ACCA Applied Skills · Financial Management · Efficient market hypothesis (EMH) and practical considerations in the valuation of shares
A director of Zeta Co buys shares just before an unpublished takeover bid is announced and makes a large profit. Prices rose sharply on the announcement. Which conclusion is best supported by this evidence?
The evidence shows the market is not strong form efficient. Strong form efficiency says even private, inside information is already reflected in prices, so no one could profit from it. The director earned an abnormal return using unpublished information, which contradicts that form.
- AThe market is not strong form efficient, because private information gave an abnormal returnCorrect
- BThe market is not semi-strong form efficient, because prices rose on the announcement
- CThe market is not weak form efficient, because prices rose after the announcement
- DThe market is semi-strong form efficient, so the director could not have profited
Explanation
Strong form efficiency means prices reflect all information, including private information. A profit from unpublished inside information shows this form does not hold. Option B is wrong because a rapid price reaction to newly published news is consistent with semi-strong efficiency.
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