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HRM (2012-14) Batch, XLRI

Prof. Mohanty

Basic FinancialManagement

Hypothesis

What will you do when

You value a stock at Rs.200 It is available in the market at Rs.50

Give Me Rs.50

Head: I give YouRs.200

Tail: I give YouRs.200

Will you play this game?

What EMH Says

Investors are rational.

Any money making opportunity willimmediately be grabbed. ow uppose you n a s. no e yng nex

to the hostel. For how long will it remain there?

Therefore the stock price at any time willalways incorporate all information in it.

Price =Intrinsic Value.

There is no free lunch.

Implications of EMH

There is no Free Lunch

If you made a lot of money, that is notnecessarily due to your ability.

The dividing line between ability and luck is verythin.

Dont expect such high returns to come in future.

Invest in a diversified portfolio and expect adecent return from this portfolio.

You may get more (or less). But that could nothave been predicted.

Suppose the market were not

efficient

Who will not believe in Market

Efficiency?

Brokerage Houses:

Mutual Funds

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HRM (2012-14) Batch, XLRI

Prof. Mohanty

Why Some People Do NotBelieve in EMH?

Empirical Evidence Behavior of Investors

Bubbles in themarket When the internet bubble busted, over $8

trillion of market value evaporated. It is asif a years output of the economies ofGermany, France, England, Italy, Spain,Holland, and Russia completelyevaporated.

Different InvestmentPhilosophies

One Question: Three Answers

A stock is trading at Rs.200. You think its truevalue is Rs.50. What will you do?

Castle in the Air Philosophy

Firm Foundation Approach

Efficient Market Hypothesis

Castle in the Air Theory

Also called Greater Fool Theory

A thing is worth only what someone.

Latin Proverb

Technical Analysis

EMH and Technical Analysis

Weak-form Efficiency

Can you predict the future stock prices by usingpast stock prices data?

es: ar e s wea - orm ne c e n

No:Market is weak-form efficient.

Market is inefficient: There are patterns inpast stock prices. They tend to repeat.

Market is efficient: There is no pattern. It isan optical illusion.

AxisBank(Correlation= 0.001) Titan(Correlation= 0.004)

10%

5%

0%

5%

10%

15%

20%

25%

20% 10% 0% 10% 20% 30%

10%

0%

10%

20%

30%

20% 10% 0% 10% 20% 30%

Wipro(Correlation= 0.048) ITC(Correlation= 0.032)

20%

15%

20%

25%

20%

15%

10%

5%

0%

5%

10%

15%

20%

25%

30% 20% 1 0% 0 % 1 0% 2 0% 3 0%

15%

10%

5%

0%

5%

10%

15%

15% 10% 5% 0% 5% 10% 1 5%

EMH Versus TechnicalAnalysis

Technical analysis.

Stock prices do

follow trends or

EMH.

No such pattern

exists. This patternpatterns.

There are investorswho have mademoney usingtechnical analysis.

or trend is an opticalillusion. The markethas no memory.

There are investorswho have lostmoney usingtechnical analysis.

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HRM (2012-14) Batch, XLRI

Prof. Mohanty

Technical Analysis Report

The markets rise after a period of reaccumulation is a

bullish sign. Nevertheless, fulcrum characteristics arenot yet clearly present and a resistance area exists40 points higher in the Dow, So it is clearly prematureo say e nex eg o e u mar e s up. , n ecoming weeks, a test of the lows holds and themarket breaks out of its flags, a further rise would beindicated. Should the lows be violated, a continuationof the intermediate term downtrend is called for. Inview of the current situation, it is a distinct possibilitythat traders will sit in the wings awaiting a clearerdelineation of the trend and the market will move in anarrow trading range.

Some other theories to makeyou lose money

Contrarian Theory

You BUY (SELL) when somebody else SELLS(BUYS).

Orange J uice Theory

Why Some People UseTechnical Analysis

.

Firm Foundation Theory Fundamental analysis

Economic analysis

Industry analysis

Believes that people behaveirrationally

Semistrong-form Efficiency

Can you predict the future stock prices by usingpublicly available data?

Yes:Market is semistrong-form inefficient

No: Market is semistrong-form efficient.

How SGX attempts to make

the market efficient

SGX-MAS research initiative

Covers 187 companies

Free membership

Should cover less-researched topics

Fundamental AnalysisVersus EMH

Fundamental analysis

Excess return can

be earned by using

EMH

Excess return

cannot be earnedfundamentalanalysis

Examples ofWarren Buffet andPeter Lynch

by usingfundamentalanalysisconsistently

Borrel CantelliLemma

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HRM (2012-14) Batch, XLRI

Prof. Mohanty

Empirical Evidence on Semi-strong Efficiency

Market is semi-strong efficient Performanceof themutual funds

Market is semi-strong inefficient Day of the week effect

Month effect (not found in India)

Value vs. Glamour stocks

Size effect

And many more

Day of the Week Effect: IndianEvidence Month Effect: India

Strong Form Efficiency

Market discounts all the informationavailable about the stock.

This includes information available to the.

Strong-form Efficiency

Can you predict the future stock prices by usingall types of data?

Yes:Market is strong-form inefficient

No:Market is strong-form efficient.

Empirical evidence shows that marketis strong form inefficient.

Moral of the Story

EMH is based on valid arguments

Unless you have very strong evidence

,the market is efficient

Examples of finance companies

A joke to summarize EMH