Chapter 13: Efficiency Of Capital Markets and Random Walks Flashcards
The degree to which stock prices reflect all available relevant information.
Efficient Capital Markets (A market that efficiently processes information)
The theory that stock price changes have the same distribution and are independent of each other, so the past movement or trend of a stock price or market cannot be used to predict its future movement
Random Walk Hypothesis
A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities (formula)
CAPM (risk free rate + beta (expected market return -risk free rate))
The general idea behind CAPM is that
Investors need to be compensated in two ways: time value of money and risk
In the CAPM, the time value of money is represented by
The risk free rate and it compensates the investors for placing what in any investment over a period of time
Beta(expected market return - risk free rate) represents the amount of
Compensation the investor needs for taking on additional risk
A theory on how risk-averse investors can construct portfolios in order to optimize market risk for expected returns, emphasizing that risk is an inherent part of higher reward
Modern Portfolio Theory (Portfolio Theory or Portfolio Management Theory)
A relationship between the risk an expected return on a stock.
Risk/Return Line
The higher the risk, the greater the return the stock should have
When the stock prices react immediately to new information
Immediate Adjustment (efficient markets do this)
When the stock prices react slowly to new news
Gradual adjustment
Occurs when the market slowly processes news and investors are able to take advantage of this by earning large, high returns on a stock.
Abnormally high returns (efficient markets would not allow this high a return as they would process information instantaneously)
One of the different degrees of efficient market hypothesis (EMH) that claims all past prices of a stock are reflected in today’s stock price. Therefore, technical analysis cannot be used to predict and beat a market
Weak form of efficient market
A class of EMH (Efficient Market Hypothesis) that implies all public information is calculated into a stock’s current share price. Meaning that neither fundamental nor technical analysis can be used to achieve superior gains
Semi-Strong Form of Efficient Market
The strongest version of market efficiency. It states all information in a market, whether public or private, is accounted for in a stock price. Not even insider information could give an investor the advantage
Strong form of efficient market
How much you have gained after all expenses
Gross Return
