Chapter Four 1 Chemical Reactions in Aqueous Solutions Chapter Four.
CHAPTER FOUR
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1 CHAPTER FOUR EFFICIENT MARKETS, INVESTMENT VALUE AND MARKET PRICE
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CHAPTER FOUR. EFFICIENT MARKETS, INVESTMENT VALUE AND MARKET PRICE. DEMAND AND SUPPLY. HOW IS THE DEMAND FOR SECURITIES DETERMINED? Definition : the demand for a security is a schedule of prices and quantities demanded by investors at all possible prices. - PowerPoint PPT Presentation
Transcript of CHAPTER FOUR
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CHAPTER FOUR
EFFICIENT MARKETS, INVESTMENT VALUE AND
MARKET PRICE
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DEMAND AND SUPPLY
• HOW IS THE DEMAND FOR SECURITIES DETERMINED?– Definition: the demand for a security is a
schedule of prices and quantities demanded by investors at all possible prices.
– the demand is determined by summing the individual schedules for all investors in the market
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DEMAND AND SUPPLY
• DEMAND SCHEDULES:– When all demand schedules in the market are
combined, the result is an aggregate table of prices and quantities demanded.
– When graphed, the curve slopes from the upper left to the lower right.
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The Market Demand Schedule for IBM Stock
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IBM
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DEMAND AND SUPPLY
• HOW IS THE SUPPLY OF SECURITIES DETERMINED?– Individual brokers hold a collection of market
orders to sell at all possible prices– In combining the market orders, the resulting
market supply graph curves upward and to the right
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The Market Supply Schedule for IBM Stock
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$20
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IBM S
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DEMAND AND SUPPLY
• THE INTERACTION OF SUPPLY AND DEMAND:– The Market opens:
• an open outcry system begins as – the clerk calls out the prices for IBM
– if no buyer, clerk goes to next lower price
– if no seller, clerk raises price
– prices are called until the quantity demanded equals the quantity supplied at the “right price.”
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How Market Price Is Determined for IBM Stock
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buyerssellers
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DEMAND AND SUPPLY
• SHIFTS IN SUPPLY AND DEMAND:– What may cause a change in demand?
• more optimistic (pessimistic) investors enter the market
• investors income may change
• the supply or demand for a complementary product for the stock changes
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DEMAND AND SUPPLY
• SHIFTS IN SUPPLY AND DEMAND:– What may cause a shift in supply?
• the profitability of IBM changes
• the management of the firm changes
• the costs of the firm change
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MARKET EFFICIENCY
• WHAT IS AN EFFICIENT MARKET?– It is allocationally efficient when it distributes
funds to the most promising investments
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MARKET EFFICIENCY
– Informationally (externally) efficient• distributes information quickly and widely
• prices adjust rapidly in an unbiased manner
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MARKET EFFICIENCY
– Operationally (internally) efficient• brokers and dealers compete fairly
• low transaction costs
• high speed transactions
MARKET EFFICIENCY
• THE EFFICIENT MARKET MODEL:– Concerned with Informational Efficiency
–Also known as:• Efficient Market Theory (EMT)
• Efficient Market Hypothesis (EMH)
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MARKET EFFICIENCY
• THE EFFICIENT MARKET MODEL:– Assumptions:
• costless access to available information
• capable analysis skills by participants
• close attention to market prices which adjust appropriately
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MARKET EFFICIENCY
• THE EFFICIENT MARKET MODEL:– Investment Value
• the present value of the security’s future returns as estimated by informed investors
• a market is said to be efficient when the investment value equals the market value at all times
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MARKET EFFICIENCY
THE EFFICIENT MARKETMODEL
all informationinsider
information
public information
THE FAMA MARKET MODEL
• THE FAMA MARKET MODEL (EQUATION)
tjttjttj prEpE ,1,1, |1|
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THE FAMA MARKET MODEL
• In words -• The expected price for any security E(r)
• at the end of the period (t+1)
• is based on the security’s expected normal rate of return during that period E(rj,t+1)
• given the information set at time t (
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THE FAMA MARKET MODEL
• E(rj,t+1) is determined by
• the information set available to investors at the start
of period
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THE FAMA MARKET MODEL
• Implication:• if markets are perfectly efficient, investors cannot earn
abnormal returns based on the information set because
where xj,t+1 is the difference in price at t+1 between what is the
price and what investors expect
t t j t j t jp E p x | 1 , 1 , 1 ,
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THE FAMA MARKET MODEL
– Implication:
• In an efficient market
• there will be no expected under- or overvaluation of securities based on the available information set
0|1, ttjxE
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THE FAMA MARKET MODEL
• SECURITY PRICE CHANGES ARE A RANDOM WALK– What happens when new information arrives
changing t ?
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THE FAMA MARKET MODEL
• In an efficient market the new information is
incorporated into prices immediately.
• positive and negative information are as equally
probable
• if temporary inefficiencies cause mispricing,
investors seeking profit opportunities eliminate the
opportunities
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THE FAMA MARKET MODEL
• SUMMARY OBSERVATIONS ABOUT EFFICIENT MARKETS:– Investors will make a fair return but no more on
their investments
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THE FAMA MARKET MODEL
• SUMMARY OBSERVATIONS ABOUT EFFICIENT MARKETS:– by searching for inefficiencies, investors
ensure market efficiency
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THE FAMA MARKET MODEL
• SUMMARY OBSERVATIONS ABOUT EFFICIENT MARKETS:– publicly known investment strategies cannot
generate abnormal returns
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THE FAMA MARKET MODEL
• SUMMARY OBSERVATIONS ABOUT EFFICIENT MARKETS:– some investors will display impressive
performance records
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THE FAMA MARKET MODEL
• SUMMARY OBSERVATIONS ABOUT EFFICIENT MARKETS:– professional investors should fare no better than
ordinary investors when selecting securities
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THE FAMA MARKET MODEL
• SUMMARY OBSERVATIONS ABOUT EFFICIENT MARKETS:– past performance is not an indicator of future
performance
