Question 1
A loan officer states that “Thousands of dollars can be saved by switching to a 15-year mortgage from a 30-year mortgage.” Calculate the difference in payments on a 30-year mortgage at 9% interest versus a 15-year mortgage with 8.5% interest. Both mortgages are for $100,000 and have monthly payments. What is the difference in total dollars that will be paid to the lender under each loan? | Loan amount = $100,000 | Loan term | 15 years = 180 months | 30 years = 360 months | Interest | 8.5% p.a | 9% p.a | Payment | Monthly | Monthly | Total amount paid | ? | ? |

* 15-year mortgage:
Monthly payment= (8.5%12×100,000)1-1+8.5%12-180=$984.7396
Total amount paid=984.7396×180=$177,253.128 * 30-year mortgage:
Monthly payment= (9%12×100,000)1-1+9%12-360=$804.6226
Total amount paid=804.6226×360=$289,664.136 * Conclusion:
If one were to switch from 30-year mortgage to 15-year mortgage, he/she would save:
289,664.136 – 177,253.128 = $112,411.008

Question 2
Explain how competition among investors can lead to efficient markets? Your discussion should include the different forms of market efficiency.
__________
We may all know that the objective of many companies is to ‘maximize’ the value of the shares, through which investors benefit from. Under many circumstances, especially under academic perspective, it is assumed that investors would react quickly to news about a specific company released in the market, and accordingly, the company’s shares price would likely adjust to reflect such news’s impact on the company’s value.
In a sense that share prices should accurately reflect any available information, the ‘Efficient Market Hypothesis’ (EMH) is a statement that comes into place. According to Fama (1970), an actually efficient market is a market in which security prices “fully reflect” any available information. Hence, securities prices change once new information is released. However, the key point is, once new information becomes available, the reaction of market prices to it “should” be instantaneous and unbiased. In the later part of this assignment, I will be discussing more on the importance of this theory as well as its implication based these characteristics.
Talking about the mechanism of characterizing the degree of efficiency of a market, it was first introduced by Fama (1970) as he suggested a method which is “on the basis of the type of information incorporated into prices of assets traded on the market”. Hence, an efficient market can come in 3 main forms: Weak form, semi-strong form, and strong form. In a weak-form efficient market, securities are traded at the price which incorporated all information contained “only” in the past record of prices. Next, in a semi-strong form of efficient market, securities are also traded at the price which incorporated all information contained in past prices series and all other publicly available information. In other words, semi-strong form of efficient market is a weak-form efficient market with publicly available information. Last but not least, it is strong-form efficient market. When prices reflect all privately held information, additionally with publicly available information, then the market is said to be strong-form efficient.
Those efficient market’s forms are some of most important implications of the EMH theory. For instance, the implication of strong-form efficiency is that an investor cannot gain any abnormal profit thanks to inside information. May would argue its practical sense as if a strong-form efficient market holds, everybody believes it is true, then nobody would have an incentive to seek information because there is no reward by doing so. As long as it is not a strong-form efficient market, there are always incentives for investors to seek information. Bases on this concept, the role of investors’ competition in market’s efficiency will not be hard to elaborate. I will proceed to discuss about how competition among investors can lead to efficient markets through analyzing two specific characteristics of an efficient market: instantaneousness and un-biasness.
Instead of talking about an instantaneous price reaction, I would like to work the other way, seeing how a non-instantaneous price reaction would be. A non-instantaneous price reaction literally means that the price does not reflect new information came out at all. For example, let’s suppose that a copper mining company’s shares are open for trade between 9:00 AM to 2:00 PM. On a particular day, the first trade happens to be at 11:00 AM and the price is $1 per share. At 11:15 AM, the company announces an expected piece of news that it has found one big gold mine in one of its copper mining sites. Obviously this is good news; and its share price should have gone up as a result, suppose this news warrants an increase in share price from $1 to $2 per share. At 11:25 AM, a shareholder of the company decides to sell his shares. Unfortunately, he has not heard the news of the gold mine discovery so he asks only $1 per share for his shares. The sale is made at $1 per share. At 11:30 AM, another shareholder who has heard the news decides to sell her shares. Her asking price is $2 per share. The sale is made at $2 per share. At this point, the market is considered in efficient. The price at 11:25 AM does not reflect the released news at 11:15 AM. The market eventually reacts to the news at 11:30 AM but the reaction was not instantaneous. The reaction should have happened at 11:25 AM trade. In conclusion, if the competition between investors in seeking information were to increases, the reaction of the market to the news would likely be faster. In other words, the higher the completion among investors, the higher the efficiency in the market.
Similarly, instead of talking about unbiased price reaction, I would like to discuss how a biased price reaction looks like. Using the same scenario as the above example, on a particular day, the first trade happens to be at 11:00 AM and the price is also $1 per share. At 11:15 AM, the company also announces an expected piece of news: one of its mining sites has just collapsed due to earthquake. Investors become very panic, and the next trade at 11:25 AM is at only 50 cents per share. Shortly after, calmer investors prevail and it is remembered that the company already has insurance for its facility. At 11:30 AM, the share price is now 75 cents per share. In this case, the market is also considered inefficient. The price established at 11:25 AM (50 cents per share), was an overreaction from the market. Given the information available to the market at 11:25AM, it should have been recognized at that time as an overreaction. In conclusion, competition among informed potential investors should have prevented such a low price occurring, notwithstanding the fact that poorly informed sellers had panicked.
To put it in a nutshell, if the EMH theory holds, in order to strengthen the efficiency of the market, competition among investors should also be strengthened. No matters whether an efficient market is in strong form, or semi-strong form, or weak form; two characteristics of an efficient market is still instantaneousness and un-biasness.
Bibliography
Fama, E. (1970). Efficient Capital Markets: A Review of Theory and Empirical Work. Journal of Finance, 383–417.
Parkin, M. (2011). Economics (9th ed.). Boston: Pearson.
Pierson, G., Rob, B., Steve , E., Peter, H., & Sean, P. (2009). Business Finance. New South Wales: McGraw-Hill Australia.