Forum 6 & 7

Forum 6 & 7

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Forum 6 & 7

Forum 6 Efficient Market
The efficient market hypothesis is interpreted in a weak form, a semi-strong form, and a strong form. How can we differentiate its various forms?

A market is efficient if transaction prices fully reflect in an unbiased manner all available price-sensitive information the market hypothesis is divided into weak market hypothesis, semi strong form of efficiency and the strong form of efficiency (Broyles, 2003).

The weak form of efficiency market hypothesis assumes that, the share prices fully reflect all security market information contained in past price movements, which include rates of return, trading volume, block trades etc. therefore it is pointless basing trading rules on share price history, as the future cannot be predicted.

The semi strong form of efficient market hypothesis explains that share prices fully reflect all the relevant publicly available information. This includes not only the past price movements but also all the public information such as stock prices, earnings and dividend announcements. This implies that there is no need of scrutinizing publicly available information after it has been released because the market is already absorbed into the price.

The strong efficiency market hypothesis assumes that the stock prices fully reflect all information from public and private sources. According to this hypothesis, nobody has the monopolistic access to information relevant to the investment. It encompasses both the weak and the semi strong forms. Here the focus is on the insider trading, in which only a few privileged individuals like the directors can trade in shares, as they know more compared to the normal investor in the market (Bhole, 2009).

Forum 7 Binds & Interest Rates
Discuss the relationship between bond prices and interest rates. What impact do changing interest rates have on the price of long-term bonds versus short-term bonds?

Bond prices and their interest rates vary inversely. For a specific absolute change in bond prices when rates fall exceeds the proportionate decrease in bond prices when the rates rises. The proportionate difference increases with maturity and is larger the lower the bond’s interest payment. Long-term bond changes proportionately more in price than short-term bonds for a given change in interest rate.

Bonds that take a long time to mature will have a grater risk to the company issuing the bond and will experience financial trouble. It occasionally may be difficult to sell a long-maturity bond because investors may be unwilling to lock in their money at low rates for long maturities, during low interest rate periods. Long maturities have increased interest rate risk because their prices fluctuate more, per a given change in market interest rates, than do the prices of short-maturity bonds, for the same rate of change. Further, if you buy a long bond during a high interest rate period to lock in the high yield, the bond will be called away and refinanced at lower rates when interest rates decline (Bhole, 2009).

Shorter maturities have less risk, so their interest rates do not have to be as high as long-term maturities to be able to attract buyers. There is less risk that a company’s financial status will go down during a 5-year term than during a 40-year term. They mature before there is any risk of the bond being pulled off the market for refinancing at lower rates. In fact, the main problem with short maturities arises during periods of high interest rates when investors want to lock in the high yields for as long a period of time as possible.

References

Bhole, L. M., & Mahakud, J. (2009). Financial institutions and markets: Structure, growth and innovations. New Delhi: Tata McGraw-Hill.

Broyles, J. E. (2003). Financial management and real options. Chichester: Wiley.