Random Walk:

The theory illustrates that it is impossible to predict the future movement in price or value of the stock by just understanding its previouspattern.

Evidence on balance favors efficient market hypothesis; for exampleif an investor has invested in three different sectors which are petroleum, cement, and fashion, and that the wantsthe overall return of 2%, and currently,the investoris getting -1% due tothe underperformance of cement industry. Now the investor intends to divest from the cement industry and will invest in risk-free bonds which could increase the overall portfolio return to 1%. Moreover, the cement company wants to buy back its shares to increase share price and reduce the future dividend amounts.

Answer Number 6:

Equity Beta:

Equity Beta can be said asa measure of systematic risk and volatility of a security or portfolio.

Beta is also used in Capital Asset pricing model which is used to calculate the expected return of Equity holders. Overall,Stock Market has an equity Beta of 1.0. If the Beta of the Company is less than 1.0, it can be said that the company is less risky than the stock market. If the company has an equity Beta of exactly 1.0, then it can be said that the firmis under moderate risk and if the company has an Equity Beta of more than 1.0, then it can be stated that the company is riskier than the market.However, the Investor might want to increase their returns if the Beta of the Company is increasing.

There are certain situations under which thecurrent Beta of the Company cannot be used to calculate the expected returns of the Equity holders such as:

 

When the Company is Diversifying:

When the companyis diversifying,i.e., the companyis considering operating in an industry in which it has no experience to operatein, then in that case the current Beta of the cannot be used because the business risk of the company is changing. In this case, the company needs to calculate new Beta Equity which is calculated through theun-gearing and re-gearing channel.

Un-Gearing:Inun-gearing Equity Beta of the proxy company (a company which is operating in the new industry) is used to calculate the Asset Beta of the enterprise.

Re-gearing: In Re-gearing, the asset beta calculated in un-gearing is used to derive the new Equity Beta of the Company.

The revised Equity Beta is used to calculate the new Cost of Equity.

When the Capital Structure of the company is changing:

The existing Equity Beta can be employed by the corporation if the capital structure is changing because the risk of investor changes if the capital structure of the company is changing. For example, if the company wants to raise new debt finance, then additional debt funding will increase its level of gearing and will ultimately result in the changing in risk of the investor. On the other hand, if an enterprise is considering paying off its debt finance, then this will decrease its gearing level and will ultimately result in the decline in thedegree of risk of an investor.

Un-gearing: In this case, theold capital structure of the company would be used to calculate the Asset Beta…………………..

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