FMI REPORT

ON

LONG-TERM SOURCES OF FINANCE

FOR

FIRST INTERNALS PRESENTATION

SUBMITTED TO:

HIMANSHU PURI

SUBMITTED BY:

SWAPNA (95)

MANOJ (94)

KANCHAN (100)

ANCHIT (101)

LALIT VERMA (103)

VIPIN (10)
  INTRODUCTION

In finance, the efficient-market hypothesis (EMH) asserts that financial markets are
"informationally efficient". That is, one cannot consistently achieve returns in excess of average
market returns on a risk-adjusted basis, given the information publicly available at the time the
investment is made.

An investment theory that states it is impossible to "beat the market" because stock market
efficiency causes existing share prices to always incorporate and reflect all relevant information.
According to the EMH, stocks always trade at their fair value on stock exchanges, making it
impossible for investors to either purchase undervalued stocks or sell stocks for inflated
prices. As such, it should be impossible to outperform the overall market through expert stock
selection or market timing, and that the only way an investor can possibly obtain higher returns
is by purchasing riskier investments. In an efficient financial market, an asset’s price should be
the best possible estimate of its economic values.

DEFINITION OF EFFICIENT MARKET

The term “efficient markets” is defined as follows:

"In an efficient market, competition among the many intelligent participants leads to a situation
where, at any point in time, actual prices of individual securities already reflect the effects of
information based both on events that have already occurred and on events which, as of now, the
market expects to take place in the future. In other words, in an efficient market at any point in
time the actual price of a security will be a good estimate of its intrinsic value."

 An efficient capital market is a market that is efficient in processing information.

 We are talking about an “informationally efficient” market, as opposed to a

“transactionally efficient” market. In other words, we mean that the market quickly and
correctly adjusts to new information.

 In an informationally efficient market, the prices of securities observed at any time are
based on “correct” evaluation of all information available at that time.

 Therefore, in an efficient market, prices immediately and fully reflect available

information.

A precise definition needs to answer two questions:

1. What is “all available information”?

2. What does it mean to “reflect all available information”?
Different answers to these questions give rise to different versions of market efficiency.
Intuitive answers to these two questions:

1. All available information includes:

(a) Past prices – Weak form.
(b) All public information – Semi-Strong Form.- past prices, news, etc.
(c) All information including inside information – Strong Form.

2. “Prices reflect all available information” means that financial

transactions at market prices, using the available information,
are zero NPV activities.

What would cause a stock price to change?

A reasonable answer is that the price would change if investors obtain new information about the
stock that causes them to revise their forecast about the stock’s future return. Secondaly, new
information that causes investors to be more optimistic would cause them to revalue the stock
price higher. Negative information would result in lower price revaluations. Since new
information arrives in the market in an unpredictable (random) fashion, prices will change
randomly as well. New information is the cause of securities price changes. Since one cannot
predict whether the next piece of new information will be favorable or unfavorable for a stock,
the future changes in stock prices are similarly unpredictable

Versions of the Efficient Market Hypothesis

There are three versions of the EMH
 The weak form,
 semi-strong and
 strong forms of the hypothesis.

These versions differ by their notions of what is meant by the term µ all available information.

The EMH Graphically

 In this diagram, the circles represent the amount of information that each form of the
EMH includes.
 Note that the weak form covers the least amount of information, and the strong form
covers all information.
 Also note that each successive form includes the previous ones.
 Strong Form

Semi-Strong

Weak Form

1. The weak form efficient markets hypothesis

The weak form hypothesis maintains that past stock price changes cannot be used to earn above
average profits. (Because this information is available to all, and thus, already incorporated in
market price.)

The weak form hypothesis asserts that stock prices already reflect all information that can be
derived by examining market trading data such as the history of past prices, trading volume or
short interest. The version of the hypothesis implies that trend analysis is fruitless. The weak
form hypothesis holds that if such data ever conveyed reliable signals about future performance,
all investors already would have learned to exploit the signals. Ultimately, the signals lose their
value as they become widely known because a buy signal, for instance, would result in an
immediate price increase.

Studies show that systems that try to predict the future course of stock prices based upon some
rule derived from the history (past days, weeks, or months) of past stock price changes do not
make profit greater than a simple buy and hold strategy. Statistical analysis of successive stock
price changes reveals that the correlation between price changes is approximately zero.

 The weak form of the EMH says that past prices, volume, and other market statistics
provide no information that can be used to predict future prices.
 If stock price changes are random, then past prices cannot be used to forecast future
prices.
 Price changes should be random because it is information that drives these changes, and
information arrives randomly.
 Prices should change very quickly and to the correct level when new information arrives
(see next slide).
 This form of the EMH, if correct, repudiates technical analysis.
 Most research supports the notion that the markets are weak form efficient.
If a market is weak form efficient, then technical analysis should not be effective in picking
stocks for above average profits.

Technical analysis is the term describing the many systems for investing based on indicators
such as charts of past price data, volume of trading, short selling statistics, odd lot trading, etc.

Insert ur part here t2 maharaj

Implications of EMH
1. Trust market prices.

 Buying and selling assets are zero NPV activities, giving only risk-adjusted returns.
 Market prices give best estimate of value for projects.
 Firms receive “fair” value for securities they issue.

2. Read into prices.

 If market price reflects all available information, we can extract information from prices.

3. There are no financial illusions.

 Market price reflects value only from an asset’s payoff.

 It is not easy to trick the market.

4. Value comes from economic rents such as

 superior information
 superior technology
 access to cheap resources