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Thursday, 26 March 2015

INVESTMENT ANALYSIS (Answers to some Past Question)

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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