Sheikh Abbas
Ali Datoo
Wilson Man
Chirag Shamdasani
Hermanraj Singh
Rachel Tam
The Meaning of Efficiency
 What happen when a large amount of rational
investors interacting in a securities market?
 Characteristics of market prices of securities traded in
market
 How are prices affected by new information?
The Meaning of Efficiency
2 conditions
 Ideal conditions
 Information is free
 Non-ideal conditions
 Information is not free
The Meaning of Efficiency
 Investors who spend considerable time and money to
use information sources to guide their investment
decisions are known as informed
 Move quickly given the new information
 Market becomes efficient when a sufficient number
of investors behave this way
The Meaning of Efficiency
Semi-strong form:
 An efficient securities market is one where the prices of
securities traded on that market at all times fully
reflect all information that is publicly known about
those securities
The Meaning of Efficiency
4 points about efficiency:
1. Market prices are efficient with respect to publicly
known information
2. Market efficiency is a relative concept
3. Investing is a fair game if the market is efficient
4. Given market efficiency, a security’s market price
should fluctuate randomly over time
How do Market Prices Fully Reflect all
Available Information?
 Market price of a security is the result of demand and
supply of the security by investors
 Investors are still likely to react differently given the
same information
 The differences average out
 Assume individual decisions are independent
Section 4.3
According to W. H. Beaver,
 Accounting policies adopted by firms do not affect
their security prices
 If the benefits of disclosing information outweighs its
cost, the information
should be disclosed
Quick question...
 DO YOU GUYS AGREE? DO THE POLICIES
ADOPTED BY ACCOUNTANTS FOR FINANCIAL
STATEMENT PURPOSES MATTER? DOES THIS
ARGUMENT BY BEAVER HOLD UP IN REALITY?
Empirical evidence showed...
 There is in fact no increase in securities prices
by changing to an accounting method that
increases reported earnings
 Price-earnings ratio was higher for firms that
reported with accelerated methods than those
that reported with straight-line methods

When reports using one were converted to the other,
price-earning ratios were “essentially equal”
According to W. H. Beaver, (cont.)
 Accountants compete with other information
providers
 (ex: newspapers, websites, management
disclosures)
 Firms don’t need to simplify their financial
statements for everybody to understand
 Investors without the time or knowledge to properly
interpret information can look to the informed
Thinking critically...
 DO YOU AGREE? IS THIS ACCOUNTING’S MAIN
ROLE? WHO DO YOU SEE AS COMPETITION FOR
THE ACCOUNTING PROFESSION?
 DOES THIS MAKE SENSE? WOULD INVESTORS
HAVE INCENTIVE TO DO RESEARCH IF
ADVANTAGES WERE SHORT-LIVED?
Topic 4.4
The Informativeness of Price
A Logical
Inconsistency
Football
Forecasting
The Informativeness of Price
Liquidity/
Noise
Traders
The Informativeness of Price –
Voluntary Disclosure
 disclosure of information beyond the minimum
requirement of GAAP and other reporting
standards
 Do not want to reveal information that would
give away competitive advantage
 Conservative accounting polices
Topic 4.5
Returns
• Net Rate of Return
R jt 
Pjt  D jt
Pj ,t 1
1
• Gross Rate of Return
Pj ,t  D j ,t
1  R j ,t 
Pj ,t 1
• Net Rate of Return + 1 = Gross Rate of Return
Returns
 Ex Post Returns
Pjt  D jt
R jt 
1
Pj ,t 1
 Ex Ante Returns
E R jt  
E Pjt  D jt 
Pj ,t 1
1
CAPM
ER jt   R f 1   j   j ERMt 
Rjt
Rate of return of stock j
during time t
Rf
Rate of return of risk free
asset
RMt Rate of return of Market
during time t
βj
Risk associated with
stock j
Significance
ER jt   R f 1   j   j ERMt 
E R jt  
E Pjt  D jt 
Pj ,t 1
1
• What is the effect of new information?
– Ex. If investors believe Djt will be higher then what
changes?
•
Pj,t-1 must compensate since E(Rjt) is held constant
• What is the effect of an improved information
reporting system?
– Allows investors to better predict the future reducing
their risk and reducing β
– Lowers the firms cost of capital
– Industry wide impact
Significance
 Applying the CAPM
 Allows investors to identify returns that were not
expected at the beginning of the period

On average ε is zero
R jt  R f 1   j   j RMt  jt
 CAPM allows researchers to easily estimate β through
regression analysis
Estimation Risk
 Not everyone may have the same belief about β
 Large differences create volatility
 High volatility results in risk premiums being demanded
 Information asymmetry (insider information)
 If it exists then investors require risk premium
Topic 4.6
Information Asymmetry
 When one party in the market knows something about
the product being traded that the other party does not
 The Used Car Market
Pooling
 Lack of information leads to lowering the price the
buyer is willing to pay.
 Can be tackled by using independent disclosure
devices (eg. Safety certificates).
 Allows the market to operate but not at maximum
efficiency.
Fundamental Value
 The fundamental value of a share is the value it would
have in an efficient market if there is no inside
information. That is, all information is publicly
available.
 Only a theoretical ideal. Not possible as it can reveal
strategic information and is not cost effective.
INSIDER
TRADING
Topics 4.7 & 4.8
Securities Market
 Securities provide the means for capital to be raised for
investment needs

It is socially desirable for markets to work well.
Socially Desirable?
 This means that firms prices reflect their fundamental
value
 This is achieved if more useful information is provided
to investors, resulting in better capital allocation
Other Implications
 Firms are sometimes constrained on taking advantage
of growth opportunities due to it’s ability to obtain
financing.

It is easier to obtain financing the higher the quality of
financial reporting in their respective country
Attaining Securities
Markets that Work Well
 Issue: Security prices do not fully reflect fundamental
value in the presence of inside information
 Remedies:
 Regulation
 Incentives
MD&A
 Provides a narrative explanation of company
operations (financial condition, performance and
future prospects.
History
 Based on the requirements of National Instrument 51-
102 of the OSC in 2004
 Was later adopted across Canada and similar
requirements exist in other jurisdiction such as the
United States.
Question
 Discuss the advantages and possible disadvantages of
additional disclosure requirements such as MD&A.
Objectives
 Help current/prospective investors understand the
financial statements
 Discuss any information not fully reflected in the
financial statements
 Any trends/risks
 Provide information about the variability of earnings
and cash flow
Disclosure Requirements
 Discuss firm performance in relation to assets,
liabilities and revenue
 Indicate what accounting principles are used in the
financials or if there were any changes
 Future outlook
 Relevance/ Reliability tradeoff
MD&A
 Is a requirement that emphasizes full disclosure
 Reduces estimation risk due to its forward looking
nature
 Attempts to make the markets work better by
disclosing inside information
Conclusion
Thanks for listening!
Questions?