EMH and Off Balance Sheet Term Paper

  • Length: 15 pages
  • Subject: Economics
  • Type: Term Paper
  • Paper: #81640266

Excerpt from Term Paper :

This indicates that none is capable of outperforming the market with the use of something that 'that everybody else knows'. Still there exists a number of financial analysis those study the past trend of stock prices and the trend in trading volume as an effort to generate profit. Such technical analysis is viewed by Efficient Market Hypothesis as not effective in forecasting the variations in the fluctuations of future prices. The semi-strong form of Efficient Market Hypothesis reflects that all openly available information is already integrated into the asset prices. Speaking other way, all openly available market information is completely reflected in the current price of the securities.

The public information depicted not only the past prices but also includes the data published in the financial statements of the company, the declarations made in the company, economic and others factors. It also specifies that none is capable of outperforming the market with utilization of the information that everybody knows. This ensures that the financial statements of the company are not considered to be of much use in predicting the future trends of price fluctuations and securing high investment returns. The strong form of Efficient Market Hypothesis specifies that the private information or insider information is rapidly integrated into the market prices and therefore is not utilized to gather abnormal trading profits. Similarly, all information irrespective of public or private is fully reproduced in the prevailing market price of the securities.

This implies that the insider that is the management of the company even is not capable of taking advantage from the information they retain. They are not able to take the benefits of availing the latest information such as the decisions made just ten minutes ago so as to effectively make profit. The underlying principle behind the hypothesis is that the market predictions are unprejudiced. Therefore, the information is integrated and assessed into the market price in much more purposefully and enlightening way than the insiders in the management itself retains. An extension of the Efficient Market Hypothesis is seen in the random walk model which upheld the truism that the markets can never be persistently crashed, making the arbitration impossible and the 'free lunches' are generally unavailable. [Efficient Market Hypothesis]

The strong form of Efficient Market Hypothesis indicates that the securities prices integrate all the available information. It is, however, quite evident that the insiders those in the management have enough scope to benefit in terms of higher profits from the available trading on information not yet incorporated into the market prices. Seyhun, therefore, viewed that the strong form of Efficient Market Hypothesis cannot exist amidst real world phenomenon which can not be considered as unprivileged. Efforts have also made to include the weak form of Efficient Market Hypothesis in the current research analysis, incorporating the tests of market efficiency. The extension of the concept of the weak form was visualized by Fama in 1991 for incorporating predictions future returns with the use of accounting or macro-economic variables However, widespread differences of opinion prevails on the magnitude of market efficiency. This is further aggravated by the problem of joint hypothesis.

The evaluation of market efficiency involves an asset pricing model. If the trend is against the market efficiency it is inferred that either the market is inefficient or it may be that the model is quite erroneous. Ample research findings have been advanced to substantiate the inefficiencies involved in the model making the efficacy of the model suspicious. However, among all these three forms of the Efficient Market Hypothesis, the semi-strong form of Efficiency Market Hypothesis is considered to constitute the fundamental basis of the most of the empirical studies. The semi-strong form of Efficient Market Hypothesis assumes that the security prices incorporate all the openly available information. There exist no undervalued or overvalued securities that obvert the trading rules to influence for superior returns. A release of new information is completely integrated into the price rapidly. The advent of the updated information facilitated evaluation that has evidenced profound influences over the stock prices instantaneously. [the Efficient Market Hypothesis on Trial: A Survey]

The Efficient Market Hypothesis infers that none can outperform the market on the basis of the security selection or through market timing. It is seen that the Efficient Market Hypothesis involves many negative inferences that influence the investment strategies considerably. Normally the influence of Efficient Market Hypothesis can be perceived in two directions. Firstly it is from the investor's perspective. The past trend with regard to the price and volume in respect of trading is considered as the base for forecasting the prospective prices. The indication of random walk recommends that the prices in respect of the securities are influenced considerably the information. The information that is considered favorable enhances the price and unfavorable information on the other hand declines the price. On this jargon it is considered proper to assess the value of the technical analysis as a technique for selecting the security investments.

The fundamentals analysis involves utilization of the market information so as to determine the intrinsic value of securities in order to determine those securities that are undervalued. Moreover, the form of semi-strong market efficiency indicates that the fundamentals analysis cannot be used to outperform the market. The equity research and valuation in an efficient market are perceived to costly affairs and entails no advantage. The probability of attaining an undervalued stock is considered only 50%. It is perceived that most of the time the advantages accrued out of the benefits from information collection and equity research may not even surpass the costs incurred in the research activity. The passive investment strategy is recommended to be followed by the investors as the best available investment strategy that does not try to beat the market. The investors are required not to select the securities randomly in consonance with their risk aversion or the tax positions. This however, does not necessarily imply that there is lack of any portfolio management.

Having randomly diversifying securities, carrying little or no information cost and minimal execution costs so as to optimize the returns, this is regarded as the superior strategy. No value addition is visible in case of the portfolio managers and investment strategists. In order to match the desire risk level of the investor an inflexible buy and hold policy is not considered optimal. Moreover, the portfolio manager should choose a portfolio that is motivated towards the time and risk profile of the investor. Secondly, the influence of the Efficient Market Hypothesis is perceived from the Financial Managers Perspective. It should be understood by the managers that the response of the markets may be to under react or over react to information. The share price of the company said to reflect the information about their announcements.

The performance of the company can be assessed from the trend of the share prices during the past periods and the management is considered liable for it. The issue of new shares is required to be avoided by the managers when the share is under priced. This is visualized to have aggravated the situation. In general conditions thus the Efficient Market Hypothesis provides essential approach to the pricing behavior. Under these circumstances the investors expect only a normal rate of return while the company is anticipated to attain the appropriate value for the securities. Thus the Efficient Market Hypothesis entails that the published reports of financial analysts do not influence significantly the prices of securities recommending the investors not to attempt to outguess the market, buy and hold and diversify with no load mutual fund. [Efficient Market Hypothesis]

The off-balance sheet financing also commonly known as synthetic lease is considered to be a loan for IRS purposes. However, it resorts to lease documentation and also processed in consonance with the lease accounting. The off-balance-sheet financing is seen to extend the lowest probable cost of possession to the corporations involved in trade. The peculiar savings in respect of off-balance sheet financing are visualized to be at the range of 30-50% in comparison to the traditional lease. The off-balance sheet financing entails several benefits in respect of the financial reporting as well as for the taxation purposes. The benefits accrued in respect of the financial reporting includes among others that it is not necessary that the real estate is not shown in the balance sheet. Thus the lessor becomes the owner in this case. This has the evidence of better balance sheet adjustments in the form of saving of cash and resulting in the improvements of the conventional measure.

Since no real estate is involved the earning of the companies are not visualized to decline as a result of the depreciation. This ensures higher earnings to the companies and EPS. This also results in the enhanced stock price and market valuation. The advantages of the off-balance sheet financing are also visualized in connection with tax payments. Since the user owns the real estate the companies resorting to…

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