Financial Markets: Risk, Efficiency, and International Transactions

This report provides a comprehensive analysis of financial markets, focusing on market efficiency, particularly in the context of the London Stock Exchange (LSE). It explores the Efficient Market Hypothesis (EMH) in its weak, semi-strong, and strong forms, evaluating the efficiency of the LSE. The report also examines the key roles and functions of capital markets in relation to money markets and how money markets influence asset prices. Furthermore, it delves into the nature of potential risks in international transactions, including foreign exchange, economic, and political risks, and how traders utilize forward foreign exchange markets to manage these risks. The report also discusses the Eurocurrency market and its usefulness in facilitating international trade. It concludes with a discussion of various financial market terms and concepts, providing a thorough overview of the subject matter.

Financial Markets

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
MAIN BODY...................................................................................................................................1
Q1 A) Different level of market efficiency............................................................................1
B) Critically evaluate efficiency of London Stock Exchange (LSE).....................................2
Q2 Key roles and functions of capital markets with money markets and evaluate how money
markets influence asset price in capital markets....................................................................4
Q3 A) Nature of potential risks in international transaction and how traders manage risks by
forward foreign exchange markets.........................................................................................5
................................................................................................................................................7
................................................................................................................................................8
................................................................................................................................................8
................................................................................................................................................9
B) Eurocurrency market and explain its usefulness for conducting international trade
transactions.............................................................................................................................9
..............................................................................................................................................10
..............................................................................................................................................11
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Q 4 Discussing terms in financial markets...........................................................................11
CONCLUSION..............................................................................................................................13
REFERENCES..............................................................................................................................14

INTRODUCTION
Financial markets are crucial for meeting requirements of the borrowers in effective way.
Present report deals with importance of money and capital market collectively financial markets
which is required by organisation and economies to meet funds' requirement. M&S (Marks &
Spencer) Company is chosen which is engaged in retail industry and historical share prices are
taken out to analyse performance. Different forms of EMH are explained and efficiency of LSE
stock market is discussed as well. Potential risks in international market is analysed along with
forward foreign exchange markets. Eurocurrency market is explained and its usefulness in
conducting global trade transactions. Thus, financial markets are vital for channelising funds in
effective manner.
MAIN BODY
Q1 A) Different level of market efficiency
The EMH (Efficient Market Hypothesis) is effective market in which current price of
shares are listed which help to clarify investors whether they should invest in the particular
company or not. This is essentially required so that investment may be made in that organization
which could provide higher returns to them by injecting operations quite effectually. EMH forms
of market was developed by Eugune Fama in 1955. He stated that stock of the company are
traded at fair only. This cannot be used for carrying technical analysis and as such investors
cannot decide either to sell shares at inflated price or purchase the same at undervalued prices. In
relation to this, investors have no other option to make riskier investment. The different forms of
market are weak, semi-strong and strong which can be explained below-
1. Weak form-
This form of market is termed as weak as no concrete information is incorporated in
current share price of firm which can be used by investors to carry out analysis of viability of
organisation (Slabinski. 2016). It is called as weak form as historical data related to shares is
present which lays inaccurate information to investors. This cannot be used to make technical
analysis as both private and public related data are not included in current stock price instead
only past data is present which makes difficult for shareholders to assess efficiency of firm's
performance. The main example of this market is that just by relying historical variations of price
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of M&S Company, prediction of future cannot be made as no value can be garnered through
such variations.
2. Semi-strong form-
This market is much relevant in comparison to weak form because publicly available
information is traded in the current stock of prices. It is helpful as accurate information which is
made available to public are incorporated in. The public information relates to financial
statements reflecting net earnings of firm which is beneficial as stock price data can be presented
to investors. In addressing to this, no delay is made with relation to disclosure of data. Moreover,
partly private information is disclosed in share price data as well (Armour, Mayer and Polo,
2017). For instance, when M&S Company releases net income, stock price tend to change after
trading hours in the share market.
3. Strong form-
This form of market is termed as strong form as both public and private information are
incorporated in share prices in the best possible manner. It is helpful to assess efficiency of
organisation's performance as accurate price of stock is disclosed which is useful for the
investors to easily conduct technical analysis of the market in effective way. Private information
means that it is confidential one and is known to top management only. It is available within the
hands of Board of Directors like future issue of equity shares and internal information. For
instance, M&S Company's management is planning for further share issue and as such, current
prices reflect true position of firm (Arthur, 2018).
B) Critically evaluate efficiency of London Stock Exchange (LSE)
The stock market is one where securities are traded in. LSE is one of the largest stock
exchange and oldest as it dates back to almost 300 years since its formation. In this stock market,
around more than 3000 organisation are listed from numerous nations for the main objective of
trading and conducting businesses to earn huge profits quite effectually. Furthermore, it is a
financial institution ahead of several largest markets in the world. In addressing this, efficiency
of LSE can be analysed as more of the companies listed on the stock exchange are performing
well enough and as such, it can be stated that LSE is one of bigger financial institution.
Moreover, market capitalization of 3.5 trillion in the present year and efficiency can be seen. The
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trading base in terms of exchange is good as members are able to purchase and sell shares with
much ease.
The EMH forms of market are discussed such as weak, semi-strong and strong which are
important from the point of view of investors. Weak form states that historical data is
incorporated in current share price and no technical analysis can be made. On the other hand,
semi-strong form means that partly private and public information is disclosed. While, strong
market implies that public and private both are incorporated in current share price
(Baharumshah, Slesman and Devadason, 2017). It can be said that M&S Company is also
performing well and stock prices are good as well. The theory on financial market can be
explained which is APT (Arbitrage Pricing Theory). It states that return on asset may be judged
and predicted by asset in hand and related risk factors. Basically, it is an asset pricing model
which imparts risk in getting expected return on asset. This theory is just opposite to CAPM
(Capital Asset Pricing Model) that is based expected return from the market. It can be assessed
that market capitalization of M&S Company is good enough and shareholders are getting higher
returns on the securities purchased by them in the best possible way.
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Illustration 1: M&S Company stock chart

The above drawn stock chart of M&S Company shows that performance in the market is
good as clarified by the graph. For carrying market efficiency of firm, historical share prices data
for the period of 120 days are taken for analysing performance in effective manner. In simpler
words, 120 observations are made for period starting from 3rd January to 23rd June 2017. Thus,
analysis is taken out which provide clarity about the share prices of company. From the graph,
various high and low points can be extracted quite effectually. Starting the analysis of high
points which are 393.4, 389.3, 386.9 and 386.3. While, four low points are 330, 323.4, 323.8,
and 325.5. It can be assessed that highest share value is 393.4 which is on a particular day of 120
observations made and lowest point is 330.
Illustration 2: High and low points
Moreover, it can be analysed that performance of company in terms of shares was fallen
down but it again hiked up to high extent which clearly shows that LSE market is efficient as
prices were again stabilised within short time span (Bolton, Santos and Scheinkman, 2016). This
implies that shareholders are investing in the shares of the company and as such, organisation is
able to perform in the best possible manner. Thus, it can be said that LSE stock market is
efficient as clarified by the empirical evidence and firm are performing well and earning profits
in effective way.
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Q2 Key roles and functions of capital markets with money markets and evaluate how money
markets influence asset price in capital markets
The financial market consists of money and capital market which are important for
raising funds of short-term and long-term in the best possible manner. The instruments,
characteristics and participants of both the markets are described below-
Instruments of capital market-
The instruments are of two types-
1. Debt – This type of instrument is an obligation enabling party to raise necessary funds and
promising lender to repay the principal amount along with the interest accrued on it. Thus,
repayment is done according to terms and conditions of contract (Bai, Philippon and Savov,
2016).
2. Equity- This is issued by organisation in secondary market and requirements can be met.
Higher returns are generated but more risk also prevails.
Characteristics of capital market
1. Investment on long-term basis-
The capital market is basically for long-term and funds are provided for a period of more
than one year.
2. Capital formation-
The economy of country will be benefited as activities would assist in formation of
capital in the best possible manner.
Participants of capital market
The participants of such market are corporations, state government and individuals as
well in the capital market (Busch, Bauer and Orlitzky, 2016).
Instruments of money market
The main instruments of this market are as follows-
1. Treasury bills- UK government initiates control over the same as bills are of maturity of short-
term which collapses within period of one year.
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2. Commercial papers- These type of papers are not secured promissory note issued by
organisation on the basis of short time span.
Characteristics of money market
1. Liquid market- This type of market is highly liquid as maturity period is of short-term basis
usually one year (Cavalcante and et.al, 2016).
2. Safety- Market is safe enough as credit ratings are high enough as issued by firms.
3. Discount- The issues are made on discount basis which is even less than the face value of it.
Participants of money market
The major participants in this market are local government, organisations and commercial
banks to a name a few.
Moreover, the activities of money market influences asset prices in the capital markets.
These are loans, equity and prices of property. They are affected by monetary policy enacted by
the UK government. Expectation of investors like speculation is one of the major force which
influences asset prices in relation to the future economic development affecting NPV (Net
Present Value) of asset returns. Moreover, it such expectation of investors tend to change asset
prices in the capital market. It eventually affects inflation rate, interest rates, productivity level
and taxation norms as well. Furthermore, when liquidity gets reduced, then effect can be seen on
credit instruments and as such, capital market is affected leading to adverse effect on reduction
on asset prices. Hence, both types of financial market are important for regulating money on
short-term, medium and long-term in effective manner (Easley, O’Hara and Yang, 2016).
Q3 A) Nature of potential risks in international transaction and how traders manage risks by
forward foreign exchange markets
There are various kinds of risks in carrying out international transactions. The risks are
foreign exchange risk, economic risk and political risk. The types of risks have immense
possibility of failures which might prevail in the international market. Foreign exchange risk is
one of the major of the category as currencies remains more or less stable. This is evident from
the fact that when local currency of the nation decreases, income in abroad also reduces which is
a result of such depreciating value of domestic currency. While, political risk means that
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country's government initiates changes in taxation policy, trade restrictions are initiated by which
normal trading is not possible and as such, international transactions are difficult to met.
Economic risk can also prevail when buyer becomes insolvent which also affects traders
dealing in global transactions. These types of risks may be managed by using forward exchange
markets in effective manner. This market is over-the-counter (OTC) that sets asset price to be
delivered at an agreed future date so that risk can be reduced when everything becomes normal.
Moreover, in absence of government norms, regulation of forward market. Thus, foreign
exchange risk can be settled at a future date and uncertainty regarding expenditures and receipts
can be controlled. Hence, global traders are benefited by forward foreign exchange market. On
the other hand, spot rate is also relevant in this aspect (Vayanos, Eyster and Rabin, 2018). It is a
type of agreement between two parties to purchase one currency by selling other one at spot date.
The exchange rate on the basis of which such transaction is accomplished is known as spot rate.
Various risks in time period can be explained below-
1. Uncertainty appreciation period- It is termed as unlimited gathered lacking behind time frame.
2. Fluctuation period- The fluctuations can be seen in the event of overvaluation and variations
can be analysed and firm would also face the same.
3. Depreciation period- Requirement of total assets for effectively locating the capital and as
such, locations are needed to operate with much ease.
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Illus
tration 3: UK Inflation rate
It can be analysed from the above chart that in the financial year 2017, inflation was high
but it reduced in 2018 and as such, inflation is under control.
Illustration 4: UK Interest rate
The interest rate of country has reduced to 0.5 % because GDP is decreased affecting
interest rate
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Illustration 5: UK Bond rate
It can be analysed that bond rate had maximised in 2014, while in 2017, it reduced
sharply. However, it is again increased in 2018.
Illustration 6: UK FTSE 100 Index
The chart clarifies that FTSE 100 listed organisations have performed well and market
capitalization is highest in 2018.
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Illustration 7: Housing price in London
It can be analysed from the graph that about 68 % increase can be seen on average
housing prices and rents are maximised in 2016.
B) Eurocurrency market and explain its usefulness for conducting international trade transactions
The Eurocurrency market is a currency which is handled by banks. It is regarded as
money market which can be easily borrowed and lent to various nations for meeting requirement
of funds in the best possible manner. It is handled by banks usually outside domestic country and
is a legal tender for meeting requirement and lent in foreign currencies. This market is useful for
conducting trade transactions as surplus economies provide medium-term funds to deficit
economies where balance of payment is adverse (Domowitz, 2018). This resolves liquidity
problem of country as funds are effectively channelised to deficit economies and capital
formation is done benefiting economy as a whole. Thus, flow of funds takes place in
Eurocurrency market and as such, requirement of nations can be met with much ease. The graphs
related to UK, US, Euro are drawn below-
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