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Unformatted text preview: End of Chapter 10 Questions, Problems and Solutions CORPORATE FINANCE Professor Megginson February 27, 2003 Questions [See problems in book] *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** Answers to End of Chapter 10 Questions 10-1 . Informational efficiency refers to how quickly the markets incorporate new information into security prices. This can impact corporate finance and investment decisions if all information is not incorporated into the firms stock price. For example, the stock may be undervalued because managers have good news about the company that they have not imparted to the markets. If the firm is underpriced, this could impact the firms ability to raise new equity, which in turn could impact the firms financing and investment decisions. In an efficient market, a manager will not be able to enhance shareholder value through changes in financial reporting that have no impact on cash flows. Investors will see through these changes and recognize that they are cosmetic only and have no impact on firm value. 10-2. Informational efficiency refers to how quickly the markets incorporate new information into security prices. Allocative efficiency means that markets channel resources to their most productive uses. Operational efficiency determines whether market produce outputs at the lowest possible costs. The existence of one does not imply the existence of the others. All companies could be operationally inefficient, while the market is still allocative and information efficient. 10-3. Weak form efficiency states that all past information, for example about stock prices or volumes is incorporated into stock prices. This says it is not possible to earn excess returns using historical information and by implication, that technical analysis is valueless. Semi-strong form efficiency states that the market is weak form efficient and in addition incorporates all publicly available information into stock prices. This says that fundamental analysis is valueless. Strong form efficiency says that all information public or private is incorporated into stock prices. This says it is not possible to earn excess returns under any circumstances and that all securities are fairly priced, reflecting all information. 10-4 . A random walk means that stock prices move up and down randomly, reacting to new information as it as received. Since by definition, randomly received information cannot be predicted, this is the basis for weak form efficiency that it is impossible to use past price history to predict future stock prices....
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