The Role of Transaction Costs - Assignment Example

Further, information that is of value to the shareholders does not include accounting earnings but figures like total shareholder return, market-value-added, economic profit, etc. Total shareholder returns measure the total income over the equity invested by the shareholders. Shareholders, before making investment decisions tend to compare shareholder return with the required rate of returns to make their decisions. Similarly, economic profit which is the difference between the revenue and opportunity cost foregone by the investors is another important item of financial information that is used by the investors in assessing the value generation of firms.

Economic value added or EVA is another important indicator of value generation which investors take into account to make investment decisions. Accounting does not calculate economic profit or EVA or other value-added measures and rather calculates accounting profit which is a misleading measure to calculate and measure value. (Kleiman, 2007).Q#2Researching by institutional investors on financial markets obligation generally does not generate above-average returns due to various reasons. Researching the obligations of the financial market by institutional investors increases their overall transaction cost because costs incurred on researching the same finally adds up to reduce the return on the investment made.

Further, the higher transaction costs increase the overall volatility of the financial markets. Higher volatility results in a low rate of returns despite the efforts on researching the obligations of financial markets. (Hau, 2002). It is also important to understand that this research is conducted with an aim of getting the information that may help institutional investors to gain insight into the predictability of the financial markets as well as individual assets so that they can maximize their returns on the investments made into the financial markets.

However, analyzing the same fact against the efficient market hypothesis criteria, we need to understand the basic assumptions of the Efficient Market Hypothesis (EMH). The basic assumption of EMH that the information inefficient markets are distributed in such a way that price determined through the forces of supply and demand is always equal to the intrinsic value of that security. (Stanford, 2008). This assumption, therefore, gives rise to the fact that smart investors cannot outsmart others because the same information is available to all therefore the probability of earning high average returns is zero or very low therefore the fact that institutional investors despite researching the obligations of financial markets do not earn above-average rate of returns is consistent with the efficient market hypothesis.