Research Topics: Long Term Equilibrium

Long-term equilibrium Case Study

Introduction   When an industry settles into a long-term competitive equilibrium, all assets are expected to earn their opportunity cost of capital because any economic profits have already been driven away by competition in the industry in terms of expansion by existing firms or entrance by new firms. However, the Long-term equilibrium is not a static point, but rather it is a dynamic process in which the equilibrium is constantly changing. In this process, firms enjoy economic profits due to either industry characteristics, such as industry concentration and industry-level barrier to entry, or firm characteristics, such as monopoly power and competitive advantages. It is because of economic profits that we advocate the use of the discounted cash flow analysis in capital budgeting to look for projects with positive net present values (Brealey and Myers, 2000). Thus, the existence of economic profits does not contradict the EMH as long as stock price fully reflects fundamental information about a firm’s earnings generating ability such that at a particular time an investor cannot earn an abnormal return from a stock investment (Kothari, 2001).   The CAPM only assumes efficient portfolios; it is not the same concept as the EMH. Although market-based event studies in accounting and finance generally assume the descriptive validity of both the EMH and the CAPM, the CAPM does not have to be maintained in an association study, where raw stock return is used as the dependent variable.   Even with the existing evidence often cited by critics, one cannot rule out the CAPM as the asset pricing model that still enjoys the broadest support in both the academic and the practicing community. The bottom line is that there is no widely accepted alternative model for computing expected returns. This explains why the CAPM continues to dominate capital markets research in accounting and finance.   This study attempted to investigate the use of the capital asset pricing model in order to explain the discount rate and how it affects the discount rate of return. Specifically, it shall address the issue of discrepancy in the rate of return between large and small companies.   Credit:ivythesis.typepad.com

Long-term equilibrium Case Study

Introduction When an industry settles into a long-term competitive equilibrium, all assets are expected to earn their opportunity cost ...

FINANCIAL MARKETS AND LONG TERM FUNDING

What are American Depositary Receipts (ADRs)? They are shares of a non-US company that is bought by an investment bank in the foreign markets for the purpose of trading in the US markets.  When non-US share purchase is done, investment banks register them to Securities and Exchange Commission (SEC) and have the option to transfer the daily trading operations of the shares to depository banks[1].  ADRs are also viewed as certificate that evidences the quantity of share ownership of a corporation beyond its own market.  They can represent either certificates or real securities and their price are quoted in the purchaser’s currency as well as governed by host country policies.  The investment banker also has the option to keep its foreign shares public or private.  Typically, ADRs are sold by to wide range of investors and those with minimum investment capability (i.e. 0 Million worth of stocks)[2].    According to several studies, listed-ADRs are exchanged with higher values compared to those that are not listed.  Further, cross-listing ADRs also performed positively with regards to value of the firm because of the benefits of forecasting and scope of analysis.  In contrast to embryonic stage of ADRs, these two later stages are considered more mature and aggressive giving them the capacity to increase liquidity, shareholder base, information, disclosure and lessen volatility, cost of capital and variability in analysis[3].  However, these benefits are limited to investment banks under sponsored ADR programs especially to trade in certain US markets such as NYSE.  Under these program, investment banks have obtained specific rights of a common stockholder (i.e. right to vote)[4].     Advantages of ADRs? For Macquarie Bank, they can provide diversification facility which can minimize investment risks in the home markets.  They also adopt the Bank’s local policy and national regulations which enhances upper hand over information and familiarity.  As a result, trading issues are more manageable and contracting to foreign companies is relatively easy.  There are also zero custody charges and in fact the foreign company is liable for paying the Bank in its effort and risk to shoulder transaction risks/ costs in issuing foreign stocks in its own market.  Foreign securities will also have lower-than-home valuation when traded in the host market making them more lucrative to speculators and as well long-term investors. Under sponsored ADRs, the Bank also receives dividends first before distribution to ADR holders[5].    What are the regulation problems? Although the Bank has potential benefits, there are also regulatory bottlenecks.  For example, in the advent of litigation against the foreign company, a win in US court may not assure compliance and necessary remedy for the case in favor of the Bank.  There is a need to settle the matter in the home country of the foreign firm.  However, transaction costs that attached to the process can be substantial to affect not only the financial position of the Bank but also its international portfolio.  Further, regulations of foreign countries vary greatly to US environment.  Specific issues to consider are the period of clearance and settlement of trading, efficiency of trading reports and rules of safeguarding shares in depository banks[6].   What are the potential risks in ADR investments? In currency exchange issues, the value of ADRs is affected by the changes in economic variables of the foreign country.  Generally, their value rises when foreign currency dropping while decreases when foreign currency is increasing.  Second, there is a tendency for reduced liquidity when ADRs are purchased by an inexperienced investment or depository banks.  The lack of knowledge may cause ADRs to be viewed by the host market as risky and no recourse is applied to minimize such impression.  Third, ADR holders must pay tax in US dollar denominations even if they are in the home market.  As a result, this increases their risks to currency fluctuations[7].   ADRs are not commonly traded on large exchanges such as NASDAQ and NYSE rather on bulletins which make their price with larger variance.  In effect, establishing investment decision based on data can be difficult especially when the investor has a pre-determined price in mind[8].  For the investors in the host market, information about the foreign company may also take a long time before presentation.  Therefore, there is a risk of outdated data and relevance to timely decision-making.  There are also bank charges being implemented by depository banks who are handling the operational processes of ADRs.  These fees could reduced the dividends and affect the liquidity of shares.  These banks traditionally pass the costs of operations to host investors[9].                                  Credit:ivythesis.typepad.com

FINANCIAL MARKETS AND LONG TERM FUNDING

What are American Depositary Receipts (ADRs)? They are shares of a non-US company that is bought by an investment bank in the foreign mar...