Question

1.) You go to see your financial advisor and they tell you that as you get older you should shift your retirement portfolio to a more conservative mixture of stocks and bonds. They tell you that over the years bonds give you a steadier stream of income that will allow you to live more comfortably with less risk. They inform you that stocks are too risky to own the older you get and bonds give you leverage against them to protect you in retirement. Explain why you should fire or not fire this financial advisor.

2.) Interest rates have been known to fluctuate widely over the years throughout history. Discuss why it would be a better idea for the government to slowly raise interest rates instead of reacting to catastrophic worldwide events.

3.) Explain how improper financing principles for a publicly traded company creates a problem between the shareholders of a company and the management of a company. Also include how the ability to manipulate annual statements (including the notes) factor into shareholder actions.

4.) Using the concept of beta and standard deviation, explain why it is highly unlikely that any investor or for that matter pension fund, private equity firm, venture capitalist, or anyone on TV shows(Hint: American Greed, Shark Tank) could ever beat the market average.

Answer 1

1. We should not fire the financial advisor, since he has been giving right advice. Bonds, with the semi annual or annual coupon payments give you steady income and hence, you can use that for the household and daily expenses. Also, bonds and stocks are negatively correlated.

2. Central bank should slowly increase or decrease the interest rates, since it's effects are not felt immediately and it takes time to reflect the change in the interest rates. Hence, to avoid any catastrophic effects of changes in the interest rates, like hyperinflation, devaluation, or flight to safety, central bank should not change the interest rates drastically.

3. There will be always a conflict or agency problem between shareholders and management. Hence, whenever there is conflict of interests, shareholders will ask for more clarification to understand what goes behind the financing which has been chosen which could be debt or equity raising. This financing will see the immediate reacreaction from the shareholders. Also, manipulation of accounting statements will see immediate drop in the share prices.

4. Due to eexpectations of the future growth, and the riskiness of the firm will lead to a required return from the shareholders and accordongly share prices will reflect the market sentiments. Hence, all the information has been factored in the share price and hence efficient markets do not let anyone outperform.