Topic7- Efficent market theory Flashcards
What is an efficient market?
An efficient market is where only returns can be obtained (no abnormal profits) due to there not being structured undervaluation or overvaluation of securities.
What does the present price of a typical share reveal?
The present price of a typical share reveals important past & present information about the firm.
E.g. company’s profits, financial position & future potential
A shares price should reflect its true economical value
Why do we need efficient markets?
To support the purchase of assets/shares
- Pay the honest price
- Strengthens investors trust & confidence
Presents company’s managers with appropriate message
- Efficient markets essential for shareholders wealth maximization
Helps the issuing of resources
- to where it is most requires & to present managers with the discount rate
What happens to new information in the financial world?
In the financial world new information revealed gathers a fast reaction from investors who take advantage of any profitable opportunities before they vanish rapidly
What happens if markets aren’t efficient?
- Investors conducts their own investigation to verify the price as they might not trust that the current prices are true
- Entitled investors might be able to exploit the general public continuously
What are the 3 forms of efficiency?
Weak Form- present share price represents all past information
Semi-strong Form- present share price represents all information public ally available
Strong- Form- present share price represents all public or private information that is relevant
What is the weak form efficiency theory?
Weak form efficiency is the theory that claims that a shares current price is not affected by past price movements
This means that investors are unable to find any patterns in order to exploit price movements
What are the tests for weak form efficiency?
Random walk hypothesis
- prices pursue a random walk
- price changes over time are unrelated to each other
Toss a coin
- 50/50 split head or tail
- likewise, share prices are not predictable
What happens in a semi-strong form efficiency market?
In a semi-strong form efficiency market, security prices represent all public ally known & available information
It would be essential to investigate public information like the financial statements in order to recognize underpriced or overpriced shares
What is the “value” vs. “growth” investment idea?
The “value” investment method has continuously outperformed the “growth” style
Value stock- market value is similar to book value of shares
Growth stock- opposite, market prices much higher than book value of stocks
What does the “size effect” highlight?
The “size effect” highlights that if you invest in small stock instead of large stock you will receive a higher return
What is sin stock?
If you choose to invest in stock from establishments such as casinos (that produce alcohol or cigarettes), you will receive a higher return
What is strong form efficiency markets?
In a market that is strong form efficiency, it claims that stock prices fully relevant all public & private information
This would mean that stock prices are never overvalued or undervalued (fairly priced)
No one can make higher returns as the same information is available to everyone, which is why it’s not common as it is unusual to be able to know ALL information
