Business finance : theory and practice

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Further reading l The current price of any security represents a consensus view of the security’s current worth – its price is the result of the actions of buyers and sellers, each with different perceptions of the value of the security. The evidence on CME l Research studies have been conducted that look at efficiency at three different levels: l weak form (WF); l semi-strong form (SSF); and l strong form (SF). l WF efficiency would exist if it were not possible to make abnormal profits from security investing relying on past security price movements (for example, with the use of charts) or technical rules to indicate when to buy and sell. l Evidence shows that the world’s leading markets are WF efficient. l SSF efficiency would exist if it were not possible to make abnormal profits from security investing relying on the analysis of publicly available information to indicate when to buy and sell. l Evidence shows that the world’s leading stock markets are SSF efficient. l SF efficiency would exist if it were not possible to make abnormal profits from security investing relying on the analysis of information available only to insiders to indicate when to buy and sell. l Evidence shows that the world’s leading markets are not SF efficient. Implications of CME l Implication for investors: only if they have access to information not available to the public can they expect, except by chance, to make better-than-average returns, given the risk class of the securities concerned. l Implications for financial managers: l It is difficult to fool investors. l The market rationally values the business. l Efforts to enhance share value should have that effect. l Managers may have a short-term interest in withholding information. l The LSE rationally values assets with risky returns. Further reading The role and operation of the LSE are covered by a number of texts including Arnold (2005). Facts and figures on the LSE are published monthly in The Stock Exchange Fact Sheets (http://www.londonstockexchange.com/en-gb/about/statistics/factsheets/ ). Capital market efficiency is well reviewed in the literature, for example in Emery, Finnerty and Stowe (2007). For an impressive review of empirical studies of market efficiency, see Dimson and Mussavian (1998) (available on http://faculty.london.edu/edimson/market.pdf). 271
Chapter 9 • The secondary capital market and its efficiency REVIEW QUESTIONS Suggested answers to review questions appear in Appendix 3. 9.1 What are the two roles of members of the LSE in respect of their secondary market activities? 9.2 When UK shareholders have shares that they wish to sell, must the sale be made through the LSE? 9.3 What is ‘price efficiency’ in the context of stock markets? 9.4 Is a market that is ‘strong-form efficient’ necessarily ‘semi-strong-form efficient’? 9.5 Without any knowledge of the evidence surrounding the efficiency of the LSE, would you expect it to be efficient? Explain your response. 9.6 Must all of the world’s stock markets be price efficient? Explain your response. PROBLEMS Sample answers to problems marked with an asterisk appear in Appendix 4. (Problems 9.1 to 9.6 are all basic-level problems.) 9.1* ‘The shares of XYZ plc are underpriced at the moment.’ How logical is this statement about some shares quoted on the LSE? 9.2* ‘Capital market efficiency in the semi-strong form implies that all investors have all of the knowledge that is publicly available and which bears on the value of all securities traded in the market.’ Comment on this statement. 9.3* ‘In view of the fact that the market is efficient in the semi-strong form, there is no value to investors in businesses publishing financial reports, because the information contained in those reports is already impounded in share prices before that information is published.’ Comment on this statement. 9.4 ‘A graph of the daily price of a share looks similar to that which would be obtained by plotting a series of cumulative random numbers. This shows clearly that share prices move randomly at the whim of investors, indicating that the market is not price efficient.’ Comment on this statement. 9.5 ‘A particular professionally managed UK equity investment fund produced better returns last year than any of its rivals. This means that it is likely to outperform its rivals again this year.’ Comment on this statement. 9.6 ‘An efficient capital market is one in which the market portfolio contains no systematic risk.’ Is this statement correct? Explain. 272
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Business Finance Theory and Practic
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We work with leading authors to dev
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Pearson Education Limited Edinburgh
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Contents 3 Financial (accounting) s
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Contents 7.12 Arbitrage pricing mod
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Contents 12.6 Dividends: the eviden
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Guided tour of the book Objectives
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Supporting resources Visit www.pear
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Preface updated and expanded. Where
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PART 1 The business finance environ
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Chapter 1 • Introduction 1.1 The
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Chapter 1 • Introduction 1.3 The
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Chapter 1 • Introduction Since it
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Chapter 1 • Introduction Where di
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Chapter 1 • Introduction concerne
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Chapter 1 • Introduction Borrowin
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Chapter 1 • Introduction time is
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Chapter 1 • Introduction Private
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Chapter 2 • A framework for finan
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Chapter 3 • Financial statements
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Openmirrors.com Chapter 3 • Finan
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Chapter 4 Investment appraisal meth
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Net present value (most unlikely in
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Net present value Investment opport
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Net present value The process, show
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Openmirrors.com Internal rate of re
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Internal rate of return Year Cash f
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Internal rate of return opportunity
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Internal rate of return However, no
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Payback period Continuing to assess
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Accounting (unadjusted) rate of ret
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Investment appraisal methods used i
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Further reading l Conclusions on PB
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Problems Calculate: (a) the net pre
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Problems 4.6 Cool Ltd’s main fina
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Chapter 5 Practical aspects of inve
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Cash flows or accounting flows? Inv
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Do cash flows really occur at year
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Taxation Forecasting cash flows Inv
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Taxation Having considered the basi
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An example of an investment apprais
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Capital rationing Example 5.6 A bus
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Capital rationing There is no mathe
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Replacement decisions Helpful but l
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Routines for use with investment pr
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Investment appraisal and strategic
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Value-based management Select strat
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Value-based management Corporation
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l l Value-based management Use capi
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Real options 5.13 Real options ‘
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Summary Capital rationing l l l l M
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Problems PROBLEMS Sample answers to
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Problems by 31 December 20X7. The c
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Problems Based on an estimated cons
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Chapter 6 Risk in investment apprai
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Sensitivity analysis Example 6.1 Gr
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Sensitivity analysis (6) Cost of ca
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Use of probabilities Clearly, these
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Use of probabilities Solution This
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Expected value Possible outcome NPV
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Systematic and specific risk If, ho
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Utility theory Figure 6.2 Utility o
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Attitudes to risk and expected valu
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Summary Summary Risk l Risk is of v
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Problems REVIEW QUESTIONS Suggested
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Problems Project Initial outlay NPV
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Problems Estimates of the various f
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Problems ‘ There are sets of mult
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The relevance of security prices Th
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Security investment and risk Exampl
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Portfolio theory portfolio. Further
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Portfolio theory Table 7.1 Risk and
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Portfolio theory Figure 7.4 The ris
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Portfolio theory Figure 7.6 The eff
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Portfolio theory tangential to r f
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Capital asset pricing model Beta: a
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CAPM: an example of beta estimation
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CAPM - what went wrong? CAPM has be
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Arbitrage pricing model point is se
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l Portfolio theory - where are we n
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Review questions l l Managers diver
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Appendix: Derivation of CAPM APPEND
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Appendix: Derivation of CAPM or E(r
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Chapter 8 Sources of long-term fina
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Ordinary (equity) capital Figure 8.
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Problems A board meeting has been s
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Appendix I: Proof of the MM cost of
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Appendix II: Proof of the MM cost o
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Modigliani and Miller on dividends
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The traditional view on dividends W
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l l l l Other factors raising an eq
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Other factors is interpreted advers
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l l l Dividends: the evidence a ten
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Dividends: the evidence attract ins
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Conclusions on dividends Agency Age
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Problems l l l l Debt finance - rel
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Problems It has been estimated that
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Appendix: Proof of the MM dividend
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PART 4 Integrated decisions There a
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Chapter 13 • Management of workin
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Chapter 15 International aspects of
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Chapter 15 • International aspect
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Chapter 16 Small businesses Objecti
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Chapter 16 • Small businesses The
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Chapter 16 • Small businesses 16.
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Chapter 16 • Small businesses sma
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Chapter 16 • Small businesses l l
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Chapter 16 • Small businesses Fig
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Chapter 16 • Small businesses Sol
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Chapter 16 • Small businesses 16.
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Chapter 16 • Small businesses l l
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Chapter 16 • Small businesses REV
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Chapter 16 • Small businesses Bal
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Chapter 16 • Small businesses (b)
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Chapter 16 • Small businesses ‘
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Appendix 2 Annuity table Present va
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Appendix 3 • Suggested answers to
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Appendix 4 Suggested answers to sel
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Glossary Accounting rate of return
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Glossary Forward (foreign exchange)
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Glossary of its effective life. It
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References Aharony, J. and Swary, I
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References Dimson, E., Marsh, P. an
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References markets. Journal of Busi
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Index Note: Page references in bold
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Index Draper, P. 399 Drury, C. 121,
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Index Mehrotra, V. 314 Memoranda of
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Index Stock Exchange Automated Quot
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