Term Paper on "EMH and Off Balance Sheet Financing"

Term Paper 15 pages (5443 words) Sources: 1+

[EXCERPT] . . . .

EMH and off balance Sheet Financing

The studies over the fluctuations of prices in the stock markets have attracted researcher since a considerable period of time. Presently the financial market research have been an exciting field involving query of the past consequences and proposals of the new solutions. However, considerable debate is going on over the hypothesis of market efficiency. The speculative market strategy propounded by John Maynard Keynes necessitated complete reformulation in view of the unstable characteristics of the stock market. In view of its growing importance in the context of the stock market behavior the field of study of market efficiency worth detail analysis with reference to its emerging lines of thought. [the Efficient Market Hypothesis on Trial: A Survey] the concept of Efficient Market Hypothesis traces its origin to the Ph.D. dissertation of Eugene Fama. The point of reference put forth by Fama made it clear that amidst an active market situation involving fully aware and smart investors the securities are visualized to have appropriately priced and also reflects all available information. [the Efficient Market Hypothesis & the Random Walk Theory]

Fama observed that when a market is efficient no information or analysis is anticipated to result in out performance of an appropriate paradigm. According to him an efficient market is taken to mean the existence of innumerable balanced, profit maximizers actively under competition each attempting to forecast the future market prices of individual securities. There exists a mechanism where the prevailing information is freely available to all the participants. The resulting competition among the smart and fully aware participants in the efficient market paves the way to a situation where at any particular point of time the real value of the individual securities reflect the impact of information on the basis of both on events that have already transpired and on events that as of now the market anticipates to take place in the future. Thus the efficient market at any point in time reflects that the actual value of a security is considered to be a good measure of its intrinsic value. [the Efficient Market Hypothesis & the Random Walk Theory]

The financial market deals with the exchange of capital and credit that comprises of the money markets and the capital markets. The money market deals with the short-term debt securities that are particularly regarded as secured and a highly liquidated investment. The capital market on the other hand deals with the long-term debts or securities. The market efficiency implies to a condition where in the current prices reflect all the openly available information about a security. The market efficiency is based on the basic principle that the competition drives all information into the price rapidly. The best price that the investors afford in a financial market in respect of a financial asset is actually the present value of future cash payments that is discounted at a higher rate to reimburse us for the uncertainty in the cash flow projections. In this way the financial market actually deals with the trading of actual information as a commodity in financial market for the future cash flows and information about the level of certainty. The financial markets become efficient when new information is rapidly integrated in to the prices so as to make itself the information. The present market price, in other words, reflects the all presently propounded information. In such circumstances the prevailing market price in any financial market could be the most-unbiased estimation of the value of the investment. [Efficient Market Hypothesis]

The securities markets are strangled with innumerable smart, well-remunerated and fairly skilled investors in search of under and over values securities for trading. The market is said to be more efficient when there exists more number of participants and faster is the propagation of information. A prolonged debate about market efficiency gives rise to the hundreds and thousands of the empirical studies with a view to determining whether the specific markets are in fact efficient and if so to what magnitude. Paradoxically, the efficient markets if believed by each and every investor to be efficient obvert the very idea of efficiency and the market is not efficient, since no one attempts to analyze the securities. In reality the market efficiency depends upon market participants those assume the market to be inefficient and engage in trading of securities with a view to outperforming the market.

Robert C. Higgins in his publication, Analysis for financial Management depicts the market efficiency to describe the process of response of the prices in competitive market to the infusion of new information. He symbolized the advent of new information into the competitive market to the advent of a lamb chop to a group of flesh eating piranha, the investors being the representative for piranhas. As soon as the lamb chop reaches the water, there occurs much hue and cry and chaos while the piranhas are consuming the meat. Once the meat is finished leaving only the bone, the water becomes stable. This happens also in case of the market. Once the new information approaches the competitive market there is much confusion as the investors purchase and sells the sureties basing on the news resulting in significant fluctuation in the prices. Once the prices become stable and equilibrated the information is discarded just like the worthless bone. [the Efficient Market Hypothesis & the Random Walk Theory]

The further analysis of the old information fetches no valid intelligence similar to the fact that the biting on the left out bone will fetch no more meat. However, practically speaking no market is said to be either perfectly efficient or completely inefficient. It is evident that all the markets are efficient to a certain degree and some markets are observed to be more efficient than that of the others. In stead of being an issue of black or white this is symbolized to be the concerned with shades and gray. Where there is deficiency in market perfection the smarter investors thrive to outperform the comparatively ignorant investors. To illustrate, the government bond markets are visualized to be extremely efficient while the real estate and venture capital markets having no continuous markets are perceived o be less efficient due to the fact that the participants are having varying degrees of information. The argumentation over efficient market significantly influences the decision between the active and passive investing.

The active managers consider that the less efficient markets extend enough scope to the efficient managers to outperform in the market. But it is quite significant to acknowledge that a majority of the active managers amidst a given market condition under perform the appropriate paradigm in the long run irrespective of the fact of efficient or inefficient market. This is so because the active management is regarded as a zero-sum game in which the participant is visualized to make profit only when another less fortunate active participant to lose. It is also quite evident that with addition of costs even the marginally successful active managers are seen to under-perform. It is worthwhile that the investment professionals should find out the part played by the efficient markets.

The acceptance of the Efficient Market Hypothesis is justified on the ground that the primary role of a portfolio manager is the basic responsibility of the portfolio manager is to analyze and invest appropriately based on the basis of the tax considerations of the investor and the risk profile. The optimal portfolios are expected to change with the influence of elements like age, tax bracket, risk aversion and employment. The liability of the portfolio manager in such efficient market is to modify a portfolio to cater to such requirement rather than just beating the market. [the Efficient Market Hypothesis & the Random Walk Theory]

The Efficient Market Hypothesis has been taken as one of the fundamental base in the current financial economic analysis. In 1960 Fama first afford to explain the term in terms of reaction of the market prices to the newly available information. The market is said to be efficient when the possible responses to the market prices to the advent of new information is immediate and unprejudiced. The Efficient Market Hypothesis entails the basic ideology that the information is instantaneously and efficiently integrated into the asset prices at any particular point in time so that the old information is not used to forecast any future price movements. Basing on this ideology the economists attempt to distinguish between three forms of Efficient Market Hypothesis basing on the magnitude and level of available information. The weak form of Efficient Market Hypothesis specifies that the prevailing asset prices already reflect the past price and volume information.

The information integrated with the past trend of prices of a security is completely reflected in the prevailing market price in respect of the security. The concept of weak form is attached to this in view of the fact that the security prices at this stage are considered to be the most publicly and… READ MORE

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