4. B Points) For each of the following scenarios, discuss whether profit t oppor

Question

4. B Points) For each of the following scenarios, discuss whether profit t opportunities exist from trading in the stock of the firm under the conditions that (1) the market is not weak form efficient, (2) the market is weak form but not semi-strong form efficient, (3) the market is semi-strong form but not strong form efficient, and (4) the market is strong form efficient a. The stock price has risen steadily each day for the past 30 days. b. The financial statements for a company were released three days ago, and you believe you've uncovered cred some anomalics n the company's inventory and cost control reporting techniques that are causing the firm's true liquidity strength to be understated. c. You observe that the senior managers of a company have been buying a lot of the company's stock on the open market over the past week.

Explanation / Answer

a). If the market is not weak form efficient, then this information could be acted on and a profit earned from following the price trend. Under (2), (3), and (4), this information is fullyimpounded in the current price and no abnormal profit opportunity exists.

b).  Under (2), if the market is not semi-strong form efficient, then this information could be used to buy the stock “cheap” before the rest of the market discovers the financial statement anomaly.Since (2) is stronger than (1), both imply that a profit opportunity exists; under (3) and (4), this information is fully impounded in the current price and no profit opportunity exists.

c).  Under (3), if the market is not strong form efficient, then this information could be used as a profitable trading strategy, by noting the buying activity of the insiders as a signal that the stockis underpriced or that good news is imminent. Since (1) and (2) are weaker than (3), all threeimply that a profit opportunity exists. Under (4), this information does not signal any profit opportunity for traders; any pertinent information the manager - insiders may have is fully reflected in the current share price.

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