Submitted By :

Muhammad Waqas
Submitted To :
Sir Saqib
Subject :
Corporate Finance
Section :
BBA 8 th
Roll No :
7317
Riphah International University
Faisalabad
Question 1.
What is efficient market? Explain efficient market hypothesis (EMH) and types of EMH. Give
your argument about Pakistan Stock Exchange, in which type it falls?

Answer:

Efficient market hypothesis (EMH) and types of EMH

The Efficient Markets Hypothesis (EMH) is an investment theory primarily derived from
concepts attributed to Eugene Fame’s research as detailed in his 1970 book, “Efficient Capital
Markets: A Review of Theory and Empirical Work.” Fame put forth the basic idea that it is
virtually impossible to consistently “beat the market” – to make investment returns that
outperform the overall market average as reflected by major stock indexes such as the  S&P 500
Index.

according to Fame’s theory, while an investor might get lucky and buy a stock that brings him
huge short-term profits, over the long term he cannot realistically hope to achieve a return on
investment that is substantially higher than the market average.

Understanding the Efficient Markets Hypothesis

Fame’s investment theory – which carries essentially the same implication for investors as
the Random Walk Theory – is based on a number of assumptions about securities markets and
how they function. The assumptions include the one idea critical to the validity of the efficient
markets hypothesis: the belief that all information relevant to stock prices is freely and widely
available, “universally shared” among all investors.

As there are always a large number of both buyers and sellers in the market, price movements
always occur efficiently (i.e., in a timely, up-to-date manner). Thus, stocks are always trading at
their current fair market value.

The major conclusion of the theory is that since stocks always trade at their fair market value,
then it is virtually impossible to either buy undervalued stocks at a bargain or sell overvalued
stocks for extra profits. Neither expert stock analysis nor carefully implemented market timing
strategies can hope to average doing any better than the performance of the overall market. If
that’s true, then the only way investors can generate superior returns is by taking on much
greater risk.
 

Variations of the Efficient Markets Hypothesis

There are three variations of the hypothesis – the weak, semi-strong, and strong forms – which

represent three different assumed levels of market efficiency.

1. Weak Form

The weak form of the EMH assumes that the prices of securities reflect all available public
market information but may not reflect new information that is not yet publicly available. It
additionally assumes that past information regarding price, volume, and returns is independent
of future prices.

The weak form EMH implies that technical trading strategies cannot provide consistent excess
returns because past price performance can’t predict future price action that will be based on
new information. The weak form, while it discounts technical analysis, leaves open the
possibility that superior fundamental analysis may provide a means of outperforming the
overall market average return on investment.

2. Semi-strong Form

The semi-strong form of the theory dismisses the usefulness of both technical and fundamental
analysis. The semi-strong form of the EMH incorporates the weak form assumptions and
expands on this by assuming that prices adjust quickly to any new public information that
becomes available, therefore rendering fundamental analysis incapable of having any predictive
power about future price movements. For example, when the monthly Non-farm Payroll
Report in the U.S. is released each month, you can see prices rapidly adjusting as the market
takes in the new information.

3. Strong Form

The strong form of the EMH holds that prices always reflect the entirety of both public and
private information. This includes all publicly available information, both historical and new, or
current, as well as insider information. Even information not publicly available to investors,
such as private information known only to a company’s CEO, is assumed to be always already
factored into the company’s current stock price.

So, according to the strong form of the EMH, not even insider knowledge can give investors a
predictive edge that will enable them to consistently generate returns that outperform the
overall market average.
 

Arguments For and Against the EMH

Supporters and opponents of the efficient markets hypothesis can both make a case to support
their views. Supporters of the EMH often argue their case based either on the basic logic of the
theory or on a number of studies that have been done that seem to support it.

A long-term study by Morningstar found that, over a 10-year span of time, the only types of
actively managed funds that were able to outperform index funds even half of the time were
U.S. small growth funds and emerging markets funds. Other studies have revealed that less
than one in four of even the best-performing active fund managers proves capable of
outperforming index funds on a consistent basis.

Note that such data calls into question the whole investment advisory business model that has
investment companies paying out huge amounts of money to top fund managers, based on the
belief that those money managers will be able to generate returns well above the average
overall market return.

Opponents of the efficient markets hypothesis advance the simple fact that there ARE traders
and investors – people such as John Templeton, Peter Lynch, and Paul Tudor Jones – who DO
consistently, year in and year out, generate returns on investment that dwarf the performance
of the overall market. According to the EMH, that should be impossible other than by blind luck.
However, blind luck can’t explain the same people beating the market by a wide margin, over
and over again. over a long span of time.

In addition, those who argue that the EMH theory is not a valid one point out that there are
indeed times when excessive optimism or pessimism in the markets drives prices to trade at
excessively high or low prices, clearly showing that securities, in fact, do not always trade at
their fair market value.

Pakistan Stock Exchange fall in weak form.

Question no 2.
Question 3.

How corporate finance helps the managers to make the financial decisions

Answer

Corporate finance is important to all managers because it allows a manager to be able to

predict the funds the company will need for their upcoming projects and think about ways to
organize and acquire those funds.

Corporate finance is concerned primarily with making investment and financing decisions; that
is, making sure that money is being used in the best way. A company can finance a project by
using either internal funds (money the company already has), borrowing, or selling equity.

Corporate finance is the division of finance that deals with how corporations deal with funding

sources, capital structuring, and investment decisions. Corporate finance is primarily concerned
with maximizing shareholder value through long and short-term financial planning and the
implementation of various strategies.