Question

1. What is efficient market hypothesis? Explain the difference between technical and fundamental analysis and indicate which one is rendered useless if markets are weakly efficient?

2. What is the major source of financing investments in corporate America? Has there been more debt or equity issuance overall in recent years?

Answer 1

• 1.The Efficient Market Hypothesis (EMH) essentially says that all known information about investment securities, such as stocks, is already factored into the prices of those securities. Therefore, assuming this is true, no amount of analysis can give an investor an edge over other investors.
• EMH does not require that investors be rational; it says that individual investors will act randomly but, as a whole, the market is always "right." In simple terms, "efficient" implies "normal." For example, an unusual reaction to unusual information is normal.
• The efficient market hypothesis states that share prices reflect all relevant information, and that it is impossible to beat the market or achieve above-average returns on a sustainable basis.
• There are three forms of EMH: Weak, Semi-strong and Strong. Here's what each says about the market.
• Weak Form EMH: -Suggests that all past information is priced into securities. Fundamental analysis of securities can provide an investor with information to produce returns above market averages in the short term but there are no "patterns" that exist. Therefore fundamental analysis does not provide long-term advantage and technical analysis will not work.
• Semi-Strong Form EMH:- Implies that neither fundamental analysis nor technical analysis can provide an advantage for an investor and that new information is instantly priced in to securities.
• Strong Form EMH:- Says that all information, both public and private, is priced into stocks and that no investor can gain advantage over the market as a whole. Strong Form EMH does not say some investors or money managers are incapable of capturing abnormally high returns but that there are always outliers included in the averages.
• Technical analysis and fundamental analysis are the two main schools of thought when it comes to analyzing the financial markets. Technical analysis looks at the price movement of a security and uses this data to predict future price movements. Fundamental analysis instead looks at economic and financial factors that influence a business.
• Technical analysts typically begin their analysis with charts, while fundamental analysts start with a company’s financial statements.
• Fundamental analysts try to determine a company’s value by looking at its income statement, balance sheet, and cash flow statement. In financial terms, the analyst tries to measure a company’s intrinsic value by discounting the value of future projected cash flows to a net present value. A stock price that trades below a company’s intrinsic value is considered a good investment opportunity and vice versa.
• Technical analysts believe that there’s no reason to analyze a company’s financial statements since the stock price already includes all relevant information. Instead, the analyst focuses on analyzing the stock chart itself for hints into where the price may be headed.
• Fundamental analysis takes a long-term approach to investing compared to the short-term approach taken by technical analysis. While stock charts can be delimited in weeks, days, or even minutes, fundamental analysis often looks at data over multiple quarters or years.
• Technical analysis and fundamental analysis have different goals in mind. Technical analysts try to identify many short- to medium-term trades where they can flip a stock, while fundamental analysts try to make long-term investments in a stock’s underlying business.
• A good way to conceptualize the difference is to compare it to someone buying a home to flip versus someone that’s buying a home to live in for years to come.
• Technical analysis and fundamental analysis are often seen as opposing approaches to analyzing securities, but many investors have experienced success by combining the two techniques. For example, an investor may use fundamental analysis to identify an undervalued stock and use technical analysis to find a specific entry and exit point for the position.
  
• Weak form efficiency does not consider technical analysis to be accurate and asserts that even fundamental analysis, at times, can be flawed. It is therefore extremely hard, according to weak form efficiency, to outperform the market, especially in the short term.
• For example, if a person agrees with this type of efficiency, they believe that there is no point in having a financial advisor or active portfolio manager. Instead, investors who advocate for weak form efficiency assume they can randomly pick an investment or a portfolio with little risk.
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