Financial Markets and Securities Offerings Paper 2
Financial market efficiency implies that
Answer (A) is correct. The efficient markets hypothesis (EMH) states that current stock prices immediately and fully reflect all relevant information. Hence, the market is continuously adjusting to new information and acting to correct pricing errors. Thus, the price of a security, which reflects an assessment of future cash flows, must equal the present value of those flows (NPV = 0) if the security is accurately priced. Furthermore, if all securities are accurately priced, every security has an NPV of $0, and all securities are therefore perfect substitutes.
The strong form of the efficient markets hypothesis (EMH) states that current market prices of securities reflect
Answer (B) is correct. The EMH states that stock prices reflect all relevant information, so the market is continuously adjusting to new information. Stock prices are in equilibrium, so investors cannot earn abnormal returns. The strong form of the EMH states that all public and private information is instantaneously reflected in current market prices of securities. Thus, investors cannot earn abnormal returns.
The semistrong form of the efficient markets hypothesis (EMH) states that current market prices of securities reflect
Answer (D) is correct. According to the EMH, stock prices are in equilibrium and investors cannot obtain abnormal returns, that is, returns in excess of the riskiness of their investments. The semistrong form of the EMH postulates that current market prices reflect all publicly available information. However, investors with inside information can still earn an abnormal return.
The weak form of the efficient markets hypothesis (EMH) states that current market prices of securities reflect
Answer (A) is correct. The EMH states that stock prices fully reflect all relevant information, including public and private information. The securities prices are in equilibrium because they are always adjusting to new information. The weak form of the EMH states that only past price movements are reflected in current securities prices and no abnormal returns can be earned.
Moody’s and Standard & Poor’s debt ratings depend on
Answer (A) is correct. Debt ratings are based on the probability of default and the protection for investors in case of default.
If a bond is rated below BBB, it is called
Answer (C) is correct. AAA and AA are Standard & Poor’s highest ratings. They signify the highest quality. Bonds rated A and BBB are investment grade. Bonds rated below BBB are speculative high-yield or low-grade bonds (junk bonds).
Which one of the options below best describes a public offering where there is less price uncertainty due to the existence of a benchmark price?
Answer (B) is correct. Later issues of stock by the same company are subsequent offerings. Secondary markets provide for the trading of previously issued securities. The sale of the stock in the primary market can be used as a benchmark because the same type of securities were already issued in this market.
Confidential negotiations between Company A and Company B were completed this morning. It was decided that in 1 week, it will be publicly announced that Company A will acquire Company B for a cash offer of a 30% premium over Company B’s current market price. If the stock price of Company B does not react at all today but rises by 30% with the public announcement next week, this implies that the market is
Answer (C) is correct. Semi-strong form implies that all publicly available information is reflected in security prices. The 30% increase at the declaration of the merger shows that this is the case. Strong form implies that all public and private information is reflected in security prices. Since the stock price did not change when the deal occurred privately, this is not strong form efficient.
Which of the following statements is not correct with regard to initial public offerings (IPOs)?
Answer (C) is correct. Best-efforts offerings do not provide the firm with greater assurance that all offered shares will be sold. It is a best-efforts only offering. Thus, there can be no assurance that any or all of the shares being offered will be sold.
The most important considerations with respect to short term
(b) The requirement is to identify the most important
consideration with respect to short-tem investments. Answer (b)
is correct because short-term investments must be available to
convert to cash when needed. Therefore, risk and liquidity are
the most important considerations. Answers (a), (c), and (d) are
incorrect because they are important considerations with respect
to long-term investments.