Financial Markets Analysis: Monetary Policy, IFC, and CAPM Evaluation

This report delves into the intricacies of financial markets, evaluating the effectiveness of monetary policy conducted by the Monetary Authority of Singapore (MAS) and its unique approach to maintain price stability. It then compares and contrasts Singapore and Hong Kong as leading international financial centers, highlighting the key differences that contribute to their success, with a focus on their financial structures and market dynamics. The report further explores the Capital Asset Pricing Model (CAPM), explaining its significance, implications, and inherent weaknesses. Finally, it addresses the concept of asymmetric information within financial markets, providing examples and assessing the role of these markets in mitigating information imbalances. The report provides a comprehensive overview of critical aspects of financial markets, offering valuable insights into various concepts and their practical implications.

Running Head: FINANCIAL MARKETS
FINANCIAL MARKETS
Name of the Student
Name of the University
Author Note

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Table of Contents
Introduction................................................................................................................................2
Discussion..................................................................................................................................2
Answer to Question1)............................................................................................................2
Effectiveness of Monetary Policy conducted by MAS..........................................................2
Answer to Question 2)...........................................................................................................4
Key Unique Differences to be Successful International Financial Centre.............................4
Answer to Question 3)...........................................................................................................8
Significance, Implications and Weaknesses of CAPM..........................................................8
Answer to Question 4).........................................................................................................10
Asymmetric Information and Solving Problem by Financial Markets................................10
Conclusion................................................................................................................................12
Reference..................................................................................................................................14

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Introduction
Financial market is the place, where individuals are engaged in any form of the
financial transactions. This market is the platform, where sellers and buyers are engaged in
the sale and purchase of the financial products such as bonds, shares, mutual funds and
others. Financial market helps in creating liquidity, which allows to grow the businesses and
entrepreneurs for raising the money for ventures (Loh 2014). Hence, this report aims to
evaluate effectiveness of monetary policy conducted by MAS. Further, discussion will be on
key unique difference between the Hong Kong and Singapore that enables these countries to
be successful international financial centre. Moreover, explanation will be on significance,
implications and weaknesses of CAPM. Lastly, explanation will be on term asymmetric
information and assessment will be on the way financial markets helps in solving problems of
the asymmetric information.
Discussion
Answer to Question1)
Effectiveness of Monetary Policy conducted by MAS
The increasing globalization as well as rising flows of international capital has
resulted into complex determination of the appropriate monetary policy for the small and
open economies, for instance Singapore. The policymakers face challenge for assessing
different trade-off among the objectives of policy, evaluation of the economic development
that are likely to be most significant in medium term, identification of key constraints on
operating regime and estimating required degrees of the transparency of monetary policy. In
this particular context, unique monetary framework has been adopted by Singapore that is
centered on management of exchange rate and which is primarily aimed at promoting
stability of price, as the basis for the sustainable growth of economy (Baharumshah and Soon

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2015). The policy framework of MAS focusses operationally on the management of
Singapore dollar against undisclosed basket of the currencies of big competitors and the
trading partners. This basket composition is revised and reviewed on periodically basis for
taking into account the changes in trade patterns of the Singapore, however, there is no
disclosure of details concerning boundaries and index of target band. MAS helps in guiding
rate of exchange to depreciate or appreciate. This depends mainly on whether the expected
pressures of inflationary are weaker and stronger (Mas.gov.sg. 2020). In case of recognizing
monetary policy lags, MAS measures stance of appropriate policy and it operates in the
forward-looking manner with the help of taking into account anticipated developments and
trends in external environment and domestic economy. The policies of MAS have been
complemented by the recent efforts for enhancing transparency and increasing disclosures
through release of “Monetary Policy Statement” and economic development analysis in its
“Macroeconomic Review” (IMF eLibrary. 2020).
The Singapore’s monetary policy is centred on rate of exchange. In open and small
economy of Singapore, rate of exchange is more effective tool for the maintenance of price
stability. “The Monetary Authority of Singapore” is the central bank of Singapore and
monitory policy is conducted for maintaining stability of price favorable to the sustained
growth of the economy. Further, MAS brings out full ranges of functions of the central
banking that is related to the formulation and implementation of monetary policy (Bianchi
and Deschamps 2018). The objective of MAS is enshrined in the act of MAS. One of the
main objectives of the monetary policy is ensuring lower inflation as sound basis for the
sustained growth of economy. The monetary policy of Singapore is centered on the
management of the exchange rate compared to interest rates or money supply. It reflects that
in open as well as small economy of Singapore, rate of exchange is most effective tool in
maintenance of the price stability (Loh 2014).

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In open and small economy of Singapore, where the gross imports and exports of the
goods and services exceeds three hundred percent of the GDP and the expenditure is having
higher content of import, the rate of exchange has stronger impact on the inflation compared
to rate of interest. Consequently, framework of the monetary policy of MAS is centred on the
management of Singapore dollar against the trade-weighted basket of the currencies. It is
termed as “Singapore dollar nominal effective exchange rate”. MAS conducts the operations
of money market for providing sufficient liquidity for the well-functioning system of banking
and meeting the demand of banks for the reserve and the settlement balances (Mas.gov.sg.
2020).
Answer to Question 2)
Key Unique Differences to be Successful International Financial Centre
The position of Singapore is leading “international financial centre”. The rise of city
to the prominence as IFC is sign as well as determinant to the strength of economy. As per
latest interaction of “Global Financial Centre Index”, currently, Singapore is ranked in fourth
position for world’s most competitive centre of finance, trailing Hong Kong by only four
point, who is its closest competitor. Singapore is ranked in fourth position in “Xinhua-Dow
Jones International Centers Development Index” and Sixth in “Deloitte Wealth Management
Centre Ranking 2015”.
Hong Kong has been succeeded as an “international financial centre” because it is
having its historical design or accident, followed sound principles of the free market with the
minimal intervention of government. Market is having habit of moving around the artificial
barrier that is created against them. This free market is enshrined in the one country and two
principle system. Usually, Hong Kong is not challenged from the other centres, however, the
challenges come from the requirement to maintain confidence. There are two confidence
aspects, which affects market efficiency. The first one is requirement for the political

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stability, in the absence of which market cannot thrive (Woo 2015). In this concern, Hong
Kong has enjoyed long political stability. This country applies concept of the one country and
two systems. However, the main reason behind success of Hong Kong as “international
financial centre” have been preserved in the basic law and Joint declaration. The second
aspect of confidence lies in freedom and ability of entrepreneur in making uses of their own
judgement and skills for acting in the best interest. The pool of the entrepreneurial talent of
Hong Kong is envy of world (Chiu 2018).
Singapore owes the strength from its derivative markets and foreign exchange,
whereas, Hong Kong succeeds on its offshore lending and industry of fund management.
Therefore, Hong Kong and the Singapore complements each other for providing the financial
services to the clients. Moreover, there consists of no “zero-sum competition” in between
two, each of which serves two different geographic regions. In case, if Singapore is not
successful in the development of its industry of fund management, then Hong Kong will be
affected badly. It is because industry in the region is still at the stage of infant and prospects
of market for the expansion is still great. Hence, deciding factor for Hong Kong or Singapore
to emerge as second IFC, will depend on the speed with which these two centres in order to
recover from the Asian financial crisis will be using technological development and efficient
provision of wide financial services or products ranges are tailored to international client’s
needs at the competitive prices (Edb.gov.hk. 2020).
Since 1960, Hong Kong and Singapore have been competing with each other to be
next IFC after Tokyo. When market of Asian dollar was first introduced, Singapore had head
start in year 1968. However, Hong Kong lagged behind due to its moratorium on the licenses
of banking arises from crisis of banking in year 1965 and also this country refused to abolish
interest withholding tax on the deposits of foreign currency. Despite of the hindrance, Hong
Kong gain its momentum afterwards through different measures for developing itself into the

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IFC (Hkma.gov.hk. 2020). After reversion to the rule of China in 1997, Hong Kong started
functioning as IFC with the China as its major neighborhood. On contrary, the government of
Singapore has publicly indicated that Singapore will be developed as second IFC in Asia-
Pacific region in next millennium after Tokyo. Therefore, Hong Kong and Singapore are
direct competitors in race of second place. Each one is having its own different comparative
advantage that makes the comparison somewhat difficult (Töpfer and Hall 2018).
Singapore and Hong Kong share various similarities in their financial structure. Both
of the country does not own the central bank, rather they own respective authorities of
monetary, which does not have issuing powers. The issuing power is delegated to the third
party. The issuance of currency in Singapore is prerogative power of Currency board,
however, the exchange rate system of Singapore is under the managed floating system. In the
system of banking, each country follows the structure of three-tier with some of the variances
(Woo 2015). Hong Kong develops the integrated system of banking, tied with
internationalization of the Hong Kong dollar, whereas, Singapore is having offshore system
of banking, which is specialized in Asian-dollar market. In Hong Kong, “non-bank financial
institutions” are retained privatively including different funds of Hong Kong, where as
Singapore is having strong presence of the non-bank financial institutions. The government
of Singapore has been using staid institutions for the macroeconomic stabilization as well as
economic restructuring (Woo 2015).

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Table 1: Financial Structure of the Singapore and Hong Kong
Table 2: Financial Market in the Singapore and Hong Kong
Singapore does not provide services for clearing and the settlement, as there are
restrictions on transactions in the Singapore dollar terms. However, compared to this Hong
Kong provides the services for the clearing as well as settlement of the cross-border payments

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and transactions in the foreign exchange market of Hong Kong. Further, Singapore involves
large number of third country currencies, for instance, dollar of US, Deutschmark and Yen
with the local trading of currency amounts to not more than 5%. Contrary to this, the trade of
US$/HK$ predominates in foreign exchange market of Hong Kong (Chiu 2018).
Answer to Question 3)
Significance, Implications and Weaknesses of CAPM
CAPM Significance
“CAPM” is measure of the relationship between the expected return and risk of
investment in the security. It is used for analyzing the securities and helps in pricing them,
given expected rate of the return and risk of investment in security. Every investment
involves certain risk. There might be difference between actual and expected return. Further,
cost of equity is the discount rate that is applied for expecting cash flows of equity that helps
in determining price that one is willing to pay for such flows of cash (Ronzani, Candido and
Maldonado 2017). By nature, investors are conservative, they decide to take risks only when
they can forecast return on their expectation from investment. The investors calculate and
they get the idea of required rate of return on the investment that is based on the assessment
of the risk using “CAPM” (Novak 2015). Following are the main significance of CAPM:
 CAPM considers only market or systematic risk. This helps to eliminate vagueness
related with risk of the individual security and only the market general risk that has
degree of the certainty, becomes major factor. CAPM makes the assumption that
investors hold diversified set of portfolio and hence, unsystematic risk eradicates
between holdings of stock (Novak 2015).
 CAPM is used widely in the industry of finance for the calculation of cost of equity
for the calculation of WACC that is used extensively for checking cost of the

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financing from the various sources. It is considered as better model for calculating
cost of equity, in comparison to the model such as dividend growth model.
 This model is universally applied and easy to use model. CAPM helps in making
comparison between the stocks of different companies and countries (Nwani 2015).
Graph 3: CAPM
Implication of CAPM
“CAPM” is based on different assumptions. These assumptions help in providing
logical basis for the measurement of risk and relating the risk and return. Following are the
implications of “CAPM”:
 The investors will try always to combine the risk-free asset with the market portfolio
of the risky asset. Investment in the risky assets will be in proportion to its value of
market.
 The compensation will be given to investors for the risk, which will not be diversified.
This is termed to be systematic risk related to market. Beta is covariance ratio that is
between market return and asset return. The beta divided by the market variance is
most suitable asset’s risk measure (Yadav 2016).

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 Investors expects returns from the investment in accordance with risk. It indicates
linear relationship in between expected return of asset and its beta (Vendrame, Tucker
and Guermat 2016).
Weakness of CAPM
Apart from various benefits, CAPM also suffers from some weaknesses, which are as
follows:
 Rf is yield on the short-term securities of government that is most commonly accepted
rate. However, the issue with this input is that daily changes in yield creates volatility.
 It is difficult for determining proxy beta for properly assessment of project and can
affect the reliability of outcome.
 CAPM is based on the various unrealistic assumptions.
 Beta does not remain stable over period of time (Sattar 2017).
Answer to Question 4)
Asymmetric Information and Solving Problem by Financial Markets
Asymmetric information is the failure of information that occurs when one of the
party to the economic transaction, possesses more or greater material knowledge compared to
other party. It typically shows when the seller of goods or services is having better knowledge
in comparison to buyer. Almost all economic transactions are consisting of information
asymmetries. Asymmetric information is division and specialization of knowledge, which is
applied to business trade. For instance, typically doctors know more regarding the medical
practices compared to their patients. It is because doctors are having extensive backgrounds
of medical school, which their patients are not having. This equally applies to other
professions (Glode and Opp 2016).

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In the financial market, asymmetric information is problem such as lending and
borrowing. In this market, borrower is having much better information regarding his financial
state in comparison to the lender. Further, lender finds its difficult to know whether there are
the chances that borrower will default. Lender to some of the extent tries overcoming this by
observing at the past history of credit and evidences of the reliable salary. It does not give full
picture, as it only gives limited set of information. Moreover, the consequences of this is that
the lenders charges higher rates for compensating for risk. In case of having perfect
information, the banks would not require to charge the risk premium (Fuchs, Öry and
Skrzypacz 2016).
Asymmetric information leads towards either adverse selection or moral hazards. The
occurrence of adverse selection is when undesired outcome happens because sellers and
buyers are having access to the various information and the occurrence of moral hazard is
when party takes risks because cost of the risk will not bear by party. Both of the situation
results in the failure of market (Benhabib, Liu and Wang 2016). Moreover, financial market
helps in solving the problems of asymmetric information by the help of following points:
 Information Availability: It involves creation of the opportunities for having greater
access to the information to users. It is not possible for providing all information at a
time, however significant information should be given to user for making educated
decision.
 Warranties and Guarantees: These benefits help in offering cushion to the
consumers against the faulty products. It is also beneficial in negotiation of the prices.
 Subsidies and Taxes: The intervention of government by the policies is common in
the case of market imperfection. The government strikes balance between the losers
and gainers (Fuchs, Öry and Skrzypacz 2016).

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 Industrial Standards: The industries set certain pre-conditions to be met in order to
provide goods and services. It ensures offering higher-quality services and products in
market. The asymmetry of information can be harmful in the case of adverse selection
in market.
 Monitoring and Controlling: Sufficient level of monitoring and controlling are the
other big challenges. In the absence of proper monitoring as well as controlling,
companies may get impacted by different problems executed by the illegal
beneficiaries.
 Licensing and Liability Laws: It is the part of regulations of consumer protection in
which certain permits or licenses are required for selling certain goods and services.
In case of not meeting industry standards by firms, severe penalties are imposed
(Kurlat and Veldkamp 2015).
Conclusion
Therefore, this report concludes that monetary policy of Singapore is placed around
managing the trade-weighted rate of exchange with the objective of ensuring stability of price
over medium term as the basis for the sustainable growth of economy. Further, it has been
analyzed that the both Hong Kong and Singapore complement each other in providing the
financial services to its clients. However, there are certain key unique differences that makes
it to be successful international financial centres. Moreover, it has been analyzed that despite
some of the weakness, CAPM offers numerous benefits and significance to its users such as
easy to use, diversified portfolio, systematic risk and financial and business risk variability.
Lastly, it can be said that asymmetric information is situation in which there are unequal
knowledge in between parties of transaction that results in unusual benefit to party with the
additional knowledge. Its problem is long-standing phenomenon, which is expected to prevail
because of differences in the perception and lack of the smooth parties.

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