Bbf305 Price Impact Of Dividend Assessment Answers

Your investment client asks for information concerning the benefits of active portfolio management. She is particularly interested in the question of whether active managers can be expect3ed to consistently exploit inefficiencies in the capital markets to produce above-average returns without assuming higher risk.
(a) Identify and explain 2 examples of empirical evidence that tend to support the EMH.
(b) Identify and explain 2 examples of empirical evidence that tend to refute the EMH.
(c) Discuss reasons why an investor might choose not to index even if the markets were in semi-strong form. 

Question 2:
James is evaluating the expected performance of two common stocks, stock A and stock B. he has gathered the following information:
The risk-free rate is 5%
The expected return on the market portfolio is 11.5%
The beta of stock A is 1.5
The beta of stock B is 0.8

Based on his own analysis, James’ forecast of the returns on the two stocks are 13.25% for stock A and 11.25% for stock B. Calculate the required rate of return for stock A and B. Explain whether each stock is undervalued, overvalued, or fairly valued.
Question 3:
You conducted a research on finding TWO (2) “best” mutual funds to be invested.

(i) Recommend TWO (2) mutual funds offered by any mutual fund companies in Malaysia with justifications. (ii) analyse what is the best allocation between the two recommended funds (hint: draw the efficient frontier and CAL to determine the best combination). 

The semi-strong form of EMH accepts support from a number of studies which reveals that new information rapidly blends into the market prices of the stocks. In this market, one knows that which information or events have economic importance and which haven’t (Marwala and Evan, 2017). A list of examples is illustrated as below:

• Price Impact of dividend changes: In a number of studies it has been concluded that the change in dividend impact the price of stocks. When these changes are publicly announced, then stock prices are adjusted rapidly without further drift in CAR (Cumulative Abnormal return). These results back the semi-strong EMH.
• Initial Public Offering (IPOs): Generally it is seen in the market that the underwriter’s prices their IPOs below the actual price of the stock, but a number of studies have observed that this under-pricing is quickly adjusted in the market (Degutis and Lina, 2014). In a day or two prices are adjusted.
• Takeover Announcement: Takeover announcements have economic significance. The effect of this information is seen quickly in prices of their respective stocks.

Part B

The prediction of the price of stocks on the basis of publicly available information regarding the characteristics of the company and calendar effects doesn’t support the semi-strong form of EMH. List of examples which refute the EMH is illustrated as below:

• Superior returns to small or neglected firms: It is observed by the analyst that small firms derive greater risk-adjusted returns as compared to the big firms.
• Calendar Effects: Numerous studies have affirmed a seasonality to stock price performance. The January Effect (small stock outperforms large stocks in January) and various other calendar effects also refute semi-strong EMH.
• Low Price Earning Stocks.
• Very poor performance in the last few months.

Part C

Semi-strong form efficiency defines that prices of the security reflect all available information of the market and non-public market information. It determines that only through the significant non-public information; assist the investor to produce the return more than the average return, moreover by applying the technical analysis or fundamental analysis, investor cannot achieve the excellent return on the investment (Jovanovic, Stelios and Christophe, 2016).

Therefore even if the conditions of the market are efficient, then also investor may not choose to index, as investor is required to choose a portfolio to particular tax consideration or to particular risk management issues. For instance, for mitigating a particular source of risk, it is essential for investor to hedge the security. In addition to this, an investor might choose not to index even if the markets are efficient because he or she may need a tailored portfolio to specific risk management issue or specific tax consideration.

Question 2

Exptected return % as per CAPM Model:

Risk-Free Rate + Beta of Stock (Expected Rate of Return – Risk-Free Rate)

Required Rate of Return of Stock A

= 5+ 1.5 (11.5 - 5)

= 5 + 9.75

= 14.75%

Required Rate of Return of Stock B

= 5 + 0.8 (11.5 – 5)

= 5 + 5.2

= 10.2%

Overvaluation or Undervaluation of Shares

If CAPM is > expected rate of return by investor, then security is said to be undervalued

 If CAPM is < expected rate of return by investor then security is said to be overvalued (Song, 2018)

Here James has forecasted return for Stock A at 13.25%, and Expected rate of return is 14.75%, Stock A is undervalued hence James should purchase it. In case of stock, B forecasted return is lower than the expected return. Hence James should not purchase the same.

Question 3

A mutual fund is an investment vehicle which is funded by the shareholders for investing in the securities such as Bonds, stocks, money market instrument and many more. The performance of the mutual fund is measured by the risk and return provided to the investors. A mutual fund is the risk management tool for the investor therefore from the last few decades the importance of the mutual fund significantly increased (Johannes, Arthur and Nicholas, 2014).  For analyzing the optimal portfolio for the investor two best mutual funds of Malaysia has been selected which are CIMB- Principal Asia Pacific Dynamic Income Fund and Kenanga Growth Fund.

The CIMB- Principal Asia Pacific Dynamic Income Fund launched on 24^th April 2011 with the aim to provide consistent income to the investors through investments in the Asia Pacific ex-japan region and similarly to in the medium and long-term achieve the capital appreciation. Apart from this fund, Kenanga Growth fund is another best mutual fund of Malaysia with the objective to provide the long-term growth to the investors.

For evaluating the optimum portfolio following calculation is required

Calculation of the return by CIMB- Principal Asia Pacific Dynamic Income Fund

The annual return of the fund in the last five year is as follows-

Year	Return (CIMB- Principal Asia Pacific Dynamic Income Fund)	Return (Kenanga Growth fund)
	X	Y
2013	20.58	26.35
2014	18.57	9.31
2015	8.91	20.91
2016	6.82	-0.05
2017	27.52	25.83

In the present study return is considered as the average of the last year return of both the fund. By this return from (CIMB- Principal Asia Pacific Dynamic Income Fund) was 16.48% and the return from Kenanga growth fund is 16.47%.  Further risk of both the fund is calculated by using the formula

By applying the above formula; it has been seen that the risk of the (CIMB- Principal Asia Pacific Dynamic Income Fund) was 7.66 and the risk of the Kenanga growth fund was 10.28.

Further for calculation of the correlation coefficient between the above two fund following formula will be considered-

Here the X represents the return of the (CIMB- Principal Asia Pacific Dynamic Income Fund) of the last five year and the Y represents the return of the Kenanga growth fund of the last five year. By applying the above formula the correlation coefficient between the two funds was .6465 which represents the moderate co-relation between the two funds.

Analysis of the above calculation

Fund	Return	Risk	Correlation coefficient between two funds
(CIMB- Principal Asia Pacific Dynamic Income Fund)	16.48%	7.66
Kenanga growth fund	16.47%	10.28
			.6465

By considering the above data, it has been noted that return from both the fund is slightly differenct, however; the risk in the Kenanga growth fund is very high as compare to the CIMB- Principal Asia Pacific Dynamic Income Fund.  On the basis of the correlation between the two funds the risk and return profile of the portfolio will change therefore by applying the efficient frontier tool optimum portfolio for the investor will be 100% investment in CIMB- Principal Asia Pacific Dynamic Income Fund as they are providing similar return with lower risk (Pettenuzzo and Francesco, 2016).

References

Degutis, Augustas, and Lina Novickyt?. "The efficient market hypothesis: a critical review of literature and methodology." Ekonomika 93, no. 2 (2014).

Johannes, Michael, Arthur Korteweg, and Nicholas Polson. "Sequential learning, predictability, and optimal portfolio returns." The Journal of Finance 69, no. 2 (2014): 611-644.

Jovanovic, Franck, Stelios Andreadakis, and Christophe Schinckus. "Efficient market hypothesis and fraud on the market theory a new perspective for class actions." Research in International Business and Finance 38 (2016): 177-190.

Marwala, Tshilidzi, and Evan Hurwitz. "Efficient Market Hypothesis." In Artificial Intelligence and Economic Theory: Skynet in the Market, pp. 101-110. Springer, Cham, 2017. 

Pettenuzzo, Davide, and Francesco Ravazzolo. "Optimal Portfolio Choice Under Decision?Based Model Combinations." Journal of applied econometrics 31, no. 7 (2016): 1312-1332. 

Song, Chengjiao. "Analysis of Stock IPO Price Based on CAPM Model." Insight-Statistics 1, no. 1 (2018).