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Homework answers / question archive / Complete the following sentence
Complete the following sentence. If prices capture all relevant information, then the prices will follow a ____________.
Select one:
Random walk
Predictable patternQuestion How would the value of a firm be affected by the following events?
A. The introduction of a new product designed to increase the firm’s cash inflows is delayed by
one year. The size of the expected cash flows is not affected.
B. A firm announces to the press that its cash earnings for the coming year will be 10 percent
higher than previously forecast.
Summary of the question :
If price captures all relevant information, then the prices will follow a _________
Answer :
Predictable pattern
Reason : Based on the Efficient Market Hypothesis, which states that all relevant information is reflected in the share prices, then the price would be predicatble. However, this is not only the current information but also expectations about future incomes. Since future information is presently not available, the share price tends to take a random walk....i.e move in any direction.
So if prices were to capture all relevant information, it would follow a predictable pattern. But actually prices do not capture all relevant informaiton because all information is not available to all investors. hence, prices dont capture all information and that is why they may move in any direction
Solution
A
The value of the firm would go down due to the increase in the amount of time it takes to receive the cash inflows.
B
The value of the firm would go up due to the increase in expected cash inflows.
