Week 9 Flashcards
What is the overall efficient market hypothesis? What does it mean for stock prices?
The efficient market hypothesis states that all the security prices reflect all available information, if this is the case stock prices should be a random walk with a positive trend because in a very competitive market the price should follow available information, and new information is unpredictable.
What are the three forms of the efficient market hypothesis? What will we gain if we utilise information the market already knows?
Weak: The relevant information for stock prices is only the historical prices and other trading data.
Semi-Strong: All publicly available data, e.g best prices, volume data, growth forecasts etc.
Strong: All relevant information, including insider information.
If we use any information already known to the market to predict stock prices then our prediction will be useless, as the prices should already reflect this information.
What are the main implications of the efficient market hypothesis for technical analysis and fundamental analysis?
Technical analysis tries to use historical prices and volume information to predict future price changes. This should be useless under efficient market hypothesis, even if the market is only weak form efficient.
Fundamental analysis uses economic and accounting information to predict stock price changes or assess a firm’s value. This can predict the market if the market is only weak form efficient.
What are some of the tests for weak form analysis?
For short horizons there is a positive serial correlation, though typically small, for intermediate horizon (3-12 months) there is a momentum effect. Over the long horizons there is a negative serial correlation (reversal effect), meaning overperforming stocks tend to underperform in the next period.
What are some of the tests of the semi-strong form?
These involve examining anomalies, like that small firms experience high returns in January, that neglected firms tend to have return anomalies, and that prices respond to earnings announcements.
Why can the strong efficient market hypothesis not be true?
Insiders have been shown to be able to trade profiatably in their own stocks.
What is a bond?
A bond is a security wherein the issuer agrees to make specific payments over time on specific dates, they have a par value (face value) detailing the final payment to the holder on the maturity date. THe coupon rate is the percentage of the face value that is paid annually.
What is a bond indenture? What is a zero coupon bond? What are the bid and ask rate for bonds typically expressed as?
A bond indenture is the contract between the bond issuer and holder. A zero coupon bond gives no coupon, only the par value, and as such typically sell at discount. The bid and ask rate are typically expressed as percentages of the bid and ask rate.
What is the difference between treasure notes and treasury bonds?
Treasury notes last for 1 to 10 years, while treasury bonds last 10-30 years.
What are the types of corporate bonds?
Callable bonds, these give the issuer the right to repurchase the bonds before maturity at a specific call price.
Convertible bonds, these give the bond holder the right to exchange the bond for a given number of shares.
Puttable bonds, these give the bond holder the right to eextend the bond life for some years, or to exchange for the core value at some date.
Floating rate bonds have coupon rates that reset according to market rates
How do we find the correct price of a bond?
The price of a bond should be equal to the present value o all future coupons + the present value of the par value.
What happens to bond values if interest rates go up?
If interest rates go up then the required return is higher, this means the present value of bonds will decrease and therefore they will lose value.
What is a bond’s yield to maturity?
The interest rate that makes the present value of the bond’s payments equal to its actual price. It is the average yearly return that will be earned if it is bought now and held until maturity. To find it we solve for the discount rate.
It assumes that all bond coupons can be reinvested at the YTM rate.
What is a bond’s current yield/yield to call?
The annual coupon divided by the bond price. It is calculated the same as yield to maturity, but time until call replaces time until maturity, and call price replaces par value.
Typically premium bonds are more likely to be called than discount bonds. This means that callable bonds will typically have a maximum premium.
What occurs to current yield and yield to maturity for premium and discount bonds?
Current yield will be lower than the coupon rate for bonds selling at a premium and current yield will be greater than yield to maturity and vice versa.
