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Solution of Chapter 3

This document summarizes the solutions to several questions about market efficiency and insider trading. For question 1, the correct answer is that trading on inside information would not yield excess returns under the weak and semi-strong forms of market efficiency but could under the strong form. For question 2, a golf membership purchase by management that does not raise shareholder value represents both adverse selection and an agency problem. For question 3, insider trading by executives that yields abnormal profits violates the strong form of market efficiency and is illegal.

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Zafar Hafeez
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76 views2 pages

Solution of Chapter 3

This document summarizes the solutions to several questions about market efficiency and insider trading. For question 1, the correct answer is that trading on inside information would not yield excess returns under the weak and semi-strong forms of market efficiency but could under the strong form. For question 2, a golf membership purchase by management that does not raise shareholder value represents both adverse selection and an agency problem. For question 3, insider trading by executives that yields abnormal profits violates the strong form of market efficiency and is illegal.

Uploaded by

Zafar Hafeez
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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SOLUTION OF CHAPTER 3

Question 1
The correct answer is B. Trading on inside information would not yield excess returns to
investors if the stock market were efficient according to the weak form of market efficiency
and the semistrong form of market efficiency, but not efficient according to the strong form
of market efficiency.
Option A is incorrect because it suggests that trading on inside information would not yield
excess returns if the market were efficient according to the weak form but not efficient
according to the semistrong or strong form. However, if the market is not efficient according
to the weak form, then trading on inside information could potentially yield excess returns.
Option C is also incorrect because it suggests that trading on inside information would not
yield excess returns regardless of the form of market efficiency, which is not true.
Option D is incorrect because it suggests that trading on inside information would yield
excess returns regardless of the form of market efficiency, which is not consistent with the
concept of market efficiency.
Question 2
The correct answer is B. The manager's decision to purchase a golf membership for senior
executives, even if he does not believe it will raise shareholder value, represents both adverse
selection and an agency problem.
So, the decision represents both adverse selection (information imbalance) and an agency
problem (misalignment of interests between the manager and shareholders). Therefore, option
B is the correct answer.
Question 3
Insider trading by corporate executives that yields abnormal profits is a violation of securities
laws and regulations. It is important to note that the Efficient Market Hypothesis (EMH) does
not determine whether insider trading is illegal; it focuses on the efficiency of the market in
reflecting all available information in stock prices.
The correct answer is:
B. Insider trading by corporate executives that yields abnormal profits is a violation of the
strong form of the efficient market hypothesis (EMH) and is subject to investigation by the
Securities and Exchange Commission (SEC).
The strong form of the EMH assumes that all information, including insider information, is
already reflected in stock prices. Therefore, trading on such information is considered illegal
and unethical, and the SEC is responsible for investigating and enforcing insider trading
regulations.
Question 5
In summary:
Situations A and D likely involve violations of insider trading laws.
Situation B involves a violation of insider trading laws.
Situation C does not appear to involve a violation of insider trading laws, as the individual is
not personally trading on the information.
Please note that insider trading laws are complex, and whether a specific situation constitutes
a violation may depend on various factors and the interpretation of the law by relevant
authorities. Consulting with legal experts is recommended when dealing with such matters.

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