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Efficient Financial Markets

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Real world financial markets such as the NYSE or the foreign exchange (foreign currency) markets are assumed to be "efficient" in their structure and operation. Indeed if they are not (or not approximately efficient) much of contemporary financial theory would not apply to them. What is an efficient market, why are they important and what are the various forms of market efficiency? Please provide examples of each.

Please support answer with a minimum of three quality academic and/or industry references. Ex: Examples of acceptable references include:
The Financial Times
The Economist
The Wall Street Journal
The Journal of Finance
Harvard Business Review

Examples of unacceptable references include:
Yahoo Answers
Personal blogs.

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Efficient Financial Markets:

Market efficiency is championed by the efficient market theory. Through this market structure, the prices that are in the business environment fully reflect on the information that is held on a particular stock. This eradicates the benefit of other investors having the ability of predicting the returns that will be obtained from the stock. By virtue that an efficient market is a market structure where the market prices adjust rapidly to the new information, significant information is availed to all the organizations in the market at the same time (What, 2009).

Importance of Efficient Markets:

There are a lot of advantages that can be derived from the efficient market structure. The fact that the nature of information is not limited to specific business entities and individuals means that equal opportunity in the business market will be attained. This will propel the operations of the business organizations by virtue that the information in the business environment will be reflected in the stock price (Cohen, ...

Solution Summary

The solution discusses what is an efficient financial market and why they are important.

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1. The term of the lease is 5 years, and the lease agreement is non-cancellable, requiring equal rental payments of £9,276 at the beginning of each year;
2. The machine has a fair value at the inception of the lease of £40,000, an estimated economic life of 5 years, and no residual value;
3. Alice plc's incremental borrowing rate is 10% per year;
4. Alice plc depreciates similar equipment that it owns on a straight-line basis;
5. Louise Leasing plc has set the annual rental to earn a rate of return on its investment of 8% per year; this fact is known to Alice plc.


(a) Should the above lease agreement be accounted for as a finance or an operating lease? Give reasons to justify your answer.

(b) Prepare the journal entries for Alice plc that relate to the above lease agreement during years 1 and 2 for each of the following assumptions:

(i) The lease is classified as a finance lease;

The actuarial method should be used to allocate finance charges to accounting periods during the lease term.

(ii) The lease is classified as an operating lease.

(c) With reference to (b) discuss the extent to which the distinction between a finance lease and an operating lease is important for financial reporting and analysis.

2-a) Describe the factors that should be taken into consideration by firms when forming their capital structure.

2-b) Describe the "Efficient Market Hypothesis" (EMH). Explain how the "Efficient Market Hypothesis" is used to explain the stock market behaviour.

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