Public vs. Private Equity Securities
The public securities market is still significantly larger than the private securities market,... Read More
Most, if not all, markets can be thought of as existing on a spectrum between perfect efficiency and complete inefficiency. This is because several factors contribute to or impede the efficiency of a market, including market participants, information availability and financial disclosure, and limits to trading.
Market Participants
In general, as the number and sophistication of participants within a market increase, the market becomes more efficient.
Information Availability and Financial Disclosure
The more information market participants have, the more accurate the market’s estimates of intrinsic value, thus creating greater market efficiency. In highly efficient markets, information is provided to all market participants simultaneously, and the advantage of insiders is limited.
Limits to Trading
The act of arbitrage is believed to increase market efficiency. Pure arbitrage typically involves buying an asset in one market and selling the same asset in a different market at a higher price. For example, when market participants believe a security is overvalued, they can perform a short sale – or the sale of a borrowed security. Some regulators argue that short selling puts inefficient downward pressure on securities leading to market crashes, but research generally shows that short selling helps supply and demand effectively determine market prices.
Question
As more market participants opt for passive management over active management, market efficiency is likely to:
- Increase.
- Decrease.
- Remain unchanged.
Solution
The correct answer is B.
Passive management does not generally try to exploit market inefficiency but instead assumes that the market is highly efficient and passive investors will ultimately earn higher returns by reducing management fees as much as possible. At least, in theory, the popularity of active over passive management has an inverse relationship to its effectiveness. Therefore, as passive management becomes more common, there are fewer active market participants to find and profit from price inefficiencies, and market efficiency is likely to decrease.
Sergio Torrico
2021-07-23
Excelente para el FRM 2
Escribo esta revisión en español para los hispanohablantes, soy de Bolivia, y utilicé
AnalystPrep para dudas y consultas sobre mi preparación para el FRM nivel 2 (lo tomé una sola vez y aprobé muy bien), siempre tuve un soporte claro, directo y rápido, el material sale rápido cuando hay cambios en el temario de GARP, y los ejercicios y exámenes son muy útiles para practicar.
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2021-07-17
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2021-07-16
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2021-06-28
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2021-06-22
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2021-05-10
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2021-03-24
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2021-03-18
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