) given public information alone, companies cannot reliably be labeled undervalued or overvalued relative to the general stock market

(E) some mutual fund managers are better than others at generating a higher rate of return on investments

Originally posted by gurpreet07 on 03 Oct 2009, 10:21.
Last edited by Skywalker18 on 04 Oct 2018, 23:02, edited 2 times in total.
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Re: Many managers of mutual funds proclaim that they have been able to gen  [#permalink]

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New post 15 Sep 2010, 08:56
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gurpreet07 wrote:
Many managers of mutual funds proclaim that they have been able to generate consistently higher rates of return on their investments than the general stock market bu buying shares of undervalued companies. Classical economic theory, however, proposes the "efficient capital markets hypothesis", which proposes that stock prices accurately reflect the value of the underlying investments, incorporating all information available to the public. if the efficient capital markets hypothesis is correct, then it should be expected that_____________.

A) mutual fund managers, in order to compete with each other, will bid up the prices of certain stocks beyond their true values

B) mutual fund managers use insider information, an illegal practice, to generate higher rates of return than the general stock market

C) stock price will rise over time

D) given public information alone, companies cannot reliably be labeled undervalued or overvalued relative to to the general stock market

E) some mutual fund managers are better than others at generating a higher rate of return on investments


In questions like this one, we need to understand how the different parts of the passage are related. Here, the linking word is 'however'. That is, the second half of the passage is going to contradict the first part. I think in some of the posts above, people were looking for ways that the second half might support the first, and that is not how the passage is structured.

So the second half of the passage describes an alternative theory that contradicts the fund managers' claim. Noticing that alone might lead you to D, but more specifically, the passage states that by the efficient capital markets hypothesis, 'stock prices accurately reflect the value of underlying investments, incorporating all information available to the public', so according to this hypothesis, stock prices are correctly valued based on public information, and it is thus impossible for a stock to be overvalued or undervalued. That's what D says.
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Re: Many managers of mutual funds proclaim that they have been able to gen  [#permalink]

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New post 19 Apr 2011, 08:12
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By the same logic "B" should be a strong contender too..
As it weakens the fund manager's claim..
ur views??
IanStewart wrote:
gurpreet07 wrote:
Many managers of mutual funds proclaim that they have been able to generate consistently higher rates of return on their investments than the general stock market bu buying shares of undervalued companies. Classical economic theory, however, proposes the "efficient capital markets hypothesis", which proposes that stock prices accurately reflect the value of the underlying investments, incorporating all information available to the public. if the efficient capital markets hypothesis is correct, then it should be expected that_____________.

A) mutual fund managers, in order to compete with each other, will bid up the prices of certain stocks beyond their true values

B) mutual fund managers use insider information, an illegal practice, to generate higher rates of return than the general stock market

C) stock price will rise over time

D) given public information alone, companies cannot reliably be labeled undervalued or overvalued relative to to the general stock market

E) some mutual fund managers are better than others at generating a higher rate of return on investments


In questions like this one, we need to understand how the different parts of the passage are related. Here, the linking word is 'however'. That is, the second half of the passage is going to contradict the first part. I think in some of the posts above, people were looking for ways that the second half might support the first, and that is not how the passage is structured.

So the second half of the passage describes an alternative theory that contradicts the fund managers' claim. Noticing that alone might lead you to D, but more specifically, the passage states that by the efficient capital markets hypothesis, 'stock prices accurately reflect the value of underlying investments, incorporating all information available to the public', so according to this hypothesis, stock prices are correctly valued based on public information, and it is thus impossible for a stock to be overvalued or undervalued. That's what D says.

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Re: Many managers of mutual funds proclaim that they have been able to gen  [#permalink]

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New post 19 Apr 2011, 09:41
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vijayahir wrote:
By the same logic "B" should be a strong contender too..
As it weakens the fund manager's claim..
ur views??


Unfortunately in the original post, the actual *question* wasn't even included, which makes it a bit difficult to evaluate. I've assumed it's asking for the answer which most logically completes the passage. B is too strong. From the passage, we know that Classical Economic Theory says that stock cannot be undervalued. We also know mutual fund managers *claim* to profit by buying stock which is undervalued. But if Classical Economic Theory is true, that only means that the managers are wrong - they might be lying, or they might think they are buying undervalued stock but are actually buying appropriately valued stock and they may have been 'lucky' to make a profit, or they might be involved in insider trading, among many, many possibilities. It is not logical to conclude that they must have been engaged in something as specific as insider trading when there are so many other possible explanations, which makes B the wrong answer here.
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Re: Many managers of mutual funds proclaim that they have been able to gen  [#permalink]

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New post 19 Apr 2011, 16:57
Only D makes sense, let me explain how.

"Efficient capital markets hypothesis" states that the current price of the stock represents sum total of all public information. For example if a company is expected to make money by introducing an innovative product, its current price already reflects the effect of the news. But, what the hypothesis does not say is whether the company is undervalued or overvalued, i.e. whether the current stock price exceeds sum of future cashflows. This where D comes in, and provides explanation for the gap between hypothesis and the fund managers' claim. No other option comes close.

gurpreet07 wrote:

A) mutual fund managers, in order to compete with each other, will bid up the prices of certain stocks beyond their true values
Unsubstantiated claim.

B) mutual fund managers use insider information, an illegal practice, to generate higher rates of return than the general stock market
Absurd, and does not follow from the premises.

C) stock price will rise over time
Absurd, and does not follow from the premises.

D) given public information alone, companies cannot reliably be labeled undervalued or overvalued relative to to the general stock market
Correct as explained earlier.

E) some mutual fund managers are better than others at generating a higher rate of return on investments
Perhaps true, but the statement does not explain anything.
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Re: Many managers of mutual funds proclaim that they have been able to gen  [#permalink]

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New post 23 Aug 2018, 22:35
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Hi There , Requesting you POV on this question with explanation.
thanks
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Re: Many managers of mutual funds proclaim that they have been able to gen  [#permalink]

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New post 23 Aug 2018, 22:50
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Re: Many managers of mutual funds proclaim that they have been able to gen &nbs [#permalink] 23 Aug 2018, 22:50
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