Financial Market Harvard Case Solution & Analysis

Financial Market Case Study Solution

Introduction

The market is defined as a place where potential buyers and sellers exchange goods and services at an agreed price. Financial markets are the markets in which financial securities and commodities are traded at a price that reflects demand and supply. Financial securities mainly include stocks, bonds, communities, derivatives, and others. The price of financial market securities highly depends upon the information published by the companies.If a company declares that it is going to pay a dividend in the next month then due to this information the market price of that stock will increase. Hence we can say that the price of market securities highly depends upon information. Therefore, there are many theories which cover this particular aspect of the market, these are broadly classified into efficient market and non-efficient market.

Market Efficiency:

The concept of market efficiency was first introduced by Eugene Fama in 1970. His theory suggested that it is not possible for anyone to take advantage of the stock market because all information which can affect the stock price was already built into the stock price, therefore, all investors have the same information and hence no one can take benefit on the basis of information. Mainly there are three types of efficient markets weak-form efficiency, semi-strong efficiency, and strong-form efficiency. (Heakal, 2013)

Weak-form Efficiency: In this form of efficiency a financial security reflects all the past information which can affect the price of that security. This means that this form of efficient market does not incorporate or predict any future information which can affect the security price. (Robert, 1996)

Semi-strong Efficiency:In this form of efficient market all publically available information is appropriately reflected in the security price. Therefore,in this form of market only those people can take advantage who have some inside information. (NICOLAAS GROENEWOLD, 1993)

Strong-form Efficiency:In this form of efficient market a security price reflects all inside and publically available information. Therefore, no one can take advantage in this market because there is no data available to the investor which can give essence to them over others. (Allan, 2004)

Active Fund Management

Active management uses human resource either individual or a team to manage the fund portfolio. These managers use analytical research, their own judgment, experience, and forecast to make a decision about in which stock, bond or securities they should invest.

Investors of active management do not believe in the efficient market because they believe that a profit on securities can be earned by applying different strategies to identify mis priced securities.

Passive Fund Management 

Passive fund management is also known as passive strategy, passive investing or index investing. It is highly associated with mutual and exchange-traded funds because in this fund, portfolio shows a market index method. In this form of fund management, the manager chooses different investing strategies to make buy and sell decision so that he can beat the market.

Financial Market Harvard Case Solution & Analysis

Investors of the passive market believe on efficient market hypothesis because they assume that stock price reflects all the information which can affect it. And hence they consider that the best investing strategy will be the investment in index funds. So we can conclude that the passive fund management is basically the opposite of active fund management.

Market Efficiency

Many economists and psychologists and journalists commented that generally, individuals tend to overreact to the information along with this stock price also over reacts to the information due to which investors having contrarian strategies (selling past winners and buying past losers) earn abnormal returns. De Bondt and Thaler in 1985 conducted a research and concluded that stocks that were held for approximately 3 to 5 years and performed poorly during the holding period achieved a higher return than the stock that were held for the same period and performed well. (NARASIMHAN, 1993)

Variations in equity returns might be affected either by a change in expected returns or by market efficiency and stock overreaction.This argument can be explained by examining the return in short-term intervals because the systematic risk does not affect fundamental valuation in short intervals in an efficient market. By conducting the research, we conclude that the winner and losers of one-week reverse in the next week in a way that reflects arbitrage profits. This indicates the inefficiency in the market for liquidity about large price variation. (Lehmann, 1990)

This research examines the relationship among the stock price of eighteen national stock markets. The results from these research suggest that the world stock markets are semi-strong efficient markets because stock price only reflects all publically available information. As the market does not have inside information, therefore,the stock price incorporates only that information which is publically available. So we can conclude that the investors who have any inside information can take benefit from it as yet this will not be adjusted in the stock price. (Kam C. Chan, 2003)

Most of the people incline to overreact to unexpected and dramatic news events. This attitude is positively correlated with the stock price because the stock price is heavily based on the investor’s attitude hence this indicates the market as a semi-strong market because stock price reflects all available information.Furthermore,experimental psychology research result suggests that loser’s portfolio earns exceptional returns after five years of formation of the portfolio. (WERNER F. M. De BONDT, 1985).......................

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