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In: Finance

2. For each of the following scenarios, discuss whether profit opportunities exist from trading in the...

2. For each of the following scenarios, discuss whether profit opportunities exist from trading in the stock of the firm under the -conditions that

(1) the market is not weak form efficient,

(2) the market is weak form efficient,

(3) the market is semistrong form efficient, and

(4) the market is strong form efficient.

a. The stock price has risen steadily each day for the past 30 days.

b. The financial statements for a company were released three days ago, and you believe you've uncovered some anomalies in the company’s inventory and cost control reporting techniques that are causing the firm’s true liquidity strength to be understated.

c. You observe that the senior managers of a company have been buying a lot of the company’s stock on the open market over the past week.

Solutions

Expert Solution

Answer 2)

Situation a. Under condition 1. The market is not weak form efficient: The information may be used to earn profit from following the price trend in market . While under condition (2), (3), and (4), the current price movement of stock is reflection of all available information  , so no abnormal profit can be earned.

Situation b. Under condition (2), if the market doesn't have semi-strong form of efficiency, such information may use to earn extra profit , as we can buy stock on cheap price  before any one else discover the anomaly in financial statement. But under condition (3) and (4), this information will impact the price on stock in market So , so no abnormal profit can be earned.

Situation c. Under condition (3), if the market doesn't have strong form of efficiency, such information may use to earn extra profit as the buying from managers is a signal of under-price situation. Since condition (1) and condition (2) are clearly less effective than condition (3), so, all 3 provide profit opportunity for investors. Under condition (4), this information has already discounted in the current price , So , so no abnormal profit can be earned.

jeff jeffy answered 1 year ago
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