Question

A technical analyst believes a stock should be trading at $90, a fundamental analyst uses public information to arrive at a fair price of $80, and the company’s management believes the stock is worth $60. Currently, the stock is trading at $70. If you believe the semi-strong form of market efficiency holds, which of the following actions would make the most sense for you to take with the cash in your brokerage account:

1. Afterreviewingthestockpricechart,youagreewiththetechnicalanalyst,andyoubuythestockwhichis undervalued so you can profit when the stock price increases

2. Afterreviewingthepublicallyavailablefinancialstatements,youagreewiththesell-sideanalystthatthe company is overvalued, and you decide to sell the stock to profit when the stock price declines

3. After reviewing the publically available financial statements, you agree with the sell-side analyst that the company is undervalued, and you decide to purchase the stock to profit when the stock price increases

4. Aftercallingyoursisterwhoworksforthecompany,youlearnthatclinicaltrialsforthecompany’sphase

   III drug are not going well; you hold your cash and wait until this information is released to the public

5. After calling your sister who works for the company, you learn that clinical trials for the company’ phase III drug the company produces are not going well; you short the stock until this news is released to the public

Answer 1

The semi-strong form of market efficiency states that the stock price in the market adjusts rapidly to any new available public information.

Since the publicly available information suggest that the price should be $80 and the current stock price is $70, so in order to profit from this, the correct answer is:

After reviewing the publically available financial statements, you agree with the sell-side analyst that the company is undervalued, and you decide to purchase the stock to profit when the stock price increases