Efficient Market Hypothesis Case Study Example | Topics and Well Written Essays - 2000 words

Efficient Market Hypothesis - Case Study mannequinIn fact investors can predict the future personal line of credit prices, based on the past stock prices and even by analyzing financial information such as company earnings and asset esteems. This paper would examine the relationship between EMH and the future predictions of stock prices based on technical and fundamental analysis.When stocks go up by high percentages the analysts could say that it was due to the efficacy of stock markets and in that locationfore the positive rally reflected the rightful(a) performance of the company. Efficient markets do exist in hypothesis (Dobbins, & Witt, 1979). For example according to financial theory there are efficient stock markets that especially dont permit market manipulation by investors. in time the practical scenario negates this proposition very often. For instance the rally of the stock could be attributed partly to the equity complete and not to the efficiency of the mark ets.According to many financial economists that future stock/share prices are partially predictable on the basis of past stock price patterns as well as several(prenominal) fundamental valuation metrics. Further economists pointed that these predictable patterns lead investors to earn excess returns with reference to excess try adjusted rates. The following three problems explain why excessive reliance on fundamental financial analysis isnt going to benefit the investor or shareholder.As(a). Asset substitution problem As and when debt to equity proportionality increases investors tend to substitute new assets through new investment therefore relatively increasing debt in place of equity. Assuming that investing is riskier, there is still a fairer chance of success against failure thus obliging both debt-holders and share holders to condone such risky investment decisions on the part of guidance (Campbell, 1987). Successful investments on shares lead to cumulative share holder benefits while unsuccessful ones lead to cumulative debt-holder woes.(b). Underinvestment problem Investors would not hesitate to reject investment in shares with positive Net Present measure (NPV) because they would not be bothered to increase the value of the firm any more than to allow the accrual of benefits associated with riskier debt to debt-holders themselves rather than to share holders.(c). Free cash flow problem Finally there is the problem of ingenuous cash flow. In the absence of free cash flow benefits accruing to investors, the management has a tendency to cut down the value of the firm through prodigal behavior, such as granting bonuses and higher salaries. Therefore higher levels of supplement would act as a preventive factor of such behavior and ensure discipline. 2. Overall analysisNext there is the problem of taxes. When corporate taxes are considered the firm is entitled to interest expense deduction which enables it to increase value of its assets. Accordi ng to Modigliani and Miller (1963) the tax exemption allows the firm to reduce the leverage-based premium in the cost associated with facts of life the equity capital. Subsequently Miller added personal taxes to the equation.Some authors go a long way to discuss the nigh efficient ways in managing systematic risk, unsystematic risk and total