5. Geothermal corporation issued a press release before the stock market opened

Question

5. Geothermal corporation issued a press release before the stock market opened announcing that its earnings are above last year’s earnings. Explain how each of the following individual scenarios could be consistent with the semi-strong form of market efficiency.

(a) When trading opened after the announcement, the stock price quickly decreased by 20%.

(b) The stock price of Geothermal increased slowly over the 30 days before the announcement that earnings were higher than last year.

(c) The stock price decreased by 10% immediately following the announcement but then increased throughout the day so that the closing price was only 2% below the previous day.

Explanation / Answer

In semi-strong market efficiency information moves & flows semi quickly( but not too quickly as in case of strong market efficiency)

a) In this case stock price quickly decline because the information is available in public as the announcement is done. Here public information is useless because in semi-strong market efficiency the information is available to all investors publicly.So investors cannot take advantage over the other.

b) But inside information can have advantage in this, like company officials, CEO, buddies etc may know the information about the company before announcement. So they take action before the announcment & have slight advantage over the normal investors.Like in this case before the announcement was done the insiders invest in stocks knowing that the company is performing best so the prices will surely increases in future i.e after announcement.So these investor receive more profits as compared to normal investors, who invest after seeing the company reports & documents when released.

c). The stock price decreased immediately after announcement because information is available in public, so the investors take action & sell there stocks after having a bad news or reports about the company, but then increased throughout the day just because of insiders who may know that compay is improving in terms of business by seeing the information available in company, so take action accordingly & started investing in it before the announcement in public & have an advantage over this lead to increase the price of stock slowly.

NOTE:- In semi-strong market efficiency fundamental as well as technical analysis are not effective because they are both based on public information.

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