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5 Pages • Topic Notes • Year: Pre-2021
EFB201 Tutorial 2 Solutions 1. What is an efficient capital market? Illustrate with an example. An efficient capital market is one in which prices adjust instantaneously and in an unbiased fashion to the receipt of new information. For example, if a company announces an unexpectedly large increase in profit, then this information should be impounded in the company’s share price within a very short time and there should be no expectation of making abnormal returns by purchasing shares in the company at the new price. Likewise, if the RBA unexpectedly drops interest rates, we would expect Commonwealth Bond prices to rise. 2. What would cause a market to be efficient? The main argument in support of efficiency is the existence of a competitive market in which numerous investors are competing in an effort to make abnormal returns. It is suggested that, in such a market, investors will seek information and take immediate action to buy or sell securities based on any new information. As a result, information will be impounded very quickly in market prices. Market efficiency may be improved by an increase in the quantity and quality of information that is made publicly available, and a reduction in restrictions on insider trading.
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