Issues in Index Construction
Index providers generally take a top-down approach to constructing a portfolio by defining:... Read More
A well-functioning financial system has complete markets with effective financial intermediaries and financial instruments, allowing:
Efficient financial systems have tools to address financial issues and liquid markets with low trading costs. They provide timely financial information, ensuring that market prices accurately reflect available data. This way, prices respond to changes in fundamental value rather than just liquidity needs. Well-functioning markets promote efficient resource allocation, placing resources where they’re most valuable.
Question
Which of the following is least likely a characteristic of a well-functioning financial system?
- Instruments that solve financial problems.
- Market prices that always equal fundamental value.
- Markets where assets can be easily traded at low cost.
Solution
The correct answer is B.
Informational efficiency in well-functioning financial systems should allow investors to estimate fundamental values and cause price changes to correlate with changes in fundamental value. However, fundamental value estimates in well-functioning financial systems will not necessarily always match actual fundamental value.