Question

The Efficient Market Hypothesis is an investment theory that assumes that it is impossible to beat the market because the prices of securities fully reflect all available information.

Discussion Questions:

Explain if the financial markets are efficient. If so, why? If not, why?

Detail the implications of the efficient market hypothesis for investors who buy and sell stocks in an attempt to beat the market.

Answer 1

yes according to the efficient market hypotheses the financial markets are efficient in that they truly and completely reflect all the available information, and it is not possible to beat the markets by trading securities.

there are 3 forms of market efficiency :

strong form: where the stock price completely reflect all the available information (public or private ) and the insiders cannot take any kind of advantage by getting access to stock information earlier than other investors. that is they buy the stock at lower prices and sell the stock when the release of positive information which they has earlier access to releases, is when they sell the stock at higher prices.

semi-strong form : in this form, news of any uncertain event , earthquake or natural calamity or financial meltdown is released the stock instantly reflects that information. as a result of which the investors cannot profit from it.

weak form of market efficiency :the price of the stock today, reflects the events in the past ( whether events that are specific to the firm or events happening due to the changes in the economy.) therefore, the stocks reflect all historic information.

but there have a number of investors who have been successful in beating the market, and generating positive returns due to so called market anomalies.

different investors view stocks differently some may purchase believing them to be undervalued , some may purchase high growth stocks. investors value stocks differently, it is impossible to value stocks in an efficient market.

not all investors earn the same return . there have been instances where mutual funds schemes have suffered huge losses and also made great profits which is higher than the market return.

with superior stock selection and analytical ability an investor can successfully beat the market.

conclusion: markets are not 100% efficient. in order to achieve market efficiency there should be a universally accepted method to value stocks. people should accept the fact that their gains or losses is similar to the gains and losses of the other market participants. every individual is investing in the market with a complete analysis of the stock and there has no role of sentiments and emotions in choosing the stocks . we do not see that any of these conditions can ne met in the real world.

if the investors buy or sell securities in an attempt to beat the market and they believe that the trading cost are nil. then they merely earn the market rate of return. in the presence of trading costs the return falls to negative.