Financial Markets

Student name: Nguyen Bao Linh

Student ID: F14-129

Word count: 4000 words (excluding tables, charts, and graphs)

 Table of Contents

Question 1:........................................................................................................................................................4

a. Different levels of market efficiency.......................................................................................................4

b. The efficiency of the stock exchange market in an emerging economy.................................................6

Question 2:......................................................................................................................................................10

a. Similarities and differences between capital market and money market..............................................10

b. Money markets’ activities influence asset price in the capital markets................................................13

Question 3:......................................................................................................................................................15

a. Fixed and floating exchange rate system..............................................................................................15

b. Developing/ emerging countries tend to favor a fixed exchange rate system.......................................15

Question 4:......................................................................................................................................................17

a. Asian-dollar and Euro-dollar markets...................................................................................................17

b. Forward foreign exchange markets.......................................................................................................18

c. Adverse selection..................................................................................................................................20

References.......................................................................................................................................................21

Appendix.........................................................................................................................................................26

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 List of Tables/ Figures and Appendix

Table 1: Forms of efficient market.....................................................................................................................5

Table 2: Capital market vs Money Market.......................................................................................................12

Figure 1: Daily Return of India Stock Exchange...............................................................................................7

Figure 2: Daily Return of Vedanta Ltd & JSW Steel Ltd...................................................................................8

Figure 3: Stock price of Vedanta Ltd.................................................................................................................9

Figure 4: Stock price of JSW Steel Ltd............................................................................................................10

Figure 5: Fed Fund Rate vs US Treasury Bond Index in 2022........................................................................14

Figure 6: Quatar’s export in 2022....................................................................................................................16

Figure 7: Asian US dollar bonds by country of issuance from 2010 to 2019..................................................17

Figure 8: Sales volume of futures contracts at some Vietnamese commercial banks......................................19

Appendix 1: Daily Return Of India Stock Exchange Index.............................................................................26

Appendix 2: Daily Return Of Vedanta Ltd (Vdan) Index................................................................................26

Appendix 3: Daily Return Of Jsw Steel Ltd (Jstl) Index.................................................................................27

Appendix 4: Stock Price Of Vedanta Ltd (Vdan) Index...................................................................................27

Appendix 5: Stock Price Of Jsw Steel Ltd (Jstl) Index....................................................................................27

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Question 1:

a. Different levels of market efficiency

Since the 1960s, Paul A. Samuelson and Eugene F. Fama have worked towards the efficient market
hypothesis (EMH), which asserts that market prices precisely reflect all information that is currently
accessible. Theoretical frameworks and empirical investigations of financial securities prices have adopted
this concept extensively (Samuelson, 1965; Fama, 1970). It is impossible to generate superior returns
(beyond the market) by utilizing all available information , and hence according to this theory, which asserts
that equities should consistently trade at their fair market value.

According to the efficient market hypothesis, the market value is expected to reflect the assimilation of all
relevant data accessible at any given point in time. Nevertheless, the influence on stock values is contingent
upon various sources of information, leading to the formulation of three distinct variations of the Efficient
Market Hypothesis as proposed by Fama (1965):

Weak Form Efficiency

The concept of weak form market efficiency posits that the prices of securities traded in the market cannot
be accurately forecasted based solely on previous price information (Naseer and Bin Tariq, 2015). Hence,
it is not feasible for investors to generate abnormal returns by relying just on historical information like
trading price and trading volume of firm shares. This also implies that technical analysis will be helpless
for investors in exploring potential stocks for investment, while fundamental analysis which is based on
corporate related information is still useful for investors in selecting good stocks.

According to a study conducted by Ryaly, Kumar and Urlankula (2014), South Korea, Japan, Singapore,
and Hong Kong have been identified as nations that exhibit characteristics of weak form efficiency
markets. This conclusion was drawn based on an analysis of daily stock index data spanning from July
1997 to November 2013. Similarly, Research conducted by Ansari and Chen (2013) also provided
substantial evidence supporting the results of the above study.

Semi-strong Form Efficiency

According to the semi-strong form of the market efficiency hypothesis, all publicly available information
– including historical information and newly announced news - is entirely incorporated into current prices
(Clarke, Jandik and Mandelker, 2000). Specifically, iIn addition to historical prices, public information
comprises data disclosed in the financial statements of a company, including annual reports, earnings
reports, dividends, and announced merger plans, as well as projections regarding macroeconomic
variables (e.g., unemployment and inflation). Public information is not inherently restricted to financial
matters (Clarke, Jandik and Mandelker, 2000). Given that the current price of a stock is determined using
all publicly accessible information, investors are unable to utilize technical or fundamental analysis to
achieve superior returns in the market. Only undisclosed information can assist investors in enhancing

4
their returns to levels surpassing the overall market performance (Clarke, Jandik and Mandelker, 2000).

Lanjong (1983), Barnes (1986), Laurence (1986) and Neoh (1986) assert that the Malaysian market
demonstrates a high level of efficiency in the weak form but lacks efficiency in the semi-strong form. On
the other hand, Kok and Goh (1993, 1995) and Yong (1989) indicated that Malaysia does not exhibit weak
form efficiency. Hussin, Ahmed and Ying (2010) presented empirical support for the semi-strong
efficiency of the Malaysian stock market, which aligns with the conclusions drawn by Isa and
Subramaniam (1992) and Hiau et al. (2002). In general, the empirical findings suggest that the Malaysian
Stock Exchange has not yet achieved its full level of efficiency in the semi-strong form, which is in line
with the observations made by Nasir and Mohamad (1993) who concluded that the Malaysian Stock
Exchange tends to be near to being efficient in the semi-strong form.

Strong Form Efficiency

The strong form of the market efficiency hypothesis posits that the present price integrates every piece of
available information, including public and private data (also referred to as “inside information”). The
primary distinction between the semi-strong and strong efficiency hypotheses asserts that, under the latter
hypothesis, it is impossible for any individual to systematically gain profits through trading based on non-
public information (Clarke, Jandik and Mandelker, 2000). Consequently, investors are unable to utilize
fundamental or technical analysis, and any gathered information or completed research does not enable
them to “beat the market” and generate gains that surpass the typical returns of the market (Clarke, Jandik
and Mandelker, 2000).

Czekaj, Woś and Żarnowski (2001) conducted a study to assess the efficacy of the strong version of Stock
Exchanges in various stages of development. The findings of the study provide evidence supporting the
theory that there is a strong form efficiency present on the Warsaw Stock Exchange. These findings
exhibit a resemblance to the research conducted by Potocki and Swist (2012).

Table 1: Forms of efficient market

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 b. The efficiency of the stock exchange market in an emerging economy

Emerging stock market

- Country: India is one of the emerging markets according to MSCI (2023).

- Stock market index: Nifty 50 (NSEI)
- Two specific stock firms: Vedanta Ltd (VDAN) and JSW Steel Ltd (JSTL)

Dataset

- Data source: investing.com

- Time frame: 90 days from July 3rd 2023 to November 2nd 2023
- Data frequency: daily

Literature

According to Dupernex (2007), he posits a connection between the concept of stock prices adhering to a
random walk and the efficient market hypothesis (EMH). The underlying assumption is that investors
promptly respond to any informational advantages they possess, thereby reducing potential profit
opportunities. Thus, prices consistently incorporate all relevant information, leaving no room for profit
through information-based trading (Lo and MacKinley, 1999). This results in a random walk pattern,
whereby the sequence of price changes becomes increasingly random as the market becomes more efficient.

Several studies have examined the Market Efficiency of the Indian Stock Exchange and have yielded
varying conclusions. The study conducted by Gupta and Basu (2007) aimed to assess the weak form
efficiency of Indian stock markets between 1991 and 2006. To achieve this, the researchers employed a run-
in test and variance ratio test. This study indicates that the dataset deviates from the random walk model,
implying that the Indian stock market does not exhibit weak form efficiency. This conclusion aligns with a
previous study conducted by Srinivasan, (2010), where unit testing was utilized to examine the random walk
hypothesis using daily data sets spanning from 1997 to 2010. Chaudhary (2014) conducted research that
aligns with the finding that the Indian stock market exhibits weak form inefficiency. The study analyzed
daily data spanning a period of 10 years, from 2003 to 2013.

On the other hand, numerous studies have examined the semi-strong efficient market hypothesis (EMH) in
the Indian market, specifically in relation to event announcements such as dividends, bonuses, and rights
issues. In the study titled “Testing Semi-Strong Form of Efficient Market Hypothesis in Relation to the
Impact of Foreign Institutional Investors’ (FII’s) Investments on Indian Capital Market”, Khan and Ikram
(2010) employed simple correlation and linear regression techniques to analyse monthly data obtained from
the National and Bombay Stock Exchanges. The findings indicate that the Indian stock market exhibits
semi-strong efficiency. The Indian market exhibits semi-efficiency, as observed in the study of Mishra
(2005).

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In addition, Gupta and Sardana (2018) contend that the Indian stock market demonstrates efficiency in both
weak and semi-strong forms, as discussed in their study titled “A Study on the Semi Strong Form of
Efficiency in Indian Stock Market”. This study employs Serial Correlation testing to examine the weak form
of market efficiency and utilizes the Event study method to analyze the semi-strong form of market
efficiency.

In summary, it is evident that the Indian stock market has been subject to varying perspectives regarding its
market efficiency. The primary objective of this study is to ascertain the level of efficiency exhibited by the
Indian stock market, specifically focusing on whether it can be classified as weak or semi-strong form
efficiency. By conducting a thorough analysis, this research aims to shed light on the extent to which market
information is incorporated into stock prices in a timely and accurate manner.

Empirical evidence

1. Weak form efficiency testing

The dataset utilized in this study was obtained from the Indian stock market, encompassing a time frame of
90 days spanning from July 3rd to November 2nd, 2023. In the context of the stock market, the data that is
gathered will be utilized for the purpose of examining the weak form efficiency. This examination will be
conducted by employing the Daily profit formula, which is outlined below:

Daily Return (%) of India Stock Exchange

1.50%
1.00%
0.50%
0.00%
-0.50%
-1.00%
-1.50%
-2.00%
23 23 23 23 23 23 23 23 23 23 23 23 23 23 23 23 23 23 23 23 23
/20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20
3 9 5 1 7 2 8 4 0 6 1 7 3 9 5 1 7 3 9 5 1
7/ 7/ 7/1 7/2 7/2 8/ 8/ 8/1 8/2 8/2 9/ 9/ 9/1 9/1 9/2 10/ 10/ 0/1 0/1 0/2 0/3
1 1 1 1

Figure 1: Daily Return of India Stock Exchange

Source: (Investing, 2023b), (Appendix 1, p.26)

As can be seen in Figure 1, the daily returns of the Indian stock market exhibit significant fluctuations over
a span of 90 days. These fluctuations appear to be random in nature, thereby providing empirical evidence in

7
support of the random walk theory, which posits that stock prices follow a stochastic process. This
observation underscores the notion that stock market movements cannot be predicted with certainty, as they
are influenced by a multitude of factors that are inherently unpredictable. Hence, based on the analysis
conducted, it can be deduced that the Indian stock market exhibits characteristics of weak form efficiency.
Consequently, investors are unable to achieve abnormal returns by solely relying on the historical patterns of
stock prices.

Daily Return (%) of Vedanta & JSW Steel

8.00%
6.00%
4.00%
2.00%
0.00%
-2.00%
-4.00%
-6.00%
-8.00%
3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3
202 202 202 202 202 202 202 202 202 202 202 202 202 202 202 202 202 202 202 202 202
3/ 9/ 5/ 1/ 7/ 2/ 8/ 4/ 0/ 6/ 1/ 7/ 3/ 9/ 5/ 1/ 7/ 3/ 9/ 5/ 1/
7/ 7/ 7/1 7/2 7/2 8/ 8/ 8/1 8/2 8/2 9/ 9/ 9/1 9/1 9/2 10/ 10/ 0/1 0/1 0/2 0/3
1 1 1 1

Vedanta Ltd JSW Steel Ltd

Figure 2: Daily Return of Vedanta Ltd & JSW Steel Ltd

Source: (Investing, 2023c, 2023a), (Appendix 2, p.26), (Appendix 3, p.27)

Figure 2 illustrates the daily profitability trends of two prominent companies, namely Vedanta and JSW
Steel, over a span of 90 days. It is evident from the graph that the daily profits of both companies exhibited
considerable fluctuations, characterized by frequent oscillations in an unpredictable manner. These
fluctuations lacked any discernible pattern, rendering the movements of these companies' profits impervious
to accurate prediction. In relation to Vedanta's profit index, it experienced a significant and notable surge,
reaching a value of 6.82% on September 29. This substantial increase occurred merely two days after a
substantial decline, wherein the profit index had sharply decreased to -6.70%. In a manner akin to the
aforementioned second company, JSW Steel, it can be observed that there is a lack of discernible pattern in
the stock price returns, as they exhibit a fluctuating nature within the range of -2.73% to 3.43%. It can be
posited that the stock market in India exhibits characteristics of weak form efficiency. Consequently,
investors encounter challenges in discerning and capitalizing on discernible patterns or trends in stock
prices, thereby limiting their ability to generate returns that surpass the overall market performance.

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 2. Semi-strong efficiency testing

Stock price of Vedanta

290

285
278.1
280

275

270

265

260
t - t - t - t - t - t - t - t - t - t - t - t - t - t - t - t = t + t + t + t + t + t + t + t + t + t + t + t + t + t + t +
15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Figure 3: Stock price of Vedanta Ltd

Source: (Investing, 2023c), (Appendix 4, p.27)

On June 30th 2023 (t = 0), Vedanta Ltd announced a decrease of 40% in net profit of the second quarter,
amounting to Rs 2,640 crore (NSE, 2023). The group's financial statement revealed a consolidated nett profit
of Rs 4,421 crore and a declaration of an interim dividend of Rs 18.50 per share (Jagannath, 2023). The
stock price earlier hit a nadir of 276.2 Rupees and exhibited a moderate upward trend, reaching 279.95
Rupees. Subsequently, the stock price further declined to 277.95 Rupees one day prior to the announcement.
On the day of the announcement, the stock price reverted to 278.1, but there was no discernible alteration
until 5 days following the release. It is evident that the stock price remained unchanged on day t = 0, thereby
indicating a sluggish response of the stock price in incorporating new information. Based on the analysis of
the provided chart, it can be inferred that the Indian stock market does not exhibit characteristics of semi-
strong efficiency.

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 Stock price of JSW Steel
800

780

760 748.95

740

720

700

680
t - t - t - t - t - t - t - t - t - t - t - t - t - t - t - t = t + t + t + t + t + t + t + t + t + t + t + t + t + t + t +
15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Figure 4: Stock price of JSW Steel Ltd

Source: (Investing, 2023a), (Appendix 5, p.27)

On October 20th 2023 (t = 0), JSW Steel released their Q2 FY24 results, reporting a net profit of Rs 2,760
crore, which is higher than the previous quarter’s net profit of Rs 2,338 crore (Mint, 2023). The stock price
reached its peak of 790.7 Rupees 5 days prior to the news, and subsequently declined to 748.95 on the day
of the announcement. Following the announcement, the stock price continued to decline to 728.7 Rupees
and 724.45 Rupees respectively over a span of 6 days. During the period from the 9th to the 15th day, there
was a substantial fluctuation in the new stock price. It is evident that with the release of new information, the
stock price remained unchanged, indicating that the Indian market lacks semi-strong efficiency.

Conclusion

Based on the aforementioned tests and analysis conducted on weak and semi-strong form efficiency, the
findings of this study lead to the conclusion that the stock market in India can be classified as a weak form
efficient market. However, when examining the evidence pertaining to efficiency in the semi-strong form,
the study reveals limited indications of efficiency. The findings presented in this study diverge from the
aforementioned conclusions, potentially attributable to variances in research methodologies or study periods.

Question 2:

a. Similarities and differences between capital market and money market

Capital Market Money Market

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Definition The capital market refers to the The money market facilitates the
marketplace in which firms and purchase and sale of short-term priced
governments issue financial documents and provides large
instruments, such as bonds and shares, institutions, banks, and governments
to fulfil their long-term financial with the means to satisfy their short-
requirements. term capital requirements.

Similarities

The “money market” and “capital market” are constituent components of the broader financial market. Both
the money market and the capital market play a crucial role in facilitating the flow of capital within the
economy.

Since interest rates on the money market influence the issuance and purchase of securities on the capital
market, the two markets are perpetually complementary and mutually supportive. Simultaneously,
fluctuations in money market prices and interest rates have an immediate impact on the capital market.

Differences

Roles and functions Capital markets provide medium to Money markets provide short-term to
long-term investment capital to firms governments, commercial banks, and
and governments, enabling them to other large institutions, promoting
pursue expansion and growth initiatives economic stability and prosperity.
that contribute to the overall growth of
the economy.

Different from money market, capital The money market is where the central
market does not serve as a chain in the bank’s monetary policy goals are put
transmission process of the central into reality, allowing the bank to
bank’s monetary policy. Rather than achieve its policymaking mission.
that, capital market transactions reflect
the act of central bank. An increase or
decrease in interest rate will affect
investors’ expectation about the market
and alter their investment behavior.

The capital market also contributes to Money markets play a crucial role in
the long-term regulation of facilitating the circulation of currency
consumption by facilitating the within the economy by offering short-
investment of dormant funds and term financial instruments that enable
savings from individuals in further both organizations and individuals to

11
 economic development initiatives. engage in transactions and build up their
cash reserves.

About market liquidity creation, the Money market enhance the market
capital market supports liquidity in the liquidity by investing in short-term debt
aspect of financial assets, such as stocks securities of high quality. These
and bonds. Investors can conveniently securities are characterized by their
purchase, sell, and convert assets, stability and limited price volatility,
thereby enhancing asset management which ensures capital preservation and
efficiency and fulfilling their financial facilitates easy access to liquid funds.
requirements. This has resulted in a consistent revenue
stream and has gained popularity as a
method of cash management for both
individual and institutional investors.

Other than roles and functions, two markets also witness following differences

Types Primary market and secondary market None

Features Long term (> 1 year) Short term (< 1 year)

Low liquidity due to long-term maturity High liquidity due to maturity ranging
(initial maturity of more than 5 years) from one day to 1 year, therefore many
and no specified time. investors are willing to invest their
money for short periods of time.

High risk because the mobilized capital Low interest rate risk due to changes in
is invested in long-term projects. market interest rates does not have
much impact on short-term assets.

Higher returns due to longer term as Low returns because money market
well as the risk that investors accept. returns are equal to the cost of capital or
the prevailing interest rate in the
economy so earning a return in excess
of the interest rate is impossible.

Instruments Bonds and stocks Bills of Exchange or Commercial Bills,

Treasury Bills (T-Bills), Commercial
Papers (CP), Certificate of Deposits
(CD), Repurchase Agreements,
Banker’s Acceptance and Call & Notice

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 Money

Participants Commercial banks, stock exchanges

and retail investors, insurance Banks and other financial institutions
companies, mutual funds

Table 2: Capital market vs Money Market

Source: (Howells and Bain, 2007, 2008a, 2008b)

b. Money markets’ activities influence asset price in the capital markets

Monetary policy refers to the set of actions implemented by the central bank to influence macroeconomic
objectives, including price stability, interest rates, unemployment, and economic growth (Le, 2023a). These
measures often involve the use of interest rate tools, reserve requirement, and open market operations (Le,
2023a).

Monetary policy influences the stock market as a result of its significant instruments that influence all facets
of the economy in order to stabilize the macroeconomy and control pricing. Monetary policy, according to
Smirlock and Yawitz (1985), influences market interest rates and, by extension, stock prices via two primary
channels.

To commence, the implementation of monetary policy tightening can be achieved by implementing higher
policy interest rates (short-term rate), such as the prime rate, which subsequently causes a surge in the
market interest rate employed to discount cash flows within the valuation model. As a consequence, there is
a decline in retail prices of stocks.

The second pathway involves the influence of monetary policy on future cash flow expectations, including
corporate earnings. The money market’s interest rate policies are believed to have negative relationship with
the corporate earnings, which then affects the investors’ expectation on the potential growth of firms coupled
with their demand of stocks. This at the end result in changes in the prices of stocks.

For example, a tightening monetary policy tightening has the potential to inhibit economic activity and
subsequently impact the future revenue prospects of businesses. Monetary tightening, as elucidated by
Bernanke and Gertler (1995), can result in a contraction of corporate net cash flow via interest rate hikes,
subsequently impact the future revenue prospects of businesses. As a consequence of monetary policy
tightening, aggregate demand and consumer expenditures are diminished, and interest rates rise. This
discourages investors from buying these firm shares and then a decrease in the share price will be exercised.

Furthermore, an escalation in market interest rates will diminish the financial capacity of the organization,
thereby subjecting it to a greater risk premium when seeking external funding. Therefore, the organization is
compelled to terminate or defer lucrative investment prospects, thereby diminishing its prospective earnings
capacity.

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Conversely, the imposition of stringent monetary policies might impede commercial banks from extending
credit to enterprises. Through risk premiums, monetary policy may also have an impact on stock pricing. As
a result of monetary tightening and expectations of a recessionary cycle, investors may perceive stocks as
high-risk investments. In order to offset the augmented risk, investors require greater discounts, a condition
that can solely be fulfilled by means of diminished stock prices.

Fed Fund Rate (%) vs US Treasury Bond (USD)

480 5
470 4.5
460 4
450 3.5
440 3
430 2.5
420 2
USD

%
410 1.5
400 1
390 0.5
380 0
2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2
202 202 202 202 202 202 202 202 202 202 202 202 202 202 202 202 202 202 202 202 202 202
3/ 0/ 6/ 3/ 2/ 9/ 5/ 2/ 9/ 5/ 2/ 9/ 6/ 2/ 9/ 5/ 2/ 9/ 5/ 2/ 9/ 6/
1/ 1/2 2/ 2/2 3/1 3/2 4/1 5/ 5/1 6/ 6/2 7/ 7/2 8/1 8/2 9/1 10/ 0/1 11/ 1/2 12/ 2/2
1 1 1

Treasury Bond Index Fed Fund Rate

Figure 5: Fed Fund Rate vs US Treasury Bond Index in 2022

Source: (S&P Dow Jones Indices, 2023), (Fred, 2023)

The escalating tensions between Russia and Ukraine have resulted in an increase in prices for raw
commodities, which are crucial for the global economy. This has further burdened governments that are
already grappling with the challenge of growing inflation. The fighting and sanctions have resulted in an
increase in commodity prices due to supply disruptions, leading to a significant supply crisis in Europe.

Various countries worldwide are currently experiencing significant inflationary pressures, notably the United
States. In March 2022, the inflation rate in the US rose to 8.5% (Statista, 2023a). Consequently, the Federal
Reserve raised the benchmark interest rate to 1.58% by June 2022 (Macro Trends, 2023). Following the
Federal Reserve’s decision to increase interest rates, bond prices had a substantial decline, dropping from
470.35 USD in January to 425.16 USD in June (S&P Dow Jones Indices, 2023).

The Federal Reserve’s decision to raise interest rates leads to higher borrowing expenses, resulting in
decreased demand for loans from firms and consumers. Consequently, there is a reduced demand for bonds
due to restricted financial resources (Curry, 2023). Consequently, the US government has forced to decrease
bond prices in order to provide investors greater interest payments and entice potential buyers.

14
In 2022, the Fed funds rate showed a consistent increase, while Treasury bond prices generally exhibited a
decline. To summarize, this data has shown a negative correlation between interest rates and bond prices. Put
simply, an increase in interest rates in the money market will lead to a decrease in asset prices in the capital
market.

Question 3:

a. Fixed and floating exchange rate system

A fixed exchange rate is a policy implemented by a government or central bank that links the official
currency exchange rate of a country to the currency of another country or the value of gold (Howells and
Bain, 1947). The objective of a fixed exchange rate system is to maintain the value of a currency within a
limited range.

On the other hand, a floating exchange rate is a system where the value of a nation’s currency is determined
by the foreign exchange market, taking into account the balance between the currency’s supply and demand
compared to other currencies (Howells and Bain, 1947). This stands in opposition to fixed exchange rates,
when the government has full or primary control over determining the exchange rate.

At fixed exchange rates, currency values may depreciate or be revalued; conversely, at floating exchange
rates, currency values may appreciate and depreciate. Moreover, the central bank participates and intervenes
in the fixed exchange rate regime, whereas this is absent in the floating exchange rate regime (Howells and
Bain, 1947). Besides, the fixed exchange rate regime necessitates the maintenance of foreign exchange
reserves, whereas the other system does not.

b. Developing/ emerging countries tend to favor a fixed exchange rate system

Emerging countries appear to benefit from fixed exchange rate systems due to the fact that these systems are
well-suited to certain characteristics of these markets. Specifically, emergent countries commonly participate
in international trade in order to stimulate economic expansion, thereby facilitating their transition towards a
developed economy (Gorodnichenko, Svejnar and Terrell, 2010). Consequently, these nations will primarily
concentrate on promoting global investment and exporting endeavors. Emerging markets sometimes adopt
“pegged or fixed exchange rate systems”, particularly by pegging their domestic currency to the currency of
a more robust economy. The primary benefit is the mitigation of volatility in the pegged currency compared
to other foreign currencies (Klein et al., 2006). This approach facilitates the entry of domestic enterprises
into foreign markets by reducing the risk associated with currency rate fluctuations. As a result, it stimulates
international trade and investment.

When considering another notable characteristic, it is worth noting that currency volatility in emerging
markets is generally regarded as relatively high. This can be attributed to the fact that these markets are
significantly influenced by fluctuations in commodity prices (Mohanty and Klau, 2001). An example of the
impact of a stronger US currency is the increase in the cost of imported goods from the United States. When

15
the US currency gains strength, it leads to a higher exchange rate, resulting in a rise in the prices of imported
goods. This phenomenon occurs because a stronger currency makes it more expensive for foreign buyers to
purchase goods denominated in that currency. Consequently, the increased cost of imported goods can have
significant implications for consumers and businesses alike, potentially affecting trade balances, inflation
rates, and overall economic stability (Ghosh and Ostry, 2009). As a result, it is anticipated that there will be
a significant increase in the inflation rate within emerging markets. Hence, it is common for emerging
markets to establish a fixed exchange rate regime, wherein their currency is pegged to a stronger currency
such as the United States Dollar (USD). This strategic move enables these markets to effectively manage
and stabilize the value of their currency (Klein et al., 2006). When a currency of a developed economy
strengthens, it often leads to a ripple effect in the currency markets, positively impacting the value of
currencies in emerging markets. Therefore, emerging markets have the ability to stabilize prices and manage
inflation.

2% 1% The Export Structure of Qatar

3% 1%

3% Mineral fuels, mineral oils

Fertilizers
Plastics and articles thereof
Aluminum and articles thereof
Chemicals

90% Materials
Ships, boats and floating structures
Vehicles and parts, accessories
Iron and steel

Figure 6: Quatar’s export in 2022

Source: (Trend Economy, 2023)

For example, Qatar is classified as an emerging market according to the MSCI (2023) and it adopts a fixed
exchange rate system by pegging the Qatari Riyal to the US Dollar at a rate of QR 3.64 per USD (Qatar
Central, 2023). The implementation of a fixed exchange rate regime has the potential to effectively stabilize
both the exchange rate and inflation within this nation. Specifically, Qatar’s economy is highly reliant on the
extraction and utilization of gas and oil (Noureddine, 2023). The majority of export agreements and invoices
are denominated in USD, underscoring the significance of linking pricing to the USD. The USD peg will
ensure the stability of the Qatari Riyal, consequently fostering stability that facilitates international
commerce and investment by mitigating the risk of currency volatility (Faster Capital, 2023). In addition, the

16
stability of the Qatari Riya has a favorable effect on the country’s overall economic performance. It
mitigates inflationary pressure and facilitates the maintenance of price stability, thereby fostering sustainable
economic growth (Faster Capital, 2023). Qatar effectively manages inflation by implementing a fixed
exchange rate, maintaining it at a low rate of 4.96% despite the prevailing high world inflation in 2022
(Statista, 2023b). This has facilitated the establishment of a secure and foreseeable business climate, thereby
enticing international investment and bolstering Qatar’s economic expansion. Undoubtedly, Qatar has
emerged as the foremost global producer and distributor of liquefied natural gas (LNG), with its gross
domestic product (GDP) mostly reliant on income generated from oil and natural gas. Qatar’s oil and gas
earnings during the first half of 2022 has amounted to 32 billion USD, accounting for 41% of the country’s
GDP (Nhat, 2023; Noureddine, 2023).

Question 4:

a. Asian-dollar and Euro-dollar markets

Asian-dollar markets

The Asian dollar market refers to a financial market in which the US dollar serves as the primary currency
for conducting trade and payment transactions in Asian nations (Kim, 2020). The Asian Dollar market,
situated in Singapore, is accessible not only to Singaporeans and local institutions but also to prominent
Asian financial hubs like Hong Kong and Tokyo. The market comprises several participants, including
“International Central Banks, Commercial Banks, governments, local and multinational enterprises, and
individuals” (Kim, 2020). The financial securities traded in this market include “Asian Dollar Bonds,
Floating Rate securities, Loan Syndication, and Certificates of Deposit” (Spell, 2023).

This financial market offers manifold advantages to both investors and borrowers. Specifically, it offers an
advanced communication network that connects all significant financial markets, facilitating seamless
collaboration among players (Shelton, 1981). Many Asian countries suffer from a dearth of local capital to
stimulate economic growth. Consequently, this market can serve as a means to mobilize funds for them.
Furthermore, the Asia-Dollar market operates outside of national authority and regulation, granting it a
higher level of flexibility compared to other financial markets.

17
 Figure 7: Asian US dollar bonds by country of issuance from 2010 to 2019
Source: (Zhong, Hu and Ding, 2019)

As an illustration, the Asian market for US dollar bonds has experienced significant growth, reaching a total
value of $1.1 trillion in outstanding bonds, as depicted in Figure 7. Besides, numerous countries are issuing
Asian Dollar bonds in the Asian Dollar market, with China leading in terms of the highest number of Asian
Dollar Bonds issued in 2018. Asia is facing more limitations in meeting the financial needs of its enterprises
due to the more stringent regulatory capital requirements imposed by Asian banks (Zhong, Hu and Ding,
2019). Consequently, numerous Asian corporations have escalated their dependence on bond markets,
particularly those denominated in US dollars.

Euro-dollar markets

The Euro-dollar market is a prominent market primarily situated in Europe, facilitating the lending and
borrowing of major convertible currencies worldwide (Le, 2023b). The primary currency exchanged in the
market is the dollar, while major European currencies, including “the British pound, Swiss franc, German
mark, Dutch guilder, and French franc”, are also traded. The Eurodollar market attracts participation from
various entities, such as commercial banks, private banks, investment banking firms, and financial
corporations from other countries, due to the comparatively higher interest rates offered on deposits in this
market (Altaian, 1967). This market enables financial institutions and banks to circumvent local regulations
and restrictions on credit rates in their operating jurisdiction (Richmond, 1993). The main instrument used in
the European currency market for long-term investment goals is Eurobonds.

Banks and financial organizations can open accounts in several countries with varied pricing and
transactions because the Eurodollar market trades billions of USD every day and has many currencies (Le,
2023b). Since the Eurodollar market is flexible, transactions may be completed rapidly and institutions can
simply transfer money between countries.

18
Furthermore, the presence of several merchants and financial institutions in this market has resulted in
significant liquidity, facilitating the identification of potential buyers or sellers for loans or deposit accounts.
Subsequently, establishing favorable circumstances for financial institutions and businesses to readily obtain
capital resources. Furthermore, the Eurocurrency market is valued based on current market prices, meaning
that prices can fluctuate over time (Le, 2023b). This presents lucrative prospects for financial institutions
and multinational corporations to generate profits or mitigate financial risks through strategic purchasing
and selling at opportune moments.

For example, Japanese investors purchased a significant quantity of euro-denominated bonds, marking the
highest level in over a year, due to the increase in yields and the favorable conditions for currency hedging.
According to the most recent balance-of-payments report released in Tokyo on Tuesday, investors obtained a
net total of 1.15 trillion-yen ($10 billion) worth of securities in January. According to the statistics, they sold
Russian bonds worth 15.4 billion yen, which is the highest amount since March 2014 (Mogi and Kondo,
2022).

b. Forward foreign exchange markets

Foreign exchange can be purchased and sold not only immediately, but also in advance for delivery on a
specific future date (Lall, 1967). The foreign exchange market, often known as the Forex or Exchange
market, is where the buying and selling of foreign currencies occur. It is also the site where exchange rates
are determined based on the connection between supply and demand. Exchange markets are essential for
facilitating international trade, investment, and borrowing as they enable countries with different national
currencies to convert them into the currencies of other countries in order to carry out transactions (Nguyen,
2019).

In the context of foreign markets, a forward exchange contract, also referred to as “an FEC” or “forward
cover”, is an agreement between a bank and its customer. This agreement establishes a predetermined
exchange rate for the purchase and sale of one currency in exchange for another currency. The transaction is
scheduled for a future date that has been mutually agreed upon (Standard Bank, 2004). Forward exchange
contracts (FECs) serve as a hedging tool that functions similarly to an insurance policy. They safeguard
traders and clients against potential unfavorable changes in exchange rates that may transpire between the
contract date and the settlement date.

Banks have made ongoing advancements in their operations, introducing various derivatives such as forward
contracts, spot contracts, futures contracts, swap contracts, and option contracts (Nguyen, 2019). Financial
tools can generate substantial profits for banks, yet their involvement in this sector also exposes them to
significant risks. While these tools have been implemented and advanced in global markets, the participation
of commercial banks in derivative contract transactions remains limited in Vietnam.

19
 Figure 8: Sales volume of futures contracts at some Vietnamese commercial banks
Source: (Nguyen et al., 2018)

Data was collected from the annual reports of six commercial banks, namely Vietinbank, Vietcombank,
Techcombank, Eximbank, BIDV, and ACB, for the period spanning from 2009 to 2017. The highest
currency revenue recorded was 98,203,380 million VND in Techcombank, while Vietinbank had the lowest
revenue of 437,355 million VND among the selected commercial banks surveyed. Forward contracts were
introduced in Vietnam as the initial derivative financial instrument according to Decision No. 65/1999/QD-
NHNN7 issued on February 25, 1999. However, there is currently limited understanding regarding the
advantages of this contract. Consequently, there is limited participation from entities and insufficient
awareness among intermediary organizations regarding the benefits of implementing this operation, which
hinders their promotion of the tool. Moreover, Vietnam faces a dearth of regulatory and legal documentation
pertaining to forward contracts. As a result, these contracts are predominantly utilized in relation to foreign
exchange products within the country (Nguyen et al., 2018).

c. Adverse selection

Adverse selection arises from “information asymmetry”, wherein one party possesses superior and more
accurate information compared to the other party(Nickolas, 2022). Adverse selection refers to a situation
where there is a lack of information symmetry prior to the formation of a contract or agreement (Nguyen,
2023). These cases may arise in various sectors such as the insurance industry, capital markets, and
conventional markets, where there is a presence of risk or opportunities for arbitrage.

Adverse selection can have negative consequences for both buyers and sellers, contingent upon the specific
circumstances (Borad, 2022). Asymmetric information arises within the capital market when individuals
possessing non-public information about securities, known as insiders, hold a significant informational
advantage. Under such circumstances, regular investors may incur financial losses and experience
significant setbacks in their investment endeavors.

20
For example, in the period 2021-2022, due to the general impact of the Covid-19 epidemic, Tan Hoang Minh
encountered many financial difficulties, with nearly 20,000 billion VND in debt (Pham, 2023). In the
context of many due and overdue debts, Do Anh Dung, chairman Tan Hoang Minh, along with deputy
general director Do Hoang Viet used the legal entity of 3 subsidiaries to disguise business activities to issue
individual bond packages to mobilize capital (Cong thong tin dien tu, 2023). Moreover, THM engaged in
collusion with auditing firms to manipulate financial statements, thereby enabling companies to meet the
requirements for bond issuance (Pham, 2023). The dissemination of inaccurate and deceptive information, as
well as the deliberate suppression of truth, during private bond offerings, has resulted in substantial financial
losses for investors. According to the investigation agency, Tan Hoang Minh misappropriated a total of
8,600 billion VND from over 6,600 customers who had signed bond investment contracts and transfer
contracts (Pham, 2023).

21
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 Appendix
APPENDIX 1: DAILY RETURN OF INDIA STOCK EXCHANGE INDEX

APPENDIX 2: DAILY RETURN OF VEDANTA LTD (VDAN) INDEX

27
APPENDIX 3: DAILY RETURN OF JSW STEEL LTD (JSTL) INDEX

APPENDIX 4: STOCK PRICE OF VEDANTA LTD (VDAN) INDEX

APPENDIX 5: STOCK PRICE OF JSW STEEL LTD (JSTL) INDEX

28