INVESTMENT ANALYSIS
Questions and Answers
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Question:
What is Capital Market Efficiency?
Distinguish between the various forms of market efficiency?
Answer:
Capital Market Efficiency is a
market where securities prices quickly and fully reflect all available information. If a market is efficient, earning or all
devices intended to have performed, the market will be useless. No scheme device by any individual should
result in consistently higher result than those realized on a buy and hold
strategy. In an efficient market, the
same rate of return for a given level of risk should be realized by all investors.
The behaviors of any participants
or group should not influence the price of a security in the market.
The forms of market efficiency categorized
by FAMA are as follows:
i.
Weak form
ii.
Semi-
strong form
iii.
Strong form
i)
Weak form
efficiency: this is concerned with the adjustment of securities prices
to historical price or returning information.
If the market is weak form, no investor can earn any excess or abnormal
return base on historical price or returning information.
ii)
Semi-Strong
Form: Semi – strong form efficiency is concerned with whether
security prices fully reflect or publicly available information. Semi – Strong form efficiency requires the
market to be weak form efficiency.
iii)
Strong Form
Efficiency: Strong form Efficiency is concerned with whether the
security prices fully reflect all the information available to public or not.
Question:
Discuss the implications of capital market efficiency for
corporate financial management.
Answers:
If the capital market is efficient,
it will have the following implication for financial manager.
a.
The real financial position of a company will always
be reflected in a company share price
b.
Since strong form of efficient market hypothesis does
not hold, management with unfavorable information about their company. They ought not to release such information to
the public.
Question:
Explain the difference between a rights issue and a scrip
issue. Your answer should include
comment on the reasons many companies make such issues and the effect of the
issues on private investors.
Answer:
Right issues are shares issued to
existing share holders. The existing shareholders
have right to entitlement of further share in proportion to the existing shares. The reasons to make a right – issue by
company are as follows; time of inflation
for funding expansion project.
While Scrip issues are shares given to share holders by their
firm or company in place of cash dividend or in addition to divided. This issued on ratio basis.
Question:
State the assumptions and limitations of the capital asset
pricing model (CAPM)
Answer:
Capital
Asset Pricing Model Assumptions are as follows:
i.
That capital market is efficient and investors are
well informed
ii.
That transaction cost are zero
iii.
Restriction on investment should be negligible
iv.
No single investment should be large enough to affect
the market price of stock
v.
The investors are in generally agreement about the
likely performance and the risk of individual securities.
Limitations
of Capital Asset Pricing Model are as follows:
i.
It based on highly restrictive assumptions
ii.
There are serious doubt about its investibility i.e.
the assumption cannot be realistic in practical term
iii.
The market factor is not the sole factor influencing
the stock return
Question:
Compare and contrast the Capital Asset Pricing Model (CAPM)
with the Arbitrage Pricing Model (APM)
Answer:
i.
Capital Asset Pricing Model uses one risk variable,
the market portfolio while the Arbitrage pricing model uses several.
ii.
The Arbitrage Pricing Model factors are typically
Macro-Economics. They are related
broadly to the economy but when you use the Capital Asset Pricing Model, the single
factor will reflect the variation in the Arbitrage Pricing Model
iii.
APT is an equilibrium model of security prices as is
the Capital Asset Pricing Model
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