Evaluating Investment Opportunities in Imperfectly Efficient Market

The imperfectly efficient market provides investors with profit-making opportunities by identifying undervalued or overvalued securities. An asset management company invests clients' money in various investment options to earn a higher return, and its main philosophy is diversification, which distributes risk across different investments, requires active participation, and involves research into each option. Diversification helps reduce systematic and unsystematic risks and can lead to higher returns.

Asset Management Company
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Contents
Answer 1......................................................................................................................................................3
Answer 2......................................................................................................................................................5
Answer 3......................................................................................................................................................7
References...................................................................................................................................................9
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Answer 1
Market efficiency
Market efficiency means that situation in the financial market where the expected return of the market is
equal to the required rate for return (Hamid, 2017). The market price of the securities is equal to the
intrinsic value of the security and they should not be either overpriced or underpriced.
Asset allocation
Asset allocation is a techniques used by the financial experts to get highest return by investing in different
investing option and at the same time the risk of the portfolio should also be maintained as per the choice
of investor (Andonov, 2017). The asset allocation can also be used to hedge the risk of the portfolio and to
reduce the risk to a minimum required level.
Holding period
The holding period of a security is the period by which investor hold that particular security in its
portfolio. In simple form holding period can be calculated as the number of day between the purchase and
sale of the security.
Market portfolio
Market portfolio is defined as a portfolio of all the securities that are presently available in the market.
The market portfolio is calculated by weightage of each type of securities (Paranjape, 2013). Therefore in
this case the weight of the each type of security is calculated by dividing the market value of the security
with the aggregate market value of all the securities that are available in the market
The strategy used in the efficient market by the investors
In an efficient market the price of the securities nor undervalued neither overvalued and is not expected to
fluctuate in the future period also apart from unforeseeable events that can influence the price of the
security. Thus in this type of market the only sensible way to earn better return is to invest in the company
which is performing better than others and giving higher returns as compared to the other companies in
the market. The prediction of the future price is worthless as the prediction of stock price is simply
prediction of the future which is not practical. Simple trading is the better option and a good strategy to
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earn good return. The positive and negative information that are associated with the security should be
evaluated and studied as they can change the price of the stock in the future. The external factors
associated with the stock will become more important as that they become the price fixture for the
investors in the financial market.
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Answer 2
Expected return
It is the return expected from a particular investment option that is available in the market. The expected
return is calculated with the help of different formula available such as CAPM method ( Martin, I., 2017).
The expected return will be as per the expectation of the client in respect of that particular investment
option.
Market return
Market rate of return is return which will be available on the market portfolio. This market rate of return
is calculated keeping mind the market risk premium of the present time (Weinstein, 2014). It will be
higher than risk free rate of return and usually lower that the expected rate of return of a particular
investing option for which the expected return is calculated.
Required return
Required return is defined as the minimum rate of return an investor is expected if the investor is willing
to invest in the particular investing option available in the market. The required rate of return is calculated
with the risk free rate of return and the market rate of return available in the present condition. The
required rate of return is an important factor to be considered by the investor as it will be considered
while making the investment decision (Prat, R., 2016). The required rate of return will be the present
value of the all cash inflow from the security for which the required rate of return will be calculated.
Undervaluation of security
A security is said to be undervalued if the price of a particular security is lower than the intrinsic value of
that security. Intrinsic value of the security is just the present value of all the future cash inflow from that
security (Korinek, 2016). The undervalued security can also be measured with the help of PE ratio.
Overvaluation of security
Overvaluation of the security is just the opposite phenomena of the undervaluation of the security. The
security is said to be overvalued when the price of the security is more than the intrinsic value of the
security. It also can be measured by PE ratio.
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Investment decision in an imperfectly efficient market
Imperfectly efficient market is the market where the security is either undervalued or overvalued. The
imperfectly efficient market provides the investors with some profit making opportunities. If the security
is undervalued the security should be purchased and a long position should be created by the investor. But
if the security is overvalued than a short position should be created by the investor by selling the
securities in the market. The imperfectly efficient market gives profit making opportunities to those only
that can make accurate calculation of the intrinsic value of the shares. The overvaluation of
undervaluation of the security is determined only if the correct intrinsic value is calculated by the
investor. The determination of the undervalued and overvalued security gives the investor opportunity
only if that recognition is made within proper timeline.
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Answer 3
Investment philosophy for an asset management company
An asset management company is company that takes the money of its clients and invests the money into
different investment option that is available in the market. The motive behind investing the pooled money
of clients in the different investing option is to earn a higher return which could not be earned by the
client if they invested themselves in the market. The different investing options of the asset management
company are mutual funds, pension plans and hedge funds. The asset management company earns profit
from its business activities by charging some percentage of commission on the profit earned by the clients
on their investment in the company (VAIDYA). The asset management company usually invests large
amount money into different portfolio. This money comprised of different clients and not from single
client. The asset management company is more professionally capable than the individual investors
therefore there is higher chance of getting higher return form asset management company.
The main and most successful investment philosophy of the investment used by the asset management
companies are diversification of the investing option. This investment philosophy helps in getting higher
returns in the market and also can be used to hedge against the risk of the market. This philosophy
however does not ensure complete success in the industry of asset Management Company but is far better
investment philosophy than any other known in today’s time. The diversification allots following main
advantages to the asset management company:
Diversification allots a lot of options: The diversification is mainly focuses on investing in different stock
options. The finance market is comprised of large number of investing options such as mutual funds,
hedge funds, pension plans, equity and debentures etc. the diversification of the investment distributes the
risk in all the area rather than concentrating it on a single investment option.
Diversification requires active participation: diversification strategy is not a onetime strategy. It means
that the diversification strategy has to be supervised from time to time to ensure that the portfolio is
bringing higher return (Campbell, 2016). The larger the diversification more numbers of experts will be
required by the asset management company to look after the portfolio. These experts should be experts in
their own field of investment.
Research of diversification: the diversification strategy involves a deep research in the different
investment option and the best possible option should be selected by the asset management company. The
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different investment option available for asset management company possess their own advantage and
disadvantages and these should be considered by the asset management company in order to achieve their
pre-determined target. There are two type of risk available in the market that are systematic and
unsystematic risk and proper diversification helps the asset management company in reducing both the
risk to a minimum level however these cannot be reduced to the full extent even after such a strong
strategy as diversification.
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References
Hamid, K., Suleman, M.T., Ali Shah, S.Z., Akash, I. and Shahid, R., 2017. Testing the weak form of
efficient market hypothesis: Empirical evidence from Asia-Pacific markets.
Martin, I., 2017. What is the Expected Return on the Market?. The Quarterly Journal of
Economics, 132(1), pp.367-433.
Andonov, A., Bauer, R.M. and Cremers, K.M., 2017. Pension fund asset allocation and liability discount
rates. The Review of Financial Studies, p.hhx020.
Paranjape-Voditel, P. and Deshpande, U., 2013. A stock market portfolio recommender system based on
association rule mining. Applied Soft Computing, 13(2), pp.1055-1063.
Weinstein, R., 2014. Firm recruiting strategies, educational attainment, and the labor market return to
higher education(Doctoral dissertation, Boston University).
Prat, R., 2016. Five Objections Against Using a Size Premium When Estimating the Required Return of
Capital with the Capital Asset Pricing Model.
Korinek, A. and Serven, L., 2016. Undervaluation through foreign reserve accumulation: Static losses,
dynamic gains. Journal of International Money and Finance, 64, pp.104-136.
Campbell, J.D., Jardine, A.K. and McGlynn, J. eds., 2016. Asset management excellence: optimizing
equipment life-cycle decisions. CRC Press.
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