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Chapter 18 Market Efficiency

Answer Test your understanding 1

(1) It is at most semi-strong.(2) It is not efficient at all.

(3) It is strong form.

(4) It is at most weak form.

Examination Style uestion

Answer 1

!eak form efficiency"

1. Stock market efficiency usually refers to the way in which the prices of traded

financial securities reflect rele ant information. !hen research indicates that

share prices fully and fairly reflect past information " a stock market is

descri#ed as weak-form efficient.

2. In estors cannot generate a#normal returns #y analysing past information "

such as share price mo ements in pre ious time periods" in such a market" since

research shows that there is no correlation #etween share price mo ements in

successi e periods of time. Share prices appear to follow a $random walk% #y

responding to new information as it #ecomes a aila#le.$1 % marks&

Semi'strong from"

1. !hen research indicates that share prices fully and fairly reflect pu#lic

information as well as past information " a stock market is descri#ed as semi-

strong form efficient.

2. In estors cannot generate a#normal returns #y analysing either pu#lic

information( such as pu#lished company reports( or past information " since

research shows that share prices respond &uickly and accurately to newinformation as it #ecomes pu#licly a aila#le.

$1 % marks&

Strong from"

1. If research indicates that share prices fully and fairly reflect not only pu#lic

information and past information( #ut pri)ate information as well " a stock

market is descri#ed as strong form efficient.

2. ' en in)estors with access to insider information cannot generate a#normal

returns in such a market . esting for strong form efficiency is indirect in

nature" e amining for e ample the performance of e pert analysts such as fund

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managers. Stock markets are not held to #e strong form efficient.

$1 % marks&

Significance of semi'strong form efficiency"

1. he significance to a listed company of its shares #eing traded on a stock

market which is found to #e semi-strong form efficient is that any information

relating to the company is *uickly and accurately reflected in its share

price .

2. Managers will not #e a#le to decei)e the market #y the timing or

presentation of new information " such as annual reports or analysts% #riefings"

since the market processes the information &uickly and accurately to produce

fair prices.

3. Managers should therefore simply concentrate on making financial

decisions which increase the wealth of shareholders .

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ACCA Marking Scheme

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