GSBS6130 Corporate Finance For Efficient Hypothesis Market

A. What are the important factors that should be considered by tertiary sector employees when they are deciding whether to place their superannuation contributions in the Defined Benefit Plan or the Investment Choice Plan? What issues relating to the concept of the time value of money may be important in this decision-making process? Explain. 

 

B. The efficient-market hypothesis is true, the pension fund manager might as well select a portfolio with a pin.Explain why this is not the case. 

Answers:

With the due passage of time, there has been a strong increment in the superannuation contribution. The fund manager of the superannuation provides two different plans to the employee of the tertiary that is whether they can opt for superannuation in an investment plan or to vouch for the Defined Benefit Plan.  Hence, the employees have a choice to select among the two and both the plans have their own pros and cons. When the employee of the tertiary vouches for the investment choice plan then it can be ascertained that the employee is adventurous and understand the risk associated with the transfer cost, on the other hand, those who vouch for the Defined benefit plan have a tendency to consider the tradeoffs s in their account (Damodaran, 2012). The concept of superannuation has led to savings among the individuals and invests the amount for the future especially concerning the years of retirement. This has been taken seriously by the government of Australia and prescribes the minimum contribution that is needed to be made so that compliance can be done in terms of retirement funds or superannuation in respect of the employees (Kollmorgen , 2015).

When it comes to the Defined Benefit it is a common parlance that the scheme provides immense benefits to the employees and that the expected benefits influences the employees to stay invested in the plan on the other hand, when it comes to the concept of Investment Choice plan the employees has a tendency to abandon the benefits in the search for higher returns (Brealey et. al, 2011).  Moreover, the variances in the proficiencies of the finance give an indication that the selection of Investment Choice plan is due to the transfer costs. This provides a major indication that the employees who are not willing to take any kind of risk are more inclined towards the selection of the Defined Benefit Plan (Power, 2017). However, higher returns lead to the selection of the Investment Choice Plan.

Secondly, the advantages bestowed by both the scheme are considered while selecting the plan. When it comes to the Defined Benefit Plan or Investment choice plan the employers who sponsor the program assures to give a particular level of advantage during the period of retirement.  The benefit is derived through a computation that is based on the salary that is final and the years of service (Kollmorgen, 2015). Moreover, the assurance is funded by the employers on a periodical basis. But in the case of a low fund figure, the onus is directly on the fund managers as they are responsible for bridging the gap and bring contributions for the same. When it comes to the Investment Choice Plan the employees are able to make their own choice of selection and select the kind of portfolio they require for their own superannuation. When it comes to such a plan, the employers are needed to pay a certain percentage in terms of funds contribution. When the employers contribute towards the fund in terms of his percentage, the role of the employer is discharged.  The main feature fo this plan rests in the fact that the employee is to bear the risk for the investment because the return drives as per their selection (Marsh, 2009). Further, the employers who sponsor the Defined Benefit Plan tolerate the risk that advantages accrue in excess for the risk that is anticipated in nature. When the employers sponsor the Defined Benefit Plan carries a risk that the benefits will cost more as compared to the risk that in predicted with improper returns coming from the assets that are invested. Hence, the planning is undertaken in an effective manner and various kinds of risks need to be borne in tune to the fund's operation. The noteworthy point in the Investment Choice Plan is that the employer discharges the obligation and hence, the employees are exposed to the fluctuations in the course of investment returns (Petty et. al, 2012). Thereby, in this scenario, the risk of investment rests directly on the employees.

Further, in the case of transfer of an investment plan, the factor of risk is even transferred. This means the risk and various other expenses gets associated with the employees when the transfer from defined benefit to Investment Choice Plan. The transfer takes place from the employer to an employee (Power, 2017). It is termed as risk cost transfer and it is the duty of the employee to ensure that any deficiency is borne by them.

Further expectation pertaining to the future course of action even determines the selection of the fund. The expectation of the life after post-retirement ensures a selection of the fund. The main aim of the contribution in superannuation is done with a view to providing a strong benefit to the employee post-retirement. Hence, the decision to ascertain whether or not the benefits be higher leads to the selection of the funds or the plans. It needs to be noted that the employee might be having more than a source of income excluding the superannuation in that case Investment Choice Plan can be of higher stake because having a various source of income leads to diversification and the appetite is high in terms of risks. In such a situation the employee can vouch for higher returns involving a higher level of risk. Moreover, if the employee fails to have additional sources of income apart from the funding in superannuation then Investment Choice Plan will do no good to them as it will lead to higher risk in the search for a higher level of return. When there is no additional source of income then it can be beneficial to have the Defined Benefit Plan because it leads a strong uniformity in terms of funds post retirement. Further, the traits of workers towards the factors of contribution lead to a variation in the value of advantages that is expected from the plans (Brigham & Daves, 2012). The features in such scheme are composed of service, age, post life expectation, etc.

When it comes to the evaluation of both the plans then the major risks can be seen from the values that are predicted and the switch in the jobs. As per the conduct of various researchers, it can be stated that the employees who are linked to Defined Benefit Plan undergo the market mobility of labor risk as the working life benefits are reduced owing to the methods of the earnings formula.  On the other hand, when employees switch jobs frequently than will lead to Defined Benefit Plan in multiples and the total accumulated benefits will end in smoke. Therefore, it can be taken note of the fact that employee who switches job frequently opts for an Investment Choice plan in contrast to the Defined Benefit Plan.

There are various factors that comes into play while deciding the type of plans for the employees of the tertiary sector, however, the concept of time value always play a vital role in the selection of a fund. The decision-making process is vastly influenced by the time value concept. When it comes to the selection of a superannuation plan the major drivers consists of the time that is invested along with performance, security, and cost involved (Porter & Norton, 2014). As per the time value of money, it is stated that the money value in the current scenario is more pronounced as compared to the money value in the future. The main reason that surrounds this fact is that investors must know the sound concept and understand what time scenario suits him and what length of time will be suitable for making the best return. However, the variation that surrounds the present and future value of money is the main crux of the time value of money. When the employees contribute a part of their earning for superannuation funds to attain a greater return than the income received by the employees undergoes a process of reinvestment. Here comes the utility of time value as the employee is needed to use the concept to fetch more income. As per the general notion, it is a common parlance that an investment with fetch higher returns when the time frame is huge while a shorter time frame generates a low return. Employees who ignore the concept of time value of money are bound to suffer loss. Hence, it can be commented that the investment in a proper portfolio with a proper time span will help the employee to reach the financial goal with a higher return. Moreover, it needs to be noted that the time value is vastly influenced by the traits of the investors such as risk preference because it takes a prolonged time to reach the retirement period. Hence, it is of paramount importance that the plans must be done in tune with the preference of the employees and the kind of post-retirement life he needs to spend. In totality, a holistic approach is needed to select funds and vouch for greater returns. 

Efficient Hypothesis Market

The Efficient Hypothesis Theory clearly explains that for an investor to invest in a particular market he/she only requires the price of the stock and the present value of money in the market. All the other vital information automatically comes to knowledge. The theory defines that the market can change anytime and it is unpredictable on the part of any of the investors to make strategies or take an expert advice to make a vision of the profitable stocks. It is impossible for any investor to move past the boundaries of marketing (Shah, 2013). It clearly depicts that the stocks are bound to trade at their fair prices only and for always. This limits the boundaries for any investor to plan to sell or invest in undervalued shares or to sell the stocks at a higher price (Needles & Powers, 2013). It acts as a defensive wall for the rules of trade. It is just impossible for anyone to earn higher returns in the market without taking up any vulnerable investments, this is because the time factor is also not able to predict that when the market would change or the duration for which it is stable (Melville, 2013). It is not the matter of fact that the market is acting according to the hypothesis or not, but it is never recommended by the hypothesis that any investment should be done on the basis of a pin. Pin risks generally but most probably occurs when the seller of an option is not able to determine whether the option should be put into action at that time according to the conditions of the market or not.

As a result of the seller usually ends up either getting a profit or a loss situation as he cannot remain in a neutral state. Investors depending on fund managers should always see that the money is invested in risk-free or less vulnerable portfolios. If the case is of pension then it is the duty of the managers to analyze all the conditions and opt for a less risky plan or bond of lower beta or less vulnerable (Parrino et. al, 2012). It will be an intellectual move on the part of the managers to invest the funds in different portfolios. It can also mean that investing in all types of folios, but all belonging to the same type of industries. It does not always that to invest in a single stock heavily. The fund managers should always keep in mind that to put a pin can help to get diversification but it is not always possible to get a higher amount of returns from these diverted investments (Deegan, 2011).  Losses are also expected. If the investor or the person providing the money has an additional source of income, then it becomes for the managers to throw the pin because these people generally have a large appetite for risks. The manager should also take into concern the rate of taxes as well as the tax position of the investor. It would be positive on the part of the manager to invest in plans with special tax laws as they procure advantages and increase the profit making return of the taken portfolio.     

References

Brealey, R,  Myers, S & Allen, F 2011, Principles of corporate finance, New York: McGraw-Hill/Irwin.

Brigham, E & Daves, P 2012,  Intermediate Financial Management , USA: Cengage

Damodaran, A 2012,  Investment Valuation,  New York: John Wiley & Sons.

Deegan, C. M 2011, In Financial accounting theory, North Ryde, N.S.W: McGraw-Hill.

Kollmorgen , A 2015, Superannuation fund performance and fees, viewed 21 May 2017 https://www.choice.com.au/money/financial-planning-and-investing/superannuation/articles/superannuation-funds-performance-and-fees-191115

Marsh, C 2009, Mastering financial management, Harlow: Financial Times Prentice Hall.

Melville, A 2013, International Financial Reporting – A Practical Guide, 4th edition, Pearson, Education Limited, UK

Needles, B.E & Powers, M 2013, Principles of Financial Accounting, Financial Accounting Series: Cengage Learning.

Parrino, R, Kidwell, D. & Bates, T 2012, Fundamentals of corporate finance, Hoboken,

Petty, J. W, Titman, S., Keown, A. J., Martin, J. D., Burrow, M & Nguyen, H., 2012, Financial Management: Principles and Applications, 6th ed., Australia: Pearson Education Australia.

Porter, G & Norton, C 2014, Financial Accounting: The Impact on Decision Maker, Texas: Cengage Learning

Power, T 2017, Fund choice: Comparing super funds in 8 steps, viewed 21 May 2017 https://www.superguide.com.au/boost-your-superannuation/comparing-super-funds-in-8-steps

Shah, P 2013, Financial Accounting, London: Oxford University Press