Question

3. Which of the following information would provide evidence against the efficient market hypothesis based on public information? Circle all that apply (no explanation necessary).

i. Mutual fund managers do not on average make superior returns.

ii. You can make superior returns by buying stocks after the announcement of an abnormal rise in dividends

iii. High Price/Earnings stocks tend to have negative abnormal returns.

iv. Stock prices in companies rise on average when it is announced that they are the target of a takeover bid.

Answer 1

The capital market is considered to be efficient in three different forms:

1. Weak Form: It deals with the information regarding the past sequence of security price movements.
2. Semi-Strong Form: It deals with publicly available information.
3. Strong Form: Information available to both public and private.

From the above question asked, the answer will be (ii) and (iv). Both are based on public information. As

(ii) After the announcement of declaring an abnormal rise in the dividend to the public. In the hope of getting a high dividend, more public investors will buy the share, which results in rising the share price and can earn a superior return on selling on the new current price.

(iv) The announcement of the takeover bid indicates the public investors that there will be an acquiring of another company which will lead to an increase in resources by combining both the companies. As the resources are increased, the growth of the company will also increase. Expecting that, more public investors will purchase the share which results in rising the share price and can earn superior return on selling on the new current price.

Other options (i) and (iii) are not related to public information rather it is based on information regarding the past sequence of security price movements.