Corporate Financial Strategy: Valuation, Bond Analysis, EMH Theory

This article covers topics related to Corporate Financial Strategy such as valuation, bond analysis, and EMH theory. It includes examples and explanations of concepts such as the law of one price, zero coupon bonds, and the efficient market hypothesis.

MODULE TITLE:
CORPORATE FINANCIAL
STRATEGY

Section A
Question: 1
a.
V= D/ K
Where
V= value
D = dividend in next year
K = required rate of return
V= 8/ 7 %
V= 114.3
Thus, with this it can be stated that the price of share of company A is £114.3
b.
The law of one price is one of the theory of economics, according to which after considering the
currency exchange (by expressing the price in similar currency), the price of all the similar
products in different markets should be the same. It is useful in ensuring the similar purchasing
power in the markets across the globe. It is not exactly the absence of arbitrage opportunities
rather a weaker condition of it (de Azevedo, 2017). Therefore, absence of arbitrage opportunity
can be felt with the application of this theoretical concept.
Question 2
It is easy to value A’s debt as zero coupon bond does not pay any interest amount during the life
of the bond and pay a single amount at maturity which is equal to the face value of the bond. The
difference where the bond is issued at discount and repaid at face value. The face value of the
bond is itself the debt of the company (Guduza and Phiri, 2017). But in case of company B’s
bond, it has a coupon attached to it which requires the company to pay fixed amount of coupon
and also at maturity the payment of face value plus interest needs to be made.
Question 3
A
Gain from merger
Cost Amount
Total cash 30000000
Value of company 25000000

5000000
Add-
Marketing cost 400000
Administrative cost 300000
Distribution cost 100000
Total gain 5800000
B
Cost of cash offer= 30000000+2700000= 32700000
C
Cost of share alternative
50 % holding in major
Value of Major = 40000000
50 % of 40000000= 20000000
D
Question 4
A. False
B. True
C. True
D. True
E. True
F. False
G. True
Question 5
Total 10000 ounces
Price= 1250
Spot price= 1100

Purchase cost= 10000 * 1250 = 12500000
Dragon motors can now buy the contract currently at 1100 that is
10000 * 1100 = 11000000
Profit or loss incurred =
10,000 × ($1,250 − $1,100) = $1,500,000
The cost in the spot market plus the loss in the futures markets gives a total cost of $12,500,000.
Question 6
A
Cost of car = 150000
Interest rate = 9 %
Sum need to be set aside = FV = PV * [1+ (I / n)] (n* t)
= 104792.12
Thus, it can be stated that for providing the sum in four years the person will have to eep the total
of 104792.12 aside today.
B
Amount to be paid yearly = 12000
Interest rate = 7 %
Money need to set aside is
FV = PV * [1+ (I / n)] (n* t)
FV = 12000 * [1 + (0.07/ 4)]
FV= 53279.32
This simply means that for covering the fees, the person need to keep aside 53279 today so that
they can cover the cost or future.
Section B
Question: 8
a) and b)
For Bond X

Year Cash flow factor Present value of cash flows
1 90 0.935 84.15
2 90 0.873 78.57
3 90 0.816 73.44
4 90 0.763 68.67
5 90 0.713 64.17
6 1090 0.666 725.94
Bond price 1094.94
Bond duration 4.94
settlement 1-Apr-11 Assumption for a period of 6 years
Maturity 31-Mar-17
Coupon 9%
Yield 7%
Frequency 1
For bond Y
Year Cash flow factor Present value of cash flows
1 60 0.935 56.1
2 60 0.873 52.38
3 60 0.816 48.96
4 60 0.763 45.78
5 60 0.713 42.78
6 1060 0.666 705.96
Bond price 951.96
Bond duration 5.19
settlement 1-Apr-11 Assumption for a period of 6 years
Maturity 31-Mar-
17
Coupon 6%
Yield 7%
Frequency 1
c) Reason for Bond X and Y having different durations is due to the difference in the coupon rate
offered by these two bonds. The rule of thumb is that when the coupon rate is lower, the duration
of such bond is long due to the reason that proportionately lower payments are received prior to
the final maturity. When the coupon of the bond is higher, its duration is short due to the reason
that more of the payments are received prior to final maturity (Kholesta, 2019). In the above

case, bond X has higher coupon rate due to which its duration is short as compared to bond Y
having lower coupon rate and longer duration.
d)
Year Cash flow factor Present value of cash flows
1 90 0.930233 83.72093023
2 90 0.865333 77.8799351
3 90 0.804961 72.44645126
4 90 0.748801 67.39204768
5 90 0.696559 62.69027691
6 1090 0.647962 706.2780551
Bond price 1070.407696 7.5% YTM
Year Cash flow factor Present value of cash flows
1 90 0.938967 84.50704225
2 90 0.881659 79.34933545
3 90 0.827849 74.50641826
4 90 0.777323 69.95907818
5 90 0.729881 65.68927529
6 1090 0.685334 747.0141895
Bond price 1121.025339 6.5% YTM
Volatility of bond = % Change in price / % change in Yield
% change in price = 1121-1070.41 / 1070.41 = 4.7%
Volatility = 4.7% / 1% = 4.7%
e)
Volatility to yield for bond Y = % change in price / % change in Yield
Year Cash flow factor Present value of cash flows
1 60 0.930233 55.81395349
2 60 0.865333 51.91995673
3 60 0.804961 48.29763417
4 60 0.748801 44.92803179
5 60 0.696559 41.79351794
6 1060 0.647962 686.8392096

Bond price 929.5923037 7.5% YTM
Year Cash flow factor Present value of cash flows
1 60 0.938967 56.33802817
2 60 0.881659 52.89955697
3 60 0.827849 49.67094551
4 60 0.777323 46.63938545
5 60 0.729881 43.79285019
6 1060 0.685334 726.4541659
Bond price 975.7949322 6.5% YTM
Volatility of Bond Y = % Change in price / % change in Yield
% change in price = 975.79 – 929.59 / 929.59 = 4.97%
Volatility = 4.97% / 1% = 4.97%
f)
Convertible bonds are that fixed income security of the public limited company which can be
converted into common stock of the company (Sardana and Gupta, 2018).
Benefits to investors
 Earning can be increased in terms of dividend received on shares instead of fixed income
on bonds.
 Investors can have the benefit of enjoying ownership in the company.
Section C
Question: 10
EMH theory:
According to EMH theory, the share price of the company
itself reflects all the information. It has hypothesized that on exchanges,
stocks are traded at their fair market value. Those who favors this theory
believed that investors get benefitted from investing in a low cost and passive
portfolio. However those who criticizes this theory believes that it is
possible to overrule the market and also the stock can vary from its fair
market value (Thomsett, 2019). EMH is basically theoretical interpretation of the market in 3
different forms

Under this
theory it is believed that there is no scope of earning excess profits by
investing as each and every security is fairly and accurately priced already. Therefore,
there is a very less scope of beating the market, however matching returns with
that of market can be obtained through investing in passive indexes. It does
not require an investor to be rational. The act of investors is random. The market
as a whole is always right or can be say that the market is efficient in terms
of provision of information.
Forms of EMH: Three forms of EMH theory can be mainly understood by their weak, semi-
strong and strong market types. Three forms of EMH are as follows:
Weak form: As per this form, all the historical information are
priced into securities. Fundamentals of the company can be utilized to generate
higher returns than the market averages in the short period. There exists no
patterns. Fundamental analysis therefore does not provide for benefits in the
long run and not even the technical analysis works in the long run (BANKOTI, N., 2017). Weak
is that market where there is no technical analysis possible between prices.
Semi – Strong form: As per this form, neither technical
analysis nor fundamental analysis can provide investors with additional advantage
than the market and states that any new information or news or rumors about the
company get instantly priced into securities. . Semi strong is that where information is available
to public but cannot be used.
Strong form: According to this form of EMH, each and every
information may it be private or public gets priced into securities and hence
allows no investor to gain extra advantage than the market as a whole. However,
it does not implies that it is not possible to get abnormal or high returns due
to the presence of outliers in the averages. Strong is that where information can be used to take
relevant decisions.

The EMH theory mainly pertains to the fact that share prices help in denoting all the relevant
information. The stocks are dented at their fair market prices which is one of the key advantages
in any particular share market (Peón, Antelo and Calvo, 2019). The investors are able to
formulate a realistic and true view regarding what are the different speculative gains that can be
obtained by investing in different share types and forms.
However, there are certain disadvantages of efficient market hypothesis such as market are
irrational, stock market is not gambling and fundamental and technical analysis work. Among
them markets are irrational is the first disadvantage of the efficient market hypothesis as this
theory states that the market situation is efficient but by reviewing the past it can be stated that
stock market suddenly changes due to stock and panic.

REFERENCES
Books and Journal
BANKOTI, N., 2017. A THEORETICAL FRAMEWORK ON EFFICIENT MARKET
THEORY. CLEAR International Journal of Research in Commerce &
Management, 8(5).
de Azevedo, R.M.M., 2017. Characterization of the Turbulent Structure in Compound Channel
Flows (Doctoral dissertation, Universidade NOVA de Lisboa (Portugal)).
Guduza, S. and Phiri, A., 2017. Efficient Market Hypothesis: Evidence from the JSE equity and
bond markets.
Kholesta, A.K., 2019. Weak Form Efficient Market Hypothesis and January Effect; Study Case
in LQ45 Index of Indonesia Stock Exchange Market Period 2016-2018. Jurnal
Manajemen Update. 8(4).
Peón, D., Antelo, M. and Calvo, A., 2019. A guide on empirical tests of the EMH. Review of
Accounting and Finance.
Sardana, S. and Gupta, P., 2018. A Study on Efficient Market Hypothesis in Hotels Sector in
Thomsett, M. C., 2019. The Theory of Trends: Dow, EMH, and RMH in Context. In Practical
Trend Analysis (pp. 1-24). De Gruyter.