Financial Management For Macroeconomic Condition And Composition

Factors influencing the expected return on a portfolio

Describe about the Financial Management for Macroeconomic Condition and Composition.

Q1 (i) factors influencing the expected return on a portfolio

The rate on a portfolio depends on many factors like macroeconomic conditions and portfolio composition and we have to see that to what extent it meets the financial objectives of the investors.

In portfolio investment the assets which we are mixing determines the return. There is always a risk return tradeoff in each asset when the risk is higher the higher the volatility and the return potential. We can take an example shares are more risky and volatile than bonds, the expected rate of return on shares can exceed than bonds over long term period.

The strategic and operational fundamentals of the businesses affect the expected rate of returns. The company should be in a position to take the advantage of the opportunities and it can respond to the competitive threats effectively.

The macroeconomic conditions affect the expected rates of return .when the economy is growing economy that means more people have jobs and they spend more. For the businesses there is increase in sales, profits and the business now make the investment in new employees and equipment.

The fiscal policy, political stability and regulations also affects on the expected rate of return .when the fiscal deficits are large it reduce the flexibility of government which results the borrowing cost of business become higher (Basu, 2011).

Q1 (ii) Distinguish between Selection and Allocation in the Context of Portfolio Management

Allocation means the ability by which we can allocate the assets to various sectors or groups. It measures our ability how effectively we can allocate the assets to different sectors. It measures that when the stock is overweighting or when it is underweighting of sectors and it is relative to a benchmark whether it contributes either positive or it may be negative to the accounts overall return (Interactive brokers, N.D).

Selection means the ability by which securities are selected from a sector which is relative to a benchmark. It is a part of manager’s skills and performance attributable when he is selecting securities. When the manager’s choice of security is bullish, benchmark will be under weight on choosing security. On the other hand, if a manager’s choice on a security is bearish, then the benchmark will be over weight on the choosing security (Rau, 2013).

QB1) market efficiency and 3 notions of market efficiency

This concept is taken from the market hypothesis, and it suggests that the price of the security reflects all the news about the security.

The important point to consider is that if the market is efficient the security price is not affected by any information which is expected by the investor’s. Only that information will impact the price that is not fully expected by the investors. The 3 notions of market efficiency are as follows.

The weak form states that the present stock price of the stock   show all the data of past market. So the stock price will be reflected by the past data and the trader cannot guess the prices of stocks in future based on past stock price.

Semi strong form states that the present stocks prices show the information which is publically available and it also includes the past information. This form also encompasses the weak-form. So any investor does not use the information which is publically available to identify the mispriced securities.

The Capital Asset Pricing Model (CAPM)

The strong form states that stocks prices will include all the information whether it is public or private .So, if a market seems to be efficient, then the traders who have insider information  of market cannot take benefit  to make abnormal profits (Maverick, 2015).

(A).The Capital Asset Pricing Model

According to CAPM, the expected return from a security is equal to the rate on risk free security adding a risk premium with it. After that, asset‘s systematic risk can be multiplied by it (Wagner, 2016).

In financial Management, risk is a part of return on security i.e.when risk is more or when risk is taken the return would be higher and lesser will be the chances of loss (Harvey, 2011).

The model depends upon certain assumptions. There are 9 assumptions. The original assumptions were:

Investors are those persons who want to maximize their wealth and for this purpose, they select the investments which give them expected return and standard deviation.

Investors have unlimited amounts that can be borrowed or lend at rate which is free form risk.

Short sales own no barriers.

The investors have same expectation which is related with market.

Financial assets are sold at market value and are divisible.

Absence of Cost of transaction.

Tax free.

The acts which the investor perform have no influence on market price.

All financial assets quantities are given and it is fixed (Eugene and Kenneth, 2004).

(b) Arbitrage pricing theory (APT) 

It is a process to determine the price of any asset. The main assumption of this theory is that various factors like macroeconomic, market and security-specific factors influence the return on assets.

The model is based on pricing of asset and on the idea that the returns on asset can be determined by studying the association between that assets and risk factors involved. Stephen Ross evolved this theory in 1976. It explains the connection of the returns of a portfolio with return of a single asset which consist the combination of independent macro-economic variables.

It is a one-period model with the assumption that the stochastic property of returns of capital assets is reliable with a structure factor. The author argue that if price of symmetry offer no opportunity over still portfolios of the property, then the expected returns on the property are just about closely connected to the factor loadings (Huber man and Wang, 2005).

QB3)

(A) In the past thirty years the founders have found out a various cross –sectional patterns related to return on equity are called effect. For Example effect of volume, price effect related to cash flow and influential effect and liquidity effect. The similar study has revealed the CAPM model of Sharpe, linter and black but it cannot explain in equity returns. So these effects are termed as anomalies, because they are not consistent with the combined theory of market competence and the properly specific asset pricing model. According to Fama, to test the market efficiency a combined test of the asset pricing model and market efficiency’s have been conducted but these anomalies do not show the proof of inefficacy prevailing in market but it shows that the asset pricing method is not clearly specified.

Arbitrage Pricing Theory (APT)

They propose 3-factor model to make clear the equity returns that is called Fama–French model. The factor has argument that CAPM model contains two more factors. It covers the return premium of little firms above huge firm and of high B/M firms in excess of short b/m firms. Fama and French (1993, 1996) explained that the 2 extra factor which is connected to dimension and B/M that detain the danger is orthogonal to market factor and, so their model is a multifactor danger based model (Ghaghara, Lee And Veeraraghavan, 2009)

(B) According to the studies made by Fama and French mainly their 1993 and 1996 studies it display that their model is performing well in USA .The adjustedr2’s from their regressions are around 80–90 percent. And furthermore their model explain a number of CAPM anomaly as a consequence of their work and like study made by additional researchers the Fama–French model have turn into fairly..

There is a restraint in Australian investigation  is that the asset pricing models are experienced on a  big number of portfolio , and B/M portfolios are used as the test portfolios next Fama and French .the market of Australia is very small than the US market and the market comprise of only few stock. So we can say that it is not appropriate to test the model on a huge number of portfolio. The main cause is that the normal divergence of the portfolio income is too high as the no of stocks in the portfolio is very little this will prejudice the analysis that the model is rejected.

So we have to examine the model on lesser number of portfolios. In this study, model can be tested on a much lesser number of portfolios. Main objective behind their work is that if the model gives good description about equity returns then it is able to explain the returns of the test portfolio created by sorts on which is recognized CAPM anomaly. The model become accepted because it explain the returns on many sets of test portfolios in the USA and the Australian research has not tested the Fama–French model on the groups of portfolios which is  formed by sorting on a broad variety of firm feature. So the second motivator to test the model on portfolio which is created by sorts the characteristics  which is known to give details the  cross-sectional difference in equity returns in order to inspect whether the model explain any experiential belongings.

Finally, in 2007 Gharghori find a feeble proof of a leverage effect and various studies of Australia have examined the volume, B/M and liquidity effects and the majority of the findings are consistent with the determining Australian text.

Hence it is less proof about the E/P and leverage effect in Australia and according to information, print work on the C/P effect. So an inspiration of the current study is to reinstate whether the size, B/M, E/P, C/P, leverage and liquidity effects subsist in Australia (Gharghor, Lee and Veeraraghavan, 2009).

Equity return anomalies

Part C

QC.1.a Motives behind mergers and takeovers

We split the motive behind merger and takeover into 3 main groups: 

These motives are easily justified and the transactions are mostly significant and essential. success will not be guaranteed only if there is a strong intentional motive The management of process of integration may be poor, wrong target may be chosen or price paid is of higher value.

Financial Goal is a key element in all takeovers and mergers all are intended to attain a acceptable rate of return for the investment and danger been taken, however, there may be situation when the reason behind the transaction is monetary rather than planned. The financial returns are very important and it derives the deal.

When any M&A fails we can trace it back and called them as “managerial motives”. It is a not a good news for a shareholder of a business who is in takeover business, this transaction of merger and takeover destroys the amount of shareholder value (Riley, 2012).

QC.1.b Corporate control means the right to appoint, fires and set the payment is set for the managers who holds top position.

When the bidding company takeoff the firm; the controlling privileges of the firm which is acquired are transfer to the acquiring firm BOD. The controlling rights are retained by the corporate boards and they hand over the privileges to supervise the corporate wealth to the managers. So the resources of the target are managed by acquiring firm top management.

Takeover can be done by 3 methods like tender offer, merger, through proxy contest, and most of the time all the 3 elements are present. In merger the company who is bidding offer to the company to buy common stock at a value which is surplus of the target firm earlier MV. And when we talk about mergers they are manage with the target manager’s directly it is approved by the BOD of the target company before the vote of shareholders approval. Tender offer means directly buy the shares of shareholders who make a decision on their own whether they wanted to give their shares for sale.  Proxy contests take place when a dissatisfied group mostly led by an unhappy manager or by large stockholder and they attempt to increase the seats on the BOD of the target firm (Jensen and Ruback, 1983).

Manne’s  article initiate an interest in how controlling market  attracts big corporation, and in a lot of cases the information about many facets of the market for corporate control has enlarged significantly. This body of technical information about the business conquest market provide  the answer of the question stated below:

How large the shareholders of both the firms of gains?

Due to opposition of the bids by the manager of target firms it diminish the shareholder prosperity?

Does antitrust resistance to takeovers compel costs on merger firms?

Whether proxy contests exaggerated shareholder wealth?

voting rights of the corporate  are precious?

Short evidences provide a supportive guide to the more in depth conversation that follow. Many studies guess that what are the effects of mergers on the stock prices the participate companies.

Fama-French 3-factor model

There are 2 tables 1, & 2 and they present a précis of changes in the  prices of stocks  for both winning and failed takeover in the study. The returns in the tables represent our mixture of the evidence. Discussion of the details of the studies and the issues that lie behind the estimates in the tables is contained in section 2, ‘the prosperity effects of takeover activities’.

Table 1

Abnormal percentage stock price change linked

With winning company takeovers                              

takeover technique	target %	bidder %
Tender offer	30	4
Merger	20	0
Proxy contests	8	N.A

Abnormal percentage stock price changes associated

With failed company takeover bids                              

takeover technique	target %	bidder %
Tender offer	-3	-1
Merger	-3	-5
Proxy contests	8	N.A

Table 1 depicts that target firms has a winning takeovers experience statistically important and the prices are changed twenty percent in mergers and thirty percent in abnormal tender offers. The firm which is  acquiring   realize  a major abnormal profit of  four percent  of  in tender offers and 0  in mergers.  And the second tabledepicts that together the companies that is bidders and targets suffers  a  little negative abnormal stock cost change in failed merger and tender offer takeovers, even though only the -5% return for failed bidders in mergers is considerably dissimilar as of 0.

Stockholders  holding  proxy contests in the corporation earn normal abnormal returns of about eight percent . It was astonished that these returns are not significantly lesser when the insurgent group lose the competition. The difference between the large stock price increase for winning target firms and the irrelevant stock price changes for failed targets indicate that the profit of mergers are realize only when power of the target firm’s assets is transfer to a acquiring firm. It suggest that the target firm stockholders have harmed when the managers of the target oppose the takeover bid and take additional measures that decrease the chances of winning acquisition. Moreover, the target managers have change when, the takeover loose control, reputation and the value of organization human capital, they can resist the takeover bid still.

They take advantage significantly from the acquisition. When management resist to a bid it will gain stockholders when it lead to a superior takeover cost or else the prices of stock  greater than before. When the management resist it effects on share shareholder prosperity and it is an experiential substance.

Now we see the result of corporate network on the takeover.  And we see that the companies which are better connected are more lively bidders. Both the companies have 1 or 2 directors common, there are always a chances that the transaction will be completed fruitfully without arguments and the time taken in the negotiation is very short a bidder and a target have 1 or more directors in general, the probability that the takeover transaction will be successfully completed augments, and the length of the discussions is shorter. The associated targets often accept offers that occupy equity.

The worth of the  information of the directors network consist of directors ability how they collect the information which is non public about the  target or bidder and the synergies in an M&A. corporations who have  superior information can access (through networks) are and they discover precious targets and can start more takeovers.

The 1^st question that is asked is that the takeovers occur between the firms having familiar directors? It may be possible that the firms, who want to take over another firm, offer a directorship to any director of a potential target or bidder, respectively.

One of the significant issues of negotiation is the payment method it may be in money, equity or both.

So it all depends on market conditions, the acquiring company policy which he adopts against the target company that the takeovers increase the value of the target, or the bidder company, or its aggregate market value (Renneboog and Zhao, 2014).

References

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