Geothermal corporation issued a press release before the stock market opened ann

Question

Geothermal corporation issued a press release before the stock market opened announcing that its earnings have decreased by 30% over the last year earnings. Explain how each of the following individual scenarios could be consistent with the semi-strong form of market efficiency.

   (a) When trading opened after the announcement and throughout the first day, there was no stock price change after the company announced the 30% decrease in earnings.

   (b) The stock price of Geothermal increased slowly over the 30 days before the announcement of the 30% decrease in earnings.

   (c) The stock price decreased by 10% immediately following the announcement but then increased throughout the day so that the closing price was only 2% below the previous day.

Explanation / Answer

a) In the first scenario, a substantive decrease in earnings was expected as the past financial results of the company were not very encouraging and hence, the stock price of the Geothermal had already corrected itself by being traded at the correct level which is in keeping with its financial standing in the market.Hence, the announcements didn't have much impact in the price of the stock.

b) Over the past thirty days, there were expectations of the recovery of the company on account of satisfying performances of other companies in the same industry. Hence, there were expectations from the company of bouncing back from its dismal performances in the past and doing somewhat well.

c)10% decrease in stock price following the results could be attributed to distress selling of the stock in the market owing to its poor result. But later on, some goverrnment notification or sudden external factors revived the hopes in investors of its quick recovery leading to quick buying of stocks with the expectation of rapid gains curtailed its downslide and resulting in ending at 2% below the previous day.

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