Professional Documents
Culture Documents
On
Dr.N.S.VISHWANATH
I would like to express my gratitude to Dr. N.S. Vishwanath, Project guide, for
his invaluable suggestion and encouragement, which are imperative for the completion of
this project.
Words cannot express the immense gratitude I have for my parents who have
been instrumental in shaping my career. I am thankful to all my friends and to all the
Preveen.N.P
Contents
o Introduction 2
o Problem Statement 4
o Theoretical Framework 5
o Review of literature 7
o Research Methodology 11
o Conceptual Definitions 13
o Criteria for selection and review of SENSEX constituents 15
Findings 56
Conclusion 57
o In Conclusion
References 59
o Bibliography
This research is done in the field of Indian share markets taking into
account only three years data from Feb. 2002 to Feb 2005. The research includes
how the share prices of various selected companies vary w.r.t. to economic
factors. The research work includes the collection of data regarding the share
prices of the selected companies during the past three years and the SENSEX.
located books listed in the library catalogue and traced through the list of
references provided in various research works. The main objective is to study how
share prices vary w.r.t economic factors and to enable the investors in exploring
rigorous analysis. Certain areas such as arbitrage pricing theory, option pricing
theory, agency theory, and signaling theory are virtually unrehearsed in the Indian
context. Besides, very little theoretical work has been done by researchers in
Background:
It is widely believed that stock market is related to macroeconomic fundamentals
of an economy, as companies that are listed for trading in stock exchanges are the
ones who contribute significantly to the economy's growth. The notion that
macroeconomic factors can drive the movement of stock prices is now widely
accepted. However, it was only in the past decade or so that attempts have been
made to capture the effect of economic forces in a theoretical framework and
calibrate these effects empirically. According to standard stock valuation model,
the determinants of stock price are the expected cash flows from the stock and the
required rate of return. Chen, Roll and Ross (1986) showed that economic
variables have a systematic influence on stock return as a result of their effect on
future dividends and discount rate and they provided the foundation for the belief
in the existence of a long-term equilibrium relationship between stock price and
related macroeconomic variables. A central issue in macroeconomics is the
question of how financial markets are connected to the real side of the economy.
The issue has gained momentum due to increasing cross border movement of
funds as fund managers try to move to markets where possibility of higher returns
vis-à-vis risk is high. The ongoing integration of international capital markets and
the repeated occurrence of large financial crises have raised the concern about the
Volatile markets are characterized by wide price fluctuations and heavy trading
within a short span of time. Volatility is a traditional worry of investors, and is
associated with fast-growing stocks, high P/Es, smaller companies, Information
Technology (IT) firms. Volatility of stock market is usually caused by company
news, economic factors like changes in forex rates, inflation rates, interest rates
etc.
Share prices fluctuations affect the investor’s wealth creation. In this context, the
study of the impact of economic events on the movement of share prices in stock
market is undertaken.
Hypothesis:
In pure financial terms, volatility is defined as, 'the degree to which the priceof a
security, commodity, or market rises or falls within a short-term period’. As is
evident from the definition, volatility relates to the variability in the price of a
security. In the context of the stock market, volatility of the market refers to the
volatility of the indices of the securities within the market. In India, for instance,
the Bombay Stock Exchange (BSE) SENSEX (a 30 scrip weighted index of
market capitalization) would be one of the relevant indices to look into for
examining stock market volatility. When examining the issue of stock market
volatility, it is relevant to measure percentage volatility of stock return. This
reflects the percentage change in the value of the amount invested in the stock
market. It reflects the change in the investor's wealth. Theorists use various
measures of volatility like standard deviation, variance, co-efficient of variation, to
measure volatility of stock market return.
(or standard deviation) lag of a variable and the variance (standard deviation) of its
residuals in predicting the current value of the variable.
The less known, but important measure of volatility is 'implied volatility'. This
measure is the result of an important fact about derivatives: The price of the
derivative along with the price of the underlying security produces two
observations of the security's price. Arbitrageurs have used this fact to profit by
determining whether a security is improperly priced relative to its derivative
(Mullins, 2000).
From the existing literature, the linkage between macroeconomic variables and
stock prices have been established for major markets like US, Japan while for
other markets the same cannot be said for certainty.
This paper discusses that the stock market and the economy are deeply
Intertwined so that when something happens in one it affects the other.
Paper Summary:
This paper relates that stock market declines have a wide-ranging effect on many
sectors of the economy; therefore, the health of the stock market is seen as an
indicator of the general economic health. The author points out that drops in the
stock market often translate into decreased net worth for both households and
businesses, thereby, decreasing consumer spending and confidence, which
damages the economy. The paper concludes that one of a number of solutions
proposed to help stimulate the US economy includes tax rate cuts.
"Certainly, the stock market is only one of the factors that can impact the
economy. Savage notes that almost all Americans are familiar with the textbook
example that World War II played an important part in stimulating America's
economy. Importantly, given America’s recent actions in Iraq, war can have a
significant economic impact as well. Economist Robert Genetski notes that there
are several important caveats on war's impact on the economy. He notes that
markets often soar in anticipation of a quick victory, but that if the "battle was to
be prolonged; any market rally would be quashed. This prediction bodes poorly
This paper looks at the effect; the stock market has on the U.S. economy. It looks
at the effects of a declining stock market and a rising stock market. Also discussed
are to what extent the economy effects the stock market and how much the two are
intertwined. The paper also includes opinions and analyses from different experts
in economics, which help explain the relationship between the stock market and
the economy.
Recent declines in the stock market have had a detrimental impact the economy
both in the United States and abroad. The stock market and the economy are
deeply intertwined. As such, stock market declines have a wide-ranging effect
on many sectors of the economy. Importantly, the health of the stock market is
seen as an indicator of the general economic health. Thus, any decline in the
stock market is often seen as a negative prediction for the economy. Drops in
the stock market often translate into decreased net worth for both households
and businesses, and thereby decrease consumer spending and confidence,
resulting damage to the economy."
Secondary Data:
Data collected was of BSE-SENSEX for the period From Feb 2002 to Feb.
2005 . The data would be collected from websites like “domain-b.com”,
“economictimes.com”, bseindia.com”, Business newspaper, and journals.
Tools:
Tool to be used is correlation analysis using coefficient of determination
and T-test for hypothesis testing .
The Reason for choosing BSE-SENSEX comprising of 30 scrips from a
specified and non-specified list, is because the index has established a place
amongst investors, chartists, technical analysts of the market, the newspapers and
all other concerned with the securities market. Moreover, it has been widely
accepted as a fair reflector of the trend of prices on the Mumbai stock market
2) High P/E:
P/E can be defined as a valuation ratio of a company's current share price
compared to its per-share earnings.
Calculated as:
P/E shows how much investors are willing to pay per rupee of earnings.
In general, a high P/E means high projected earnings in the future.
However, the P/E ratio actually doesn't tell us a whole lot by itself. It's usually
only useful to compare the P/E ratios of companies in the same industry, or to the
market in general, or against the company's own historical P/E.
Sensex movement
8,000.00
7,000.00
6,000.00
month end close
5,000.00
4,000.00 Close
3,000.00
2,000.00
1,000.00
0.00
Au 2
Au 3
Au 04
M 2
M 3
M 4
05
No 2
No 3
No 4
Fe 2
Fe 3
Fe 4
-0
-0
0
0
0
0
v-0
v-0
v-0
-
b-
b-
b-
b-
g-
g-
g-
ay
ay
ay
Fe
month/year
The above graph shows the movement of SENSEX from February 2002 to
February 2005.As shown in the graph SENSEX has moved from 3562.31 in
February 2002 to 6713.86 in February 2005.
The scrip selection and review policy for BSE Indices is based on the objective of;
1. Final Rank: The scrip should figure in the top 100 companies listed by Final
Rank. The final rank is arrived at by assigning 75% weight age to the rank on
the basis of six-month average full market capitalization and 25% weight age
to the liquidity rank based on six-month average daily turnover & six-month
average impact cost.
2. Trading Frequency: The scrip should have been traded on each and every
trading day for the last six months. Exceptions can be made for extreme
reasons like scrip suspension etc.
Track Record:
In the opinion of the Committee, the company should have an acceptable track
record
Index Review Frequency:
The Index Committee meets every quarter to review all BSE indices. However,
every review meeting need not necessarily result in a change in the index
constituents. In case of a revision in the Index constituents, the announcement of
the incoming and outgoing scrips is made six weeks in advance of the actual
implementation of the revision of the Index.
While selecting scrip from SENSEX, only those scrips were taken for study,
which was there in SENSEX on Feb 2005, and also from the day they are included
in SENSEX from March 2002. (All the co-efficient have been calculated)
Given this fact, the consequences of such inflows on the stock market become an
important aspect of any study of capital inflows to a country. These papers briefly
examine the consequences and study two of these consequences viz., liquidity and
volatility in some depth in the case of India. This paper is divided into two
sections. Section 1 evaluates the impact of capital inflows on stock market
liquidity and Section 2 examines the impact on stock market volatility.
This was written for Business India, and was carried in its July 19, 2004 issue
with the same title.
As someone once said with a dash of humor, `Inflation is when you pay fifteen
dollars for the ten dollar haircut you used to get for five dollars when you had
hair.' But the de
nt inflation makes in your investments is far from humorous. In
fact over the long-term the `damage' is significant enough to make the most
unflappable investor sit up and take notice. First, let's understand inflation a little
better. Simply speaking, an inflationary situation is where there is `too much
money chasing too few goods'. As products/services are scarce in relation to the
money available in the hands of buyers, prices of the products/services rise to
adjust for the larger quantum of money chasing them.
Let's understand this with the help of an example. Let's assume Rs 500 fetches you
1 gram of gold. Suppose there is a shortfall in the global supply of gold. The
obvious implication is that gold prices will rise to adjust for the sustained demand
at lower supply. This may sound complicated but it's a thumb rule of demand
-
supply - high demand combined with limited supply leads to higher prices. Let's
say gold prices rise by 10%. The revised rate of 1 gram of gold will be Rs 550.
However, in real terms (i.e. in terms of the commodity in question) the value of
the rupee would have declined from 1 gram of gold for Rs 500 to only 0.91 gram
of gold for Rs 500. So the value of the rupee has eroded. In other words, the same
quantum has money now fetches you fewer goods. Now you know why that
haircut does not cost the same as it did even 2 years ago!
This could be as good a time as any what with the Wholesale Price Index (WPI)
breaching the 6% level. In his exclusive interview with Personalfn, Mr. Rakesh
Mohan (Deputy Governor - Reserve Bank of India) put things in perspective by
stating that inflation was fuelled more by higher prices of commodities like steel
and petroleum at the global level than by consumer goods like food products at the
domestic level. So it may appear that the inflationary situation we see today is
more of a comment on the price spiral at the global level than the domestic level.
Nonetheless, the fact of the matter is whether you like/understand it or not, the
danger posed by inflation is real and present and as an investor you have to take
steps to safeguard your interests. You not only need to be careful about future
investments, you also need to review existing investments. In other words, you
need to bring a fresh perspective to your investments.
Risk-averse investors who traditionally shun risk and embrace the safety of
assured returns probably feel they are immune to inflation and its effects.
However, nothing could be further from the truth. If there is one class of investor
category who are completely exposed to the `menace' of inflation it's the -risk
averse, bond/fixed deposit investor. As a matter of fact, the security and comfort
associated with assured return schemes comes at a price - inflation! Inflation eats
into the returns offered by assured return schemes like fixed deposits and small
savings schemes, thereby leaving investors with dismal real returns.
So how does the risk-averse investor counter this menace? There are 2 options at
his disposal.
Typically, in inflationary times you should not lock your money in long-term
bonds (like the RBI Bond for instance) and in fixed deposits with a longer tenure
(over 1-Yr). This is because rising inflation is generally followed by rising interest
rates as explained earlier. Banks/institutions raise their deposit/coupon rates so
investors who are already invested in these deposits/bonds witness what is known
as an `opportunity loss'. However, fresh investors will clock a higher return on
their deposits/bonds. So when there is even a likelihood of rates on deposits/bonds
rising, choose short-term deposits. These investments will give you the required
liquidity you need while ensuring that you do not lose out in case interest rates
were to rise.
By the same logic, shun long-term debt funds. Inflation is a damper on the price of
longer maturity bonds. These bonds are the worst hit when the debt market is in
the grip of inflation frenzy. Under inflationary conditions, bond prices fall and this
pulls down the net asset values (NAVs) of bond /gsec funds. So existing investors
see erosion in their debt fund NAVs. Again the way to counter this threat is to
stick to short-term bond funds, which are relatively immune from the peril of
inflation.
These bonds compensate you for the rise in inflation (or the decline in the
purchasing power of the currency). As yet they do not have a presence in the
domestic debt market. The good news is that the Reserve Bank of India (in
consultation with Government of India) proposes to introduce Capital Indexed
Bonds in the country.
Offer inflation-linked returns on both the coupon rate (interest rate offered
by the instrument) and principal repayments as well. This would be
achieved by adjusting the principal amount in tune with changing inflation
rate.
This is pretty much what the risk-averse investor has on his plate in inflationary
times. On the other hand, the risk-taking investor has one more option to counter
inflation - equities.
Equities
It's no secret that no asset class evokes as much excitement as stocks/equities.
However, in our view this excitement is often misplaced. Stocks stimulate
unbridled enthusiasm and fervor for the wrong reasons. Investors take to stocks
because of their ability to clock exponential growth over a shorter time frame. For
the serious, risk-taking investor stocks have a higher appeal - their ability to
effectively counter inflation and give superior real returns over the long-term vis-
à-vis any other asset class. This is a fact attested to by several studies.
(Growth indicates avg. growth rate over a 15-Yr time frame. Graph sourced
from HDFC Mutual Fund)
The yawning void between inflation and investment in equities is evident from the
above graph. Equally evident is the narrow gap between inflation and peer asset
classes - fixed deposits and gold.
In addition to the asset classes we have outlined, there are some other
unconventional, but effective, investment avenues to outpace inflation.
Commodities
The key factors that determine the price of a commodity like gold for example
(mine output for one) are different from factors that impact the value of other
Property
Property is again a preferred investment avenue as in such times prices tend to rise
upwards in line with the increase in cost of construction. The only deterrent here is
that the minimum amount you need to invest here is substantial and beyond the
reach of most investors. An alternative can be real estate mutual funds, which are
quite popular in international markets. If SEBI and AMFI have their way, this
could become a reality in the Indian context.
So while inflation is a concern there is no need for you to be a sitting duck every
time it rears its head. Fortunately for you, even an under-developed financial
market like India offers you enough interesting and rewarding opportunities to
make inflation seem like just another day at the office.
6
inflation in %
5 High
4 Low
0
may
july
January
February
May
July
January
February
May
July
January
February
august
August
August
october
September
November
December
September
November
December
september
november
december
October
October
march
April
june
March
April
June
March
April
June
50
49
48
47
46
high
re/$
45
low
44
43
42
41
40
J
J
J
J
J
J
J
N
D
N
D
N
D
O
O
F
F
M
M
M
M
M
M
A
A
S
A
S
A
S
The above graph shows the movement of Re-$ from March 2002 to
February 2005. Re has strengthened from 49.06 in March 2002 to 43.4 in February
2005.
2) ACCShare price:
Correlation coefficient (r) = 0.319779
From the above table, While comparing the changes in the Re-$ exchange
rate with the changes in the BSE SENSEX values, we get a correlation of
0.319779.
r2 = 0.10226, Now r2 * 100 = 10.226 % .
Therefore from the above, we can interpret that the changes in Re-$
exchange rate affects the ACC share price value negligibly.
Result: t- is significant in case of FII. They affect the share prices positively.
2) Inflation
Predictors: (Constant), % change
Adjusted R Standard error
Model R R square square of estimate
Results: In the above two cases they are insignificant and have negligible
influence on share prices
3) Effect of changes of FII Flow in share market and its influence on BSE
SENSEX value is very affective. Its affects on almost all scrips of SENSEX are
very high.
5) Incase of foreign exchange markets, they are relatively consistent and do not
make much impact on Indian stock market.
The present study examines the causal relationship between Net FII investments,
inflation and foreign exchange and the Indian stock market represented by market
capitalization of BSE. During the past three years there have been several ups and
downs in the Indian stock market and Foreign portfolio investment patterns,
consequent upon several changes affecting the Indian economy, like the
technology slowdown, Ketan Parekh scam, September 11 attack on WTC, to name
a few. There have been attempts to find the determinants and impacts of FII
investment in India. By using monthly data from Feb 2002 to Feb 2005, we tried
to capture the cause effect nature of FII, inflation and foreign exchange and Stock
market. There is evidence of causality from BSE market capitalization and NSE
market capitalization to net FII investment. The study infers that when market
capitalization (the product of total trading volumes and prices of shares) is high,
FIIs are more attracted for investing' (they buy heavily). The reverse happens (FI
Is
sell heavily) when market capitalization is low. While there is causation from
current month, two month and three month lag market capitalization of both BSE
and NSE, no causation was found from the one month lag values to net FII
investment. We have also found significant impact of net investment on market
capitalization or Indian stock exchanges. When FII s are net buyers, prices and
trading volume both go up thereby increasing the market capitalization. On the
other hand heavy selling by FIIs brings down the market capitalization by reduced
trading volume and/or share prices. However, it is found that the current month's
FII investment pattern has a significant impact on the current month's NSE and
BSE market capitalization but past investment by FIIs does not have any
significant impact. The study found causation from FII net inflow to market
capitalization of BSE as well as from BSE to FII net inflows as was found by
Chakrabarti (2001) and Kumar(200l) using different methodology.
1) It is recommend that since the FII have a considerable positive affect on share
prices the government should encourage their investment which in turn boosts the
economy.
2) Rupee-$ Exchange rate and Inflation Rate don’t affect share prices. So this
factors need not to be considers while making any investment in shares.
3) FII affects the share market the most. So close examination of the FII
investments should be tracked while making investments.
4) If FII starts selling shares it is better to exit and vice versa, more investment
into the market can be entertained.
- IGNOU
Websites
• www.moneycontrol.com
• www.bseindia.com
• www.nseindia.com
• www.indiainfoline.com
• www.karvy.com
• www.domain-b.com
• www.investopedia.com
National dailies
• Business Lines