Chapter 7 Homework

What are the implications of the efficient market hypothesis for investors who buy and sell stocks in an attempt to "beat the market"?

Ignoring trading costs, on average, such investors merely earn what the market offers; the trades all have zero NPV. If trading costs exist, then these investors lose by the amount of the costs.

If a market is semi-strong-form efficient, is it also weak-form efficient? Explain.

Yes, historical information is also public information; weak form efficiency is a subset of semi-strong form efficiency.

Which of the following statements are true about the efficient markets hypothesis? a. It implies perfect forecasting ability. b. It implies that prices reflect all available information. c. It implies an irrational market. d. It implies that prices do not fluctuate. e. It results from keen competition among investors.

b. It implies that prices reflect all available information. e. It results from keen competition among investors.

Aerotech, an aerospace technology research firm, announced this morning that it hired the world's most knowledgeable and prolific space researchers. Before today, Aerotech's stock had been selling for $100. Assume that no other information is received over the next week and the stock market as a whole does not move. a. What do expect will happen to Aerotech's stock? b. Consider the following scenarios: i. The stock price jumps to $118 on the day of the announcement. In subsequent days it floats up to $123, and then falls back down to $116. ii. The stock price jumps up to $116 and remains at that level. iii. The stock price gradually climbs to $116 over the next week. Which investment scenario(s) indicate market efficiency? Which do not? Why?

a. Aerotech's stock price should rise immediately after the announcement of the positive news. b. Only scenario (ii) indicates market efficiency. In that case, the price of the stock rises immediately to the level that reflects the new information, eliminating all possibility of abnormal returns. In the other two scenarios, there are periods of time during which an investor could trade on the information and earn abnormal returns.