Question

We have discussed stocks, capital budgeting and M&As. Discuss how the efficient market hypothesis can be used to explain the results we see in each area.

Answer 1

Efficient market hypothesis is meaning that stock markets are efficient in nature and all the publicly available information and the privately available information have already been Discounted into the stock prices so there is a transparent market with rational investors where there is no scope of hedging and arbitraging and making an additional rate of return.

Efficient market hypothesis can be discussed in terms of stocks because stocks are listed and all the publicly available information and privately available information have already been discounted into the stock prices and there is no scope for active management of shares.

It can also be discussed in the form of the capital budgeting because Efficient market hypothesis Advocates that there is no possibility of hedging and arbitraging in the market and capital budgeting decisions should be made after ascertainment of risk exposure because it cannot be hedged with fluctuations of different factors.

Efficient market hypothesis can be associated with merger and acquisition because there would not be any price advantage to the shareholders of merging company or acquiring company and there would not be a scope of under valuation or over valuation of shares and the pricing would be done at fair valuations because all the information will be discounted in the stock prices.