ASSIGNMENT SUBMISSION

NAME: NGUYEN THANH LAM

CLASS: MBAOUM0516 - K21C
INSTRUCTOR: DR. LINH NGUYEN
 Question 1:
Market efficiency was developed in 1970 by Economist Eugene Fama whose theory on
efficient market hypothesis (EMH), stated that it is not possible for an investor to outperform
the market because all available information is already built into all stock prices. Discuss why
a financial decision maker such as a corporate treasurer or CFO should be concerned with
market efficiency.

ANSWER:

Market efficiency and its effect to individual investors

When people talk about market efficiency they are referring to the degree to which the aggregate
decisions of all the market's participants accurately reflect the value of public companies and
their common shares at any moment in time. This requires determining a company's intrinsic
value and constantly updating those valuations as new information becomes known. The faster
and more accurate the market is able to price securities, the more efficient it is said to be.

This principle is called the efficient market hypothesis, which asserts that the market is able to
correctly price securities in a timely manner based on the latest information available and
therefore there are no undervalued stocks to be had since every stock is always trading at a price
equal to their intrinsic value. However, the theory has its detractors who believe the market
overreacts to economic changes, resulting in stocks becoming overpriced or underpriced, and
they have their own historical data to back it up.

For example, consider the boom (and subsequent bursting) of the dotcom bubble in the late
nineties and early noughties. Countless technology companies (many of which had not even
turned a profit) were driven up to unreasonable price levels by an overly bullish market. It was a
year or two before the bubble burst, or the market adjusted itself, which can be seen as evidence
that the market is not entirely efficient, at least not all of the time. In fact, it is not uncommon for
a given stock to experience an upward spike in a short period, only to fall back down again

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(sometimes even within the same trading day). Surely, these types of price movements do not
entirely support the efficient market hypothesis.

For a market to become efficient, investors must perceive that the market is inefficient and
possible to beat. Ironically, investment strategies intended to take advantage of inefficiencies are
actually the fuel that keeps a market efficient.

A market has to be large and liquid. Accessibility and cost information must be widely available
and released to investors at more or less the same time. Transaction costs have to be cheaper than
an investment strategy's expected profits. Investors must also have enough funds to take
advantage of inefficiency until, according to the EMH, it disappears again.

It is reasonable to conclude that the market is considerably efficient most of the time. However,
history has proved that the market can overreact to new information (both positively and
negatively). As an individual investor or more important, an CFO as the question mentioned, the
best thing you can do to ensure you pay an accurate price for your shares is to research a
company before purchasing their stock, and analyze whether or not the market appears to be
reasonable in its pricing.

The four following factors also explain why a CFO should be concerned with market efficiency:

Accounting choices, financial choices and market efficiency

Early studies find that stock prices do not react to changes in accounting method, such as last-in
first-out (LIFO) vs first-in first-out (FIFO). These findings are consistent with the semi-strong
form EMH and suggest that Gilding the lily by restating financial performance in a deceptively
favorable light is unlikely to increase value unless it can also decrease taxes, bankruptcy costs or
agency costs
The timing decision
Studies find that firms that issue new equity have negative abnormal returns in following years,
and firms that repurchase equity have positive abnormal return in following years, suggesting
that managers time equity sales (repurchases) correctly. If managers use information not
publicly available to time security sales, the evidence is consistent with the strong form.
Speculation and efficient markets

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If financial markets are efficient, firm should not waste their time trying to forecast the issues of
debt and equity. Their forecasts will likely be no better than chance. This is not to say, however,
that firms should randomly choose the maturity or the denomination of their debt. A firm should
choose these parameters carefully. However, the choice should be based on other rationales, not
an attempt to beat the market.
Information in market prices
Managers can reap many benefits by paying attention to market prices. For example,
managers should pay attention to the stock price reaction to any of their announcements,
whether it concerns a new venture, a divestitures, a restructuring ect.

Question 2:
Empirical evidence indicates that stock price declines with the announcement of seasoned
equity offerings. Discuss the possible reasons why the stock price typically drops on the
announcement of a seasoned new equity issue.

ANSWER:

1. DEFINITION OF SEASONED EQUITY OFFERINGS

Seasoned equity offerings (SEOs), more descriptively termed secondary equity offerings are the
issue of stock by a firm that has already completed a primary issue. A seasoned equity offering is
a new equity issue by an already publicly traded company or an issue of additional securities
from an established company whose securities already trade in the secondary market.
Bayless and Chaplinsky (1996) presented the level of demand for capital as a major determinant
of the equity issuance decision. However, equity offerings are essentially the least preferable
way of attracting cash and companies will only be inclined to do so when the benefits outweigh
the costs. Therefore management will only issue new shares when the market overvalues the
shares relative to the beliefs of management. Decisions by the firms management to attract
funds by issuing equity is therefore undertaken if funds cannot be attracted in any other way, or
if the shares of the company are overvalued such that the benefits of an issue outweigh the costs.
A firm may issue common stock for a number of reasons: to alter the ownership structure of the
firm by introducing new investors, to finance new investments, or to alter the leverage of the
firm. Listed companies have the opportunity to raise additional equity by offering equity to the

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public through the securities exchange.

2. STOCK PRICE PERFORMANCE

Stock price performance is the behavior of security prices in response to certain market
conditions or events. Individual asset prices are influenced by a wide variety of unanticipated
events and some events have a more persistent effect on asset prices than do others (Erleman &
Wallestam, 2007). An increase or a decrease in stock price performance is an important indicator
of both the market performance of a firm as well its market value.
Stock price performance is measured by the rate of return on the stock. When a stock price is
higher than in a prior period, the stock records a superior price performance, and vice versa.
Stock returns are computed by taking the change in market price of a stock over a holding
period divided by the price of the security at the beginning of the holding period. Alternatively,
stock price performance may be measured by the abnormal rate of return on the stock which is
calculated as the actual return on the stock less the expected return for the stock.

3. SEASONED EQUITY OFFERINGS AND STOCK PRICE PERFORMANCE

Stock market prices will react to information on the announcement of seasoned equity offerings
depending on the informational efficiency of the market. In an inefficient market, which is
characterized by some imperfections, stock market prices are not expected to rapidly reflect new
information concerning the announcement of seasoned equity offerings. On the other hand, in an
efficient market, new information is instantaneously reflected in stock prices and makes it
difficult for any participant to possess comparative advantage in the acquisition of information
that can outperform the market by generation of abnormal returns. In such a market, there is no
significant difference in stock performance between the period prior to the announcement of
equity offerings and after the offering announcement.
Empirical studies show evidence of superior stock price performance prior to the announcement
of seasoned equity offerings. Stock price performance then deteriorates after the offering
announcement and becomes significantly negative during the decision period. For instance,
Myers and Majluf (1984), Krasker (1986), Noe (1988), Korajczyk, et al. (1990c), and Lucas and
McDonald (1990) predict a negative price effect of an equity issue. This price drop will be larger
with larger informational asymmetry and larger equity issue. Lucas and McDonald (1990) show
that, on average, equity issues will be preceded by abnormal stock price increases.

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 Question 3:

Google search of the phrase beat the market yields more than 14 million results. Many are
investing and trading strategies that promise to outperform a market benchmark. The idea of
generating market-beating returns is pervasive.

Suppose you invest in the stock market and double your money in a single year while the
market, on average, earned a return of only about 15%. Is your performance a violation of
market efficiency? Explain.

ANSWER:

When someone says they beat the market they usually mean their portfolio(s) achieved greater
returns than the S&P 500.

More people feel they beat the market than actually do so. Jackson National Life did a survey of
financial advisors in 2013 asking how many had beaten the market in 2011 and 2012. Fully 75%
of the financial advisors claimed they had beaten the market. That is not surprising if there is no
data to verify the returns. Experiments have been done asking how many drivers feel they are
better than average and 75% or so will say they are better than average. There is data for
financial advisors for that period of time.

Cerulli and Associates did a study of actual returns of financial advisors. They found the
cumulative return of financial advisors for 2011-2012 was 4%. The S&P 500 was up 17%. It is
impossible that 75% of advisors beat the market. When I worked for national firms those
brokerages did not track actual performance. It was just a feeling not based on facts.

To be sure that a financial advisor does indeed beat the market that advisor has to have an
independent party compute returns for all clients including those who terminate their accounts.
Then a composite can be put together and compared to the S&P 500. You can see an example by

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checking my webpage www.adamsfinancialconcepts.com. Those returns can be audited and
verified by an independent party.

Beating the market is difficult to do. Eugene Fama shared the Nobel Prize in Economics in 2013.
His work showed fewer than seven percent (7%) of professional money managers actually beat
the market over the longer term.

Financial economists have debated the ecient market hypothesis (EMH) for decades. Most
formal tests of market eciency test whether risk-adjusted security returns are predictable by
measuring the protability of investment strategies designed to exploit potential mispricing.
Although such tests are good at determining whether a particular strategy represented a potential
prot opportunity, they place a heavy burden on the econometricians ability to identify trading
strategies that have power to reject the null. If the econometrician chooses strategies that are not
properly designed to exploit existing mispricing, he will fail to detect market ineciency.
Furthermore, such tests do not identify whether the proposed strategies were actually exploited,
or even recognized, by sophisticated investors at the time of their trading decisions. Often
econometricians employ nancial, econometric, and computational databases and technology
that were not readily available to investors at the time of their trades.1 Thus, some authors have
suggested that the traditional ecient market hypothesis is too strong, and have proposed milder
notions of eciency that reect reasonable constraints on the ability of intelligent investors to
process information (see, e.g., the adaptive eciency argument of Daniel and Titman (1999)).
In a similar spirit, my research suggests that even this milder form of market eciency is
violated.
Traders that can be classied among the top 10 percent (based on the performance of their other
trades) buy stocks that earn abnormal returns of between 12 and 15 basis points per day during
the following week. These ndings are robust to dierent forms of risk adjustment, to the
removal of small stocks from the sample, and to the removal of any rms in which the account
has traded more than once. Similarly, there are also individual investors who consistently place
underperforming trades. Traders classied among the bottom 10 percent of all traders place
trades that can expect to lose up to 12 basis points per day during the subsequent week. In long
horizon (holding period) returns, successful investors outperform unsuccessful investors by

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about eight percent per year. A trading strategy that exploits the information in investors trades
earns risk-adjusted returns of about ve basis points per day.

The ability of individual traders at a discount brokerage to select outperforming companies is not
conned to small rms or to only a few rms in which the traders transact frequently; and some
investors persistently trade so as to underperform. The ability of some individual investors to
achieve persistent abnormal performance implies a violation of semi-strong form market
eciency. An interesting further question is whether large brokerage rms are aware of the value
of the information contained in their customers trades

Back to the question if my performance violates the market, I would conclude that we dont have
enough information for the most accurate answer since determining it depends on the 4 elements
as following:

Which market index are they referring to?

Over what time frame?
Is the performance before or after fees, costs, taxes, etc?
How have they accomplished it (just to validate the possibility, or not)

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 Question 4:
Horseshoe Corporation is planning to raise fresh equity capital by selling a large new issue of
common stock. Horseshoe, a publicly traded corporation, is trying to choose between an
underwritten cash offer and a rights offering (not underwritten) to current shareholders,
Horseshoes management is interested in maximizing the wealth of current shareholders and has
asked you for advice on the choice of issue method. What is your recommendation? Explain.

ANSWER:

THE CONCEPT OF WEALTH MAXIMIZATION DEFINED AS FOLLOWS:

It simply means maximization of shareholders wealth. It is a combination of two words viz. wealth
and maximization. A wealth of a shareholder maximizes when the net worth of a company
maximizes. To be even more meticulous, a shareholder holds share in the company/business and
his wealth will improve if the share price in the market increases which in turn is a function of net
worth. This is because wealth maximization is also known as net worth maximization.

Wealth MaximizationFinance managers are the agents of shareholders and their job is to look after
the interest of the shareholders. The objective of any shareholder or investor would be a good
return on their capital and safety of their capital. Both these objectives are well served by wealth
maximization as a decision criterion to business

RIGHT OFFERING

A rights offering (issue) is an issue of rights to a company's existing shareholders that entitles them
to buy additional shares directly from the company in proportion to their existing holdings, within
a fixed time period. In a rights offering, the subscription price at which each share may be
purchased is generally at a discount to the current market price. Rights are often transferable,
allowing the holder to sell them on the open market.
Companies generally offer rights when they need to raise money. They may need to raise money
for a variety of reasons, for example to pay off debt, purchase equipment or acquire another
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company. The benefit to a company of raising money through a rights offering is that the company
can bypass underwriting fees. In some cases, a company may use a rights offering to raise money
if there are no other viable financing alternatives. This is common during economic slowdowns
when banks become reluctant to lend to companies. The benefit of a rights offering to shareholders
is that shares are generally offered at a discount. Sometimes this discount can be quite steep, it all
depends on how much a company feels it needs to encourage its shareholders to participate in the
rights offering.

CASH OFFER

Cash offers are mostly made as underwritten offers in which the allotment of new shares is largely
at the discretion of the underwriter(s). As a result, a considerable number of new shares may be
allotted to the new blockholders (Brennan and Franks, 1997). Bennedsen and Wolfenzon (2000)
argue that control dilution due to new blockholders reduces the incumbents private benefits. Even
in the sense of monitoring by outside blockholders, control-diluting cash offers will cause the
controlling shareholders to lose some private benefits of control anyway

THE CHOICE BETWEEN UNDERWRITTEN CASH OFFERING AND RIGHT

OFFERING TO MAXIMIZE SHAREHOLDERS WEALTH

This paper argues that even if controlling shareholders commit to the full subscription to their
entitled rightsa situation where they can avoid both control dilution and the kind of adverse
selection
recognized in the literature, conflicts of interest between controlling shareholders and uninformed
investors still arise because of private benefits of control. Unlike rights issues, control-diluting
cash offers are likely to substantially weaken the incumbent controlling shareholders control on
the firm, and at the same time provide a window of opportunity for rent-seeking new blockholders
to facilitate their participation in control benefits sharing. We argue that the larger the control
benefits in a target firm, the more attractive it is to intruders, and the more the incumbents are
concerned with the possibility of their loss of control benefits to the intruders, because undoing
such coveted intrusion can be very costly. Thus, the incumbents with large control benefits may

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not be able to afford to use control-diluting cash offers and have to resort to rights issues in order
to safeguard their private benefits during SEOs. It follows that under asymmetric information
about private benefits of control, the choice of SEO flotation method can convey significant
information about firm value which is, ceteris paribus, negatively related to an issuers private
benefits. Our theory supports three important equilibriums, which help us explain why (a) firms
with large control benefits (low-value firms) choose rights issues and firms with small control
benefits (high-value firms) choose cash offers, like in Hong Kong and the U.K.; (b) why almost
all firms in the U.S. market choose cash offers; and (c) why almost all firms in many other markets,
as is the case in most European counties, choose rights issues. The two extreme cases have almost
never been analyzed together in the literature. This paper, however, shows that the choice of the
two flotation methods in the U.S. (cash offer dominating) and in most European countries (rights
dominating), although sharply contrasting, can be explained by the argument based on the intrusion
induced losses of incumbents control benefits. Unlike U.S. managers, controlling shareholders of
most European firms would suffer a significant loss of control benefits after control-diluting cash
offers and hence have to resort to rights issues to safeguard their large control benefits. It is also
worth mentioning that our theory sheds new light on the evolution of the choice of SEO flotation
methodthat is, given that the U.S. has achieved a significant improvement in protection of small
investors (against the type of expropriation through self-dealing transactions) well ahead of other
countries, this well-developed market has become the first to abandon rights issues to a great
extent. The notion that rights issues can safeguard corporate insiders large control benefits also
helps explain the mixed announcement effects of rights issues around the world. In the separating
equilibrium, given investment opportunities, when the information gap about control benefits is
big, rights issues are likely to produce negative announcement effects. This is because the negative
effect of large control benefits revealed in rights issues is likely to overwhelm any positive effects
of the investment opportunities. On the other hand, outside investors gain from the new
investment, if the issuer has a very good new project, can subdue a negative valuation effect of
revealed control benefits, producing a positive announcement effect for rights issues.
In the rights-pooling equilibrium, adding the assumption of asymmetric information about
investment opportunities still makes our model tractable; as a result, asymmetric information about
control benefits and asymmetric information about investment opportunities jointly determine the

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announcement effects. Given the negative connotation of rights issues, the expected control
benefits conditional on the decision of issuing-to-invest, i.e. rights issue, must be greater than the
expected control benefits conditional on the decision of doing nothing. If this positive expectation
differential is more than offset by the expected NPV of new investment (conditional on the
decision of issuing-to-invest), rights issues produce positive announcement effects. Conversely,
given investment opportunities, negative announcement effects for rights issues occur if the market
expects larger control benefits involved when firms go ahead with the rights issue.
While such a value-destroying move is rational for controlling shareholders in some cases, their
expropriation from uninformed investors cannot be rampant and is to some extent contained in our
framework because the incentive alignment role of insider ownership starts to work if
expropriation aggravates.

THIS IS THE END OF THE ANSWER TO THE ASSIGNMENT

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REFERENCES:
Ben McClure. Understanding Rights Issues. December 29th , 2015
http://www.investopedia.com/articles/stocks/05/062905.asp

Massimo Massa, Theo Vermaelen, and Moqi Xu. Rights offerings, trading, and regulation: A
global perspective, October 2013

Robert Faff - Monash University. Rights Offerings, Renounceability and Underwritten Status,
November 2015

Tim Plaehn. What Are the Benefits of Cash vs. Stock Merger? 2017
http://budgeting.thenest.com/benefits-cash-vs-stock-merger-32124.html

Kate Stalter, Contributor | May 11, 2015, at 11:05 a.m.

Why Investors Should Stop Trying to Beat the Market
http://money.usnews.com/money/personal-finance/mutual-funds/articles/2015/05/11/why-
investors-should-stop-trying-to-beat-the-
market?utm_content=26728534&utm_medium=social&utm_source=facebook

Journal of Corporation Law, Vol. 32, 2007

SMU Dedman School of Law Legal Studies Research Paper No. 228 Aug 2015
Maximizing the Wealth of Fictional Shareholders: Which Fiction Should Directors Embrace?

Amy Fontinelle. Is it possible to beat the market?

http://www.investopedia.com/ask/answers/12/beating-the-market.asp

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