6 Secondary Market Activity, Behavioural Finance and Related Strategies

Question 1

What are the two main methods of analysing a company?

Answer 1

Fundamental analysis
Technical analysis

Question 2

What is fundamental analysis?

Answer 2

Looking at the fundamental characteristics of a company

Question 3

What is technical analysis?

Answer 3

Measuring historical patterns

Question 4

What is the rational behind technical analysis?

Answer 4

• Share price behaviour repeats itself over time.
• Share prices are determined by the demand/supply relationship and the “intrinsic value” is just one factor of this complex function.
• Other influences, many of which are psychologically based, are present and these are reflected in share prices

Question 5

Are fundamental and technical analysis mutually exclusive?

Answer 5

No, some people choose which shares to invest in by using fundamental analysis but decide on the timing of their purchases using technical analysis

Question 6

What is the random walk hypothesis?

Answer 6

• Suggests that past prices do not affect current
• Stocks randomly walk around fair price
• There is no way to systematically gain returns
  o Some people will the, being the existing share holders but there is no way of predicting this
• Therefore the best portfolio following this is one diversified against systematic risk

Question 7

Who published “A Random Walk Down Wall Street”?

Answer 7

Burton G. Malkiel

Question 8

Have empirical studies backed up the random walk hypothesis?

Answer 8

Correlation tests
o Are successive price changes independent random variables? If so, then no correlation
Runs tests
o Expected length of sequence (run) of price movements

Question 9

What is the adjustment process?

Answer 9

The securities market is defined as efficient if
1. The prices of the securities traded act as though they fully reflect all available information
2. These prices react instantaneously, or nearly so, in an unbiased fashion, to new information

Question 10

What is the market efficiency paradox?

Answer 10

We need keeping the market near efficiency the analysts to keep trading and make the markets efficient but when they have reached the efficiency there is no need for the analysists. There is an equilibrium of analysts

Question 11

What are the three requirements for random prices?

Answer 11

1. If all available info provided free to all market participants
2. Participants have same investment horizons
3. Participants have same expectations about prices
   This is all about pricing efficiency but need other operational/dynamic efficiencies in the market to underpin overall allocation efficiency