Question

(a) Identify the institutions that assist deficit and surplus units to arrange direct financing and briefly describe their activities.

(b) Discuss the main implications of the efficient market hypothesis

(minimum:250 words)

Answer 1

a) Followings are the institutions that assist deficit and surplus units to arrange direct financing (without any intermediate financing institutions) and briefly describe their activities:

• Stock market - Individuals buy stocks (IPO) to fund directly the activities of the companies.
• Bond market - Individuals directly buys newly issued commercial papers (CPs) from a business entity such as a company or government.
• Crowdsourcing platform - A lot of Crowdsourcing platforms such as Kickstarter assist surplus units to arrange direct financing for deficit units to finance their projects.
• P2P (Peer-to-peer) lending platform - Such a platform provides online services by matching lenders with borrowers for direct financing.
• Angel investors - Wealthy investors directly connect with startups and fund their ideas.

b) Followings are the main implications of the Efficient market hypothesis (EMH):

• The efficient market hypothesis (EMH) tells that all available and relevant information is already incorporated into market prices and so the value of the entity reflects its true value and thus there are no underpriced or overpriced entities for taking arbitrage activities. It assumes a negligible transaction cost of incorporating the information.
• As the value reflects all information, there is no way to investors can systematically outperform the market and profit from mispricings, because such opportunities would never come.
• In such a world, active investors can't do anything. That is, there is no price-arbitrage opportunity for cashing in. So, passive index investing is the right thing to do.