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Principles of Corporate (9th Edition)
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Problem

Market efficiency True or false? The efficient-market hypothesis assumes that

a. There are no taxes.

b. There is perfect foresight.

c. Successive price changes are independent.

d. Investors are irrational.

e. There are no transaction costs.

f. Forecasts are unbiased.

Step-by-step solution

State true or false with respect to the efficient-market hypothesis as follows:

(a)

There are no taxes. This statement is false.

Efficient market hypothesis is an investment theory. This theory states that it is impossible to beat
the market. This is because the stock market efficiency causes the shares to reflect all the
relevant information.

As per the theory, stocks always trade on fair value on stock exchange. This does not lead to
investors buying undervalued or overvalued stock.

The efficient market hypothesis does not have any assumption of no tax. Hence, taxes are there
for efficient-market hypothesis.

Comment

(b)

There is perfect foresight. This statement is false.

Efficient market hypotheses states that the price of stock cannot be perfectly forecasted. It is a
free play market which cannot be controlled or correctly estimated. The stock prices are decided
based upon internal and external factors and demand and supply of shares.

Comment

(c)

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Recommended solutions for you in Chapter 14

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Successive price changes are independent. . This statement is true.

Efficient market hypothesis states that price of stocks are independent to the price of stock on
any other day. It is a free play market which cannot be controlled or correctly estimated.

The stock prices are decided based upon internal and external factors and demand and supply of
shares.

Comment

(d)

Investors are irrational. This statement is false.

Efficient-market hypothesis states that the investors are rational. Investors invest based upon
their requirement of return and risk. Investors in need of high return will select shares with high
return which will have high risk too.

But the decision will be based upon past experiences or studies and present and future
knowledge of external factors.

Comment

(e)

There are no transaction costs. This statement is false.

Efficient-market hypothesis does not assume that transaction costs are not present. For
economic exchange of securities, transaction cost occurs. Economic transactions of exchange of
securities have transaction cost in the form of commissions or fees.

Comment

(f)

Forecasts are unbiased. This statement is true.

Efficient-markets hypothesis make forecasts which are not related to any other decision. In other
words, estimates are unprejudiced.

It is a free play market which cannot be controlled or correctly estimated. The stock prices are
decided based upon internal and external factors and demand and supply of shares.

Comment

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Chapter 14, Problem 14PQ

“If the efficient-market hypothesis is true, the
pension fund manager might as well select a
portfolio with a pin.” Explain why…

Chapter 14, Problem 11PQ

Which of the following observations appear to
indicate market inefficiency? Explain whether the
observation appears to…

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