Question

You believe that capital markets are semi-strongly efficient. McDonald's announces stronger than expected quarterly earnings. What is likely to happen to the share price? Is there a way to profit from the announcement? What if the strong earnings were expected, what would happen to the share price?

could you please explain in detail ?

Answer 1

A semi strong capital market means the market will absorb all the public information available in the market and it will be reflected in the share price. In the given scenario, when people were expecting decent quarterly earning by McDonald, but McDonald announced stronger earning, then it was unexpected in nature, then share price of McDonald, will absorb the information and share price will rise. It will help investors gain profit, who had bought or hold shares of the company just before the announcement. Since expectation was lower, then share price was also lower before the announcement. If people bought it before the announcement, then they can get higher capital gain after the announcement. Hence, arbitrage opportunity is created for the investors who will buy before the announcement at lower price and sell at higher price after the announcement.

If strong earning is expected, then it is already absorbed by the share price and its price has increased even before the actual announcement takes place. It means that share price is already increased. It will not create any arbitrage or profit making opportunity, because share price is already at the higher side. It happens because people know that McDonald announces higher earning.