StrongPCMP4e-ch08.pptVIP

Chapter 8The Capital Markets and Market Efficiency No matter how many winners you’ve got, if you either leverage too much or do anything that gives you the chance of having a zero in there, it’ll all turn into pumpkins and mice. Warren Buffett Outline Introduction Role of the Capital Markets Efficient Market Hypothesis Anomalies Introduction Capital market theory springs from the notion that: People like return People do not like risk Dispersion around expected return is a reasonable measure of risk Role of the Capital Markets Definition Economic Function Continuous Pricing Function Fair Price Function Definition Capital markets trade securities with lives of more than one year Examples of capital markets New York Stock Exchange (NYSE) American Stock Exchange (AMEX) Chicago Board of Trade Chicago Board Options Exchange (CBOE) Economic Function The economic function of capital markets facilitates the transfer of money from savers to borrowers e.g., mortgages, Treasury bonds, corporate stocks and bonds Continuous Pricing Function The continuous pricing function of capital markets means prices are available moment by moment Continuous prices are an advantage to investors Investors are less confident in their ability to get a quick quotation for securities that do not trade often Fair Price Function The fair price function of capital markets means that an investor can trust the financial system The function removes the fear of buying or selling at an unreasonable price The more participants and the more formal the marketplace, the greater the likelihood that the buyer is getting a fair price Efficient Market Hypothesis Definition Types of Efficiency Weak Form Semi-Strong Form Strong Form Semi-Efficient Market Hypothesis Security Prices and Random Walks Definition The efficient market hypothesis (EMH) is the theory supporting the notion that market prices are in fact fair The EMH is perhaps the most important paradigm in finance Types of Efficiency Ope