7. Efficient markets hypothesis The concept of market efficiency underpins almos

Question

7. Efficient markets hypothesis The concept of market efficiency underpins almost all financial theory and decision models. When financial markets are efficient, the price of a security-such as a share of a particular corporation's common stock-should be the present value estimate of the firm's expected cash flows discounted by its appropriate rate of return (also called the intrinsic value of the stock. Almost all financial theory and decision models assume that the financial markets are efficient. The informational efficiency of financial markets determines the ability of investors to "beat" the market and earn excess (or abnormal) returns on their investments. If the markets are efficient, they will react rapidly as new relevant information becomes available. Financial theorists have identified three levels of informational efficiency that reflect what information is incorporated in stock prices. Consider the following statement, and identify the form of capital market efficiency under the efficient market hypothesis based on this statement: Current market prices reflect all relevant publicly available information. This statement is consistent with: O Weak-form efficiency Strong-form efficiency O Semistrong-form efficiency

Explanation / Answer

1.

Option B, strong market efficiency. This further reflects that invesotr would not be able to earn more than the average return because all the tpyes of information is already out and is incorporated in the price. So any piece of information in his possession is useless.

2. In weak efficiency form, market price is based upon historical and current information. There is no reflection of future events in the price. Since increase in EPS is a good sign of growth, there is a good chance that the stock price would increase and set at the new equilibrium level. Thus answer would be Option B

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