Question

Which of the following is inconsistent with the concept of semi-strong efficient markets?

A. A diner in New York City restaurant overhears two men at the next table talking about a merger between their two firms and earns higher profits by purchasing stock based on this information.

B. An investor observes that the bonds of an airline that has filed for bankruptcy are selling for an extremely low price and decides to purchase some of the bonds. Fortunately, the airline overcomes its financial difficulties, the bond payments are made as promised, and the investor earns an extraordinary high return on this investment.

C. An investor hears a financial analyst on television claim that investors can earn unusually high returns by buying stocks near the end of December and selling them early in January. By following this advice, the investor does earn an abnormal high return on his portfolio.

D. All of the above are inconsistent with the concept of semi-strong efficient markets.

E. Both (B) and (C) are inconsistent with the concept of semi-strong efficient markets.

Answer 1

The correct answer is option (E)

In semi strong from, a market is assumed to have fully absorbed all the past and publicly available information. Prices are reflection of all the information in the past and currently in the public domain. Therefore there is no possibility of abnormal return except in case of insider trading, where a trader has access to some private information that is yet not available in public domain.

In this case, statement A is an example of insider trading. In a semi strong for of efficiency, a person having access to insider information can make abnormal returns. Hence, A is consistent.

Statements (B) and (C) are situations where abnormal returns are possible based on public information. These are inconsistent with semi strong form of market efficiency.

Hence, correct answer is option (E)