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Stock price, Beating the Market & Market Efficiency

1. A stock market analyst is able to identify mispriced stocks by comparing the average price for the last 10 days to the average price for the last 60 days. If this is true, what do you know about the market?

2. What are the implications of the efficient market hypothesis for investors who buy and sell stocks in an attempt to "beat the market"?

3. There are several celebrated investors and stock pickers frequently mentioned in the financial press who have recorded huge returns on their investments over the past two decades. Is the success of these particular investors an invalidation of the EMH? Explain.

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1. A stock market analyst is able to identify mispriced stocks by comparing the average price for the last 10 days to the average price for the last 60 days. If this is true, what do you know about the market?

A stock's price is affected by its intrinsic value, which is determined by the true level and riskiness of the cash flows it is likely to provide, and investors' perceptions about the stock's intrinsic value. In a well-functioning market, investors' perceptions should be closely related to the stock's intrinsic value, in which case the stock price would be a reasonably accurate reflection of its true value. Otherwise, in a market that is not function that well will be easier for investors to locate mispriced stocks and would be easier to pursue an offer for underpriced stocks.

One form of market efficiency that describes this is the Weak-Form Efficiency. This form states that all information contained in past stock price movements is fully reflected in current market prices. If this were true, then information about recent trends in stock prices would be of no use in selecting stocks-the fact that a stock has risen for the past three days, for example, would give us no useful clues as to what it will do today or tomorrow. ...

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