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THEORIES OF INVESTMENT 9.EFFICIENT MARKET THEORY.

Efficient Market Theory is one of the Investment Theories, and the theory postulates that at any given point of time the prices of securities being traded in a stock market or any other financial market fully reflects all available information and data. People buy securities thinking that the price shall move up, and they sell securities thinking that the price shall go down. Now, according to Efficient Market Theory, as the prices fully reflect all the available information, any price movement upward or downward is a matter of luck. However, like many Investment Theories, the Efficient Market Theory has also its plus and negative points. The Firm Foundation Theory is one of the important Investment Theories. It postulates that any financial asset like a stock or real estates like a piece of property has an intrinsic value. The condition in the market either keeps the price below the intrinsic value or above the intrinsic value - it rarely remains at or around the intrinsic value. This position offers the investor a choice - in case, he.she is able to buy the stock or the real estate below its intrinsic value, he/she shall make profits when the price goes above the intrinsic value. EFFICIENT MARKET SELECTION The third major approach is very different from either of the approaches mentioned already. The Efficient Market Hypothesis (EMH) assumes that markets are efficient processors of information, and that securities prices already reflect all the information available at any given time. So attempts to speculate on extra information are fruitless because all information is already applied. Proponents of the EMH approach offer this advice: choose the general types of securities you want in a portfolio based on the amount of risk desired, your need for cash flow and your tax situation. Diversify the portfolio within these general types, so you spread the risk and then hold onto it. EMH does not recommend trading on the advice of analysts and speculators, but it does concede that it is the trading of these analysts and speculators that makes the market efficient in the first place. Their research provides the market with its current information. These are just three general and broad approaches to the challenge of playing the market, and it might help the less experienced investor become more aware of the complexities of the stock market to realize that three such diverse theories could all have some support among the experts on Wall Street. Efficient Market Hypothesis Very few people are neutral on efficient market hypothesis (EMH). You either believe in it and adhere to passive, broad market investing strategies, or you detest it and focus on picking stocks based on growth potential, undervalued assets and so on. The EMH states that the market price for shares incorporates all the known information about that stock. This means that the stock is accurately valued until a future event changes that valuation. Because the future is uncertain, an adherent to EMH is far better off owning a wide swath of stocks and profiting from the general rise of the market.

10. FIRM FOUNDATION THEORY

The firm-foundation theory argues that each investment instrument, be it a common stock or a piece of real estate, has a firm anchor of something called intrinsic value, which can be determined by careful analysis of present conditions and future prospects. When market prices fall below (rise above) this firm foundation of intrinsic value, a buying (selling) opportunity arises, because this fluctuation will eventually be corrected or so the theory goes. Investing then becomes a dull but straightforward matter of comparing something's actual price with its firm foundation of value. It is difficult to ascribe to any one individual the credit for originating the firm-foundation theory. S. Eliot Guild is often given this distinction, but the classic development of the technique and particularly of the nuances associated with it was worked out by John B. Williams. In The Theory of Investment Value, Williams presented an actual formula for determining the intrinsic value of stock. Williams based his approach on dividend income. In a fiendishly clever attempt to keep things from being simple, he introduced the concept of "discounting" into the process. Discounting basically involves looking at income backwards. Rather than seeing how much money you will have next year (say $1.05 if you put $1 in a savings bank at 5 percent interest), you look at money expected in the future and see how much less it is currently worth (thus, next year's $1 is worth today only about 95, which could be invested at 5 percent to produce approximately $1 at that time). Williams actually was serious about this. He went on to argue that the intrinsic value of a stock was equal to the present (or discounted) value of all its future dividends. Investors were advised to "discount" the value of moneys received later. Because so few people understood it, the term caught on and "discounting" now enjoys popular usage among investment people. It received a further boost under the aegis of Professor Irving Fisher of Yale, a distinguished economist and investor. The logic of the firm-foundation theory is quite respectable and can be illustrated best with common stocks. The theory stresses that a stock's value ought to be based on the stream of earnings a firm will be able to distribute in the future in the form of dividends. It stands to reason that the greater the present dividends and their rate of increase, the greater the value of the stock; thus, differences in growth rates are a major factor in stock valuation. Now the slippery little factor of future expectations sneaks in. Security analysts must estimate not only long-term growth rates but also how long an extraordinary growth can be maintained. When the market gets overly enthusiastic about how far in the future growth can continue, it is popularly held on Wall Street that stocks are discounting not only the future but perhaps even the hereafter. The point is that the firm-foundation theory relies on some tricky forecasts of the extent and duration of future growth. The foundation of intrinsic value may thus be less dependable than is claimed. The firm-foundation theory is not confined to economists alone. Thanks to a very influential book, Graham and Dodd's Security Analysis, a whole generation of Wall Street security analysts was converted to the fold. Sound investment management, the practicing analysts learned, simply consisted of buying securities whose prices were temporarily below intrinsic value and selling ones whose prices were temporarily too high. It was that easy. Of course, instructions for determining intrinsic value were furnished, and any analyst worth his or her salt could calculate it with just a few taps of the calculator or personal computer. Perhaps the most successful disciple of the Graham and Dodd approach was a canny midwesterner named Warren Buffett,

who is often called "the sage of Omaha." Buffett has compiled a legendary investment record, allegedly following the approach of the firm-foundation theory. 11. Life Cycle Theory of Investing Discussion of lifecycle investing theory may seem a bit academic for a wealth management practice website, but we felt a brief discussion of the main points may be helpful. Much of this material is sourced from Professor Zvi Bodies article, Thoughts on the Future: Life-Cycle Investing in Theory and Practice. Financial Analysts Journal, vol. 59, no. 1. For more information, please contact us. The challenges facing us today in planning for lifetime financial security is very different from previous generations. One might think that new challenges would lead to new solutions. Yet, the wealth management industry today is often still working to an outdated theoretical model, and not surprisingly, it is proposing outdated strategies and solutions. Clients come to us knowing that aside from what they create for themselves, there are few, if any, reliable financial safety nets available to them in old age. The defined benefit pension plan is virtually dead. State pension plans are acknowledged to be insolvent. In the real world, insolvency means no can pay. What the state will eventually do about this is an open question. States have reached the point where they are saying, "Yes, we have a problem". They are still working towards "This is what we will do about it". Furthermore, people are living longer and health care costs are increasing. Family support is not as available as in prior generations, and there are some very unrealistic expectations about appropriate savings rates and expected investment returns. As we have seen in the market turmoil recently. The Swiss market index returned -11% from 1998 to 2008. To these challenges, the Wealth Management industry by and large responds with the old paradigm view outlined in the table below. We feel strongly that the new paradigm is far more appropriate to the challenges and issues facing us today and we try to incorporate that into our planning and advice. Life Cycle Theory of Investing Discussion of lifecycle investing theory may seem a bit academic for a wealth management practice website, but we felt a brief discussion of the main points may be helpful. Much of this material is sourced from Professor Zvi Bodies article, Thoughts on the Future: Life-Cycle Investing in Theory and Practice. Financial Analysts Journal, vol. 59, no. 1. For more information, please contact us. The challenges facing us today in planning for lifetime financial security is very different from previous generations. One might think that new challenges would lead to new solutions. Yet, the wealth management industry today is often still working to an outdated theoretical model, and not surprisingly, it is proposing outdated strategies and solutions. Clients come to us knowing that aside from what they create for themselves, there are few, if any, reliable financial safety nets available to them in old age. The defined benefit pension plan is virtually dead. State pension plans are acknowledged to be insolvent. In the real world, insolvency means no can pay. What the state will eventually do about this is an open question. States have reached the point where they are saying, "Yes, we have a problem". They are still working towards "This is what we will do about it".

Furthermore, people are living longer and health care costs are increasing. Family support is not as available as in prior generations, and there are some very unrealistic expectations about appropriate savings rates and expected investment returns. As we have seen in the market turmoil recently. The Swiss market index returned -11% from 1998 to 2008. To these challenges, the Wealth Management industry by and large responds with the old paradigm view outlined in the table below. We feel strongly that the new paradigm is far more appropriate to the challenges and issues facing us today and we try to incorporate that into our planning and advice.

12. MARKOWITZ PORTFOLIO SELECTION THEORY

The Portfolio Theory also known as Modern Portfolio Theory was first developed by Harry Markowitz. He had introduced the theory in his paper Portfolio Selection which was published in the Journal of Finance in 1952. In 1990, he along with Merton Miller and William Sharpe won the Nobel Prize in Economic Sciences for the Theory. The theory suggests a hypothesis on the basis of which, expected return on a portfolio for a given amount of portfolio risk is attempted to be maximized or alternately the risk on a given level of expected return is attempted to be minimized. This is done so by choosing the quantities of various securities cautiously taking mainly into consideration the way in which the price of each security changes in comparison to that of every other security in the portfolio, rather than choosing securities individually. In other words, the theory uses mathematical models to construct an ideal portfolio for an investor that gives maximum return depending on his risk appetite by taking into consideration the relationship between risk and return. According to the theory, each security has its own risks and that a portfolio of diverse securities shall be of lower risk than a single security portfolio. Simply put, the theory emphasizes on the importance of diversifying to reduce risk. Early on, investors stressed on individually picking high yielding stocks to earn maximum profits. So if one particular industry was offering good returns; an investor would have landed up picking all stocks of his portfolio from the same industry thereby making it a highly unwise act of portfolio management. Although it was intuitively understandable, the Portfolio Theory was the first of its kind to mathematically prove it. The main outcome of the Portfolio Theory is that with optimum diversification, the risk weight of a portfolio shall be less than the average risk weights of the securities it contains. The Theory uses standard deviation as a substitute to risk and the standard deviation of expected returns is expressed as follows: (W a2a2 + W aW bCovab) Where: Wa is the size of the portfolio in security a, a is the standard deviation of the expected return of the security a, and Covab is the covariance of the expected returns of the securities a and b

With the assumption that the covariance is less than 1 (which is not a practical assumption), it is derived that the weighted average of the standard deviation of the expected returns of the securities shall be more. As such the theory proves that diversification of securities in a portfolio reduces risk. The Efficient Frontier: In 1958, James Tobin added to the Portfolio Theory by introducing the Efficient Frontier. According to the theory, every possible combination of securities can be plotted on a graph comprising of the standard deviation of the securities and their expected returns on its two axes. The collection of all such portfolios on the risk-return space defines an area, which is bordered by an upward sloping line. This line is termed as the efficient frontier. The collection of Portfolios which fall on the efficient frontier are the efficient or optimum portfolios that have the lowest amount of risk for a given amount of return or alternately the highest level of return for a given level of risk. The Two Mutual Fund Theorem An important outcome of the analysis provided by the theory of the efficient frontier was the Two Mutual Fund Theorem. According to the theorem, a combination of any two portfolios held on the efficient frontier leads to the generation of an efficient portfolio. The two portfolios held on the efficient frontier are the mutual funds as mentioned in the name of the theorem.   Portfolio Theory Key Assumptions The Portfolio Theory is based on many assumptions, most of which weaken the Theory to some degree. The key assumptions of the theory are listed below: Assumptions from the Efficient Market Hypothesis*: 1. All investors aim to maximize profit and minimize risk. 2. All investors act rationally and are risk averse. 3. All investors receive the same information at the same time. * The Efficient Market Hypothesis is the basis of all financial models. The term efficient market was first introduced by Fama in 1965 and defined as a market where large numbers of rational and risk averse investors trade actively to maximize profits and minimize risks on the basis of the same information which is freely available to all the investors at the same time. Other Assumptions: 1. Investors do not need to pay any taxes or transaction costs 2. Investors can buy any security of any size 3. Investors can lend or borrow any amount of securities at the risk free rate 4. Investors are price takers and their actions do not influence prices 5. The correlations between assets are always fixed and constant 6. Return on assets are normally distributed 7. Investors have the exact idea of potential returns Portfolio Theory Limitations

Although the Theory is popularly used as a tool by investment institutions, the assumptions have received criticisms due to important findings in others areas of study, especially from the field of behavioural economics. For instance, the assumption that all investors act rationally has been proved wrong by behavioural economists. Also, the supposition that all investors have the exact idea of potential returns has been disproved by studies done in the field of behavioural finance as the expectations of investors are normally biased. The theory of all investors being equally informed stands false as the market is quite asymmetrical when it comes to information due to the presence of elements such as insider trading or simply more informed investors. The assumption that investors do not need to pay any taxes or transaction costs also does not hold true. The hypothesis of investors being able to buy securities of any sizes is not practical as some securities have minimum order sizes and securities cannot be bought or sold in fractions. Each investor also has a credit limit and hence he cannot lend or borrow unlimited amounts of shares. The theory that the actions of investors have no impact on the market is also completely flawed as large amounts of sale or purchase of individual securities influence the price of the security or related securities. Also the correlations between assets are never fixed and constant as correlations change with changes in universal relations that exist between fundamental assets. Further, it has also been observed that the return on assets is not always normally distributed due to frequent swings in the market. Further, the theory mathematically calculates expected values based on past performance to measure the correlations between risk and return. However, past performance is not a guarantee of performance in the future as has been observed by experienced investors. Considering only past performances leads to the leaving out of current scenarios or circumstances that might not have been present during the time when collection of the past data had taken place. The theory also does not take into account its own impact on the market. The theory is not practical as it only mathematically represents the future based on historical measurements of values of risk, return and correlation measures. Such an arrangement tends to ignore newer conditions which might not have existed during the time when the historical data was compiled. Applications of the Portfolio Theory In spite of its drawbacks, the theory is widely used in financial risk management and has played a key role in the way institutional portfolios are managed today. The theory is also used by some experts in project portfolios of non-financial instruments. The theory has also found ground in fields other than finance. In the 1970s the theory was used in the area of regional science to derive the relationship between economic growth and variability. It has also been used in the field of social psychology to concept the model of self. The theory has also been utilized to replicate the uncertainty and relationship between documents in information retrieval. Conclusion The Portfolio Theory broadly explains the relationship between risk and reward and has laid the foundation for management of portfolios as it is done today. It emphasizes on the significance of the relationship between securities and diversification to create optimal portfolios and reduce risk. It derives two main conclusions which is of significance even today. The first being that

volatility is most dangerous if the time horizon is short and the second being that diversification reduces risk as the risk value of a diversified portfolio is less than the average risk of each of its component securities. Although the theory was not completely practical due to limitations in its assumptions, it paved the way for todays method of value at risk measures. The theory has also undergone many attempts to be improvised with more realistic postulates. The Post Modern Portfolio Theory is an extension of the theory. It has taken into consideration two of the main limitations of the original portfolio theory and has designed an improvised model by adopting non-normally distributed, asymmetric measures of risk and recognizing that investors have individual investment objectives and are comfortable with any amounts of return that fulfil their minimum objectives. Although the theory is an improvisation to the older theory, it has its own limitations. The Black Litterman Model is another extension of the Portfolio Theory. One of the problems faced during the application of the original portfolio theory was that when a portfolio is created based on only statistical measures of risk and returns, the results obtained are overly simplistic. This problem was overcome in the Black Litterman Model by simply postulating that the initial expected returns are the basically required returns so as to maintain equilibrium of the portfolio with that of the market. Portfolio Theory Modern portfolio theory (MPT)or portfolio theorywas introduced by Harry Markowitz with his paper Portfolio Selection, which appeared in the 1952 Journal of Finance. Thirty-eight years later, he shared a Nobel Prize with Merton Miller and William Sharpe for what has become a broad theory for portfolio selection. Prior to Markowitzs work, investors focused on assessing the risks and rewards of individual securities in constructing their portfolios. Standard investment advice was to identify those securities that offered the best opportunities for gain with the least risk and then construct a portfolio from these. Following this advice, an investor might conclude that railroad stocks all offered good risk-reward characteristics and compile a portfolio entirely from these. Intuitively, this would be foolish. Markowitz formalized this intuition. Detailing a mathematics of diversification, he proposed that investors focus on selecting portfolios based on those portfolios overall riskreward characteristics instead of merely compiling portfolios from securities that each individually have attractive risk-reward characteristics. In a nutshell, inventors should select portfolios not individual securities. If we treat single-period returns for various securities as random variables, we can assign them expected values, standard deviations and correlations. Based on these, we can calculate the expected return and volatility of any portfolio constructed with those securities. We may treat volatility and expected return as proxys for risk and reward. Out of the entire universe of possible portfolios, certain ones will optimally balance risk and reward. These comprise what Markowitz called an efficient frontier of portfolios. An investor should select a portfolio that lies on the efficient frontier.

James Tobin (1958) expanded on Markowitzs work by adding a risk-free asset to the analysis. This made it possible to leverage or deleverage portfolios on the efficient frontier. This lead to the notions of a super-efficient portfolio and the capital market line. Through leverage, portfolios on the capital market line are able to outperform portfolio on the efficient frontier. Sharpe (1964) formalized the capital asset pricing model (CAPM). This makes strong assumptions that lead to interesting conclusions. Not only does the market portfolio sit on the efficient frontier, but it is actually Tobins super-efficient portfolio. According to CAPM, all investors should hold the market portfolio, leveraged or de-leveraged with positions in the risk-free asset. CAPM also introduced beta and relates an assets expected return to its beta. Portfolio theory provides a context for understanding the interactions of systematic risk and reward. It has shaped how institutional portfolios are managed and motivated the use of passive investment techniques. The mathematics of portfolio theory is used in financial risk management and was a theoretical precursor for todays value-at-risk measures.
13. SELLING THEORIES

Selling Theories 1. AIDAS Theory: Where A stands for Attention I stand for Interest D stand for Desire A stand for Action S stand for Satisfaction 2. Right set of circumstances: This theory is similar to that of situation response theory. I.e. salesperson must secure attention, gain interest, present and get desired response. It depends upon the skills the salesperson utilizes to a set of circumstances for predictable response. Sales personnel try to apply this theory; although they experience difficulties in many rightful selling situations as it cannot be manipulated. The set of circumstances includes external and internal factors which the salesperson tries to create favourable for getting desired response from a given situation. This theory is known as seller-oriented theory. 3.Buying Formula theory of selling: This theory is known as Buyer-oriented theory .It looks out at buyers side i.e. needs and expectation . The theory supports the thinking process that goes on in prospects mind that causes decision to buy/not to buy. Buying Formula Need (problem) solution purchase .

Since, purchase results in continuous relationship between buying and selling. So a fourth element must be preset. Need (problem) solution purchase satisfaction. When need is felt solution may involve two components. Need (problem) solution purchase satisfn/dissatisfn. To ensure purchase the component trade name must be considered adequate & buyer must experience pleasant feeling. Adequacy Need/problem product & services and Trade name Purchase satisfaction Pleasant feeling

4. BEHAVIORAL EQUATIONTHEORY: Using Stimuli-Response Model, this theory has developed. Four essentials elements required in learning process to explain buying behavior and purchasing decision process. Drives: a strong internal stimuli that impel the buyers response i)Innate drive (psychological) -ii)learned drive (status/social) Cues: weak stimuli when the buyers respond. i)Triggering cue-activates decision process for given product. ii) Non triggering cue influences the decision process but not activate. iii) Specific product/information-also functions as triggering cue. Response: What buyer does? Reinforcement: event that strengthens buyers tendency of response. B= P X D X K X V. B=Response. P= Predisposition/inward response tendency habit. D= Present drive level. K= incentive potential i.e. value of the product/potential satisfaction of the buyer. V= Intensity of all customer.

14. THE 10 PERCENT RULE

The Ten Percent Rule

The Ten Percent Rule sees its application in various fields and in fact is tweaked based on where it finds its use. It has been used as a thumb rule from sports to investments.

Originally the rule came into existence based on empirical observations when it was seen that out of an action, objects or elements infused, only 10% would reach a pre-desired state and of these, only a further 10% would reach the ultimate desired state. Think of it as a reformed form of a principle similar to the 80/20 principle. It is a conservative but safe approach to investment and particularly applies to new forms of investment instruments or practices.

Let us try an understand it with the help of hypothetical example. Let us say that you invent a new form of investment instrument which tries to price speculation or emotions. As per the 10 Percent Rule, out of your target investors, only 10% would ever come to know about this and understand it and of these only 10% will actually invest in the instrument. This in other words means that only 1% of you all probable customers will actually invest. This rule does not state that this will happen every time, but the chances are that more often than not, this rule will apply to any new action infused into the world i.e. the success stories we talk about are the 1% which succeed after 99 previous failed attempts. Arguably a theory with a lot of limitations, but interesting nonetheless.... The 10 Percent Rule (overview)) Edit The 10 Percent Rule is one of the Investment Theories. The 10 Percent Rule helps the investor in identifying and understanding broad market swings. It is a simple rule and assists the investor

in avoiding defective value judgments. The investor calculates the value of his/ her portfolio at a specified interval, say every week. Once in a month the weekly values are aggregated and average value is determined. In case, the monthly average continues to rise, the investor does not have to take any action - the profits may be allowed to run. However, a 10 percent fall in the monthly value of investments is considered a signal to sell and liquidate the portfolio fully, and sometimes partially. On the other hand, if after such a liquidation, the notional value of the portfolio (so liquidated) rises by 10 percent, it give a signal to buy and re-create the same portfolio or a different portfolio of the same value. In 10 Percent Rule, the construction of the initial and subsequent portfolio plays the most significant role. Thus, a portfolio of Blue Chips shall perform differently than a portfolio of average stocks or Junk Stocks.
15. THE WINDBAG THEORY

1. Bird in the hand theory Bird-in-the-hand Theory Bird-in-the-hand Theory is one of the major theories concerning dividend policy in an entreprise. This theory was developed by Myron Gordon and John Lintner as a response to Modigliani and Miller'sdividend irrelevance theory. Gordon and Lintner claimed that MM made a mistake assuming lack of impact of dividend policy on firm's cost of capital. They argued that lower payouts result in higher costs of capital. They suggested that investors prefer dividend as it is more certain than capital gains that might or might not appear if they let the firm retain its earnings. The authors indicated that the higher capital gains/dividend ratio is, the larger total return is required by investors due to increased risk. In other words, Gordon and Lintner claimed that one percent drop in dividend payout has to be offset by more than one percent of additional growth. Bird-in-the-hand theory was criticised by Modigliani and Miller who claimed that dividend policy does not affect the firm's cost of capital and that investors are totally indifferent if they receive more dividend or capital gains. They called Gordon and Lintner's theory a bird-in-the-hand fallacy indicating that most investors will reinvest the dividend in the similar or even the same company and that company's riskiness is only affected by its cash-flows from operating assets. Definition of 'Bird In Hand' A theory that postulates that investors prefer dividends from a stock to potential capital gains because of the inherent uncertainty of the latter. Based on the adage that a bird in the hand is worth two in the bush, the bird-in-hand theory states that investors prefer the certainty of dividend payments to the possibility of substantially higher future capital gains. The theory was developed by Myron Gordon and John Lintner as a counterpoint to the Modigliani-Miller dividend irrelevance theory, which maintains that investors are indifferent to whether their returns from holding a stock arise from dividends or capital gains. Under the bird-

in-hand theory, stocks with high dividend payouts are sought by investors and consequently command a higher market price. Assessing the Bird in the hand theory in business The aim sought by the proponents of the irrelevance proposition hypothesis is that the cash dividends policy has no effect on the company value or the capital cost. Consequently, the cash dividends policy will not affect the returns on capital required. Many other theorists (Lintner 1962; Gordon 1963) see that the returns on capital required rise when the cash dividends ratio decreases because investors are less sure of their capital gains resulting than the return earnings and rising stock prices from obtaining these cash dividend. Those writers (Lintner 1962; Gordon 1963) think that investors evaluate the dollar, which they receive from cash dividends, more than the dollar they would receive from capital gains. The reason is that the dollar received from cash dividends today is less risky than the future dollar received from capital gains. It is known that investors evaluate share prices through a predictable future cash flow per share and then discount it in a rate reflecting the risks. This discount rate has a positive relation with risks, therefore the discount rate which is used to determine share price with future capital gains will be greater. As a result, the company's share price which has a low cash dividend and high return earnings for future capital gains will be less than the share price which has high cash dividends. Therefore, the share price will drop when return earnings increase for future capital gains. A preliminary reading of the "bird in the hand theory" shows that it seems acceptable on the basis that shares with high cash dividend are less risky. With the stability of other factors affecting the share price, the less risky stocks are more expensive. The question to be raised here is: Has the dividends policy affected the company's risk level? Or do the risks affect the dividends policy? Among the reasons proposed by Rozeff (1982) in his study to explain how the companies with high-risk distribute low cash dividends is the fact that the managers are aware that these companies profits have uncertainty risks. So the managers prefer low cash dividends because they don't want to find themselves forced in the coming years, with profits of many uncertainty risks to reduce cash dividends rate which is familiar for shareholders because they are evaluate the consistency in cash dividend level more than cash dividend its self (Gombola and Feng-Ving 1993). This means that the high risk for the company has led to a reduction in the cash dividends rate distributed. Also, the decrease in cash dividends is a result of the company high risks and not vice versa. To sum up, the "bird in hand theory" proposes that capital gains are more risky than cash dividends and that investors prefer companies that distribute cash dividends more than the companies that hold the profits to convert them into capital gains. Because of their preferences, the investors are paying higher prices for the company's shares with cash dividends, compared with the company holds their profits when other factors are fixed. On other words, this theory indicates that if the company wants to maximize their share price, then they should pay a high dividend ratio (Baker and Powell 1999). However, (M&M, 1961) assumption does not accept this concept and says it is "Bird in-theHand Fallacy". (Bhatacharya, 1979) says that future cash flow risk for any project determines its risk; therefore, any incremental in cash dividend now will decrease shares price after cash dividend and the decrease future cash flow risk by increase cash dividend today will not increase companies value. An accurate reading of the "bird in the hand" theory, as stated by Gordon (1959), shows that this theory tends to consider the investment policy and not the cash dividends policy as it seems from the initial reading. The result that can be drawn from this theory is that the companies that distribute low cash dividends are often high-risk investment companies. Due to high investment risks, investors would discount future cash flows of low cash dividends - companies with high

risks - with a larger discount rate when they evaluate these companies' shares prices. As such, they find themselves willing to pay a less price for the shares of these companies with the stability of other factors. In other words, the discount rate used to determine these companies' shares price depends solely on the risk level, regardless of the dividends policy followed by these companies. The cash dividends policy, on its part, is only the inevitable result of the company's risk level, and not the reason for it. 2. Signalling theory

Signalling theory (See Chapters 23 and 36 of the Vernimmen) Signalling theory is based on the assumption that information is not equally available to all parties at the same time, and that information asymmetry is the rule. Information asymmetries (see also asymmetry issuer/investor) can result in very low valuations or a sub-optimum Investment policy. Signalling theory states that corporate financial decisions are signals sent by the company's managers to Investors in order to shake up these asymmetries. These signals are the cornerstone of financial communications policy.

Signaling Effect Theory As per this theory, the managers use the change in cash dividends distributed rates as a means to deliver information to investors about the company (Denis, Denis et al. 1994). This theory supporters believe that the increase in the cash dividends rate is deemed an effective means of delivering information to investors because competitors cannot use the company's tradition of the same means unless they have actually the same capacity to achieve future profit (see:Charest 1978; Asquith and Mullins Jr 1983; Kalay and Loewenstein 1986; Impson 1997; Doron and Ziv 2001). When M&M (Merton and Modigliani 1961) introduced their hypothesis about the Irrelevance Proposition on the company's cash dividends policy of the company's market value, one of the assumptions has been that all investors have the same information and ability for understanding and analyzing available information. Therefore, they have the same future outlooks concerning the company. Also, the investors and managers have the same information and therefore they have the same future expectations for the company. In practical life, however, and because of what is known as asymmetric information (Dewenter and Warther 1998), investors have different expectations and information with respect to the company's future profits and risks. Furthermore, by virtue of their position within the company and the nature of their work and career interests and duties, the managers have better and more accurate information and expectations than external investors regarding the company's profits and performance. As the managers have information that may not be available to external investors, they can use the change in the cash distributed dividends rate as a way to deliver such information to investors to reduce the gap information between managers and investors with the aim of creating a greater demand for the company's shares, and then influencing the company's market value and shareholders' wealth. Among the findings of Aharony and Swary's study (1980), the company's shares prices usually rise when the companies suddenly or unexpectedly tend to increase cash dividends. These prices are reduced when the company suddenly or unexpectedly reduces the cash dividends. Also Kown in his study (1981) came to the same results, adding that companies usually do not increase their cash dividends unless they expect an increase in the future profits on an ongoing basis and sufficient to cover the cash dividends increase and continue the same good level in

the coming years without being compelled to reduce the cash dividends rate in the coming years. Ross and others (Ross, Jaffe et al. 1999) find that it is not expected that the companies that do not expect future profits to increase the cash dividends rate because the costs of this process are too high and have future negative effects that exceed the temporary positive effects expected from increase cash dividends for companies that do not expect future additional profits. As such, the future increase in the cash dividends is a positive indicator of the company's future performance. If the company increases the cash dividends, it will generate positive conclusions for investors about the company's future profits, leading to an increasing demand on the part of investors on these shares, which leads to a rise in their prices. The supporters of the Signaling Effect theory believe that cash dividends is the ideal means to deliver specific information about the company to investors. However, many others see that cash dividends not the best way to communicate such information to investors. Born and Rimbey (1993) find that change in the cash dividends rate may give incomprehensible and misleading signals unless the market finds itself able to distinguish between growing companies that tend to retain their profits for investment and growth, and also companies that have exhausted all available investment opportunities available to them and don't have any such opportunities to invest funds and therefore seek to distribute their profits. When Florida Power & light company announced reducing first quarter dividend in 1994 by 32%, the market's reaction was a decline in shares prices by 20%. After it became clear that the reduction in cash dividends was not a result of the expected future financial difficulties, but was due to a strategic decision to improve the company's financial flexibility and growth opportunities, the share prices have witnessed a gradual rise. This example gives evidence that the cash dividends distributions sometimes may give a misleading indicator. Sending a positive signal, the increase in the cash dividends may involve some negative repercussions on the company if these are understood in a certain way. For example, if the company is growing and accomplishing noticeable improvement and high returns on investment, and at the same time it did not distribute any dividends during the previous period, the dividends distribution might be looked at by shareholders as a negative indicator. This change can be explained by the company's inability to find new investment opportunities or that the investment opportunities available to the company are no longer profitable as is the case before. Such an understanding of cash dividends increase would lead to a decline in the company's shares value. Through proper understanding of the Signaling Effect theory, it is clear that the positive or negative expectation of investors on the company's future performance leads to an increase or decline in the company's shares price, and not an increase or decrease in the cash dividends rate. The change in the ratio is only a means through which investors can expect the company's future performance. The M&M study (1961) asserts that the investors' reaction to change in cash dividends policy does not necessarily mean that investors prefer cash dividends to capital gains as they are proof of the importance of the cash dividends policy content of information. The empirical studies examining the information content of dividends policy, or the Signaling Effect theory, have, in many cases, projected inconsistent results as is the case with all theories of dividends policy. But all studies agree on the existence of an information content for the dividends policy leading to an increase in stock prices if the company tends to increase the cash dividends ratio unexpectedly reduces the price of shares in case the company seeks to reduce the cash dividends and studies differ on the reasons for the increase or decrease in stock prices between the information content reason alone or the information content with the investors' wish for cash dividends and their preference for companies that distribute cash dividends. At this point, a basic question is raised here: Does the change in the distributed cash dividends rate represent the most efficient means available for the company to deliver information to investors, with the aim of influencing the market's value? The answer for this question which encompasses small companies, which don't have enough means to communicate information to investors, might be 'yes', in that the cash dividends could be the most efficient means of

communicating information in such companies. As to large companies, which are supposed to possess sufficient means of communicating information to multiple investors with a view to narrow the information gap between what investors know and what the company wants investors to know, the change in the cash dividends may not be the least costly way or the more efficient one for delivering such information. For example, the information may be transformed in the most efficient or less costly ways; and it may have the same change effect in the proportion of cash dividends through the analytical reports published and distributed by the company. Need an essay? You can buy essay help from us today!

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