On May 15, 1997, the governmnt of Kuait offered to sell 170 million BP shares, w

Question

On May 15, 1997, the governmnt of Kuait offered to sell 170 million BP shares, worth about $2 billion. Goldman Sachs was conacted after the stock market closed in London and given one hour to decide whether to bid on the stock. They decided to offer 710.5 pence ($11.59) per share, and Kuwait accepted. Then Goldman Sachs went looking for buyers. They lined up 500 institutional and individual investors worldwide, and resold all the shares at 716 pence ($11.70). The resale was complete before the London Stock Exchange opened the next morning. Goldman Sachs made $15 million overnight. What does this deal say about market efficiency? Discuss.

Explanation / Answer

the governmnt of Kuait offered to sell 170 million BP shares, worth about $2 billion Goldman Sachs decided to offer 710.5 pence ($11.59) per share, and Kuwait accepted. they lined up 500 institutional and individual investors worldwide, and resold all the shares at 716 pence ($11.70). Goldman Sachs made $15 million overnight. Definition of 'Market Efficiency' The degree to which stock prices reflect all available, relevant information. Market efficiency was developed in 1970 by Economist Eugene Fama who's theory efficient market hypothesis (EMH), stated that it is not possible for an investor to outperform the market because all available information is already built into all stock prices. Investors who agree with this statement tend to buy index funds that track overall market performance. Beyond the normal utility maximizing agents, the efficient-market hypothesis requires that agents have rational expectations; that on average the population is correct (even if no one person is) and whenever new relevant information appears, the agents update their expectations appropriately. Note that it is not required that the agents be rational. EMH allows that when faced with new information, some investors may overreact and some may underreact. All that is required by the EMH is that investors' reactions be random and follow a normal distribution pattern so that the net effect on market prices cannot be reliably exploited to make an abnormal profit, especially when considering transaction costs (including commissions and spreads). Thus, any one person can be wrong about the market—indeed, everyone can be—but the market as a whole is always right. There are three common forms in which the efficient-market hypothesis is commonly stated—weak-form efficiency, semi-strong-form efficiency and strong-form efficiency, each of which has different implications for how markets work. In weak-form efficiency, future prices cannot be predicted by analyzing prices from the past. Excess returns cannot be earned in the long run by using investment strategies based on historical share prices or other historical data.

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