Efficient Market Hypothesis

3-1 EMH Assessment

Preparation

Use the Capella library or the Internet to research the Efficient Market Hypothesis, specifically taking note of the three levels of market efficiency.

Instructions

Use your research to write a paper in which you complete the following:

1.  Explain the Efficient Markets Hypothesis (EHM).

2.  Distinguish among the three levels of market efficiency.

3.  Briefly explain the implications of the EMH on financial decisions.

4.  Use at least two research resources to support your ideas.

Other Requirements

·  Length: Your paper should be 1–2 typed, double-spaced pages. In addition, include a title page and references page.

3-2 Unit 3 Problems Assessment

Overview

For this assessment, you will apply the necessary knowledge to apply evaluations principles and evaluate capital expenditure projects.

Instructions

For this assessment, complete Problems 1–5. You may need an HP 10B II Business Calculator to complete the following problems. You may use Word or Excel to complete the assessments throughout this course, but you will find Excel to be most helpful for creating spreadsheets.

Problem 3-1: Bond Valuation

You have two bonds in your portfolio. Each bond has a face value of $1000 and pays an 8 percent annual coupon. Bond X matures in 1 year, and Bond Y matures in 15 years.

1.  If the going interest rate is 4 percent, 9 percent, and 14 percent, what will the value of each bond be? Assume Bond X only has one more interest payment to be made at maturity. Assume there are 15 more payments to be made on Bond Y.

2.  The longer-term bond’s price varies more than the shorter-term bond’s price when interest rates change. Explain why.

Problem 3-2: Yield to Call

Five years ago, XYZ Inc. issued 20-year bonds with a 12 percent annual coupon rate at their $1,000 par value. The bonds had 5 years of call protection and an 8 percent call premium. Yesterday, XYZ Inc. called the bonds.

For this problem, imagine that the investor who purchased the bonds when they were issued held them until they were called. Considering this, compute the realized rate of return. Should the investor be happy with XYZ Inc. calling the bonds? Why or why not?

Problem 3-3: Yield to Maturity

XYZ Inc. bonds have 5 years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 8 percent.

1.  What is the yield to maturity at a current market price of (1) $800 and (2) $1,200?

2.  If a “fair” market interest rate for such bonds was 12 percent—that is, is rd=12%—would you pay $800 for each bond? Why or why not?

Problem 3-4: After-Tax Cost of Debt

The XYZ Inc.’s currently outstanding bonds have a 10 percent yield to maturity and an 8 percent coupon. It can issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 40 percent, what is XYZ’s after-tax cost of debt?

Problem 3-5: New Project Analysis

XYZ Inc. needs to install a new manufacturing machine. The base price is $100,000. Installation costs are $10,000. After 3 years the machine will be sold for $75,000. Applicable depreciation rates are 33 percent, 45 percent, 15 percent, and 7 percent. The machine would require a $5,000 increase in net operating working capital (increased inventory less increased accounts payables). Revenue would not be affected. Pretax labor costs would decline by $40,000 per year. The marginal tax rate is 40 percent, and the WACC is 10 percent. Also, the firm spent $7,000 in feasibility tests.

1.  $7,000 was spent last year. How should this be handled?

2.  For capital budgeting purposes, what is the initial investment outlay for the machine? That is, what is the Year 0 project cash flow?