Question

• n your view, what are the determinants of a company's beta?
• How would you estimate the cost of debt for a firm whose only debt issues are privately held by institutional investors? Does it make a difference if the company's debt is privately placed as opposed to being publicly traded?
• Why do we use an aftertax figure for cost of debt but not for cost of equity?
• What do we mean by market efficiency? In your opinion, are financial markets efficient?
• Does the success of Warren Buffet and Jim Simons invalidate the Efficient Market Hypothesis? Explain.
• Assume market efficiency. Suppose you just heard a press conference given by the FED chairperson indicating that the recession is over and the economy is again entering an expansion. After learning about this prediction, can you profit in the stock market?
• n your view, what are the determinants of a company's beta?
• How would you estimate the cost of debt for a firm whose only debt issues are privately held by institutional investors? Does it make a difference if the company's debt is privately placed as opposed to being publicly traded?
• Why do we use an aftertax figure for cost of debt but not for cost of equity?
• What do we mean by market efficiency? In your opinion, are financial markets efficient?
• Does the success of Warren Buffet and Jim Simons invalidate the Efficient Market Hypothesis? Explain.
• Assume market efficiency. Suppose you just heard a press conference given by the FED chairperson indicating that the recession is over and the economy is again entering an expansion. After learning about this prediction, can you profit in the stock market?
• n your view, what are the determinants of a company's beta?
• How would you estimate the cost of debt for a firm whose only debt issues are privately held by institutional investors? Does it make a difference if the company's debt is privately placed as opposed to being publicly traded?
• Why do we use an aftertax figure for cost of debt but not for cost of equity?
• What do we mean by market efficiency? In your opinion, are financial markets efficient?
• Does the success of Warren Buffet and Jim Simons invalidate the Efficient Market Hypothesis? Explain.
• Assume market efficiency. Suppose you just heard a press conference given by the FED chairperson indicating that the recession is over and the economy is again entering an expansion. After learning about this prediction, can you profit in the stock market?

Answer 1

1) The beta of a firm is a measure of systematic risk and it measures risk in relative to the market. The major factors which determine the beta of the company are it financial leverage in its capital structure. The higher the level of debt in its capital structure higher would be the levered beta and lower the level of debt lower would be the levered beta. The beta of a company is also affected by the operational risk of the company or business risk, higher the risk associated higher would be the beta.

2) There are many approaches to calculating the cost of debt like bond YTM calculation or adding risk premium to the similar maturity T-bonds. Here since the bond is privately placed then to calculate the cost of debt for similar bond we can find a other bond in the market which are similar to it in terms of maturity and credit risk or we can take a T-bond with similar maturity and add a risk premium to this private placed bond. The risk premium would consist of default, liquidity, inflation and others if necessary. It does make a difference because if the bond is publicly traded then its price can be calculated easily where if the bond is privately placed then its value cannot be estimated easily.

3) We use an after-tax figure for the cost of debt because the interest payment on the debt is tax deductible but if the company is paying dividend to the equity shareholders of the company then that is not tax deductible. So, the after-tax cost of debt for the company is lower.

4) Market efficiency means that the price of the security is considering all the information that can affect the price of the security and there is very less information asymmetricity in the market so any new information would be very quickly adjusted in the price and it would be very difficult for any investor to consistently generate excess return from the market. There are basically three forms of market efficiency, weak form efficient, semi-strong form efficient and strong form efficient. In my opinion in the long-term financial markets are efficient but in the short-term because of the excess, markets are not efficient so an investor can generate alpha by finding securities which are undervalued.

5) The success of these people does not invalidate the efficient market hypothesis but it reinforces the fact that markets are not efficient in the short-term but they are efficient in the long-term. These investors have always focused on value investing means that buying undervalued securities which have fallen in value but have the high potential to grow. Because of intra-day trading the market price can deviate significantly from its intrinsic value but in the long term the stock price will be close to its intrinsic value. If we are assuming that markets are strong form efficient then we would not be able to benefit from the information by the Fed because that information would already have been adjusted in the price of the security but if we assume the weak form of efficient market then we can find security which are undervalued and have the high potential to grow and can benefit from it in the long term.