6.2. Market Efficiency and Investment Strategies

Question 1

Under what circumstances can active management provide value?

Answer 1

• managers need to have an information advantage
• market efficiency tells what types of information is incorporated into prices
• three forms of market efficiency:
- strong: all available information
- semi-strong: public information
- weak form: historical trading informaiton

Question 2

Active management and weak form of market efficiency

Answer 2

• prices completely reflect historical trading information
• prices follow a random walk
•investors cannot realize abnormal return if their strategy is only based on historical trading information
•managers need to have additional information:
- accounting information
- other information of the firm
- third-party information

Question 3

Active management and weak semi-strong form of market efficiency

Answer 3

• prices reflect historical information and other publicly available information
• managers need further information:
- insider information
- legal alternative: generating genuinely new information that can hardly be obtained by other market participants

Question 4

Active management and strong form of market efficiency

Answer 4

• prices reflect all relevant information

* investors cannot realize abnormal returns even if they would use insider information

Question 5

Rule 10b5-1

Answer 5

• allows insiders to set up predetermine plan to trade company securities
• designed to cover situations in which nonpublic information was not a factor for the trade
• does not allow the executive to influence purchases or sales

Question 6

Who counts as “insider”?

Answer 6

• Management: 
  - CEO and other officers
  - Chairman and other board members
• Large shareholders: 
  - Shareholders who own more than 10 % 
• Other people:
  - E. g. lawyers and consultants 
•Transactions by insiders relatives are reported as trades from the insider himself

Question 7

Evidence for inefficient market.

Answer 7

• Regulations of insider trades are in place
• Insider trades are profitable
• The observation of abnormal returns indicates but does not prove market inefficiency