Question

Q No. 5: a. What do we mean by the term Efficient Capital Market? Explain the different forms of market efficiency. What factors contribute to an efficient market?

b. What is exchange rate exposure? What are the various factors that influence exchange rate of a country? What are the factors that influence the Purchasing Power Parity Theory to hold in real world?

c. Define financial derivatives? Differentiate amongst forwards, futures, options and swaps.

(Subject is Corporate finance (Answer require immegiately)

Answer 1

5.a. Efficient capital market will mean that there will be complete discounting of public information and private information and there would not be no chance for active investors to make extra rate of return so it will be advocating passive investment.

strong form of market efficiency advocates that all the privately available information as well as publicly available information have been discounted into the prices of stock.

semi-strong form of market efficiency advocates that all the publicly available information has been discounted into the prices of stock but privately available information have not be discounted into the stock.

Weak form of market efficiency will advocate that prices are reflective of past trends and historical prices so current prices cannot be helping in making a future prediction.

In strong form of market, return can only be made through new information taking excessive risk whereas, in semi-strong form of market, exccess return can be made by insider informations and in weak Efficient market, one who can read the fundamentals can we capitalise upon discrepancy in price and intrinsic value.

B. Exchange rate exposure will be exposure due to fluctuation in exchange rate between different country.

Types of factor that will influence exchange rate will be inflation and interest rates along with transaction and political risk and monetary policy.

Purchasing power parity will be influenced by exchange rate and inflation in two countries so it will advocate that the price of same commodity in two country will always be equal.

C. Financial derivatives will mean that this will be providing forward and futures options which will be the deriving the value out of underlying asset.

Forward Market contracts are standardized contract which will be done between two parties having counterparty risk in order to hedge future exposure.

Options are part of derivative which will provide rights to buy certain number of shares or options to sell a certain number of shares at maturity.

Futures will be providing up with customised contract which will be helping in order to hedge future risk arising out of fluctuations in receivables and payables.

Swaps are derivative contract which will be helping in swapping risk ibetween two parties like interest rate swap and currency swap.