Market efficiency implications What does the efficient-market hypothesis have to say about these two statements? a. “I notice that short-term interest rates are about 1% below long-term rates. We should borrow short-term” b. “I notice that interest rates in Japan are lower than rates in the United States. We would do better to borrow Japanese yen rather than U.S. dollars.”

PRIN.OF CORPORATE FINANCE

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ISBN: 9781260013900

Author: BREALEY

Publisher: RENT MCG

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Exchange Rate Risk

It is the possibility that the value of a currency will fluctuate in the future. In the wake of globalization, business establishments have increasingly ventured into international markets. The volume of international trade has prospered excellently in t…

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Chapter 13, Problem 13PS

Market efficiency implications What does the efficient-market hypothesis have to say about these two statements?

a. “I notice that short-term interest rates are about 1% below long-term rates. We should borrow short-term”
b. “I notice that interest rates in Japan are lower than rates in the United States. We would do better to borrow Japanese yen rather than U.S. dollars.”

Definition Definition Degree to which financial markets incorporate all available information into the prices of assets. In a more efficient market, the prices reflect the available information more than that in a weak efficient market. It is difficult for investors to outperform the market in a strong efficient market. This is because all the available information is already discounted in the asset's price. However, in a weak-form efficiency, the market does not reflect all information in the asset's price. As a result, it becomes easier to generate better returns in a weak form or an inefficient market.

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Chapter 13, Problem 12PS

Chapter 13, Problem 14PS

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Relative inflation rates affect interest rates, exchange rates, the overall economic health of a country, and the operations and profitability of multinational companies. Consider the following statement: Countries with lower inflation rates will have lower interest rates. Based on your understanding of the relationship between relative inflation rates and exchange rates, identify whether the preceding statement is valid or invalid. O The statement is valid, because the nominal interest rate is the sum of the real interest rate plus inflation, so lower inflation rates would result in lower interest rates O The statement is invalid, because the nominal interest rate is independent of the inflation rate. The currency of a country with a higher inflation rate than the U.S. inflation rate will over time against the dollar.

Relative inflation rates affect interest rates, exchange rates, the overall economic health of a country, and the operations and profitability of multinational companies. Consider the following statement: If companies borrow from countries with low interest rates, the potential gains from the interest savings will likely be multiplied when the lending country's currency appreciates. Based on your understanding of the relationship between relative inflation rates and exchange rates, identify whether the preceding statement is valid or invalid. The statement is invalid, because as the currency of the lending country appreciates, it becomes more expensive for the borrowing company to repay the initial loan. The statement is valid, because as the currency of the lending country appreciates, it becomes cheaper to repay the initial loan and thus increase savings. If companies borrow from countries with low interest rates, the potential gains from the interest savings will likely be by the…

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Solution Summary: The author analyzes the perception of the efficient market hypothesis regarding the given statements, stating that there is no simple way to make money.

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