Essentials of Accounting and Finance

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On these markets there are a few types of transactions, primary and secondary transactions. If Apple was selling stock and you purchased it directly from them it would be a primary. Conversely, if you were to buy Apple stock from an underwriter who is reselling the stock to you, that would be a secondary transaction. Buying stuck secondhand in the dealer market could be more expensive. Dealers will naturally inflate the price of the stock so that they can make a profit off of what they are selling (Brigham & Houston, 1998).

When a privately held company decides to sell shares publicly they list on the initial public offering market. Companies usually choose to go public depending on the state of the market. If the market is is strong many companies will go public to bring in new capital (Brigham & Houston, 1998).

Stock market efficiency is important. When the markets are efficient investors can buy and sell stock with confidence in the value they are getting. When the market is inefficient, when stock are under or overvalued, investors pull their money out of the market. This leads to poor allocation of capital and economic stagnation (Brigham & Houston, 1998).Efficiency is based on how closely the intrinsic value of a stock compares to the market price of that stock. If a stock is in equilibrium, its intrinsic value and market value are close, it’s price is considered to be more efficient than a stock that’s values aren’t wildly different.

Based on the market and the new FDA approvals, it’s probably a good idea to buy several shares of the stock mentioned on TV. Since the market is efficient currently, you’ll be getting a fair price for the stock as long as you trust that the analysts information is correct. In regards to the IPO that you’re interested in, it’d be best if you purchased the shares in the IPO. If you wait for the shares to become available in the open market you won’t get as much bang for your buck.

To better understand market efficiency, it may be best to research the theories on what makes the market efficient. The efficient markets hypothesis, which is a modern finance theory, states that if a stock price is undervalued, rational traders will buy the stock therefore pushing up the prices to proper levels. The inverse happens if a stocks is overvalued (Brigham & Houston, 1998). The way things really work out constrict this theory many times. This has led the the creation of the behavioral finance field. There are two main points that criticise the EMH. The first being that it’s difficult and risky for traders to take advantage of mispriced stocks. Factors contributing to this are lack of capital or fear that the same forces that pushed the stock's price down will keep it artificially low. The second is more theoretical. It deals with the psychology behind why mispricings happen and how individuals view potential losses and gains. Understanding the psychology behind why traders make the choices they do can leader to making choices that will lead to a more efficient market.

Resources

Brigham, E. F., & Houston, J. F. (1998). Fundamentals of financial management. Mason, OH: Thomson/South Western.