Sunday, March 1, 2009

Corporate Finance chpter 13

Corporate financing decisions and efficient capital markets


  1. The Different Types of Efficiency

Weak Form

Security prices reflect all historical information.

Semistrong Form

Security prices reflect all publicly available information.

Strong Form

Security prices reflect all information—public and private.


Studies fall into three broad categories:

1. Are changes in stock prices random? Are there profitable “trading rules?”

2. Event studies: does the market quickly and accurately respond to new information?

3. The record of professionally managed investment firms.


Financial Economists have sorted themselves into three camps:

1. Market efficiency

2. Behavioral finance

3. Those that admit that they do not know


The EMH has three implications for corporate finance:

1. The price of a company’s stock cannot be affected by a change in accounting.

2. Financial managers cannot “time” issues of stocks and bonds using publicly available information.

3. A firm can sell as many shares of stocks or bonds as it desires without depressing prices.

The Behavioral Challenge

Rationality

People are not always rational.

Many investors fail to diversify, trade too much, and seem to try to maximize taxes by selling winners and holding losers.

Independent Deviations from Rationality

Psychologists argue that people deviate from rationality in predictable ways:

Representativeness: drawing conclusions from too little data

This can lead to bubbles in security prices.

Conservativism: people are too slow in adjusting their beliefs to new information.

Security prices seem to respond too slowly to earnings surprises.

Arbitrage

Suppose that your superior, rational, analysis shows that company ABC is overpriced.

Arbitrage would suggest that you should short the shares.

After the rest of the investors come to their senses, you make money because you were smart enough to “sell high and buy low.”

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