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1. How executive compensation can be used to reduce agency problems between shareholders and management of a company

How executive compensation can be used to reduce agency problems between shareholders and management of a company

 

The agency relationship is defined as the relationship between the principals (owners of the business) and the agents such as the company executives. An agent has the decision making authority that affects the wellbeing of the principals. Examples of agents and principals are as per the table below.

PRINCIPAL

AGENT

Clients Of lawyers

Lawyers

Investors in a Money Market

Money Managers

Share Holders Of a firm

Managers

 

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2. Fairfux asks for information concerning the benefits of active portfolio management. She is particularly interested in the question of whether active managers can be expected to consistently exploit inefficiencies in the capital markets to produce above

Fairfux asks for information concerning the benefits of active portfolio management. She is particularly interested in the question of whether active managers can be expected to consistently exploit inefficiencies in the capital markets to produce above-average returns without assuming higher risk. The semi-strong form of the efficient market hypothesis (EMH) asserts that all publicly available information is rapidly and correctly reflected in securities prices. This assertion implies that investors cannot expect to derive above-average returns from purchases made after the information has become public because security prices already reflect the information i) Identify and explain three examples of empirical evidence that tend to support the EMH implication stated above.

The efficient market hypothesis (EMH) has been the central proposition of finance since the early 1970s and is one of the most studied hypotheses in all the social sciences, yet there is still no consensus, even among financial economists, as to whether the EMH holds. The following are examples of empirical evidence that tend to support the EMH implication;

1. Past good performances do not support good performances in the future. A firm whose performance has been good in the past does not guarantee good performance in the future. 

Identify and explain three examples of empirical evidence that tend to refute the EMH implication stated above

 

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3. X Ltd recently paid an annual dividend on its stock of $2 per share. The divided is expected to grow at $l per share for the next four years. Thereafter the dividend is expected to grow at 5 % per year indefinitely. The required rate of return on st

X Ltd recently paid an annual dividend on its stock of $.2 per share. The divided is expected to grow at $.l per share for the next four years. Thereafter the dividend is expected to grow at 5 % per year indefinitely. The required rate of return on stocks with similar risk is 12%. 'What is the intrinsic value of X Ltd.’s stock?

 

Expected dividend at end of each year:

 

 

Year-end

Annual growth amount /rate

Dividend value (Shs.)

0

 

2

1 (D1)

By Shs. 1

3

2 (D2)

By Shs. 1

4

3 (D3)

By Shs. 1

5

4 (D4)

By Shs. 1

6

5 (D5)

5%

6.30

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4. Discuss the relationship between the required rate of return on a stock, the firms return on equity, the plow back rate, the growth rate and the value of the firm.

Value of stock = 

Where g = ROE * Plow back rate

Where plow back rate = 1-payout ratio

 

The Firm value of the stock will depend on the dividend anticipated to be paid to investors, the required rate of return, and the firm’s growth rate. The relationship of the value of stock and required rate of return will be inverse because the higher the anticipated rate of return by the investors, the lower will be the value of the stock.

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5. If there is an increase in interest rates which would you rather have shorted, long-term bonds, or short-term bonds

IF THERE IS AN INCREASE IN INTEREST RATES WHICH WOULD YOU RATHER HAVE SHORTED, LONG-TERM BONDS, OR SHORT-TERM BONDS

Short term bonds have less interest rate sensitivity. Interest rate increases at a decreasing rate. A 10-year bond has a much greater interest rate risk than a 1 yr bond has however a 30 yr bond has only a slightly greater interest rate risk than a 10 yr bond. 

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