ADVANCED THEORY FINAL EXAM
QUESTIONS WITH 100% CORRECT
ANSWERS [GRADED A+]
What is the measurement approach? - ✔✔To decision usefulness--an
approach to financial reporting under which accountants undertake a
responsibility to incorporate current values into the financial statements
proper, providing that this can be done with reasonable reliability, thereby
recognizing an increased obligation to assist investors to predict firm
performance and value
Why are accountants moving toward the measurement approach? -
✔✔Securities market may not be as efficient as previously believed. If
investors don't behave as rational decision theory, measurement approach
would help. Better measurements increase accountant's role in explaining
share price changes. Ohlson's clean surplus theory. Better measurement
decreases auditor's liability when firms financially suffer.
©morren2026/2027.Year published 2026.
,What does behavioral finance find that casts doubt on market efficiency? -
✔✔1. Limited attention: Individuals may not have the time, inclination, or
ability to process all available information. Will concentrate on information
that is readily available such as the "bottom line" and ignore information in
notes and elsewhere in the annual report
2. Overconfidence: They overestimate the precision of information they
collect themselves. Ex: An investor who privately researches a firm may
overreact to the evidence he/she obtains
3. Representativeness: Individual assigns too much weight to evidence that
is consistent with the individual's impressions of the population from which
the evidence is drawn.
4. Self-attribution bias: Individuals feel that good decision outcomes are
due to their abilities; whereas bad outcomes are due to unfortunate
realizations of states of nature (not their fault)
5. Motivated Reasoning: Individuals accept at face value information that is
consistent with their preferences (GN). If info is inconsistent with their
preferences, received with skepticism, and individual attempts to discredit it
©morren2026/2027.Year published 2026.
,What is prospect theory? - ✔✔Behavioral based alternative to rational
decision theory. An investor considering a risky investment (prospect) will
separately evaluate prospective gains and losses. SEE PAGE 194
Prospect theory assumes loss aversion- individuals dislike even very small
losses. Beginning at the point where the investment starts to lose value, the
investor's rate of utility loss is greater than the rate of utility increase for a
gain in value. Investor holds on to losing stocks and sells winners. Investor
behaves based on payoff probabilities.
Is Beta Dead? - ✔✔Beta isn't dead, it's just unstable.
Yes: Beta predicts better using 50 years of data than 28 years (study)
No: Not beta, investor confidence affects share returns
c. Other risk variables explain stock returns (book-to-market, firm size,
momentum)—suggests increased role of reporting on risk
Is there excess market volatility? - ✔✔Study: Assume market inefficiency-
stock prices depend on dividends, but aggregate stock price volatility is
greater than aggregrate dividend volatility
©morren2026/2027.Year published 2026.
, a. Shiller found that the variability of the stock market index was several
times greater than the variability of aggregate dividends. Evidence of
market inefficiency. Behavioural factors increase stock market volatility.
Model of Daniel, Hirshleifer, and Subrahmanyam implies excess market
volatility as share prices overshoot and then fall back. Share price begins to
rise. Rational investors anticipate the actions of less sophisticated investors
and instead "jump on the bandwagon" to take advantage of price run up
while it lasts. Result: excess volatility in market since share price exceeds
its efficient market value.
What anomalies exist? - ✔✔Post Announcement Drift (PAD): Efficient
securities market theory predicts immediate response to GN or BN. Thus,
investors underestimate the effect of current earnings on future earnings
Accruals anomaly: Markets respond when operating cash flow is high, not
when accruals are high. Thus, investors are slow in understanding the
different properties of accruals and operating cash flows
Reason for accruals anomaly:
©morren2026/2027.Year published 2026.
QUESTIONS WITH 100% CORRECT
ANSWERS [GRADED A+]
What is the measurement approach? - ✔✔To decision usefulness--an
approach to financial reporting under which accountants undertake a
responsibility to incorporate current values into the financial statements
proper, providing that this can be done with reasonable reliability, thereby
recognizing an increased obligation to assist investors to predict firm
performance and value
Why are accountants moving toward the measurement approach? -
✔✔Securities market may not be as efficient as previously believed. If
investors don't behave as rational decision theory, measurement approach
would help. Better measurements increase accountant's role in explaining
share price changes. Ohlson's clean surplus theory. Better measurement
decreases auditor's liability when firms financially suffer.
©morren2026/2027.Year published 2026.
,What does behavioral finance find that casts doubt on market efficiency? -
✔✔1. Limited attention: Individuals may not have the time, inclination, or
ability to process all available information. Will concentrate on information
that is readily available such as the "bottom line" and ignore information in
notes and elsewhere in the annual report
2. Overconfidence: They overestimate the precision of information they
collect themselves. Ex: An investor who privately researches a firm may
overreact to the evidence he/she obtains
3. Representativeness: Individual assigns too much weight to evidence that
is consistent with the individual's impressions of the population from which
the evidence is drawn.
4. Self-attribution bias: Individuals feel that good decision outcomes are
due to their abilities; whereas bad outcomes are due to unfortunate
realizations of states of nature (not their fault)
5. Motivated Reasoning: Individuals accept at face value information that is
consistent with their preferences (GN). If info is inconsistent with their
preferences, received with skepticism, and individual attempts to discredit it
©morren2026/2027.Year published 2026.
,What is prospect theory? - ✔✔Behavioral based alternative to rational
decision theory. An investor considering a risky investment (prospect) will
separately evaluate prospective gains and losses. SEE PAGE 194
Prospect theory assumes loss aversion- individuals dislike even very small
losses. Beginning at the point where the investment starts to lose value, the
investor's rate of utility loss is greater than the rate of utility increase for a
gain in value. Investor holds on to losing stocks and sells winners. Investor
behaves based on payoff probabilities.
Is Beta Dead? - ✔✔Beta isn't dead, it's just unstable.
Yes: Beta predicts better using 50 years of data than 28 years (study)
No: Not beta, investor confidence affects share returns
c. Other risk variables explain stock returns (book-to-market, firm size,
momentum)—suggests increased role of reporting on risk
Is there excess market volatility? - ✔✔Study: Assume market inefficiency-
stock prices depend on dividends, but aggregate stock price volatility is
greater than aggregrate dividend volatility
©morren2026/2027.Year published 2026.
, a. Shiller found that the variability of the stock market index was several
times greater than the variability of aggregate dividends. Evidence of
market inefficiency. Behavioural factors increase stock market volatility.
Model of Daniel, Hirshleifer, and Subrahmanyam implies excess market
volatility as share prices overshoot and then fall back. Share price begins to
rise. Rational investors anticipate the actions of less sophisticated investors
and instead "jump on the bandwagon" to take advantage of price run up
while it lasts. Result: excess volatility in market since share price exceeds
its efficient market value.
What anomalies exist? - ✔✔Post Announcement Drift (PAD): Efficient
securities market theory predicts immediate response to GN or BN. Thus,
investors underestimate the effect of current earnings on future earnings
Accruals anomaly: Markets respond when operating cash flow is high, not
when accruals are high. Thus, investors are slow in understanding the
different properties of accruals and operating cash flows
Reason for accruals anomaly:
©morren2026/2027.Year published 2026.
