LECTURE 6 Flashcards
(17 cards)
3 Qs to financing decisions
- How much debt and equity - K structure
- What types of debt and equity - SR/LR, payout policy
- When the sell them
2 different payout policies
- Pay shareholders dividends
2. Repurchase shares
3 ways financing decisions can create value
- Lack of knowledge of investors about risk of complex securities
- Reduce cost or increase subsidies
- Create new complex & specialised securities
What can we use to show subsidised financing can create value?
NPV
EMH states that…
prices reflect all relevant and available info, assets on SML, impossible to benefit from finding assets not on SML all the time - can only in SR and with luck. Immediate adjustment.
What do we assume about info?
Freely available to all investors
3 conditions to lead to efficiency
- Rationality & homogenous
- Independent deviations from rationality - no herding
- Arbitrageurs act quickly to force prices back to equilibrium.
Weak EMH
Only data available = historical prices
Almost quick but small time lag
Some reasonable analysis may allow investors to profit
Weak EMH model
Random walk Pt = Pt-1 + E(r) + et No serial correlation between past and current prices No pattern = cannot predict Returns across days uncorrelated
Evidence against weak EMH
MOMENTUM - evidence returns are actually correlated across days
Semi strong EMH
Past prices + other PUBLIC info
Very quick - almost no time lag
Some investors with private info can profit but only for very short period of time.
Semi strong EMH model
Abnormal returns: ARt = Rit - Rmt
Stock return - return on market index
No time lag: info release at time t affects ARt
strong EMH
All public + private info
Instantaneous - no delay
No investor has superiority and no time to profit
How to test strong EMH
See if a hedge fund consistently manages to outperform the market index
Why are there limits to arbitrage?
Not risk-free and without cost - may need to borrow, limits to number of shares they can buy and slow reactions.
5 lessons of EMH
- Markets have no memory
- trust market prices
- Use info hidden in the data
- No need to use hedge funds- do it yourself
- Shares perfect substitutes - what matters is risk-return not name of company.
3 implications of inefficient markets
- Do nt engage in speculation if financial manager of nn-financial company
- If share mis-priced, do not issue more shares - if overpriced encourage shareholders to sell, if underpriced borrow.
- If share price caught in a bubble, increase real assets
