Investment Analysis Coursework 2001 Essay Example | Topics and Well Written Essays - 2000 words

Investment Analysis Coursework 2001 - Essay Example ‘Herd’ implies a social grouping of people, who have similar understanding or perception about anything. Here ‘herd’ implies the people, who have the same viewpoint within the stock market. The above statement briefs that market movements are dependent on individuals. If a person buys a particular stock and he is a popular figure in the community and society, then every individual intends to purchase this stock and this is simply because the first person has bought it, not because of the market value of the stock. â€Å"Perhaps 100 people were simply imitating the coin flipping call of some terribly persuasive personality† (Buffett n.d. p. 4). The ‘margin of safety’ principle implies that safety should be ensured while buying stocks. Walter has justified that while dealing in the stock market, it should always be remembered that it is other people’s money which is being handled. Therefore it reinforces the ethics to strongly avert losses while dealing in stocks. It should always be remembered that money is real and therefore should be handled appropriately. If the net worth of a business is $1 and it can be obtained at 40 cents, then it aims to generate profit. In the stock markets risks and rewards are correlated because as the stock grows riskier, more are the returns from this stock. Even though a high risk stock would be able to generate more returns, yet a risky stock can also generate less or nil returns because the stock’s performance is dependent upon its market performance, which is guarded by several principles. Rational pricing is very important in the stock market, as this pricing is needed for fixed income securities and bonds. Rational pricing implies such a type of pricing, which represents that the market price of the assets in the stock market is free of any arbitrage pricing. Eugene Fama has been propounded as the father of the theory of ‘efficient market hypothesis’. Fam a stated two theories related to the efficient market hypothesis. The first theory was classifying the markets on the basis of three types of efficiency. Fama classified three forms of efficiency which are as follows: Strong form efficiency Semi strong form efficiency Weak form efficiency The strong form efficiency implies that all information related to the firm is incorporated in the price of the stock of the firm. The strong form tests are concerned with whether investors or investor groups have monopolistic access in determining the price of a stock. The semi strong form tests imply the prices are adjusted according to the information available about the firm in their announcements to the public, such as announcements of annual earnings, the stock splits etc. that the firm has witnessed. The weak form efficiency is such a test, where only the historical prices of stocks have been displayed to the public and no other details about the firm is divulged. Fama describes the market e fficiency hypothesis to be very simple, which simply points out that the market price of a stock represents all the vital information about the firm. The second concept, which Fama stated with respect to the efficient market hypothesis, was the concept of market efficiency, which can be rejected only with a rejection of the