Chapter 4
On the Efficient Markets Hypothesis
Problems
4.1 Interest Rates [2]
Consider the following statement.
Long term interest rates are at record highs. Most companies therefore find it cheaper to finance with common stock or relatively inexpensive short-term bank loans.
What does the Efficient Market Hypothesis have to say about the correctness of this?
4.2 Semistrong [3]
Can you expect to earn excess returns if you make trades based on your broker’s information about record earnings for a stock, rumors about a merger of a firm, or yesterday’s announcement of a successful test of a new product, if the market is semi-strong form efficient?
4.3 UPS [3]
On 1/10/85, the following announcement was made: “Early today the Justice Department reached a decision in the UPC case. UPC has been found guilty of discriminatory practices in hiring. For the next five years, UPC must pay $2 million each year to a fund representing victims of UPC policies.” Should investors not buy UPC stock after the announcement because the litigation will cause an abnormally low rate of return over the next five years? 4.4 Management [3]
Your broker claims that well–managed firms are not necessarily more profitable investment opportunities than firms with an average management. She cites an empirical study where 17 well–managed firms and a control group of 17 average firms were followed for 8 years after the former were reported in the press to be “excelling” as far as management is concerned. Is this evidence that the stock market does not recognize good management?
4.5 TTC [3]
TTC has released this quarter’s earning report. It states that it changed how it accounts for inventory. The change does not change taxes, but the resulting earnings are 20% higher than what it would have been under the old accounting system. There is no other surprises in the earnings report.
1. Would the stock price now jump on the release of this earnings report?
4.6 Investing? [3]
Does the following statement make sense in view of the Efficient Markets Hypothesis (EMH)?
The Japanese economy has deep structural problems, which the Japanese seem reluctant to overcome.
We do not see any major change in this situation over the next two to three years. Hence, we advise against investing in the Tokyo stock market, because we expect returns to be below average