Chapter 2: Financial Markets and Institutions (2-7)

What is fully reflected in current stock prices?

All information contained in past stock price movements.

What is the efficient markets hypothesis (EMH)?

It implies that on average, asset prices are about equal to their intrinsic values.

In semi strong form efficient markets does it pay to over analyze annual reports looking for undervalued stocks?

No, if the market is semi strong form efficient it's because they have already been incorporated in the current stock prices

Does EMH suggest that the market price will not change?

No. As new information comes to the market, people quickly adjust their expectations of the true value of the companies, and trade accordingly. All the trading will move market prices, and bring the market towards a new equilibrium state.

Can investors consistently "beat the market" if the market is efficient?

No. In efficient markets, investors cannot consistently "beat the market" except through good luck or better information.

When markets are inefficient, what is the effect of investors being afraid to invest?

Poor allocation of capital and economic stagnation

What does it mean for a market to be efficient?

Securities are normally in equilibrium and are fairly priced (or close to intrinsic value).

What is semi-strong form market efficiency?

Semi-strong form contends that all publicly available information is immediately incorporated into stock prices

What is strong form market efficiency?

Strong form contends that even company insiders, with inside information, cannot earn abnormally high returns.

When markets are efficient, investors can buy and sell stocks and be confident in what?

That they are getting good prices

Definition of market price

The current price of a stock

Intrinsic value definiton

The price at which the stock would sell if investors had all knowable information about a stock

definition of equilibrium price

The price that balances buy and sell orders at any given time

True or false: if markets are truly efficient, then stock prices will rapidly adjust to all relevant information as it becomes available

True

True or false: intrinsic value changes over time as the company succeeds or fails with new projects, competitors enter or exit the market, and so forth.

True

True or false: market price tends to fluctuate around the intrinsic value

True

True or false: In semi strong form efficient markets, superior analysts can still profit by finding and using new information.

True.

What is weak form efficiency?

Weak form contends that information on past stock price movements cannot be used to predict future stock prices

What are the three levels of market efficiency?

Weak form, semi strong form, and strong form efficiency

What is technical analysis?

When people look at historical prices to try to determine what direction the stock price is going next. Also known as charting a since they look at historical charts.