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FIN200 Corporate Financial of Efficient Market Hypothesis

1. What are the important factors that should be considered by tertiary sector employees when they are deciding whether to place their superannuation contributions in the Defined Benefit Plan or the Investment Choice Plan? What issues relating to the concept of the time value of money may be important in this decision-making process? Explain.
 
2. “If the efficient-market hypothesis is true, the pension fund manager might as well select a portfolio with a pin.” Explain why this is not the case.

Answer

The fruitful habit of making investments and savings has been an encouragement and it is the result of the concept of superannuation contributions. This concept provides for a better future to all the ones making an investment in different funds, getting results in the form of returns at the time of retirement. For tertiary employees, two different types of plans are available, one Defined Benefit Plan and second Investment Choice Plan, but wise opting of the particular fund for an individual is also important while taking up a superannuation fund. Putting money in such funds requires a lot of decision-making process which could be helped if the investor has a good idea of the time value of money concept (Berk et.al, 2015). For a more efficient and effective investment, it is vital to have a proper hypothesis of the market which means that the investor is aware of the condition and the price of the stock and assets in the market. Such analysis also highlights the managing procedure of the portfolio makers and managers.

Superannuation contribution

The attention towards the field of superannuation contribution has increased to a much higher rate over the years and is going on increasing. These superannuation funds provide safe and healthy retirement life which is the demand of the hour.  The government of many countries has already been in action for the past years by mandating a fixed minimum amount for all the employees to be deposited in some superannuation fund which will provide them with healthy returns. Due to the mandatory contributions in the funds, people are now understanding the relevance of such in


vestments and saving for the future. It’s been recorded that the amount getting deposited due to the mandatory contributions is increasing over the years (Deegan, 2011). After the process of investment now it is the duty of the financial institutions to use the money in such a way that it is made available to the individuals at the time of retirement and most importantly with returns.

The economic sector is divided into three part of which the tertiary divisions an important part. The work of the tertiary department is similar to that of an elderly folk, that shares its experience with the productivity primary and secondary divisions as any risk occurrence is first reported to the tertiary first (Petty et. al, 2012). It was first mandatory for all the employees to deposit three percent of their salaries in the superannuation funds, but now it‘s rate has been increased to nine percent since the year 2005. It is compulsory for all the employees to make superannuation investments. It was the major requirement of the hour to decrease the increasing pressure of the social security department for payments of pensions for the assistance of individual at the age of retirement (Melville, 2013). Unisuper Ltd in a perfect example of an individual industry-based superannuation fund which is for the employees of the tertiary division. In the past few years, there has been a change in the types and methods in the investment options which have proved to be a boon as they offer a wider range of investment pattern and ways to take care of one’s investment. Defined Benefit Plan and Investment Choice Plan are the two basic and important investment plans.

The Defined Benefit Plan is a superannuation fund which provides the employee with returns at the age of retirement. A fixed amount needs to be deposited and a fixed return is provided to the employee based on a calculation by a simple formula. No management is required in this type of investment plans. The main advantage of such investments is that any effect in the market or on the performance of the portfolio will not affect the return amount (Davies & Crawford, 2012). But in the case of the Investment Choice Plan, any change can have an adverse affect on the return amount. As per this investment method, an employee can choose to have his/her superannuation funds nominated as bring invested in Secure Fund, Shares Funds, Trustees Selection Funds, and Stable Funds. These types of funds can easily be discriminated on the basis of the managerial skills required and a number of risks to which the investments of an individual are exposed (Matt & Simon, 2014).              

Factors that are vital

Opting for the correct superannuation fund for the investor is to be paid attention but another matter of great significance is the evaluation of the risks that follows. Tertiary employees who want to stay on par with the investment risks and are willing to get reputed returns can easily choose Defined Choice Plan (Peirson et.al, 2015). On the other hand, the employees who have a sufficient risk appetite and desire to get a return at the same time can take up Investment Choice Plan, but this plan involves a great deal of intelligence as immense strategy is required to peruse such plans (ASIC, 2016). Only opting for the best superannuation doesn’t help, but attention should also be paid towards other relevant factors. The ability of an employee is the first priority of all the factors as not only for choosing a portfolio wisely but also for managing it correctly which permits knowledgeable persons to plan everything and to minimize a well as prevent their losses (Albrecht et. al, 2011). In case the review of the portfolios cannot be done by the personnel or cannot direct the movement then one not take up the managing responsibility. In such a case the employees should be clever enough to pass on the managerial duty to the employees as any occurrence of losses will not have an impact on the employee.

Such employees having an additional source of income can take a chance to opt for the Investment Choice Plan, as they already a superannuation fund to get them return which makes their risk appetite bigger. This pattern of investment is also recommended as the investors have an additional source of income and who knows that a risky step can provide them with huge profits which will strengthen their financial assets. Considering the ones who don’t have any additional source of income can trust on Defined Benefit Plan as it provides the investor with a fixed profit for a fixed amount at the end of the working life or at retirement (Needles & Powers, 2013). The occurrence of risks in such plans is negligible. Thus it is important for the employees to decide wisely and also to take care and look out for the loopholes that follow the great returns from the superannuation funds.  

Discussion on Time Value of Money

On the basis of the opportunity cost of funds, financial decisions are taken which result in getting future cash flows of significant worth, this importance of the cash flows are recognized by the time value of money. It is important and also helpful for the investors to have money in their at present rather than in the future because money has a nature to get its value depleted with time in the market. AS an overall view, time value of money forms a basic platform for investment. The present value of money is of more concern and importance to the investors because they live in the present time. This present value of money can be increased by investing it to gain interest over a defined sum which will support the financial conditions of the investors who can use them as per their requirements. This concept also puts the investors to think about the particular type of superannuation contributions in which the investor should invest and it also helps in making decisions related to the present value of money (Damodaran, 2012). There is a marked difference between the present value of money as compared to its future value and this difference is referred to as the time value of money.

Employees provide the superannuation funds with a respected part of its income throughout the life. The assets arising from such investments can be further invested in any other superannuation fund which will lead to a better financial condition. But getting profit over a defined value is not a rapid process and requires patience and a long period of time to grow to a respected amount. It is a matter of fact and always reported that more time leads to a higher value of the assets earned. Employees also follow the time value money concept to make profits as these investors always calculate the future value of money as compared to its present value. For an employee investing in a superannuation fund, it is important for the employee to know the advantages and to have a thorough knowledge of the concept of time value of money, as a lack in the idea can lead an employee to make bad decisions fatal for the incoming returns (Brigham & Daves, 2012).

Efficient Market Hypothesis

The concept of EMH articulates the view that the share prices is an answer of the expectation that is prevalent in the market and contains all the information that is circulated into the market. In short, the stock price is reflected by the market information. Therefore, it can be commented that it provides the desired information. However, the hypothesis may not be true owing to the fact that the market might flow in a different manner and therefore fair price might remain out of reach. The mindset of the investors cannot be predicted in an accurate manner as it is influenced by various factors and hence, the real prices might be distant (Fama, 1998).  Therefore, anything based on such a theory might not provide an accurate result. If it is assumed that the stock market behaves in an accurate manner then it can be commented that the market adheres to the random walk theory but in the real scenario the situations tend to be different and uncertain 9 Marsh, 2009). With the shortfalls mentioned above the fund manager will not be in a position to select a portfolio with a pin. The portfolio that is selected might not turn out to be a diversified one and may be vulnerable to various kinds of risks thereby rewards might be a different story (Brealey et.al, 2011). Moreover, the portfolio might be susceptible to systematic risks that pose a threat to the investors. Further, if the investors are having an investment in a different class than efficient market hypothesis cannot be very risky because the portfolio can have a high beta if the risk preference is high.

A fund manager is required to provide an adequate return to the investors and the history of the stock market indicates that the control mechanism is yet to debut. There are risks that can be predicted and some are inherent that cannot be controlled. Moreover, markets contain no memory and money making from the stock market is not an easy job. Long-term and short-term interest rates even come into the picture thereby the selection of portfolio needs to be done in a calculated manner and systematic terms (Arnold, 2010). When it comes to the stock of companies of smaller size, the market size remains relatively small in contrast to the companies of higher stature. It clearly indicates that the prices of the smaller companies stocks are due to the inefficiency of the market.

The behavior and pattern of stocks are completely different as per their traits considering the competition prevalent in the market, volatility and the financial capacity, etc.  Therefore, it is difficult to consider the stock movements with ease. The performance of the market in tune to the efficient market hypothesis might be a different concept altogether because stock prices are influenced by innumerable factors and some cannot be predicted (Bodie et. al, 2014). As per the discussion, it can be indicated that the fund manager cannot select a portfolio with a pin and hence needs to be skillful enough to choose diversification as the means of selection.

Essay response

Not all superannuation is made for all employees, so it is their duty to choose and plan their investment wisely and carefully as their can also is prone to some kind of losses at the time. This can be a cause of targeting for higher returns which can have a flurry of bad years too. Immense patience is required to capture the desired results in the form of returns. It is imperative that the manger must be well acquainted with the latest technique and aware of the happening so as to take a brisk action. Thus we can say that this particular concept is the basis for effective decision-making.

Moreover, the managers cannot select a portfolio with a pin because there are various factors that influences the stock market and the stock prices respond in vague manner at times. Therefore, going by the trend may coincide and give the desired return but such a case will not be a normal happening and hence, is a difficult job for the portfolio managers. The portfolio managers must rest on diversification and usage of the latest mechanism for better returns.

References

Albrecht, W, Stice, E & Stice, J 2011, Financial accounting, Mason, OH: Thomson/South-Western.

Arnold, G 2010, The Financial Times Guide to Investing,  Prentice Hall.

ASIC 2016, Type of funds, viewed 18 May 2017 https://www.moneysmart.gov.au/superannuation-and-retirement/how-super-works/choosing-a-super-fund/types-of-super-funds

Berk, J, DeMarzo, P & Stangeland, D 2015, Corporate Finance, Canadian Toronto: Pearson Canada.

Bodie, Z, Kane, A. & Marcus, A. J 2014, Investments,  McGraw Hill

Brealey, R, Myers, S. & Allen, F 2011, Principles of corporate finance, New York: McGraw-Hill/Irwin.

Brigham, E & Daves, P 2012,  Intermediate Financial Management , USA: Cengage

Damodaran, A 2012, Investment Valuation, New York: John Wiley & Sons.

Davies, T & Crawford, I 2012, Financial accounting, Harlow, England: Pearson.

Deegan, C. M 2011, In Financial accounting theory, North Ryde, N.S.W: McGraw-Hill.

Fama, E.F 1998, ‘Market Efficiency, Long-term Returns, and Behavioral Finance’, Journal of Financial Economics, vol. 49, pp. 283-306

Marsh, C 2009, Mastering financial management, Harlow: Financial Times Prentice Hall.

Matt B & Simon P 2014, Accounting and Finance For Managers, Kogan Page Limited

Melville, A 2013, International Financial Reporting – A Practical Guide, 4th edition, Pearson, Education Limited, UK

Needles, B.E. &  Powers, M 2013, Principles of Financial Accounting, Financial Accounting Series: Cengage Learning.

Peirson, G,  Brown, R, Easton, S., Howard, P & Pinder, S 2015,  Business Finance, 12th ed., North Ryde: McGraw-Hill Australia.

Petty, J. W, Titman, S, Keown, A. J, Martin, J. D, Burrow, M & Nguyen, H., 2012, Financial Management: Principles and Applications, 6th ed., Australia: Pearson Education Australia.

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