Theory of efficient market ( also known as effiecient market hypothesis or EMH)

- developed by Eugene fama

- States that the financial markets are “informationally efficient.” Therefore,stocks
at any point in time are fairly and accurately priced and always reflect the
available information to the public.

The theory of efficient market comprises three levels and primarily based on the
timeliness and availability of market information (whether good or bad news) to
the stockholders.
*Weak-form Efficiency
-this level describes a situation where a stock’s historical performances cannot be
used as a metric or tool predict future stock prices.The determination of price using
historical performances is called technical analysis. This is called weak-form
efficiency because other tools can still be performed to predict the market such as
fundamental analysis and insider or internal information.
*Semi-form efficiency
- This level, on the other hand, describes a situation where new and fresh market
information is already available to the public including the stakeholders.
-Therefore, prices already include the adjustments for all new information. Despite
performing a thorough fundamental and technical analysis of the stock market, it is
not possible to achieve excess return.
-Fundamental analysis is the study of the internal ( financial standing,
management, operations, marketing) and external forces (economic, socio-
cultural,technological) that can affect the stock prices.
*Strong-form efficiency
-This level is the strongest level of market efficiency bacause in this situation, stick
prices already incorporate the adjustments from both public and internal
information.
Despite the strong supporters of the theory of efficient market, critics presented
different points to challenge the reliability of this theory. A financial market is inefficient
when the following situations happen.

1. Public information is not always spread quickly and efficiently. This means that
selected people may know part of the information but not all. Investors who will
receive and act on the “good news” will of course take advantage of it.
Consequently, if the info. Flows quickly and efficiently, then all investors would have
an equal opportunity to take advantage of the information.
EXAMPLE:
XYZ corporation, a financial institution, allows its employees to buy its own
stocks as one of the employees’ benefits. Internally, it was announced that the
company earned more than double its last year’s income. However, the announcement
was only made public a month after the company’s internal declaration of its dramatic
increase in net income. In this case, the employees will take the opportunity to buy
more stocks from XYZ corporation as they know the “good news” first before tha
public.
2. Insider information or trading may cause unfair opportunity to tha public. The
U.S. Securities and Exchange Commssion (SEC) defines insider trading as illegal
insider trading that refers generally to buying or selling a security, in breach of a
fiduciary duty or other relationship of trust and confidence, while in possesion ot
material, nonpublic info. about the security. Insider trading violations may also
include “tipping” such information, securities trading by the person “tripped,” and
securities trading by those who misappropriate such information.
EXAMPLE:
If CEO Nina tells the increase in its annual income to her friend, Ana,
before announcing to the public, Ana will of course buy the stocks immediately
after receiving the news. Nina then announces the “good news” to the public two
days after telling the news to Ana. After the public announcement, the stock prices
increased and Ana decided to sell the stocks. Ana then earned a huge amount of
money by buying stocks at a lower price and selling it at a higher price.
3. Stock prices are volatile and can be affected by human error and emotional
decision-making. It is inevitable that investors will overreact especially to bad
news. Hence, it would result in a stiff decline of the stock’s prices.
EXAMPLE:
A retail food company announces that it will sell 10% of its branches. An
investor may overreact to this bad and immediately sell his or her stocks instead of
keeping the stocks until the price increases again.
THEORY OF EFFICIENT MARKET
1-5 ( TRUE or FALSE)
1.Semi-form Efficiency is the strongest level of market efficiency.
2. Strong-form Efficiency describes a situation where a stock’s historical
performances is fully reflected on the current stock market price or value.
3. Fundamental Analysis is the study of the internal and external forces.
4. Weak-form Efficiency in this level describes a situation where new and fresh
market info. Is already availableto the public including the stakeholder.
5. Theory of efficient market states that financial markets are “ informationally
efficient.”
6. What is SEC? (meaning)
7. This information is not always spread quickly and efficiently.
8. This information may cause unfair opportunity to the public.
9. Volatile and can be affected by human error and emotional decision-making.
10. Theory of efficient market also known as. (blank)