Question

The efficient market hypothesis states that it is impossible for investors to consistently beat the market. Is it also impossible for investors to consistently do worse that the market –

that is, it is possible to pick a bad portfolio of stocks that will do worse than the market? Explain. Ignore trading costs or fees paid to money managers.

b. Assuming that the U.S. Government will never default on its loans, is investing in U.S. government bonds completely riskless? Explain why or why not

Answer 1

According to the Efficient Market Hypothesis, stocks always trade at their fair value on exchanges, making it practically impossible for investors to purchase undervalued stocks or sell stocks at inflated prices. Therefore, we can say that it's impossible to outperform the overall market even through expert stock selection or top notch market timing. The only way left for an investor to gain higher returns is to purchase riskier investments.

We should understand that the US government bonds are heavily backed by the US government, meaning that they wouldn't default on their loans alongide, America has the most powerful economy in the world. These multitude of factors suggest us that these bonds are risk free but not completely. As long as one holds on to the bond till maturity it's risk free. But there are some significant risks if you plan to sell the bond before maturity. Therefore US government bonds are not completely riskless.

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