The EMH posits that market prices reflect all available information. This has several implications for fund allocation:

• Passive vs. Active Management:
  • If markets are efficient, actively managed funds (those that try to outperform the market) are unlikely to consistently beat the market after fees.
  • This suggests investors may be better off with passively managed funds, like index funds, that track the overall market performance.
• Market Timing:
  • The EMH suggests it’s difficult to consistently time the market and buy low/sell high.
  • Investors should focus on long-term asset allocation based on risk tolerance and investment goals.
• Diversification:
  • Even in an efficient market, diversification remains crucial to manage risk.
  • By spreading investments across different asset classes, investors can mitigate the impact of unexpected market movements.

However, the EMH is not without its critics. Market anomalies and inefficiencies may exist, allowing some skilled investors to outperform the market. Additionally, the definition of “all available information” can be debated.

Organized Financial Markets vs. Financial Intermediaries:

Organized Financial Markets: These are platforms where buyers and sellers meet to trade financial instruments like stocks, bonds, and derivatives. They facilitate efficient allocation of capital by:

• Price Discovery: Through supply and demand forces, markets determine the fair market value of financial assets.
• Liquidity: Markets provide a way to buy and sell assets quickly and efficiently.
• Information Dissemination: Markets aggregate and disseminate information, allowing investors to make informed decisions.

Financial Intermediaries: These institutions act as middlemen connecting investors and borrowers. Their functions include:

• Pooling of Funds: Intermediaries like banks and mutual funds gather smaller investments from various individuals and invest them in larger amounts.
• Risk Transformation: Intermediaries can transform the risk profile of investments. For example, banks take deposits with short maturities and offer loans with longer maturities.
• Information Asymmetry Mitigation: Intermediaries can gather and analyze information, reducing information asymmetry between investors and borrowers.

Similarities: Both play a vital role in facilitating the flow of funds within an economy. Differences: Organized markets provide a platform for trading, while intermediaries connect investors and borrowers directly.

Answers to Additional Questions:

1. True. Bonds of similar maturities are substitutes for each other. When interest rates rise for one bond, investors may be incentivized to buy the other, causing its interest rate to also rise.
2. No. The relationship between money supply and stock prices can be complex. While a rising money supply may sometimes lead to higher stock prices, it’s not a guaranteed outcome. Other factors like investor sentiment and economic conditions can also influence stock prices.
3. Financial intermediaries in Saudi Arabia can help lower transaction costs in two ways:
   • Economies of Scale: By pooling funds from many investors, intermediaries can negotiate lower fees and commissions when buying and selling securities.
   • Technological Infrastructure: Intermediaries can invest in online platforms and digital services that streamline the trading process, reducing transaction costs for individual investors.
4. Conflicts of interest can make financial service firms less efficient in several ways:
   • Recommendations: Financial advisors may recommend products that generate higher commissions for the firm, even if they are not the best fit for the client’s needs.
   • Short-term Focus: Focusing on short-term profits might lead to risky or unethical practices, neglecting long-term client satisfaction and stability.