Efficient Markets Flashcards
Describe Capital Markets
Capital markets are long term markets which consist of securities having maturities greater than one year. They are a means of allocating the available capital to the most efficient users.
Competitors for capital in capital markets
companies (domestic and international) and government (provincial, municipal, and federal)
Efficient securities market
one where prices of securities traded on that market at all times fully reflect all information that is publicly known about those securities
True or False: Different investors will react identical to the same information since they all proceed rationally
False
What 4 things will investors adjust their state probabilities for? (examples too)
1) Economy wide factors (state of global economy, inflation rates)
2) Accounting information (income - annual and quarterly reports)
3) Industry specific information (ex - pharmaceutical companies during covid)
4) Firm specific information
Markets are efficient when:
1) Prices adjust rapidly to new information
2) There is a continuous market in prices
3) the market can absorb large dollar amounts of securities without price destabilization
Is market efficiency a relative or absolute term?
Relative term
3 forms of market efficiency
1) Weak form (all past information is included in the price)
2) Semi-strong form (all public and past information is included in the price)
3) Strong form (all private, public, and past information is included in the price)
Efficiency implications for financial accounting (4)
1) Content not form disclosure is valued by the market
2) More information is more valuable
3) Accounting information is only one source of information used by investors and will survive if relevant
4) No concern about naive investors
Finish this sentence: “Accounting is a mechanism to enable communication and reduce ______”
“information asymmetry”
Describe information asymmetry
one type of participant in the market will know something about the asset being traded that another type of participant does not know
types if information asymmetry (2)
1) Adverse selection (insider trading)
2) Moral hazard (shirking)
Finish this sentence: “_______ of a share is the value it would have in an efficient market if there was no inside information”
” Fundamental value”
Social implications associated with information asymmetry (3)
1) Security prices do not reflect fundamental value (allocation of scarce capital)
2) Cost of capital (countries with more firm-specific info incorporated into share price enjoy greater capital allocation efficiency)
3) Regulated & Market Incentives (regulation and promote disclosures. Creates an incentive to release information)
What value will the market price of a security always move back to, regardless of whether it deviates from it
intrinsic value
Capital asset pricing model
in an efficient market the risk premium on each stock would be proportional to the risk premium on the entire market where the constant of proportionality (beta) is related to the covariance of the individual stock’s return with that of the market
what is the Capital Asset Pricing Model (CAPM) use
1) Price depends on investor expectations
2) Allows for separation of returns
3) Provides convenient way to estimate beta
Fill in the blank: “A ____abnormal share return constitutes evidence that investors are reacting favourably to unexpected good news in earning”
Positive
