FIN201 Corporate Finance- Technical Analysis of Finance

= ($5695 - $5226) / $5226

= 8.97%

27. c) Ending share price of BHP = $27.42

 Beginning share price of BHP = $23.45

Dividends paid = $1.13

Return on share of BHP =  [dividends + (ending share value – beginning share value)] / beginning share value

= [$1.13 + ($27.42 - $23.45)] / $23.45

= 21.74%

Present value of the lump sum amount = FV * [1/(1+i)^t ]

FV = $100,000 , I = 11% , t = 15 years

Therefore present value of lump sum amount = 100000* [1/(1+0.11)¹⁵ ]

= $20,900

Now $209,00 is the first annual cash flow in the beginning of the 4^th year of the perpetuity. This becomes a delayed perpetuity. From the delayed perpetuity, we calculate the annual cash flow of perpetuity.

Delayed perpetuity = (annual cash flow / r) * (1/1+i)^t

20900 = (annual cash flow / 0.11) * (1/1.11)⁴

Therefore annual cash flow of perpetuity = $3490.04

Efficient Market Hypothesis (EMH) states that for efficient markets, the share prices are always accurate and they reflect all the available information about the stock (Sewell, 2012).  Three forms of EMH are said to exist which are weak form of EMH, semi strong form and strong form of EMH. According to the theory, since the share prices reflect all the available information about the stock, it is impossible for any individual investor or trader to make abnormal gains from selling or buying the shares because even if a stock is under-priced or overpriced, the buying and selling activities will bring the share back to its intrinsic value.

However, analysts believe that with the use of technical analysis and fundamental analysis, it is possible for an investor to make abnormal gains.

1. a) Technical analysis – It is assumed by analysts that the stock prices and the sentiments of the investors follow a specific pattern and by analysing this pattern using technical analysis, the future stock prices can be predicted and thereby gains which are above the market returns can be made. However, the weak form of EMH states that all the past information of the stock is incorporated in the stock prices and it is not possible to make gains by analysing the past information. Also EMH argues that technical analysis will not hold true because investors have access to information beyond the past data which is in the form of financial data presented in the company financial statements which help in determining the intrinsic value of a stock. Thus, technical analysis is useless according to EMH and no investor can make abnormal gains by predicting the stock price based on the past data.
2. b) Fundamental analysis – under fundamental analysis, an analyst studies the financial statements of a company like balance sheet, income statement and cash flow statement to arrive at the intrinsic value of the stock (Bodie, Kane, & Marcus, 2001).  It is assumed that the investor can then pick the undervalued stocks and make abnormal gains. However, the semi strong form of EMH states that all publicly available information is incorporated into the stock prices, thus eliminating the possibility of excessive returns with the use of fundamental analysis. According to the theory, the stock prices reflect the present value of all the expected future cash flows of the company (Ray, 1995). Also strong form EMH further confirms that fundamental analysis cannot help investors to outperform the market because the strong form states that the private information is also incorporated into the stock, thus there is no information left to be incorporated and hence an investor cannot make excessive gains since the stock price reflects all private and public information.

Portfolio standard deviation = w2A*σ2(RA) + w2B*σ2(RB) + 2*(wA)*(wB)*Cov(RA, RB)

First we calculate the covariance for the various correlations and then the portfolio standard deviation.

1) Correlation is 1

Correlation coefficient = Covariance_A,B / σ_Aσ_B

1 = Covariance_A,B  / 0.12*0.6

Covariance_A,B  = 0.0072

Portfolio standard deviation = sq. root (0.3^{2 *}0.12² +0.7^{2 *}0.06² + 2*0.3*0.7 *0.0072)

= 0.078

2) Correlation is 0.5

0.5 = Covariance_A,B  / 0.12*0.6

Covariance_A,B  = 0.0036

Portfolio standard deviation = sq. root (0.3^{2 *}0.12² +0.7^{2 *}0.06² + 2*0.3*0.7 *0.0036)

= 0.067

3) Correlation is 0

0 = Covariance_A,B  / 0.12*0.6

Covariance_A,B  = 0

Portfolio standard deviation = sq. root (0.3^{2 *}0.12² +0.7^{2 *}0.06² + 2*0.3*0.7 *0)

= 0.05

4) Correlation is -1

-1 = Covariance_A,B  / 0.12*0.6

Covariance_A,B  = -0.0072

Portfolio standard deviation = sq. root (0.3^{2 *}0.12² +0.7^{2 *}0.06² + 2*0.3*0.7 *-0.0072)

= 0.006

Correlation between two assets measures the degree of relationship between returns of two assets. A positive correlation means when the returns of one asset are increasing the returns of other asset will also increase and vice versa. Correlation ranges from -1 to +1.

From the above we see that as the correlation between the assets increases, the standard deviation of the portfolio also increases. The portfolio deviation is highest at 0.078 when the correlation between assets A and B is 1 and the lowest at 0.006 when the correlation is -1. Investors use correlation between assets to diversify their portfolio. A diversified portfolio will have assets with negative correlation so that when the prices of one asset falls, the price of the other asset should increase in order to maximize the total returns and minimize the losses (Harvey, 2001). Diversification helps in minimizing the risk.

Bibliography

Harvey, C. (2001, February 27). Global Financial Management.

Ray, B. (1995). The Theory of Stock Market Efficiency: Accomplishments and Limitations. Journal of Corporate Finance.

Sewell, M. (2012). Efficienct Market Hypothesis: An Empirical Evidence. International Journal of Statistics and Probability.