Question

9. Efficient markets hypothesis 

Which of the following are consistent with the efficient markets hypothesis? Check all that apply. 

1. You should spend several hours a day studying the business section of your local newspaper to determine which stocks to add to your Investment portfolio 

2. An average person in the market will believe that all stocks are fairly valued. 

3. A positive release about a company will increase the value and stock price for that firm.

Answer 1

Ans: Efficient marked hypothesis suggests that-:

• An average person in the market will believe that all stocks are fairly priced.
• A positive news about the company would increase the value and stock price for that firm.

Explanation-: The efficient market hypothesis advocates that all stocks are fairly priced.

• The information regarding the stock and the company is fairly reflected in the prices. (Any positive information or negative information will be reflected in prices)
• It is impossible to predict the pattern and trend of the stock market because it follows a random walk. (So it does not suggest to do a long analysis about which stock is to be taken up for investment as they follow a random walk)

Answer 2

Ans:

B) At the market price, the number of people who believe the stock is overvalued exactly equals the number of people who think the stock is undervalued.

C) A positive news release about a company will increase the value and stock price for that firm.

Explanation:

Option B is technically consistent with the hypothesis, but the hypothesis doesn't really have anything to do with the 'number' of people believing stock is undervalued or overvalued. Since option B is technically 'consistent' with the hypothesis, it could be true.

Option C is consistent with the hypothesis.

Option A is largely inconsistent with the efficient market hypothesis since, in an efficient market, all the information in the business sections of the newspapers is already taken into account in the prices of the stocks and shares that are available.