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Question 3d

The equity beta of Fence Co is 0•9 and the company has issued 10 million ordinary shares. The market value of each ordinary share is $7•50. The company is also financed by 7% bonds with a nominal value of $100 per bond, which will be redeemed in seven years’ time at nominal value. The bonds have a total nominal value of $14 million. Interest on the bonds has just been paid and the current market value of each bond is $107•14.

The equity beta of Fence Co is 0•9 and the company has issued 10 million ordinary shares. The market value of each ordinary share is $7•50. The company is also financed by 7% bonds with a nominal value of $100 per bond, which will be redeemed in seven years’ time at nominal value. The bonds have a total nominal value of $14 million. Interest on the bonds has just been paid and the current market value of each bond is $107•14.

The risk-free rate of return is 4% per year and the average return on the stock market is 11% per year. Both companies pay corporation tax at a rate of 20% per year.

Required:

(d)Discuss the differences between weak form, semi-strong form and strong form capital market efficiency, and discuss the significance of the efficient market hypothesis (EMH) for the financial manager. (8 marks) (25 marks)