NASAA Series 66 Uniform Combined State Law ExaminationClient Investment Recommendations and StrategiesHard
A financial advisor is explaining the concept of the efficient market hypothesis (EMH) to a new client. The client asks about the implications of the 'strong form' of EMH for active portfolio management. Which of the following statements accurately describes this implication?
- AThere is no benefit to active management as all public information is already reflected in stock prices.
- BActive management may generate abnormal returns by utilizing fundamental analysis.
- CTechnical analysis can still be used to identify mispriced securities and generate excess returns.
- DNeither public nor private (insider) information can be used to consistently achieve abnormal returns.
Show answer & explanationAnswer & explanation
Correct answer: D. Neither public nor private (insider) information can be used to consistently achieve abnormal returns.
The strong form of EMH states that all information, both public and private (insider), is already reflected in security prices. Therefore, no investor, not even those with insider information, can consistently achieve abnormal returns through active management.
Why the other options are wrong
- A. This describes the semi-strong form of EMH, not the strong form which includes private information.
- B. This contradicts the strong form, which states neither public nor private information can lead to abnormal returns.
- C. Technical analysis is ineffective under the weak form of EMH, and therefore also under the stronger forms.
Strong Form EMH
The most stringent version of the Efficient Market Hypothesis, asserting that security prices fully reflect all public and private (insider) information, making it impossible to consistently achieve abnormal returns.
- Implies that even insider information cannot lead to sustained excess profits.
- Suggests that active management is futile for outperforming the market.
- Often considered an ideal theoretical benchmark, not fully observed in reality.
Memory trick: Weak: price history is known; Semi-Strong: public news is sown; Strong: all secrets are shown.