Stock Market Efficiencies - Assignment Example

Stock Market Efficiencies There are three forms of stock market efficiencies which include: - weak, semi-strong and strong forms of efficiencies. Weak form efficiency is one of the three degrees of efficient market hypothesis (EMH) that claims all the past prices of stock as they are reflected in today’s stock prices. In this case technical analysis cannot be used to predict and beat a market. Proponents of this form of market efficiency claim that fundamental analysis can be used to identify stocks that are undervalued and overvalued enabling research by investors looking for profitable companies to invest in. semi-strong form of efficiency is a class of EMH which claims that all public information is calculated into a stock’s current price hence there is no way either fundamental or technical analysis is applicable to achieve superior gains. It claims only non-publicly available information can be used by investors to earn abnormal returns on their investments as all the other remaining information is accounted for in the prices of the stocks and no fundamental or technical analysis will result into above normal returns. Strong form efficiency is the strongest as the name suggests as it states all the information in a stock market irrespective of whether public or private. All such information is accounted for in the stock price and not even insider information could give an investor advantage hence profits exceeding normal returns cannot be made regardless of the amount of research or information available to the investors. If a company trades its shares in a stock market with a semi-strong efficient market, the investors are likely to use the privately available information to make abnormal returns on their investment. Answer 2 The increase of the interest rates by the central bank results into loans from commercial banks being expensive as they also raise their interest rates to cover for the rise by the central bank. The firm has decided to invest in shares and fixed rate bank loans as well as an overdraft from the same bank. The inflation caused by the rise in interest rates by the central bank will impact on the operations of Tintin given the nature of the goods that they deal in which are luxury goods. Such forms of goods during inflation are not necessary for the consumers and the buyers. Therefore, one thing that has to happen is that the sales by Tintin will have to drastically reduce by a wide margin as the purchases of such goods by consumers will go down due to their escalated prices and a lack in their necessity. In addition, the long run is likely to see the bank adjusting their interest rates to accommodate the changes which results into an increase in the operation costs of Tintin due to increased rates of interest. The increased costs have an extended impact which translates into the reduced earnings of the firm, the economic situation at such times is volatile and the economic component which experiences this is the business people since they find it quite hard to balance between demand and supply. Answer 3 3. (a) There are a number of incomes which are not taxed or are not subjected to income tax. They include:- incomes realized by taxpayers to the extent of debts forgiven, payments from state sickness or disability funds, compensation received under the workers compensation act, interest earned from tax exempt municipal bonds, income from the sale of one’s primary residence whether it is sold on profit or at a loss. Others include:- incomes in form of life insurance money and non taxable gifts as a gift is exactly what it sounds like, fringe benefits from employers and child support funds as well as foster care payments. All these are not subject to income tax according to the law. 3. (b) Higher rate tax payers are subjected to a different tax rate brackets as compared to the lower rate tax payers. Therefore as the lower rate tax payers will be paying tax at 20%, the higher rate tax payers will pay the taxes at 40%. Therefore an investor who received a 90 pound net dividend and is a higher rate tax payer will not pay any tax as the amount do not fall in the bracket. 3. (c) If an investor received a 100 pound gilt interest they will not pay any tax irrespective of the type of tax payer they are. This is because this amount does not even fall in the minimum tax bracket, a bracket that is subject to taxation according to the tax payer rates. Answer 4 Risk with regards to investments can be termed as the possibility of Loss or the occurrence of adverse or unwelcomed developments. In other words, it is the effect that uncertainty has on company investment objectives. It is the variability that has the possibility of occurring in the future returns of any project. Uncertainty on the other hand means the impossibility of knowing the exact result of a course of action, situation or decision. In the decisions of a business to invest they face a lot of uncertainties which involves some elements of risk. There are risks which are inevitable in any form of investment decision that is made and such risks include the delay in payment of cash flows, the risk that the investee company is likely to collapse and also the risk that the management may invest funds in risky projects. Such risks have to be incorporated and hence the use of sensitivity analysis and probability analysis. The basis upon which the methods described work is due to the fact that return on investment on projects are affected by factors such as:- sales, investments, tax rates and costs of sales. These two forms of analysis will hence measure the extent to which the projects cash flows would change in response to the changes in the above mentioned factors. The factors are then identified as they affect the project’s cash flows hence establishing a mathematical relationship between these factors. The analysis of how each of these factors change affects cash flows is done. If the cash flows of the project are found to be sensitive using the mathematical values derived to the shift in any of these factors, such a project is considered risky and hence avoided. Answer 5 5. (a) Assets with different replacement life cycles pose a great problem when investment appraisal is conducted on them. The problem here is the means to use in the determination of the optimum time to replace the asset most so in the context that the asset forms a natural chain. The solution to this problem is though the use of Equivalent Annual Annuity (EAA) which is an expression of all the present NPVs, this is because the method provides a basis upon which an optimum time of asset replacement can be determined. 5. (b) In the event that an investment project presents multiple Internal Rates of Return (IRRs), there is a likelihood of confusion in investment appraisal a situation which may result into wrong decisions being made about investment. Therefore, the solution for such circumstances is to do the interpretation with regards to present values with the identification of the investment as net investment or borrowing. 5. (c) In the event that business risks are different from current operation risks, the operation risks will have significant cumulative effects. This is detrimental to the investment appraisal as the decisions to be arrived at may not conform to the required standards of appraisal. The solution to this problem is to change the risk determination strategy that would have the impact of translating previous risks into current risks to enable ease and accuracy in decision making. Read More