Investment: Efficient Market Hypothesis and Behavioural Finance

This document discusses the efficient market hypothesis and behavioural finance in the context of investment. It explains the factors that limit the ability to profit from mispricing. It also covers technical analysis, fundamental analysis, and theories of the term structure of interest rates.

INVESTMENT
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Contents
Contents...........................................................................................................................................2
QUESTION 2..................................................................................................................................3
Explanation of efficient market hypothesis with the school of thought termed behavioural
finance..........................................................................................................................................3
Explanation of factors that limit ability to profit from mispricing.............................................3
QUESTION 3..................................................................................................................................4
QUESTION 4..................................................................................................................................4
Technical analysis in the form of charting..................................................................................4
Fundamental analysis:.................................................................................................................4
It is the process of looking at a business at the basic or fundamental financial level. This types
of analysis examine kept ratios of a business o determine its financial health and gives an idea
of the value of stock.....................................................................................................................4
QUESTION 5..................................................................................................................................5
Explanation of theories of the term structure of interest rates.....................................................5
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QUESTION 2
Explanation of efficient market hypothesis with the school of thought termed behavioural finance
Regarding with investment perspective the efficient market hypothesise and behavioural finance
have differ perception from each other’s .According to the efficient market hypothesis investors
act like rational and they are the most essential part for financial market. On the other side
behaviour fiancé treated personals as normal and they did not behave rational according to
behaviour fiancé model..The hypothesis of effected market is considered that prices of
investment and securities will be reach at their equilibrium point because they are informational
efficient. On the side behaviour fiancé says that individual have differ psychologies and they
have emotional biases thus they act irrationally. Both models have their own benefits and
drawback, researchers use both methods has they have different perception and assumptions but
theses model useful in the situation of financial cries and save investors from loss of uncertainty.
Theses model help in providing best combination of portfolio through which investors able to
earn more profits at minimum risk(Ananzeh, 2014).
Explanation of factors that limit ability to profit from mispricing.
Arbitrage: It can define as taking advantages of various prices in between two or more than two
markets. Profit may be earn by difference arises of 2 markets rates. Arbitrage situation accurse
when investors purchase securities from one market and sold it in another market at higher
price. It can be defined as an opportunity for the traders. Following are the limit ability to reports
from miss pricing
Fundamental risk: Arbitrageurs effect if security are selling in market which have dies not have
any subsisted and they have high risk theses type of security traders not earn profit of Arbitrage.
Noise trader risk: Theses factors affect the fundamental value of security they changes its value
the arbitrageur forced, to invest additoal capital to traders in the security.
Implimentation cost: Short selling process affect the pricing introduce the profit margin of the
traders.
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Performance cost: Pressure of high performance among traders and attain the previous goal is
also affect the Arbitrage value.
QUESTION 3
1) Calculation of expected return:
The CAPM is an alternative approach to the problem of measuring the cost of capital This model
attempts to measure the relationship between risk and capital market. CAPM presents a liner
relationship between the required rates of return of a security and relates it to market related risk
or Beta. The equation of this theory:
E(Rj)= Rf+B(E(Rm)-Rf)
E(Rj)= Expected return on security j
Rf = risk free return
B=beta of security
E (Rm) Expected return on market portfolio
I9Stock x= 5+0.8(14-5) =12.2
Stock Y = 5+1.5(17-5= 23
QUESTION 4
Technical analysis in the form of charting
Technical analysis attempts to explain and forecast changes in security prices by studying only
the market data.
Bar charts: It has a series of vertical bars types which represent each day price movement. Each
bar has a range from the day‘s lower set price to highest price. A small cross on each bar
signifies the day’s closing price. The bar can horizontally orient. Sometimes a stretched panic is
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used instead of a solid bar. It is a visual display used to compare the amount or frequency of
occurrence of different character of data and it is used to compare groups of data (Amutha and
Rajini, 2016).
Fundamental analysis:
It is the process of looking at a business at the basic or fundamental financial level. This types of
analysis examine kept ratios of a business o determine its financial health and gives an idea
of the value of stock.
Fundamental analysis assess the fair market value of the equate shares by examining the assets
earnings prospects cash flows projections and dividend potential. it differ from technical analysis
who essentially early on price and volume trends and other market indicators to identify trading
opportunities . Basically it refers to an examination of the intrinsic worth of the company. Many
investors use fundamental analysis alone or in combination with other tools to evaluate stocks for
investment propose. The goal is to determine the current worth and more important how the
market values the stock; Fundamental analysis has a logical progression from the general to
specific.
the main objective of this analysis is to conduct stock valuation and predict its probable price
evolution. To make a projection on its business performance. for evaluate its managing and make
internal business decisions.
QUESTION 5
Explanation of theories of the term structure of interest rates
Structure of interest rate differ the relationship of securities at various level of market price.
1) Pure expectation theory: The securities yield curve would be impacted from future
expectation of market rates. There will be 3 tapes of curve which shoes he changes of
yield rate in future. Positive shaped curve shows they the rate will be raise in future. Flat
curve represent that rates remains constant and inverted curve shoes they inters rate must
be fallen in future.
2) Liquidity theory: These theory based on the assumption that investors like to invest in
short term then in long term securities because long term securities contain heavy risk.
This theory is naturally biased towards positively sloped curve.
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3) Preferred habitat theory: Postulates of the curve shows the future rates of the securities
but they not accept the notion of liquidity because of investors prefers for long term
holdings. According to this theory investors would like to match their assets and
liabilities(Halliday and Blouin‐Demers, 2014).
Calculation of forward rate: It is the discounted rate that makes the preset value of the
cash flow receivables from owning the bond equal to the price of the bond .
Forward rate: (1=sn)/n/1+sn-1
Here fn is the future interest rates = spot interest rate sn-1 is equal to the yield of maturely of
zero coupon bonds..
Here the value of forward rate for the year 2 is 2.5 and for the year 3 is 5.4
Following are the factors which are the reasons of decline in forward rate:
Recession: It may be possibility that the value of bond decrease due to ression period of time.
Political stability: Government changes their policies regarding forming investment and taxations
policies it will directly affect the bond valuation.
Interest rate: Changes of flexibility in interest rate also effect the valuation of former rate.
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REFRENCES
Books and journals
Ananzeh, I .E. N., 2014. Testing the weak form of efficient market hypothesis: Empirical
evidence from Jordan. International Business and Management, 9(2), pp.119-123.
Amutha, W. M. and Rajini, V., 2016. Cost benefit and technical analysis of rural electrification
alternatives in southern India using HOMER. Renewable and Sustainable Energy
Reviews, 62, pp.236-246.
Halliday, W. D. and Blouin‐Demers, G., 2014. Red flour beetles balance thermoregulation and
food acquisition via density‐dependent habitat selection. Journal of Zoology, 294(3), pp.198-205.
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