Eugene Fama is known for Efficient Markets Hypothesis (EMH), which comes to the conclusion that it is almost impossible to outperform the overall market.
Part 1(a) Please respond to the discussion post.
Eugene Fama is known for Efficient Markets Hypothesis (EMH), which comes to the conclusion that it is almost impossible to outperform the overall market. In his hypothesis, he identifies three different levels of market efficiency: weak form, semi-strong form, and strong form. Weak form “assumes that the prices of securities reflect all available public market information but may not reflect new information that is not yet publicly available” (CFI Team, 2022). In a semi-strong market theory, the price adjusts so quickly to any new public information that it is impossible to predict the future movement of the stock or financial instrument. In this theory, both fundamental and technical analysis are not useful as the price moves too quickly to and predicting any price movements is impossible. Finally, in strong form, EMH states that the current price always reflects all information available, both public and private. In strong form, even insider trading would not help beat the market consistently. In my opinion, the weak form of the EMH is the most sensible. As we can see in certain situations, the release of private information to the public can have a large impact of stock prices, such as during quarterly and annual earnings releases. If the strong form were true, even this private information should not affect the price of the stock. It’s also important to note that the EMH assumes that securities always trade at fair market value, which is not always the case.
The publicly traded company I chose is Walmart (WMT). Walmart’s beta is according to Yahoo Finance is 0.52. The beta is used as a measure of sensitivity of the security to the overall market risk factors. The average beta of a stock is about 1. This means that if the market rises 1%, the stock with a beta of 1 will tend to rise 1% as well (Berk et al., 2020). If the beta is 2, it will rise 2%. The same can be said if the market decreases 1%. For Walmart with a beta of 0.52, it means that when the market rises 1%, it typically rises by 0.5%, and decrease 0.5% when the market falls 1%. With a low beta, Walmart is a less risky stick and remains relatively stable despite fluctuations in the market. This makes sense as Walmart sells a lot of staples such as food and clothing which people always needs, even if the market is not doing well. The main issues with using beta as a metric is that is only uses past data. It does not account for any new information that may have an impact on the future of the company.
References
Berk, J., & DeMarzo, P. (2020). Sensitivity to Systematic Risk: Beta. In Corporate finance (pp. 349–349). essay, Pearson Education Limited.
CFI Team. (2022, January 22). Efficient Markets hypothesis. Corporate Finance Institute. Retrieved July 28, 2022, from https://corporatefinanceinstitute.com/resources/kn…
Yahoo! (2022, July 29). Walmart Inc. (WMT) stock price, news, Quote & History. Yahoo! Finance. Retrieved July 28, 2022, from https://finance.yahoo.com/quote/WMT?p=WMT&.tsrc=fi…
Part 1(b) Please respond to the discussion post. Must be at least 500 words. Use 2 in text citations. And the citations should be websites that are based in the United States. Try to add to the discussion post.
Capital Asset Pricing Model (CAPM) is a model that is used to describe relationships of an entire system instead of only one individual part. When the market portfolio is efficient, all the stocks fall on the security market line, this means investors can purchase stocks that exceed the required rate of return. Events such as natural disasters, terrorism, war, and inflation can trigger change in the market. These events can trigger how the market will fluctuate by increasing or decreasing earnings on portfolios, small stocks, world portfolios, corporate bonds, and treasury bills (Berk & DeMarzo, 2019, p. 325). The book pointed out an example that if our great grandparents had invested $100.00 in small stocks, by the end of 2018 the earnings would have been up to 5.8 million (Berk & DeMarzo, 2019, p. 326). The book also mentions how the market can be misleading by providing the same example but instead the $100.00 is invested in small stock around the time of the depression. The funds invested in small stock would have grown to $181 by 1928 but depreciated to $15.00 in 1932, due to the significant effect of the great depression (Berk & DeMarzo, 2019, p. 326.). Many investors both high risk and low risk lost earnings due to loss of employment leading to their savings being depleted. One limitation to market efficiency can be the releasing of financial statements due to regulation; the information is accurate and current so if investors see good returns, they are more likely to invest. Passing the Sarbanes-Oxley Act of 2002 made the market more efficient because accurate information is being provided (Investopedia, 2022).
The beta value for Roku, Inc. (ROKU) calculated over a five-year period is 1.93 (NASDAQ, 2022). Since this value is higher than 1.0 and beta is a measure of a stock’s risk and volatility compared to the market, this indicates that stocks in this company are more volatile than the market portfolio, carrying 1.93 times the systematic risk. Stocks in technology companies tend to have a higher beta value (Berk & DeMarzo, 2019, p. 376). Given that Roku, Inc. produces streaming devices, it makes sense that its stock is sensitive to external forces which affect the economy like the pandemic. The lockdown caused an increase in consumer demand for in-home entertainment and consequently demand for their products increased.
One of the biggest limitations of using beta to predict volatility is that it is usually computed over a long historical period to smoothen the effects of unusual events or external forces. A reliable beta is based on historical data therefore beta does not consider new market information or changes in corporate structure and is not a very good predictor of future performance and risk. Also, newly established companies with insufficient historical data will not have a reliable beta. Finally, combining stocks to create an efficient and well-diversified investment portfolio reduces the overall risk so for investors holding their stocks, the beta value of a single stock is less useful than the combined risk of the portfolio.
References
Berk, J. B., & DeMarzo, P. M. (2019). Corporate finance: The Core (5th ed.). Pearson
Investopedia. (2022, July 8). Market efficiency definition. Investopedia. Retrieved July 26, 2022, from https://www.investopedia.com/terms/m/marketefficie…
NASDAQ. (2022, July 26). Roku, Inc. [Stock quote and chart]. Retrieved July 26, 2022, from https://finance.yahoo.com/quote/ROKU.
Part 2. Please read instructions thoroughly
Complete the Data Case Presented in Chapter 4.
Your submission should be a one-page executive summary of what you found in your analysis with two external citations and a copy of the Microsoft Excel spreadsheet that you used to complete your analysis. Graphs and figures should be presented as appendices (i.e. not presented within the body of the executive summary).
Case 2: Instructions
Assume today is March 16, 2016. Natasha Kingery is 30 years old and has a Bachelor of Science degree in computer science. She is currently employed as a Tier 2 field service representative for a telephony corporation located in Seattle, Washington, and earns $38,000 a year that she anticipates will grow at 3% per year. Natasha hopes to retire at age 65 and has just begun to think about the future.
Natasha has $75,000 that she recently inherited from her aunt. She invested this money in 30-year Treasury Bonds. She is considering whether she should further her education and would use her inheritance to pay for it. If Natasha lacked the cash to pay for her tuition upfront, she could borrow the money. More intriguingly, she could sell a fraction of her future earnings, an idea that has received attention from researchers and entrepreneurs; see M. Palacios, Investing in Human Capital: A Capital Markets Approach to Student Funding, Cambridge University Press, 2004.
She has investigated a couple of options and is asking for your help as a financial planning intern to determine the financial consequences associated with each option. Natasha has already been accepted to both of these programs, and could start either one soon.
One alternative that Natasha is considering is attaining a certification in network design. This certification would automatically promote her to a Tier 3 field service representative in her company. The base salary for a Tier 3 representative is $10,000 more than what she currently earns and she anticipates that this salary differential will grow at a rate of 3% a year as long as she keeps working. The certification program requires the completion of 20 Web-based courses and a score of 80% or better on an exam at the end of the course work. She has learned that the average amount of time necessary to finish the program is one year. The total cost of the program is $5000, due when she enrolls in the program. Because she will do all the work for the certification on her own time, Natasha does not expect to lose any income during the certification.
Another option is going back to school for an MBA degree. With an MBA degree, Natasha expects to be promoted to a managerial position in her current firm. The managerial position pays $20,000 a year more than her current position. She expects that this salary differential will also grow at a rate of 3% per year for as long as she keeps working. The evening program, which will take three years to complete, costs $25,000 per year, due at the beginning of each of her three years in school. Because she will attend classes in the evening, Natasha doesn’t expect to lose any income while she is earning her MBA if she chooses to undertake the MBA.
Determine the interest rate she is currently earning on her inheritance by going to the U.S. Treasury Department Web site (treasury.gov) and selecting “Data” on the main menu. Then select “Daily Treasury Yield Curve Rates” under the Interest Rate heading and enter the appropriate year, 2016, and then search down the list for March 16 to obtain the closing yield or interest rate that she is earning. Use this interest rate as the discount rate for the remainder of this problem.
Create a timeline in Excel for her current situation, as well as the certification program and MBA degree options, using the following assumptions:
Salaries for the year are paid only once, at the end of the year.
The salary increase becomes effective immediately upon graduating from the MBA program or being certified. That is, because the increases become effective immediately but salaries are paid at the end of the year, the first salary increase will be paid exactly one year after graduation or certification.
Calculate the present value of the salary differential for completing the certification program. Subtract the cost of the program to get the NPV of undertaking the certification program.
Calculate the present value of the salary differential for completing the MBA degree. Calculate the present value of the cost of the MBA program. Based on your calculations, determine the NPV of undertaking the MBA.
Based on your answers to Questions 3 and 4, what advice would you give to Natasha? What if the two programs are mutually exclusive? That is, if Natasha undertakes one of the programs there is no further benefit to undertaking the other program. Would your advice be different?
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