WEEK -5-1 DiSCUSION RESPOND

WEEK -5-1 DiSCUSION RESPOND

1-Instruction question

I have heard that many house purchases are based upon emotion, would this mean that this market is fair?

 

2- Instruction question

Did the concept of Fair Markets scare everyone away?

 

3- Class mates discussion

 

According to Maranjian (2013), all financial matters carry some risk—even cash reserves or previous profits. Maranjian explained how return on investments was one of the primary sources for making money.  It is not easy to understand the relationship between market rates, discount rates, and what makes fair markets thrive?  When markets are at their peak, investors are satisfied, and their goals for success become a reality.  However, the goal for many organization is diversification, Chua, Kritzman, & Page, 2009) argued that “upside diversification is undesirable; investors should seek unification on the upside” (p. 26).  Moreover, the business portfolio is a strategic plan to measure a firm’s growth ability in a fair and competitive market.

 

Fair Markets

 

It does not seem like markets are fair when organization revenue decline due to lack of supply and demand.  Therefore, the New York Stock Exchange (NYSE), National Association of Securities Dealers Automated Quotations (NASDAQ), and Chicago Mercantile Exchange (CME) markets are there to regulate and increase liquidity and help organizations trade more efficiently (Berk & DeMarzo, 2014; http://www.bloomberg.com, n.d.).  The NYSE serves the market to ensure fair and orderly marketing trading exists (Berk & DeMarzo, 2014).  Berk and DeMarzo stated that “several high-profile corporate scandals during the early part of the twenty-first century prompted tougher regulations designed to address corporate abuses” (p. 813).  The NYSE has four roles:

 

•          The auctioneer is bidding from investors in a competitive market and everyone in the market to see bids;
•          The agent, utilized to ensure electronic bidding is transacted appropriately in care of other investors once stocks have maximized or reached its limit;
•          The catalyst is responsible for analyzing the interest and making sure there is enough interest is available for each stock; and
•          The principal makes necessary adjustments by purchasing or selling stock from their investment; this enables them to equalize the market.

 

The second largest market opposed to the NYSE, which is an American stock exchange market that is capitalized is the NASDAQ (Yun & Stunda, 2015).  The NASDAQ market that uses electronic networks to purchase or sell stock securities for large investment companies (Yun & Stunda, 2015).  The NASDAQ is responsible for regulating stock inventories purchase or sold to individual dealers or customers. The CME market is one of the largest open interest contract markets that trade interest rates, equities, currencies, and commodities all around the world including New York City (http://www.bloomberg.com, n.d.).  The CME supports alternative investment trading for real estate and weather (http://www.bloomberg.com, n.d.).  Although the CME is a Designated Self-Regulatory Organization (DSRO), it has audit authority over many local and global organizations (http://www.bloomberg.com, n.d.).

 

Importance of Fair Markets

 

Horn (2015) argued that a fair market system will encourage organizations to innovate and manufactures products or provide services that boost profit instead of market-warping found on Wall Street.  Horn further explained how promoting a fair market system would be beneficial compared to markets lowering prices and advancing innovation due to markets weakening competition.  According to Markowitz (1952), businesses that produce and sell the same product often do poorly when market prices plunge compared to other companies producing products may gain assets.  The relationship between market price and discount rates differ but coincide with one another.  Market price depends on supply and demand, the market demand and assets or products can be sold during specified times (Berk & DeMarzo, 2014; Horn, 2015).  The discount rate is the interest rate from the Federal Reserve depository; the discount rate enables entity’s to stay current with their reserve requirement (Berk & DeMarzo, 2014).  The purpose of fair markets is stability, the supply for good and services according to market demand fall in line with supply and demand which determines the market price for an item, but if a shift occurs the market price will change (Berk & DeMarzo, 2014; Horn, 2015).  Also, if the supply is constant within the market, then demand of market price will increase.  Overall, fair market value enables an organization to receive additional benefits such as an increase in assets, tax benefits, and improve financial statements.

 

Real Estate Investments

 

Berk and DeMarzo (2014) explained the risk-adjusted discount rate as an approximation of present cash value for high-risk investments. According to statistics, “real estate executives ranked Chicago 14th among 75 U.S. markets for investment attractiveness in 2015, according to the “Emerging Trends in Real Estate” report, an annual publication by the Urban Land Institute and PricewaterhouseCoopers LLP” (Maidenberg, 2014, para. 1 ). Goldsborough (2016) reported a 2,800 square-foot four-bedroom brick home in Chicago sold for $825,000 instead of the listed price of $642,500; the original owners paid $800,000 in 2006 for the home. In Baghdad, Iraq a four bedroom house lists for $1800 per m2), in a safe area with two floors and the USD price $40,000/YR or they will rent the home (http://www.4321property.com/iraq/ad262497/, n.d., para. 1). The house in Baghdad was “constructed on 600 m2 land (20-meter width and 30-meter depth), with a front garden of approx. area 160 m2, and three car garage” (http://www.4321property.com/iraq/ad262497/, n.d., para. 2).

 

Risks and Fast-Food Restaurant Chains

 

Yes, a food fast chain such as McDonalds can incur more risk offering a new sandwich because there is no guarantee that innovation will increase revenue for food chains.  Sharpe (1964) argued that there is no way know the true meaning and understand the relationship of an asset and risk factors with no theory.  Horovitz (2014) explained how McDonald’s Chief Executive Officer (CEO) explained how change comes with risks like when they added chicken to their menu.  However, “Teens and young adults continue to abandon McDonald’s for what they perceive as fresher, healthier and more customizable menu choices at favorites such as Chipotle, Panera and Five Guys” (Horovitz, 2014, para. 9). In a survey given to seventy-five Boston students, not one believed that McDonalds could promote a healthy menu compared to Wendy’s (Horovitz, 2014).  Furthermore, despite the type of business all experience risks and the risks depends on consumers.

 

References

 

Berk, J., & DeMarzo, P. (2014). Corporate finance (3^rd ed.). Boston, MA: Prentice Hall.

 

Chua, D. B., Kritzman, M., & Page, S. (2009). The myth of diversification. Journal of Portfolio Management, 36(1), 26-35.

 

Goldsborough, B. (2016). TV news couple Jordan, Farr buy house in Evanston. Retrieved from http://www.chicagotribune.com/classified/realestate/elitestreet/ct-elite-street-jordan-farr-0331-biz-20160328-column.html

 

Horovitz, B. (2014). McDonald’s expands custom sandwich option. Retrieved from http://www.usatoday.com/story/money/business/2014/12/07/mcdonalds-fast-food-restaurants-create-your-taste-millennials/19943987/

 

Horn, B. (2015). Promote fair markets, not free markets. Retrieved from https://ourfuture.org/20150309/promote-fair-markets-not-free-markets

 

Maidenberg, M. (2014). Chicago’s a like, not a love, for real estate investors. Retrieved from http://www.chicagobusiness.com/realestate/20141027/CRED02/141029845/chicagos-a-like-not-a-love-for-real-estate-investors

 

Maranjian, S. (2013). What is risk and return? Retrieved from http://www.dailyfinance.com/2013/04/24/what-is-risk-and-return/

 

Markowitz, H. (1952). Portfolio selection. Journal of Finance, 7(1), 77-91.

 

Sharpe, W. F. (1964). Capital asset prices: a theory of market equilibrium under conditions of risk. Journal of Finance, 19(3), 425-442.

 

Yun, C., & Stunda, R. A. (2015). Where to invest: NYSE or NASDAQ?. ASBBS Ejournal, 11(1), 68-79.

 

(n.d.). (2016). Diversified financial services company overview of Chicago mercantile exchange Inc. Retrieved from http://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=3564772

 

(n.d.). 4321 Property. Retrieved from http://www.jacklester.co.uk/4321/4321_property_logow30.png

 

 

4- Class mate discussion

 

Risk and Return Relationships

Most business decision involves risks and such risks are evaluated by managers for an optimal choice. For instance there is much risk in trading on stocks than purchasing of bonds, (Berk & DeMarzo, 2014) and yet the authors found stock to yield more returns than bonds. The fairness of the markets where these financial assets are being traded is a subject of debate particularly in the US. In this paper, I present an evaluation of popular stock exchanges’ fairness, an analysis of the level of risk incurred in decision making scenarios. Again, I present an assessment of the relationship between market prices and discount rates used in decision making, and comparison of real estate investments in Baghdad and Chicago. Finally, I evaluate the risk incurred by fast food business such as McDonald’s in offering new sandwich or opening a new store.

FAIRNESS OF NYSE, NASDAQ, and CME

The theory of fair markets (TFM) has been described as a better alternative to the efficient market hypothesis (EMH), and the capital asset pricing model (CAPM), (Frankfurter, 2006). According to the author, TFM seeks to support a market that makes the society better off and where markets are carefully monitored, corrected by democratically elected government as well as through social, labor, and other laws. If market fairness is measured by the above definition, one may conclude that the most popular stock exchanges in the US are all fair. However, there is so much debate against such position as well as many SEC regulations whose objectives are geared toward achievement of markets fairness, (Jonathan, & O’hara, 1999). Again, the level of fairness and the areas of fairness do not have absolute definitions.

It is important for these markets to be fair for obvious reasons and such reasons forms the purpose of SEC regulations whose achievements are explained below. Through the SEC, the popular US stock exchanges have achieved reduced trading cost, being policed against insider trading, fraud, as well as bringing competitiveness into the market through innovation and technology. These achievements are as opposed to what obtains in many other regions. Notwithstanding such views of fairness in NYSE, NASDAQ, and CME, there are issues of lack of surveillance of fraud and manipulations in the markets. Again, there are issues of conflict of interest among brokers and dealers as well as the challenges that arise from alternative trading systems (ATSs). For instance, there are problems of fragmentations and trading outside the organized exchange trading which come with third party effects.

Another challenge to market fairness arises from high frequency traders (HFTs) whose power of incumbency does not allow new entrants to compete favorably, (Baron, Brogaard and Kirilenko, 2016). Also, there is this problem of the winner-take-all nature of arbitrage-oriented HFT, (Jones, 2013). So, with the above findings, one can conclude that the popular stock exchanges above are fair to some extent but not in all ramifications. Again, there was a petition to SEC in 2011 by a law firm that the regulation by SEC in 1934 requiring investors with more 5% share holding of an issuer’s outstanding shares is made known to the market within 10 days. The petitioners requested that the time be reduced from 10 days to 1 day only as they found that some investors are capitalizing on the time lag make the market unfair to other participants, (Emmerich, Mirvis, Robinson and Savitt, 2013).

Analysis of the Level of Risk Incurred in Decision-making Scenarios

Decision making scenarios come with uncertainty regarding the future and particularly in the selection or choice of portfolio, it has a risk element. Therefore, decision makers have to use anticipation or expectations to decide what they want. The rules that guide these expectations or anticipations are to maximize the discounted value of future returns, (Markowitz, 1952).Such rules give allowance for risks in decision making. The level of risk incurred in decision making is not constant or uniform for all investment and business projects. The manager therefore will seek to evaluate all risks and apply mitigating models in risk taking and risk management. The risks in the aspect of portfolio management can be handled through investment diversifications, (Chua, Kritzman & Page, 2009).

Assessment of the Relationship between Market Prices and Discount Rates used in Decision Making

The market prices and discount rates used in decision making are related in many ways. In the major exchanges, this has become a subject of debate regarding the relationship of the two issues and how the major markets react to government announcements on discount rates changes. A study on ex post returns over a 58-year period indicated that the markets were efficient and fair. Again, there was an evidence of some predictability in return patterns, (Prather & Bertin, 1999).

Comparison of a Real Estate Investment in Baghdad with a similar Investment in Chicago

Appropriate Risk-Adjusted Discount Rates for Baghdad and Chicago Real Estate Investments

In my opinion, real estate investment in Baghdad and real estate investment in Chicago are mutually exclusive projects based on the differing risks and lifespan in such investment locations. For instance, the building characteristics in Chicago such as age, class, maintenance, market forces, and vacancy rates, (McDonald & Dermisi, 2008), are different. However, to compare such projects, we can adopt the lowest common multiple (LCM), the equivalent annual value EAV, or the constant chain of replacement (CCR), (Brown & Burrows, 2003). To achieve this, we need to use an appropriate discount rate to transform the NPV of these projects to an LCM, CCR, or EAV. Such arithmetic device will help us achieve the needed comparison. Judging by the economic, political, and environmental risks that are more in Baghdad than in Chicago, there is more certainty as per the estimates of Chicago real estate investment. Therefore, the appropriate risk-adjusted discount rate should be lower for Chicago real estate investment than for Baghdad. It is important however, to note that a risk-adjusted discount rate that seems appropriate may have a huge impact on the present value when there are small changes, (Gallagher & Zumwalt, 1991).

Would a fast-food restaurant chain, such as McDonald’s, incur more risk by offering a new sandwich or opening a new store? Why?

Some research has been carried out on McDonald’s establishment of new restaurants and the impact on customer patronage and eating behaviors, (Thornton, et al. 2016). The results show that the eating behaviors of customers did not change. Again, another research on McDonald’s found that tourists use McDonald’s to negotiate the work of tourism, shape meaningful encounters with destinations and cultures, (Osman, Johns & Lugosi, 2014). There are certainly associated risks in new business decisions whether in McDonald’s or any other firm. The decision to offer new sandwich may come with the risk of not affecting the consumption level as well as income generation. Also, the decision of opening a new store will come with its own risks. Depending on the environment, McDonald’s may encounter political risk, higher taxation risks, and cultural differences risks among others.

References

Baron, M., Brogaard, J., & Kirilenko, A.(2016).Risk and return in high-frequency trading, 1-61, Available at:http://dx.doi.org/10.2139/ssrn.2433118.

Berk, J., & DeMarzo, P.(2014). Corporate finance (3^rd ed.). Boston, MA: Prentice Hall.

Brown, C., & Burrows, G.,(2003).Risk-adjusted discount rates and projects of unequal lives, Australian Accounting Review, 13(1), 57-65.

Chua, D. B., Kritzman, M., & Page, S.(2009).The myth of diversification, Journal of Portfolio Management, 36(1), 26–35.

Emmerich, A. O., Mirvis, T. N., Robinson, E. S., & Savitt, W.(2013).Fair markets and fair disclosure: some thoughts on the law and economics of block holder disclosure, and the use and abuse of shareholder power, Columbia Law and Economics Working Paper No. 428, Harvard Business Law Review 135(2013), 1-22.

Frankfurter, M. G.(2006).The Theory of Fair Markets (TFM) toward a new finance paradigm, International Review of Financial Analysis, 15(2), 130-144.

Gallagher, T. J., & Zumwalt, J. K.(1991).Risk-Adjusted Discount Rates Revisited, The Financial Review, 26(1), 105-114.

Jonathan, R. M., & O’hara, M.(1999).Regulating exchanges and alternative trading systems: a law and economics perspective,Faculty Scholarship Series, Paper 3872, 1-39.

Jones, M .C.(2013).What do we know about high-frequency trading?, Colombia Business School Research Paper, 3(3), 1-56.

Lesser, I. L., et al.(2013).Adolescent Purchasing Behavior at McDonald’s and Subway, Journal of Adolescent Health, 53(4), 441-445.

Markowitz, H.(1952).Portfolio selection, Journal of Finance, 7(1), 77–91.

Markowitz, H. (2010). Portfolio theory: As I still see it. Annual Review of Financial Economics, 2, 1–23.

McDonald, J. F., & Dermisi, S.(2008).Capitalization Rates, Discount Rates, and Net Operating Income: The Case of Downtown Chicago Office Buildings, Journal of Real Estate Portfolio Management, 14(4), 363-374.

Osman, H., Johns, N., & Lugosi, P.(2014).Commercial hospitality in destination experiences: McDonald’s and tourists’ consumption of space, Tourism Management, 42(1), 238-247.

Prather, L., & Bertin, W. J.(1999).Market efficiency, discount-rate changes, and stock returns: A long-term perspective, Journal of Economics and Finance, 23(1), 56-63.

Thornton, et al.(2016).The impact of a new McDonald’s restaurant on eating behaviors and perceptions of local residents: A natural experiment using repeated cross-sectional data, Health & Place, 39(1), 86-91.

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