Corporate Finance Report: Efficient Market Hypothesis and Models

This report delves into the core concepts of corporate finance, primarily focusing on the efficient market hypothesis (EMH) and its various forms: weak, semi-strong, and strong. It analyzes how the EMH impacts investment strategies and market analysis, including the Malaysian market's efficiency. The report further examines the Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Theory (APT), highlighting their differences, assumptions, and similarities in valuing risky assets and determining the required rate of return. It provides a comparative analysis of the two models, discussing their strengths, weaknesses, and practical applications in financial decision-making. The report also includes a discussion on the implications of the theories for investors and financial markets.

Running head: CONCEPT OF CORPORATE FINANCE
Concept of Corporate Finance
Name of the Student
Name of the University
Author note

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Table of Contents
Question 1..................................................................................................................................2
Question 2..................................................................................................................................5
Reference....................................................................................................................................8

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Question 1
Efficient market hypothesis (EMH)
The efficient hypothesis is one of the utmost significant theory of investment by
which the price of the shares reflects all the data and reliable alpha generation is not
conceivable. In relation with the model of efficient market hypothesis both the technical and
the fundamental analysis can not provide risk adjusted extra returns, or alpha, constantly and
only insider data can effect in massive risk adjusted returns. Conferring to the concept of
efficient market hypothesis, shares usually operated at their fair value on stock exchanges,
making it difficult for the investor to take decision regarding buying and selling of any
undervalued or overvalued stock.
Even though it is a foundation of contemporary financial model, the efficient market
hypothesis is very debatable and very complex method. The stock market analysts state that it
is meaningless to explore for undervalued shares or to make predictions of the market by
either fundamental or technical analysis (Kilic and BUĞAN 2016).
While from the academic point of view the EMH is the best method to analyse the
stock market, but there are also many variation in that view also for instance it has been
observed that investors like warren buffet have regularly beat the market over long period of
time through fundamental analysis which according to the description of efficient market
hypothesis is impossible. The perception of EMH is also proved wrong by some of the major
instances in the share market, like the fall of the share market in the year 1987 by 20 percent
in a solitary day as an indication that stock price can extremely diverge from their fair value
(Ţiţan, Alexandra Gabriela 2015).
The efficient market hypothesis is one of the hypothesis that is major fact in the
mainstream financial dissertation as it has been detected to have enormous consequences in

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the operation of the financial markets in the entire world. The efficient market hypothesis
thus gives an overview about the current condition of the stock market of a particular country
and help the investor to determine the efficiency of the market and based on that the investor
can take decision regarding the decision of selecting the right stock among all the other
stocks that are traded in the market. (Bakar and Yi 2016)
There are three forms of market as per the market hypothesis these are, feeble form
efficiency, semi strong form efficiency and the strong form hypothesis. all the three form of
hypothesis are explained in details in the following points:
Weak form efficiency
A market is considered as the weak form efficient when the present prices of the
securities immediately and completely shows all the information of securities and the investor
will be able to get all the information easily from the market. The weak form proposes that
the present share prices reproduce all the data of historical prices and that no procedure of
technical analysis can be successfully utilised to assist investors in making trading
pronouncements. Believers for the weak form efficiency theory beliefs that by means of the
fundamental analysis underrated and overestimated stocks can be unbendable, and investors
can research the financial statements of the companies to rise their probabilities of making
higher return than normal profits from the market (Hamid et al 2017).
Semi strong form
The semi strong form efficiency theory follows the belief that, as all the data that is
available in the public platform are used in the valuation of the existing price of the stocks,
the investors cannot utilise the data of their fundamental and technical analyse to predict the
price of the shares. The researchers who believed the semi strong efficiency theory states that
the data that is not voluntarily accessible to the public can aid the investors to improve their

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returns of investments above the market returns. The semi strong form of efficiency thus
makes the investors to believe that to predict the price of the shares they should give more
emphasis on the data that are available on the public domain and that the individual technical
or fundamental research will not be that effective (Bahmani-Oskooee et al 2017).
Strong form
The strong form variety of the efficient market hypothesis provides that no
information or data can predict the market be it available from the public domain or the
information that is available from the technical or fundamental research of any individual
research analysts. The strong form provides that it will not be possible for the stakeholders to
make profit from the market only on the basis of the data that is available from the public
domain or any share market tips from any individual who claim himself as a market research
analyst. The strong form provides that the investors will not be able to get a return more than
the market return irrespective of the fact that the investor take the help of various research
analysts and also with the help of market information (Urquhart and McGroarty 2016).
Malaysian market belongs to which form of efficient market hypothesis.
As long as the financial market is concerned, for many years many researchers try to
evaluate the form of the market of the Malaysian stock market and the testing models of the
stock market and predict the price of the stocks that are traded in the Malaysian stock
exchange. There study examines the Kuala Lumpur stock market and came to the view that
the Malaysia will be efficient if the return on the stocks follow random walk. The researchers
study the daily closing price of the stock exchange of Kuala Lumpur for a time period of 5
years. The presence of arbitrary walk for bursa Malaysia index has been analysed by the
methods of auto correlation, Q statistics and the run test and invent that the Kuala Lumpur
stock exchange was not effective and comes under the weak form of market efficiency

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hypothesis. the results of the research suggest that the stock prices of the Malaysian stock
exchange do not shows all the information about the past stock prices and that will result into
irregular return for the investors through misusing the market ineptitude. These
characteristics of the Malaysian market indicates that the weak form efficiency exist in the
stock market of Malaysia (Singh Leepsa and Kushwaha 2016).
Question 2
Difference between capital asset pricing model and the arbitrage pricing theory
The main differences of the capital assets pricing model and the arbitrage pricing theory are
stated below:
The capital assets pricing model considers only single factor for any decision making
while on the other hand the arbitrage pricing theory considers multi factors.
The capital asset pricing model depends on the past data on the other hand the
arbitrage pricing theory uses the futuristic data and make decision on the basis of these data
(Soon Baharumshah and Chan 2015).
The result that is generated from the capital assets pricing method is more trustworthy
as it takes the past data to calculate the value of securities on the other hand the calculations
made under the arbitrage pricing theory are made on the basis of probability so for that reason
it can not be trusted like the CAPM method (Barberis et al 2017).
The calculation of the capital assets pricing method is simple and can be easily
interpreted whereas the calculations made under the arbitrage pricing theory are very
complex and difficult to estimate as it considers various estimations (Renault et al 2018).

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There are some differences in the assumptions of the capital assets pricing model and
the arbitrage pricing model these are stated below:
The assumptions of CAPM
 Transaction cost is not taken into consideration
 Dividable assets
 No restrictions are made in the investment of assets
 The expected utility of the investors will increase.
 Investors will not be able to influence the prices of the securities.
 The beliefs of the model are homogenous in nature
 The assets are considered to be marketable
 Single time period is considered for the calculation
Assumptions made under the arbitrage pricing theory
 It is expected that the returns under this method will follow the equation
 Risk aversion is the main tendency of the investors that follows the arbitrage pricing
theory.
 Transactions costs are neglected
 No restrictions are imposed on the availability of the assets.
 No restrictions are imposed on short selling
 The possibilities of arbitrage facilities do not exist
 The investors think the same thing under this arbitrage pricing theory.
In medium to short time span the arbitrage pricing theory is very informative but for short
term this theory cannot give accurate results to the investors. In comparison to this the CAPM
gives accurate results to the investors for short term period rather than providing information
for the long-term perspective (Burzoni et al 2017).

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Similarities between the capital assets pricing model and the arbitrage pricing theory
Both the capital market pricing model and the arbitrage pricing model are made on the
belief of capital market efficiency so both the model has some similar characteristics. Both
the models provide information to the investors about, how risky assets are valued in the
market steadiness and they give decisions makers with the estimates of essential rate of return
on the securities that are risky in nature. Both the capital assets pricing model and the
arbitrage pricing model use the covariances of the stocks for analysis. For the analysis of the
risks of the stocks both the models take the help of beta (Kisman and Restiyanita 2015).

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Reference
Bahmani-Oskooee, M., Chang, T., Chen, T.H. and Tzeng, H.W., 2016. Revisiting the
efficient market hypothesis in transition countries using quantile unit root test. Economics
Bulletin, 36(4), pp.2171-2182.
Bakar, S. and Yi, A.N.C., 2016. The impact of psychological factors on investors’ decision
making in malaysian stock market: a case of Klang Valley and Pahang. Procedia Economics
and Finance, 35, pp.319-328.
Barberis, N., Greenwood, R., Jin, L. and Shleifer, A., 2015. X-CAPM: An extrapolative
capital asset pricing model. Journal of financial economics, 115(1), pp.1-24.
Burzoni, M., Frittelli, M., Hou, Z., Maggis, M. and Obłój, J., 2019. Pointwise arbitrage
pricing theory in discrete time. Mathematics of Operations Research.
Hamid, K., Suleman, M.T., Ali Shah, S.Z., Akash, I. and Shahid, R., 2017. Testing the weak
form of efficient market hypothesis: Empirical evidence from Asia-Pacific
markets. Available at SSRN 2912908.
Kilic, Y. and BUĞAN, M.F., 2016. The Efficient Market Hypothesis: Evidence from
Turkey. International Journal of Academic Research in Business and Social Sciences, 6(10),
pp.2222-6990.
Kisman, Z. and Restiyanita, S., 2015. M. The Validity of Capital Asset Pricing Model
(CAPM) and Arbitrage Pricing Theory (APT) in Predicting the Return of Stocks in Indonesia
Stock Exchange. American Journal of Economics, Finance and Management Vol, 1, pp.184-
189.
Renault, E., van der Heijden, T. and Werker, B.J., 2018. Arbitrage pricing theory for
idiosyncratic variance factors. Available at SSRN 3065854.

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Singh, R., Leepsa, N.M. and Kushwaha, N., 2016. Testing the weak form of efficient market
hypothesis in carbon efficient stock indices along with their benchmark indices in select
countries. Iranian Journal of Management Studies, 9(3), pp.627-650.
Soon, S.V., Baharumshah, A.Z. and Chan, T.H., 2015. Efficiency market hypothesis in an
emerging market: does it really hold for Malaysia. Jurnal Pengurusan, 42, pp.31-42.
Ţiţan, Alexandra Gabriela. "The efficient market hypothesis: Review of specialized literature
and empirical research." Procedia Economics and Finance32 (2015): 442-449.
Urquhart, A. and McGroarty, F., 2016. Are stock markets really efficient? Evidence of the
adaptive market hypothesis. International Review of Financial Analysis, 47, pp.39-49.