Brokers Awareness program 5

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Brokers Awareness program(5)

• Dr. Mounther Barakat
• Securities and Commodities Authority

2
?????? ????? ??????? ?????? ??????

• ?. ???? ????? ??????
• ???? ??????? ??????? ??????

3
Margin Trading??????? ???????

• Margin is the amount you put up to trade without
  paying the full balance.
• Initial margin (IM) is the value of your equity
  in the margin trade.
• Maintenance margin (MM) is the minimum equity you
  need to maintain at all time.
• Margin call (MC) is the amount that you need to
  put up to bring your equity back to the initial
  margin.

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Margin Trading??????? ???????

• XYZ is now selling at DHS10. You have DHS5000 and
  would like to purchase 1000 shares. Your broker
  is willing to extend you a loan at the call money
  rate2 for processing and other costs.
  Maintenance margin is 37.5.
• Calculate your profits and losses in the case of
  10 price move in both directions.
• Calculate the minimum price before getting a
  margin call.

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Margin Trading??????? ???????
Price _at_ DHS10
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Margin Trading??????? ???????
Price up by 10 _at_ DHS11
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Margin Trading??????? ???????

• Return with and without use of margins.
• Without margin
• R(11000-10000)/1000010.
• With margin
• R(6000-5000)/500020.
• Your margin is
• 6000/1100054.54

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Margin Trading??????? ???????
Price down by 10 _at_ DHS9
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Margin Trading??????? ???????

• Return with and without use of margins.
• Without margin
• R (9000-10000)/10000 -10.
• With margin
• R (4000- 5000)/ 5000 -20.
• Your margin is
• 4000/900044.44

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Margin Trading??????? ???????

• The minimum price before hitting the first margin
  call is
• P(IMP0)/(1-MM)
• In our example
• P(.510)/(1-.375)8

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Margin Trading??????? ???????
Price _at_ DHS11 which the margin call price.
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Margin Trading??????? ???????

• Return with and without use of margins.
• Without margin
• R (8000-10000)/10000 -20.
• With margin
• R (3000- 5000)/ 5000 -40.
• Your margin is
• 3000/800037.5

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Margin Trading??????? ???????

• Need to add cash to the account to go back to 50
  or as agreed with the broker.
• Margin call calculations
• cash PNIM-Eq
• Cash 810000.5-3000
• 1000

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Margin Trading??????? ???????
Your margin now is MEq/Inv. 4000/8000 50
back to IM.
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Margin Trading??????? ???????

• See XLS file for further training

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Short Selling and Margins?????? ?????? ???
???????

• Margin is the amount of cash you put up as a
  security against the increase in your liability
  due to short selling.
• Initial margin (IM) is the value of your cash
  balance against the short sold position
  (liability).
• Maintenance margin (MM) is the minimum equity you
  need to maintain at all time.
• Margin call (MC) is the amount that you need to
  put up to bring your equity back to the initial
  margin.

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Short Selling and Margins?????? ?????? ???
???????

• XYZ is now selling at DHS10. You would like to
  short 1000 shares. Your broker requires a 50
  cash margin paid up front. Maintenance margin is
  37.5.
• Calculate your profits and losses in the case of
  5 price move in both directions.
• Calculate the minimum price before getting a
  margin call.

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Short Selling and Margins?????? ?????? ???
???????
Price _at_ DHS10
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Short Selling and Margins?????? ?????? ???
???????
Price up by 5 _at_ DHS10.50
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Short Selling and Margins?????? ?????? ???
???????

• Return with and without use of short selling.
• Without short selling
• R(10500-10000)/100005.
• With short selling
• R(4500-5000)/5000-10.
• Your margin is
• 4500/1050042.86

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Short Selling and Margins?????? ?????? ???
???????
Price down by 5 _at_ DHS9.5
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Short Selling and Margins?????? ?????? ???
???????

• Return with and without use of short selling.
• Without short selling
• R(9500-10000)/10000-5.
• With short selling
• R(5500-5000)/500010.
• Your margin is
• 5500/950057.89

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Short Selling and Margins?????? ?????? ???
???????

• The minimum price before hitting the first margin
  call is
• PP0(1IM)/(1MM)
• In our example
• P10(1.5)/(1.375)10.909

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Short Selling and Margins?????? ?????? ???
???????
Price _at_ DHS10.909
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Short Selling and Margins?????? ?????? ???
???????

• Return with and without use of short selling.
• Without short selling
• R(10909-10000)/100009.09.
• With short selling
• R(4091-5000)/5000-18.18.
• Your margin is
• 5500/950037.5

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Short Selling and Margins?????? ?????? ???
???????
Price _at_ DHS12
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Short Selling and Margins?????? ?????? ???
???????

• The position now is 12000 and the equity is 3000.
• The drop in equity is equal to the difference
  between the initial position and the current
  position value.
• That makes our margin below the 37.5 maintenance
  margin.
• Cash is needed to go back to the initial margin.

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Short Selling and Margins?????? ?????? ???
???????

• Need to add cash to the account to go back to 50
  or as agreed with the broker.
• The drop in equity is equal to
• Current position initial position
• 12000-10000 2000
• The value of current equity is equal to
• the initial equity the drop
• 5000-2000 3000
• The margin now is equal to
• Current equity/current position
• 3000/12000 25
• This less than the 37.5 maintenance margin. To
  go back to the initial margin, we need to add
  cash to answer the margin call.

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Short Selling and Margins?????? ?????? ???
???????

• To go back to the initial margin of 50 we need
  to make equity equal to half the current
  liability position
• IMP1N 0.5121000 6000
• Margin call calculations
• Margin call amount
• Current Equity requirement-Current equity
• 6000-3000 3000

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Short Selling and Margins?????? ?????? ???
???????

• See XLS file for further training

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Advanced Margin Calculations?????? ???? ????
??????

• Margin Accounts can become very complex
  especially if there are multiple diverse
  transactions.
• An example would be to calculate the margin
  requirements for buying a stock on margin and
  short selling another.
• Or, you may want to add to that some other
  securities purchased without the use of margin.
• Or, add to all of the above margin calculations
  for futures contracts and options premiums.
• Will revisit later on.

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Segregation of Clients Accounts??? ????????

• Client Money is separated from brokers money.
• Brokers can no longer use one client money (free
  of charge) to lend to other clients for stock
  purchases.
• Benefits
• Lower risk.
• Enhance the availability of cash for clients
  withdrawals.

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Segregation of Clients Accounts??? ????????

• Where does the cash go? To banks.
• Why then move the cash from brokers to banks? Two
  reasons
• Banks enjoy higher liquidity and greater
  readiness to answer cash demand.
• Bank capital is structured to have a component
  that accounts for these deposits, brokers do not.

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Segregation of Clients Accounts??? ????????

• What are the problems with brokers practice of
  using clients cash to finance other clients stock
  purchases?
• Risk of illiquidity
• Strains on leveraged brokers accounts
• No brokers capital rules to protect loans made to
  clients using other clients money
• Brokers are not allowed to make such loans by
  legal definition of brokering
• There are no regulations for margin trading in
  place.

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Segregation of Clients Accounts??? ????????

• What are the problems of account segregation? -
  Lower liquidity for trading.
• Well this liquidity is not allowed in the first
  place and markets should have never used this
  extra liquidity.

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Segregation of Clients Accounts??? ????????

• If brokers are so concerned about this lack of
  liquidity and they think it is not healthy to
  stay without it then why not bear the cost of
  borrowing from banks to create this claimed extra
  liquidity?
• In no way does the SCA condone or encourage
  brokers to do so, not until the regulations that
  deal with that are ready.
• These regulations are being worked on and will be
  ready very soon.

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Segregation of Clients Accounts??? ????????

• So, to avoid this lack of liquidity, why didnt
  SCA delay account segregation until after it had
  such regulations in place?
• Well, SCA never allowed lending by brokers and
  such lending should not be happening.

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Segregation of Clients Accounts??? ????????

• What is the difference between the current
  informal lending and the lending under SCA
  regulations?

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Segregation of Clients Accounts??? ????????

• Under the regulations things will be
• Organized
• Safe
• Fair
• And controllable

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Market Making???? ?????

• Evidence shows that two of the main problems that
  emerging markets face are
• Capital supply shortage and
• low liquidity
• Market making is thought to be a good tool to
  remedy these problems.

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Market Making???? ?????

• The tools other than market making that are used
  to by emerging markets to remedy the above
  problems are
• market segmentation (trading hours, main and
  parallel markets),
• different trading phases (continuous and auction
  trading),
• introduction of special incentives for submission
  of limit orders (hidden reserve orders, standing
  orders, etc).

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Market Making???? ?????

• The implementation of the market making system
  contributes the following
• promotes liquidity,
• lowers transaction costs,
• reduces volatility and
• improves daily turnover of the listed securities

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Market Making???? ?????

• Four types of market making systems which are
  applied in modern stock markets
• The quote-driven market making system,
• The centralized market making system in an
  order-driven market electronic
• The centralized market making system in an
  order-driven market Floor
• The noncentralized market making system in an
  order-driven market.

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Market Making???? ?????
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Market Making???? ?????

• Market making (dealer) system in a quote-driven,
  electronic market
• public investors generally cannot trade directly
  among themselves.
• In order for buyers (sellers) to execute an order
  they have to contact a market maker (dealer) who
  uses his/her own inventory in the transaction.
• There is more than one market maker per company
  who announces on a continuous basis quotes to buy
  and sell a number of shares at a particular
  price.
• Dealers compete among themselves for more
  competitive bid and/or ask prices that will
  attract the order flow from public
• Certain exchanges prohibit the use of market
  makers for their high liquidity stocks. In LSE,
  the 100 stocks that belong to the SETS system are
  traded electronically.
• Stock markets that apply this system are the
  NASDAQ and the London Stock Exchange (LSE).

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Market Making???? ?????

• Centralized market making system in an
  order-driven, floor-based market
• All potential buyers or sellers can directly
  trade among themselves
• Requires the use of a single market maker that
  has monopolistic information on both the market
  orders and the limit order book.
• There exist a floor, which is a physical location
  where market makers reside and interact with
  orders that come electronically to their terminal
  and with orders that come from floor brokers.
• Market makers are required to announce quotes on
  a continuous basis that reflect both the limit
  order book interest and floor brokers intentions
• As a result, market makers only provide the
  necessary liquidity from their own account when
  there is a lack of either a buy or a sell
  interest.
• Typically this scenario occurs when there is a
  temporary disparity between supply and demand
  that asks for the market makers intervention in
  order to come up with an equilibrium price.
• Floor-based markets where a centralized market
  making system is applied are the NYSE and the
  eight stock markets in Germany (Deutsche Börse).

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Market Making???? ?????

• Centralized market making system in an
  order-driven electronic market
• Same as the floor-based market with a single
  market maker in the centralized dual role of
  matching buyers and sellers and providing the
  necessary liquidity when needed.
• The only major difference is that in an order
  driven market there is neither a floor nor floor
  brokers to interact with the limit order book for
  providing extra liquidity.
• Such a system was applied in the Amsterdam Stock
  Exchange (prior to its inclusion in Euronext).

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Market Making???? ?????

• Non-Centralized market making system in an
  order-driven electronic market.
• There can be more than one per company
• required to announce limit orders to buy and sell
  on a continuous basis
• They do not possess any monopolistic information
  on the incoming orders or the limit order book.
• They compete with investors for order flow.
• This system is applied in Euronext, in the
  Italian Stock Exchange (ISE) and in the Athens
  Stock Exchange (ASE), among others.

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Market Making???? ?????
50
Market Making???? ?????
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Market Making???? ?????

• Costs and Challenges of Applying a Market Making
  System to Emerging Markets Factors for
  Consideration
• current exchange design and the costs of
  restructuring
• current investors sentiment towards the exchange
  both domestically and internationally
• the market design in countries hosting the target
  foreign capital
• size of the emerging market.

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Market Making???? ?????

• 1- current exchange design and the costs of
  restructuring
• The least costly to implement in terms of both
  machinery and technical personnel and supplies,
  is the noncentralized market making system.
• The quote-driven market making system is much
  more costly as it requires more capital for the
  system to be fully functional.
• The centralized (especially floor systems) are
  extremely costly.
• This should not be a major problem in the UAE.

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Market Making???? ?????

• 2- Current Investors Sentiment Towards the
  Exchange - Domestically and Internationally
• Market making has many requirements that are not
  currently available in the UAE, som of which are
• Experienced financial researchers
• Short selling, security borrowing, high
  liquidity, derivative securities to hedge MM
  portfolios.
• Do we think of a centralized MM to be trust
  worthy.
• Collusion is possible in Quote or non centralized

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Market Making???? ?????

• 3- Market Designs in Countries Hosting the Target
  Foreign Capital
• Are foreigners used to our system
• Do they trust our regulations and market
  participants
• The answer is yes, due to
• the increasing international interest in the UAE
• the UAEs ability to adapt to new systems,
  methodologies and technologies.

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Market Making???? ?????

• 4- Size of the Emerging Market
• Looking at the capitalization of the markets that
  employ either the centralized market making
  system or the quote-driven market making system,
  we observe that these are much larger on average
  than other markets that follow the
  non-centralized market making system.
• The UAE markets are small once compares to quote
  and centralized markets

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Market Making???? ?????

• Conclusion
• Noncentralized is the closest fit to the UAE.

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What Are Conflicts of Interest and Why Are They
Important?????? ????? ??????? ???????

• Financial intermediaries engage in a variety of
  activities to collect, produce, and distribute
  information. By providing large volume of each
  service the realize economies of scale and by
  providing multiple services, they realize
  economies of scope.
• However, these services may be competing with one
  another, and this creates the potential for a
  conflict of interest (e.g. IBF and BF)

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What Are Conflicts of Interest and Why Are They
Important?????? ????? ??????? ???????

• The conflicts of interest may arise as the
  concealment of information or the dissemination
  of misleading information.
• We care about these conflicts of interest because
  a reduction in the quality of information
  increases the presence of asymmetric information.
  
• This will lead to adverse selection and moral
  hazard

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Ethics and Conflicts of Interest???? ?????? ?
????? ???????

• Conflicts of interest generate incentives to
  provide false or misleading information. This
  behavior is considered unethical.
• One way to limit these conflicts is to make
  workers aware of the ethics issues at stake, so
  that they are less likely to engage in unethical
  behavior.

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Types of Conflicts of Interest????? ????? ???????

• Four areas of financial service activities that
  harbor the greatest potential for generating
  conflicts of interest. These are
• Underwriting and research in investment banking
• Auditing and consulting in accounting firms
• Credit assessment and consulting in
  credit-rating agencies
• Universal banking

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Underwriting and Research in Investment
Banking????? ??????? ??? ????? ????? ?????????
?????? ??????? ???????? ?????? ?? ????? ???????
???????

• Some investment banks both underwrite new
  securities sold to the public as well as provide
  research (recommendations) to the investing
  public
• When revenues from underwriting exceed brokerage
  commissions, favorable research will attract more
  business, at the expense of unbiased
  recommendations to the investing public.

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Underwriting and Research in Investment
Banking????? ??????? ??? ????? ????? ?????????
?????? ??????? ???????? ?????? ?? ????? ???????
???????

• In initial public offerings of equity,
  underwriters direct the new shares as they wish,
  typically to their best clients or potential new
  clients.
• Since most IPOs are underpriced, many of these
  shares are immediately sold for a profit (called
  spinning). This immediate profit may appear as
  nothing more than payment for future business.

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Auditing and Consulting in Accounting
Firms??????? ?????? ?????? ?????????? ??? ?????
????????

• The role of auditors in public firms is to
  provide an unbiased view of the financial reports
  to reduce asymmetric information between the
  firms management and the investing public.
• By also providing management advisory services
  (such as systems support), the auditor has an
  incentive to fudge the audit if the fees from
  other services are substantial.

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Auditing and Consulting in Accounting
Firms??????? ?????? ?????? ?????????? ??? ?????
????????

• Auditors also have a conflict of interest since
  they are paid by the firm they audit. If the
  auditor gives an unfavorable audit report, the
  auditor may lose the auditing business as well.
• A well known case of the failure of auditors to
  provide unbiased reports was Arthur Andersens
  audit of Enron.

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Credit Assessment and Consulting in Credit-Rating
Agencies????? ?? ??????? ??? ?????? ????? ???????

• Bond investors rely on credit-rating agency
  assessment of firms debt (debt ratings).
• However, ratings are only provided when the firm
  pays the agency. Agencies, then, have an
  incentive provide better ratings to attract
  business.

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Credit Assessment and Consulting in Credit-Rating
Agencies????? ?? ??????? ??? ?????? ????? ???????

• Rating agencies have also started providing firms
  with other services, and have the same conflicts
  as auditors in this regard.

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Universal Banking????? ??????? ??? ????? ???? ??
???? ????? ?? ?? ????

• Universal banking refers to institutions that
  provide some combination of commercial banking,
  investment banking, and insurance services.

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Universal Banking????? ??????? ??? ????? ???? ??
???? ????? ?? ?? ????

• Issuers that use the underwriting services of a
  bank will also benefit from sale of its products
  to the banks other (retail) customers. Customers
  should expect unbiased advice, but may not get
  it.
• Bank managers may push investing products of its
  affiliates, even if they arent in customers
  best interest.

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Universal Banking????? ??????? ??? ????? ???? ??
???? ????? ?? ?? ????

• Lenders with private (bad) information have an
  incentive to withhold the information during
  security issuances in order to get paid
  themselves, at the expenses of the investing
  public.
• Lenders may offer favorable terms to secure
  future underwriting business.

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Universal Banking????? ??????? ??? ????? ???? ??
???? ????? ?? ?? ????

• Banks may use strong-arm tactics to sell its
  affiliate insurance products.

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When Are Conflicts of Interest a Serious
Problem???? ???? ??????? ?? ??????? ????? ????

• Conflicts of interest are a problem when they
  lead to a decreased flow of reliable information
  (increased asymmetric information).
• However, even with potential conflicts, the
  incentives (financial gain) may not be present to
  actually act on them.

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Conflicts of Interest Empirical Evidence.?????
??????? ?????? ?????

• Empirical evidence suggests that rating agency
  debt ratings are unbiased, despite being paid by
  the firms.
• Underwriting and commercial banking also appeared
  to be free from exploitations. Many banks
  spun-off their investment banking activities to
  separate the functions.

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Conflicts of Interest Empirical Evidence.?????
??????? ?????? ?????

• Empirical evidence also suggests that the
  investing public recommendations are made by the
  underwriters analysts.
• However, when temporary rewards to highly trusted
  firms may extract reputational rents from the
  investing public by seeking short-term gains at
  the expense of their future reputation.

74
Suggested actions to minimize conflict of
interest and fraudulent practices.?????? ??????
????? ??????? ?????????? ????? ???????

• Beside
• A- the known laws (SCA law, Company law, fraud
  laws, fin markets law, banking laws, exchangers
  law)
• B- and the monitoring and examining of the SCA,
  Government agencies, internal and external
  auditing
• Establish a Public Company Accounting Oversight
  Board to supervise accounting firms.
• Prohibit public accounting firms from engaging in
  nonaudit services to a client it is also
  auditing.
• Members of the boards audit committee must be
  independent.

75
Suggested actions to minimize conflict of
interest and fraudulent practices.?????? ??????
????? ??????? ?????????? ????? ???????

• Require the reporting of off-balance sheet
  activities.
• Increase the charges for white-collar crimes and
  obstruction.

76
Suggested actions to minimize conflict of
interest and fraudulent practices.?????? ??????
????? ??????? ?????????? ????? ???????

• Firms must severe the link between underwriting
  and research activities.
• Firms must make public analyst recommendations
  and target prices.

77
Suggested actions to minimize conflict of
interest and fraudulent practices.?????? ??????
????? ??????? ?????????? ????? ???????

• Brokerage firms required to obtain third-party,
  independent research for their clients.
• Massive fines and very harsh penalties even for
  the smallest of violations.

78
Policies to Remedy Conflicts of Interest??????
?????? ?? ?????? ?????? ?????? ???????

• A trade-off between potential conflicts of
  interest and economies of scale exists. Simply
  eliminating any potential conflict may not be the
  best solution
• The existence of a conflict of interest does not
  mean that the conflict will have severe
  consequences.
• Even if incentives to exploit conflicts are high,
  eliminating the conflict may be worse if it
  reduces the flow of reliable information.

79
Policies to Remedy Conflicts of Interest??????
?????? ?? ?????? ?????? ?????? ???????

• Leave It to the Market an appealing approach
  that relies on market forces, but has the problem
  that the market has a short memory for past
  problems.
• Regulate for Transparency regulate mandatory
  disclosure, even if it is more costly than the
  information provided.

80
Policies to Remedy Conflicts of Interest??????
?????? ?? ?????? ?????? ?????? ???????

• Supervisory Oversight force firms to provide
  private information to a supervisor, who can act
  on it as deemed necessary.
• Separation of Functions separate those functions
  that create conflicts, either within firms or (in
  extreme cases) by not allowing those functions
  within the same firm.

81
Policies to Remedy Conflicts of Interest??????
?????? ?? ?????? ?????? ?????? ???????

• Socialization of Information Production look to
  public funding for information providers, such as
  credit agencies.
• Non government societies, peer pressure and the
  code of ethics.

82
(No Transcript)
83
Efficient Market Hypothesis????? ????? ?????

• This equation tells us that current prices in a
  financial market will be set so that the optimal
  forecast of a securitys return using all
  available information equals the securitys
  equilibrium return.
• ???? ?????? ??????? ????? ????? ?????? ???????
  ??? ??? ???? ????????? ??????? ???? ????????.
• Financial economists state it more simply A
  securitys price fully reflects all available
  information in an efficient market.
• Efficient market condition holds even if there
  are uninformed, irrational participants in market

84
Rationale Behind the Hypothesis ??? ??????? ??
???? ??? ????????

• When an unexploited profit opportunity arises on
  a security (so-called because, on average, people
  would be earning more than they should, given the
  characteristics of that security), investors will
  rush to buy until the price rises to the point
  that the returns are normal again.

85
Rationale Behind the Hypothesis (cont.) ???
??????? ?? ???? ??? ????????

• In an efficient market, all unexploited profit
  opportunities will be eliminated.
• Not every investor need be aware of every
  security and situation, as long as a few keep
  their eyes open for unexploited profit
  opportunities, they will eliminate the profit
  opportunities that appear because in so doing,
  they make a profit.

86
Example on elimination of unexploited profits
87
Stronger Version of the Efficient Market
Hypothesis ???? ???? ?????? ????? ?????

• Many financial economists take the EMH one step
  further in their analysis of financial markets.
  Not only do they define an efficient market as
  one in which expectations are optimal forecasts
  using all available information, but they also
  add the condition that an efficient market is one
  in which prices are always correct and reflect
  market fundamentals (items that have a direct
  impact on future income streams of the
  securities)
• ??????? ????? ??? ??????? ??? ??????. ????????
  ????? ??? ????????? ???????? ????? ?????? ?????
  ?????.

88
Stronger Version of the Efficient Market
Hypothesis (2)

• This stronger view of market efficiency has
  several important implications in the academic
  field of finance
• It implies that in an efficient capital market,
  one investment is as good as any other because
  the securities prices are correct. ????
  ??????????? ???? ??? ?????? ?????? ?????? ???????
• It implies that a securitys price reflects all
  available information about the intrinsic value
  of the security.
• ????? ?????? ???? ???? ????????? ????????
  ????????? ?????? ?????? ??????

89
Stronger Version of the Efficient Market
Hypothesis (2)

• It implies that security prices can be used by
  managers of both financial and nonfinancial firms
  to assess their cost of capital (cost of
  financing their investments) accurately and hence
  that security prices can be used to help them
  make the correct decisions about whether a
  specific investment is worth making or not.
• ????? ??????? ?? ????? ????? ??? ????? ????
  ???????? ?? ????? ????????

90
Evidence on Efficient Market Hypothesis ???????
???????

• Favorable Evidence ?????? ?????? ???????
• Investment analysts and mutual funds don't beat
  the market
• Stock prices reflect publicly available info
  anticipated announcements don't affect stock
  price
• Stock prices and exchange rates close to random
  walk if predictions of ?P big, Rof gt R ?
  predictions of ?P small
• Technical analysis does not outperform market

91
Evidence in Favor of Market Efficiency

• Performance of Investment Analysts and Mutual
  Funds should not be able to consistently beat the
  market
• ?? ???? ???? ?? ???? ???? ?????? ???? ?? ????
  ????? ????? ?????? ??????
• The Investment Dartboard often beats
  investment managers.
• Mutual funds not only do not outperform the
  market on average, but when they are separated
  into groups according to whether they had the
  highest or lowest profits in a chosen period, the
  mutual funds that did well in the first period do
  not beat the market in the second period.

92
Evidence in Favor of Market Efficiency

• Performance of Investment Analysts and Mutual
  Funds should not be able to consistently beat the
  market
• Investment strategies using inside information is
  the only proven method to beat the market. It
  is illegal to trade on such information, but that
  is not true in all countries.
• ??????? ??????? ????? ???? ?? ???? ????? ??
  ?????? ??? ??????? ?????? ??? ?? ???? ????? ?????
  ?????? ????????

93
Evidence in Favor of Market Efficiency

• Do Stock Prices Reflect Publicly Available
  Information as the EMH predicts they will?
• Thus if information is already publicly
  available, a positive announcement about a
  company will not, on average, raise the price of
  its stock because this information is already
  reflected in the stock price.
• ??? ???? ??????? ???? ???? ????????? ??? ???????
  ?? ????? ??? ????? ?? ?????? ??? ??? ??? ???????
  ????? ???? ?????? ??????

94
Evidence in Favor of Market Efficiency

• Do Stock Prices Reflect Publicly Available
  Information as the EMH predicts they will?
• Early empirical evidence confirms favorable
  earnings announcements or announcements of stock
  splits (a division of a share of stock into
  multiple shares, which is usually followed by
  higher earnings) do not, on average, cause stock
  prices to rise.
• ???????? ??????? ????? ?? ??????? ?? ????? ??????
  ?????? ?? ?? ????? ?? ????????? ?? ?????? ?????
  ?? ?? ???? ???

95
Evidence in Favor of Market Efficiency

• Random-Walk Behavior of Stock Prices that is,
  future changes in stock prices should, for all
  practical purposes, be unpredictable
• ????? ??? ???????? ??????? ????????? ??????
  ??????
• If stock is predicted to rise, people will buy to
  equilibrium level, if stock is predicted to fall,
  people will sell to equilibrium level (both in
  concert with EMH)
• Thus, if stock prices were predictable, thereby
  causing the above behavior, price changes would
  be near zero, which has not been the case
  historically

96
Evidence in Favor of Market Efficiency

• Technical Analysis means to study past stock
  price data and search for patterns such as trends
  and regular cycles, suggesting rules for when to
  buy and sell stocks
• ??????? ?????? ????? ????? ??? ????? ????? ??????
• The EMH suggests that technical analysis is a
  waste of time
• The simplest way to understand why is to use the
  random-walk result that holds that past stock
  price data cannot help predict changes.
  Therefore, technical analysis, which relies on
  such data to produce its forecasts, cannot
  successfully predict changes in stock prices

97
Evidence on Efficient Market Hypothesis

• Unfavorable Evidence ????? ???? ??? ???????
• Small-firm effect small firms have abnormally
  high returns
• January effect high returns in January
• Market overreaction
• Excessive volatility
• Mean reversion
• New information is not always immediately
  incorporated into stock prices

98
THE PRACTICING MANAGER Implications for
Investing????? ??????? ???????? ???????
??????????

• How valuable are published reports by investment
  advisors?
• Should you be skeptical of hot tips?
• Do stock prices always rise when there is good
  news?
• Efficient Markets prescription for investor

99
Implications for Investing

• How valuable are published reports by investment
  advisors?
• ?? ?? ???? ???????? ??????? ?? ????? ????????

100
Implications for Investing

• Should you be skeptical of hot tips?
• ?? ??? ?? ??????? ??????? ?????? ???? ???? ???
  ????? ???????
• YES. The EMH indicates that you should be
  skeptical of hot tips since, if the stock market
  is efficient, it has already priced the hot tip
  stock so that its expected return will equal the
  equilibrium return.
• Thus, the hot tip is not particularly valuable
  and will not enable you to earn an abnormally
  high return.

101
Implications for Investing

• Should you be skeptical of hot tips?
• As soon as the information hits the street, the
  unexploited profit opportunity it creates will be
  quickly eliminated.
• The stocks price will already reflect the
  information, and you should expect to realize
  only the equilibrium return.

102
Implications for Investing

• Do stock prices always rise when there is good
  news?
• ?? ?????? ??????? ??????? ?? ???? ????? ????
  ???????
• NO. In an efficient market, stock prices will
  respond to announcements only when the
  information being announced is new and
  unexpected.
• So, if good news was expected (or as good as
  expected), there will be no stock price response.
• And, if good news was unexpected (or not as good
  as expected), there will be a stock price
  response.

103
Implications for Investing

• Efficient Markets prescription for investor
• ????? ????? ?????? ???? ?? ?????? ?????????
• Investors should not try to outguess the market
  by constantly buying and selling securities. This
  process does nothing but incur commissions costs
  on each trade.

104
Implications for Investing

• Efficient Markets prescription for investor
• ?????? ????????? ???? ?? ??????? ??????? ???? ??
  ????? ?????
• Instead, the investor should pursue a buy and
  hold strategypurchase stocks and hold them for
  long periods of time. This will lead to the same
  returns, on average, but the investors net
  profits will be higher because fewer brokerage
  commissions will have to be paid.

105
Implications for Investing

• Efficient Markets prescription for investor
• ??????? ?? ?????? ??????? ??? ????? ????? ??????
  ???? ???? ?????????? ?????????? ?? ??????
  ????????? ???????? ????????
• It is frequently a sensible strategy for a small
  investor, whose costs of managing a portfolio may
  be high relative to its size, to buy into a
  mutual fund rather than individual stocks.
  Because the EMH indicates that no mutual fund can
  consistently outperform the market, an investor
  should not buy into one that has high management
  fees or that pays sales commissions to brokers
  but rather should purchase a no-load
  (commission-free) mutual fund that has low
  management fees.

106
Behavioral Finance ??????? ???????

• Dissatisfaction with using the EMH to explain
  events like 1987s Black Monday gave rise to the
  new field of behavioral finance, in which
  concepts from psychology, sociology, and other
  social sciences are applied to understand the
  behavior of securities prices
• ??? ??????? ????? ????? ?????? ?? ???????
  ???????? ???? ??????? ??????????
• EMH suggests that smart money would engage in
  short sales to combat overpriced securities, yet
  short sale volume is low, leading to behavior
  theories about loss aversion
• Other behavior analysis points to investor
  overconfidence as perpetuating stock price
  bubbles

107
Why Should Capital MarketsBe Efficient??????
??? ?? ???? ??????? ?????

• The premises of an efficient market
• A large number of competing profit-maximizing
  participants analyze and value securities, each
  independently of the others
• New information regarding securities comes to the
  market in a random fashion
• Profit-maximizing investors adjust security
  prices rapidly to reflect the effect of new
  information
• Conclusion the expected returns implicit in the
  current price of a security should reflect its
  risk

108
AlternativeEfficient Market Hypotheses (EMH)??
?????? ????? ????? ??????

• Random Walk Hypothesis changes in security
  prices occur randomly
• ?????? ????????
• Fair Game Model current market price reflect
  all available information about a security and
  the expected return based upon this price is
  consistent with its risk
• ?????? ???????
• Efficient Market Hypothesis (EMH) - divided into
  three sub-hypotheses depending on the information
  set involved
• 3 ??????? ?????? ????? ??????

109
Efficient Market Hypotheses (EMH)

• Weak-Form EMH - prices reflect all
  security-market information
• ?????? ???????
• Semistrong-form EMH - prices reflect all public
  information
• ?????? ????????
• Strong-form EMH - prices reflect all public and
  private information
• ?????? ??????

110
Weak-Form EMH????? ????????? ????????? ??
??????? ????? ??????? ?? ???? ?? ??? ?? ????? ???
???? ????? ?????? ????????

• Current prices reflect all security-market
  information, including the historical sequence of
  prices, rates of return, trading volume data, and
  other market-generated information
• This implies that past rates of return and other
  market data should have no relationship with
  future rates of return

111
Semistrong-Form EMH????????? ?????? ?????? ????
?? ??????? ???????? ?? ???? ?? ??? ?? ????? ???
???? ????? ?????? ????????

• Current security prices reflect all public
  information, including market and non-market
  information
• This implies that decisions made on new
  information after it is public should not lead to
  above-average risk-adjusted profits from those
  transactions

112
Strong-Form EMH????? ????????? ??????? ???????
??????? ?? ???? ?? ??? ?? ????? ??? ???? ?????
?????? ????????

• Stock prices fully reflect all information from
  public and private sources
• This implies that no group of investors should be
  able to consistently derive above-average
  risk-adjusted rates of return
• This assumes perfect markets in which all
  information is cost-free and available to
  everyone at the same time

113
Tests and Results of Weak-Form EMH?????? ???????
?????? ???????

• Statistical tests of independence between rates
  of return
• Autocorrelation tests have mixed results
• Active Vs. Buy and Hold show varying results

114
Tests and Results of Weak-Form EMH????? ??? ???
?????? ??????? ?????? ???? ???

• Comparison of trading rules to a buy-and-hold
  policy is difficult because trading rules can be
  complex and there are too many to test them all
• Filter rules yield above-average profits, but
  only before taking into account transactions
  costs
• Trading rule results have been mixed, and most
  have not been able to beat a buy-and-hold policy
• Results generally support the weak-form EMH, but
  results are not unanimous

115
Tests of the Semistrong Form of Market
Efficiency ?????? ??????? ?????? ????????

• These tests involve a joint hypothesis and are
  dependent both on market efficiency and the asset
  pricing model used
• ????? ??????? ????????
• They use
• 1- Event studies ?????? ?????
• 2- Trading volumes and price ?????? ????? ?????
  ???? ???????
• 3- Multipliers ?????????

116
Tests and Results of Semistrong-Form EMH

• The January Anomaly ????? ???????
• Stocks with negative returns during the prior
  year had higher returns right after the first of
  the year
• Tax selling toward the end of the year has been
  mentioned as the reason for this phenomenon
• Such a seasonal pattern is inconsistent with the
  EMH

117
Tests and Results of Semistrong-Form EMH

• Other calendar effects
• All the markets cumulative advance occurs during
  the first half of trading months
• Monday/weekend returns were significantly negative

118
Tests and Results of Semistrong-Form EMH

• The size effect (total market value) ?????
  ??????? ???????
• The studies indicate that risk-adjusted returns
  for extended periods indicate that the small
  firms consistently experienced significantly
  larger risk-adjusted returns than large firms
• The small-firm effect is not stable from year to
  year
• Firm size is a major efficient market anomaly

119
Tests and Results of Semistrong-Form EMH

• Neglected Firms ????? ??????? ???????
• Firms divided by number of analysts following a
  stock
• Neglected firm effect caused by lack of
  information and limited institutional interest
• Neglected firm concept applied across size classes

120
Tests and Results of Semistrong-form EMH

• Trading volume ????? ??? ???????
• Studied relationship between returns, market
  value, and trading activity.
• No significant difference was found between the
  mean returns of the highest and lowest trading
  activity portfolios

121
Tests and Results of Semistrong-Form EMH

• Ratio of Book Value of a firms Equity to Market
  Value of its equity ????? ????? ???????
• Significant positive relationship found between
  current values for this ratio and future stock
  returns
• Results inconsistent with the EMH
• Size and BV/MV dominate other ratios such as E/P
  ratio or leverage ????? ????? ???????

122
Evidence Against Market Efficiency

• Market Overreaction recent research suggests
  that stock prices may overreact to news
  announcements and that the pricing errors are
  corrected only slowly
• ????? ?????? ??? ????? ????????? ???????
• When corporations announce a major change in
  earnings, say, a large decline, the stock price
  may overshoot, and after an initial large
  decline, it may rise back to more normal levels
  over a period of several weeks.
• This violates the EMH because an investor could
  earn abnormally high returns, on average, by
  buying a stock immediately after a poor earnings
  announcement and then selling it after a couple
  of weeks when it has risen back to normal levels.

123
Evidence Against Market Efficiency

• Excessive Volatility the stock market appears to
  display excessive volatility that is,
  fluctuations in stock prices may be much greater
  than is warranted by fluctuations in their
  fundamental value.
• ????? ??????? ??????
• Researchers have found that fluctuations in the
  SP 500 stock index could not be justified by the
  subsequent fluctuations in the dividends of the
  stocks making up this index.
• Other research finds that there are smaller
  fluctuations in stock prices when stock markets
  are closed, has produced a consensus that stock
  market prices appear to be driven by factors
  other than fundamentals.

124
Evidence Against Market Efficiency

• Mean Reversion Some researchers have found that
  stocks with low returns today tend to have high
  returns in the future, and vice versa.
• ????? ?????? ??? ???? ?????
• Hence stocks that have done poorly in the past
  are more likely to do well in the future because
  mean reversion indicates that there will be a
  predictable positive change in the future price,
  suggesting that stock prices are not a random
  walk.
• Newer data is less conclusive nevertheless, mean
  reversion remains controversial.

125
Evidence Against Market Efficiency

• New Information Is Not Always Immediately
  Incorporated into Stock Prices
• ????? ???? ????? ?? ??????? ?? ????????? ???????
• Although generally true, recent evidence suggests
  that, inconsistent with the efficient market
  hypothesis, stock prices do not instantaneously
  adjust to profit announcements.
• Instead, on average stock prices continue to rise
  for some time after the announcement of
  unexpectedly high profits, and they continue to
  fall after surprisingly low profit announcements.

126
Tests and Results of Semistrong-Form EMH

• ??????? ?????? ????? ?? ?????? ????? ?????
  ???????
• Event studies examine how fast stock prices
  adjust to specific significant economic events
• Stock split studies show that splits do not
  result in abnormal gains after the split
  announcement, but before
• Initial public offerings seems to be underpriced
  by almost 18, but that varies over time, and the
  price is adjusted within one day after the
  offering
• Listing of a stock on an national exchange may
  offer some short term profit opportunities for
  investors

127
Tests and Results of Semistrong-Form EMH

• Event studies (continued)
• Stock prices quickly adjust to unexpected world
  events and economic news and hence do not provide
  opportunities for abnormal profits
• Announcements of accounting changes are quickly
  adjusted for and do not seem to provide
  opportunities
• Stock prices rapidly adjust to corporate events
  such as mergers and offerings
• The above studies provide support for the
  semistrong-form EMH

128
Summary on the Semistrong-Form EMH

• Evidence is mixed
• ???? ?????? ????? ???? ?? ????? ??? ???????
  ???????
• strong support from numerous event studies
• Studies on predicting rates of return for a
  cross-section of stocks indicates markets are not
  semistrong efficient (e.g. use of multipliers
  like PE, or calendar effects

129
Tests and Results of Strong-Form EMH ??????
??????? ?????? ??????

• Strong-form EMH contends that stock prices fully
  reflect all information, both public and private
• This implies that no group of investors has
  access to private information that will allow
  them to consistently earn above-average profits

130
Testing Groups of Investors

• Corporate insiders
• Stock exchange specialists
• Security analysts
• Professional money managers (e.g. investment
  funds managers)

131
Corporate Insider Trading ?????? ???? ?????
?????????

• Corporate insiders include major corporate
  officers, directors, and owners of 10 or more of
  any equity class of securities
• Insiders must report to the SEC each month on
  their transactions in the stock of the firm for
  which they are insiders
• These insider trades are made public about six
  weeks later and allowed to be studied

132
Corporate Insider Trading ???????? ???? ??
????????? ?????? ???? ???? ???? ?? ???????????
?? ????? ??? ??? ??????? ??????

• Corporate insiders generally experience
  above-average profits especially on purchase
  transaction
• This implies that many insiders had private
  information from which they derived above-average
  returns on their company stock

133
Corporate Insider Trading

• Studies showed that public investors who traded
  with the insiders based on announced transactions
  would have enjoyed excess risk-adjusted returns
  (after commissions), but the markets now seem to
  have eliminated this inefficiency (soon after it
  was discovered)

134
Stock Exchange Specialists ???????? ???? ??
???????? ????? ?????? ??? ??????? ?? ???? ?????
?????? ?????? ???? ???? ???? ?? ???????? ??
????? ??? ??? ??????? ??????

• Specialists have monopolistic access to
  information about unfilled limit orders
• You would expect specialists to derive
  above-average returns from this information
• The data generally supports this expectation

135
Security Analysts ???????? ???? ?? ????????
???????? ????? ?????? ??? ??????? ?? ???? ?????
?????? ?????? ???? ???? ???? ?? ???????? ??
????? ??? ??? ??????? ??????

• Tests have considered whether it is possible to
  identify a set of analysts who have the ability
  to select undervalued stocks
• This looks at whether, after a stock selection by
  an analyst is made known, a significant abnormal
  return is available to those who follow their
  recommendations

136
The Value Line Enigma (PSE is considering similar
system) ???????? ???? ?? ??????????? ?? VL
?????? ???? ???? ???? ?? ??????? ?? ????? ???
??? ??????? ??????

• Value Line (VL) publishes financial information
  on about 1,700 stocks
• The report includes a timing rank from 1 down to
  5
• Firms ranked 1 substantially outperform the
  market
• Firms ranked 5 substantially underperform the
  market
• Changes in rankings result in a fast price
  adjustment

137
Professional Money Managers ???????? ???? ??
????? ????????? ????? ?????? ??? ??????? ?? ????
????? ?????? ?????? ???? ???? ???? ?? ????????
?? ????? ??? ??? ??????? ??????

• Trained professionals, working full time at
  investment management
• If any investor can achieve above-average
  returns, it should be this group
• If any non-insider can obtain inside information,
  it would be this group due to the extensive
  management interviews that they conduct and due
  to high stakes in owned firms

138
Performance of Professional Money Managers

• Most tests examine mutual funds
• New tests also examine trust departments,
  insurance companies, and investment advisors
• Risk-adjusted, after expenses, returns of mutual
  funds generally show that most funds did not
  match aggregate market performance

139
Conclusions Regarding the Strong-Form EMH

• ???????? ???? ?? ????? ??? ??? ??????? ?????? ??
  ???? ???????
• Mixed results, but not much support
• Tests for corporate insiders and stock exchange
  specialists do not support the hypothesis (Both
  groups seem to have monopolistic access to
  important information and use it to derive
  above-average returns)

140
Conclusions Regarding the Strong-Form EMH

• Tests results for analysts are concentrated on
  Value Line rankings
• Results have changed over time. Currently tend to
  support EMH
• Individual analyst recommendations seem to
  contain significant information
• Performance of professional money managers seem
  to provide support for strong-form EMH

141
Efficient Markets and Technical Analysis?????
????? ?????? ???????? ?????

• Assumptions of technical analysis directly oppose
  the notion of efficient markets
• ??????? ????? ?? ????? ?????? ????? ??? ?????????
  ??? ?????? ??????
• Technicians believe that new information is not
  immediately available to everyone, but
  disseminated from the informed professional first
  to the aggressive investing public and then to
  the masses

142
Efficient Markets and Technical Analysis ?????
????? ?????? ???????? ?????

• Technicians also believe that investors do not
  analyze information and act immediately - it
  takes time
• ?? ?? ???????? ??????? ?????? ?? ?????????? ??
  ????? ????????? ????? ??? ???? ????? ?? ???????
  ???? ??????? ?????????? ????
• Therefore, stock prices move to a new equilibrium
  after the release of new information in a gradual
  manner, causing trends in stock price movements
  that persist for periods

143
Efficient Markets and Technical Analysis ?????
????? ?????? ???????? ?????

• ???? ?????? ?? ?????????????? ?????? ???? ?? ????
  ???? ?????? ??? ??? ??????? ????? ?????
• Technical analysts develop systems to detect
  movement to a new equilibrium (breakout) and
  trade based on that
• Contradicts rapid price adjustments indicated by
  the EMH
• If the capital market is weak-form efficient, a
  trading system that depends on past trading data
  can have no value

144
Efficient Markets and Fundamental Analysis ?????
????? ?????? ???????? ???????

• ??????? ??????? ???? ????? ???? ?????? ??????
  ????? ?????? ?? ????????? ???????? ??????
• Fundamental analysts believe that there is a
  basic intrinsic value for the aggregate stock
  market, various industries, or individual
  securities and these values depend on underlying
  economic factors
• Investors should determine the intrinsic value of
  an investment at a point in time and compare it
  to the market price

145
Efficient Markets and Fundamental Analysis ?????
????? ?????? ???????? ???????

• ????? ??? ??????? ???? ????? ??? ??? ???????
• If you can do a superior job of estimating
  intrinsic value you can make superior market
  timing decisions and generate above-average
  returns
• This involves aggregate market analysis, industry
  analysis, company analysis, and portfolio
  management
• Intrinsic value analysis should start with
  aggregate market analysis

146
Efficient Markets and Investment Fund Management
????? ????? ?????? ?????? ??????? ???????????

• ??????? ??????? ???????? ?? ????? ????? ???? ??
  ?????? ???? ???????
• Investment Fund Managers with Superior Analysts
• concentrate efforts in stocks that do not receive
  the attention given by institutional Investment
  Fund managers to the top-tier stocks
• the market for these neglected stocks may be less
  efficient than the market for large well-known
  stocks

147
Efficient Markets and Investment Fund Management
????? ????? ?????? ?????? ??????? ???????????

• ??????? ???????? ?????? ??? ???? ???? ??????
  ????? ????? ??????? ???????? ?????
• Investment Fund Managers without Superior
  Analysts
• Determine and quantify your client's risk
  preferences
• Construct the appropriate portfolio
• Diversify completely on a global basis to
  eliminate all unsystematic risk
• Maintain the desired risk level by rebalancing
  the portfolio whenever necessary
• Minimize total transaction costs

148
The Rationale and Use of Index Funds???? ?????
?????? ?????? ????? ??? ?? ?????? ??? ???? ?????
????? ????? ??????? ??????? ?? ????? ?????????
?????? ????? ???? ????? ?????