Corporate Finance - Market Hypothesis - Assessment Answer

Corporate Finance Assignment

Assignment Task

What would be the implication to the efficient market hypothesis? Which version of the efficient market hypothesis does this event Emily?

Introduction

Efficient market hypothesis (EMH) is a widely accepted theory that puts forth the belief that stock market is extremely efficient in reflecting data and information about individual scrips and the market as a whole. Generally it is believed that all information about a particular stock spreads quickly, and the same is incorporated into the stock price without delay. Thus, neither fundamental analysis (analysis of company financials such as company earnings, net profitability, etc.) nor technical analysis (the study of past stock prices) helps investors to select undervalued stocks to earn higher returns in contrast to investing in a self selected portfolio of individual scrips with almost similar risks.

The theory presents itself in three basic formats: weak form, semi-strong form and strong form.

The Weak form EMH implies that market is capable of incorporating all market information. The fundamental analysis here can provide investors with information to produce above average market returns in the short run. Due to lack of any set patterns, fundamental analysis cannot provide any long-term advantage or forecasting opportunities and technical analysis shall not work. With these assumptions, the weak form of EMH asserts that any rules based on fundamental or technical analysis cannot help the trader to buy or sell any particular stock.

Semi-strong form of EMH implies that neither of the forms of analysis (fundamental analysis and technical analysis) can be beneficial for an investor and that new information is quickly adjusted into the securities price. Only the information that is not readily available to the public can help investors increase their return, and they cannot benefit by speculating on the new information.

The Strong form of EMH advocates that all the information irrespective of their availability incorporates itself into the stock, and there is a complete lack of any information that can give the investors any leverage on the market.

The stock price movement of Qantas for two days reflects that after the disclosure of annual reports investors have actively traded in the stock. The volume of transaction proves that after the material revelation the average trading for this stock almost doubled itself which is an indication of investors profit booking. The next day transaction volume reflects that the firm is back in resuming its normal course of action. As the disclosure of annual reports forms a part of fundamental analysis, the average investor can only benefit from the stock in the long run based on the available information. The opening stock prices of Qantas on 24^thAugust were adjusted with the disclosures of annual reports and showed the investors reaction on the annual reports.

The performance of Qantas over the three-day period reflects the weak form of the efficient market hypothesis. Here the average investor seems to benefit from the fundamental analysis for the short run. Due to the absence of any technical analysis in this form the common investor has been able to leverage the information about the annual reports and performed better than the average market by selling their holdings.