Financial Management Return with Australian Market

Question: Discuss about the Financial Management for Return with Australian Market. Answer: Introduction This assignment is divided into three parts. Part A describes factors for determining expected return of a portfolio and difference between selection and allocation of portfolio management. Part B includes market efficiency in the form of weak, semi strong and strong market and brief introduction of Capital Asset Pricing Model and Arbitrage Pricing Theory. And it also includes effects in equity returns with contest to Australian market. Part C included motives behind mergers and takeovers. Part A 1.i) Factors determine the expected return of a portfolio: Expected return can be determined by the weighted average of the profits of assets under the portfolio (Petty, Titman, Keown, Martin, Martin Burrow, 2015). Expected return of a portfolio can be calculated by following formula: Expected Return E(R) = W1R1 + W2R2 +. + WnRn Example: If there is two funds in a portfolio, one is stocks and another is bonds. The rate of return for stock fund is 6% and for bond fund is 10% and allocation of each asset is 50%, then expected return will be as follows: E (R) = (0.06)*(0.50) + (0.10)*(0.50) = 0.08 or 8% There are some factors which influence the rate of return of a portfolio, such as asset mix of investments, strategic and operational fundamentals of business and conditions of macroeconomic. Fiscal policy, regulations and political stability are some other factors which influence the expected return of portfolio (Zacks, 2011). 1.ii) Distinguish between selection and allocation in the context of portfolio management: Selection of portfolio is a process of strategic decision. Selection tells the ability of selecting securities from related benchmark sector. Selection process is used to ensure the maximum return on projects which have been selected (Morris Pinto, 2010). Portfolio selection is complex process which is used to select best option from available all alternatives. Allocation is the strategic tool of distributing investment portfolio across various assets. It tells about the ability by which assets can be allocated or distributed to various sectors or groups. It is a measuring tool of ability that how effectively assets are allocated. It is also known as decision process by which allocation might be strong or effective (Cooper, Edgett Kleinschmidt, 2001). Part B Notions of weak-form, semi-strong-form and strong-form of market efficiency: Available information can be measured by the use of market efficiency. It grants maximum opportunities to vendors and customers to effect transactions with least price of transaction (Villalta, 2012). If the market is efficient, no investor can earn extra profit. So it can be said that if market is efficient, no one beat the market. The 3 notions of market efficiency are (Market Efficiency): First is weak-form efficiency, under it recent price produce the information enclosed in past prices. In other words, it says that the recent price of stock reflects all the data of past market. To evaluate under-valued stocks, chart and technical analysis which reflects past prices would not be useful. The second form of market efficiency is semi-strong form, which states that the recent price reflects the information enclosed all public information like financial statements and reports and also include past information. This information is not useful in evaluating under-valued stocks. The third and last form of market efficiency is strong form efficiency, which states that the recent price shows all information (like public and private). So, investors would not be able to evaluate under-valued stocks. Capital Asset Pricing Model (CAPM): It is mathematical approach to evaluate profitability of financial asset. It is used to calculate return on an asset, relative to risk involved (Saeger, 2015). Return and risk are simultaneous to each other. If the risk is more, the return would be higher and chances of losses would be offset with it. Finance professionals use capital asset pricing model to calculate return on investments. The main objective of capital asset pricing model is to inform the investors about profitability and risk available with financial asset in which they want to invest. Capital asset pricing model consider the financial risk factor. (Source: Beta, Capital Asset Pricing Model, thismatter.com) The above graph shows that risk free rate is 4%. If beta is zero then it is equal to risk free rate while beta is more than zero then risk is equal to the market. Arbitrage Pricing Theory (APT): Arbitrage pricing theory is asset pricing approach. Return on asset can be determined by studying the association between that assets and risk factors involved. To evaluate asset value based on law of one price and no arbitrage, arbitrage pricing theory is used (Koch, 2009). APT is also known as alternative model of CAPM. Some assumptions taken under arbitrage pricing theory are as follows (Lecture 6: Arbitrage Pricing Theory): All securities have probable values and variances. Diversified portfolios can be formed by some agents. Taxes will not applicable. Transaction costs will not apply. Patterns (effects) in equity returns: 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 same research has shown that CAPM model cannot clarify model in equity returns. So these patterns are termed as anomalies, because they are not dependable with the joint assumption of market competence. Both Fama and French argued that CAPM is misspecified and they suggest a new three-factor model to clarify return on equity, which is known as FamaFrench model. This factor is an argument of the CAPM model with further factors. It captures the premium of return of big company under small company and of low B/M industry under high B/M industry (Gharghori, Lee Veeraraghavan, 2009). Effects seen in the Australian market: As per studies in 1993 and 1996, Fama and French shows that capital asset pricing model is effectively working in USA. The adjusted r2s derived from their regressions are approximately 8090 %. Fama and French model clarify various CAPM anomalies as outcome of their work and related studies made by other researchers. The Fama and 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 can be used to test portfolios the next Fama and French. The market of Australia is very small compared to US market and the market contains only few stocks. So it can be said that to test the model on a huge number of portfolio, it is not suitable. The main reason 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 it is important 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 will be able to explain the returns of the test portfolio created by sorts on which is recognized CAPM anomaly. The model will be accepted because it explains the returns on many sets of test portfolios in the USA and the Australian research has not tested the FamaFrench 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 pathetic 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 (Gharghori, Lee Veeraraghavan, 2009). Part C Motives behind mergers and takeovers: Merger: When two or more companies agreed to combine into one company, it is known as merger. Under merger two or more similar companies merged with each other and worked combined. Takeover: When a large company acquires or purchases a smaller company, it is known as takeover. Under takeover large company which acquires smaller company, takes full control over the smaller company. Motives for mergers and takeovers are divided into three main groups by Johnson Scholes (Riley, 2012), which are as follows: (1) Strategic (2) Financial (3) Managerial Strategic motives: 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 motives: 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. Managerial motives: When any merger or takeover fails, then it can be traced back and called them as managerial motives. Takeover is a bad news for a shareholder of a business, this transaction of merger and takeover destroys the amount of shareholder value. 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 talk about mergers they are manage with the target managers 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 Ruback, 1983). An overview of the issues and evidence: Mannes article initiated 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. Technical information about the business takeover market provides 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 diminishes the stakeholder 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. There are 2 tables 1, 2 and they present a prcis 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. Table 1 Abnormal percentage stock price change linked With winning company takeovers Takeover technique Target (%) Bidders (%) Tender offers 30 4 Mergers 20 0 Proxy contests 8 n.a. Table 2 Abnormal percentage stock price changes associated With unsuccessful corporate takeover bids(1). Takeover technique Target (%) Bidders (%) Tender offers -3 -1 Mergers -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 realizes a major abnormal profit of four percent of in tender offers and zero in mergers. And the second table depicts 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 zero. 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 uprising group lose the competition. The difference under 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 firms 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 been changed when, the takeover loses control, reputation and the manual capital of organization, and 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 is greater than before. When the management resist it effects on share shareholder prosperity and it is an experiential substance. Under corporate finance, study the effect of corporate networks on the takeover process. And it can be seen that the companies which are better connected are more active bidders. When both the companies have one or more directors in common, there will be chance that the transaction will be completed successfully without arguments and the time taken in the negotiation is very short. The connected targets frequently accept offers that involve 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 MA. corporations who have superior information can access (through networks) are and they discover precious targets and can start more takeovers. Merger and Acquisition (MA) frequency: The 1st 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 important issues of negotiation is the payment method it may be in cash, equity or a mixture of 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 Zhao, 2014). 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