(a) The weak form of the efficient market hypothesis states that the current share price reflects all
information contained in the past price movements of that share. This implies that a study of the
trends in share prices over a prior period will not help in predicting the way in which the value or
price of those shares will move in the future. In other words there is no place for Chartism or
technical analysis. Statistical evidence suggests that the efficient market hypothesis does hold in its
weak form.
The semi-strong form of the efficient market hypothesis encompasses the weak form and adds that
share prices also reflect all current publicly available information, for instance a detailed analysis of
published accounts. If the semi-strong form holds, then a detailed analysis of published accounts will
not assist in a prediction of future share price movements, since the share price already contains all
relevant information shown in those accounts or made public since the issue of those accounts. As
such it would only be possible to predict share price movements if unpublished information were
known, in other words through insider information. Statistical evidence suggests that the semi-strong
form of the efficient market hypothesis is valid.
The strong form of the efficient market hypothesis proposes that the current share price reflects all
information relevant to the company, whether or not that information has been made public. If this
is the case then it will never be possible to predict share price movements. The implication of this
statement is that there would be no scope for gains to be made on share trading through the
obtaining of inside (unpublished) information. Clearly this appears not to hold in practice, since
legislation has been set to prevent insider dealing.
(b) Share price rises after announcement of high earnings.
The market will have assessed the likely level of the company's earnings from information which
has been available to the public and the share price will be based on that assessment. If subsequent
information suggests that the estimate of earnings was inaccurate the share price should adjust immediately under the semi-strong form of the efficient market hypothesis. In the situation
described there was an immediate share price movement, but this continued over the following two
or three days. This would suggest that the market is not absolutely efficient in the semi-strong form,
because if it were the entire adjustment should have occurred immediately on announcement of the
earnings figure.
It is also true that the market is not efficient in the strong form, otherwise the high earnings figure
would have been known before it was published and as such reflected in the share price. Since the
share price moved on announcement of the earnings, the strong form cannot hold.
Return on professionally managed portfolios
The suggestion that the return on professionally managed portfolios is likely to be no better than that which
could be achieved by any investor would be supported by the strong form of the efficient market hypothesis.
Assuming portfolio managers are not party to inside, unpublished information, this view would also be held
by the semi-strong form of the efficient market hypothesis. However, if this proposition were to be unduly
accepted there would be no demand for professionally managed portfolios. Since this is not the case,
investors must perceive some benefit of placing their funds in the hands of portfolio managers. This would
therefore suggest that the market is not efficient in either the semi-strong or strong form.
Share price movements around the fiscal year end.
The downward movement on share prices just before the year end followed a subsequent upward movement
is due more to supply and demand effects than the efficient market hypothesis. There is no information
specific to a particular security which causes the managers of portfolios or other investors to sell and then re-buy:
it is simply the result of tax effects which apply universally to all shares across the market.
Kavungya answered the question on April 22, 2021 at 06:57
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(a) To discuss whether share option schemes for either directors or employees generally, can benefit the
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Fuelit plc is an electricity supplier in the UK. The company has historically generated the majority of its
electricity using a coal fueled power station, but as a result of the closure of many coal mines and
depleted coal resources, is now considering what type of new power station to invest in. The alternatives
are a gas fueled power station, or a new type of efficient nuclear power station.
Both types of power station are expected to generate annual revenues at current prices of Sh.800 million.
The expected operating life of both types of power station is 25 years.
Other information:
(i) Whichever power station is selected, electricity generation is scheduled to commence in three
years time.
(ii) If gas is used most of the workers at the existing coal fired station can be transferred to the new
power station. After tax redundancy costs are expected to total Sh.4 million in year four. If nuclear
power is selected fewer workers will be required and after tax redundancy costs will total Sh.36
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at 10% reflecting the impact on financial gearing of a larger bond issue.
(iv) Costs of building the new power stations would be payable in two equal installments in one and two
years time.
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(vi) The company‟s equity beta is expected to be 0.7 if the gas station is chosen and 1.4 if
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per year in the UK and an average of 5% per year in the member countries of the Euro bloc in
the European Union.
(viii) Corporate tax is at the rate of 30% payable in the same year that the liability arises.
(ix) Tax allowable depreciation is at the rte of 10% per year on a straight line basis.
(x) At the end of twenty-five years of operations the gas plant is expected to cost Sh.25 million
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depending upon what form of disposal is available for nuclear waste.
Required:
(a) Estimate the expected NPV of EACH OF investment in a gas fueled power station and
investment in a nuclear fueled power station.
State clearly any assumptions that you make.
(NB: It is recommended that annuity tables are used wherever possible)
(b) Discuss other information that might assist the decision process.
Date posted: April 22, 2021. Answers (1)
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Date posted: April 21, 2021. Answers (1)
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Required:
(a) Estimate the risk and return of the portfolio of five investments, and briefly explain the significance of your results.
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Date posted: April 21, 2021. Answers (1)
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and why companies might use them. Include in your discussion comment on the...(Solved)
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(i) Corporate share repurchases (buy-backs); and
(ii) Share (stock) splits;
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Date posted: April 21, 2021. Answers (1)
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The finance department of Beela Electronics has been criticized by the company's board of
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The consultant suggests that economic growth and political stability are twice as important as the
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The consultant states in the report that previous clients have not invested in countries with a total weighted score of less than 30 out of a maximum possible 100 (with economic growth and political stability double weighted). The consultant therefore recommends that no investment in Africa should be undertaken.
Required:
(a) Discuss whether or not Beela electronics should use the technique suggested by the consultant in
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Unglow's share price until winter in three months time, but do not wish to sell the shares at present. No dividends are due to be paid by Uniglow during the next three months.
Market data:
Uniglow's current share price: Sh.20
Call option exercise price: Sh.20
Time to expiry: 3 months
Interest rates (annual): 6%
Volatility of Uniglow's shares 50% (standard deviation per year)
Assume that option contracts are for the purchase or sale of units of 1,000 shares.
Required:
(i) Devise a delta hedge that is expected to protect the investment against changes in the share price
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Date posted: April 20, 2021. Answers (1)
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Issue costs are estimated to be 1% for debt financing (excluding the subsidized loan), and 4% for
equity financing. These costs are not tax allowable.
The corporate tax rate is 30%.
Required:
(a) Estimate the Adjusted Present Value (APV) of the proposed investment.
(b) Comment upon the circumstances under which APV might be a better method of evaluating a
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Date posted: April 20, 2021. Answers (1)
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The company has employed an external consultant to estimate risk/return data relevant to the three projects.
Required:
(a) Evaluate which project should be selected. Do not use information provided later in the question
requirements in your evaluation.
State clearly any assumptions that you make in all parts of this question.
(b) Estimate Jetter's cost of capital prior to undertaking the investment. Briefly discuss (do not
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The profitability index of 1.3 also relates to this part of the question.
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Briefly discuss the reason for using an adjusted beta such as this:
Date posted: April 20, 2021. Answers (1)
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Summarized financial data for TYR plc is shown below:
TYR's cost of equity is estimated to be 11%.
Required:
(a) Explain, with supporting evidence, the current dividend policy of TYR plc, and briefly discuss
whether or not this appears to be successful.
(b) Identify and consider additional information that might assist the managers of TYR in assessing
whether the dividend policy has been successful.
(c) Evaluate whether or not the company's share price at the end of 2001 was what might have
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Date posted: April 20, 2021. Answers (1)