Question

XYZ Ltd. is a large retail company listed on a major stock exchange, and its reported net income for the year ended December 31, 2019, is $5 million. The earnings were announced to the public on March 31, 2020. Just before the release of the 2019 earnings on March 31, 2020, financial analysts had predicted the company’s net income for 2019 to be $7 million.

Assumptions

■ No other news about XYZ Ltd. was released to the public on March 31, 2020.

■ No significant economy-wide events affecting share prices occurred on March 31, 2020

Consider the two situations below:

i The $2 million deviation of forecasted earnings from actual earnings is completely accounted for by XYZ Ltd.’s having closed down a number of its retail outlets.

ii The $2 million deviation of the forecasted earnings from actual earnings is completely accounted for by a fire in XYZ Ltd.’s largest retail outlet, which had caused

the outlet to be closed temporarily for six months.

A. Which event would likely cause the largest impact on the share price in an efficient market – a loss from a fire disaster that disrupts business for a short period of time, or a similar size loss from closing a large number of stores?

B. Would the market reaction to the fire disaster be positive or negative? Would you expect the market reaction to the store closings to be positive or negative? Defend and explain each answer.

[assume that the market was unaware of the fire disaster or the store closings, as the case might be, prior to the earnings announcement. Thus, when the company reported earnings, it also disclosed for the first time the cause of the earnings shortfall. The assumption means that we have a scenario where the disclosure of the earnings shortfall and the simultaneous disclosure of the reason for the shortfall is both news to the market.]

Answer 1

A)  Answer : The largest impact on its share price of a XYZ Ltd in an efficient market; Event is having closed down a number of its retail outlets without specific valid grounds or reasons will definitely impact on shareholders sentiment hence share price tend to decline. Hence XYZ company should specify the reasons behind the closing down the retail outlets. XYZ company should disclose clearly its business operations and why they are closing the business. if it does not disclose business operations and reasons behind closing down business, the share price of XYZ Ltd will be highly volatile. its an example of weak form of an efficient market hypothesis which means investors will only access publicly available  information but not private information of the company. in this case study company didn't disclose reasons behind closing down its retail outlets to the investors.

B) Answer : Since the company has disclose the reason behind closing the XYZ company retail outlets due to fire diaster. The investors in the market will take positive way

1) Because the XYZ company must have insured its retail outlets. even though its retail outlets close downs also it doesn't impact on its overall business.

2) The xyz company must have claimed from insurance company to recover loss incurred on account of fire diaster of its retail outlets.

Overall shareholders or investors and market reaction is positive even though the XYZ company has fire diaster and close downs its retail outlets because of above reasons and its disclose all the privately available information to investors in the market. its is also called as Strong form of efficient market hypothesis which means the company discloses publicly and privately available information to investors in the market. so the market price of XYZ company fairly determined.