127) What is stock market efficiency?

Stock market efficiency - championed in the efficient market hypothesis (EMH) formulated by Eugene Fama in 1970, suggests that at any given time, prices fully reflect all available information on a particular stock and/or market. According to the EMH, no investor has an advantage in predicting a return on a stock price because no one has access to information not already available to everyone else.

The Effect of Efficiency: Non-Predictability

The nature of information does not have to be limited to financial news and research alone; indeed, information about political, economic and social events, combined with how investors perceive such information, whether true or rumored, will be reflected in the stock price. According to the EMH, as prices respond only to information available in the market, and because all market participants are privy to the same information, no one will have the ability to out-profit anyone else.

In efficient markets, prices become not predictable but random, so no investment pattern can be discerned. A planned approach to investment, therefore, cannot be

Anomalies: The Challenge to Efficiency

In the real world of investment, however, there are obvious arguments against the EMH. There are investors who have beaten the market, whose investment strategy focuses on undervalued stocks, made billions and set an example for numerous followers. There are portfolio managers who have better track records than others, and there are investment houses with more renowned research analysis than others.

Degrees of Efficiency

Accepting the EMH in its purest form may be difficult; however, three identified EMH classifications aim to reflect the degree to which it can be applied to markets:

1. Strong efficiency - This is the strongest version, which states that all information in a market, whether public or private, is accounted for in a stock price. Not even insider information could give an investor an advantage.

2. Semi-strong efficiency - This form of EMH implies that all public information is calculated into a stock's current share price. Neither fundamental nor technical analysis can be used to achieve superior gains.

3. Weak efficiency - This type of EMH claims that all past prices of a stock are reflected in today's stock price. Therefore, technical analysis cannot be used to predict and beat a market.

The Bottom Line

In the real world, markets cannot be absolutely efficient or wholly inefficient. It might be reasonable to see markets as essentially a mixture of both, wherein daily decisions and events cannot always be reflected immediately into a market. If all participants were to believe that the market is efficient, no one would seek extraordinary profits, which is the force that keeps the wheels of the market turning.

128) What is a corporate credit rating?

A corporate credit rating is an evaluation of the credit worthiness of a corporate debtor (a business or company). The evaluation is made by a credit rating agency of the debtor's ability to pay back the debt and the likelihood of default.

Credit ratings are determined by credit ratings agencies. The credit rating represents the credit rating agency's evaluation of qualitative and quantitative information for a company; including non-public information obtained by the credit rating agencies' analysts.

Credit ratings are not based on mathematical formulas. Instead, credit rating agencies use their judgment and experience in determining what public and private information should be considered in giving a rating to a particular company. Credit rating is used by individuals and entities that purchase the bonds issued by companies to determine the likelihood that the company will pay its bond obligations

A poor credit rating indicates a credit rating agency's opinion that the company has a high risk of defaulting, based on the agency's analysis of the entity's history and analysis of long term economic prospects.

Credit ratings that concern corporations are usually of a corporation's financial instruments i.e. debt security such as a bond, but corporations themselves are also sometimes rated. Ratings are assigned by credit rating agencies, the largest of which are Standard & Poor's, Moody's and Fitch Ratings. They use letter designations such as A, B, C. Higher grades are intended to represent a lower probability of default.

Agencies do not attach a hard number of probability of default to each grade, preferring descriptive definitions such as: "the obligor's capacity to meet its financial commitment on the obligation is extremely strong," or "less vulnerable to non-payment than other speculative issues ..." (Standard and Poors' definition of a AAA rated and a BB rated bond respectively).

Different rating agencies may use variations of an alphabetical combination of lower and upper case letters, with either plus or minus signs or numbers added to further fine tune the rating. It goes as follows, from excellent to poor: AAA, AA(high), AA, AA(low), A(high), A, A(low), BBB(high), BBB, BBB(low), BB(high), BB, BB(low), B(high), B, B(low), CCC(high), CCC, CCC(low), CC(high), CC, CC(low), C(high), C, C(low) and D.