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CMA Final · Strategic Financial Management · Efficient Market Hypothesis

Shares of Kaveri Motors were expected to give a return of 12% for a day, based on the market model. On the day of a bonus announcement, the actual return was 17%. Over the next 3 days the actual returns were 12.5%, 11.5% and 12% against an expected 12% each day. In a semi-strong efficient market, how would the abnormal returns pattern be best described?

Abnormal return on announcement day is 17% minus 12%, which is 5%. Over the following three days abnormal returns are 0.5%, minus 0.5% and zero, cumulating to nil. This immediate one-time adjustment without later drift is what a semi-strong efficient market shows.

  1. AAbnormal return of 5% on the announcement day, with cumulative abnormal return near zero afterwardsCorrect
  2. BAbnormal return of 5% on the announcement day, rising steadily over the next 3 days
  3. CAbnormal return of 17% on the announcement day, since expected return is ignored
  4. DAbnormal return of 5% each day for 4 days as the market adjusts slowly

Explanation

Abnormal return = actual - expected = 17% - 12% = 5% on the announcement day. In the next 3 days the abnormal returns are +0.5%, -0.5% and 0%, summing to 0. This instant adjustment with no drift is the semi-strong pattern; a slow drift would indicate inefficiency.

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