Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 1 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter 7 Forecasting Share Price Movements

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 2 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Learning Objectives Understand the factors that determine the price of a firm’s shares Contrast fundamental analysis techniques with technical analysis Explain the theoretical concepts of the random walk and efficient market market hypotheses

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 3 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 7.1Introduction 7.2Fundamental Analysis: Bottom-up Approach 7.3Fundamental Analysis: Top-down Approach 7.4Technical Analysis 7.5Program Trading 7.6Random Walk and Efficient Market Hypothesis 7.7Summary

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 4 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.1Introduction Share price is determined by supply and demand of a company’s shares Expectation of bad company performance causes investors to sell their shares, increasing supply and reducing the price Similarly expectation of good company performance increases demand and leads to an increase in share price

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 5 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.1 Introduction (cont.) What causes the shifts in demand and supply of a company’s securities on the secondary market? Three approaches taken in analysing this question – Fundamental analysis: bottom-up – Fundamental analysis: top-down – Technical analysis

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 6 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 7.1Introduction 7.2Fundamental Analysis: Bottom-up Approach 7.3Fundamental Analysis: Top-down Approach 7.4Technical Analysis 7.5Program Trading 7.6Random Walk and Efficient Market Hypothesis 7.7Summary

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 7 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.2 Fundamental Analysis: Bottom-up Approach Fundamental analysis – Considers macro and micro factors that impact upon future share price changes  Macro factors include interest rates, economic growth, business investment  Micro factors are firm-specific and relate to management’s impact on company performance

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 8 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.2 Fundamental Analysis: Bottom-up Approach (cont.) Focuses on ratios and other measures of the firm’s financial characteristics and performance Considers such factors as – Accounting ratios which consider a company’s capital structure, liquidity, debt servicing, profitability, share price and risk (see Chapter 6), and make comparisons with firms in the same industry

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 9 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.2 Fundamental Analysis: Bottom-up Approach (cont.) Considers such factors as (cont.) – Additional information on key management changes, corporate mission and strategic direction and trend analysis of accounting ratios

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 10 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.2 Fundamental Analysis: Bottom-up Approach (cont.)

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 11 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 7.1Introduction 7.2Fundamental Analysis: Bottom-up Approach 7.3Fundamental Analysis: Top-down Approach 7.4Technical Analysis 7.5Program Trading 7.6Random Walk and Efficient Market Hypothesis 7.7Summary

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 12 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.3 Fundamental Analysis: Top-down Approach Forecasts and analyses the economic environment, and considers the impact on firms and industry sectors

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 13 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.3 Fundamental Analysis: Top-down Approach (cont.) Considers such factors as – International economies – Rate of economic growth – Exchange rates – Domestic economy  Interest rates, growth rate, balance of payments, inflation, wage growth

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 14 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Consider such factors as international economies The higher the growth rate in the rest of the world, the greater will be the demand for Australian exports The sectors which benefit from international growth will depend on the source of the growth

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 15 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Consider such factors as international economies (cont.) Growth can be driven by – Increased consumer demand – Increased business investment in equipment

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 16 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Consider such factors as rate of economic growth Generally, greater domestic growth leads to increased profitability of firms However, high growth may lead to – Deterioration in balance of payments – Increase in inflationary pressures – Pressure on wages

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 17 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Consider such factors as rate of economic growth (cont.) The presence of any of these factors may lead to a reduction in firm profitability

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 18 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Consider such factors as exchange rates Affect the domestic currency profit of exporters that quote their products in foreign currency prices – A strengthening of the Australian dollar (AUD) makes these firms worse off, as the AUD value of their exports is now less

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 19 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Consider such factors as exchange rates (cont.) Exchange rates also affect firms indirectly – e.g. devaluation of currency increases cost of imports, thereby increasing inflation

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 20 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Consider such factors as domestic economy Interest rates Have both a direct and indirect impact on firms’ value – Direct effect on profitability  Represents the cost of debt finance for borrowers and the return for finance providers – Indirect effect on profitability  Rise in interest rates may indicate a slowing of economic activity  Future reduction in profitability

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 21 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Consider such factors as domestic economy (cont.) Current account of balance of payments If current account is in deficit i.e. total international payments exceed total international receipts, then – Some export income is diverted to service debt – Need to borrow foreign currency to service debt

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 22 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Consider such factors as domestic economy (cont.) Current account of balance of payments (cont.) Indirect effect on firms’ profitability – Government may increase interest rates to slow economic growth and control the debt

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 23 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Consider such factors as domestic economy (cont.) Inflationary pressures Effect of inflation on firms’ real profit Tax treatment of inflation – Makes historical-based depreciation allowances inappropriate – Combined with higher replacement costs leads to an overstatement of after-tax profit

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 24 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Consider such factors as domestic economy (cont.) Inflationary pressures (cont.) Inventory – ‘Inflated’ selling price of inventory creates an illusion of inventory profits

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 25 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Consider such factors as domestic economy (cont.) Wages growth Increase in wages growth raises the amount of business profit used for salaries This will impact most heavily on those firms that are highly labour intensive

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 26 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 7.1Introduction 7.2Fundamental Analysis: Bottom-up Approach 7.3Fundamental Analysis: Top-down Approach 7.4Technical Analysis 7.5Program Trading 7.6Random Walk and Efficient Market Hypothesis 7.7Summary

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 27 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.4 Technical Analysis Explains and forecasts share price movements based on past price behaviour Assumes markets are dominated at certain times by a mass psychology, from which regular patterns emerge Two main forecasting models – Moving average (MA) – Charting

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 28 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models Moving average (MA) models Smooths out a series facilitating the identification of trends in the series Calculation of MA – Assuming a five-day moving average – The MA is calculated by taking the average of the price series for the preceding five days

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 29 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models (cont.) Moving average (MA) models (cont.) Trading rules – Buy when the price series cuts the MA from below – Buy when the MA series is rising strongly and the price series cuts or touches the MA from above for only a few observations

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 30 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models (cont.) Moving average (MA) models (cont.) Trading rules (cont.) – Sell when the MA flattens or declines and the price series cuts MA from above – Sell when the MA is in decline and the price series cuts or touches the MA from below for only a few observations

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 31 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models (cont.) Moving average (MA) models (cont.) Typically for daily price series both 10-day (short-term) and 30-day (medium-term) moving averages are calculated Weighted moving averages – The most recent information is given the greatest weight

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 32 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models (cont.) Charting Investigate patterns in price charts Several techniques – Trend lines – Support and resistance lines – Continuation patterns – Reversal patterns

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 33 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models (cont.) Charting (cont.) Several techniques include trend lines – Trends are regular movements in share prices – Three types of trends  Uptrend line—connecting the lower points of rising price series  Downtrend line—connecting the higher points of falling price series  Sideways trend

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 34 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models (cont.) Charting (cont.) Several techniques include trend lines (cont.) – Critical issue is determining when the trend is going to change

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 35 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models (cont.) Charting (cont.) Several techniques include support and resistance lines – Support levels—where there is sufficient demand to halt further price falls – Resistance levels—where there is sufficient supply to halt further price increases – ‘Strong’ levels—historical support and resistance

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 36 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models (cont.) Charting (cont.) Several techniques include support and resistance lines (cont.) – ‘Weak’ levels—support and resistance based on more recent activity

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 37 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models (cont.) Charting (cont.) Several techniques include continuation patterns – Sideways share trading that does not normally signal a change in a trend – Two types  Triangles—composed of a series of price fluctuations, each smaller than it’s predecessor Symmetrical triangle (no change in trend); ascending triangle (uptrend); descending triangle; (downtrend)

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 38 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models (cont.) Charting (cont.) Several techniques include continuation patterns (cont.) – Two types (cont.)  Pennants and flags—form during a sharp rise in prices (‘the pole’), trading volume then reduces and then increases suddenly to take prices sharply higher

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 39 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models (cont.) Charting (cont.) Several techniques include reversal patterns – Occurs after a major market move – Results in a ‘head and shoulders’ (H/S) pattern

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 40 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models (cont.) Charting (cont.) Several techniques include reversal patterns (cont.) – H/S consists of three successive rallies and reactions  Left shoulder—formed by volume-strong rally on up trend, followed by reduced-volume reaction  Head—second rally increases price before reaction moves price back to previous low

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 41 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Two main forecasting models (cont.) Charting (cont.) Several techniques include reversal patterns (cont.) – H/S consists of three successive rallies and reactions (cont.)  Right shoulder—final rally marked by reduced volume indicating price weakness

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 42 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 7.1 Introduction 7.2Fundamental Analysis: Bottom-up Approach 7.3Fundamental Analysis: Top-down Approach 7.4Technical Analysis 7.5Program Trading 7.6Random Walk and Efficient Market Hypothesis 7.7Summary

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 43 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.5 Program Trading Refers to buy and sell strategies generated by computer programs Programs range between – Simple buy/sell orders based on moving averages – Complex monitoring of both derivatives and share markets for the purpose of hedging or speculation Program trading increases the speed at which prices change

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 44 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 7.1Introduction 7.2Fundamental Analysis: Bottom-up Approach 7.3Fundamental Analysis: Top-down Approach 7.4Technical Analysis 7.5Program Trading 7.6Random Walk and Efficient Market Hypothesis 7.7Summary

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 45 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.6 Random Walk and Efficient Market Hypothesis (EMH) Random walk – Share price is assumed to be formed by investor’s expectations of future cash flows (i.e. intrinsic value) – Price will change in response to new information; since information arrives in a random fashion, stock prices adjust in an unpredictable fashion

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 46 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.6 Random Walk and Efficient Market Hypothesis (EMH) (cont.) Random walk (cont.) – Each observation in the (price) series is assumed to be independent of the previous price – There is an equal probability that the next price will move up, down or remain unchanged

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 47 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.6 Random Walk and Efficient Market Hypothesis (EMH) (cont.) Efficient market hypothesis (EMH) – EMH proposes that markets are informationally efficient if prices adjust immediately to new information – It is not possible for an investor to make abnormal profits through superior information

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 48 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.6 Random Walk and Efficient Market Hypothesis (EMH) (cont.) Efficient market hypothesis (EMH) (cont.) – Three forms  Weak form—historic price data reflected in share price  Semi-strong form—all publicly available information is reflected in share price  Strong form—public and private information is fully reflected in share price

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 49 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 7.1Introduction 7.2Fundamental Analysis: Bottom-up Approach 7.3Fundamental Analysis: Top-down Approach 7.4Technical Analysis 7.5Program Trading 7.6Random Walk and Efficient Market Hypothesis 7.7Summary

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 50 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.7 Summary Demand and supply determines the price of shares Demand and supply of shares is determined by expectations about future – Company performance  Fundamental analysis Bottom-up approach Top-down approach – Share price movement  Technical analysis Moving averages models Charting

Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 51 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 7.7 Summary (cont.) Program trading involves buy and sell orders generated by computer programs Random walk hypothesis is where the price of a share is independent of its previous price Efficient market hypothesis prices adjust immediately to new information