Why the Capital Markets Are Expected to Be Efficient - Assignment Example

Why the capital markets are expected to be ‘efficient’? Discuss Introduction The purpose of writing the paper is to provide an overview of the work which has been done in a very important area for doing the research on the financial papers to give detailed results of the common stock returns. It has been done not to be getting down in any way of technical details. The paper has got lot of important research in the discussion above. Throughout this discussion the empirical result is to maintain the financial theory of this research paper. Is it possible for investors to find trends in the past stock prices and beat the market? Explain the tests which are used to analyze the relation between the past performance and stock returns. The test which they have used for the relation between the past performance and stock returns are as follows: Markowitz Portfolio selection: This model is the single period model, where an investor can form a portfolio at the beginning of this selection process. The objective of this model is to maximize the expected return of the portfolio and to increase the level of risk. The expected return and the standard deviation are changing in a specific way. The ways in which they are being added do vary from other portfolio securities. This model is specified for those investors who are very desperate to take the risk regarding the business choose portfolio A, whereas the investors who are risk averse choose the portfolio B. Capital Asset Pricing Model (CAPM): In this model it has assumed that investors used the Markowitz in getting a portfolios, this model further assumes that there is a risk free asset which give a certain return to the investors. Having a risk free asset the investors do not have any efficient frontier that they can perform to do. In order to keep the market equilibrium it has stated that the quantity supplied is equal to the quantity demanded. So the investors can make a combination for the market portfolio and as well as for the risk free asset. If the CAPM has an accurate description than there is a positive relation that can be observed by the investors which compensates the bearing of the asset. The CAPM varies from the market portfolio that is being getting from different market places. Arbitrage Pricing Theory (APT): The CAPM is the simplest models that can be understand by the investors. As it have been stated that the CAPM is a model that is being used for the financial market equilibrium, and the APT is the opportunity for arbitrating the present in the efficient financial market. The APT has some factors which causes asset returns systematically from their expected values. It also stated that the factors which are being using also get a return which varies together from the other specified firm. This assumption is less restricted that it is used in the CAPM factor. Inter temporal Capital Asset Pricing Model (ICAPM): Both the above mentioned theories are single period method used in the research; they ignore the multi-period source of in the capital markets. The ICAPM framework is recognized the opportunity to the investors to hedge themselves in the unfavorable condition for make it available for the investment that are to be made in the efficient capital market. The most important insights of the ICAPM are the need to reflect the hedging that is demanding in the asset equation of the model. It is not stated that how many factors are there present in the models but somehow the ICAPM give us some guidance to understand or to make pout the factors that can be put to. ‘Fundamental analysis enables investors to earn abnormal profits.’ When the investors invest the capital in a stock market then the purpose of generating the profits into their investment is been done in the past. As a result the investors will not only try to make a fair return from the investment he made, but will try to expose every market and the information that has been given will seek to a abnormal returns. But to getting more factors which can lead to make an abnormal return throughout the fundamental or any technical analysis. The relevant way to give a brief discussion of the key terms that are being considering in the efficient market hypothesis which can reject the possibility of beating the market. In a strong efficient market it not possible to earn a very high profit by trading on the particular public available information, in other words, the investors who have advance knowledge about the management improvement can able to earn a high profit on trading the market. The market implies that the investors can not earn a very high adjusted risk that can lead to a profit oriented. When a positive stock respond well to the favorable information that is about the economy’s progress of the business cycle, that should not show the abnormal returns around the anticipated, that can get a actual recovery of the news that are reflecting in the current market scenario. The negative abnormal return is just the stock purchase that is suggested by the deferred of their purchase until the new is published publically. The information is more valuable than the information that is from the insider of those abnormal returns. A very small stock does not have any considerable in the amount that is being given to the market research for performing in the companies that they are representing it. Some neglected firm is implies on a greater degree of uncertain with some of the small companies. The positive effect of the CAPM is trading the stock in the necessarily to violate the efficient market hypothesis. If the market is having a premium risk that are moving in a recession, to violate the efficient market hypothesis that would apply that the investors can take advantage of the predicted risk and can earn a excess risk adjusted returns. In a changing risk premium it also requires rates of returns for the stocks than the inefficient market. The efficient market has theory that implies the three form of efficient, the current share in which the price is always influencing and representing the relevant information for the past prices that have being set by the efficient capital market. The efficient market has some equity price that reflects the past price in the market research. The fundamental analysis is a process which can examine it precisely the share price that is based on the business that has already being stated by the market researcher. The fundamental analysis are including of the earnings, cash flow, revenue and acquisition that are developing the product in the regular environment. To determine a fair quote for a price of share seek the abnormal returns. The fundamental analysis tries to determine and to do prediction about the future prices by analyzing the business statistics. It is one of the most advanced techniques for the new investors and for the insiders. The shares are analyzed and are submitted in lots of calculations which lead to technical investors. Define strong-form efficient market hypothesis (EMH) and discuss the results of a study that tests strong-form EMH. In the financial market the investors have the maximum price that is willing to pay actually the current value and the future cash payments that are discounted in the high rate of interest to compensate the uncertainty in the cash flow of the project that are done by the investors in the markets. The investors what they are doing is the actual trading for the financial market for the future cash flow project. The Efficient Market Hypothesis (EMH) is one of the most consented of modern financial economics. The idea of EMH is the information is quickly and efficiently incorporated in any point of time, so that the information cannot be used in future for the price movements. The three version of the (EMH) are discussed below on the depended level of available information. The weak form EMH is stipulated by the current prices that are already reflected by the in the past price of the volume and the information that they are providing. The information contained all the past history and the security is fully reflected in the current stock price of the company. It is said to be the weak form because the security prices are public and can be easily accessible that the information that are needed. In the weak form there are number of researcher who are studying about the past stocks and trading the volume of the particular data to generate profits (Satchell 162). This type of study is also called the technical analysis that is maintained by the EMH for predicting the future prices. The semi strong form of EMH, tells about the public available information that is similar and already it is affected by the asset price of the market. In other way in this type of form the public information is available and is fully reflected to the current market price. The public information is not only used for the past prices but it also helps in reporting the data for generating the profits in the market. This type of information available is called the forecasting future movements and securing which secures high investment returns. The strong from EMH, it is stipulated with the private information or the internal information too, it is applied in the market and therefore it cannot be used to make the abnormal profit. All the information that is public or private is reflected in the security current market price. It means the management is not able to gain information from the inside that they can hold. They do not have the right to take the profit from the managers without their permission. The aim behind is to support the future development and the information that is being provided to the market and which can evaluate the market price in an objective and in an informative way from the internal sources. The fundamental analysis is used to take information from the intrinsic value of securities in order to find out the securities that are being undervalued by the market research. However the semi strong form of market suggests the fundamental analysis that is performed in the market. For the efficient market equity research and the valuation is hardly cost task that provide benefits. The finding of the undervalued stock is that they are collecting and the equity research will not cover the cost for doing the research Conclusion In this research paper some of the pricing models being used for making understand the efficient capital market. The pricing models are the Markowitz portfolio system in which it has been defined the portfolio for the investors to make a expected return from the investment that are being made in the market. Some investors who are more likely to take risk will choose portfolio and those who do not want to get into risk will choose b. The next pricing model that is the CAPM in which it has been discussed about the risk free asset returns that varies from different investment market. The investors do not have any other frontiers so that they can perform the task that has been assigned to do so. In the arbitrage capital pricing model it tells about the about the returns that are to be get in the systematically way so that the investors can get their return that have been made throughout the year. The efficient market hypothesis is the most important part of the financial economics which helps the investors to know about the price in got the current market price information that are being flowing by the public and to make it more effective in the weak form of the efficient market hypothesis. The market researcher are still studying the past prices and as well as the current stock prices for doing the trading in the future market. Work cited Satchell, Stephen. Forecasting Expected Returns in the Financial Markets. 2011. Web. 23rd April, 2014. London: Academic Press. Print. Read More