Investments Final Study Guide

Investments Final Study Guide - Investments 17 + 18: Market...

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Investments 17 + 18: Market Efficiency Defintion – An efficient capital market is one in which security prices reflect all information. General Implications: If markets are efficient, The market portfolio is most efficient risky portfolio and the optimal investment strategy is to buy and hold the market portfolio. (also known as passive or index) If markets are not efficient, The market portfolio may not be the most efficient risky portfolio and some investors may be better off adopting an active strategy where they trade a subset of the market portfolio. Must consider: 1. Transaction Costs 2. Managerial Costs 3. Tax consequences Specific Implications: If markets are efficient , 1. Prices adjust instantaneously to new information (news releases) 2. Price reactions to new information will be unbiased (market doesn’t consistently under/over react in certain manner) 3. Investors unable to earn + abnormal returns on consistent basis. Abnormal return = Actual – Expected by CAPM (depends on risk expected) Note: a stock may outperform the market based on return alone, and not be considered abnormal because the CAPM predicted that its risk level should earn a higher rate of return than the market. It is possible to have a negative abnormal return. CAPM: E(r)= Rf + B (Rm – Rf) Markets are efficient with: sufficient conditions. 1. costless information. 2.
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Investments Final Study Guide - Investments 17 + 18: Market...

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