Explanation of Capital Market and Informational Efficiency

Capital Markets are the places where the ones with amount/capital in hand can make investments in various stocks and securities and other financial instruments of companies (Rossi 2016). Stock Market, Foreign Exchange Markets and market for Bonds are the most commonly accessed markets. The report aims at explaining the concept of Capital Markets and the importance of efficiency of information in the capital markets. The report tells us about the effects of news on the share market. The report, later on, focuses on the issues that have their place of occurrence in a country like the US, and which has the effects over stock markets of other countries like Australia.  

a. Capital Markets and Informational Efficiency in Capital Markets:

Capital Markets are the places where the ones with the capital in hand can make investments in various stocks and securities and other financial instruments. The Capital Markets are usually distinguished into Primary Market & Secondary Market. Primary market deals with sale and purchase of new securities whereas Secondary market deals in trading of securities between the investors that have been already issued (Chung et al 2019). The common markets are Stock Markets, Foreign Exchange Markets and market for Bonds.

Capital markets are virtual platforms and are computer operated. In a primary market, the investors can buy the requisite securities from the company directly. The stock exchanges are operated by Government bodies where all listed companies list their shares and securities for trading (Kannadhasan et al 2018). For example, in an IPO (Initial Public Offering), a company offers its potential investors to buy its stocks or bonds which are opted by many large and small investors through stock market on a direct basis. In a secondary market, the securities are traded through some mediator platforms which are regulated by the Securities & Exchange Commission (SEC). For example- NYSE (New York Stock Exchange), ASX (Australian Stock Exchange), etc.

Informational efficiency in the Capital Markets is when all the information related to a stock of the company is reflected in its market price. This means that while fixing a stock price, if the company has taken into consideration every efficient information about that stock, then such market price shall not be considered overvalued or undervalued (Zhou, Sun & Liu 2019). In the competitive world, it gets very important for the market to have informational efficiency as any slight information may change the prices to a large extent (Chung et al 2019). It is said that due to various speculation activities, investors’ and traders’ research and other similar factors, there occurs stock market price changes even before a relevant press release gets issued. But, if the market is informationally efficient, there will be no or least change in market price because the company has already inculcated the effect of such press release and other related information in its stock market price. The hypothesis related to informational efficiency (Efficient Market Hypothesis) states that the stocks are always traded on stock exchanges at fair value and there are no possibilities of their being undervalued or overvalued (Kannadhasan et al 2018). This is because of the informational efficiency of the capital markets. As the market becomes strongly informational efficient, it reduces the chances of arbitrage and unexplainable returns from markets.

Effects of Political and Economic Events in the US on the Australian Share Prices

b. Relationship between US information and Australian Share Prices:

The main elements that trigger the share price of companies in a country are its profitability, the ownership strength, reputation and credibility (Beyer, Downes & Rapley 2017). Other than these elements, the share prices of companies may be affected by any climatic disturbances, high-level financial frauds or such reasons occurred in the country or any other country with which the country has regular trade relations (BMK 2019). Now talking about the effects of economic and political events in the US which affect the Australian share prices, the following points would justify the effects:

• The United States is the biggest economic partner of Australia in terms of trade and investment. Both way trade that is between the two countries amounts to approximately US$65 billion and the investment tie-ups amount to approximately US$1.1 trillion. Almost one-fourth of foreign investment in Australia is done by the US (Australia in the USA 2019). In 2005, the US & Australia entered into an agreement related to trade which was called AUSFTA after which US exports to the country of Australia rose by 91% approximately (Australia in the USA 2019).
• A major part of US investment is in Australia among all the countries in Asia- Pacific. Moreover, there is a large trade surplus of US with Australia.
• Australia also exports many food commodities to the US and is the largest exporter of beef to the US. The export of beef provides major income to the agriculture sector of Australia (Australia in the USA 2019).
• Australia also gives a massive amount of income to the US through tourism which Australian citizens give to the US by travelling and spending in the US.
• Australia is a big market of US technology and ammunition supplies at the same time.

The above points are only a summarization of the trade relations between Australia and the US and are not the exhaustive proof of trade relation between both the countries. There may be many other trade relations between them. As Australia’s major economic dependence is on the US from the exports income and other financial help, thus any slightest economic or political event may hinder or prosper the economic state of Australia which in turn gets depicted through fall or rise in share prices respectively (BMK 2019). Other economic variables of the US such as a change in interest rates, change in exchange rates, change in GNP, etc. also affect its closely related countries such as Australia (Australia in the USA 2019).

c. Trade relations between different countries

More than 50% of the oil needs of the world are fulfilled by middle-east countries mainly Iran & Iraq who have massive controls over oil supplies and its rates. The companies dealing in oil have their share prices high and fluctuating because the demand for oil is always high and uncertain. However, the share prices tend to fall or plunge if any trade war or any uncertainty is looming upon the oil supplies from the Gulf countries to the world. For example, if a company from Iraq which is responsible for oil supplies and its pricing fails to fulfil its supply commitments on designated dates, not only the prices shoot up but also the derivative contracts attached to such deals get affected. The competitor companies’ share prices shoot up if they seize the initiative and make supplies. The prices of oil globally also tend to increase because of the uncertainty of supply from the Gulf countries. The oil companies in the US have to utilize their reserve quantity at this point of time and the news of this scenario decreases the share prices of the US companies (Appendix 1).

Examples of Different Markets Worldwide and their Relationship with the US Share Market

Sometimes, a mightier country like the US can affect the deal or restrict the conditions with a country for dealing with other countries which also affects the changes in share prices of the native country. For example- the US can sign a contract with Iran-Iraq and put supply constraints to other countries like China to mature a deal. In such cases, a country like Iran & Iraq gets into trouble whether or not to go ahead with the deal because a country like the US has the largest consumption of crude oil and also Iran & Iraq get US dollars in exchange of oil exports which are useful in other import payments like food grains and technology (Damani 2020) (Appendix 2).

As per above press release, the Indian Stock Exchange Sensex gets a hit of 2.56% recently due to disruption in oil supplies and production which shows that crude oil and its supply hits any country badly as it increases the oil prices, transportation cost and increase in import payments because if the supply is reduced, the price automatically increases which has multiple effects.

Yes, the Australian share market has a reasonable informational efficiency. But, we cannot say that it has perfect informational efficiency as it is a hypothetical situation. No country can achieve complete efficiency in an uncertain economic environment. The Australian stock market is one of the most typical markets to deal in. But still, the management and conduct of share pricing are done by the Australian Stock Exchange regulators very well. The informational efficiency can be seen when the share prices do not change miserably with a slightest economic change (Rosi & Gunradi 2018). This means that the regulators already try to incorporate the effects of possible economic or political events that might take place shortly. This is done by a regular study of the global market and keeping an eye over the press releases over the world related to stock markets.

An example of informational efficiency can be given:

If the Australian government has trade links or business agreements with the country from where the information is coming then the news will have an impact on the ASX and Australian economy otherwise news from an un-associated country with Australia will not affect ASX (Rangvid, Santa-Clara & Schmeling 2016). For example in the case of Australian trade deals with American banking/financial sector, any adverse or favourable news from American finance sector will affect ASX.

Argument on Whether or Not the Australian Share Market Has Informational Efficiency

Conclusion

Every stock market of a country is a major source of financing of every listed company. The stock market regulates the trading of the shares and stocks of every listed company. The Stock exchange at times to curb the mal practise by the companies (to raise share prices and its demand) put restrictions on the company. Sometimes the company float false news of mergers and sell off to affect its share prices. The companies should not resort to any such practises and disclose every little information to the market regulators. Stock markets are driven by news and sentiments across global markets like America, China & India etc.  

The market regulators ASX have to keep a close look at the company’s operations and major deals. The ASX is very strict in its compliances as it gives only 5 days to the company directors to report their transaction in the company’s shares which shows that ASX has little tolerances on non-compliances and non-reporting.

References

Australia in the USA. (2019). Trade and Investment.  Retrieved from:  https://usa.embassy.gov.au/trade-and-investment

Beyer, B., Downes, J., & Rapley, E. T. (2017). Internal capital market inefficiencies, shareholder payout, and abnormal leverage. Journal of Corporate Finance, 43, 39–57

BMK. (2019). How The US Share market will affect Australian shares. Retrieved from:  https://bmkfinancialservices.com.au/us-share-market-will-affect-australian-shares/

Chari, A., Henry, P. B., & Sasson, D. (2012). Capital market integration and wages. American Economic Journal: Macroeconomics, 4(2), 102–132.

Chung, D. Y., Hrazdil, K., Novak, J., & Suwanyangyuan, N. (2019). Does the large amount of information in corporate disclosures hinder or enhance price discovery in the capital market? Journal of Contemporary Accounting & Economics, 15(1), 36–52. https://doi.org/10.1016/j.jcae.2018.12.001

Damani, M. (2020). Crude oil outlook turns bearish on US-Iran relief, surplus fears. Retrieved from: https://economictimes.indiatimes.com/markets/commodities/views/crude-oil-outlook-turns-bearish-on-us-iran-relief-surplus-fears/articleshow/73276228.cms

Kannadhasan, M., Thakur, B. P. S., Aramvalarthan, S., & Radhakrishnan, A. (2018). Modelling volatility in emerging capital market: the case of Indian capital market. Academy of Accounting and Financial Studies Journal, 22(1).

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Rangvid, J., Santa-Clara, P., & Schmeling, M. (2016). Capital market integration and consumption risk sharing over the long run. Journal of International Economics, 103, 27–43.

Rosi, M. & Gunradi, A. (2018). Efficient Market Hypothesis And Stock Market Anomalies: Empirical Evidence In Four European Countries. Journal of Applied Business Research 34(1):183-192 

Rossi, M. (2016). The Capital Asset Pricing Model: A critical literature review. Global Business and Economics Review, 18(5), 604-617.

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