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Chapter 13: Corporate-Financing Decisions and
Efficient Capital Markets
13.1 a. Firms should accept financing proposals with positive net present values (NPVs).
b. Firms can create valuable financing opportunities in three ways:
Fool investors. A firm can issue a complex security to receive more than the fair market
value. Financial managers attempt to package securities to receive the greatest value.
Reduce costs or increase subsidies. A firm can package securities to reduce taxes.
Such a security will increase the value of the firm. In addition, financing techniques
involve many costs, such as accountants, lawyers, and investment bankers. Packaging
securities in a way to reduce these costs will also increase the value of the firm.
Create a new security. A previously unsatisfied investor may pay extra for a specialized
security catering to his or her needs. Corporations gain from developing unique
securities by issuing these securities at premium prices.
13.2 Weak form. Market prices reflect information contained in historical prices. Investors are unable
to earn abnormal returns using historical prices to predict future price movements.
Semi-strong form. In addition to historical data, market prices reflect all publicly-available
information. Investors with insider, or private information, are able to earn abnormal returns.
Strong form. Market prices reflect all information, public or private. Investors are unable to earn
abnormal returns using insider information or historical prices to predict future price movements.
13.3 a. False. Market efficiency implies that prices reflect all available information, but it does
not imply certain knowledge. Many pieces of information that are available and reflected
in prices are fairly uncertain. Efficiency of markets does not eliminate that uncertainty
and therefore does not imply perfect forecasting ability.
b. True. Market efficiency exists when prices reflect all available information. To be
efficient in the weak form, the market must incorporate all historical data into prices.
Under the semi-strong form of the hypothesis, the market incorporates all publicly–
available information in addition to the historical data. In strong form efficient markets,
prices reflect all publicly and privately available information.
c. False. Market efficiency implies that market participants are rational. Rational people
will immediately act upon new information and will bid prices up or down to reflect that
information.
d. False. In efficient markets, prices reflect all available information. Thus, prices will
fluctuate whenever new information becomes available.
e. True. Competition among investors results in the rapid transmission of new market
information. In efficient markets, prices immediately reflect new information as
investors bid the stock price up or down.
13.4 a. Aerotech’s stock price should rise immediately after the announcement of the positive
news.
b. Only scenario (ii) indicates market efficiency. In that case, the price of the stock rises
immediately to the level that reflects the new information, eliminating all possibility of
abnormal returns. In the other two scenarios, there are periods of time during which an
investor could trade on the information and earn abnormal returns.
13.5 False. The stock price would have adjusted before the founder’s death only if investors had
perfect forecasting ability. The 12.5% increase in the stock price after the founder’s death
indicates that either the market did not anticipate the death or that the market had anticipated it
imperfectly. However, the market reacted immediately to the new information, implying
efficiency. It is interesting that the stock price rose after the announcement of the founder’s death.
This price behavior indicates that the market felt he was a liability to the firm.
13.6 The announcement should not deter investors from buying UPC’s stock. If the market is semi–
strong form efficient, the stock price will have already reflected the present value of the payments
that UPC must make. The expected return after the announcement should still be equal to the
expected return before the announcement. UPC’s current stockholders bear the burden of the loss,
since the stock price falls on the announcement. After the announcement, the expected return
moves back to its original level.
13.7 The market is generally considered to be efficient up to the semi-strong form. Therefore, no
systematic profit can be made by trading on publicly-available information. Although illegal, the
lead engineer of the device can profit from purchasing the firm’s stock before the news release on
the implementation of the new technology. The price should immediately and fully adjust to the
new information in the article. Thus, no abnormal return can be expected from purchasing after
