THEORY OF

Dr. Muhammad Anees Khan

Associate Professor (Finance)
Department of Management Studies

FINANCE
Bahria University, Islamabad
manees.buic@bahria.edu.pk
lookanees123@gmail.com
00923105462529
Market Mechanism?
MARKET EFFICIENCY THEORY
Market Efficiency Theory: Indicates the adjustment of prices on arrival of
new information.
Weak form efficiency, also known as the random walk theory, states
that future securities' prices are random and not influenced by past
events. Weak form of EMH is tested using the Kolmogorov-Smirnov
goodness of fit test, run test and autocorrelation test. The K-S test result
concludes that in general the stock price movement does not follow random
walk. The results of the runs test reveals that share prices of seven companies
do not follow random walk.
Semi-strong form efficiency refers to a market where share prices fully
and fairly reflect all publicly available information in addition to all past
information.
Strong form efficiency refers to a market efficiency in which prices of
stocks reflects all the information in a market, be it private or public.
 MARKET MICROSTRUCTURE
The study of how security market set prices, compensate market
makers and incorporate private information into equilibrium price
levels.
BID/ASK Spread Model: Firstly, Market Structure/Spread model
study the relative merits of different market structures (Monopoly
specialists versus multiple dealer markets, electronic order book versus
human dealer markets etc.) and examine the determinants of the size of
the bid-ask spread that dealers earn in different markets.
Price formation models: Secondly, Price formation models analyze
how private information is incorporated into securities prices and
study – among other things – how trade size, aggregate trading
volume, and price levels are related.
 CAPITAL STRUCTURE
Miller and Modigliani theory mentions two propositions.
Proposition I states that the market value of any firm is
independent of the amount of debt or equity in capital structure.
Proposition II states that the cost of equity is directly related and
incremental to the percentage of debt in capital structure.

The signaling theory was first coined by Ross (1977) who posits
that if managers have inside information, their choice of capital
structure will signal information to the market.
 CAPITAL STRUCTURE
The trade-off theory of capital structure is the idea that a
company chooses how much debt finance and how much
equity finance to use by balancing the costs and benefits.

The agency cost of debt is the conflict that arises between

shareholders and debtholders of a public company. Agency
costs of debt arise when debtholders place limits on the use of
their capital if they believe that management will take actions that
favor shareholders instead of debtholders.