Question

QUESTION THREE

In the context of the efficient market hypothesis;

1. Describe the weak form, the semi-strong form and the strong form of capital market efficiency.                                                                      (9 Marks)
2. Which form, if any, do you favor and why?                                                                                      (3 Marks)
3. In your opinion, in what form is our Zambian capital market and why. (4 Marks)
4. What should be done, if any, to bring it to the form you favour?                                                                                      (4 Marks)

[TOTAL: 20 MARKS]

Answer 1

1. The Efficient Market Hypothesis (EMH) essentially says that all known information about investment securities, such as stocks, is already factored into the prices of those securities. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stock or sell stocks.

A Weak Efficient Market Hypothesis
The weak form of EMH says that you cannot predict future stock prices on the basis of past stock prices. Weak-form EMH is a shot aimed directly at technical analysis. If past stock prices don’t help to predict future prices, there’s no point in looking at them — no point in trying to discern patterns in stock charts.
B. Semi-Strong Efficient Market Hypothesis
The semi-strong form of EMH says that you cannot use any published information to predict future prices. Semi-strong EMH is a shot aimed at fundamental analysis. If all published information is already reflected in a stock’s price, then there’s nothing to be gained from looking at financial statements or from paying somebody (i.e., a fund manager) to do that for you.
C. Strong Efficient Market Hypothesis
The strong form of EMH says that everything that is knowable — even unpublished information — has already been reflected in present prices. The implication here would be that even if you have some inside information and could legally trade based upon it, you would gain nothing by doing so.

2. Strong Efficient Market Hypothesis comes in favourable condition as all information, whether public or private, is fully reflected in a security’s current market price. This means no long-term gains are possible, even for the management of a company, with access to insider information. They are not able to take the advantage to profit from information such as a takeover decision which may have been made a few minutes ago. The rationale to support this is that the market anticipates in an unbiased manner, future developments and therefore information has been incorporated and evaluated into the market price in a much more objective and informative way than company insiders can take advantage of.

3. While the Efficient Market Hypothesis (EHM) has been widely accepted as robust by many researchers in the field of capital markets, the hypothesis, the weak form efficiency of the Zimbabwe Stock Exchange (ZSE) is tested. Stock returns used in the analysis were controlled for thin trading and it was discovered that once returns are controlled for thin trading, they are independent of each other across time. They proposes that if markets are efficient then professional investment management is of little value if any; hence the position of professional investment managers in efficient markets is investigated. Although the ZSE is found to be efficient, at least in the weak form, it is argued that achieving efficiency does not necessarily make the investment manager’s role obsolete. Investment managers are needed even when the market can be proved to be efficient.

4. EMH asserts that financial markets are informational efficient and should therefore move unpredictably. In consequence of this, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made.