by Anthony Head

　　28 Oct 2003

　　y examiner's report on Paper 2.4 at the June 2003 session noted the need for students to improve their understanding of market efficiency. This article addresses this issue and also discusses other market matters contained in Section 2 of the Paper 2.4 syllabus， 'the financial management environment'

　　Capital markets， efficiency and fair prices

　　Investors in capital markets want to be sure that the prices they pay for securities， such as ordinary shares and bonds， are fair prices. In order for security prices to be fair， the capital markets must be able to process relevant information quickly and accurately. Relevant information is anything that could affect security prices e.g. previous movements in security prices， newly-released company financial statements， changes in interest rates or details of sales of their own company’s shares by company directors. We say that a capital market is efficient when we are confident that security prices are fair. A capital market can be efficient when share prices in general are falling (a bear market) or rising (a bull market).

　　Types of efficiency

　　It is usual to identify four types of capital market efficiency1：

　　1. Operational efficiency requires that transaction costs are low and do not hinder investors in the sale or purchase of securities.

　　2. Informational efficiency means that relevant information is widely available to all investors at low cost.

　　3. Pricing efficiency refers to the ability of capital markets to process information quickly and accurately， and arises as a consequence of operational efficiency and informational efficiency.

　　4. Allocational efficiency means that capital markets are able to allocate available funds to their most productive use and arises as a result of pricing efficiency.

　　Most of the research into market efficiency has been into pricing efficiency.