A. Explain and justify the stage that this bubble is currently in.
The concept of financial bubble can be described as the phenomenon in which the price of an asset increases quickly due to the speculative demand. This happens due to the higher than expected demand for the underlying security or an asset in comparison to its supply. The stock market of the United Kingdom is also experiencing a financial bubble due to the Brexit deal, which will be effective from 01, Jan, 2021. A purported 'Brexit' is the thing that this enemy of EU party promised for. Their thinking is that the European Union is just harming for the United Kingdom and the United Kingdom would be in an ideal situation without the European Association. Be that as it may, what are the genuine outcomes if Great Britain leaves the European Union (Busch and Matthes, 2016). Since something like this never has occurred, 'specialists' can just conjecture on what could occur. It has been an all-around talked about subject for as far back as months. This chance emerges in light of the fact that the banks are not, at this point ready to maintain their European organizations from the United Kingdom. The companies listed on the FTSE-100 are experiencing the bubble as the demand for the stocks has been rising due to the irrational behaviour of the investors, even when the fundamental of the stocks are not that good. The exit of the UK from the common economy of the European Union is due from last four years, which will affect the businesses of the companies operating in the boundaries of the country. The deal is seemed to benefit the companies due to the common belief which is causing the prices of the major constituents of the FTSE-100 to soar to the unsustainable levels (Tetlow and Stojanovic, 2018).
The instinct behind taking a gander at the securities exchange return of a nation is that as per the "Efficient Market Hypothesis" by Fama, securities exchange returns are an impression of all accessible data about the financial exchange. Furthermore, hence changes in the securities exchange returns are clarified by another inflow of data that is either great or horrible. Since an ever increasing number of organizations are deciding to open up to the world, the securities exchange return is an extraordinary sign of how well an economy of a nation is doing. Expansions in stock costs are a marker that the loads of a firm are high sought after. This expansion sought after among financial specialists depends on positive development assumptions regarding the firm. This positive development of firms in a nation will be converted into a positive monetary development in this nation. Such a development will be caught by the nation's securities exchange record that will be more sought after (Busch and Matthes, 2016).
The stock market of the United Kingdom is in the third stage of the financial bubble trajectory which is termed as the Euphoric stage. As it can be described that valuations of the companies have reached rooftop and there are people willing to pay more for the available stocks this due to the demand and supply relationship lead to the prices of the stocks reaching new high day by day. As the deadline day of the deal is coming near the prices of the stocks of the companies that are might get benefit from the deal are higher in demand and people are willing to pay whatever the amount is asked by the seller in the market. This has helped in the creation of the speculative bubble in the stock market and the market is operating the Euphoric stage (Busch and Matthes, 2016).
B. Analyse how financial markets and their participants contributed to the formation of this bubble.
The stock market has several participants some of which are directly involved in the functioning of it while others are indirectly involved.
Principal Market: it is composed of contracts which encourage the acquisition by corporation's funds for the long-term by issuing new debt as well as securities. You recognize that businesses make new issues of shares and/or debentures at their stage of formation and, if necessary, for company expansion subsequently. Typically, it is achieved through private placement of friends, family and financial institutions or by establishing a public concern. The primary market contributes to the speculation bubble as around 80-90% of the IPO's are launched during the times when the market is inflated. This IPO's also provide general public new opportunities to invest their money. Of the total IPO's launched around 10% of them becomes successful in the longer term. The companies are planning to launch IPO's on the eve of the completion of the Brexit deal as public's will have a positive perception of the market (Busch and Matthes, 2016).
Stock exchange: they play an equally significant role in the mobilization of long-term funds by supplying shareholdings and debentures with the requisite liquidity. It offers a position where, without any, these securities can be encashed Difficulty and postponement. It is an organized market in which stock and bonds are frequently traded with a high degree of confidentiality and stability. A stock exchange holds a full list of all trades taking place in various stocks on a daily basis and provides the press and other media with frequent reports on their rates and trading volumes. In reality, you can now get details about the minute-to-minute movement of the prices of selected shares on TV channels every day. It encourages investors to make fast choices on the buying and selling of the shares they are involved in. The shifts in the economic health of a country are mirrored in stock markets, as share prices are particularly vulnerable to changing economic, social and political circumstances. It's noted that the share price continues to improve during times of economic growth. In the other hand, when there is economic stagnation, rates begin to decline and, as a result of deflation, market practices slow down (Laurini and Chaim, 2020).
Companies: the companies which are also the participants of the stock market as their performance is reflected in the index which is the barometer of the perspective of the general public towards the economic scenario of the nation. The companies also contributes to this bubbles as their prices also reflects the sentiments of the market even when the fundamentals of the companies not in good health. This has happened due to the Brexit scenario as companies in the United Kingdom are expecting low competition from the members of the EU after the deal. This has put the forecasts of the UK's companies in green trajectory, but on the other hand they will also lose the business they were doing under the common trade agreement of the European Union (Laurini and Chaim, 2020).
Stock Brokers: the stock brokers are the party which facilitates the sale and purchase of stocks on behalf of the investors; they are the middlemen and one of the important participants of the stock market. They are the ones that charges commission on the execution of the orders of the clients. They contribute to this bubble in the way that some of the ill-informed investors or the speculators take their advice as they pretend to be the ones having high knowledge of the stocks. They mostly don't have any logical reasons for their recommendations and put out their choices to their clients, purely based on their intuition. The Brexit deal would actually have a positive impact on some of the industries but that won't be realized in near future. They are the ones having direct contact to the retail investors and have significantly higher contribution to the creation of the speculation bubble of the UK's stock market (Girardin et al., 2018).
Investors and Speculators: the investors and speculators are different from each other in the sense the investors are the people who try to acquire the returns in the market by undertaking the mean or below mean risk and they also have long-term horizon for their investment in other words, their holding period is longer. The speculators on the other hand try to acquire the higher than the average returns than the market by undertaking the higher risk than the average. The investors are responsible to taking the bubble to the next level as they tend to behave in herd strategy (Hu and Oxley, 2018). This means that the positive outlook created by the news of the Brexit in media put fire of this further and investors are buying the stocks just because everyone has a positive outlook towards the news of Brexit. This creates new demand for the stocks and takes the bubble to the next level. The speculators like the inflated market because they can generate higher returns in this type of bubbles as their main motive is to acquire higher returns and exit from the position. They are having the bigger chunk of the support to the creation of this bubble as they can inflate the market keeping the fundamentals aside (Pan, 2020).
C. Summarise and justify the factors that will cause this bubble to move to the next stage.
The market is in the Euphoric phase and will move to the profit taking phase. The Euphoric phase will gradually transform to the profit taking phase as soon as the deal completes and everything will return to normal that is all the inflated stock market will experience correction and the stocks will come down to the intrinsic value. Once the things settle after Jan 01, 2021, the market will shift to the next phase where the decline will start. In the next phase, the speculators will sell their positions and try to book the profit before the burst of the bubble that is the fifth and last stage of this bubble (Corbet et al., 2020). According to JM Keynes, the market can remain inflated longer than the investors and the speculators can remain solvent. The optimistic perspective of the general public will at last will settle at the last stage of the bubble which is the panic stage, only one event or the one bad news it will all it takes to burst this bubble, which will only be initiated by the speculators who will start to book profits at the peak of the market and there will be some people who'll start to lose money and the others will gain that as it is a zero sum game (Mazur et al., 2020). The bubble will burst due to the fact there are not enough economic factors that are supporting the rise of the stock market currently and after Jan 01, 2021, people will realise that this Brexit deal won't have its effect in the short-run and it will take some time to bring out the positive effect if there are. The companies will lose out the businesses as there were the companies based out of the UK doing business with the partners of the European Union and their financial figures will also be affected due to the Brexit. This scenario will also be one of the important factors to take the bubble to the next stage as the financial forecasts wouldn't reflect the positive outlook in the financials of the companies and the speculators and also other institutional speculators would sell their positions and the market will shift to the profit taking phase (Taffler et al., 2017).
To conclude it can be said, the financial bubble of the stock market of the UK has been due to the Brexit deal and there is overenthusiasm from the general public and the participants of the market are contributing heavily towards taking the bubble to the next stage. And this bubble will burst in the short span of time as there is a totally irrational behaviour of the people supporting the rise of the stock market, people who are the long term investors will wait for the bubble to burst and buy the stocks at the lower or the right prices as this will have higher chances of their returns to be higher.
Belke, A. and Gros, D., 2017. The economic impact of Brexit: Evidence from modelling free trade agreements. Atlantic Economic Journal, 45(3), pp.317-331.
Busch, B. and Matthes, J., 2016. Brexit-the economic impact: A meta-analysis (No. 10/2016). IW-Report.
Corbet, S., Larkin, C., Lucey, B. and Yarovaya, L., 2020. KODAKCoin: a blockchain revolution or exploiting a potential cryptocurrency bubble?. Applied Economics Letters, 27(7), pp.518-524.
Girardin, E., Joyeux, R. and Shi, S., 2018. Stock Market Bubble Migration: From Shanghai to Hong Kong. In Uncertainty, Expectations and Asset Price Dynamics (pp. 173-192). Springer, Cham.
Hu, Y. and Oxley, L., 2018. Bubble contagion: Evidence from Japan's asset price bubble of the 1980-90s. Journal of the Japanese and International Economies, 50, pp.89-95.
Laurini, M.P. and Chaim, P., 2020. Brazilian stock market bubble in the 2010s. SN Business & Economics, 1(1), pp.1-19.
Mazur, M., Dang, M. and Vega, M., 2020. COVID-19 and the march 2020 stock market crash. Evidence from S&P1500. Finance Research Letters, p.101690.
Pan, W.F., 2020. Does Investor Sentiment Drive Stock Market Bubbles? Beware of Excessive Optimism!. Journal of Behavioral Finance, 21(1), pp.27-41.
Taffler, R.J., Agarwal, V. and Wang, C., 2017. Asset pricing bubbles and investor emotions: An empirical analysis of the 2014-2016 Chinese stock market bubble. In Behavioural Finance Working Group Meeting, Queen Mary University London, June.
Tetlow, G. and Stojanovic, A., 2018. Understanding the economic impact of Brexit. Institute for government, pp.2-76.
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