Phyill Young

Scroll down to Check Second Paper

Capital Market Efficiency

FIN/571

Capital Market Efficiency

In this paper, one will explain what it means to have efficient capital market by describing the behavioral challenges in achieving efficiency, by discussing the three forms of market efficiency, the implications to corporate finance and discuss whether one considers the real estate market an efficient capital market. In finance, it is important for investors to understand whether a market is efficient. Investors must also understand how the market works. An effective capital market identifies current prices and information. “Capital market efficiency is judged by its success in incorporating and inducting information, generally about the basic value of securities, into the price of securities” (Finance-Maps of World, 2016). When there is a change in the value of stocks, investors and traders alike react in ways which help them gain a higher profit.

There are three forms of market efficiency, the weak form, the semi-strong form, and the strong form. A weak efficiency implies which all stock prices and information is accurate based current prices. It also suggests there is no analysis which can be used to help investors make good trading decisions. An analysis would only identify the value of stock. Research would need to be done by investors to help them make decisions which would make them money. The semi-strong form holds to the belief which says, all information is publicly accessible, investors again cannot use analysis to make more money (Ross, Westerfield, Jaffe & Jordan, 2016). They believe which the information is no public provides the information needed to help them advance in the market. The strong form concludes all information, both public and private is included in current stock prices. With this form, there is no additional information which would help investors advance.

From a corporate finance perspective, there is no right predication with regards to the price of stock. “If capital markets were completely efficient, then the market value of the firm would reflect the present value of a firms’ expected future net cash flow” (Shanken & Smith, 1996). Finance managers need to consider all aspects of the market and maximize the firm’s value. Also, there is no benefit to anyone if the earnings per share is manipulated. When dealing with returns it is important to understand security returns are based on how the company performs in the market.

Real estate markets are not efficient. If one believes the market is efficient then it means they accept the fluctuations are based on information which is not public. Housing rates fluctuate often, usually due to supply and demand. Housing will continue to be built, which increases the supply but if there is no demand, the costs will decrease. There are too many variables in real estate which can cause prices to go up and down. Foreclosures and short sales are random, and not information which is not public.

In conclusion, having an efficient capital market is very important to businesses because the prices reflected are in real time. The information it provides help to maximize “opportunities to purchasers and sellers of securities to effect transactions without increasing transaction costs” (Investopedia, 2017). The belief in the three types of efficiencies all depends on the perspective of the investor, purchaser, or seller.

References

Finance-Maps of World. (2016). Efficient Capital Market. Retrieved from

https://finance.mapsofworld.com/capital-market/efficient.html

Investopedia. (2017). Efficient Market Hypothesis. Retrieved from

http://www.investopedia.com/terms/e/efficientmarkethypothesis.asp

Ross, Westerfield, Jaffe & Jordan. (2016). Corporate Finance. (11th edition), New York,

NY: McGraw-Hill.

Shanken, J., & Smith, C. W. (1996). Implications of Capital Markets Research for

Corporate Finance. Financial Management, 25(1), 99-104.

Paper 2

What it means to have efficient capital market,

Efficient capital market is a market where the share prices reflects the new information, accurately and in real time. Capital market efficiency is usually judged through its success in incorporating as well as inducting general information about the main value of securities, into the price of securities

Describe the behavioral challenges in achieving efficiency.

Behavioral economists attribute the inefficiency in financial markets to a combination of biases like overconfidence, overreaction, representative bias, information bias, among other predictable human errors involving reasoning and processing of information.  These error lead to most investors preferring growth stocks to value stock though buying at expensive prices, this enables those who reason correctly to profit from bargaining neglected value stocks and the overreacted selling of growth stocks. Usually, Investors prefer safer funds in autumn as well as riskier funds in spring.

Discuss the three forms of market efficiency

Weak-form efficiency

In weak-form efficiency, by analyzing prices from the past, future prices cannot be predicted. Excess returns also cannot be earned through using investment strategies that are based on either historical share prices or other historical data. This implies that future price movements are usually determined entirely by not the information that are contained in the price series. Therefore, prices ought to follow a random walk.

Semi-strong-form efficiency

Semi-strong-form efficiency implies that share prices changes with publicly available new information rapidly in an unbiased fashion, this ensures no excess returns can be earned through trading on that information. It also implies that neither analysis of fundamental nor technical analysis techniques will be in a position to reliably produce excess returns.

Strong-form efficiency

In strong-form efficiency, this is where the share prices reflects all the information, public as well as private, and that no one can earn excess returns. To test for strong-form efficiency, there is a need for market to exist where investors cannot repeatedly earn excess returns for a long time

What are the implications to corporate finance? 

If capital markets were completely efficient, the market value of the firm should then reflect present todays value of the firm's expectation of the future net cash flows. This has some important implications for corporate finance. First, managers ought to maximize today’s market value of the firm. Second, no benefit is accrued by manipulating earnings per share. Third, security returns are crucial measures of a firm’s performance. Fourth, in case of new securities being issued at market prices, this reflects an unbiased assessment of future payoffs. Finally, the much financial markets fall short efficiency still places an upper bound on such concerns.

Would you consider the real estate market an efficient capital market? Please explain why or why not. I would not consider the real estate market an efficient capital market given that Real estate don't have fluid and continuous markets, I consider it to be less efficient because different participants may have varying amounts and quality of information.

References

Olsen, E.O. (1969) “A Competitive Theory of the Housing Market”

Jones, Steven L.; Netter, Jeffry M. (2008). "Efficient Capital Markets"

Myers, Stewart C.(1974) "Interactions of Corporate Financing and Investment Decisions—Implications for Capital Budgeting."

Paper 2

Capital Market efficiency

Introduction

The stock market fluctuates every day, sometimes the market closes high and sometimes it closes below the previous days. Capital market efficiency refers to how the share prices change in a day of trading. It uses the latest information available and in real time (Capital Market Efficiency, 2017). The Capital market is expected to share and incorporate the information available so that the shares being traded can reflect the current market value. This helps promote trading efficiently and competitively.

Efficient Capital Market

Efficient Capital can be achieved by providing the latest information available, the value of stocks get traded with many competitors and all these competitors are searching for the highest profit. The three basic forms of Efficient Capital Market (EMH) are Weak, Semi-Strong and Strong-form (Efficient Capital Market, 2017). The weak refers to the market being efficient. Therefore, it reflects all available information and the stock prices reflect previous history such as the rates of return but these stocks are volatile and are much higher risk. The Semi Strong form refers to the market information being available from public and private sectors, and making it impossible to profit from new information after the market trade is complete. The form is where non-public investors can make the most profit. The Strong Form refers to the use of both weak and semi forms and relies that stock prices have release all information and investors will not earn excess in profits because all the information is included in the security values (Efficient Capital Market, 2017).

Corporate Financing

Decisions taken by organizations can have financial implications. The pecking order theory describes the process an organization would normally follow when it comes to financing.  It describes the order of financing as being internal, debt and last equity.  If an organization can finance its own projects using internal monies, that means it has good financial standing and there is no need for outside financing sources (Efficient Capital Market. 2017).   Financing with Debt seems odd to me because is used thru the issuing of bonds. Lastly, Equity, the organization no longer can finance any other way so they decide to sell stocks.  This decision can have two implications.  One, there is a possibility the organization is in trouble and needs money fast to continue producing and second, would stocks hold its price or would they drop dramatically. 

Real Estate Efficiency

Considering the real estate market as in efficient capital market would be ideal in the current economy as it has settled from a bad recession. Currently in my neighborhood, the real estate market is in high demand, hence the high prices in homes for sale (Locke, 2007). For the most, real estate capital market would be one that I would invest on in such homes as fix it uppers. There can be quick money right now as one can buy low, fix them up and resale at current market value.

Conclusion

Capital Market Efficiency is only as good as the information provided from the private and public sectors. Public trade organization have been forced to be transparent by the Sarbanes-Oxley Act of 2002 which basically states that organizations must release and share their financial statements in order to create transparency between the firm and its shareholders (The Sarbanes-Oxley Act . 2006).  But information can also affect the way cash flow is handled in common stock. Investors can get spook and run away, but it can also show great financial status that would raise the demand for the stock making it more valuable. It is up to the organization to use the proper EMH to conduct their business.

References

Capital Market Efficiency. (2017). Retrieved from

http://www.investopedia.com/walkthrough/corporate-finance/4/capital-markets/capital-market-efficiency.aspx

Efficient Capital Market. (2017). Retrieved from

http://finance.mapsofworld.com/capital-market/efficient.html

Efficient Capital Market. (2017). Retrieved from

http://www.investorwords.com/15368/efficient_capital_market.html

Locke, S. M. (2007). Real Estate Market Efficiency. Retrieved from

http://www.tandfonline.com/doi/abs/10.1080/02640828608723910?journalCode=rjpr19

The Sarbanes-Oxley Act . (2006). Retrieved from

http://www.soxlaw.com/