# Brokers Awareness program 5 - PowerPoint PPT Presentation

Title: Brokers Awareness program 5

1
Brokers Awareness program(5)
• Dr. Mounther Barakat
• Securities and Commodities Authority

2
?????? ????? ??????? ?????? ??????
• ?. ???? ????? ??????
• ???? ??????? ??????? ??????

3
• Margin is the amount you put up to trade without
paying the full balance.
• Initial margin (IM) is the value of your equity
• Maintenance margin (MM) is the minimum equity you
need to maintain at all time.
• Margin call (MC) is the amount that you need to
put up to bring your equity back to the initial
margin.

4
• XYZ is now selling at DHS10. You have DHS5000 and
would like to purchase 1000 shares. Your broker
is willing to extend you a loan at the call money
rate2 for processing and other costs.
Maintenance margin is 37.5.
• Calculate your profits and losses in the case of
10 price move in both directions.
• Calculate the minimum price before getting a
margin call.

5
Price _at_ DHS10
6
Price up by 10 _at_ DHS11
7
• Return with and without use of margins.
• Without margin
• R(11000-10000)/1000010.
• With margin
• R(6000-5000)/500020.
• 6000/1100054.54

8
Price down by 10 _at_ DHS9
9
• Return with and without use of margins.
• Without margin
• R (9000-10000)/10000 -10.
• With margin
• R (4000- 5000)/ 5000 -20.
• 4000/900044.44

10
• The minimum price before hitting the first margin
call is
• P(IMP0)/(1-MM)
• In our example
• P(.510)/(1-.375)8

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Price _at_ DHS11 which the margin call price.
12
• Return with and without use of margins.
• Without margin
• R (8000-10000)/10000 -20.
• With margin
• R (3000- 5000)/ 5000 -40.
• 3000/800037.5

13
• Need to add cash to the account to go back to 50
or as agreed with the broker.
• Margin call calculations
• cash PNIM-Eq
• Cash 810000.5-3000
• 1000

14
Your margin now is MEq/Inv. 4000/8000 50
back to IM.
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• See XLS file for further training

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Short Selling and Margins?????? ?????? ???
???????
• Margin is the amount of cash you put up as a
security against the increase in your liability
due to short selling.
• Initial margin (IM) is the value of your cash
balance against the short sold position
(liability).
• Maintenance margin (MM) is the minimum equity you
need to maintain at all time.
• Margin call (MC) is the amount that you need to
put up to bring your equity back to the initial
margin.

17
Short Selling and Margins?????? ?????? ???
???????
• XYZ is now selling at DHS10. You would like to
short 1000 shares. Your broker requires a 50
cash margin paid up front. Maintenance margin is
37.5.
• Calculate your profits and losses in the case of
5 price move in both directions.
• Calculate the minimum price before getting a
margin call.

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Short Selling and Margins?????? ?????? ???
???????
Price _at_ DHS10
19
Short Selling and Margins?????? ?????? ???
???????
Price up by 5 _at_ DHS10.50
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Short Selling and Margins?????? ?????? ???
???????
• Return with and without use of short selling.
• Without short selling
• R(10500-10000)/100005.
• With short selling
• R(4500-5000)/5000-10.
• 4500/1050042.86

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Short Selling and Margins?????? ?????? ???
???????
Price down by 5 _at_ DHS9.5
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Short Selling and Margins?????? ?????? ???
???????
• Return with and without use of short selling.
• Without short selling
• R(9500-10000)/10000-5.
• With short selling
• R(5500-5000)/500010.
• 5500/950057.89

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Short Selling and Margins?????? ?????? ???
???????
• The minimum price before hitting the first margin
call is
• PP0(1IM)/(1MM)
• In our example
• P10(1.5)/(1.375)10.909

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Short Selling and Margins?????? ?????? ???
???????
Price _at_ DHS10.909
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Short Selling and Margins?????? ?????? ???
???????
• Return with and without use of short selling.
• Without short selling
• R(10909-10000)/100009.09.
• With short selling
• R(4091-5000)/5000-18.18.
• 5500/950037.5

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Short Selling and Margins?????? ?????? ???
???????
Price _at_ DHS12
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Short Selling and Margins?????? ?????? ???
???????
• The position now is 12000 and the equity is 3000.
• The drop in equity is equal to the difference
between the initial position and the current
position value.
• That makes our margin below the 37.5 maintenance
margin.
• Cash is needed to go back to the initial margin.

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Short Selling and Margins?????? ?????? ???
???????
• Need to add cash to the account to go back to 50
or as agreed with the broker.
• The drop in equity is equal to
• Current position initial position
• 12000-10000 2000
• The value of current equity is equal to
• the initial equity the drop
• 5000-2000 3000
• The margin now is equal to
• Current equity/current position
• 3000/12000 25
• This less than the 37.5 maintenance margin. To
go back to the initial margin, we need to add
cash to answer the margin call.

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Short Selling and Margins?????? ?????? ???
???????
• To go back to the initial margin of 50 we need
to make equity equal to half the current
liability position
• IMP1N 0.5121000 6000
• Margin call calculations
• Margin call amount
• Current Equity requirement-Current equity
• 6000-3000 3000

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Short Selling and Margins?????? ?????? ???
???????
• See XLS file for further training

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??????
• Margin Accounts can become very complex
especially if there are multiple diverse
transactions.
• An example would be to calculate the margin
requirements for buying a stock on margin and
short selling another.
• Or, you may want to add to that some other
securities purchased without the use of margin.
• Or, add to all of the above margin calculations
for futures contracts and options premiums.
• Will revisit later on.

32
Segregation of Clients Accounts??? ????????
• Client Money is separated from brokers money.
• Brokers can no longer use one client money (free
of charge) to lend to other clients for stock
purchases.
• Benefits
• Lower risk.
• Enhance the availability of cash for clients
withdrawals.

33
Segregation of Clients Accounts??? ????????
• Where does the cash go? To banks.
• Why then move the cash from brokers to banks? Two
reasons
• Banks enjoy higher liquidity and greater
• Bank capital is structured to have a component
that accounts for these deposits, brokers do not.

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Segregation of Clients Accounts??? ????????
• What are the problems with brokers practice of
using clients cash to finance other clients stock
purchases?
• Risk of illiquidity
• Strains on leveraged brokers accounts
• No brokers capital rules to protect loans made to
clients using other clients money
• Brokers are not allowed to make such loans by
legal definition of brokering
• There are no regulations for margin trading in
place.

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Segregation of Clients Accounts??? ????????
• What are the problems of account segregation? -
• Well this liquidity is not allowed in the first
place and markets should have never used this
extra liquidity.

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Segregation of Clients Accounts??? ????????
liquidity and they think it is not healthy to
stay without it then why not bear the cost of
borrowing from banks to create this claimed extra
liquidity?
• In no way does the SCA condone or encourage
brokers to do so, not until the regulations that
• These regulations are being worked on and will be

37
Segregation of Clients Accounts??? ????????
• So, to avoid this lack of liquidity, why didnt
SCA delay account segregation until after it had
such regulations in place?
• Well, SCA never allowed lending by brokers and
such lending should not be happening.

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Segregation of Clients Accounts??? ????????
• What is the difference between the current
informal lending and the lending under SCA
regulations?

39
Segregation of Clients Accounts??? ????????
• Under the regulations things will be
• Organized
• Safe
• Fair
• And controllable

40
Market Making???? ?????
• Evidence shows that two of the main problems that
emerging markets face are
• Capital supply shortage and
• low liquidity
• Market making is thought to be a good tool to
remedy these problems.

41
Market Making???? ?????
• The tools other than market making that are used
to by emerging markets to remedy the above
problems are
• market segmentation (trading hours, main and
parallel markets),
• different trading phases (continuous and auction
• introduction of special incentives for submission
of limit orders (hidden reserve orders, standing
orders, etc).

42
Market Making???? ?????
• The implementation of the market making system
contributes the following
• promotes liquidity,
• lowers transaction costs,
• reduces volatility and
• improves daily turnover of the listed securities

43
Market Making???? ?????
• Four types of market making systems which are
applied in modern stock markets
• The quote-driven market making system,
• The centralized market making system in an
order-driven market electronic
• The centralized market making system in an
order-driven market Floor
• The noncentralized market making system in an
order-driven market.

44
Market Making???? ?????
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Market Making???? ?????
• Market making (dealer) system in a quote-driven,
electronic market
• public investors generally cannot trade directly
among themselves.
• In order for buyers (sellers) to execute an order
they have to contact a market maker (dealer) who
uses his/her own inventory in the transaction.
• There is more than one market maker per company
who announces on a continuous basis quotes to buy
and sell a number of shares at a particular
price.
• Dealers compete among themselves for more
competitive bid and/or ask prices that will
attract the order flow from public
• Certain exchanges prohibit the use of market
makers for their high liquidity stocks. In LSE,
the 100 stocks that belong to the SETS system are
• Stock markets that apply this system are the
NASDAQ and the London Stock Exchange (LSE).

46
Market Making???? ?????
• Centralized market making system in an
order-driven, floor-based market
• All potential buyers or sellers can directly
• Requires the use of a single market maker that
has monopolistic information on both the market
orders and the limit order book.
• There exist a floor, which is a physical location
where market makers reside and interact with
orders that come electronically to their terminal
and with orders that come from floor brokers.
• Market makers are required to announce quotes on
a continuous basis that reflect both the limit
order book interest and floor brokers intentions
• As a result, market makers only provide the
necessary liquidity from their own account when
there is a lack of either a buy or a sell
interest.
• Typically this scenario occurs when there is a
temporary disparity between supply and demand
that asks for the market makers intervention in
order to come up with an equilibrium price.
• Floor-based markets where a centralized market
making system is applied are the NYSE and the
eight stock markets in Germany (Deutsche Börse).

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Market Making???? ?????
• Centralized market making system in an
order-driven electronic market
• Same as the floor-based market with a single
market maker in the centralized dual role of
matching buyers and sellers and providing the
necessary liquidity when needed.
• The only major difference is that in an order
driven market there is neither a floor nor floor
brokers to interact with the limit order book for
providing extra liquidity.
• Such a system was applied in the Amsterdam Stock
Exchange (prior to its inclusion in Euronext).

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Market Making???? ?????
• Non-Centralized market making system in an
order-driven electronic market.
• There can be more than one per company
• required to announce limit orders to buy and sell
on a continuous basis
• They do not possess any monopolistic information
on the incoming orders or the limit order book.
• They compete with investors for order flow.
• This system is applied in Euronext, in the
Italian Stock Exchange (ISE) and in the Athens
Stock Exchange (ASE), among others.

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Market Making???? ?????
50
Market Making???? ?????
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Market Making???? ?????
• Costs and Challenges of Applying a Market Making
System to Emerging Markets Factors for
Consideration
• current exchange design and the costs of
restructuring
• current investors sentiment towards the exchange
both domestically and internationally
foreign capital
• size of the emerging market.

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Market Making???? ?????
• 1- current exchange design and the costs of
restructuring
• The least costly to implement in terms of both
machinery and technical personnel and supplies,
is the noncentralized market making system.
• The quote-driven market making system is much
more costly as it requires more capital for the
system to be fully functional.
• The centralized (especially floor systems) are
extremely costly.
• This should not be a major problem in the UAE.

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Market Making???? ?????
• 2- Current Investors Sentiment Towards the
Exchange - Domestically and Internationally
• Market making has many requirements that are not
currently available in the UAE, som of which are
• Experienced financial researchers
• Short selling, security borrowing, high
liquidity, derivative securities to hedge MM
portfolios.
• Do we think of a centralized MM to be trust
worthy.
• Collusion is possible in Quote or non centralized

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Market Making???? ?????
• 3- Market Designs in Countries Hosting the Target
Foreign Capital
• Are foreigners used to our system
• Do they trust our regulations and market
participants
• The answer is yes, due to
• the increasing international interest in the UAE
• the UAEs ability to adapt to new systems,
methodologies and technologies.

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Market Making???? ?????
• 4- Size of the Emerging Market
• Looking at the capitalization of the markets that
employ either the centralized market making
system or the quote-driven market making system,
we observe that these are much larger on average
than other markets that follow the
non-centralized market making system.
• The UAE markets are small once compares to quote
and centralized markets

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Market Making???? ?????
• Conclusion
• Noncentralized is the closest fit to the UAE.

57
What Are Conflicts of Interest and Why Are They
Important?????? ????? ??????? ???????
• Financial intermediaries engage in a variety of
activities to collect, produce, and distribute
information. By providing large volume of each
service the realize economies of scale and by
providing multiple services, they realize
economies of scope.
• However, these services may be competing with one
another, and this creates the potential for a
conflict of interest (e.g. IBF and BF)

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What Are Conflicts of Interest and Why Are They
Important?????? ????? ??????? ???????
• The conflicts of interest may arise as the
concealment of information or the dissemination
• We care about these conflicts of interest because
a reduction in the quality of information
increases the presence of asymmetric information.
hazard

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Ethics and Conflicts of Interest???? ?????? ?
????? ???????
• Conflicts of interest generate incentives to
provide false or misleading information. This
behavior is considered unethical.
• One way to limit these conflicts is to make
workers aware of the ethics issues at stake, so
that they are less likely to engage in unethical
behavior.

60
Types of Conflicts of Interest????? ????? ???????
• Four areas of financial service activities that
harbor the greatest potential for generating
conflicts of interest. These are
• Underwriting and research in investment banking
• Auditing and consulting in accounting firms
• Credit assessment and consulting in
credit-rating agencies
• Universal banking

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Underwriting and Research in Investment
Banking????? ??????? ??? ????? ????? ?????????
?????? ??????? ???????? ?????? ?? ????? ???????
???????
• Some investment banks both underwrite new
securities sold to the public as well as provide
research (recommendations) to the investing
public
• When revenues from underwriting exceed brokerage
commissions, favorable research will attract more
business, at the expense of unbiased
recommendations to the investing public.

62
Underwriting and Research in Investment
Banking????? ??????? ??? ????? ????? ?????????
?????? ??????? ???????? ?????? ?? ????? ???????
???????
• In initial public offerings of equity,
underwriters direct the new shares as they wish,
typically to their best clients or potential new
clients.
• Since most IPOs are underpriced, many of these
shares are immediately sold for a profit (called
spinning). This immediate profit may appear as
nothing more than payment for future business.

63
Auditing and Consulting in Accounting
Firms??????? ?????? ?????? ?????????? ??? ?????
????????
• The role of auditors in public firms is to
provide an unbiased view of the financial reports
to reduce asymmetric information between the
firms management and the investing public.
• By also providing management advisory services
(such as systems support), the auditor has an
incentive to fudge the audit if the fees from
other services are substantial.

64
Auditing and Consulting in Accounting
Firms??????? ?????? ?????? ?????????? ??? ?????
????????
• Auditors also have a conflict of interest since
they are paid by the firm they audit. If the
auditor gives an unfavorable audit report, the
auditor may lose the auditing business as well.
• A well known case of the failure of auditors to
provide unbiased reports was Arthur Andersens
audit of Enron.

65
Credit Assessment and Consulting in Credit-Rating
Agencies????? ?? ??????? ??? ?????? ????? ???????
• Bond investors rely on credit-rating agency
assessment of firms debt (debt ratings).
• However, ratings are only provided when the firm
pays the agency. Agencies, then, have an
incentive provide better ratings to attract

66
Credit Assessment and Consulting in Credit-Rating
Agencies????? ?? ??????? ??? ?????? ????? ???????
• Rating agencies have also started providing firms
with other services, and have the same conflicts
as auditors in this regard.

67
Universal Banking????? ??????? ??? ????? ???? ??
???? ????? ?? ?? ????
• Universal banking refers to institutions that
provide some combination of commercial banking,
investment banking, and insurance services.

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Universal Banking????? ??????? ??? ????? ???? ??
???? ????? ?? ?? ????
• Issuers that use the underwriting services of a
bank will also benefit from sale of its products
to the banks other (retail) customers. Customers
should expect unbiased advice, but may not get
it.
• Bank managers may push investing products of its
affiliates, even if they arent in customers
best interest.

69
Universal Banking????? ??????? ??? ????? ???? ??
???? ????? ?? ?? ????
• Lenders with private (bad) information have an
incentive to withhold the information during
security issuances in order to get paid
themselves, at the expenses of the investing
public.
• Lenders may offer favorable terms to secure

70
Universal Banking????? ??????? ??? ????? ???? ??
???? ????? ?? ?? ????
• Banks may use strong-arm tactics to sell its
affiliate insurance products.

71
When Are Conflicts of Interest a Serious
Problem???? ???? ??????? ?? ??????? ????? ????
• Conflicts of interest are a problem when they
lead to a decreased flow of reliable information
(increased asymmetric information).
• However, even with potential conflicts, the
incentives (financial gain) may not be present to
actually act on them.

72
Conflicts of Interest Empirical Evidence.?????
??????? ?????? ?????
• Empirical evidence suggests that rating agency
debt ratings are unbiased, despite being paid by
the firms.
• Underwriting and commercial banking also appeared
to be free from exploitations. Many banks
spun-off their investment banking activities to
separate the functions.

73
Conflicts of Interest Empirical Evidence.?????
??????? ?????? ?????
• Empirical evidence also suggests that the
investing public recommendations are made by the
underwriters analysts.
• However, when temporary rewards to highly trusted
firms may extract reputational rents from the
investing public by seeking short-term gains at
the expense of their future reputation.

74
Suggested actions to minimize conflict of
interest and fraudulent practices.?????? ??????
????? ??????? ?????????? ????? ???????
• Beside
• A- the known laws (SCA law, Company law, fraud
laws, fin markets law, banking laws, exchangers
law)
• B- and the monitoring and examining of the SCA,
Government agencies, internal and external
auditing
• Establish a Public Company Accounting Oversight
Board to supervise accounting firms.
• Prohibit public accounting firms from engaging in
nonaudit services to a client it is also
auditing.
• Members of the boards audit committee must be
independent.

75
Suggested actions to minimize conflict of
interest and fraudulent practices.?????? ??????
????? ??????? ?????????? ????? ???????
• Require the reporting of off-balance sheet
activities.
• Increase the charges for white-collar crimes and
obstruction.

76
Suggested actions to minimize conflict of
interest and fraudulent practices.?????? ??????
????? ??????? ?????????? ????? ???????
• Firms must severe the link between underwriting
and research activities.
• Firms must make public analyst recommendations
and target prices.

77
Suggested actions to minimize conflict of
interest and fraudulent practices.?????? ??????
????? ??????? ?????????? ????? ???????
• Brokerage firms required to obtain third-party,
independent research for their clients.
• Massive fines and very harsh penalties even for
the smallest of violations.

78
Policies to Remedy Conflicts of Interest??????
?????? ?? ?????? ?????? ?????? ???????
• A trade-off between potential conflicts of
interest and economies of scale exists. Simply
eliminating any potential conflict may not be the
best solution
• The existence of a conflict of interest does not
mean that the conflict will have severe
consequences.
• Even if incentives to exploit conflicts are high,
eliminating the conflict may be worse if it
reduces the flow of reliable information.

79
Policies to Remedy Conflicts of Interest??????
?????? ?? ?????? ?????? ?????? ???????
• Leave It to the Market an appealing approach
that relies on market forces, but has the problem
that the market has a short memory for past
problems.
• Regulate for Transparency regulate mandatory
disclosure, even if it is more costly than the
information provided.

80
Policies to Remedy Conflicts of Interest??????
?????? ?? ?????? ?????? ?????? ???????
• Supervisory Oversight force firms to provide
private information to a supervisor, who can act
on it as deemed necessary.
• Separation of Functions separate those functions
that create conflicts, either within firms or (in
extreme cases) by not allowing those functions
within the same firm.

81
Policies to Remedy Conflicts of Interest??????
?????? ?? ?????? ?????? ?????? ???????
• Socialization of Information Production look to
public funding for information providers, such as
credit agencies.
• Non government societies, peer pressure and the
code of ethics.

82
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83
Efficient Market Hypothesis????? ????? ?????
• This equation tells us that current prices in a
financial market will be set so that the optimal
forecast of a securitys return using all
available information equals the securitys
equilibrium return.
• ???? ?????? ??????? ????? ????? ?????? ???????
??? ??? ???? ????????? ??????? ???? ????????.
• Financial economists state it more simply A
securitys price fully reflects all available
information in an efficient market.
• Efficient market condition holds even if there
are uninformed, irrational participants in market

84
Rationale Behind the Hypothesis ??? ??????? ??
???? ??? ????????
• When an unexploited profit opportunity arises on
a security (so-called because, on average, people
would be earning more than they should, given the
characteristics of that security), investors will
rush to buy until the price rises to the point
that the returns are normal again.

85
Rationale Behind the Hypothesis (cont.) ???
??????? ?? ???? ??? ????????
• In an efficient market, all unexploited profit
opportunities will be eliminated.
• Not every investor need be aware of every
security and situation, as long as a few keep
their eyes open for unexploited profit
opportunities, they will eliminate the profit
opportunities that appear because in so doing,
they make a profit.

86
Example on elimination of unexploited profits
87
Stronger Version of the Efficient Market
Hypothesis ???? ???? ?????? ????? ?????
• Many financial economists take the EMH one step
further in their analysis of financial markets.
Not only do they define an efficient market as
one in which expectations are optimal forecasts
using all available information, but they also
add the condition that an efficient market is one
in which prices are always correct and reflect
market fundamentals (items that have a direct
impact on future income streams of the
securities)
• ??????? ????? ??? ??????? ??? ??????. ????????
????? ??? ????????? ???????? ????? ?????? ?????
?????.

88
Stronger Version of the Efficient Market
Hypothesis (2)
• This stronger view of market efficiency has
several important implications in the academic
field of finance
• It implies that in an efficient capital market,
one investment is as good as any other because
the securities prices are correct. ????
??????????? ???? ??? ?????? ?????? ?????? ???????
• It implies that a securitys price reflects all
available information about the intrinsic value
of the security.
• ????? ?????? ???? ???? ????????? ????????
????????? ?????? ?????? ??????

89
Stronger Version of the Efficient Market
Hypothesis (2)
• It implies that security prices can be used by
managers of both financial and nonfinancial firms
to assess their cost of capital (cost of
financing their investments) accurately and hence
that security prices can be used to help them
make the correct decisions about whether a
specific investment is worth making or not.
• ????? ??????? ?? ????? ????? ??? ????? ????
???????? ?? ????? ????????

90
Evidence on Efficient Market Hypothesis ???????
???????
• Favorable Evidence ?????? ?????? ???????
• Investment analysts and mutual funds don't beat
the market
• Stock prices reflect publicly available info
anticipated announcements don't affect stock
price
• Stock prices and exchange rates close to random
walk if predictions of ?P big, Rof gt R ?
predictions of ?P small
• Technical analysis does not outperform market

91
Evidence in Favor of Market Efficiency
• Performance of Investment Analysts and Mutual
Funds should not be able to consistently beat the
market
• ?? ???? ???? ?? ???? ???? ?????? ???? ?? ????
????? ????? ?????? ??????
• The Investment Dartboard often beats
investment managers.
• Mutual funds not only do not outperform the
market on average, but when they are separated
into groups according to whether they had the
highest or lowest profits in a chosen period, the
mutual funds that did well in the first period do
not beat the market in the second period.

92
Evidence in Favor of Market Efficiency
• Performance of Investment Analysts and Mutual
Funds should not be able to consistently beat the
market
• Investment strategies using inside information is
the only proven method to beat the market. It
is illegal to trade on such information, but that
is not true in all countries.
• ??????? ??????? ????? ???? ?? ???? ????? ??
?????? ??? ??????? ?????? ??? ?? ???? ????? ?????
?????? ????????

93
Evidence in Favor of Market Efficiency
• Do Stock Prices Reflect Publicly Available
Information as the EMH predicts they will?
• Thus if information is already publicly
available, a positive announcement about a
company will not, on average, raise the price of
its stock because this information is already
reflected in the stock price.
• ??? ???? ??????? ???? ???? ????????? ??? ???????
?? ????? ??? ????? ?? ?????? ??? ??? ??? ???????
????? ???? ?????? ??????

94
Evidence in Favor of Market Efficiency
• Do Stock Prices Reflect Publicly Available
Information as the EMH predicts they will?
• Early empirical evidence confirms favorable
earnings announcements or announcements of stock
splits (a division of a share of stock into
multiple shares, which is usually followed by
higher earnings) do not, on average, cause stock
prices to rise.
• ???????? ??????? ????? ?? ??????? ?? ????? ??????
?????? ?? ?? ????? ?? ????????? ?? ?????? ?????
?? ?? ???? ???

95
Evidence in Favor of Market Efficiency
• Random-Walk Behavior of Stock Prices that is,
future changes in stock prices should, for all
practical purposes, be unpredictable
• ????? ??? ???????? ??????? ????????? ??????
??????
• If stock is predicted to rise, people will buy to
equilibrium level, if stock is predicted to fall,
people will sell to equilibrium level (both in
concert with EMH)
• Thus, if stock prices were predictable, thereby
causing the above behavior, price changes would
be near zero, which has not been the case
historically

96
Evidence in Favor of Market Efficiency
• Technical Analysis means to study past stock
price data and search for patterns such as trends
and regular cycles, suggesting rules for when to
• ??????? ?????? ????? ????? ??? ????? ????? ??????
• The EMH suggests that technical analysis is a
waste of time
• The simplest way to understand why is to use the
random-walk result that holds that past stock
price data cannot help predict changes.
Therefore, technical analysis, which relies on
such data to produce its forecasts, cannot
successfully predict changes in stock prices

97
Evidence on Efficient Market Hypothesis
• Unfavorable Evidence ????? ???? ??? ???????
• Small-firm effect small firms have abnormally
high returns
• January effect high returns in January
• Market overreaction
• Excessive volatility
• Mean reversion
• New information is not always immediately
incorporated into stock prices

98
THE PRACTICING MANAGER Implications for
Investing????? ??????? ???????? ???????
??????????
• How valuable are published reports by investment
• Should you be skeptical of hot tips?
• Do stock prices always rise when there is good
news?
• Efficient Markets prescription for investor

99
Implications for Investing
• How valuable are published reports by investment
• ?? ?? ???? ???????? ??????? ?? ????? ????????

100
Implications for Investing
• Should you be skeptical of hot tips?
• ?? ??? ?? ??????? ??????? ?????? ???? ???? ???
????? ???????
• YES. The EMH indicates that you should be
skeptical of hot tips since, if the stock market
is efficient, it has already priced the hot tip
stock so that its expected return will equal the
equilibrium return.
• Thus, the hot tip is not particularly valuable
and will not enable you to earn an abnormally
high return.

101
Implications for Investing
• Should you be skeptical of hot tips?
• As soon as the information hits the street, the
unexploited profit opportunity it creates will be
quickly eliminated.
• The stocks price will already reflect the
information, and you should expect to realize
only the equilibrium return.

102
Implications for Investing
• Do stock prices always rise when there is good
news?
• ?? ?????? ??????? ??????? ?? ???? ????? ????
???????
• NO. In an efficient market, stock prices will
respond to announcements only when the
information being announced is new and
unexpected.
• So, if good news was expected (or as good as
expected), there will be no stock price response.
• And, if good news was unexpected (or not as good
as expected), there will be a stock price
response.

103
Implications for Investing
• Efficient Markets prescription for investor
• ????? ????? ?????? ???? ?? ?????? ?????????
• Investors should not try to outguess the market
by constantly buying and selling securities. This
process does nothing but incur commissions costs

104
Implications for Investing
• Efficient Markets prescription for investor
• ?????? ????????? ???? ?? ??????? ??????? ???? ??
????? ?????
hold strategypurchase stocks and hold them for
long periods of time. This will lead to the same
returns, on average, but the investors net
profits will be higher because fewer brokerage
commissions will have to be paid.

105
Implications for Investing
• Efficient Markets prescription for investor
• ??????? ?? ?????? ??????? ??? ????? ????? ??????
???? ???? ?????????? ?????????? ?? ??????
????????? ???????? ????????
• It is frequently a sensible strategy for a small
investor, whose costs of managing a portfolio may
be high relative to its size, to buy into a
mutual fund rather than individual stocks.
Because the EMH indicates that no mutual fund can
consistently outperform the market, an investor
should not buy into one that has high management
fees or that pays sales commissions to brokers
but rather should purchase a no-load
(commission-free) mutual fund that has low
management fees.

106
Behavioral Finance ??????? ???????
• Dissatisfaction with using the EMH to explain
events like 1987s Black Monday gave rise to the
new field of behavioral finance, in which
concepts from psychology, sociology, and other
social sciences are applied to understand the
behavior of securities prices
• ??? ??????? ????? ????? ?????? ?? ???????
???????? ???? ??????? ??????????
• EMH suggests that smart money would engage in
short sales to combat overpriced securities, yet
short sale volume is low, leading to behavior
• Other behavior analysis points to investor
overconfidence as perpetuating stock price
bubbles

107
Why Should Capital MarketsBe Efficient??????
??? ?? ???? ??????? ?????
• The premises of an efficient market
• A large number of competing profit-maximizing
participants analyze and value securities, each
independently of the others
• New information regarding securities comes to the
market in a random fashion
prices rapidly to reflect the effect of new
information
• Conclusion the expected returns implicit in the
current price of a security should reflect its
risk

108
AlternativeEfficient Market Hypotheses (EMH)??
?????? ????? ????? ??????
• Random Walk Hypothesis changes in security
prices occur randomly
• ?????? ????????
• Fair Game Model current market price reflect
all available information about a security and
the expected return based upon this price is
consistent with its risk
• ?????? ???????
• Efficient Market Hypothesis (EMH) - divided into
three sub-hypotheses depending on the information
set involved
• 3 ??????? ?????? ????? ??????

109
Efficient Market Hypotheses (EMH)
• Weak-Form EMH - prices reflect all
security-market information
• ?????? ???????
• Semistrong-form EMH - prices reflect all public
information
• ?????? ????????
• Strong-form EMH - prices reflect all public and
private information
• ?????? ??????

110
Weak-Form EMH????? ????????? ????????? ??
??????? ????? ??????? ?? ???? ?? ??? ?? ????? ???
???? ????? ?????? ????????
• Current prices reflect all security-market
information, including the historical sequence of
prices, rates of return, trading volume data, and
other market-generated information
• This implies that past rates of return and other
market data should have no relationship with
future rates of return

111
Semistrong-Form EMH????????? ?????? ?????? ????
?? ??????? ???????? ?? ???? ?? ??? ?? ????? ???
???? ????? ?????? ????????
• Current security prices reflect all public
information, including market and non-market
information
• This implies that decisions made on new
information after it is public should not lead to
transactions

112
Strong-Form EMH????? ????????? ??????? ???????
??????? ?? ???? ?? ??? ?? ????? ??? ???? ?????
?????? ????????
• Stock prices fully reflect all information from
public and private sources
• This implies that no group of investors should be
able to consistently derive above-average
• This assumes perfect markets in which all
information is cost-free and available to
everyone at the same time

113
Tests and Results of Weak-Form EMH?????? ???????
?????? ???????
• Statistical tests of independence between rates
of return
• Autocorrelation tests have mixed results
• Active Vs. Buy and Hold show varying results

114
Tests and Results of Weak-Form EMH????? ??? ???
?????? ??????? ?????? ???? ???
policy is difficult because trading rules can be
complex and there are too many to test them all
• Filter rules yield above-average profits, but
only before taking into account transactions
costs
• Trading rule results have been mixed, and most
have not been able to beat a buy-and-hold policy
• Results generally support the weak-form EMH, but
results are not unanimous

115
Tests of the Semistrong Form of Market
Efficiency ?????? ??????? ?????? ????????
• These tests involve a joint hypothesis and are
dependent both on market efficiency and the asset
pricing model used
• ????? ??????? ????????
• They use
• 1- Event studies ?????? ?????
• 2- Trading volumes and price ?????? ????? ?????
???? ???????
• 3- Multipliers ?????????

116
Tests and Results of Semistrong-Form EMH
• The January Anomaly ????? ???????
• Stocks with negative returns during the prior
year had higher returns right after the first of
the year
• Tax selling toward the end of the year has been
mentioned as the reason for this phenomenon
• Such a seasonal pattern is inconsistent with the
EMH

117
Tests and Results of Semistrong-Form EMH
• Other calendar effects
• All the markets cumulative advance occurs during
the first half of trading months
• Monday/weekend returns were significantly negative

118
Tests and Results of Semistrong-Form EMH
• The size effect (total market value) ?????
??????? ???????
• The studies indicate that risk-adjusted returns
for extended periods indicate that the small
firms consistently experienced significantly
larger risk-adjusted returns than large firms
• The small-firm effect is not stable from year to
year
• Firm size is a major efficient market anomaly

119
Tests and Results of Semistrong-Form EMH
• Neglected Firms ????? ??????? ???????
• Firms divided by number of analysts following a
stock
• Neglected firm effect caused by lack of
information and limited institutional interest
• Neglected firm concept applied across size classes

120
Tests and Results of Semistrong-form EMH
• Trading volume ????? ??? ???????
• Studied relationship between returns, market
• No significant difference was found between the
mean returns of the highest and lowest trading
activity portfolios

121
Tests and Results of Semistrong-Form EMH
• Ratio of Book Value of a firms Equity to Market
Value of its equity ????? ????? ???????
• Significant positive relationship found between
current values for this ratio and future stock
returns
• Results inconsistent with the EMH
• Size and BV/MV dominate other ratios such as E/P
ratio or leverage ????? ????? ???????

122
Evidence Against Market Efficiency
• Market Overreaction recent research suggests
that stock prices may overreact to news
announcements and that the pricing errors are
corrected only slowly
• ????? ?????? ??? ????? ????????? ???????
• When corporations announce a major change in
earnings, say, a large decline, the stock price
may overshoot, and after an initial large
decline, it may rise back to more normal levels
over a period of several weeks.
• This violates the EMH because an investor could
earn abnormally high returns, on average, by
buying a stock immediately after a poor earnings
announcement and then selling it after a couple
of weeks when it has risen back to normal levels.

123
Evidence Against Market Efficiency
• Excessive Volatility the stock market appears to
display excessive volatility that is,
fluctuations in stock prices may be much greater
than is warranted by fluctuations in their
fundamental value.
• ????? ??????? ??????
• Researchers have found that fluctuations in the
SP 500 stock index could not be justified by the
subsequent fluctuations in the dividends of the
stocks making up this index.
• Other research finds that there are smaller
fluctuations in stock prices when stock markets
are closed, has produced a consensus that stock
market prices appear to be driven by factors
other than fundamentals.

124
Evidence Against Market Efficiency
• Mean Reversion Some researchers have found that
stocks with low returns today tend to have high
returns in the future, and vice versa.
• ????? ?????? ??? ???? ?????
• Hence stocks that have done poorly in the past
are more likely to do well in the future because
mean reversion indicates that there will be a
predictable positive change in the future price,
suggesting that stock prices are not a random
walk.
• Newer data is less conclusive nevertheless, mean
reversion remains controversial.

125
Evidence Against Market Efficiency
• New Information Is Not Always Immediately
Incorporated into Stock Prices
• ????? ???? ????? ?? ??????? ?? ????????? ???????
• Although generally true, recent evidence suggests
that, inconsistent with the efficient market
hypothesis, stock prices do not instantaneously
• Instead, on average stock prices continue to rise
for some time after the announcement of
unexpectedly high profits, and they continue to
fall after surprisingly low profit announcements.

126
Tests and Results of Semistrong-Form EMH
• ??????? ?????? ????? ?? ?????? ????? ?????
???????
• Event studies examine how fast stock prices
adjust to specific significant economic events
• Stock split studies show that splits do not
result in abnormal gains after the split
announcement, but before
• Initial public offerings seems to be underpriced
by almost 18, but that varies over time, and the
price is adjusted within one day after the
offering
• Listing of a stock on an national exchange may
offer some short term profit opportunities for
investors

127
Tests and Results of Semistrong-Form EMH
• Event studies (continued)
• Stock prices quickly adjust to unexpected world
events and economic news and hence do not provide
opportunities for abnormal profits
• Announcements of accounting changes are quickly
adjusted for and do not seem to provide
opportunities
• Stock prices rapidly adjust to corporate events
such as mergers and offerings
• The above studies provide support for the
semistrong-form EMH

128
Summary on the Semistrong-Form EMH
• Evidence is mixed
• ???? ?????? ????? ???? ?? ????? ??? ???????
???????
• strong support from numerous event studies
• Studies on predicting rates of return for a
cross-section of stocks indicates markets are not
semistrong efficient (e.g. use of multipliers
like PE, or calendar effects

129
Tests and Results of Strong-Form EMH ??????
??????? ?????? ??????
• Strong-form EMH contends that stock prices fully
reflect all information, both public and private
• This implies that no group of investors has
them to consistently earn above-average profits

130
Testing Groups of Investors
• Corporate insiders
• Stock exchange specialists
• Security analysts
• Professional money managers (e.g. investment
funds managers)

131
Corporate Insider Trading ?????? ???? ?????
?????????
• Corporate insiders include major corporate
officers, directors, and owners of 10 or more of
any equity class of securities
• Insiders must report to the SEC each month on
their transactions in the stock of the firm for
which they are insiders
weeks later and allowed to be studied

132
Corporate Insider Trading ???????? ???? ??
????????? ?????? ???? ???? ???? ?? ???????????
?? ????? ??? ??? ??????? ??????
• Corporate insiders generally experience
above-average profits especially on purchase
transaction
• This implies that many insiders had private
information from which they derived above-average
returns on their company stock

133
• Studies showed that public investors who traded
with the insiders based on announced transactions
would have enjoyed excess risk-adjusted returns
(after commissions), but the markets now seem to
have eliminated this inefficiency (soon after it
was discovered)

134
Stock Exchange Specialists ???????? ???? ??
???????? ????? ?????? ??? ??????? ?? ???? ?????
?????? ?????? ???? ???? ???? ?? ???????? ??
????? ??? ??? ??????? ??????
• You would expect specialists to derive
above-average returns from this information
• The data generally supports this expectation

135
Security Analysts ???????? ???? ?? ????????
???????? ????? ?????? ??? ??????? ?? ???? ?????
?????? ?????? ???? ???? ???? ?? ???????? ??
????? ??? ??? ??????? ??????
• Tests have considered whether it is possible to
identify a set of analysts who have the ability
to select undervalued stocks
• This looks at whether, after a stock selection by
an analyst is made known, a significant abnormal
return is available to those who follow their
recommendations

136
The Value Line Enigma (PSE is considering similar
system) ???????? ???? ?? ??????????? ?? VL
?????? ???? ???? ???? ?? ??????? ?? ????? ???
??? ??????? ??????
• Value Line (VL) publishes financial information
• The report includes a timing rank from 1 down to
5
• Firms ranked 1 substantially outperform the
market
• Firms ranked 5 substantially underperform the
market
• Changes in rankings result in a fast price

137
Professional Money Managers ???????? ???? ??
????? ????????? ????? ?????? ??? ??????? ?? ????
????? ?????? ?????? ???? ???? ???? ?? ????????
?? ????? ??? ??? ??????? ??????
• Trained professionals, working full time at
investment management
• If any investor can achieve above-average
returns, it should be this group
• If any non-insider can obtain inside information,
it would be this group due to the extensive
management interviews that they conduct and due
to high stakes in owned firms

138
Performance of Professional Money Managers
• Most tests examine mutual funds
• New tests also examine trust departments,
• Risk-adjusted, after expenses, returns of mutual
funds generally show that most funds did not
match aggregate market performance

139
Conclusions Regarding the Strong-Form EMH
• ???????? ???? ?? ????? ??? ??? ??????? ?????? ??
???? ???????
• Mixed results, but not much support
• Tests for corporate insiders and stock exchange
specialists do not support the hypothesis (Both
important information and use it to derive
above-average returns)

140
Conclusions Regarding the Strong-Form EMH
• Tests results for analysts are concentrated on
Value Line rankings
• Results have changed over time. Currently tend to
support EMH
• Individual analyst recommendations seem to
contain significant information
• Performance of professional money managers seem
to provide support for strong-form EMH

141
Efficient Markets and Technical Analysis?????
????? ?????? ???????? ?????
• Assumptions of technical analysis directly oppose
the notion of efficient markets
• ??????? ????? ?? ????? ?????? ????? ??? ?????????
??? ?????? ??????
• Technicians believe that new information is not
immediately available to everyone, but
disseminated from the informed professional first
to the aggressive investing public and then to
the masses

142
Efficient Markets and Technical Analysis ?????
????? ?????? ???????? ?????
• Technicians also believe that investors do not
analyze information and act immediately - it
takes time
• ?? ?? ???????? ??????? ?????? ?? ?????????? ??
????? ????????? ????? ??? ???? ????? ?? ???????
???? ??????? ?????????? ????
• Therefore, stock prices move to a new equilibrium
after the release of new information in a gradual
manner, causing trends in stock price movements
that persist for periods

143
Efficient Markets and Technical Analysis ?????
????? ?????? ???????? ?????
• ???? ?????? ?? ?????????????? ?????? ???? ?? ????
???? ?????? ??? ??? ??????? ????? ?????
• Technical analysts develop systems to detect
movement to a new equilibrium (breakout) and
the EMH
• If the capital market is weak-form efficient, a
can have no value

144
Efficient Markets and Fundamental Analysis ?????
????? ?????? ???????? ???????
• ??????? ??????? ???? ????? ???? ?????? ??????
????? ?????? ?? ????????? ???????? ??????
• Fundamental analysts believe that there is a
basic intrinsic value for the aggregate stock
market, various industries, or individual
securities and these values depend on underlying
economic factors
• Investors should determine the intrinsic value of
an investment at a point in time and compare it
to the market price

145
Efficient Markets and Fundamental Analysis ?????
????? ?????? ???????? ???????
• ????? ??? ??????? ???? ????? ??? ??? ???????
• If you can do a superior job of estimating
intrinsic value you can make superior market
timing decisions and generate above-average
returns
• This involves aggregate market analysis, industry
analysis, company analysis, and portfolio
management
aggregate market analysis

146
Efficient Markets and Investment Fund Management
????? ????? ?????? ?????? ??????? ???????????
• ??????? ??????? ???????? ?? ????? ????? ???? ??
?????? ???? ???????
• Investment Fund Managers with Superior Analysts
• concentrate efforts in stocks that do not receive
the attention given by institutional Investment
Fund managers to the top-tier stocks
• the market for these neglected stocks may be less
efficient than the market for large well-known
stocks

147
Efficient Markets and Investment Fund Management
????? ????? ?????? ?????? ??????? ???????????
• ??????? ???????? ?????? ??? ???? ???? ??????
????? ????? ??????? ???????? ?????
• Investment Fund Managers without Superior
Analysts
• Determine and quantify your client's risk
preferences
• Construct the appropriate portfolio
• Diversify completely on a global basis to
eliminate all unsystematic risk
• Maintain the desired risk level by rebalancing
the portfolio whenever necessary
• Minimize total transaction costs

148
The Rationale and Use of Index Funds???? ?????
?????? ?????? ????? ??? ?? ?????? ??? ???? ?????
????? ????? ??????? ??????? ?? ????? ?????????
?????? ????? ???? ????? ?????
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## Brokers Awareness program 5

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### Margin is the amount you put up to trade without paying the full ... Or, add to all of the above margin calculations for futures contracts and options premiums. ... – PowerPoint PPT presentation

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Title: Brokers Awareness program 5

1
Brokers Awareness program(5)
• Dr. Mounther Barakat
• Securities and Commodities Authority

2
?????? ????? ??????? ?????? ??????
• ?. ???? ????? ??????
• ???? ??????? ??????? ??????

3
• Margin is the amount you put up to trade without
paying the full balance.
• Initial margin (IM) is the value of your equity
• Maintenance margin (MM) is the minimum equity you
need to maintain at all time.
• Margin call (MC) is the amount that you need to
put up to bring your equity back to the initial
margin.

4
• XYZ is now selling at DHS10. You have DHS5000 and
would like to purchase 1000 shares. Your broker
is willing to extend you a loan at the call money
rate2 for processing and other costs.
Maintenance margin is 37.5.
• Calculate your profits and losses in the case of
10 price move in both directions.
• Calculate the minimum price before getting a
margin call.

5
Price _at_ DHS10
6
Price up by 10 _at_ DHS11
7
• Return with and without use of margins.
• Without margin
• R(11000-10000)/1000010.
• With margin
• R(6000-5000)/500020.
• 6000/1100054.54

8
Price down by 10 _at_ DHS9
9
• Return with and without use of margins.
• Without margin
• R (9000-10000)/10000 -10.
• With margin
• R (4000- 5000)/ 5000 -20.
• 4000/900044.44

10
• The minimum price before hitting the first margin
call is
• P(IMP0)/(1-MM)
• In our example
• P(.510)/(1-.375)8

11
Price _at_ DHS11 which the margin call price.
12
• Return with and without use of margins.
• Without margin
• R (8000-10000)/10000 -20.
• With margin
• R (3000- 5000)/ 5000 -40.
• 3000/800037.5

13
• Need to add cash to the account to go back to 50
or as agreed with the broker.
• Margin call calculations
• cash PNIM-Eq
• Cash 810000.5-3000
• 1000

14
Your margin now is MEq/Inv. 4000/8000 50
back to IM.
15
• See XLS file for further training

16
Short Selling and Margins?????? ?????? ???
???????
• Margin is the amount of cash you put up as a
security against the increase in your liability
due to short selling.
• Initial margin (IM) is the value of your cash
balance against the short sold position
(liability).
• Maintenance margin (MM) is the minimum equity you
need to maintain at all time.
• Margin call (MC) is the amount that you need to
put up to bring your equity back to the initial
margin.

17
Short Selling and Margins?????? ?????? ???
???????
• XYZ is now selling at DHS10. You would like to
short 1000 shares. Your broker requires a 50
cash margin paid up front. Maintenance margin is
37.5.
• Calculate your profits and losses in the case of
5 price move in both directions.
• Calculate the minimum price before getting a
margin call.

18
Short Selling and Margins?????? ?????? ???
???????
Price _at_ DHS10
19
Short Selling and Margins?????? ?????? ???
???????
Price up by 5 _at_ DHS10.50
20
Short Selling and Margins?????? ?????? ???
???????
• Return with and without use of short selling.
• Without short selling
• R(10500-10000)/100005.
• With short selling
• R(4500-5000)/5000-10.
• 4500/1050042.86

21
Short Selling and Margins?????? ?????? ???
???????
Price down by 5 _at_ DHS9.5
22
Short Selling and Margins?????? ?????? ???
???????
• Return with and without use of short selling.
• Without short selling
• R(9500-10000)/10000-5.
• With short selling
• R(5500-5000)/500010.
• 5500/950057.89

23
Short Selling and Margins?????? ?????? ???
???????
• The minimum price before hitting the first margin
call is
• PP0(1IM)/(1MM)
• In our example
• P10(1.5)/(1.375)10.909

24
Short Selling and Margins?????? ?????? ???
???????
Price _at_ DHS10.909
25
Short Selling and Margins?????? ?????? ???
???????
• Return with and without use of short selling.
• Without short selling
• R(10909-10000)/100009.09.
• With short selling
• R(4091-5000)/5000-18.18.
• 5500/950037.5

26
Short Selling and Margins?????? ?????? ???
???????
Price _at_ DHS12
27
Short Selling and Margins?????? ?????? ???
???????
• The position now is 12000 and the equity is 3000.
• The drop in equity is equal to the difference
between the initial position and the current
position value.
• That makes our margin below the 37.5 maintenance
margin.
• Cash is needed to go back to the initial margin.

28
Short Selling and Margins?????? ?????? ???
???????
• Need to add cash to the account to go back to 50
or as agreed with the broker.
• The drop in equity is equal to
• Current position initial position
• 12000-10000 2000
• The value of current equity is equal to
• the initial equity the drop
• 5000-2000 3000
• The margin now is equal to
• Current equity/current position
• 3000/12000 25
• This less than the 37.5 maintenance margin. To
go back to the initial margin, we need to add
cash to answer the margin call.

29
Short Selling and Margins?????? ?????? ???
???????
• To go back to the initial margin of 50 we need
to make equity equal to half the current
liability position
• IMP1N 0.5121000 6000
• Margin call calculations
• Margin call amount
• Current Equity requirement-Current equity
• 6000-3000 3000

30
Short Selling and Margins?????? ?????? ???
???????
• See XLS file for further training

31
??????
• Margin Accounts can become very complex
especially if there are multiple diverse
transactions.
• An example would be to calculate the margin
requirements for buying a stock on margin and
short selling another.
• Or, you may want to add to that some other
securities purchased without the use of margin.
• Or, add to all of the above margin calculations
for futures contracts and options premiums.
• Will revisit later on.

32
Segregation of Clients Accounts??? ????????
• Client Money is separated from brokers money.
• Brokers can no longer use one client money (free
of charge) to lend to other clients for stock
purchases.
• Benefits
• Lower risk.
• Enhance the availability of cash for clients
withdrawals.

33
Segregation of Clients Accounts??? ????????
• Where does the cash go? To banks.
• Why then move the cash from brokers to banks? Two
reasons
• Banks enjoy higher liquidity and greater
• Bank capital is structured to have a component
that accounts for these deposits, brokers do not.

34
Segregation of Clients Accounts??? ????????
• What are the problems with brokers practice of
using clients cash to finance other clients stock
purchases?
• Risk of illiquidity
• Strains on leveraged brokers accounts
• No brokers capital rules to protect loans made to
clients using other clients money
• Brokers are not allowed to make such loans by
legal definition of brokering
• There are no regulations for margin trading in
place.

35
Segregation of Clients Accounts??? ????????
• What are the problems of account segregation? -
• Well this liquidity is not allowed in the first
place and markets should have never used this
extra liquidity.

36
Segregation of Clients Accounts??? ????????
liquidity and they think it is not healthy to
stay without it then why not bear the cost of
borrowing from banks to create this claimed extra
liquidity?
• In no way does the SCA condone or encourage
brokers to do so, not until the regulations that
• These regulations are being worked on and will be

37
Segregation of Clients Accounts??? ????????
• So, to avoid this lack of liquidity, why didnt
SCA delay account segregation until after it had
such regulations in place?
• Well, SCA never allowed lending by brokers and
such lending should not be happening.

38
Segregation of Clients Accounts??? ????????
• What is the difference between the current
informal lending and the lending under SCA
regulations?

39
Segregation of Clients Accounts??? ????????
• Under the regulations things will be
• Organized
• Safe
• Fair
• And controllable

40
Market Making???? ?????
• Evidence shows that two of the main problems that
emerging markets face are
• Capital supply shortage and
• low liquidity
• Market making is thought to be a good tool to
remedy these problems.

41
Market Making???? ?????
• The tools other than market making that are used
to by emerging markets to remedy the above
problems are
• market segmentation (trading hours, main and
parallel markets),
• different trading phases (continuous and auction
• introduction of special incentives for submission
of limit orders (hidden reserve orders, standing
orders, etc).

42
Market Making???? ?????
• The implementation of the market making system
contributes the following
• promotes liquidity,
• lowers transaction costs,
• reduces volatility and
• improves daily turnover of the listed securities

43
Market Making???? ?????
• Four types of market making systems which are
applied in modern stock markets
• The quote-driven market making system,
• The centralized market making system in an
order-driven market electronic
• The centralized market making system in an
order-driven market Floor
• The noncentralized market making system in an
order-driven market.

44
Market Making???? ?????
45
Market Making???? ?????
• Market making (dealer) system in a quote-driven,
electronic market
• public investors generally cannot trade directly
among themselves.
• In order for buyers (sellers) to execute an order
they have to contact a market maker (dealer) who
uses his/her own inventory in the transaction.
• There is more than one market maker per company
who announces on a continuous basis quotes to buy
and sell a number of shares at a particular
price.
• Dealers compete among themselves for more
competitive bid and/or ask prices that will
attract the order flow from public
• Certain exchanges prohibit the use of market
makers for their high liquidity stocks. In LSE,
the 100 stocks that belong to the SETS system are
• Stock markets that apply this system are the
NASDAQ and the London Stock Exchange (LSE).

46
Market Making???? ?????
• Centralized market making system in an
order-driven, floor-based market
• All potential buyers or sellers can directly
• Requires the use of a single market maker that
has monopolistic information on both the market
orders and the limit order book.
• There exist a floor, which is a physical location
where market makers reside and interact with
orders that come electronically to their terminal
and with orders that come from floor brokers.
• Market makers are required to announce quotes on
a continuous basis that reflect both the limit
order book interest and floor brokers intentions
• As a result, market makers only provide the
necessary liquidity from their own account when
there is a lack of either a buy or a sell
interest.
• Typically this scenario occurs when there is a
temporary disparity between supply and demand
that asks for the market makers intervention in
order to come up with an equilibrium price.
• Floor-based markets where a centralized market
making system is applied are the NYSE and the
eight stock markets in Germany (Deutsche Börse).

47
Market Making???? ?????
• Centralized market making system in an
order-driven electronic market
• Same as the floor-based market with a single
market maker in the centralized dual role of
matching buyers and sellers and providing the
necessary liquidity when needed.
• The only major difference is that in an order
driven market there is neither a floor nor floor
brokers to interact with the limit order book for
providing extra liquidity.
• Such a system was applied in the Amsterdam Stock
Exchange (prior to its inclusion in Euronext).

48
Market Making???? ?????
• Non-Centralized market making system in an
order-driven electronic market.
• There can be more than one per company
• required to announce limit orders to buy and sell
on a continuous basis
• They do not possess any monopolistic information
on the incoming orders or the limit order book.
• They compete with investors for order flow.
• This system is applied in Euronext, in the
Italian Stock Exchange (ISE) and in the Athens
Stock Exchange (ASE), among others.

49
Market Making???? ?????
50
Market Making???? ?????
51
Market Making???? ?????
• Costs and Challenges of Applying a Market Making
System to Emerging Markets Factors for
Consideration
• current exchange design and the costs of
restructuring
• current investors sentiment towards the exchange
both domestically and internationally
foreign capital
• size of the emerging market.

52
Market Making???? ?????
• 1- current exchange design and the costs of
restructuring
• The least costly to implement in terms of both
machinery and technical personnel and supplies,
is the noncentralized market making system.
• The quote-driven market making system is much
more costly as it requires more capital for the
system to be fully functional.
• The centralized (especially floor systems) are
extremely costly.
• This should not be a major problem in the UAE.

53
Market Making???? ?????
• 2- Current Investors Sentiment Towards the
Exchange - Domestically and Internationally
• Market making has many requirements that are not
currently available in the UAE, som of which are
• Experienced financial researchers
• Short selling, security borrowing, high
liquidity, derivative securities to hedge MM
portfolios.
• Do we think of a centralized MM to be trust
worthy.
• Collusion is possible in Quote or non centralized

54
Market Making???? ?????
• 3- Market Designs in Countries Hosting the Target
Foreign Capital
• Are foreigners used to our system
• Do they trust our regulations and market
participants
• The answer is yes, due to
• the increasing international interest in the UAE
• the UAEs ability to adapt to new systems,
methodologies and technologies.

55
Market Making???? ?????
• 4- Size of the Emerging Market
• Looking at the capitalization of the markets that
employ either the centralized market making
system or the quote-driven market making system,
we observe that these are much larger on average
than other markets that follow the
non-centralized market making system.
• The UAE markets are small once compares to quote
and centralized markets

56
Market Making???? ?????
• Conclusion
• Noncentralized is the closest fit to the UAE.

57
What Are Conflicts of Interest and Why Are They
Important?????? ????? ??????? ???????
• Financial intermediaries engage in a variety of
activities to collect, produce, and distribute
information. By providing large volume of each
service the realize economies of scale and by
providing multiple services, they realize
economies of scope.
• However, these services may be competing with one
another, and this creates the potential for a
conflict of interest (e.g. IBF and BF)

58
What Are Conflicts of Interest and Why Are They
Important?????? ????? ??????? ???????
• The conflicts of interest may arise as the
concealment of information or the dissemination
• We care about these conflicts of interest because
a reduction in the quality of information
increases the presence of asymmetric information.
hazard

59
Ethics and Conflicts of Interest???? ?????? ?
????? ???????
• Conflicts of interest generate incentives to
provide false or misleading information. This
behavior is considered unethical.
• One way to limit these conflicts is to make
workers aware of the ethics issues at stake, so
that they are less likely to engage in unethical
behavior.

60
Types of Conflicts of Interest????? ????? ???????
• Four areas of financial service activities that
harbor the greatest potential for generating
conflicts of interest. These are
• Underwriting and research in investment banking
• Auditing and consulting in accounting firms
• Credit assessment and consulting in
credit-rating agencies
• Universal banking

61
Underwriting and Research in Investment
Banking????? ??????? ??? ????? ????? ?????????
?????? ??????? ???????? ?????? ?? ????? ???????
???????
• Some investment banks both underwrite new
securities sold to the public as well as provide
research (recommendations) to the investing
public
• When revenues from underwriting exceed brokerage
commissions, favorable research will attract more
business, at the expense of unbiased
recommendations to the investing public.

62
Underwriting and Research in Investment
Banking????? ??????? ??? ????? ????? ?????????
?????? ??????? ???????? ?????? ?? ????? ???????
???????
• In initial public offerings of equity,
underwriters direct the new shares as they wish,
typically to their best clients or potential new
clients.
• Since most IPOs are underpriced, many of these
shares are immediately sold for a profit (called
spinning). This immediate profit may appear as
nothing more than payment for future business.

63
Auditing and Consulting in Accounting
Firms??????? ?????? ?????? ?????????? ??? ?????
????????
• The role of auditors in public firms is to
provide an unbiased view of the financial reports
to reduce asymmetric information between the
firms management and the investing public.
• By also providing management advisory services
(such as systems support), the auditor has an
incentive to fudge the audit if the fees from
other services are substantial.

64
Auditing and Consulting in Accounting
Firms??????? ?????? ?????? ?????????? ??? ?????
????????
• Auditors also have a conflict of interest since
they are paid by the firm they audit. If the
auditor gives an unfavorable audit report, the
auditor may lose the auditing business as well.
• A well known case of the failure of auditors to
provide unbiased reports was Arthur Andersens
audit of Enron.

65
Credit Assessment and Consulting in Credit-Rating
Agencies????? ?? ??????? ??? ?????? ????? ???????
• Bond investors rely on credit-rating agency
assessment of firms debt (debt ratings).
• However, ratings are only provided when the firm
pays the agency. Agencies, then, have an
incentive provide better ratings to attract

66
Credit Assessment and Consulting in Credit-Rating
Agencies????? ?? ??????? ??? ?????? ????? ???????
• Rating agencies have also started providing firms
with other services, and have the same conflicts
as auditors in this regard.

67
Universal Banking????? ??????? ??? ????? ???? ??
???? ????? ?? ?? ????
• Universal banking refers to institutions that
provide some combination of commercial banking,
investment banking, and insurance services.

68
Universal Banking????? ??????? ??? ????? ???? ??
???? ????? ?? ?? ????
• Issuers that use the underwriting services of a
bank will also benefit from sale of its products
to the banks other (retail) customers. Customers
should expect unbiased advice, but may not get
it.
• Bank managers may push investing products of its
affiliates, even if they arent in customers
best interest.

69
Universal Banking????? ??????? ??? ????? ???? ??
???? ????? ?? ?? ????
• Lenders with private (bad) information have an
incentive to withhold the information during
security issuances in order to get paid
themselves, at the expenses of the investing
public.
• Lenders may offer favorable terms to secure

70
Universal Banking????? ??????? ??? ????? ???? ??
???? ????? ?? ?? ????
• Banks may use strong-arm tactics to sell its
affiliate insurance products.

71
When Are Conflicts of Interest a Serious
Problem???? ???? ??????? ?? ??????? ????? ????
• Conflicts of interest are a problem when they
lead to a decreased flow of reliable information
(increased asymmetric information).
• However, even with potential conflicts, the
incentives (financial gain) may not be present to
actually act on them.

72
Conflicts of Interest Empirical Evidence.?????
??????? ?????? ?????
• Empirical evidence suggests that rating agency
debt ratings are unbiased, despite being paid by
the firms.
• Underwriting and commercial banking also appeared
to be free from exploitations. Many banks
spun-off their investment banking activities to
separate the functions.

73
Conflicts of Interest Empirical Evidence.?????
??????? ?????? ?????
• Empirical evidence also suggests that the
investing public recommendations are made by the
underwriters analysts.
• However, when temporary rewards to highly trusted
firms may extract reputational rents from the
investing public by seeking short-term gains at
the expense of their future reputation.

74
Suggested actions to minimize conflict of
interest and fraudulent practices.?????? ??????
????? ??????? ?????????? ????? ???????
• Beside
• A- the known laws (SCA law, Company law, fraud
laws, fin markets law, banking laws, exchangers
law)
• B- and the monitoring and examining of the SCA,
Government agencies, internal and external
auditing
• Establish a Public Company Accounting Oversight
Board to supervise accounting firms.
• Prohibit public accounting firms from engaging in
nonaudit services to a client it is also
auditing.
• Members of the boards audit committee must be
independent.

75
Suggested actions to minimize conflict of
interest and fraudulent practices.?????? ??????
????? ??????? ?????????? ????? ???????
• Require the reporting of off-balance sheet
activities.
• Increase the charges for white-collar crimes and
obstruction.

76
Suggested actions to minimize conflict of
interest and fraudulent practices.?????? ??????
????? ??????? ?????????? ????? ???????
• Firms must severe the link between underwriting
and research activities.
• Firms must make public analyst recommendations
and target prices.

77
Suggested actions to minimize conflict of
interest and fraudulent practices.?????? ??????
????? ??????? ?????????? ????? ???????
• Brokerage firms required to obtain third-party,
independent research for their clients.
• Massive fines and very harsh penalties even for
the smallest of violations.

78
Policies to Remedy Conflicts of Interest??????
?????? ?? ?????? ?????? ?????? ???????
• A trade-off between potential conflicts of
interest and economies of scale exists. Simply
eliminating any potential conflict may not be the
best solution
• The existence of a conflict of interest does not
mean that the conflict will have severe
consequences.
• Even if incentives to exploit conflicts are high,
eliminating the conflict may be worse if it
reduces the flow of reliable information.

79
Policies to Remedy Conflicts of Interest??????
?????? ?? ?????? ?????? ?????? ???????
• Leave It to the Market an appealing approach
that relies on market forces, but has the problem
that the market has a short memory for past
problems.
• Regulate for Transparency regulate mandatory
disclosure, even if it is more costly than the
information provided.

80
Policies to Remedy Conflicts of Interest??????
?????? ?? ?????? ?????? ?????? ???????
• Supervisory Oversight force firms to provide
private information to a supervisor, who can act
on it as deemed necessary.
• Separation of Functions separate those functions
that create conflicts, either within firms or (in
extreme cases) by not allowing those functions
within the same firm.

81
Policies to Remedy Conflicts of Interest??????
?????? ?? ?????? ?????? ?????? ???????
• Socialization of Information Production look to
public funding for information providers, such as
credit agencies.
• Non government societies, peer pressure and the
code of ethics.

82
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83
Efficient Market Hypothesis????? ????? ?????
• This equation tells us that current prices in a
financial market will be set so that the optimal
forecast of a securitys return using all
available information equals the securitys
equilibrium return.
• ???? ?????? ??????? ????? ????? ?????? ???????
??? ??? ???? ????????? ??????? ???? ????????.
• Financial economists state it more simply A
securitys price fully reflects all available
information in an efficient market.
• Efficient market condition holds even if there
are uninformed, irrational participants in market

84
Rationale Behind the Hypothesis ??? ??????? ??
???? ??? ????????
• When an unexploited profit opportunity arises on
a security (so-called because, on average, people
would be earning more than they should, given the
characteristics of that security), investors will
rush to buy until the price rises to the point
that the returns are normal again.

85
Rationale Behind the Hypothesis (cont.) ???
??????? ?? ???? ??? ????????
• In an efficient market, all unexploited profit
opportunities will be eliminated.
• Not every investor need be aware of every
security and situation, as long as a few keep
their eyes open for unexploited profit
opportunities, they will eliminate the profit
opportunities that appear because in so doing,
they make a profit.

86
Example on elimination of unexploited profits
87
Stronger Version of the Efficient Market
Hypothesis ???? ???? ?????? ????? ?????
• Many financial economists take the EMH one step
further in their analysis of financial markets.
Not only do they define an efficient market as
one in which expectations are optimal forecasts
using all available information, but they also
add the condition that an efficient market is one
in which prices are always correct and reflect
market fundamentals (items that have a direct
impact on future income streams of the
securities)
• ??????? ????? ??? ??????? ??? ??????. ????????
????? ??? ????????? ???????? ????? ?????? ?????
?????.

88
Stronger Version of the Efficient Market
Hypothesis (2)
• This stronger view of market efficiency has
several important implications in the academic
field of finance
• It implies that in an efficient capital market,
one investment is as good as any other because
the securities prices are correct. ????
??????????? ???? ??? ?????? ?????? ?????? ???????
• It implies that a securitys price reflects all
available information about the intrinsic value
of the security.
• ????? ?????? ???? ???? ????????? ????????
????????? ?????? ?????? ??????

89
Stronger Version of the Efficient Market
Hypothesis (2)
• It implies that security prices can be used by
managers of both financial and nonfinancial firms
to assess their cost of capital (cost of
financing their investments) accurately and hence
that security prices can be used to help them
make the correct decisions about whether a
specific investment is worth making or not.
• ????? ??????? ?? ????? ????? ??? ????? ????
???????? ?? ????? ????????

90
Evidence on Efficient Market Hypothesis ???????
???????
• Favorable Evidence ?????? ?????? ???????
• Investment analysts and mutual funds don't beat
the market
• Stock prices reflect publicly available info
anticipated announcements don't affect stock
price
• Stock prices and exchange rates close to random
walk if predictions of ?P big, Rof gt R ?
predictions of ?P small
• Technical analysis does not outperform market

91
Evidence in Favor of Market Efficiency
• Performance of Investment Analysts and Mutual
Funds should not be able to consistently beat the
market
• ?? ???? ???? ?? ???? ???? ?????? ???? ?? ????
????? ????? ?????? ??????
• The Investment Dartboard often beats
investment managers.
• Mutual funds not only do not outperform the
market on average, but when they are separated
into groups according to whether they had the
highest or lowest profits in a chosen period, the
mutual funds that did well in the first period do
not beat the market in the second period.

92
Evidence in Favor of Market Efficiency
• Performance of Investment Analysts and Mutual
Funds should not be able to consistently beat the
market
• Investment strategies using inside information is
the only proven method to beat the market. It
is illegal to trade on such information, but that
is not true in all countries.
• ??????? ??????? ????? ???? ?? ???? ????? ??
?????? ??? ??????? ?????? ??? ?? ???? ????? ?????
?????? ????????

93
Evidence in Favor of Market Efficiency
• Do Stock Prices Reflect Publicly Available
Information as the EMH predicts they will?
• Thus if information is already publicly
available, a positive announcement about a
company will not, on average, raise the price of
its stock because this information is already
reflected in the stock price.
• ??? ???? ??????? ???? ???? ????????? ??? ???????
?? ????? ??? ????? ?? ?????? ??? ??? ??? ???????
????? ???? ?????? ??????

94
Evidence in Favor of Market Efficiency
• Do Stock Prices Reflect Publicly Available
Information as the EMH predicts they will?
• Early empirical evidence confirms favorable
earnings announcements or announcements of stock
splits (a division of a share of stock into
multiple shares, which is usually followed by
higher earnings) do not, on average, cause stock
prices to rise.
• ???????? ??????? ????? ?? ??????? ?? ????? ??????
?????? ?? ?? ????? ?? ????????? ?? ?????? ?????
?? ?? ???? ???

95
Evidence in Favor of Market Efficiency
• Random-Walk Behavior of Stock Prices that is,
future changes in stock prices should, for all
practical purposes, be unpredictable
• ????? ??? ???????? ??????? ????????? ??????
??????
• If stock is predicted to rise, people will buy to
equilibrium level, if stock is predicted to fall,
people will sell to equilibrium level (both in
concert with EMH)
• Thus, if stock prices were predictable, thereby
causing the above behavior, price changes would
be near zero, which has not been the case
historically

96
Evidence in Favor of Market Efficiency
• Technical Analysis means to study past stock
price data and search for patterns such as trends
and regular cycles, suggesting rules for when to
• ??????? ?????? ????? ????? ??? ????? ????? ??????
• The EMH suggests that technical analysis is a
waste of time
• The simplest way to understand why is to use the
random-walk result that holds that past stock
price data cannot help predict changes.
Therefore, technical analysis, which relies on
such data to produce its forecasts, cannot
successfully predict changes in stock prices

97
Evidence on Efficient Market Hypothesis
• Unfavorable Evidence ????? ???? ??? ???????
• Small-firm effect small firms have abnormally
high returns
• January effect high returns in January
• Market overreaction
• Excessive volatility
• Mean reversion
• New information is not always immediately
incorporated into stock prices

98
THE PRACTICING MANAGER Implications for
Investing????? ??????? ???????? ???????
??????????
• How valuable are published reports by investment
• Should you be skeptical of hot tips?
• Do stock prices always rise when there is good
news?
• Efficient Markets prescription for investor

99
Implications for Investing
• How valuable are published reports by investment
• ?? ?? ???? ???????? ??????? ?? ????? ????????

100
Implications for Investing
• Should you be skeptical of hot tips?
• ?? ??? ?? ??????? ??????? ?????? ???? ???? ???
????? ???????
• YES. The EMH indicates that you should be
skeptical of hot tips since, if the stock market
is efficient, it has already priced the hot tip
stock so that its expected return will equal the
equilibrium return.
• Thus, the hot tip is not particularly valuable
and will not enable you to earn an abnormally
high return.

101
Implications for Investing
• Should you be skeptical of hot tips?
• As soon as the information hits the street, the
unexploited profit opportunity it creates will be
quickly eliminated.
• The stocks price will already reflect the
information, and you should expect to realize
only the equilibrium return.

102
Implications for Investing
• Do stock prices always rise when there is good
news?
• ?? ?????? ??????? ??????? ?? ???? ????? ????
???????
• NO. In an efficient market, stock prices will
respond to announcements only when the
information being announced is new and
unexpected.
• So, if good news was expected (or as good as
expected), there will be no stock price response.
• And, if good news was unexpected (or not as good
as expected), there will be a stock price
response.

103
Implications for Investing
• Efficient Markets prescription for investor
• ????? ????? ?????? ???? ?? ?????? ?????????
• Investors should not try to outguess the market
by constantly buying and selling securities. This
process does nothing but incur commissions costs

104
Implications for Investing
• Efficient Markets prescription for investor
• ?????? ????????? ???? ?? ??????? ??????? ???? ??
????? ?????
hold strategypurchase stocks and hold them for
long periods of time. This will lead to the same
returns, on average, but the investors net
profits will be higher because fewer brokerage
commissions will have to be paid.

105
Implications for Investing
• Efficient Markets prescription for investor
• ??????? ?? ?????? ??????? ??? ????? ????? ??????
???? ???? ?????????? ?????????? ?? ??????
????????? ???????? ????????
• It is frequently a sensible strategy for a small
investor, whose costs of managing a portfolio may
be high relative to its size, to buy into a
mutual fund rather than individual stocks.
Because the EMH indicates that no mutual fund can
consistently outperform the market, an investor
should not buy into one that has high management
fees or that pays sales commissions to brokers
but rather should purchase a no-load
(commission-free) mutual fund that has low
management fees.

106
Behavioral Finance ??????? ???????
• Dissatisfaction with using the EMH to explain
events like 1987s Black Monday gave rise to the
new field of behavioral finance, in which
concepts from psychology, sociology, and other
social sciences are applied to understand the
behavior of securities prices
• ??? ??????? ????? ????? ?????? ?? ???????
???????? ???? ??????? ??????????
• EMH suggests that smart money would engage in
short sales to combat overpriced securities, yet
short sale volume is low, leading to behavior
• Other behavior analysis points to investor
overconfidence as perpetuating stock price
bubbles

107
Why Should Capital MarketsBe Efficient??????
??? ?? ???? ??????? ?????
• The premises of an efficient market
• A large number of competing profit-maximizing
participants analyze and value securities, each
independently of the others
• New information regarding securities comes to the
market in a random fashion
prices rapidly to reflect the effect of new
information
• Conclusion the expected returns implicit in the
current price of a security should reflect its
risk

108
AlternativeEfficient Market Hypotheses (EMH)??
?????? ????? ????? ??????
• Random Walk Hypothesis changes in security
prices occur randomly
• ?????? ????????
• Fair Game Model current market price reflect
all available information about a security and
the expected return based upon this price is
consistent with its risk
• ?????? ???????
• Efficient Market Hypothesis (EMH) - divided into
three sub-hypotheses depending on the information
set involved
• 3 ??????? ?????? ????? ??????

109
Efficient Market Hypotheses (EMH)
• Weak-Form EMH - prices reflect all
security-market information
• ?????? ???????
• Semistrong-form EMH - prices reflect all public
information
• ?????? ????????
• Strong-form EMH - prices reflect all public and
private information
• ?????? ??????

110
Weak-Form EMH????? ????????? ????????? ??
??????? ????? ??????? ?? ???? ?? ??? ?? ????? ???
???? ????? ?????? ????????
• Current prices reflect all security-market
information, including the historical sequence of
prices, rates of return, trading volume data, and
other market-generated information
• This implies that past rates of return and other
market data should have no relationship with
future rates of return

111
Semistrong-Form EMH????????? ?????? ?????? ????
?? ??????? ???????? ?? ???? ?? ??? ?? ????? ???
???? ????? ?????? ????????
• Current security prices reflect all public
information, including market and non-market
information
• This implies that decisions made on new
information after it is public should not lead to
transactions

112
Strong-Form EMH????? ????????? ??????? ???????
??????? ?? ???? ?? ??? ?? ????? ??? ???? ?????
?????? ????????
• Stock prices fully reflect all information from
public and private sources
• This implies that no group of investors should be
able to consistently derive above-average
• This assumes perfect markets in which all
information is cost-free and available to
everyone at the same time

113
Tests and Results of Weak-Form EMH?????? ???????
?????? ???????
• Statistical tests of independence between rates
of return
• Autocorrelation tests have mixed results
• Active Vs. Buy and Hold show varying results

114
Tests and Results of Weak-Form EMH????? ??? ???
?????? ??????? ?????? ???? ???
policy is difficult because trading rules can be
complex and there are too many to test them all
• Filter rules yield above-average profits, but
only before taking into account transactions
costs
• Trading rule results have been mixed, and most
have not been able to beat a buy-and-hold policy
• Results generally support the weak-form EMH, but
results are not unanimous

115
Tests of the Semistrong Form of Market
Efficiency ?????? ??????? ?????? ????????
• These tests involve a joint hypothesis and are
dependent both on market efficiency and the asset
pricing model used
• ????? ??????? ????????
• They use
• 1- Event studies ?????? ?????
• 2- Trading volumes and price ?????? ????? ?????
???? ???????
• 3- Multipliers ?????????

116
Tests and Results of Semistrong-Form EMH
• The January Anomaly ????? ???????
• Stocks with negative returns during the prior
year had higher returns right after the first of
the year
• Tax selling toward the end of the year has been
mentioned as the reason for this phenomenon
• Such a seasonal pattern is inconsistent with the
EMH

117
Tests and Results of Semistrong-Form EMH
• Other calendar effects
• All the markets cumulative advance occurs during
the first half of trading months
• Monday/weekend returns were significantly negative

118
Tests and Results of Semistrong-Form EMH
• The size effect (total market value) ?????
??????? ???????
• The studies indicate that risk-adjusted returns
for extended periods indicate that the small
firms consistently experienced significantly
larger risk-adjusted returns than large firms
• The small-firm effect is not stable from year to
year
• Firm size is a major efficient market anomaly

119
Tests and Results of Semistrong-Form EMH
• Neglected Firms ????? ??????? ???????
• Firms divided by number of analysts following a
stock
• Neglected firm effect caused by lack of
information and limited institutional interest
• Neglected firm concept applied across size classes

120
Tests and Results of Semistrong-form EMH
• Trading volume ????? ??? ???????
• Studied relationship between returns, market
• No significant difference was found between the
mean returns of the highest and lowest trading
activity portfolios

121
Tests and Results of Semistrong-Form EMH
• Ratio of Book Value of a firms Equity to Market
Value of its equity ????? ????? ???????
• Significant positive relationship found between
current values for this ratio and future stock
returns
• Results inconsistent with the EMH
• Size and BV/MV dominate other ratios such as E/P
ratio or leverage ????? ????? ???????

122
Evidence Against Market Efficiency
• Market Overreaction recent research suggests
that stock prices may overreact to news
announcements and that the pricing errors are
corrected only slowly
• ????? ?????? ??? ????? ????????? ???????
• When corporations announce a major change in
earnings, say, a large decline, the stock price
may overshoot, and after an initial large
decline, it may rise back to more normal levels
over a period of several weeks.
• This violates the EMH because an investor could
earn abnormally high returns, on average, by
buying a stock immediately after a poor earnings
announcement and then selling it after a couple
of weeks when it has risen back to normal levels.

123
Evidence Against Market Efficiency
• Excessive Volatility the stock market appears to
display excessive volatility that is,
fluctuations in stock prices may be much greater
than is warranted by fluctuations in their
fundamental value.
• ????? ??????? ??????
• Researchers have found that fluctuations in the
SP 500 stock index could not be justified by the
subsequent fluctuations in the dividends of the
stocks making up this index.
• Other research finds that there are smaller
fluctuations in stock prices when stock markets
are closed, has produced a consensus that stock
market prices appear to be driven by factors
other than fundamentals.

124
Evidence Against Market Efficiency
• Mean Reversion Some researchers have found that
stocks with low returns today tend to have high
returns in the future, and vice versa.
• ????? ?????? ??? ???? ?????
• Hence stocks that have done poorly in the past
are more likely to do well in the future because
mean reversion indicates that there will be a
predictable positive change in the future price,
suggesting that stock prices are not a random
walk.
• Newer data is less conclusive nevertheless, mean
reversion remains controversial.

125
Evidence Against Market Efficiency
• New Information Is Not Always Immediately
Incorporated into Stock Prices
• ????? ???? ????? ?? ??????? ?? ????????? ???????
• Although generally true, recent evidence suggests
that, inconsistent with the efficient market
hypothesis, stock prices do not instantaneously
• Instead, on average stock prices continue to rise
for some time after the announcement of
unexpectedly high profits, and they continue to
fall after surprisingly low profit announcements.

126
Tests and Results of Semistrong-Form EMH
• ??????? ?????? ????? ?? ?????? ????? ?????
???????
• Event studies examine how fast stock prices
adjust to specific significant economic events
• Stock split studies show that splits do not
result in abnormal gains after the split
announcement, but before
• Initial public offerings seems to be underpriced
by almost 18, but that varies over time, and the
price is adjusted within one day after the
offering
• Listing of a stock on an national exchange may
offer some short term profit opportunities for
investors

127
Tests and Results of Semistrong-Form EMH
• Event studies (continued)
• Stock prices quickly adjust to unexpected world
events and economic news and hence do not provide
opportunities for abnormal profits
• Announcements of accounting changes are quickly
adjusted for and do not seem to provide
opportunities
• Stock prices rapidly adjust to corporate events
such as mergers and offerings
• The above studies provide support for the
semistrong-form EMH

128
Summary on the Semistrong-Form EMH
• Evidence is mixed
• ???? ?????? ????? ???? ?? ????? ??? ???????
???????
• strong support from numerous event studies
• Studies on predicting rates of return for a
cross-section of stocks indicates markets are not
semistrong efficient (e.g. use of multipliers
like PE, or calendar effects

129
Tests and Results of Strong-Form EMH ??????
??????? ?????? ??????
• Strong-form EMH contends that stock prices fully
reflect all information, both public and private
• This implies that no group of investors has
them to consistently earn above-average profits

130
Testing Groups of Investors
• Corporate insiders
• Stock exchange specialists
• Security analysts
• Professional money managers (e.g. investment
funds managers)

131
Corporate Insider Trading ?????? ???? ?????
?????????
• Corporate insiders include major corporate
officers, directors, and owners of 10 or more of
any equity class of securities
• Insiders must report to the SEC each month on
their transactions in the stock of the firm for
which they are insiders
weeks later and allowed to be studied

132
Corporate Insider Trading ???????? ???? ??
????????? ?????? ???? ???? ???? ?? ???????????
?? ????? ??? ??? ??????? ??????
• Corporate insiders generally experience
above-average profits especially on purchase
transaction
• This implies that many insiders had private
information from which they derived above-average
returns on their company stock

133
• Studies showed that public investors who traded
with the insiders based on announced transactions
would have enjoyed excess risk-adjusted returns
(after commissions), but the markets now seem to
have eliminated this inefficiency (soon after it
was discovered)

134
Stock Exchange Specialists ???????? ???? ??
???????? ????? ?????? ??? ??????? ?? ???? ?????
?????? ?????? ???? ???? ???? ?? ???????? ??
????? ??? ??? ??????? ??????
• You would expect specialists to derive
above-average returns from this information
• The data generally supports this expectation

135
Security Analysts ???????? ???? ?? ????????
???????? ????? ?????? ??? ??????? ?? ???? ?????
?????? ?????? ???? ???? ???? ?? ???????? ??
????? ??? ??? ??????? ??????
• Tests have considered whether it is possible to
identify a set of analysts who have the ability
to select undervalued stocks
• This looks at whether, after a stock selection by
an analyst is made known, a significant abnormal
return is available to those who follow their
recommendations

136
The Value Line Enigma (PSE is considering similar
system) ???????? ???? ?? ??????????? ?? VL
?????? ???? ???? ???? ?? ??????? ?? ????? ???
??? ??????? ??????
• Value Line (VL) publishes financial information
• The report includes a timing rank from 1 down to
5
• Firms ranked 1 substantially outperform the
market
• Firms ranked 5 substantially underperform the
market
• Changes in rankings result in a fast price

137
Professional Money Managers ???????? ???? ??
????? ????????? ????? ?????? ??? ??????? ?? ????
????? ?????? ?????? ???? ???? ???? ?? ????????
?? ????? ??? ??? ??????? ??????
• Trained professionals, working full time at
investment management
• If any investor can achieve above-average
returns, it should be this group
• If any non-insider can obtain inside information,
it would be this group due to the extensive
management interviews that they conduct and due
to high stakes in owned firms

138
Performance of Professional Money Managers
• Most tests examine mutual funds
• New tests also examine trust departments,
• Risk-adjusted, after expenses, returns of mutual
funds generally show that most funds did not
match aggregate market performance

139
Conclusions Regarding the Strong-Form EMH
• ???????? ???? ?? ????? ??? ??? ??????? ?????? ??
???? ???????
• Mixed results, but not much support
• Tests for corporate insiders and stock exchange
specialists do not support the hypothesis (Both
important information and use it to derive
above-average returns)

140
Conclusions Regarding the Strong-Form EMH
• Tests results for analysts are concentrated on
Value Line rankings
• Results have changed over time. Currently tend to
support EMH
• Individual analyst recommendations seem to
contain significant information
• Performance of professional money managers seem
to provide support for strong-form EMH

141
Efficient Markets and Technical Analysis?????
????? ?????? ???????? ?????
• Assumptions of technical analysis directly oppose
the notion of efficient markets
• ??????? ????? ?? ????? ?????? ????? ??? ?????????
??? ?????? ??????
• Technicians believe that new information is not
immediately available to everyone, but
disseminated from the informed professional first
to the aggressive investing public and then to
the masses

142
Efficient Markets and Technical Analysis ?????
????? ?????? ???????? ?????
• Technicians also believe that investors do not
analyze information and act immediately - it
takes time
• ?? ?? ???????? ??????? ?????? ?? ?????????? ??
????? ????????? ????? ??? ???? ????? ?? ???????
???? ??????? ?????????? ????
• Therefore, stock prices move to a new equilibrium
after the release of new information in a gradual
manner, causing trends in stock price movements
that persist for periods

143
Efficient Markets and Technical Analysis ?????
????? ?????? ???????? ?????
• ???? ?????? ?? ?????????????? ?????? ???? ?? ????
???? ?????? ??? ??? ??????? ????? ?????
• Technical analysts develop systems to detect
movement to a new equilibrium (breakout) and
the EMH
• If the capital market is weak-form efficient, a
can have no value

144
Efficient Markets and Fundamental Analysis ?????
????? ?????? ???????? ???????
• ??????? ??????? ???? ????? ???? ?????? ??????
????? ?????? ?? ????????? ???????? ??????
• Fundamental analysts believe that there is a
basic intrinsic value for the aggregate stock
market, various industries, or individual
securities and these values depend on underlying
economic factors
• Investors should determine the intrinsic value of
an investment at a point in time and compare it
to the market price

145
Efficient Markets and Fundamental Analysis ?????
????? ?????? ???????? ???????
• ????? ??? ??????? ???? ????? ??? ??? ???????
• If you can do a superior job of estimating
intrinsic value you can make superior market
timing decisions and generate above-average
returns
• This involves aggregate market analysis, industry
analysis, company analysis, and portfolio
management
aggregate market analysis

146
Efficient Markets and Investment Fund Management
????? ????? ?????? ?????? ??????? ???????????
• ??????? ??????? ???????? ?? ????? ????? ???? ??
?????? ???? ???????
• Investment Fund Managers with Superior Analysts
• concentrate efforts in stocks that do not receive
the attention given by institutional Investment
Fund managers to the top-tier stocks
• the market for these neglected stocks may be less
efficient than the market for large well-known
stocks

147
Efficient Markets and Investment Fund Management
????? ????? ?????? ?????? ??????? ???????????
• ??????? ???????? ?????? ??? ???? ???? ??????
????? ????? ??????? ???????? ?????
• Investment Fund Managers without Superior
Analysts
• Determine and quantify your client's risk
preferences
• Construct the appropriate portfolio
• Diversify completely on a global basis to
eliminate all unsystematic risk
• Maintain the desired risk level by rebalancing
the portfolio whenever necessary
• Minimize total transaction costs

148
The Rationale and Use of Index Funds???? ?????
?????? ?????? ????? ??? ?? ?????? ??? ???? ?????
????? ????? ??????? ??????? ?? ????? ?????????
?????? ????? ???? ????? ?????