Disadvantages Of Derivative Markets Essay

Capital markets provide a function which facilitates the buying and selling of long-term financial securities to increase liquidity and their value, Watson & Head (2013). Hence, the Efficient Market Hypothesis (EMH) explains the relationship that exists with the prices of the capital market securities, where no individual can beat the market by regularly buying securities at a lower price than it should be. This means that in order to be an efficient market prices of securities will have to fairly and fully reflect all available information, Fama (1970). Consequently, Watson & Head (2013) believe that market efficiency refers to the speed and quality of how share price adjusts to new information. Nevertheless, the testing of the efficient markets has led to the recognition of three different forms of efficiency in which explains how information available is used within the market. In this essay, the EMH will be analysed; testing of EMH will show that the model does provide strong evidence to explain share behaviour but also anomalies will be discussed that refutes the EMH. Therefore, a judgment will be made to see which structure explains the efficient market and whether there are some implications with the EMH, as a whole.

Hedging is a significant measure of financial risk management. Since the 1970s, the increasing number of powerful companies started to control the risk of the exchange rate, the interest rate and commodity by using financial derivatives. ISDA (2013) based on the Global 500 Annual Report 2012 survey found that 88 percent of companies use foreign exchange derivatives. Modigliani & Miller (1958) believed that if the financial markets were under perfect conditions, for instance, there was no agency costs, asymmetric information, taxes and transaction costs, hedging would not increase the company 's value because investors can hedge by themselves. However, a large number of practical studies have shown that hedging is beneficial

Mr. Brown readily admitted that he was not at ease discussing the most recent approaches to risk reduction or hedging. He had received his MBA from Harvard in the 1960s and had spent most of his career working for a company that had little international exposure. Moreover, he was not familiar with derivatives such as currency options, which until recently were not widely traded. However, Mr. Brown had recently hired an assistant, Mr. Dan Pross, who had some knowledge of hedging and derivatives. As a student at UCLA, Mr. Pross had traded various types of derivatives for his own portfolio and was familiar with how they were traded. Although Mr. Pross did not have a finance background, he was, in Mr. Brown’s opinion, extremely intelligent and highly capable. Mr. Brown suggested that Mr. Pross make a presentation to the senior management on the use of derivatives to reduce risk.

In a(n) __________, countries and peoples are increasingly interconnected with respect to labor markets and business dealings.

Efficient market - A market in which the values of all assets and securities at any point in time reflect all available public information. In order to understand what causes price changes in stock prices and how securities are valued or priced in the financial markets, it is

* An efficient market is a market in which all the available information is fully incorporated into

The efficient markets theory, according to NASDAQ (n.d.) is the, “Principle that all assets are correctly priced by the market, and that there are no bargains,” (para. 1). This theory implies that supply and demand dictate the reasonable market value for products. Without high demand, the supply will be greater and prices will be lower. Respectively, as demand increases so do the prices until the supply and demand are at equilibrium.

Efficient Market- Advertises in which security prices return all available information and adjust right away to any fresh information. If the safekeeping markets are truly well

The definition of "derivatives" is also very wide, and includes options and warrants, whoever they are issued by, as well as rights and interests in respect of listed securities (or other derivatives).

Analyze the derivatives market and determine the use of derivatives to efficiently manage investment risks in an investment portfolio.

The tradeoff between the values of efficiency and equity is often found in government intervention. In theory, unbridled capitalism free from market intervention would result in the most efficient outcome. However, sometimes the most efficient result is not the best result. As Warren Buffett recently said, “the market system works, but it doesn’t work for everybody. It works in the aggregate.”

Last but not least important, an efficient capital market is one in which stock prices fully reflect all available information. However, the paradox is that since information is reflected in security prices quickly, knowing information when it is released does an investor little good. Furthermore, it is impossible to create a portfolio which would earn extraordinary risk adjusted return. As a consequence, all the technical and fundamental analysis are useless, no one can consistently outperform the market, and new

Most firms hedge at least some of their risks. Hedging can take two basic forms—namely, natural hedging and hedging by means of derivative instruments. The use of derivatives as hedges has expanded greatly in recent years.

Among the most fundamental risks, associated with exchange-traded derivatives, is variable degree of risk. According to Ernst, Koziol, & Schweizer (2011), the transactions in

equal and the price that the consumers pay for goods is equilibrium with the cost