Financial Markets: Efficiency, Risks, Eurocurrency, and Global Trade

This report provides a comprehensive analysis of financial markets, beginning with an introduction to their significance in the economy and the roles of money and capital markets. It delves into the Efficient Market Hypothesis (EMH), differentiating between weak, semi-strong, and strong forms, and applies this to a critical analysis of the London Stock Exchange (LSE). The report also compares and contrasts the functions of capital and money markets, discussing how money market activities influence asset prices in capital markets. Furthermore, it examines potential risks in global transactions and how international traders manage these risks, alongside the functions and operations of the Eurocurrency market and its importance in trade transactions. Finally, the report explains various terms related to financial markets, including the need for market regulation, concluding with the vital role these markets play at an international level in achieving economic efficiency.

Financial Markets

Table of Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY...................................................................................................................................3
Q1 A) Difference between different levels of market efficiency ...............................................3
B) Critical analysis of efficiency of London Stock Exchange.....................................................4
Q2 Compare and contrast role and functions of the capital markets over money markets.
Discuss how an activity of money market influences asset prices in capital markets...............10
Q3 A) Discussing nature of potential risks in global transactions and explaining how
international traders manage risks.............................................................................................13
B) Discussing functions and operations of Eurocurrency market and importance of this market
in trade transactions...................................................................................................................13
Q4 A) Explaining various terms related to financial markets...................................................15
CONCLUSION..............................................................................................................................16
REFERENCES..............................................................................................................................17

INTRODUCTION
Financial markets are helpful for channeling funds to the ultimate borrowers from he
lenders who have enough quantum of surpluses. Present report deals with importance or
significance of financial markets in the economy by which requirements of funds can be met
with much ease. In relation to this, money market and capital market both are explained with
their key roles and functions in effectual manner. Moreover, money market leads to influence
asset prices in capital markets are explained. Different forms of EMH are explained along with
efficiency of LSE. Various risks and their nature are discussed which occurs in global trade
transactions and how this can be managed through forward foreign market is discussed as well.
Key functions of Eurocurrency market and importance in trade transactions is enumerated in the
report. Furthermore, terms related to financial market are discussed along with need for
regulating financial market. Thus, it can be said that these markets are utmost vital in
international level as it help to achieve economic efficiency.
MAIN BODY
Q1 A) Difference between different levels of market efficiency
The Efficient Market Hypothesis (EMH) is quite useful for analyzing the current share
prices of the company in the market in effective manner. It incorporates all the relevant
information which help investors to easily analyze share prices of the firm in the best possible
way (Baharumshah, Slesman and Devadason, 2017). There are basically three types of EMH
such as weak, strong and semi-strong which can be distinguished below-
Weak Strong Semi-strong
1. This form of EMH means
that stock prices of company
in current scenario and as
such, it reflects past prices and
is based on historical data.
1. The form of EMH states it
is effective to assess share
prices as both information
available to public and
privately held information is
provided as well (Slabinski.
2016).
1. Semi-strong form states that
only information which is
imparted to use by public is
provided to the investors
2. This is weak form of the
company as it has no technical
analysis of the market can be
used to assist investors in
taking effective decisions.
2. This is termed as strong
form as all the necessary
information is listed of public
and private information and as
such, these are accounted for
current share prices.
2. It has only public
information and no private and
as such, technical analysis
cannot be used by investors for
taking decisions.
3. The weak form states that
all information such as
publicly held and private is
not included than investors
3. It is strong as private
information such as future
earnings prospectus, new
products and legal issues
3. It incorporates public
information such as financial
statements, income earnings
report etc. are only provided in

cannot assess share prices of
the company.
related information and public
one is also included by which
investors can assess current
market prices of stock in the
best possible manner.
current stock price. Thus,
shareholders cannot attain
price of shares and technical
analysis cannot be performed.
4. This type of form is weak
enough as historical data is
taken into account and as
such, current prices cannot be
ascertained in a better way
(Jermann, 2017).
4. This form is applicable
mainly where there is perfect
market. It is not possible when
restrictions on trading are
present.
4. Fundamental analysis
cannot be possible as only
partial information is available
by which decisions cannot be
made in effectual manner.
5. The example of weak form
is that just because Marks &
Spencer’s (M&S) have 30 day
down share price does not
imply that share price will
raise or not in the future. Here,
historical data is gathered
which classifies as weak form
of EMH.
5. Example of strong form is
that private information such
as equity shares’ offering
which only top management
has the access is incorporated
in the stock price.
5. Example is that partly
information of public such as
financials and partly private
includes when firm releases
income and as such, shares
prices changes in after trading
hours (Lin, Sun and Yu,
2018).
The EMH was developed by Eugene Fama who stated that shares are traded in the market
at fair value. Thus, investors cannot make technical analysis and as such, they face dilemma
either to buy under valued shares or sell the same at highly inflated prices. Thus, investors have
no choice but to make riskier investment.
B) Critical analysis of efficiency of London Stock Exchange
London Stock Exchange (LSE) is one of the largest and oldest stock exchanges operating
since 300 years ago. It has admitted more than 3000 companies from several countries for the
purpose of trading. Thus, it is well-structured stock market and important financial institution
among other bigger stock markets. The efficiency of LSE can be seen that there are various high
performance companies which are producing good quantum of profits in the country. Moreover,
firms are competing with another in order to attain greater market share in the best possible
manner. The EMH clarifies whether market is weak, semi-strong or strong which are three forms
of EMH market. These have already been discussed in above paragraphs. Weak form is that
future stock prices cannot be predicted by seeking the historical data and as such, technical
analysis cannot be possible. Investors are not able to take decisions in effective way. Semi-strong
is the one in which information is made publicly available and investors can analyze current
share price. On the other hand, strong form means that there are both public and private
information incorporated in stock price and reflected after trading hours to investors to
effectively analyze the same (Barucci and Fontana, 2017).
In relation to EMH, theory on financial market named as APT (Arbitrage Pricing Theory)
can be explained. The theory implies that it is asset pricing model means that return on asset can
be estimated by utilizing relationship between such asset and risk factors. This means that risky

asset expected return is provided by APT theory which is opposite of CAPM (Capital Asset
Pricing Model) which is based on the market expected return. Thus, risk related to asset can be
evaluated with the help of APT theory. M&S Company which is the biggest firm in UK listed on
LSE has good market capitalization and as such, investors are attracted towards the firm for
making investment and earn higher returns in the best possible manner.
Figure 1 M&S Company
The above stock chart shows that performance of company is overall good. For testing
market efficiency of company, daily historical share price indices are taken. There are 120
observations made during the period from 3rd January 2017 to 23rd June 2017. This means that
120 days of share prices were made in this analysis of M&S Company. It can be observed from
the chart that there are various high and low points in the same of historical stock prices. The
four high points are 386.3, 386.9, 389.3, and 393.4. These were the high points observed on the
closing of trading of shares on daily basis in the period. On the other hand, low points were 330,
323.4, 323.8, and 325.5. Thus, it can be analyzed that highest point was 393.4 and lowest was
330 n which share prices of the company was attained. This means that stock price hiked up to
393.4 and fallen down to 330 in the period of observations done in this context (Domowitz,
2018).
The performance of company is increased without many ups and downs in the market.
This shows that LSE is efficient enough in accordance to EMH and as such, it can be said that
performance of firm is maximized in the observation period as stock price which was declined,
again hiked to much extent and as a result, LSE is efficient. The efficiency of the exchange can
be made on this behalf as it is able to regulate markets in effective manner by which companies
are able to perform as per the desire of shareholders in the best possible way. Moreover, more
potential investors are attracting towards high performing companies such as M&S Company
and as a result, higher returns are garnered by them because of the desired earnings generated by
company with much ease (Van der Sterren, 2017). Furthermore, share prices of M&S Company
had not drastically fallen. It had picked up pace within short time duration without affecting
overall efficiency of market. Thus, it can be said that LSE is highly efficient stock exchange.

Illustration 1: High and low events

Figure 2 GBP/USD Exchange rate
It can be interpreted that GBP has gone high up to 1.5417 in comparison to USD.
Figure 3 Euro to Dollar
The Euro is also hiked in recent years as depicted by the graph.

Figure 4 UK Inflation rate
It can be interpreted that UK inflation rate has been gone down which is good for the
country.
Figure 5 UK Interest rate
It can be interpreted that interest rate has come to 0.5 % as sharp slowdown has observe
in overall GDP of the nation.

Figure 6 FTSE 100
The above graph shows that FTSE 100 listed companies are performing good as recent
five years, market capitalization has increased up to a high extent.
Q2 Compare and contrast role and functions of the capital markets over money markets. Discuss
how an activity of money market influences asset prices in capital markets.
The business requires finance so that it may meet its financial needs in the best possible
manner. It is important for company to raise amount in order to attain finance for carrying out its
daily activities in effective manner. M&S Company also requires funds so that it may be able to
perform well and achieve its objectives. Capital market has the main role to raise funds by
issuing securities. This market helps investor to attain higher dividends by investing in the
securities of the company. Capital markets satisfy needs of lenders and borrowers. Another
function of this market is that funds can be raised by issue of shares, debentures or bonds.
Moreover, foreign funds can be flowed through foreign investment which channelizes foreign
inflows of money in the best possible manner (Du and Zhu, 2017).
On the other hand, money market is known as the market where short-term requirements
of money are traded. This clearly shows that major role of this market is to firm raises money to
meet short-term needs. The function of money market is that to effectively maintain balance
between supply and demand of monetary transactions. Another function is to discount bills of
exchange helping in injecting trade growth in the best possible manner. Next function is short-
term financing help to produce short-term savings as well. This market help to impart funds to
developing sectors which requires adequate liquidity position for carrying out activities with

much ease. Another function of this market is that implementation of monetary policy is based
on the activities of money market. This means that it is a base for formulating and initiating
monetary policy by the government in effective way (Balduzzi, Brancati and Schiantarelli,
2017).
The money market activities influences asset prices in the capital markets. There are
various asset prices such as loans, equity prices, property prices etc. These prices tend to change
when money market affects these assets. The monetary policy which is prepared by the
government is highly influenced by money market. The capital market asset prices consist of
equities, shares and related securities. Investors’ expectation such as speculative or rational is the
main driving force in the capital market which eventually influences asset prices in relation to
future development of economy which automatically affects NPV (Net Present Value) of return
on assets in the future. This is evident from the fact that capital market asset prices are changed
by long-term expectations of investors and also economic development is done (Armour, Mayer
and Polo, 2017). This affects and influences changes in level of productivity, inflation level,
interest rates and taxation policy to name a few. Moreover, if liquidity of the business reduces up
to a high extent, then due to lack of liquidity, credit instruments in the capital market gets
affected and it gradually influences asset prices. Thus, it can be said that money and capital
market are part of financial markets and when monetary policy is changed, interest rate also
undergoes changes which eventually leads to influence prices of asset. Hence, money market is
quite correlated to capital market.
Instruments of capital market
Debt- It is used by M&S to effectively meet requirements and interest is paid along with
principal amount.
Equities- In secondary market, it is issued by firm and carries more risks and generates high
returns.
Characteristics of capital market
Long term investment- It is for long-term requirement of funds and cannot deal in funds less than
one year
Capital formation- activities will assist in evaluating capital formation rate of particular
economy.
Participants of capital market
The participants are local or state governments, organizations and individuals.
Characteristics of money market
Liquidity- They have maturity period of less than one year.

Higher safety- It is achieved as issues have more credit ratings.
Price discount- Issues are made on comparative discount which is less than face value.
Instruments of money market
Treasury bills- These bills are of short-term liabilities matured within one year and controlled by
UK government.
Commercial papers- It is a type of unsecured promissory note of short-term basis usually issued
by firms.
Participants of money market
Commercial banks, state government, companies are participants of this market.
UK Bond rate
It can be analyzed that lines are increased at initial stage ion 2014 and decreased in 2017
and again rising in 2018.

Housing Price in London
The average housing prices have gone to increase by 68 %. Rents have increased after
2011 and much in 2016.
Q3 A) Discussing nature of potential risks in global transactions and explaining how
international traders manage risks
The nature of potential risks in the international transactions are more because it is based
on various parameters such as foreign exchange risk, political risk, economic risks and many
other as well. It can be said that these have immense danger to international investors and traders
who have their operations in the abroad and as such, it affects them. Foreign exchange danger
arises because of constant changes occurring in the currency (Black, Devereux, Lundborg and
Majlesi, 2018). This risk prevails when value of domestic currency depreciates leading to
decrease income in abroad. On the other hand, political risk is of the nature that government
makes changes related to taxation policies, implementing trade barriers, then international
transactions cannot be made and there is a risk with respect to such policies. Economic risk
means that insolvency of buyer may prevail; concession risk in the context of economic control
may be present.
The risks can be managed effectively with the help of forward exchange markets. The
term forward market means that it is an over-the-counter (OTC) place that effectively sets the
Illustration 3: Housing price in London