ASSIGNMENT 1: DUE SEPTEMBER 23, 2014
Problem 1

(a) “The fact that firms so heavily rely on their internal capital market as a source of financing is strong evidence that internal markets are more efficient than external markets.”
ANSWER
Although internal capital is preferable to external capital based on the reasons below: * According to the pecking order theory (Myers, 1984; Myers & Majluf, 1984), firms follow a hierarchical financing pattern. Thus, firms would prefer internal funds (retained earnings) to external funds because: * External capital would result in higher cost of capital, due to direct costs such as underwriters’ fees and indirect costs such as under-pricing. * Using internal capital is much easier for managers because the cost of capital is lower and investment decisions do not need to be scrutinised by investors. * Reliance on internal capital/funds is the cheaper source of financing.

However, it does not indicate that external markets are less efficient than internal markets in any way. (b) “The stock price of a company paying out a regular dividend can be expected to fall on the payment date, not on the record date or the ex-dividend date.”
This statement is false. Investors begin to trade their shares on the ex-dividend date after a company has declared its dividend policy, and this is when the stock price of a company can be expected to change or fall. Thus, stock prices fall on the ex-dividend dates to reflect the dividend payment. On the contrarily, on the payment date, dividend checks are mailed to shareholders, and it is unlikely for the stock price to change any further.
Problem 2
ANSWERS
(a) Profit = 1000 (8) + 1000 (-6) = €2000 (b) Expected profit = 500 (8) + 1000 (-6) = - €2000 (c) The principle that has been illustrated is the Winner’s Curse. Thus, if IPOs are not