Efficient Market Hypothesis

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Fundamental analysis
Learning outcomes –
Understanding the aspects of fundamental analysis

Understanding and applying the techniques of fundamental analysis
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Fundamental analysis (FA) is a method of measuring

a security's intrinsic value by examining related economic and financial
factors.
The end goal is to arrive at a number that an investor can compare with
a security's current price in order to see whether the security is
undervalued or overvalued.
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Efficient Market Hypothesis
• The Efficient Market Hypothesis, known as EMH in the investment

community, is one of the underlying reasons investors may choose a
passive investing strategy. Although fans of index funds may not know
it, EMH helps to explain the valid rationale of buying these passive
mutual funds and exchange-traded funds (ETFs).
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?????
Which among the following is not a passive style of investing?
a) Regularly trading in stocks

b) Buying ETFs
c) Buying Index funds
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Efficient Market Hypothesis (EMH) Definition
The Efficient Market Hypothesis (EMH) essentially says that all known information
about investment securities, such as stocks, is already factored into the prices of
those securities. Therefore, assuming this is true, no amount of analysis can give an
investor an edge over other investors, collectively known as "the market.“
EMH does not require that investors be rational; it says that individual investors will
act randomly, but as a whole, the market is always "right." In simple terms,
"efficient" implies "normal."
For example, an unusual reaction to unusual information is normal. If a crowd
suddenly starts running in one direction, it's normal for you to run in that direction
as well, even if there isn't a rational reason for doing so.
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Forms of EMH
There are three forms of EMH: weak, semi-strong, and strong. Here's
what each says about the market –
Weak Form EMH: Suggests that all past information is priced into

securities. Fundamental analysis of securities can provide an investor
with information to produce returns above market averages in the
short term, but there are no "patterns" that exist.
Therefore, fundamental analysis does not provide long-term advantage
and technical analysis will not work.
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Forms of EMH
Semi-Strong Form EMH: Implies that neither fundamental analysis nor
technical analysis can provide an advantage for an investor and that
new information is instantly priced in to securities.
Strong Form EMH: Says that all information, both public and private, is
priced into stocks and that no investor can gain advantage over the
market as a whole. Strong Form EMH does not say some investors or
money managers are incapable of capturing abnormally high returns
because that there are always outliers included in the averages.
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Forms of EMH
EMH does not say that no investors can outperform the market; it says
that there are outliers that can beat the market averages; however,
there are also outliers that dramatically lose to the market. The
majority is closer to the median. Those who "win" are lucky and those
who "lose" are unlucky.
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?????
An efficient market hypothesis states all public information which is
reflected in current market prices is classified as –
a) Weak form efficiency

b) Strong form efficiency
c) Market efficiency
d) Semi strong efficiency
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?????
An efficient market is defined as one in which:
a) all participants have the same opportunity to make the make the same
returns.
b) all participants have the same legal rights and transactions costs.
c) securities’ prices quickly and fully reflect all available information.
d) securities’ prices are completely in line with the intrinsic value.
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Bottom Line
If you believe that the stock market is unpredictable with random
movements in price up and down, you would generally support the
efficient market hypothesis.
However, a short-term trader might reject the ideas put forth from
EMH because they believe that an investor can predict movements in
stock prices.
For most investors, a passive, buy-and-hold, long-term strategy is
appropriate because capital markets are mostly unpredictable with
random movements in price up and down.
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Market Efficiency
The Efficient market hypothesis (EMH) is a theory that
asserts: As a practical matter, the major financial markets
reflect all relevant information at a given time.
Market efficiency research examines the relationship

between stock prices and available information.
• The important research question: is it possible for investors to “beat
the market?”
• Prediction of the EMH theory: if a market is efficient, it is not possible
to “beat the market” (except by luck).
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What Does “Beat the Market” Mean?
The excess return on an investment is the
return in excess of that earned by other
investments that have the same risk.
“Beating the market” means consistently

earning a positive excess return.
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Forms of Market Efficiency (i.e., what information is used?)
 A Weak-form Efficient Market is one in which past prices and volume

figures are of no use in beating the market.
 If so, then technical analysis is of little use.
 A Semistrong-form Efficient Market is one in which publicly available

information is of no use in beating the market.
 If so, then fundamental analysis is of little use.
 A Strong-form Efficient Market is one in which information of any kind,

public or private, is of no use in beating the market.
• If so, then “inside information” is of little use.
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Information Sets for Market Efficiency
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Arguments against EMH
Huge market swings seem to be inconsistent with the idea that prices
accurately reflect all available information. During the flash crash the
price of Proctor and Gamble stock fluctuated from as little as a few
cents and as high as $100,000 over the course of just a few hours.
There was little to no new information about these companies
revealed during this time. More strikingly, the huge and sustained
downturns of 2000 and 2007 also do not seem to have been
precipitated
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Why Would a Market be Efficient?
The driving force toward market efficiency is simply

competition and the profit motive.
Even a relatively small performance enhancement can be

worth a tremendous amount of money (when multiplied by
the dollar amount involved).
This creates incentives to unearth relevant information and

use it.
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7-1

Understanding the aspects of fundamental analysis

Fundamental analysis (FA) is a method of measuring

• The Efficient Market Hypothesis, known as EMH in the investment

Which among the following is not a passive style of investing?

a) Regularly trading in stocks

Weak Form EMH: Suggests that all past information is priced into

a) Weak form efficiency

An efficient market is defined as one in which:

Market efficiency research examines the relationship

“Beating the market” means consistently

 A Weak-form Efficient Market is one in which past prices and volume

 A Semistrong-form Efficient Market is one in which publicly available

 A Strong-form Efficient Market is one in which information of any kind,

The driving force toward market efficiency is simply

Even a relatively small performance enhancement can be

This creates incentives to unearth relevant information and

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