Wednesday, November 16, 2011
Sunday, November 13, 2011
Maximising market value of company securities is important to investors due to the risk and return relationship involve in the decision making on the investment. The return of a security price is the change in the price of the security. If the price of the security increases, the investors would need to secure more of the securities and likewise when the price reduces.
From the company point of view, company must also understand market efficiency because any decision making made by the company will result in information to the market. In financial management, there are three important decisions namely the financing decision, investment decision and the dividend decision.
In financing decision, the choice between equity and debt will affect the overall cost of capital of the company. The cost of capital constitutes the cost of making use of capital from the market i.e. shareholders and lenders. If the market perceives the choice made by the company is less than desired it will increase their risk and as such news about the financing will be made available in the market. This will in turn affect the demand for the shares to reduce and likewise for the share price. A fall in a share price if not desired and the market being efficient will reduce the capitalization of the company.
An investment decision will affect cash flow of the company. As such investors will perceive a risk because of their potential dividend receivable or interest receivable. The perception whether good or bad, in addition to market being efficient will be translated as market information that will affect again the share price of the company.
Financing decision has an impact on investment decision and so is investment decision on dividend decision.
Dividend decision or policy i.e. how much being paid out and retained will send a signal to the market in respect to the affairs of the company such as cash flow availability, future projects potential or future commitment of the company. This will directly affect the demand for the share and the capitalization.
Therefore, the understand of market efficiency is important to company’s financial managers because to maximise the value of the company security, the manager needs to make sure the above three decision are made correctly.
Saturday, November 12, 2011
Investors observing patterns in stock market prices are known as technical analyst and chartist. They believe that there is a predictable pattern that moves overtime for the stock prices. The technical analysts also believe that they can earn abnormal profit if they timed their investment decision following the analysis of the pattern.
In the market efficiency hypothesis, investors believe that stock prices move in a random fashion i.e. prices in the market change with the availability of the information. There is no predictable pattern of the movements.
The technical analysis in this case is not consistent with the efficient market hypothesis this is because of the assumptions of the efficient market hypothesis. Firstly, EMH assume that the market possess the same available information as the information arrives. This enables the market to interpret quickly the available information to act in a consensus manner. In that case, it is impossible to earn abnormal profit among the investors.
The EMH, the strong form efficient efficiency the investors may only make abnormal profit if private information illegally obtained. In technical analyst, the private information about when prices will rise or fall may of little use in the EMH, mainly because the information is not encouraged. This form will be violated should the technical analyst is correct about the timing of the stock price movement.
The weak and semi-strong form efficiency will observe price movement with publicly available information and past information respectively and as such the prices move in a random manner.