a)In Australia, Superannuation refers to the arrangements in place for facilitating employees to save funds in order to provide them with income at the time of retirement. It is partly obligatory in the country, and is promoted by the government through tax benefits. For an effective implementation of superannuation, minimum standards have been established by the Australian government for employees’ contribution and their management a well (Chaudhry et al., 2017). The law requires an obligatory contribution by the employers to their employees on top of the employees’ wages and salaries. Since July, 2014, the contribution rate of employer has been set to 9.5 percent and is likely to rise to 12 percent in 2025. The law also encourage employees to add compulsory superannuation contributions with voluntary ones. It also includes converting employees’ wages and salaries into superannuation contributions.
Moreover, some specific rules are applied in relation to employers offering defined benefit system. There exist less number of traditional employer funds which calculate benefits using a formula on the basis of final average salary and service tenure. Basically, Australian employers are obliged to provide a minimum level of benefit (Lewis, and Stoycheva, 2016). In addition to this, superannuation fund’s investment incomes such as rents and dividends are taxed at a flat rate of fifteen percent by the superannuation fund, and in the case of sale of investment, capital gains tax is charged by the superannuation fund at 15%. Also, it can avail a capital gain tax discount if the investment is hold for one year. This discount rate has been prescribed at 33 percent and has decreased the effective capital profit tax from 15 to 10 percent. If an employee plans to retire soon, he will require a particular level of investment liquidity which are easily accessible to sell, purchase, o transfer.
In Defined Benefit Plan, employees derive benefits at the time of retirement using a formula. The determinants used in this calculation include final average salary of the employees, their age, and the number of years they have been working. The employees of tertiary sector, who take on the Defined Benefit Plan pool and invest their superannuation contribution in the selection of assets identified by the company (Clark, 2016). Also, the investment performance of the asset portfolio is immaterial and does not impact their final retirement payout (Alizadeh, T. and Farid, R., (2017). This is because employees’ benefit layout is exclusively computed by the formula and their risk of investment is borne by the company itself.
The employees in tertiary sector consider various factors when they are deciding whether to place their superannuation contributions in the Defined Benefit Plan. The degree to which the employees consider each factor plays a significant role in taking right decision (Tomlinson, 2017). These include assessment of costs related to transfer of risk, the amount and security of benefits, control over the benefits derived, investment risk behaviour, confidence in selecting investment strategy, and the most important is the knowledge of the implications of the choice made. In addition to this, some personal characteristics are also taken into account, such as sex, age, academic discipline, and financial aptitude in superannuation (Anderson et al., 2017).
Risk transfer costs are basically the type of cost related with the risk that transfer from the employer to employees in the shifting of employees from a defined benefit plan to a accumulation plan (Nikolakakis et al., 2017). Moreover, the cost of becoming informed is also covered in the cost of risk transfer. In order to make the initial choice, this cost includes time consumed to acquire, read, and understand relevant material or obtaining professional advices from financial proficient. Sometimes, this cost is extended to the cost of not becoming knowledgeable, which leads to adopting uninformed preferences or incorrect choices. In this context, worker characteristics as well as types of risks shifted to the employees are contributory factors to the variations in the expected value of benefits obtained from DBP (Ronald et al., 2017). Age at the beginning of the employment, years of service, salary during the course of employment and at the time of retirement, and endurance post-retirement are included in the characteristics of workers. The significant risks which result in variations in the expected values of DFP, and accumulation plans are usually linked with changing jobs and monetary market.
The employees of Australian companies adopt DFP in the beginning of employment. However, they are provided with an alternative to get shifted to the Investment Choice Plan within one year. While selecting this plan, the employees perform the tasks of examining, grasping, and analysing a variety of financial information along with evaluating the associated advantages of the varying superannuation plan alternatives (Podger et al., 2014). While opting for this option, employees take into account the nature of the investment strategy, allotment of assets, and identifying the related risks and returns of each alternative to decide to invest in the most profitable and feasible plan. Member Investment Choice Plan is basically a feature of fund through which the employees can decide where to invest their super funds to get super returns. For this purpose, the employees are allowed to select from a number of investment portfolios. These include growth option, balanced option, conservative option, and cash option. In Australia, various super funds offer an option to the employees of tertiary sector to invest in particular asset class options like property option or Australian shares option.
Usually superannuation fund members feel more relaxed with taking important investment decisions and are ready to accept the related financial risk. These employees tend to prefer an accumulation plan over a DBP. They also hold an individual investment account consisting of employer-sponsored and their own superannuation contribution. Moreover, these employees retain an annual payment of returns generated on the invested contribution excluding any managerial and administration charges. However, the employees who want to shift to the Investment Choice Plan are not allowed to go back to the Direct Benefit Plan. Apart from it, the final retirement payment of such employees is affected by the returns generated by their selected investment strategy and they are bound to accept the associated risks.
In Australia, as per Supervision Act 1993, except some rules in the superannuation industry, funds are not exposed to any asset requirement or investment exposure flaws. Also, there is neither least rate of return requirements nor government assurance of benefits. Some restrictions on borrowing and the application of derivatives and investments in the shares and assets of the employer sponsors of funds have been also imposed (Gerrans, and Clark, 2013). Therefore, employees prefer to invest their superannuation funds in different assets with a combination of time and risk features. The newly introduced investment performance of superannuation funds is more profitable than alternative assets like eight year bond.
Role of Net Present Value
NPV is a tool which is used by financial managers to compare the money received today with the amount that would be received in future. It is a useful tool which also considers the effect of time and interest while making the comparison (Gerrans, and Clark, 2013). There are widely used areas where employees use net present value computations in order to make wise decisions and resolve financial issues effectively. These include
Applying Net Present Value Calculations
The application of net present value is helpful in finding answers to various questions associated with finance. The requirements for retirement planning are easily assessed on monthly or yearly basis and as such the money to contribute for school funds. The employees can easily come to know the amount of investment every month for achieving their goals. For instance, on an annual rate of return of 12.2 percent, an employee needs to save $984 per month $ in order to receive one million to get retired in twenty years (Podger et al., 2014). Thus, in this way, the value of money is greatly affected by the time and NPV assists people to take judgements regarding where to allocate resources. Also, the banks are able to determine as to what rate of interest they should charge from people on lending credits and loans. The employers are also encouraged to determine a dollar value on the government pension plan.
Furthermore, the concept of time value for money is supported by the three fundamental factors. The foremost is that after giving a potential earning power, a dollar can be invested and generate interest amount over a fix period of time. Since the value of money is affected by the inflation also, it reduces the purchasing power of the people over a certain time and make it less worthy in the future(Lewis, and Stoycheva, 2016). Also, it is risky that the dollar will not be received in the future value because it is a bit tough to use in an accurate way.
b)Efficient market hypothesis theory is one of the well-known explanations of share prices. According to this theory, it is somewhat impractical to punch the market as an efficient market is instrumental in making stock prices for incorporating and reflecting all necessary information. The concept of EMH is considered as a conflicting theory by various market experts. However, the supporters of this theory state that it is useless to find out undervalued shares or to determine the trend in the market using fundamental or technical evaluationNarayan, P.K., Narayan, S., Popp, S. and Ali Ahmed, H., (2015). Moreover, the shares are normally trade at their fair value on stock exchanges, which make it difficult for the investors to buy or sell the deflated or overvalued shares in the market.
The portfolio manager can easily choose the portfolio and can obtain good returns when the market is efficient. But it has been observed that it is not the case because many a times the market is not able to behave efficiently Szapiro, A., (2017). Among various reasons, the important one is ineffective diversification of resulting portfolio, which makes the investment in the funds risky and less rewarding (Jovanovic et al., 2016). Next, it might lead to bear unlimited systematic risk for the investors. Nevertheless, the problem is reduced greatly if the investors have more wealth to invest in riskless assets but if it not so, on the basis of investors’ risk choices, the portfolio may provide a high beta.
In addition to this, the presence of tax system for investors is of crucial nature. Due to the equilibrating system, various assets provide high returns because of their high taxability (Westerlund, and Narayan, 2013). This tax-less return on the portfolio is proved to be encouraging and also makes tax status a significant variable.
Those investors who have a good knowledge of the predictability are more able to price the shares in order to reflect all the relevant information regarding the firm’s future profits. It ultimately results in making the expected return on the stock independent the changes made earlier in the prices of the securities (Kristoufek, and Vosvrda, 2016). There actually exist a few situations where the markets are not much efficient and the securities get undervalued. Big institutes like mutual funds and pension funds do not consider these securities. These also tend to avoid purchasing high stakes in any company because it brings meeting with additional requirements and the duties of being a major stockholder (Charles et al., 2016). On the other hand, a smaller stake does not affect a large fund because they consider these stocks as a mark of failure on their level of portfolio.
Efficient Market Theory has also faced many criticisms, particularly from the technical analysts. This is because sometimes investors base their expectations on past prices, earnings, and track indicators (Westerlund, and Narayan, 2013). Also, the prices of securities are largely influenced by the expectations of the investors which make investors to believe that the past prices are affected by future prices.
References
Narayan, P.K., Narayan, S., Popp, S. and Ali Ahmed, H., (2015) Is the efficient market hypothesis day-of-the-week dependent? Evidence from the banking sector. Applied Economics, 47(23), pp.2359-2378.
Jovanovic, F., Andreadakis, S. and Schinckus, C., (2016)Efficient market hypothesis and fraud on the market theory a new perspective for class actions. Research in International Business and Finance, 38, pp.177-190.
Westerlund, J. and Narayan, P., (2013) Testing the efficient market hypothesis in conditionally heteroskedastic futures markets. Journal of Futures Markets, 33(11), pp.1024-1045.
Kristoufek, L. and Vosvrda, M., (2016) currencies and market efficiency. Physica A: Statistical Mechanics and its Applications, 449, pp.27-34.
Charles, A., Darné, O., Kim, J.H. and Redor, E., (2016) Stock exchange mergers and market efficiency Applied Economics, 48(7), pp.576-589.
Chaudhry, N., Au Yong, H.H. and Veld, C., (2017) ‘How does the Funding Status of Defined Benefit Pension Plans Affect Investment Decisions of Firms in the United States?. Journal of Business Finance & Accounting, 44(1-2), pp.196-235.
Lewis, G.B. and Stoycheva, R.L., (2016) Does Pension Plan Structure Affect Turnover Patterns?. Journal of Public Administration Research and Theory, 26(4), pp.787-799.
Clark, G.L., (2016) Behaviour, choice, and British pension policy. Social Policy Review 28: Analysis and Debate in Social Policy, 2016, 28, p.3.
Tomlinson, R., (2017) An argument for metropolitan government in Australia. Cities, 63, pp.149-153.
Ronald, R., Lennartz, C. and Kadi, J., (2017) What ever happened to asset-based welfare? Shifting approaches to housing wealth and welfare security. Policy & Politics, 45(2), pp.173-193.
Alizadeh, T. and Farid, R., (2017) Political economy of telecommunication infrastructure: An investigation of the National Broadband Network early rollout and pork barrel politics in Australia. Telecommunications Policy, 41(4), pp.242-252.
Nikolakakis, T., Chattopadhyay, D. and Bazilian, M., (2017) A review of renewable investment and power system operational issues in Bangladesh. Renewable and Sustainable Energy Reviews, 68, pp.650-658.
Anderson, M., Clark, M., Ramsay, I. and Shekhar, C., (2017) Super Behaviour: A Note on Young Australian Adults’ Engagement With Their Superannuation Accounts. Australasian Accounting, Business and Finance Journal, 10(4), pp.63-75.
Szapiro, A., (2017) Improving the Defined-Contribution System: The US Can Learn from Other Countries’ Approaches to Helping Retirees Convert Their Savings into Lifetime Income. The Journal of Retirement, 4(4),pp.40-52.
Podger, A., Stanton, D. and Whiteford, P., (2014) Designing social security systems: learning from Australia and other countries. Public Administration and Development, 34(4), pp.231-250.
Gerrans, P. and Clark, G.L., (2013) Pension plan participant choice: Evidence on defined benefit and defined contribution preferences. Journal of Pension Economics and Finance, 12(04), pp.351-378.
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