A. You may not have heard of the Efficient market hypothesis, also known as EMH, but you have probably wondered why even the most experienced mutual fund portfolio managers and other professional investors often lose to the major market indexes such as the S&P 500 Index.
i. Provide a thorough explanation of an efficient market. (2 marks)
ii. Describe the three (3) forms of efficient market hypothesis. (9 marks)
iii. Does market efficiency mean you can randomly pick stocks from a stock exchange to form your portfolio? (4 marks)
iv. What does it mean by the price you pay for a stock is fair? (2marks)
B. Explain briefly the difference between a stock market and stock exchange giving an example in each case. (3 marks)
C. List and clearly explain five (5) risks management techniques available to mitigate risk in the Zambian financial markets. (5 marks)
i Efficiency of a market refers to the capability of prices to reflect all available information. Efficiency Market Hypothesis (EMH) argues that all markets are efficient, meaning there is no room of making excess profits through investing because everything is already accurately and fairly priced. Going by this, there is little hope of beating the market. However, market returns can be matched via passive index investing.
ii. The three forms of EMH are:
a. Weak Form EMH
In this form, past information is priced into securities. The securities analysis can provide information that can be used in production of returns above market averages in the short term.
b. Semi-strong Form
This form holds tha both technical and fundamental analyses cannot provide an advantage. New infonrmation is priced instantly into securities.
c. Strong Form EMH
In this form, both private and public information is priced into stocks. Consequently, no investor gains advantage over the market.
EMH only implies that the prices ought to be correct signals since it already has incorporated all information available.
iv. Fair value is the agreed sale price between a willing seller and buyer. The stock fair value is ususally determined by the market where the stock is traded.
Stock market is the sum aggregate of buyers and sellers who trade in stocks. For example OTC
Stock exchange is defined as the infrastructure that facilitates stock market activities such as buying and selling shares. For example NSE.
In this case the risk is completely avoided hence there is 0% probability of suffering loss.
ii. Loss Prevention
This technique limits losses. A risk is accepted but losses are minimized.
iii. Loss reduction.
In this case losses are minimized in case of a threat
Technique that involves dispersion of key assets. If something catastrophic occurs in one location, only assets in that location are affected.
A risk control tactic that involves creation of a back up plan necessitated by technology.