It is not possible for a financial

system to exist without the concept of interest rates. Interest rates are one of the most crucial

aspects of the financial system. They

are used to determine the cost of borrowing, the return on investment, and are

also an integral constituent of the total return on most investments. In addition, some interest rates give

insights into the future of financial markets and the economy. In addition,

interest rates are used as monetary tools by the monetary authorities (Leeds,

Von Allmen, & Schiming, 2006).

Although it is possible to operate banking system without the concept of

interest rates, as it happens in Islamic banking (Saeed, 2010), it is not

possible to run the entire financial system without interest rates.

It is

inconceivable to have an economy which has no time value of money. The concept

underlying the time value of money is that a given sum of money received today

is more than the same amount of money received in future. Time value of money is an indispensable

concept in an economy because it is influenced by inevitable forces in the

economy such as inflation, which reduces the value of money over time.

Accordingly, time value of money is applied in making of investments and all

financial decisions that involve arrangements to make or receive payment in the

future (Shim & Siegel, 2008).

Change in interest rates can be influenced by a host of

factors. One of the factors underlying change in interest rates are actions of

the monetary authority. For example, in

the United States, the FED can cause interest rates to rise or fall by selling

or buying treasuries respectively. Other key factors that influence change in

interest rates include the strength of the economy impacts supply and demand of

funds, fiscal policy, and expectations of inflationary levels (Leeds, Von

Allmen, & Schiming, 2006).

The

efficient market hypothesis argues that financial markets integrate all

information available in the public domain and that stock prices reflect all

the relevant information. Accordingly,

stock prices are accurate in average,

meaning that markets are efficient and no active investor can beat the market

by taking advantage of any public

information (Harder, 2008). The efficient market hypothesis is, however,

faulted for being weak in several aspects.

The hypothesis assumes that all investors view all available information in precisely

in the same way. However, the many

techniques of analyzing and valuing stock curtail the validity of EMH. For

example, if one investor is looking for an undervalued market opportunity and

another one assesses a stock on based on its potential for growth, the two

investors will arrive at a different evaluation of the fair market value of the

stock. Thus, because investor values

stocks differently, it is not possible to ascertain the value of a stock under

an efficient market (Harder, 2008).

Furthermore, under EMH, no investor should be able to make greater

earning that another with equal

investment amounts because the fact that they have equal possession of

information implies that they can only achieve similar returns. However, this

is not true in practice, as it is evident that there is a wide range of returns on investments achieved by a

universe of investors, investment funds and so on (Harder, 2008).