What is the efficient markets hypothesis (EMH), what are its three forms, and what are its implications?

Marketing by Geoffrey

Financial markets

Financial markets and institutions Assume that you recently graduated with a degree in finance and have just reported to work as an investment advisor at the brokerage firm of Smyth Barry & Co. Your first assignment is to explain the nature of the U.S. financial markets to Michelle Varga, a professional tennis player who has just come to the United States from Mexico. Varga is a highly ranked tennis player who expects to invest substantial amounts of money through Smyth Barry. She is also very bright, and, therefore, she would like to understand in general terms what will happen to her money. Your boss has developed the following set of questions that you must ask and answer to explain the U.S. financial system to Varga.

a. Describe the three primary ways in which capital is transferred between savers and borrowers.
b. What is a market? Differentiate between the following types of markets: physical asset versus financial markets, spot versus futures markets, money versus capital markets, primary versus secondary markets, and public versus private markets.
c. Why are financial markets essential for a healthy economy and economic growth?

d. What are derivatives? How can derivatives be used to reduce risk? Can derivatives be used to increase risk?
e. Briefly describe each of the following financial institutions: commercial banks, investment banks, mutual funds, and hedge funds.
f. What are the two leading stock markets? Describe the two basic types of stock markets.
g. If Apple Computer decided to issue additional common stock, and Varga puchased 100 shares of this stock from Smyth Barry, the underwriter, would this transaction be a primary or a secondary market transaction? Would it make a difference if Varga purchased previously outstanding Apple stock in the dealer market?
Explain.
h. What is an initial public offering (IPO)?

i. What is the efficient markets hypothesis (EMH), what are its three forms, and what are its implications?

j. After the consultation with Michelle she asked you a few final questions:
(1) While in the waiting room of your office, she overheard an analyst on a financial TV network say that a particular medical research company just received FDA approval for one of its products. On the basis of this “hot” information, Michelle wants to buy a lot of that company’s stock. Assuming the stock market is
semistrong-form efficient, what advice would you give her?

(2) She has read a number of newspaper articles about a huge IPO being carried out by a leading technology company. She wants to get as many shares in the IPO as possible, and would even be willing to buy the shares in the open market right after the issue. What advice do you have for her?