Running Head: Financial Markets (APC 313) Running Head: Financial Markets (APC 313) Running Head: Financial Markets (APC 313) Running Head: Financial Markets

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Running Head: Financial Markets (APC 313)
Financial Markets
Contents
Question 1............................................................................................................................................2
STUDENT NAME:
Professor Name:
Date:

Financial Markets (APC 313)
Answer 1...........................................................................................................................................2
Question 2.............................................................................................................................................4
Answer 2...........................................................................................................................................4
Question 3.............................................................................................................................................8
Answer 3...........................................................................................................................................8
Question 4.............................................................................................................................................9
Answer 4...........................................................................................................................................9
Referencing........................................................................................................................................12
Appendix............................................................................................................................................15
Question 1
Answer 1.
(a) As per Economists’ prediction US dollar may lose its status of being the Global
Reserve Currency. This may take place because of the following reasons:
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Financial Markets (APC 313)
i. The first two leading causes may be protectionist trade initiatives and
economic sanctions
ii. The currencies like Yuan and Euro have been actively looking for gaining the
position of Global Reserve currency and therefore China and Europe try to
make most of the trade in their own domestic currencies
iii. The factors like aggressive economic policy and huge amount of debt taken by
US is leading to de-dollarization in the entire world
iv. 70% of the trade in world takes place in US Dollars, 20% world trade in Euros
and rest 10% takes place is Asian currencies especially Yuan that is currency
of China
v. A trade in oil futures has been opened by China in their currency Yuan which
has strongly affected US dollars. Yuan the currency of China is ranked as third
important currency in the IMF (International Monetary Fund) basket.
vi. Iran is also not using US Dollar for its International settlement and has started
using Yuan in its place.
vii. Turkey is also in the plan to stop using US Dollar for International Settlement
and has already decided to settle in national currencies by entering into mutual
agreement with Iran
viii. Rise in the rates of Federal Reserve System, increasing pressure on most of the
currencies including Euro
ix. In December, 2014 the agreement for direct trading for Yuan and Rouble
between Russia and China came into force (McCormack, 2019).
Therefore, it seems Dollar may lose its status of being the world’s global currency by the
year 2030. Its position may be taken by Euro or Yuan. It can also be concluded that
American dollar may face a decline in its position in the near future.
(b) From the last many years China has been trying hard to replace US dollar from its
position of Global reserve currency. This was only possible after being successful as
reserve currency which would be beneficial for the economy of China in the
following ways:
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Financial Markets (APC 313)
i. Maximum of international transactions or cost would be in terms of Chian’s
currency Yuan. China is a country which is highly engaged in exporting the
products. These products are mostly priced in the US Dollars. In case, Yuan
become the global currency it would be really easy for China to export without
worrying about the value of US Dollar.
ii. If Yuan become the global currency it would become mandatory for the
Central banks to hold the China’s Yuan in the banks’ foreign exchange
reserves. This will raise the demand of Yuan and the bonds denominated in the
China’s Yuan would witness a fall in their interest rates.
iii. The borrowing cost of the China’s exporters would fall drastically if Yuan
become the global currency
iv. Economic influence of China would extensively rise as compared to United
States
There are many reasons listed below because of which IMF provided Yuan the status of
reserve currency:
i. People’s Bank of China had put a fixed rate of exchange of the currency Yuan
to US Dollar
ii. As a result, China witnessed a rise in economic growth as well as GDP
iii. With the growth in trade rose the popularity of China’s Yuan and in the month
of August year 2015 it was listed the fourth largest used currency in the whole
wide world (Amadeo, 2019).
However, still Yuan of China is not in a position to replace US Dollar and become the
Global reserve currency because of the following reasons:
i. Due to the attack of Corona Virus in China has deeply injured the economy of
China along with its reputation among the other existing countries (Times, 2020).
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Financial Markets (APC 313)
ii. In order to provide funds for an existing high-level trade Central bank has to
purchase the China’s currency Yuan. It requires to purchase yuan of worth $700
billion. It has been seen that the bank did not even purchase the required euro at
the time European Union was the largest economy in the world. Therefore, still
maximum of international transactions are carried out in US Dollars irrespective
of fall in the trade of US.
iii. However, China is required to bring liberalization in its capital market and let
yuan trade freely on the foreign exchange market. This may help the Central bank
to hold Yuan as the reserve currency (Amadeo, 2019).
Therefore, China’s Yuan has to compete US in terms of strength of the United States
economy, existing transparency in the financial market of US and the US monetary
policy’s stability, for becoming the global reserve currency.
Question 2.
Answer 2.
(a)
Investors are always curious to know the efficiency of the stock. There is a financial theory
called Efficient Market Hypothesis (EMH) which has a predetermined assumption that the
stocks trade at their fair value on the exchange (Staff, 2017). This theory came from the
1960’s dissertation of a Ph.D. scholar Eugene Fama (Morningstar, n.d.). According to this
theory, the prices of equity is affected by the current information and therefore the current
price of equity is not the actual price but a replication of the current information (Hamid,
Suleman, Shah and Akash, 2010).
As per EMH there exist three levels at which the stock market can be considered as efficient:
LEVEL-1: STRONG FORM EMH
This level says that the stock price of the company actually reflects both the public
information as well as private information.
LEVEL-2: SEMI-STRONG FORM EMH
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Financial Markets (APC 313)
This level says that both fundamental analysis and technical analysis can never prove helpful
for investors. The new public information is actually reflected in the share price of the
company.
LEVEL-3: WEAK FORM EMH
This level says that the past fundamental information is useful to predict returns on the stock.
At the same time, data gathered from technical analysis are of no use for achieving the
returns. This form of Efficient Market Hypothesis assumes that the market is efficient if the
stock price of the company reflects all the historical information related to the price of
company’s share (Thune, 2020).
An empirical research has been conducted to study the investment related behaviour of
mutual fund managers when they are exposed to the knowledge of Efficient Market
Hypothesis (EMH) during their higher education. It has been observed that the managers who
were exposed to the theory of Efficient Market Hypothesis in their higher education hesitate
to hold portfolios with larger number of stocks. Whereas, the managers who were not
exposed to the theory of Efficient Market Hypothesis in their higher education are highly
active and comfortable in holding portfolios with larger number of stocks. It has been seen
that the managers exposed to Efficient Market Hypothesis theory takes more systematic risk.
Exposure to the theory of Efficient Market Hypothesis hardly helps in performing better.
Somehow with this exposure managers create higher capital flows and it especially takes
place when a lower expense ratio has been charged by them and at the same time they are the
holder of stronger academic credentials (Atanasov, Pirinsky and Wang, 2018)
However, in general an efficient market has the following characteristics:
i. Accurate information needed for secure transaction are quickly available to the
interested investors
ii. The stock market is needed to operate in a way where no difference exists between
the buying or selling ability at a fixed price and the price of the previous transactions
with an assumption that no current information is available
iii. An efficient market does not witness a great price change from one transaction to
other unless some new information releases
iv. The transaction between buyers and sellers takes place above the current market price
and below the current market price
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Financial Markets (APC 313)
v. The market should be internally efficient and therefore the transaction cost is at its
minimum
vi. All the demand and supply related information should be reflected by an efficient
market which points towards its informational or external efficiency
(b) Refer Appendix
(c)
i. In developed market, the information is easily available for all the market participants
and strict regulation make it compulsory for organisations to make public all the
material information. We have taken the prices of top 50 companies (largest market
capitalisation) from S&P 500 index for 90-day period to analyse the efficient market
hypothesis. We have done the fundamental analysis for the five companies so as to get
idea of the relationship between the intrinsic price and market share price of top 50
S&P 500 companies. It can be seen that 4 out of these 5 companies have its intrinsic
value in its high and low range of the share price during this time period. Also, the
average share price for most of these companies in this 90-day period was close to
their fundamental value. So, it can be said that market prices reflect the fundamentals
of these companies. But there was overall volatility in share prices and instances of
price staying above and below these fundamentals but that can be due to over or under-
reaction to the new information because of human behaviour issues.
These top 50 S&P firms are the major companies that have great history and hence
their operations and businesses are stable and well known. So, stock prices of these
companies are expected to reflect their fundamentals. It has been observed that the
stock prices have been volatile but these prices have not stayed away for long from
their intrinsic values during this 90-day period. It reflects that these stocks prices might
be reflecting their inherent fundamentals barring few instances of serious deviations.
This can be due to irrational behaviour of investors of overreacting to the news that
may lead to price deviating from its fundamental value for short term. The constant
fluctuation in stock prices does not necessary mean that markets are inefficient as the
new information that is becoming public could be causing this continuous adjustment
of prices (Clarke, Jandik & Mandelker, n.d.). This process will help market become
efficient. Overall, these stocks seem to be priced according to their fundamental
investment properties that are known to the market participants. But time to time due
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Financial Markets (APC 313)
to the human irrational behaviour and other issues there can be discrepancies in the
intrinsic value of these stocks and their market prices.
ii. The stock prices graph shows that there isn't any positive or negative slope of the daily
stock movement of large 50 companies in S&P 500 index. As the movement of the
stock price is not guided by a certain trend which means that these stocks might follow
a random walk (Younas and Mehmood, 2018). But the graph of daily stock return
shows that it is mean reverting and also the average autocorrelations (lag of 1) for
daily returns of these stocks is a positive number. So, this means that there is
possibility of using past technical data to predict stock prices to some extent. It means
that market is not perfectly efficient as the observed behaviour in these graphs is not
following the principles of the efficient market hypothesis.
The paper by Active Managers Council (n.d.) reviews the empirical evidence about the
trends in US market efficiency and the impact of different investing styles on market
efficiency. The paper discusses a body of academic literature on how the increase in
passively managed portfolios has affected the market efficiency. Most of these studies
suggest that relatively the pricing efficiency has declined, co-movement in returns has
increased and securities prices have become more volatile. This can have a negative
effect on the efficiency of the market. But there is other side of coin that says that the
increased trading volume and intense competition between passive investors creates an
efficient market where prices can adjust to new information rapidly. So, the active
investing investment strategies will fail to perform as predicted most of the times. It
has been seen that after taking into account the additional risk and transaction costs,
active asset management is mostly a losing bet.
According to Ahmed and Satchell (2018), it has been observed that developed
financial markets aren't always perfectly efficient or inefficient. There is the degree of
efficiency that needs to be analysed rather than the presence or absence of the prefect
efficient market. The paper also says that efficiency in the market depends upon
particular period of the analysis as market can be efficient for certain period but then
changes, irrationalities and advancements can make it inefficient. S&P500 was mostly
efficient under the most generalized specification but there were pockets of data where
significant inefficiency was noted. So, to some extent recent evidence suggests that
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Financial Markets (APC 313)
there is under and over reaction in security markets at some times but the majority of
empirical evidence definitely supports the efficient market hypothesis for developed
and matures financial markets like S&P 500.
Question 3.
Answer 3.
Financial market regulation refers to the set of rules and laws governing the practices of stock
market to reduce the possibility of systemic failure, institutional failure, market manipulation,
frauds, unfair practices with investors etc. (Central Bank of Ireland, n.d.) These regulations
and laws are set by the country’s market regulator or International regulatory bodies.
Financial Market Regulations are important and needed because of the following reasons:
i. Administration of Stock Exchange: There are many countries which have more than
one stock exchange like United States, India etc. The activities of these stock
exchanges are need to be managed and supervised properly to ensure brokers are
using their clients’ information properly, insider trading is not in practice, avoidance
of market manipulation using trading etc. Here, comes the financial Markets’
Regulations to avoid all such risks and fraud.
ii. Exchange listed Companies’ Supervision: There exist ‘n’ number of companies which
are listed on stock exchange. The investors need all the relevant information that can
have effect on the companies’ stock price. The financial market regulations take care
and ensure that all listed companies disclose all the available and required information
to the investors and in this way, it safeguard the interests of investors
iii. Safeguarding the Retail Investors’ Interest: Regulations take proper measure to
educate and make aware the retail investors about the various type of products and
services existing in the financial markets. This special treatment is given to the retail
investors because they fall in the category that incurs maximum loss due to any
disruptions in the market.
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Financial Markets (APC 313)
iv. Act as Middle-man to companies and investors: Sometimes dispute arises and then
these regulators come into picture as a middle-man to settle the dispute confronted by
companies or any other customers (Amadeo, 2019).
v. These market regulations are needed to ensure there is no asymmetry in information
and non-existence of fraudulent activities to save investors from exploitation. This
built confidence in the investors to carry out their operations safely in the stock
market (Chaudary and Adebayo,2014).
Question 4.
Answer 4.
The whole global economy was hit by the financial crisis of 2008. Since the Great
Depression, financial crisis is considered to be the world’s biggest shock. This crisis has
actually devastated the entire economies of the world and gave birth to Great Recession.
During this Great Recession, the housing prices steeply dropped and unemployment
increased. This Financial crisis has left several negative effects which are still faced by the
economies (Wu, 2018).
There were million of people who lost their jobs in US, around 2.5 million business got
closed and around 4 million houses foreclosed.
Officially this recession came to an end in 2009 but there were still many people who had to
suffer which mostly included the people of US. In the year 2009 the rate of unemployment
was 10% and it got back to the pre-crisis level in 2016.
There were many factors which has led to the great recession or financial crisis. Both people
and government policies are equally responsible for housing bubble collapse which gave birth
to economic crisis and from there the Great Recession started. Before the financial crisis the
US legislation encouraged people to apply for mortgages and these mortgages came up with
adjustable rate (Denning, 2011). So, without thinking twice sub-prime mortgages were
provided to people. Also, little or no collateral was required to purchase a house. These two
are the main factors which no one ever thought could lead a great damage to the world
economy as a whole (McKinsey & Company, 2018).
Now, when we talk about the banking sector then it suffered a lot during the financial crisis
of 2008. The banks had to lose a large amount of money on the defaults made on the
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Financial Markets (APC 313)
mortgages. Interbank lending almost froze and banks were not in a position to lend further
credit to individuals or businesses. The regulatory actions introduced in the form of Basel III,
Dodd Frank Wall Street Reform and Consumer Protection Act (Mason, Balcombe and
Dalrymple, 2018) has affected the banking sector in the long term. Financial Stability
Oversight Council was also formed by the legislation which included Federal Reserve bank
and other agencies. This council was formed with a motive to help in the functioning and
coordination of larger banks (Cassidy, 2018). Even a new fund known as Orderly Liquidation
Fund was introduced to provide financial institutions to big banks facing the financial
problems.
The banking sector was almost killed by the financial crisis of 2008. During this period, a
large number of banks got closed and others were forced to get merged with the ones in
comparatively better position. The banks also witnessed a heavy crush in their common stock
prices, dividends on shares slashed and almost every investor lost a large portion of their
invested money. Apart from housing bubble burst there were many reasons which actually
led to the financial crisis which include the issue related to liquidity, bad loans which the
banks had on the books of accounts.
Now it’s been more than a decade to financial crisis and many steps are taken to improve and
place a stronger banking sector globally. Some the steps are as follows:
i. For preventing the crisis many efforts are made to make banks hold larger and at the
same time higher quality capital. Along with this, asset risk weights and capital
surcharges were increased for all those financial institutions which were globally
recognised and important. There were many other measures taken to improve the
capital strength of banks like launch of complete loss- absorbing capital, global
leverage ratio, stress tests implementation, liquidity requirements etc.
ii. The reforms like resolution policies and living wills are introduced to manage the
insolvency of reputed and big banks without affecting the entire financial system
iii. As per Krista Schwarz who is a finance professor, banking sector is much safer than it
was before the financial crisis. It has become possible due to the reforms brought by
Basel III, Dodd-Frank Wall Street Reform and Consumer Protection Act in the United
States. Basel III is a complete set of regulations needed for international banking like
acceptable liquidity, minimum capital requirement, leverage ratios etc. (Wharton
University of Pennsylvania, 2018).
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Financial Markets (APC 313)
iv. One of the reports has found that the developing countries’ banks are capitalized well
enough since the financial crisis as compared to the banks in developed countries or
countries with high-income.
v. There is a ratio which measures the amount of capital with the banks in relation to risk
weighted assets. This ratio is termed as regulatory capital ratios. The developing
countries have seen a rise in their regulatory capital ratios since the global financial
crisis. Comparatively, developed countries have witnessed a less rise in this ratio
(World Bank, 2019).
Therefore, banking sector has become somewhat safer after the financial crisis due to the
reforms taken later.
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Financial Markets (APC 313)
Referencing
Active Managers Council. (n.d.). Active Management and Market Efficiency: A Summary of
the Academic Literature. Available at:
https://higherlogicdownload.s3.amazonaws.com/INVESTMENTADVISER/4d240ae3-bc9b-4155-8bd1-
14cbac904146/UploadedImages/amc/docs/WP_AMC_Market_Efficiency.pdf (1March, 2019).
Ahmed, M.F. and Satchell, S. (2018). What Proportion of Time is a Particular Market
Inefficient? … A Method for Analysing the Frequency of Market Efficiency when Equity
Prices Follow Threshold Autoregressions. Journal of Time Series Econometrics.10(2). Pp.
DOI: https://doi.org/10.1515/jtse-2016-0021
Amadeo, K. (2019). Financial Regulations Do Regulations Keep Your Money Safer?.
Available at: https://www.thebalance.com/financial-regulations-3306234 (1 March, 2019).
Amadeo, K. (2019). How the Yuan Could Become a Global Currency China's Plan to
Replace the U.S. Dollar. Available at: https://www.thebalance.com/yuan-reserve-currency-
to-global-currency-3970465 (1 March, 2019).
Atanasov, V. Pirinsky, C. and Wang, Q. (2018). The Efficient Market Hypothesis and
Investor Behavior. Available at:
http://www.fmaconferences.org/Norway/Papers/APW_EfficientMarkets2017-
1201_FMAEU.pdf (1 March, 2019).
Cassidy, J. (2018). The Real Cost of the 2008 Financial Crisis. Available at:
https://www.newyorker.com/magazine/2018/09/17/the-real-cost-of-the-2008-financial-crisis
(1March, 2019).
Central Bank of Ireland. (n.d.). Explainer - What is financial regulation and why does it
matter?. Available at: https://www.centralbank.ie/consumer-hub/explainers/what-is-financial-
regulation-and-why-does-it-matter (1March, 2019).
Chaudary, S. and Adebayo, D.S. (2014). Why Regulate Financial Markets? The Underlying
Rationale for Financial Regulation in the Wake of the Current Crisis. Journal of European
Studies. Available at:
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e_Underlying_Rationale_for_Financial_Regulation_in_the_Wake_of_the_Current_Crisis (1
March, 2019).
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Clarke, J. Jandik, T. and Mandelker G. (n.d.). The Efficient Markets Hypothesis. Available at:
https://www.turtletrader.com/pdfs/efficient-market.pdf (1March, 2019).
Denning, S. (2011). Lest We Forget: Why We Had A Financial Crisis. Available at:
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Hamid, K. Suleman, M.T. Shah, S.Z.A. and Akash, R.S.I. (2010). Testing the Weak form of
Efficient Market Hypothesis: Empirical Evidence from Asia-Pacific Markets. International
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hasn’t) changed?. Available at: https://www.mckinsey.com/industries/financial-services/our-
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Thune, K. (2020). Efficient Markets Hypothesis (EMH). Available at:
https://www.thebalance.com/efficient-markets-hypothesis-emh-2466619 (1 March, 2019).
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Global Financial System Safer?. Available at:
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2019).
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Appendix
15