Question

Suppose the government announces that, based on a just-completed survey, the growth rate in the economy is likely to be 2% in the coming year, as compared to 5% for the past year. Will security prices increase, decrease, or stay the same following this announcement? a. Decrease--assuming the information was expected by the market. b. Increase--assuming the market was not expecting the annoucement. c. Decrease--the information was already priced into the market prices (markets are not efficient) d. Stay the same--the information was already priced into the market prices (markets are efficient)

Answer 1

When economic growth rate falls then Corporate earnings decreases.Decrease of corporate earnings will have a negative impact on the security prices resulting into decrease of the security price.

Considering the above fact (b) will not happen following the announcement.

If it is assumed that the information was expected by the market and considering that the markets are efficient ,the information would already have been priced into the market prices resulting into stay the same situation.Since for (a) and (d) both condition are not applicable together ,so both (a) and (d) will not happen following the announcement.

So (c) i.e. Decrease-the information was already priced in to the market prices.(markets are not efficient) will happen after the announcement.