CHAPTER FIVE SECURITY ANALYSIS Introduction

Transcript:CHAPTER FIVE SECURITY ANALYSIS Introduction:
CHAPTER FIVE SECURITY ANALYSIS Introduction Security analysis is the means of determining the prices of shares. It follows three security analysis approaches: Market efficiency hypothesis Fundamental analysis and Technical analysis The Efficient Market Hypothesis An efficient capital market is one in which security prices adjust rapidly to the arrival of new information and, therefore, the current prices of securities reflect all information about the security. Efficient Market Hypothesis/Theory (EMH) and Its Implication This topic/section deals with the efficient market hypothesis and its implication for determination of share prices. There are various theories which seek to provide a rationale for share price movement. The most important of these is the efficient market hypothesis, which provides theoretical underpinning for how markets take into account new information. The chapter also looks at practical issues. Definition of Efficient Markets: An efficient capital market is a market that is efficient in processing information. We are talking about an “informationally efficient” market, as opposed to a “transactionally efficient” market. In other words, we mean that the market quickly and correctly adjusts to new information. In an informationally efficient market, the prices of securities, such as share, observed at any time are based on “correct” evaluation of all information available at that time. Therefore, in an efficient market, prices immediately and fully reflect available information. Definition of Efficient Markets Professor Eugene Fama, defined market efficiency as follows: "In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic/true value." that fully reflects the available information. Fama, Eugene, "Random Walks in Stock Market Prices,” Financial Analysts Journal , 1965. Cont’d The theory behind share price movements can be explained by the three forms of the efficient market hypothesis. 1.Weak form efficiency implies that prices reflect all relevant information about past price movements and their implications. 2. Semi-strong form efficiency implies that prices reflect past price movements and publicly available knowledge. 3. Strong form efficiency implies that prices reflect past price movements, publicly available knowledge and inside knowledge. The