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BHAVAN’S ROYAL INSTITUTE OF MANAGEMENT
MBA Finance
Stock Returns and Volatility: Evidence from Indian Stock Market
PROJECT REPORT
Rohith U J
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EXECUTIVE SUMMARY
The risk appetite of investors governs their investment in financial instruments. Persons who
are minimum risk takers with return generally park their money in secure instruments but
people with a higher risk appetite generally invest in a stock market financial instrument to
achieve their financial goal. Investors with a higher risk appetite have to measure the market
performance in the basis of risk and return so that they can alter their portfolio to keep pace
with current market movement. In this research intended to study risk in terms of standard
deviation and beta of all sectoral indices of NSE with respect to nifty and their performance in
different time horizon and ranked them accordingly in terms of mean return and found out the
best performing sector in a given time frame. The first objective of the study is to analyze the
mean return of CNX Nifty and its sectoral indices. From the study it is founded that from an
investor’s point of view the overall return (average of averages) seem to be the highest for Nifty
Auto, while Nifty Metal had the lowest return.
The second objective of the study is to analyze and rank the performance of sectoral indices.
Nifty Auto was ranked as 1st with an overall performance. This was followed by Nifty Media
and Nifty FMCG among the sectoral indices. From the investors point of view bucketing the
investment in these sectors helps them to increase adjusted return with minimum risk.
The third objective of the study is to examine the extend of association between CNX Nifty
and the sectoral indices during the period. Among the sectoral indices, Nifty Financial Services
had the highest correlation with Nifty Index. In other words Nifty Financial Services had very
strong and high association with Nifty Index.
Fourth objective of the study is to examine the level of volatility among the sectorial indices.
Among all sectoral indices, Nifty Realty and Nifty PSU Bank having highest volatility. In other
words these sectors having highest standard deviation and beta which indicates the volatility in
its return.
The methodology followed for conducting the study can be specified by research design,
research approach, sample design, questionnaire design, data collection and statistical tools for
analyzing the collected data. The research design used for this study was descriptive research.
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CHAPTER 1
INTRODUCTION
Introduction
Before liberalization, Indian economy was tightly controlled and protected by number of
measures like licensing system, high tariffs and rates, limited investment in core sectors only.
During 1980’s, growth of economy was highly unsustainable because of its dependence on
borrowings to correct the current account deficit. To reduce the imbalances, the government of
India introduced economic policy in 1991 to implement structural reforms. The financial sector
at that time was much unstructured and its scope was limited only to bonds, equity, insurance,
commodity markets, mutual and pension funds.
In order to structure the security market, a regulatory authority named as SEBI (Security
Exchange Board of India) was introduced and first electronic exchange National Stock
Exchange also set up. The purpose behind this was to regularize investments, mobilization of
resources and to give credit.
A stock market is a place where buyers and sellers of stocks come together, physically or
virtually. Participants in the market can be small individuals or large fund managers who can
be situated anywhere. Investors place their orders to the professionals of a stock exchange who
executes these buying and selling orders. The stocks are listed and traded on stock exchanges.
Some exchanges are physically located, based on open outcry system where transactions are
carried out on trading floor. The other exchanges are virtual exchanges whereas a network of
computers is composed to do the transactions electronically. The whole system is order-driven,
the order placed by an investor is automatically matched with the best limit order. This system
provides more transparency as it shows all buy and sell orders.
Risk and return are both relevant to investment decisions. Post liberalization, there have been
a number of reforms that the Indian capital market has witnessed. This has caused both the risk
and return of the different sectors of the Indian market to frequently change and become
unpredictable. There is no clear answer to whether the risks and returns of these indices remain
stable over a period of time.
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According to NSE ‘A stock market index is a measure of the relative value of a group of stocks
in numerical terms. As the stocks within an index change value, the index value changes. An
index is important to measure the performance of investments against a relevant market index’.
1.1 Statement of Problem
The motives for introducing indices in India had been to contain the stock market volatility.
After the subprime crises there was drastic change in the Indian stock market.
“……..the impact of the global financial crisis unfolded in the Indian financial markets,
though reversal of capital inflows and significant correction in the domestic stock
markets on the back of sell-off in the equity market by the foreign institutional investors
(FIIs) “ (Dr. Deepak Mohanty, Executive Director RBI).
Literature on examining the impact of sub-prime crisis on market returns also seem to
inconclusive. This study tries to address the gap in the literature. It attempts to address the
following research questions.
(i) Which are the indices that are top performing?
(ii) What is the extent of association among the sectoral indices and
(iii) What is the level of volatility existing among the sectoral indices?
1.2 Objective of the Study
As mentioned above, from the research questions the following objectives were formulated.
 To analyze the mean return of CNX Nifty and its sectoral indices.
 To analyze and rank the performance of sectoral indices using Jensen's Measure
 To study extent of relationship between CNX Nifty and the sectoral indices during the
study period.
 To examine the level of volatility among the sectorial indices using GARCH
1.3 Scope of the Study
This study is an attempt to provide an empirical support to the risk and return factors across
the sectoral indices and CNX Nifty index. The findings from the study will of much interest
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both at academic and business level circles. From an academic perspective, the findings will
be of much use to understand the risk return relationship. Furthermore, for an investor, the
findings also can assist in identifying indices that generate a higher return for the given level
of risk. Accordingly, mutual fund houses, portfolio managers etc. can develop optimal
portfolios, thus enabling the investor to enjoy a higher risk-adjusted return.
1.4 Research Methodology
This study tries to describe the nature and extend of risk and return of Nifty sectoral indices
with reference to CNX Nifty. Accordingly, a descriptive research design is used for the study.
Data has been sourced from reliable secondary sources (NSE website). For this study,
purposive sampling method has been adopted. Since the study is on analyzing the risk and
return of Nifty –fifty index as well as the sectoral indices, it is important to check for data
availability. On analyzing it is found that, as for sectoral indices, out of 12, value for two indices
were missing. Thus, those indices for which values were readily available were taken for the
study and rest were omitted. Accordingly the final sample consisted of ten sectoral indices.
These include CNX Nifty Auto, CNX Nifty FMCG, CNX Nifty Financial Services, CNX Nifty
Bank, CNX Nifty Public Sector Unit Bank, CNX Nifty Realty, CNX Nifty IT, CNX Nifty
Media, CNX Nifty Pharma and CNX Nifty Metal.
As far as the variables were concerned, closing value of the index formulated by National Stock
Exchange (NSE Nifty) has been sourced from the NSE website. Similarly, daily closing price
has been taken for all the selected indices too. Data were checked for performance of returns
of sectoral indices, correlation among sectoral indices and estimation of extend of volatility of
each sectoral indices.
1.4.1 Research Approach
In this study, desk type research study that is it analyses the data relating to the volatility and
return analysis of Indian sectoral indices with reference to National Stock Exchange.
1.4.2 Data Source
For this study, data has been sourced from reliable secondary sources like NSE website.
1.4.3 Research Tool
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As mentioned earlier, the data has been sourced from reliable sources. In order to find the
performance of sectoral indices, Jensen’s Alpha is used. And to test the association between
the variables, correlation analysis is applied. Similarly, to measure the risk, standard deviation
and Beta have been used. Finally, to find extend of volatility, GARCH model is used. All
analysis were performed using MS Excel.
1.4.4 Research Period
As mentioned earlier, the variables selected have been taken for the six year period starting
from 2012 to 2017. The rationale for this period is that, during 2008 market across global were
affected due to sub-prime crisis. After by 2010 the markets started getting stabilized. Since the
study is all about determination of stock price, it is important to take a period which is not
affected by extreme shocks such as crisis, depression etc. Accordingly, this study takes a five
year period after providing a cooling period of two years after the
sub-prime crisis. In other words, the starting period is taken as 2012 and the ending period as
2017.
1.5 Limitations of the Study
 In this study, the factor that affect the stock return and volatility have been confined to
internal variables only. No macro environment factors such as inflation, GDP have been
factored in this study. Therefore future studies should aim by taking a long time series
data and should incorporate macro-environment variables while determining the
volatility.
 Moreover the study has been confined only to CNX Nifty index and its sectoral indices.
Thus, future studies should aim to analyze across multiple exchanges that too operating
in different geographies.
1.6 Chapter Scheme
The report of this study is presented in five chapters
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In the first chapter, an introduction to the topic is detailed. Further, the chapter also have
covered the statement of the problem, objective of the study, scope of the study, methodology
adopted in this study and finally the limitations of the study.
The second chapter provides an overview on the capital market industry in general. Further,
the chapter also discusses at length the global and national scenario of the capital markets. The
third chapter focuses on the reviewing the prior works that has been studied in the capital
market industry.
Data analysis and interpretation has been reported in the fourth chapter.
Finally, the fifth chapter summarizes the findings from the study and put forward certain
recommendation and suggestions
CHAPTER 2
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INDUSTRY PROFILE
2.1 Introduction
A strong and a vibrant capital market is a prerequisite for industrial development. The capital
market should be capable of meeting the requirement of credit and finance of the private
entrepreneurs. The capital market should also help in sustained national industrial
development.
The capital market provides an alternative mechanism of reallocating resource. In other words,
it channelizes household savings to the corporate sector and allocates funds among firm. In this
process, it allows both firms and households to share risk. The capital market enables the
valuation of firms on an almost continuous basis and it plays an important role in the
government of the corporate sector.
During the last two decades, capital market round the globe has been experiencing
metamorphic changes, with the advent of liberalization pertaining to the industrial policy,
licensing policy, financial services industry, interest rates, etc. Completion has become very
intense and real, thus affecting the industrial sector and financial services industry. There has
been a visible improvement in trading and settlement infrastructure, risk management system
and levels of transparency. These improvement have brought about a reduction in the
transaction costs and led to improvement in liquidity.
2.2 Meaning of Capital Market
It is an organized market mechanism for effective and efficient transfer of money capital or
financial resources from the investing class (a body of individual or institutional savers) to the
entrepreneur class (individual or institutions engaged in industry business or service) in the
private and public sectors of the economy.
In a very broad sense, it includes the market for short-term funds. H.P. Parikh has referred to
it as, “by capital market, I mean the market for all the financial instruments, short-term and
long-term as also commercial, industrial and government paper.”
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In the words of Goldsmith, “the capital market of a modern economy has two basic functions:
first the allocation of savings among users and investment; second the facilitation of the transfer
of existing assets, tangible and intangible among individual economic units.”
Grant defines capital market in a broad sense as “a series of channels through which the savings
of the community are made available for industrial and commercial enterprises and for the
public authorities. It embraces not only the system by which the public takes up long-term
securities directly or through intermediaries but also the elaborate network of institutions
responsible for short-term and medium term lenders.”
From the above definitions, it may be deducted that the function of capital market is the
collection of savings and their distribution for industrial investment. As such, the relationship
between the market, instrument, and services are integrated as well as inter-dependent.
Capital market is generally understood as the market for long-term funds. The capital market
provides long-term debt and equity finance for the government and the corporate sector. By
making long-term investment liquid, the capital market mediates between the conflicting
maturity preference of lenders and borrowers. The capital market also facilitates the dispersion
of business ownership and the reallocation of financial resources among corporations and
industries.
2.3 Functions of Capital Market
The capital market is directly responsible for the following activities:
 Mobilization or concentration of national savings for economic development
 Mobilization and import of foreign capital and foreign investment capital plus skill to
fill up the deficit in the required financial resources to maintain the expected rate of
economic growth
 Productive utilization of resources, and
 Directing the flow to funds of high yield and also strive for balanced and diversified
industrialization.
2.4 Global Scenario
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Having grown by over 3.7 percentage in 2017, the global economy is projected to continue
expanding in 2018. Healthy corporate balance sheets, accommodative macroeconomic
policies, and favorable financial market conditions are all helping to sustain the expansion.
Inflation remain reasonably subdued so far- the second-round effects of higher oil prices have
not been significant. With monetary tightening underway in most cyclically advanced
countries, inflation expectation are generally well anchored. In addition to further increase in
oil prices, however, one risk to this outlook in some countries is a significant rebound in unit
labor cost as labor markets tighten, especially if productive growth were to weaken. Further,
strong foreign exchange inflow pose a challenge for monetary policy in some emerging
markets- notably in Asia and the Commonwealth of Independent States. Without more
exchange rate flexibility, these inflows will ultimately be monetized and result in higher
inflation.
The behavior of interest rates is a central issue in the current economic outlook. The current
low level of long-term interest rates is contributing to a very favorable global financial
environment. Interest rates remain low for this stage of the business cycle, and both corporate
and emerging market spreads are near their historical lows. While the low level of long- term
rates can be partly explained by a number of factors- including the confidence of financial
markets in central banks’ commitment to low inflation, excess capacity in labor and product
markets, and continued strong demand for U.S. Treasury securities by the official sector,
especially in Asia- rates can be expected to rise more neutral levels, and spreads to increase, as
the global economic upswing continues. A major concern is that the rise not be so abrupt as to
cause disruptions in financial markets, or impact the overall global economic outlook.
A downward bias remains on short-term risks. On the upside, strong corporate balance sheets
and wealth effects from rising equity markets could lead to stronger than expected domestic
demand. On the downside, the key risk include further exchange rate volatility, faster than
expected rise in interest rate (for example, if triggered by inflationary pressure), and extended
weakness in the Euro area. Moreover, oil prices have recently risen above and continue to be
volatile. With excess capacity very low, the oil market remains highly susceptible to shocks.
Divergences in regional growth rate have also widened, and global imbalances worsened in the
past few years. Growth forecasts have been revised upwards for the United States, China and
most of other emerging economies. In the euro area and Japan, however, growth projections
have been marked down significantly, reflecting both faltering exports and weak final domestic
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demand. The U.S. current account deficit has continued to widen, it over 2.5 percent of GDP
by the end of 2017.
The continuing build-up of the large current account deficit in the United States, with
counterpart surpluses and reserve accumulation concentrated mainly in emerging Asia, is a key
concern. It is also a main source for many of the risks facing the global financial system.
Solving this global imbalance problem should be an urgent priority. The step that must be taken
by the relevant players are well-known by now, but nevertheless deserve repeating. They are:
1. Medium-term fiscal consolidation in the United States;
2. Structural reform in Europe and Japan to increase economic growth particularly labor
market reform: and
3. Great exchange rate flexibility in China and emerging Asia.
2.5 Recent trends in Global Financial Markets
In recent years, financial markets have undergone some of the most rapid and extensive
changes in any markets. We have witnessed dramatic events in global financial markets,
including the Asian crisis, the Russian crisis, and the near-collapse of Long Term Capital
Management (LTCM), which was a highly leveraged hedge fund with enormous trading
positions. More recently, there has been remarkable developments in stock prices around the
world, and in particular in stocks in the telecommunications and internet sectors.
Perhaps foremost among recent changes in world, financial markets has been there accelerating
integration and globalization. This development, which has been fostered by the liberalization
of markets, rapid technological progress and major advances in telecommunications, has
created new investment and financing opportunities for businesses and people around the
world. Easier access to global financial markets for individuals and corporations will lead to a
more efficient allocation of capital, which, in turn, will promote economic growth and
prosperity.
Apart from this ongoing integration and globalization, world financial markets have also
recently experienced increased securitization. In the past, this development has been spurred
by the surge in mergers and acquisitions and leveraged buy-outs that has taken place in markets
of late, not least in the euro area. One aspect of this securitization process has been the increase
in corporate bond issuance, which has also coincided with a diminishing supply of government
bonds in many countries, particularly in the United States.
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Other interesting developments in world financial markets include, the continued broadening
and expansion of derivatives markets. The broadening of these markets has largely come about
because rapid advances in technology, financial engineering, and risk management have helped
to enhance both the supply of and the demand for more complex and sophisticated derivatives
products. The increased use of derivatives to adjust exposure to risk in financial markets has
also contributed to the rise in the notional amounts of outstanding derivatives contracts seen in
recent years, in particular in over-the-counter (OTC) derivatives markets with interest rates and
equities as underlying securities. While the leveraged nature of derivative instruments poses
risks to individual investors, derivatives also provide scope for a more efficient allocation of
risks in the economy, which is beneficial for the functioning of financial markets, and hence
enhances the conditions for economic growth.
Among the many changes in global financial markets, developments in the euro area have been
particularly striking.
2.6 Developments in Euro Capital Markets from a Global Perspective
The launch of the Euro on 1 January 1999 was an historic event. Eleven national currencies
were converted into one single currency overnight. On 1 January 2001 Greece became the
twelfth European Union Member State to adopt the single currency. The newly created
currency area of the twelve participating EU Member States has a considerable weight in the
world economy. It accounts for around 20% of both world GDP and world exports.
The successful launch of the Euro, which is a key element in promoting economic stability and
prosperity in Europe, has boosted the integration of financial markets in the euro area. This
process of integration in European financial markets coincided with a trend towards
globalization and securitization which was already well underway.
Since its inception, Euro has been the second most widely used currency at the international
level. This reflects the importance of the euro area in the world economy. Recent trends in the
internationalization of the euro are the result of market developments and policies both inside
and outside the euro area.
The economies of, and the economic processes in, the countries currently within the euro area
have become increasingly intertwined as we have moved towards EMU. This has naturally led
to the development of more cross-border financial interconnections. At the same time, financial
flows between the euro area and the rest of the world have increased rapidly in recent years.
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As far as euro area financial markets are concerned, the introduction of the euro acted as a
catalyst for greater integration within the euro area, although this process is still far from
complete. In particular, even though euro area financial markets are not yet fully integrated at
an area-wide level, they are larger and more accessible than any of the markets that were
denominated in the predecessor currencies of the euro.
This has brought important benefits for residents in the Euro zone, particularly in the case of
fixed income securities. The first is that the introduction of the euro created the second largest
bond market in the world. The second is that, while the corporate bond market was of limited
importance in the euro area before 1998, the launch of the euro seemed to act as a catalyst for
the development of a market in which corporations could issue debt securities of unprecedented
size. Reflecting this, the amount outstanding of debt securities issued by the non-financial
corporate sector grew by an impressive 17% in 1999.The same growth rate was recorded in
2000 and – in the first six months of 2001 – growth rates of around 14% were observed.
A third observation is the increasing importance of the euro in the overall stock of "truly
international" debt securities. By the end of 2000, the euro accounted for 26% of such
securities. This share is 7 percentage points higher than the total share accounted for by the
euro's predecessor currencies at the end of 1998. The share of the euro is even larger if account
is also taken of the issuance of debt securities denominated in the home currency of the
borrower and targeted at the international financial market.
Furthermore, by virtue of its openness and its breadth, the bond market of the euro area has
become an important component in international bond markets and can be expected to develop
further in the coming years. This picture of the euro bond market in terms of size, growth and
international participation goes hand in hand with increased liquidity and efficiency. Over the
past couple of years, this has resulted in declining transaction costs, as bid-ask spreads have
narrowed.
The story is not much different in the stock markets too. There is also evidence of further
integration. A number of benchmark indices are presently available for the investors for the
euro area as a whole. In addition, derivatives markets have been established which allow market
participants to shift from taking a country perspective in their investment decisions to taking a
sector perspective across the euro area. As a result, sectoral factors should play a greater role
than before in determining share price movements over time.
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The integration of stock markets at the euro area level means that issuers across the euro area
have privileged access to a large number of investors in a large and open market place. This
has paved the way for new firms and relatively small firms to obtain finance from stock markets
that have specialized in providing funds to young and innovative firms. Recently, large number
of new listing has been reported.
2.7 Oversight of Financial Markets and Recent Institutional and Regulatory
Development
The internationalization of markets has been posing new challenges for supervisors. The new
challenges posed by recent market developments come mainly from two sources, technological
advances and the increased competition and market integration triggered by the introduction of
the Euro. Until the 1980s, financial activity was conducted within heterogeneous frameworks.
Each financial system was characterized by a different currency, legislation and supervisory
structure. In general, each sector of the financial industry – banking, securities and insurance –
had its own supervisory agency.
Financial innovation has significantly blurred the distinction between products supplied by
different intermediaries, and technological advances have had a major impact on the
importance of the physical location of the market players, since the two sides of the transaction
and the intermediary need not be close geographically. The concept of the market itself has
drastically changed, since it has become an entity not clearly identified by a physical location.
For example, a large part of the regulation relates to the definition of a market as a physical
entity. In today's financial systems it is possible to have markets, like the foreign exchange
market, that do not a have a geographical location.
Public policies have progressively adapted to the new market environment, increasing
cross-border and cross-sectoral co-operation between competent authorities and shaping new,
less cumbersome and intrusive regulatory and supervisory tools. The introduction of the euro
has further eroded sectoral and geographic segmentation, thus initiating debates in many
countries on the most efficient institutional arrangements for prudential supervision and
financial stability.
The single agency approach has recently gained ground as a response to the breakdown of
sectoral distinctions in the financial industry. Sweden and Denmark within the European Union
and Canada and Norway outside the EU, were the first countries to adopt such a model. This
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solution attracted even more attention with the reforms in the United Kingdom establishing the
Financial Services Authority. The developments which have occurred in the market seem to
favor the single supervisor approach.
In fact, financial products are now mixed and the same economic function is performed by
contracts supplied by firms belonging to different segments of the financial industry. This
implies that the traditional approach of specialized agencies is no longer perceived as
satisfactory. On the other hand, the problems related to the creation and effective management
of a universal agency are very complex. Indeed, co-ordination remains necessary, be it between
specialized agencies or between the organizational units within a universal agency.
A second issue involves the role played by central banks. There are three main arguments in
favor and three main arguments against the unification of prudential supervision and central
banking. The arguments in favor are the following. First, there is a potential for exploiting
synergies between the supervisory function and the core tasks of a central bank. A thorough
understanding of the proper functioning of payment systems and of other market infrastructures
is essential for the smooth conduct of monetary policy. Information collected for supervisory
purposes may play a significant role in this. The second argument concerns the need to focus
on systemic risk. Central banks have a privileged position from which to assess the impact of
macroeconomic shocks and the financial stability of groups of intermediaries. The third
argument concerns the independence from political interference and the technical expertise of
central banks.
On the other hand, there exists three arguments supporting the establishment of a supervisory
agency outside the central bank. The first one concerns the alleged conflict of interest between
monetary policy and prudential supervision. Many authors have argued that the body in charge
of monetary policy cannot be entrusted with supervision, because the monetary policy stance
would be affected and it would pose a threat to price stability. A second argument is based on
the observation that no clear distinction is made between the different financial products and
intermediaries belonging to distinct financial sectors. The third and final argument concerns
the need to avoid an excessive concentration of power in the central bank.
While it may be a difficult and controversial exercise to weigh up the pros and cons of the two
solutions at a general level, without making allowances for the specific environment, in the
particular context of the Euro system, the balance of the arguments leans in favor of
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maintaining a strong role for National Central Banks in prudential supervision. The reasons for
this are twofold.
First, the conflict of interest regarding monetary policy and concentration of power is no longer
relevant given the structure of the Euro system, since the introduction of the Euro has implied
an institutional separation between the monetary jurisdictions – the Euro area – and the
supervisory jurisdiction – domestically chartered institutions in individual countries. Second,
in a single currency area in which financial markets are increasingly integrated, swift and open
communications among supervisors are of vital importance for crisis prevention and
management. The dual nature of National Central Banks, which are at the same time both
national institutions and part of the Euro system, might be a valuable asset when dealing with
cross-border or area-wide issues.
2.8 International Financial Market Instruments
Funds are raised from the international financial market also through the sale of securities, such
as international equities or Euro equities, Euro bonds, medium term and short term Euro notes
and Euro commercial papers.
2.8.1 International Equities: International equities or the Euro equities do not represent debt,
nor do they represent foreign direct investment. They are comparatively a new instrument
representing foreign portfolio equity investment. In this case, the investor gets the divided and
not the interest as in case of debt instruments. On the other hand, it does not have the same
pattern of voting right that it does have in the case of foreign direct investment. In fact,
international equities are a compromise between the debt and the foreign direct investment.
They are the instruments that are presently on the preference list of the investors as well as the
issuers.
2.8.1.1 Benefit to Issuer/ Investor
The issuers issue international equities under certain conditions and with certain objectives.
1. When the domestic capital market is already flooded with its shares, the issuing company
does not like to add further stress to the domestic stock of shares since such additions will cause
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a fall in the share prices. In order to maintain the share prices, the company issues international
equities.
2. The presence of restriction on the issue of shares in the domestic market facilitates the issue
of Euro equities.
3. The company issues international equities also for the sake of gaining international
recognition among the public.
4. International equities bring in foreign exchange which is vital for a firm in a developing
country.
5. International capital is available at lower cost though the Euro equities.
6. The funds raised through such an instrument do not add to the foreign exchange exposure.
From the viewpoint of the investors, international equities bring in diversification benefits and
raise return with a given risk or lower the risk with a given return. If investment is made in
international equalities along with international bonds, diversification benefits are still greater.
2.8.2 International Bonds
International bonds are a debt instrument. They are issued by international agencies,
governments and companies for borrowing foreign currency for a specified period of time. The
issuer pays interest to the creditor and makes repayment of capital. There are different types of
such bonds. The procedure of issue is very specific. International bonds are classified as foreign
bonds and Euro bonds. There is a difference between the two, primarily on four counts.
1. In the case of foreign bond, the issuer selects a foreign financial market where the bonds
are issued in the currency of that very country.
2. Foreign bonds are underwritten normally by the underwriters of the country where they
are issued. But the Euro bonds are underwritten by the underwriters of multi nationality.
3. The maturity of a foreign bond is determined keeping in mind the investors of a particular
country where it is issued. On the other hand, the Euro bonds are tailored to the needs of
the multinational investors. In the beginning, the Euro bond market was dominated by
individuals who had generally a choice for shorter maturity, but now the institutional
investors dominate the scenes who do not seek Euro bond maturity necessarily to march
their liabilities.
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4. Foreign bonds are normally subjected to governmental regulations in the country where
they are issued.
2.8.3 Global Bonds
It is the World Bank which issued the global bonds for the first time in 1989 and 1990. Since
1992, such bonds are being issued also be companies. Presently, there are seven currencies in
which such bonds are denominated namely, the Australian dollar, Canadian dollar, Japanese
yen, DM, Finnish markka, Swedish krona and Euro. The special features of the global bonds
are:
1. They carry high ratings
2. They are normally large in size
3. They are offered for simultaneous placement in different countries
4. They are traded on “home market” basis in different regions.
2.8.3 Straight Bonds
The straight bonds are the traditional type of bonds, wherein the interest rate (coupon rate) is
fixed. It is fixed with reference to rates on treasury bonds for comparable maturity. The credit
standing of the borrower is also taken into consideration for fixing the coupon rate. Straight
bonds are of many varieties.
1. Bullet redemption bond where the repayment of principal is made at the end of the
maturity and not in installments every year.
2. A rising coupon bond where coupon rate rises over time. The benefit is that the borrower
has to pay small amount of interest payment during early years of debt.
3. Zero coupon bonds whereby it carries no interest payment. Since there is no interest
payment, it is issued at discount.
4. Bond with currency options, the investor has the right to receive payments in a currency
other than the currency of the issue.
5. The bull and bear bonds are indexed to some specific benchmark and are issued in two
trenches. The bull bonds are those where the amount of redemption rises with a rise in
the indeed. The bear bonds are those where the amount of redemption falls with a fall in
the index.
6. Debt warrant bonds have a call warrant attached with them. (Warrants are zero coupon
bonds.) The creditors have the right to purchase another bond at a given price.
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2.8.4 Floating Rate Notes
Bonds, which do not carry fixed rate of interest, are known as Floating Rate Notes (FRNs).
Such bonds were issued for the first time in Italy during 1970 and they have become common
in recent times. The interest rate is quoted as a premium or discount to a reference rate which
is invariably LIBOR. The interest rate is revised periodically, say, at every three month or every
six month period, depending upon the period to which the interest rate is referenced to. FRNs
are available in different forms. In the case of perpetual FRNs, the principal amount is never
repaid. This means they are like equity shares. They were popular during mid-1980s, but when
the investors began to ask for higher rate of interest, many issuers could not afford paying
higher rates of interest. Such bonds lost their popularity.
2.8.5 Convertible Bonds
Some of the convertible bonds have detachable warrants involving acquisition rights. In other
cases, there is automatic convertibility into a specified number of shares. Convertible bonds
command a comparatively high market value because of the convertibility privilege. The value
is the sum of the naked value existing in the absence of conversion and the conversion value.
The conversion price per share is computed by dividing the bonds face value by the conversion
factor, where the conversion factor represents the number of shares into which each bond could
be exchanged.
2.8.6 Euro Notes
Euro Notes similar to promissory notes are issued by companies for obtaining short term funds.
They emerged in early 1980s with growing securitization in the international financial market.
They are denominated in any currency other than the currency of the country where they are
issued. They represent low cost funding route. Documentation facilities are the minimum. They
can be easily tailored to suit the requirements of different kinds of borrowers. Investors too
prefer them in view of short maturity.
When the issuer plans to issue Euro notes, it hires the services of facility agents or the lead
arranger. On the advice of the lead arranger, it issues the notes, gets them underwritten and
sells them through the placement agents. After the selling period is over the underwriter buys
the unsold issues. The Euro notes carry three main cost components:
1. Underwriting fee;
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2. One time management fee for structuring, pricing and documentation; and
3. Margin on the notes themselves. The margin is either in the form of spread above/below
LIBOR or built into the note price itself.
The documentation is standardized. The documents accompanying notes are usually
underwriting agreement, paying agency agreement, and information memorandum showing,
among other things, the financial position of the issuer. The notes are settled either through
physical delivery or through clearing.
2.8.7 Euro Commercial Papers
Another attractive form of short term debt instrument that emerged during mid – 1980s is Euro
commercial paper (ECP). It is a promissory note like the short term Euro notes although it is
different from Euro notes in some ways. It is not underwritten, while the Euro notes are
underwritten. The reason is that ECP is issued only by those companies that possess a high
degree of rating. Again, the ECP route for raising funds is normally investor driven, while the
Euro notes is said to be borrower driven.
ECP came up on the pattern of domestic market commercial papers that had a beginning in the
USA and then in Canada as back as in 1950s. The prefix “Euro” means that the ECP is issued
outside the country in the currency in which it is denominated. Most of the ECPs are
denominated in US dollars, but they are different from the US commercial papers on the sense
that the ECPs have longer maturity going up to one year. Moreover, ECPs are structured on the
basis of all in costs, whereas in US commercial papers, various charges, such as front end fee
and commission are collected separately
2.8.8 Medium- Term Euro Notes
Medium term Euro notes are just an extension of short term Euro notes as they fill the gap
existing in the maturity structure of international financial market instruments. They are a
compromise between short term Euro notes and long term Euro bonds as their maturity ranges
from one year to seven years. The short term Euro notes are allowed to roll over repeatedly
over five to seven years. Every three or six months, the short term Euro notes are redeemed
and a fresh issue is made.
Alternatively, a medium term Euro note is issued to get medium term funds in foreign currency
without any need for redemption and fresh issue. Medium term Euro notes are not underwritten,
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yet there is provision for underwriting. This is for ensuring the borrowers that they get the funds
even if they lack sufficient creditworthiness. They are issued broadly on the pattern of US
medium term notes that are found there since early 1970s. Medium term Euro notes carry fixed
rate of interest, although floating rates are also there. In recent years, multicurrency structure
has come up. The issuers are mainly banks, sovereigns and international agencies.
2.9 Capital Market Structure in India
The term capital market is a wide term, encompassing all long-term claims of money-lending’s
and borrowings. It thus includes all term lending’s by banks and financial institutions and long-
term borrowings from foreign markets and new issues by companies and raising of all resources
from public through issue of new securities, deposits, loans etc.
Capital market includes issues of two major categories- marketable and non-marketable.
Whether marketable or not, these are issued by government and government departments,
companies, public sector units, mutual funds, UTI etc. LIC and GIC sell policies and collects
savings from public, which are not marketable, the other non-marketable securities or claims
are issued by the post offices as savings certificates, deposit receipts etc., non-securitized loans
and advances of banks and financial institutions, deposits with banks and companies and
securities of private limited companies and finance company deposits/loans, chit funds etc. the
marketable securities are issued through the new issues market and are traded through the stock
market.
The contributors to new issue are promoters, collaborators, if any, employees, NRIs, banks,
FIs, mutual funds are mainly merchant bankers, registrars, brokers, mutual funds etc. the
ancillary functions and complementary to the above is those of underwriters, collecting
bankers, printers, advertising agents etc. The main players in the stock market, namely, brokers,
investment consultant, portfolio managers, investment managers etc.
2.9.1 Nature of Secondary Market
Secondary markets, also known as stock market, is a market where the trade of previously
issued securities of governments, semi-governments and firms is made under a code of rule
and regulations. It is a two-way market in which the investors and stakeholders are just as likely
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to be seller as buyers. As per Section 2(3) of the Security Contract (Regulation) Act 1956, the
following securities can be traded at a stock market.
1. Shares, scrips, stocks, bonds, debenture stocks or other marketable securities of a like
nature or of any incorporated company or other body corporate.
2. Government securities; and
3. Rights or interest in securities.
2.9.1.1 Features of secondary markets are:
1. A secondary market is a market for existing long-term securities of governments, semi-
governments and corporate enterprise. There are two types of market creators-dealers and
brokers. Dealers stands ready to buy and sell at quoted prices. They hold on to the
securities until someone else comes along wishing to buy them. In contracts, brokers do
not themselves buy or sell securities. They, instead of buying the securities, would find
someone willing to buy them.
2. The secondary market can be wholesale and retail. The wholesale market is the market in
which professionals, including institutional investors trade with one another. Transactions
in the market are usually large. The retail market is the market in which the individual
investors buy and sell securities.
3. Exchanges in the wholesale secondary market for capital securities may take places in
either of the two market viz., over-the counter market (OTC) and organized exchange
market where the organization is more structured and communication is often face to face,
market is known as an organized exchange. Generally, the secondary market for
government securities is an OTC market, and that the secondary market for corporate
equities consists of both the OTC markets and exchanges. The wholesale market for bonds
in the USA is principally an OTC market; fewer than 10% of all issue are traded in the
stock exchanges.
Thus, an organized exchange is characterized as auction market that uses floor traders
who specialize in particular stocks. Exchange rule govern trading to ensure the efficient
and legal operation of the exchange and the exchange board constantly reviews these rules
to ensure that they result in competitive trading. In about 90% of trades, the specialist
matches buyers with sellers. In other 10%, the specialist may intervene by taking
ownership of the stock themselves or by selling stock from inventory.
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Unlike organized exchanges, OTC markets have market makers. Rather than trading
stocks in an auction format, they trade on an electronic network where bid and ask prices
are set by market makers.
4. In the secondary market, only those securities, which are listed in the stock exchanges,
are traded. Unlisted securities are not permitted to be dealt in the market.
5. Transactions in the secondary market must accord to the rules and by laws framed by the
stock exchanges to regulate its day-to-day operations.
2.9.2 Importance of Secondary Market
Secondary market plays crucial role in economic and industrial development of a country
through promoting capital formation and efficient allocation of capital. Secondary market
promotes capital formation by assisting in the effective mobilization of savings and
channelizing them to appropriate source of investment. The opportunity of constant evaluation
of returns on one’s investment compared to others, the liquidity that is important to investment
in fixed capital and price continuity that it ensures, instill confidence in the minds of savers.
On the other hand, by creating conditions which reasonably ensure availability of financial
resources for creating real capital, whether in private or public sector, they give impetus to
development.
A secondary market increases economic efficiency. Moreover, it also helps in directing flow
of savings into promising industries and checks the flow of capital in uneconomic and less
profitable ventures. Thus, the secondary market seeks to achieve through keeping an eye on
the exchanges. A permanent to surge in share price of a particular industry suggest that more
capital can also absorbed by the industry with the advantage. On the contrary, if share price in
an industry registers continued fall, it suggest that the industry cannot absorb the capital
profitably. Through price mechanism the secondary market prevents gluts and scarcities of
capital as between different industries and avoids misalignments between supply of capital and
the demands of industry and effects economies in the use of capital.
The secondary market also facilitates an investor to shift from one type of investment to another
according to his investment priorities without any significant depreciation in its real value.
Accordingly, an investor does not get tied for the better or for the worse, to the particular
enterprise whose shares he buys. It is this assurance that he does not have to sink or swim with
it that makes him willing to venture into investment. Further, by widening the opportunities for
investment, a secondary market enables investors to spread their risk by acquiring securities
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for different industries, and in varying proportions, which is an essential concomitant to modern
investment.
A secondary market helps to promote ‘democratic capitalism’. By distributing the ownership
of securities more widely among the public, a securities market ensures that the ownership of
business is not confined to a small number of wealthy families or to big industrial financial
conglomerates.
Thus, secondary markets serve the nation in several ways through their multifarious services.
However, to many people the secondary market is in-separately associated with speculation
with a word that carries with it a cluster of anti-social in applications and monstrously pervert
its functions and advantages. There is no denying fact that unscrupulous and unbridled
speculations breed all sorts of misfortunes. But genuine speculations, which enable the stock
exchange to render the services, stated above, need not be discouraged.
As such, while the significance of the secondary market need not belittled, it must always be
subject to the maintenance of normally conductive conditions and effective check over
unscrupulous speculation.
In summary it can be stated that, both the segments of the capital market are equally important
while not being mutually exclusive. Only when a country’s primary market is alive, it is
possible to ensure a good deal of activity in the secondary market, more so in developing
economies. Looking from the other angle, if country’s secondary market is only active but not
transparent and disciplined the cult of equity and related investment in the primary market will
be difficult to be continuously developed and sustained because the liquidity which the
secondary market imparts to such investment in the hands of the investors will be adversely
affected.
2.9.3 Procedure for Securities Trading in Stock Market in India
Trading in securities in a stock market is permitted through members of the stock market.
Anyone intending to deal in securities has to approach brokers who are members of the stock
market. National Stock Exchange of India (NSE) has laid down the following procedure for
trading in securities in the exchange:
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1. Registration of client
A firm intending to buy securities has to approach the broker and execute client registration
form wherein all details about the buyer are furnished. Likewise, the seller has also to execute
the registration form. This forms the basis for trading in the exchange through the broker.
2. Agreement
An agreement between the buyer and broker as specified by the exchange concerned is entered
into. This agreement is known as the client member agreements.
3. Placing an order
Buyer places the order in writing with the broker for the purchase of certain number of scrips
at a certain specified price. In this respect, the broker guides the client about the type of
securities to be purchased and the proper time for it. If a client is to sell the securities, then the
broker tells him about the most appropriate time for sale.
While placing an order, sometimes a definite price is given on which the purchase is to be
made, sometimes the tentative price is given and sometimes the maximum price is given. The
broker tries to make purchase as far as possible to the nearest price offered by the client. The
broker is given some choice for bargaining. The same type of choice is given to the broker for
selling the securities.
4. Order confirmation
After collecting the order from the client, the broker places the order in his computer system,
which is, in turn, transmitted to the computer system of the NSE at Mumbai. The order
confirmation slip is obtained by the broker from the exchange.
5. Trade confirmation
A trade confirmation slip is generated as soon as the order is matched by the computer against
the price generated by the matching algorithm (price-time priority). The trade confirmation slip
contains details of the trade executed. The buyer then makes payment of requisite margin
money to the broker.
6. Contract note
The broker issues a contract note to the buyer in respect of all the orders that are executed
during the day. Such a note specifies the obligation of the parties concerned, for the buyers to
make payment and the broker to make delivery of scrips. Accordingly, the buyer makes the
payment and the broker delivers the scrips to the former. And thus, the contract is concluded.
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2.9.4 Mechanism of Trade Settlement in India
The spot dealings are settled in the market itself in full. The selling broker hands over the
transfer form and share certificates to the buying broker after receiving the price. In the NSE,
settlement of trade in stock takes a certain cycle. At present, there are there are two kinds of
settlement in the NSE, viz., Rolling Settlement and Account Settlement.
1. Rolling Settlement System
In this system, the trade is executed on a certain day has to be settled after a certain number of
days depending on the nature of settlement cycle practiced by the exchange. Thus, if a
settlement cycle is specified as T+2, it signifies the trade executed on the first day (say Monday)
has to be settled on the third day (on Wednesday) i.e. after a gap of three days.
2. Accounting Period System
Under this method, trading is allowed to continue for a certain period mutually agreed upon
by the parties and is possible for the client to buy or sell for a certain number of days, and
thereby accumulate a certain position during the period. At the end of the period, his
obligation in terms of shares purchased or sold and the amount to be paid by him is figured
out and communicated to him. The obligations of a broker are calculated after netting the
trades.
Table 2.1 – Settlement Cycle at NSE
Day 1 Monday Commencement of trade cycle
Day 2 Tuesday End of trade cycle
Day 3 Thursday Work out of obligations and its communications to brokers
Day 4 Friday Delivery of shares by selling broker to the clearing house
Day 5 Monday Payment by buying broker for purchases made
Day 6 Tuesday
Receipt of amount by the selling broker and receipt of shares
by the buying broker
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Thus, it is evident that the investor has liberty to trade in any pattern of his choice during a
period between Monday and Tuesday (Table 2.1). Once the period expires, the obligation of
each broker in terms of the shares sold/ purchased and the money to be received/ paid is figured
out and duly communicated to the broker. The broker is expected to deliver the share that he
has sold on next Thursday and pay the amount due on Tuesday next.
2.9.5 Mechanism for Guaranteed Settlement
At times, either or both the parties of the trading transaction commit default in honoring their
respective commitments at the end of the settlement period. Such a situation, known as
‘counterparty default’ is likely to destabilize the functioning of the stock exchange and threaten
the sanctity and integrity of the stock market. So as to avert the occurrence of such a situation,
the NSE introduced a system called ‘Settlement Guaranteed Mechanism’. According to this
system settlement of trade is undertaken by a separate statutory agency known as ‘Clearing
Corporation’. The NSE has set up a separate fully owned subsidiary to undertake this task.
The modus operandi of settlement guarantee mechanism is that the Clearing Corporation act
as a counter party in respect of every transaction. In that capacity it ensures and verifies that
the deliveries of proceeds and shares are made and passes them on to the respective brokers. In
case a broker defaults, the clearing corporation ensure that the trade is carried out unhindered
by making payment delivery of scrips on behalf of the defaulting brokers, who is thereafter
dealt with by the corporation. Thus this mechanism help both the brokers and thereby their
investors who are assured of prompt settlement irrespective of the fulfillment of obligations by
the other party. Besides, minimizing market risk, the mechanism saves the sanctity and
integrity of the stock market. However, success of the settlement guarantee mechanism is very
much dependent upon the following factors viz.,
1. Automated trading and settlement processes
2. Robust risk management processes
3. Well-articulated settlement schedule
4. Clearance of all securities through clearing house
5. Multilateral netting (netting across locations)
6. Funds settlement through clearing house
7. Well- defined procedures for post-settlement issues.
2.9.6 Settlement of Dematerialized Securities
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In the traditional method of trading i.e. physical movement of scrips, investors experience
several problems such as time-consuming process, involvement of heavy paper work, risks due
to transiting through postal system and high percentage of bad deliveries due to the
vulnerability of physical certificates to forgery, theft mutilation, etc. The unprecedented growth
in the number of investors and volume of transactions here sent the entire settlement system
haywire.
To overcome the above problem, the Government of India enacted the Depositories Act in
1996 to institute Depository System. In depository system, the transfer and settlement of scrips
take place through the system of effecting transfer of ownership of securities by means of book
entry on the ledger of the depository without the physical movement of scrips. The depository
system, thus, eliminates paper work, facilitates automatic and transparent trading in scrips,
shortens the settlement period and ultimately contributes to the liquidity of the investment in
securities. This system is also known as ‘Scrip less Trading System’. Securities through
depository system are called ‘dematerialized securities’.
A depository is a firm wherein the securities of an investor are held in electronic form in the
same way a bank holds money. It carries out the transactions of securities by means of book
entry without physical movement of securities. The depository based settlement system is
called ‘book entry transfer settlement’. The depository acts as a defacto owner of the securities
lodged with it for the limited purpose of transfer of ownership it operates as a custodian of
securities of its clients. At present, there are two depositories in India, viz,
1. National Securities Depository Ltd. (NSDL)
2. Central Depository Services India Ltd. (CDSIL)
An investor intending to avail of the depository has to open an account with a depository
participant (DP) also known as an agent of the depository. The procedure for selling
dematerialized securities in a stock exchange except one followed in physical securities is
outlined below:
1. Investors sells securities in any of the stock exchanges linked to depository through a
broker.
2. Investor instructs his DP to debit his demat account with the number of securities sold
and credit the broker’s clearing account.
3. The broker transfers the securities to clearing corporation before the pay in day.
4. The broker receives payment from the stock exchange.
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5. The investor receive payment from the broker for the sale of securities.
2.10 Capital Market Instruments
The following instruments are being used for raising capital
1. Equity shares
2. Preference shares
3. Non-voting equity shares
4. Cumulative convertible preference shares
5. Company fixed deposits
6. Warrants
7. Debentures/bonds
8. Secured premium notes (SPNs)
9. Euro Convertible Bonds (ECBs)/ Global Depository Receipts (GDRs)
2.11 New Initiatives and Capital Market Reform Measures
Though the capital markets in India have evolved over a long-period, they gathered
considerably only after various initiatives undertaken by the Government/securities and
Exchange Board of India (SEBI) beginning the early 1990s. The activity in the market picked
up from 2003-04 significantly reflecting effectiveness of the measures initiated to develop the
market and restore investor confidence.
Various reforms initiated in the financial markets since the early 1990s have focused on:
1. Removing the restrictions on pricing of assets
2. Building of institutional and technological infrastructure
3. Strengthening the risk management practices
4. Fine-testing of the market microstructure
5. Changes in the legal framework to remove structural rigidities and
6. Widening and deepening of the market with new participants and instruments
The Indian capital market dealt in scrips of a large number of listed companies with a wide
geographical outreach, providing a world class trading and settlement system, a wide range of
product availability with a fast growing derivatives market and well laid down corporate
governance and investor protection. The reforms in the capital market are aimed at enhancing
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the efficiency safety, integrity and transparency of the market. The key reform measures for
the capital market are given below.
1. Establishment of SEBI
The Securities and Exchange Board of India (SEBI) was established in 1988. It got a legal
status in 1992. SEBI was primarily set up to regulate the activities of the merchant banks, to
control the operations of mutual funds, to work as a promoter of the stock exchange activities
and to act as a regulatory authority of new issue activities of companies. The SEBI was set up
with the fundamental objective, "to protect the interest of investors in securities market and for
matters connected therewith or incidental thereto."
The main functions of SEBI are
 To regulate the business of the stock market and other securities market.
 To promote and regulate the self-regulatory organizations.
 To prohibit fraudulent and unfair trade practices in securities market.
 To promote awareness among investors and training of intermediaries about safety of
market.
 To prohibit insider trading in securities market.
 To regulate huge acquisition of shares and takeover of companies.
2. Establishment of Creditors Rating Agencies
Three creditors rating agencies viz. The Credit Rating Information Services of India Limited
(CRISIL - 1988), the Investment Information and Credit Rating Agency of India Limited
(ICRA -1991) and Credit Analysis and Research Limited (CARE) were set up in order to assess
the financial health of different financial institutions and agencies related to the stock market
activities. It acts as a guide for the investors also in evaluating the risk of their investments.
3. Increasing of Merchant Banking Activities
Many Indian and foreign commercial banks have set up their merchant banking divisions in
the last few years. These divisions provide financial services such as underwriting facilities,
issue organizing, consultancy services, etc. It has proved as a helping hand to factors related to
the capital market.
4. Candid Performance of Indian Economy
In the last few years, Indian economy is growing at a good speed. It has attracted a huge inflow
of Foreign Institutional Investments (FII). The massive entry of FIIs in the Indian capital
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market has given good appreciation for the Indian investors in recent times. Similarly many
new companies are emerging on the horizon of the Indian capital market to raise capital for
their expansions.
5. Rising Electronic Transactions
With the rapid growth in technology, the physical transaction with more paperwork is almost
nil. Now paperless transactions are increasing at a rapid rate. It saves money, time and energy
of investors. Thus it has made investing safer and hassle free encouraging more people to join
the capital market.
6. Growing Mutual Fund Industry
The growing of mutual funds in India has certainly helped the capital market to grow. Public
sector banks, foreign banks, financial institutions and joint mutual funds between the Indian
and foreign firms have launched many new funds. A big diversification in terms of schemes,
maturity, etc. has taken place in mutual funds in India. It has given a wide choice for the
common investors to enter the capital market.
7. Growing Stock Exchanges
The number of Stock Exchange in India are increasing. Initially the BSE was the main
exchange, but now after the setting up of the NSE and the OTCEI, stock exchanges have spread
across the country. Recently a new Inter-connected Stock Exchange of India has joined the
existing stock exchanges.
8. Investor's Protection
Under the purview of the SEBI the Central Government of India has set up the Investors
Education and Protection Fund (IEPF) in 2001. It works in educating and guiding investors. It
tries to protect the interest of the small investors from frauds and malpractices in the capital
market.
9. Growth of Derivative Transactions
Since June 2000, the NSE has introduced the derivatives trading in the equities. In November
2001 it also introduced the future and options transactions. These innovative products have
given variety for the investment leading to the expansion of the capital market.
10. Insurance Sector Reforms
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Indian insurance sector has also witnessed massive reforms in last few years. The Insurance
Regulatory and Development Authority (IRDA) was set up in 2000. It paved the entry of the
private insurance firms in India. As many insurance companies invest their money in the capital
market, it has expanded.
11. Commodity Trading
Along with the trading of ordinary securities, the trading in commodities is also recently
encouraged. The Multi Commodity Exchange (MCX) is set up. The volume of such
transactions is growing at a splendid rate. Apart from these reforms the setting up of Clearing
Corporation of India Limited (CCIL), Venture Funds, etc., have resulted into the tremendous
growth of Indian capital market.
SEBI vide its press release dated March 6, 2010 has announced the decisions of the board
meeting of SEBI held on the same day. The following is an analysis of the above said decisions.
The impact of various reform measures could be seen in the primary as well as secondary
segments of the capital market. The reform in the Indian capital market would gain added
significance in the context of a measure of international of Indian capital markets.
For the Indian system to derive the full benefits and avert risks involved in the process, a
structured and sequenced integration would be needed. The great interaction of Indian and
international market would necessarily involve further improving procedures and practices.
Foreign investors are used to open trading systems within the framework of prudential
regulation. Their markets are also characterized by adequate disclosure and research based
information and severe penalties for insider trading. Our markets would need, both for their
own development and to promote fruitful linkages with foreign capital market, to conform to
these principles.
2.12 The Way Forward
The Indian financial system in India has become more market-oriented in recent years. There
has been a significant increase in financial institutions’ market activities and exposures, as well
as participation by non-financial corporations and households in the markets. Hence, market-
based risks are becoming more relevant for financial stability.
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The Reserve Bank closely monitors financial market developments considering their critical
role, while simultaneously taking measures to further develop the various segments of the
financial market under its purview, viz. the money market, the Government securities market
and the foreign exchange market. The SEBI regulates the capital market.
Various reforms initiated in the financial markets since the early 1990s have focused on (1)
removing the restrictions on pricing of assets; (2) building of institutions and technological
infrastructure; (3) strengthening the risk management practices; (4) fine tuning of the market
microstructure; (5) changes in the legal framework to remove structural rigidities; and (6)
widening and deepening of the market with new participants and instruments. The Reserve
Bank set up a separate Financial Market Department (FMD) for exclusively monitoring the
developments in the financial markets.
2.13 PESTEL Analysis of Capital Market
PESTEL is a mnemonic which in its expanded form denotes P for Political, E for Economic, S
for Social, T for Technological, L for Legal and E for Environmental. All the aspects of this
technique are crucial for any kind for any industry. The analysis of capital market is as follows:
Political
The capital market of India is very vulnerable. India has been politically instable in the past but
it is a little politically stable now-a-days. The political instability of the country has a very
strong impact on the capital market. The share market of India changes as the political changes
took place. The BSE Index, SENSEX goes up and down with any kind of small and big political
news, like, if there is news that a particular political party has withdrawn its support from the
ruling party, and then the capital market will go down with a bang. The capital market of India
is too weak and is based on speculations. The political stability of the country is very important
for the stability and growth of capital market in India. The political imbalance or balance of
the country is the major factor in deciding the capital market of India.
The political factors include:
 Employment laws
 Tax policy
 Trade restrictions; and
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 Tariffs political stability
Economical:
Whenever the annual budget is announced the capital market goes up and down with the
economic policies of the government .If the policies are supportive to the companies then the
capital market takes it positively and if there is any other policy that is not supportive and it is
not welcomed then the capital market goes down. Like, in the case of allocation of 4-G
spectrum, those companies that got the license for 4-G, they witnessed sharp growth in their
share values so the economic policies play a major part in the growth and decline of the capital
market and again if there is relaxation on any kind of taxes on items of automobile industry
then the share of automobile sector goes up and virtually strengthen the capital market. The
policy of Government of India like demonetization and GST introduction made dramatic
changes in the stock market. The economic factors include:
 Inflation rate
 Economic growth
 Exchange rates
 Interest rates
Social:
India is a country of unity in diversity .India is socially rich but the capital market is not very
attached with the social factors .Yes, there is some relation between the social factors with the
capital market. If there is any big social factor then to some extent it affects the capital market
but small social factors don’t impact at all.
The social factors include:
 Emphasis on safety
 Career attitudes
 Population growth rate
 Age distribution
 Health consciousness
Technological:
The technological factors have not that much effect on the capital market. India is technological
backward country. Same as social factors, technological factor can have an effect on an
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individual form but it cannot have a big impact on a whole of capital market. The technological
factors include:
 R&D activity
 Technology incentives
 Rate of technological change
 Automation
Environmental:
Initially the environmental factors don’t play a vital role in the capital market. But the time has
changed and people are more eco-friendly. This is really bothering them that if any firm or
industry is environment friendly or not. An increasing number of people, investors, and
corporate executives are paying importance to these facts, the capital markets still see the
environment as a liability. The environmental performance is even under-valued by the
markets.
Legal:
Legal factors play an important role in the development and sustain the capital market.
Legal issues relating to any industry or firm decides the fate of the capital market. Like after
the Hardhat Mehta scam, new rules and regulations were introduced like PAN card and
ADHAR was made necessary for trading, if any investor was investing too much money in a
small firm, then the investors were questioned etc. These regulations were meant to maintain
transparency in the capital market, but at that time, investment was discouraged. Legal factors
are necessary for the improvement and stability of the capital market.
Page | 35
CHAPTER 3
LITERATURE REVIEW
3.1 Theoretical Concept
Investment is the employment of funds with the aim of achieving additional income or growth
in value. The essential quality of an investment is that it involves ‘waiting’ for a reward. It
involves the commitment of resources which have been saved or put away from current
consumption in the hope that some benefits will accrue in future. The term ‘Investment’ does
not appear to be as simple as it has been defined. Investment has been further categorized by
financial experts and economists. It has also often been confused with the term speculation.
The following discussion will give an explanation of the various ways in which investment is
related or differentiated from the financial and economic sense and how speculation differs
from investment.
The objective of risk and return analysis is to maximize the return by creating a balance of risk.
For example, in case of working capital management, the less inventory you keep, the higher
the expected return as less of your money is locked as asset; but you also have an increased
risk of running out of raw material when you actually need it for production or maintenance.
Page | 36
Which means you lose sale. Thus all companies tries very hard to maintain minimum inventory
as possible without effecting smooth production. This is a very common example of risk return
trade-off. In case of an investment in shares/stocks, an investor accept to get a better return
than fixed deposits but he also ready to take risk of losing his money in stock market. Hence
important is to understand how much risk one can take and invest accordingly.
Risk and return are the two key determinants of share prices. Greater the risk assumed higher
will be the return. Investment which carry low risk such as government securities will offer a
low rate of return. Any rational investor would analyze the risk associated with the particular
stock and a thorough knowledge of risk helps him to plan his portfolio so as to minimize the
risk associated with the investment. Return on investment may be because of income, capital
appreciation or a positive hedge against inflation. The degree of risk depends upon the features
of asset, investment instruments, mode of investment etc.
Wider the range of possible outcomes, the greater the risk. The degree of risk in a particular
situation is not absolute. It depends on the level of information available with the entity facing
the risk. When the complete information is available, the perception of the entity differs. Two
different entities may interpret the same information differently or different expectations for
the future which would lead to two different sets of probability distribution. Hence the same
set of circumstances may translate in to different levels of risk for different people. Further
people do not make any distinction between risk and uncertainty. Though risk and uncertainty
go together, but they differ in perception.
The concept of security analysis is based on risk and return. To earn return on investment,
investment has to be made for some period which in turn implies passage of time. Dealing with
the return to be achieved requires estimate of the return on investment on investment over the
time period. Risk denotes deviation of actual return from the estimated return. The fact that the
investors do not hold a single security which they consider most profitable is enough to say
that they are interested not only in maximization of return but also minimization of risk. In fact,
there is a positive relationship between the amount of risk and expected return, greater the risk,
larger the return. One of the most difficult problems for an investor is to estimate the highest
level of risk he is able to assume.
3.1.1 Risk Return Relationship
The relationship between risk and return is a fundamental financial relationship that affects
expected rates of return on every existing asset investment. The Risk-Return relationship is
Page | 37
characterized as being a "positive" or "direct" relationship meaning that if there are
expectations of higher levels of risk associated with a particular investment then greater returns
are required as compensation for that higher expected risk. Alternatively, if an investment has
relatively lower levels of expected risk, then investors are satisfied with relatively lower
returns. This risk-return relationship holds for individual investors and business managers.
Greater degrees of risk must be compensated for with greater returns on investment. Since
investment returns reflects the degree of risk involved with the investment, investors need to
be able to determine how much of a return is appropriate for a given level of risk. This process
is referred to as "pricing the risk".
The risk and return constitute the framework for taking investment decision. Return from
equity comprises dividend and capital appreciation. To earn return on investment, i.e., to earn
dividend and to get capital appreciation, investment has to be made for some period which in
turn implies passage of time. Dealing with the return to be achieved requires estimated of the
return on investment over the time period. Risk denotes deviation of actual return from the
estimated return. This deviation of actual return from expected return may be on either side –
both above and below the expected return.
The risk from holding a security can arise because of internal and external factors. That part of
the risk which is internal that in unique and related to the firm and industry is called
‘unsystematic risk’. That part of the risk which is external and which affects all securities and
is broad in its effect is called ‘systematic risk’. The fact that investors do not hold a single
security which they consider most profitable is enough to say that they are not only interested
in the maximization of return, but also minimization of risks. The unsystematic risk is
eliminated through holding more diversified securities. Systematic risk is also known as non-
diversifiable risk as this cannot be eliminated through more securities and is also called ‘market
risk’. Therefore, diversification leads to risk reduction but only to the minimum level of market
risk.
The investors increase their required return as perceived uncertainty increases. The rate of
return differs substantially among alternative investments, and because the required return on
specific investments change over time, the factors that influence the required rate of return
must be considered.
Page | 38
Fig 3.1 Risk Return Relationship
3.1.2 Measurement of Risk and Return
The risk associated with a single asset is assessed both from a behavioral and a quantitative/
statistical point of view. The behavioral view of risk can be obtained by using (1) sensitivity
analysis and (2) probability (distribution). The statistical measures of risk of an asset or security
are (1) Standard Deviation (2) Beta
3.1.3 Sensitivity Analysis
It takes into account a number of possible outcomes/ returns estimates while evaluating an
asset/ assessing risk. In order to have a sense of the volatility among return estimates, a possible
approach is to estimates the worst (pessimistic), the expected (most likely) and the best
(optimistic) return associated with the asset. Alternatively, the level of outcomes may be related
to the state of the economy, namely, recession, normal and boom conditions. The difference
between the optimistic and the pessimistic outcomes is the range which, according to the
sensitivity analysis, is the basic measure of risk. The greater the range, the more variability
(risk) the asset is said to have.
3.1.4 The Probability Distribution
As compared to sensitive analysis, the risk associated with an asset can be assessed more
accurately with the help of probability distribution. The probability of an event represents the
likelihood/ percentage chance of its occurrence.
Return Low Risk,
Low Return
High Risk,
High Potential Return
Standard Deviation (Risk)
Page | 39
For instance, if the expectation is that a given outcome (return) will occur seven out of ten
times, it can be said to have a seventy per cent (0.70) chance of happening; if it is certain to
happen, the probability of happening is 100 per cent (1). An outcome which has a probability
of zero will never occur.
Based on the probability assigned (probability distribution of) to the rate of return, the expected
value of the return can be computed. The expected rate of return is the weighted average of all
possible returns multiplied by their respective probabilities. Thus, probabilities of the various
outcomes are used as weights. The expected return,
R= ∑Ri × Pri (i)
Where Ri = return for the ith
possible outcome
Pri = probability associated with its return
N= number of outcomes considered.
3.1.5 Standard Deviation of Return
Risk refers to the dispersion of returns around an expected value. The most common statistical
measure of risk of an asset is the standard deviation from the mean/ expected value of return.
It represents the square root of the average squared deviations of the individual return from the
expected returns. Symbolically, the standard deviation,
𝜎𝑟𝑥 = √∑(𝑅𝑖 − 𝑅)^2 × 𝑃𝑟𝑖 (ii)
The greater the standard deviation of returns, the greater the variability/ dispersion of returns
and the greater the risk of the asset/ investment. However, standard deviation is an absolute
measure of dispersion and does not consider variability of return in relation to the expected
value.
3.1.6 Beta as a Measure of Volatility
Beta is a numeric value that measures the fluctuations of a stock to changes in the overall stock
market. Beta measures the responsiveness of a stock's price to changes in the overall stock
market. This helps the investor to decide whether he wants to go for the riskier stock that is
highly correlated with the market (beta above 1), or with a less volatile one (beta below 1).
Beta is the key factor used in the Capital Asset Price Model (CAPM) which is a model that
measures the return of a stock. The volatility of the stock and systematic risk can be judged by
Page | 40
calculating beta. A positive beta value indicates that stocks generally move in the same
direction with that of the market and the vice versa.
3.1.7 GARCH model
Generalized autoregressive conditional heteroscedasticity model (henceforth GARCH
model) is a successful model for modeling and forecasting the volatility of financial market.
GARCH is probably the most commonly used financial time series model and has inspired
dozens of more sophisticated models. The basis properties are:
 Uniqueness and stationarity
 Mean Zero
 Lack of serial correlation
 Unconditional variance
3.1.8 Jensen's Alpha – Measurement of Return Performance
Jensen's Alpha, or just "Alpha", is used to measure the risk-adjusted performance of a
security or portfolio in relation to the expected market return (which is based on the capital
asset pricing model (CAPM). The higher the alpha, the more a portfolio has earned above the
level predicted. Jensen's Alpha is also known as "Jensen's Performance Index" and "Jensen's
Measure". As for investors, they need to look not only at the total return of a security or a
portfolio, but also at the extent of risk that is inherent in the security and/or the portfolio. In a
normal scenario, an investors would like to attain highest possible return at the least possible
risk.
Jensen's Alpha can help determine if the average return generated is acceptable based on the
amount of risk involved. If the return is higher than that predicted by the CAPM, the security
or portfolio is said to have a positive alpha (or an abnormal return). Investors are always
looking for opportunities where a positive alpha is involved.
r = Rf + beta x (Rm - Rf) + Jensen's measure (alpha)…… (iii)
Where:
r = the security's or portfolio's return
Rf = the risk-free rate of return
Beta = the security's or portfolio's price volatility relative to the overall market
Rm = the market return
Page | 41
3.2 Literature Review
As state earlier, this study tries to examine the extent of risk and return relationship between
Nifty sectoral indices. More over this study also focuses on analyzing the volatility of stock
market return. Accordingly in this section a detailed review of literature is described.
3.2.1 Conditional Volatility Models
The generalized autoregressive conditional heteroscedasticity (GARCH) model given by
Bollerslev (1986) has been extensively used to study high-frequency financial time series data.
Most studies find high persistence in volatility shocks, implying that "current information
remains important for the forecasts of the conditional variances for all horizons." [See Engle
and Bollerslev (1986), p. 27.]
Using nominal exchange rates, Lastrapes (1989) found that there is a considerable reduction in
the estimated persistence of volatility when monetary regime shifts are incorporated in the
standard ARCH model. Hamilton and Susmel (1994) reached similar conclusions using a
Markov switching ARCH model to account for structural/regime changes. Unlike Lastrapes
(1989), the structural breaks were determined endogenously.
Karmakar (2005) estimated conditional volatility models in an effort to capture the salient
features of stock market volatility in India. Because of the high growth of the economy and
increasing interest of foreign investors towards the country, it is important to understand the
pattern of stock market volatility to India which is time varying persistent and predictable. It
was observed that GARCH model has been fitted for almost all companies. The various
GARCH models provided good forecasts of volatility and are useful for portfolio allocation,
performance measurement, option valuation etc.
Banerjee and Sarkar (2006) attempted to model the volatility in the Indian stock market. It
was found that the Indian stock market experiences volatility clustering and hence GARCH
type models predict the market volatility better than simple volatility models, like historical
average, moving average etc. Finally, it was seen that the change in volume of trade in the
market directly affects the volatility of assets returns. (Karmakar, 2005 )
Kumar (2006) evaluated the ability of ten different statistical and econometric volatility
forecasting models to the context of Indian stock and forex markets. These competing models
were evaluated on the basis of two categories of evaluation measures – symmetric and
Page | 42
asymmetric error statistics. All the measures indicated historical mean model as the worst
performing model in the forex market and in the stock market.
Karmakar (2007) investigated the heteroscedastic behavior of the Indian stock market using
different GARCH models. First, the standard GARCH approach was used to investigate
whether stock return volatility changes over time and if so, whether it was predictable. Then,
the E-GARCH models were applied to investigate whether there is asymmetric volatility. It
was found that the volatility is an asymmetric function of past innovation, rising
proportionately more during market decline.
Bordoloi and Shankar (2010) explored to develop alternative models from the Autoregressive
Conditional Heteroskedasticity (ARCH) or its Generalization, the Generalized ARCH
(GARCH) family, to estimate volatility in the Indian equity market return. It was found that
these indicators contain information in explaining the stock returns. The Threshold GARCH
(T-GARCH) models explained the volatilities better for both the BSE Indices and S&P-CNX
500, while Exponential GARCH (EGARCH) models for the S&P CNX-NIFTY.
Srinivasan and Ibrahim (2010) attempted to model and forecast the volatility of the SENSEX
Index returns of Indian stock market. Results showed that the symmetric GARCH model
performed better in forecasting conditional variance of the SENSEX Index return rather than
the asymmetric GARCH models, despite the presence of leverage effect. Few are against
conditional volatility models.
Pandey (2005) believed that there have been quite a few extensions of the basic conditional
volatility models to incorporate observed characteristics of stock returns. It was found that for
estimating the volatility, the extreme value estimators perform better on efficiency criteria than
conditional volatility models. In terms of bias conditional volatility models performed better
than the extreme value estimators. (Srinivasan, 2010)
Lakshmi (2013) measured the volatility pattern in various Sectoral Indices in Indian stock
market using Autoregressive Conditional Heteroscedasticity. A study was conducted for the
period starting 2008 till 2012. All eleven Sectoral Indices from MSE (CNX Auto, CNX Bank,
CNX Energy, CNX Finance, CNX FMCG, CNX IT, CNX Media, CNX Metal, CNX Pharma,
CNX PSU Bank, CNX Realty) was considered for research. At the end researcher concluded
that the reality sector has highest volatility than any other sector what accounts to around 80%
whereas Nifty measured around 20%. Whereas the banking sector has lowest volatility for test
period which struggled around 12%.
Page | 43
Mohandass & Renukadevi, (2013) had modeled volatility of BSE Sectoral Indices. Their
study involved data ranging from January 2001 to June 2012 from Bombay stock Index thirteen
sector Indices. Normality test, Stationary & Heteroscedasticity of data was carried out and their
result was positive. Later they summarized by using the Box-Jenkinson methodology for
modeling. ARMA (1,1) was found suitable, since it has ARCH effect also GARCH (1,1) model
was also carried out and was found out the best model to predict the volatility of the return.
3.2.2 Relationship between Return and Volatility
Volatility is a measure of deviation from the mean return of a security. Volatility is measured
by standard deviation. When the fluctuation in prices is large, standard deviation would be high
and vice-versa. Generally, higher the risk, higher is the chances of less than expected return. If
volatility increases return decreases. Stock returns are uncertain because there is volatility in
stock prices.
Mahajan and Singh (2008) examined the empirical relationship between volume and return,
and volume and volatility in the light of competing hypothesis about market structure by using
daily data of Sensitive Index of the Bombay Stock Exchange. Consistent with mixture of
distribution hypothesis, positive contemporaneous relationship between volume and volatility
was observed.
Yakob, Beal and Delpachitra (2005) examined seasonal effects of ten Asian Pacific stock
markets, including the Indian stock market, for the period January 2000 to March 2005. They
stated that this is a period of stability and therefore ideal for examining seasonality as it was
not influenced by the Asian financial crisis of the late nineties. They concluded that the Indian
stock market exhibited a month-of-the-year effect in that statistically significant negative
returns were found in March and April whereas statistically significant positive returns were
found in May, November and December. Of these five statistically significant monthly returns,
November generated the highest positive returns whereas April generated the lowest negative
returns.
Rawashdeh & Squalli (2005) studied the sectoral efficiency of Amman Stock Exchange. Data
ranging from 1992 to 2004 was taken on a daily basis. Variance Ratio, Run test was carried out
for all the four sectors. Their finding suggested that random walk hypothesis and weak-form
of efficiency was rejected.
Mubarik & Javid (2009) investigated the relationship between trading volume and returns
and volatility of Pakistani market. The findings suggested that there was significance effect of
Page | 44
the previous day trading volume on the current return. This implied that previous day returns
and volume has explanatory power in explaining the current market returns.
Pandian & Jeyanthi (2009) made an attempt to analyze the return and volatility. It was found
that the outlook for India is remarkably good. Bank, corporate and personal balance sheets are
strong. Corporations are experiencing high profits. The stock market is at a record high.
Commodity markets are at their strongest.
Rakesh & Dhankar (2011) examined the normality of return and risk of daily, weekly,
monthly and annual returns in Indian stock market. They used parametric and non-parametric
test to prove these objectives. They have selected Sensex, BSE 100 and BSE 500 indices from
Bombay Stock Exchange (BSE) for the period 1996 to 2006. The results show that, the returns
are negatively skewed for all the indices over the period.
Asymmetry is found in risk and return in case of daily and weekly returns i.e., risk and return
relationship seems inconsistent in case of daily and weekly returns. Monthly and annual return,
however are found normally distributed for all three indices over the period of time. The study
shows the importance of time horizon in investment strategy for the Indian stock market.
Durai & Bhadurai (2011) analyzed the correlation structure of the Indian equity markets with
that of world markets. The indices considered for the study are NASDAQ composite (USA), S
& P 500 (USA), FTSE 100 (UK) and DAX 30 (Germany) classified as developed markets.
KLSE composite (Malaysia), Jakarta composite (Indonesia), Straits times (Singapore), Seoul
composite (South Korea), Nikkei (Japan), Taiwan weighted index (Taiwan) and the S & P CNX
Nifty (India) are classified as Asian market, for the period 1997 to 2006.
The logistic smooth transition regression (LSTR) model results for the conditional time varying
correlation of S & P CNX Nifty with six Asian market and S & P CNX Nifty with four
developed markets show that there is a significant regime shift in the year 2000 and there is a
considerable increase in integration in the second regime. This indicates that the S & P CNX
Nifty index is moving towards a better integration with other world markets but not at a very
noteworthy phase.
Abdalla (2012) discussed stock return volatility in the Saudi stock market. Results provided
evidence of the existence of a positive risk premium, which supported the positive correlation
hypothesis between volatility and the expected stock returns.
Page | 45
Nawazish & Sara (2012) examined the volatility patterns in Karachi Stock Exchange. They
proposed that higher order moments of returns should be considered for prudent risk
assessment. While there are some who believe that there is not much significant relationship
between returns and volatility.
Shanmugasundram & Benedict (2013) conducted a study on the volatility of the sectoral
indices with reference to NSE. In this study the risk relationship in different time intervals of
the CNX NIFTY index and five sectoral indices including Auto index, Bank index, FMCG
index, Infrastructure index and IT index was examined. The results of the study did not support
any significant difference across the risk of sectoral indices and NIFTY.
Cao, Long & Yang (2013) analyze correlation between the sectoral indices on the China Stock
market. For their study two stage analysis were done. The period 2007 & 2008 was categorized
as drastic shock period and other as general ups and downs periods. Their finding suggests that
in the first stage sectors in the study were highly correlated but in other period the sector shows
less correlation.
Madhavi (2014) proved that stock market plays a very important role in the Indian economy.
The economy directions can be measured by how the volatility index moves. Although
financial industry affected by the financial crisis so stock market is perceived to be very risky
place. But still, CAPM, Portfolio Diversification and APT always proved to be effective to
manage the risk of market.
Rajamohan & Muthukamu (2014) compared the performance of the sectoral indices of NSE.
Their main objective was to measure the influence of banking sector vis-à-vis the other sectors.
They concluded that there is a positive correlation of influence of the banking sector with other
sectors.
Bora & Adhikary (2015) conducted an empirical study on the risk-return relationship using
BSE Sensex companies. The monthly closing prices of the 30 companies was used to analyze
the risk and returns for the period between 2010 and 2013. The findings revealed positive
relation between security returns and market returns and betas were found to be unstable.
3.3 Literature Gap
Therefore, to sum up, the study mainly focused on the analysis of mean return and volatility of
sectoral indices. The articles related to risk and return analysis of sectoral indices were taken
for the reference. The literature for the study classified into (i) conditional volatility model and
Page | 46
(ii) risk and return relationship. The articles from different authors were taken for the study.
But the literature on this research paper only focused on conditional volatility model and risk
return relationship. GARCH forecasted volatility estimation was one of the model used in this
study. References related to particular model was not included in this literature. Researchers
were recommended to take articles related to volatility forecasting using GARCH model for
their further studies.
CHAPTER 4
DATA ANALYSIS AND INTERPRETATION
4.1 Introduction
As mentioned earlier the main aim of the study is to examine the return and volatility of
the different sectoral indices listed in NSE. Accordingly four objective has been identified.
• To analyze the mean return of CNX Nifty and its sectoral indices.
• To analyze and rank the performance of sectoral indices using Jensen's Measure
• To study the extend of relationship among the sectoral indices during the study period.
• To examine the level of volatility among the sectorial indices using GARCH
4.2 Mean Return of CNX Nifty and its Sectoral Indices
In this chapter the data is analyzed and result for each of the objective are reported. As for the
first objective i.e., to analyze the mean return of CNX Nifty and its sectoral indices, mean
return has been computed and results are given below.
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market
Stock return and volatility evidence from indian stock market

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Stock return and volatility evidence from indian stock market

  • 1. BHAVAN’S ROYAL INSTITUTE OF MANAGEMENT MBA Finance Stock Returns and Volatility: Evidence from Indian Stock Market PROJECT REPORT Rohith U J
  • 2. Page | 1 EXECUTIVE SUMMARY The risk appetite of investors governs their investment in financial instruments. Persons who are minimum risk takers with return generally park their money in secure instruments but people with a higher risk appetite generally invest in a stock market financial instrument to achieve their financial goal. Investors with a higher risk appetite have to measure the market performance in the basis of risk and return so that they can alter their portfolio to keep pace with current market movement. In this research intended to study risk in terms of standard deviation and beta of all sectoral indices of NSE with respect to nifty and their performance in different time horizon and ranked them accordingly in terms of mean return and found out the best performing sector in a given time frame. The first objective of the study is to analyze the mean return of CNX Nifty and its sectoral indices. From the study it is founded that from an investor’s point of view the overall return (average of averages) seem to be the highest for Nifty Auto, while Nifty Metal had the lowest return. The second objective of the study is to analyze and rank the performance of sectoral indices. Nifty Auto was ranked as 1st with an overall performance. This was followed by Nifty Media and Nifty FMCG among the sectoral indices. From the investors point of view bucketing the investment in these sectors helps them to increase adjusted return with minimum risk. The third objective of the study is to examine the extend of association between CNX Nifty and the sectoral indices during the period. Among the sectoral indices, Nifty Financial Services had the highest correlation with Nifty Index. In other words Nifty Financial Services had very strong and high association with Nifty Index. Fourth objective of the study is to examine the level of volatility among the sectorial indices. Among all sectoral indices, Nifty Realty and Nifty PSU Bank having highest volatility. In other words these sectors having highest standard deviation and beta which indicates the volatility in its return. The methodology followed for conducting the study can be specified by research design, research approach, sample design, questionnaire design, data collection and statistical tools for analyzing the collected data. The research design used for this study was descriptive research.
  • 3. Page | 2 CHAPTER 1 INTRODUCTION Introduction Before liberalization, Indian economy was tightly controlled and protected by number of measures like licensing system, high tariffs and rates, limited investment in core sectors only. During 1980’s, growth of economy was highly unsustainable because of its dependence on borrowings to correct the current account deficit. To reduce the imbalances, the government of India introduced economic policy in 1991 to implement structural reforms. The financial sector at that time was much unstructured and its scope was limited only to bonds, equity, insurance, commodity markets, mutual and pension funds. In order to structure the security market, a regulatory authority named as SEBI (Security Exchange Board of India) was introduced and first electronic exchange National Stock Exchange also set up. The purpose behind this was to regularize investments, mobilization of resources and to give credit. A stock market is a place where buyers and sellers of stocks come together, physically or virtually. Participants in the market can be small individuals or large fund managers who can be situated anywhere. Investors place their orders to the professionals of a stock exchange who executes these buying and selling orders. The stocks are listed and traded on stock exchanges. Some exchanges are physically located, based on open outcry system where transactions are carried out on trading floor. The other exchanges are virtual exchanges whereas a network of computers is composed to do the transactions electronically. The whole system is order-driven, the order placed by an investor is automatically matched with the best limit order. This system provides more transparency as it shows all buy and sell orders. Risk and return are both relevant to investment decisions. Post liberalization, there have been a number of reforms that the Indian capital market has witnessed. This has caused both the risk and return of the different sectors of the Indian market to frequently change and become unpredictable. There is no clear answer to whether the risks and returns of these indices remain stable over a period of time.
  • 4. Page | 3 According to NSE ‘A stock market index is a measure of the relative value of a group of stocks in numerical terms. As the stocks within an index change value, the index value changes. An index is important to measure the performance of investments against a relevant market index’. 1.1 Statement of Problem The motives for introducing indices in India had been to contain the stock market volatility. After the subprime crises there was drastic change in the Indian stock market. “……..the impact of the global financial crisis unfolded in the Indian financial markets, though reversal of capital inflows and significant correction in the domestic stock markets on the back of sell-off in the equity market by the foreign institutional investors (FIIs) “ (Dr. Deepak Mohanty, Executive Director RBI). Literature on examining the impact of sub-prime crisis on market returns also seem to inconclusive. This study tries to address the gap in the literature. It attempts to address the following research questions. (i) Which are the indices that are top performing? (ii) What is the extent of association among the sectoral indices and (iii) What is the level of volatility existing among the sectoral indices? 1.2 Objective of the Study As mentioned above, from the research questions the following objectives were formulated.  To analyze the mean return of CNX Nifty and its sectoral indices.  To analyze and rank the performance of sectoral indices using Jensen's Measure  To study extent of relationship between CNX Nifty and the sectoral indices during the study period.  To examine the level of volatility among the sectorial indices using GARCH 1.3 Scope of the Study This study is an attempt to provide an empirical support to the risk and return factors across the sectoral indices and CNX Nifty index. The findings from the study will of much interest
  • 5. Page | 4 both at academic and business level circles. From an academic perspective, the findings will be of much use to understand the risk return relationship. Furthermore, for an investor, the findings also can assist in identifying indices that generate a higher return for the given level of risk. Accordingly, mutual fund houses, portfolio managers etc. can develop optimal portfolios, thus enabling the investor to enjoy a higher risk-adjusted return. 1.4 Research Methodology This study tries to describe the nature and extend of risk and return of Nifty sectoral indices with reference to CNX Nifty. Accordingly, a descriptive research design is used for the study. Data has been sourced from reliable secondary sources (NSE website). For this study, purposive sampling method has been adopted. Since the study is on analyzing the risk and return of Nifty –fifty index as well as the sectoral indices, it is important to check for data availability. On analyzing it is found that, as for sectoral indices, out of 12, value for two indices were missing. Thus, those indices for which values were readily available were taken for the study and rest were omitted. Accordingly the final sample consisted of ten sectoral indices. These include CNX Nifty Auto, CNX Nifty FMCG, CNX Nifty Financial Services, CNX Nifty Bank, CNX Nifty Public Sector Unit Bank, CNX Nifty Realty, CNX Nifty IT, CNX Nifty Media, CNX Nifty Pharma and CNX Nifty Metal. As far as the variables were concerned, closing value of the index formulated by National Stock Exchange (NSE Nifty) has been sourced from the NSE website. Similarly, daily closing price has been taken for all the selected indices too. Data were checked for performance of returns of sectoral indices, correlation among sectoral indices and estimation of extend of volatility of each sectoral indices. 1.4.1 Research Approach In this study, desk type research study that is it analyses the data relating to the volatility and return analysis of Indian sectoral indices with reference to National Stock Exchange. 1.4.2 Data Source For this study, data has been sourced from reliable secondary sources like NSE website. 1.4.3 Research Tool
  • 6. Page | 5 As mentioned earlier, the data has been sourced from reliable sources. In order to find the performance of sectoral indices, Jensen’s Alpha is used. And to test the association between the variables, correlation analysis is applied. Similarly, to measure the risk, standard deviation and Beta have been used. Finally, to find extend of volatility, GARCH model is used. All analysis were performed using MS Excel. 1.4.4 Research Period As mentioned earlier, the variables selected have been taken for the six year period starting from 2012 to 2017. The rationale for this period is that, during 2008 market across global were affected due to sub-prime crisis. After by 2010 the markets started getting stabilized. Since the study is all about determination of stock price, it is important to take a period which is not affected by extreme shocks such as crisis, depression etc. Accordingly, this study takes a five year period after providing a cooling period of two years after the sub-prime crisis. In other words, the starting period is taken as 2012 and the ending period as 2017. 1.5 Limitations of the Study  In this study, the factor that affect the stock return and volatility have been confined to internal variables only. No macro environment factors such as inflation, GDP have been factored in this study. Therefore future studies should aim by taking a long time series data and should incorporate macro-environment variables while determining the volatility.  Moreover the study has been confined only to CNX Nifty index and its sectoral indices. Thus, future studies should aim to analyze across multiple exchanges that too operating in different geographies. 1.6 Chapter Scheme The report of this study is presented in five chapters
  • 7. Page | 6 In the first chapter, an introduction to the topic is detailed. Further, the chapter also have covered the statement of the problem, objective of the study, scope of the study, methodology adopted in this study and finally the limitations of the study. The second chapter provides an overview on the capital market industry in general. Further, the chapter also discusses at length the global and national scenario of the capital markets. The third chapter focuses on the reviewing the prior works that has been studied in the capital market industry. Data analysis and interpretation has been reported in the fourth chapter. Finally, the fifth chapter summarizes the findings from the study and put forward certain recommendation and suggestions CHAPTER 2
  • 8. Page | 7 INDUSTRY PROFILE 2.1 Introduction A strong and a vibrant capital market is a prerequisite for industrial development. The capital market should be capable of meeting the requirement of credit and finance of the private entrepreneurs. The capital market should also help in sustained national industrial development. The capital market provides an alternative mechanism of reallocating resource. In other words, it channelizes household savings to the corporate sector and allocates funds among firm. In this process, it allows both firms and households to share risk. The capital market enables the valuation of firms on an almost continuous basis and it plays an important role in the government of the corporate sector. During the last two decades, capital market round the globe has been experiencing metamorphic changes, with the advent of liberalization pertaining to the industrial policy, licensing policy, financial services industry, interest rates, etc. Completion has become very intense and real, thus affecting the industrial sector and financial services industry. There has been a visible improvement in trading and settlement infrastructure, risk management system and levels of transparency. These improvement have brought about a reduction in the transaction costs and led to improvement in liquidity. 2.2 Meaning of Capital Market It is an organized market mechanism for effective and efficient transfer of money capital or financial resources from the investing class (a body of individual or institutional savers) to the entrepreneur class (individual or institutions engaged in industry business or service) in the private and public sectors of the economy. In a very broad sense, it includes the market for short-term funds. H.P. Parikh has referred to it as, “by capital market, I mean the market for all the financial instruments, short-term and long-term as also commercial, industrial and government paper.”
  • 9. Page | 8 In the words of Goldsmith, “the capital market of a modern economy has two basic functions: first the allocation of savings among users and investment; second the facilitation of the transfer of existing assets, tangible and intangible among individual economic units.” Grant defines capital market in a broad sense as “a series of channels through which the savings of the community are made available for industrial and commercial enterprises and for the public authorities. It embraces not only the system by which the public takes up long-term securities directly or through intermediaries but also the elaborate network of institutions responsible for short-term and medium term lenders.” From the above definitions, it may be deducted that the function of capital market is the collection of savings and their distribution for industrial investment. As such, the relationship between the market, instrument, and services are integrated as well as inter-dependent. Capital market is generally understood as the market for long-term funds. The capital market provides long-term debt and equity finance for the government and the corporate sector. By making long-term investment liquid, the capital market mediates between the conflicting maturity preference of lenders and borrowers. The capital market also facilitates the dispersion of business ownership and the reallocation of financial resources among corporations and industries. 2.3 Functions of Capital Market The capital market is directly responsible for the following activities:  Mobilization or concentration of national savings for economic development  Mobilization and import of foreign capital and foreign investment capital plus skill to fill up the deficit in the required financial resources to maintain the expected rate of economic growth  Productive utilization of resources, and  Directing the flow to funds of high yield and also strive for balanced and diversified industrialization. 2.4 Global Scenario
  • 10. Page | 9 Having grown by over 3.7 percentage in 2017, the global economy is projected to continue expanding in 2018. Healthy corporate balance sheets, accommodative macroeconomic policies, and favorable financial market conditions are all helping to sustain the expansion. Inflation remain reasonably subdued so far- the second-round effects of higher oil prices have not been significant. With monetary tightening underway in most cyclically advanced countries, inflation expectation are generally well anchored. In addition to further increase in oil prices, however, one risk to this outlook in some countries is a significant rebound in unit labor cost as labor markets tighten, especially if productive growth were to weaken. Further, strong foreign exchange inflow pose a challenge for monetary policy in some emerging markets- notably in Asia and the Commonwealth of Independent States. Without more exchange rate flexibility, these inflows will ultimately be monetized and result in higher inflation. The behavior of interest rates is a central issue in the current economic outlook. The current low level of long-term interest rates is contributing to a very favorable global financial environment. Interest rates remain low for this stage of the business cycle, and both corporate and emerging market spreads are near their historical lows. While the low level of long- term rates can be partly explained by a number of factors- including the confidence of financial markets in central banks’ commitment to low inflation, excess capacity in labor and product markets, and continued strong demand for U.S. Treasury securities by the official sector, especially in Asia- rates can be expected to rise more neutral levels, and spreads to increase, as the global economic upswing continues. A major concern is that the rise not be so abrupt as to cause disruptions in financial markets, or impact the overall global economic outlook. A downward bias remains on short-term risks. On the upside, strong corporate balance sheets and wealth effects from rising equity markets could lead to stronger than expected domestic demand. On the downside, the key risk include further exchange rate volatility, faster than expected rise in interest rate (for example, if triggered by inflationary pressure), and extended weakness in the Euro area. Moreover, oil prices have recently risen above and continue to be volatile. With excess capacity very low, the oil market remains highly susceptible to shocks. Divergences in regional growth rate have also widened, and global imbalances worsened in the past few years. Growth forecasts have been revised upwards for the United States, China and most of other emerging economies. In the euro area and Japan, however, growth projections have been marked down significantly, reflecting both faltering exports and weak final domestic
  • 11. Page | 10 demand. The U.S. current account deficit has continued to widen, it over 2.5 percent of GDP by the end of 2017. The continuing build-up of the large current account deficit in the United States, with counterpart surpluses and reserve accumulation concentrated mainly in emerging Asia, is a key concern. It is also a main source for many of the risks facing the global financial system. Solving this global imbalance problem should be an urgent priority. The step that must be taken by the relevant players are well-known by now, but nevertheless deserve repeating. They are: 1. Medium-term fiscal consolidation in the United States; 2. Structural reform in Europe and Japan to increase economic growth particularly labor market reform: and 3. Great exchange rate flexibility in China and emerging Asia. 2.5 Recent trends in Global Financial Markets In recent years, financial markets have undergone some of the most rapid and extensive changes in any markets. We have witnessed dramatic events in global financial markets, including the Asian crisis, the Russian crisis, and the near-collapse of Long Term Capital Management (LTCM), which was a highly leveraged hedge fund with enormous trading positions. More recently, there has been remarkable developments in stock prices around the world, and in particular in stocks in the telecommunications and internet sectors. Perhaps foremost among recent changes in world, financial markets has been there accelerating integration and globalization. This development, which has been fostered by the liberalization of markets, rapid technological progress and major advances in telecommunications, has created new investment and financing opportunities for businesses and people around the world. Easier access to global financial markets for individuals and corporations will lead to a more efficient allocation of capital, which, in turn, will promote economic growth and prosperity. Apart from this ongoing integration and globalization, world financial markets have also recently experienced increased securitization. In the past, this development has been spurred by the surge in mergers and acquisitions and leveraged buy-outs that has taken place in markets of late, not least in the euro area. One aspect of this securitization process has been the increase in corporate bond issuance, which has also coincided with a diminishing supply of government bonds in many countries, particularly in the United States.
  • 12. Page | 11 Other interesting developments in world financial markets include, the continued broadening and expansion of derivatives markets. The broadening of these markets has largely come about because rapid advances in technology, financial engineering, and risk management have helped to enhance both the supply of and the demand for more complex and sophisticated derivatives products. The increased use of derivatives to adjust exposure to risk in financial markets has also contributed to the rise in the notional amounts of outstanding derivatives contracts seen in recent years, in particular in over-the-counter (OTC) derivatives markets with interest rates and equities as underlying securities. While the leveraged nature of derivative instruments poses risks to individual investors, derivatives also provide scope for a more efficient allocation of risks in the economy, which is beneficial for the functioning of financial markets, and hence enhances the conditions for economic growth. Among the many changes in global financial markets, developments in the euro area have been particularly striking. 2.6 Developments in Euro Capital Markets from a Global Perspective The launch of the Euro on 1 January 1999 was an historic event. Eleven national currencies were converted into one single currency overnight. On 1 January 2001 Greece became the twelfth European Union Member State to adopt the single currency. The newly created currency area of the twelve participating EU Member States has a considerable weight in the world economy. It accounts for around 20% of both world GDP and world exports. The successful launch of the Euro, which is a key element in promoting economic stability and prosperity in Europe, has boosted the integration of financial markets in the euro area. This process of integration in European financial markets coincided with a trend towards globalization and securitization which was already well underway. Since its inception, Euro has been the second most widely used currency at the international level. This reflects the importance of the euro area in the world economy. Recent trends in the internationalization of the euro are the result of market developments and policies both inside and outside the euro area. The economies of, and the economic processes in, the countries currently within the euro area have become increasingly intertwined as we have moved towards EMU. This has naturally led to the development of more cross-border financial interconnections. At the same time, financial flows between the euro area and the rest of the world have increased rapidly in recent years.
  • 13. Page | 12 As far as euro area financial markets are concerned, the introduction of the euro acted as a catalyst for greater integration within the euro area, although this process is still far from complete. In particular, even though euro area financial markets are not yet fully integrated at an area-wide level, they are larger and more accessible than any of the markets that were denominated in the predecessor currencies of the euro. This has brought important benefits for residents in the Euro zone, particularly in the case of fixed income securities. The first is that the introduction of the euro created the second largest bond market in the world. The second is that, while the corporate bond market was of limited importance in the euro area before 1998, the launch of the euro seemed to act as a catalyst for the development of a market in which corporations could issue debt securities of unprecedented size. Reflecting this, the amount outstanding of debt securities issued by the non-financial corporate sector grew by an impressive 17% in 1999.The same growth rate was recorded in 2000 and – in the first six months of 2001 – growth rates of around 14% were observed. A third observation is the increasing importance of the euro in the overall stock of "truly international" debt securities. By the end of 2000, the euro accounted for 26% of such securities. This share is 7 percentage points higher than the total share accounted for by the euro's predecessor currencies at the end of 1998. The share of the euro is even larger if account is also taken of the issuance of debt securities denominated in the home currency of the borrower and targeted at the international financial market. Furthermore, by virtue of its openness and its breadth, the bond market of the euro area has become an important component in international bond markets and can be expected to develop further in the coming years. This picture of the euro bond market in terms of size, growth and international participation goes hand in hand with increased liquidity and efficiency. Over the past couple of years, this has resulted in declining transaction costs, as bid-ask spreads have narrowed. The story is not much different in the stock markets too. There is also evidence of further integration. A number of benchmark indices are presently available for the investors for the euro area as a whole. In addition, derivatives markets have been established which allow market participants to shift from taking a country perspective in their investment decisions to taking a sector perspective across the euro area. As a result, sectoral factors should play a greater role than before in determining share price movements over time.
  • 14. Page | 13 The integration of stock markets at the euro area level means that issuers across the euro area have privileged access to a large number of investors in a large and open market place. This has paved the way for new firms and relatively small firms to obtain finance from stock markets that have specialized in providing funds to young and innovative firms. Recently, large number of new listing has been reported. 2.7 Oversight of Financial Markets and Recent Institutional and Regulatory Development The internationalization of markets has been posing new challenges for supervisors. The new challenges posed by recent market developments come mainly from two sources, technological advances and the increased competition and market integration triggered by the introduction of the Euro. Until the 1980s, financial activity was conducted within heterogeneous frameworks. Each financial system was characterized by a different currency, legislation and supervisory structure. In general, each sector of the financial industry – banking, securities and insurance – had its own supervisory agency. Financial innovation has significantly blurred the distinction between products supplied by different intermediaries, and technological advances have had a major impact on the importance of the physical location of the market players, since the two sides of the transaction and the intermediary need not be close geographically. The concept of the market itself has drastically changed, since it has become an entity not clearly identified by a physical location. For example, a large part of the regulation relates to the definition of a market as a physical entity. In today's financial systems it is possible to have markets, like the foreign exchange market, that do not a have a geographical location. Public policies have progressively adapted to the new market environment, increasing cross-border and cross-sectoral co-operation between competent authorities and shaping new, less cumbersome and intrusive regulatory and supervisory tools. The introduction of the euro has further eroded sectoral and geographic segmentation, thus initiating debates in many countries on the most efficient institutional arrangements for prudential supervision and financial stability. The single agency approach has recently gained ground as a response to the breakdown of sectoral distinctions in the financial industry. Sweden and Denmark within the European Union and Canada and Norway outside the EU, were the first countries to adopt such a model. This
  • 15. Page | 14 solution attracted even more attention with the reforms in the United Kingdom establishing the Financial Services Authority. The developments which have occurred in the market seem to favor the single supervisor approach. In fact, financial products are now mixed and the same economic function is performed by contracts supplied by firms belonging to different segments of the financial industry. This implies that the traditional approach of specialized agencies is no longer perceived as satisfactory. On the other hand, the problems related to the creation and effective management of a universal agency are very complex. Indeed, co-ordination remains necessary, be it between specialized agencies or between the organizational units within a universal agency. A second issue involves the role played by central banks. There are three main arguments in favor and three main arguments against the unification of prudential supervision and central banking. The arguments in favor are the following. First, there is a potential for exploiting synergies between the supervisory function and the core tasks of a central bank. A thorough understanding of the proper functioning of payment systems and of other market infrastructures is essential for the smooth conduct of monetary policy. Information collected for supervisory purposes may play a significant role in this. The second argument concerns the need to focus on systemic risk. Central banks have a privileged position from which to assess the impact of macroeconomic shocks and the financial stability of groups of intermediaries. The third argument concerns the independence from political interference and the technical expertise of central banks. On the other hand, there exists three arguments supporting the establishment of a supervisory agency outside the central bank. The first one concerns the alleged conflict of interest between monetary policy and prudential supervision. Many authors have argued that the body in charge of monetary policy cannot be entrusted with supervision, because the monetary policy stance would be affected and it would pose a threat to price stability. A second argument is based on the observation that no clear distinction is made between the different financial products and intermediaries belonging to distinct financial sectors. The third and final argument concerns the need to avoid an excessive concentration of power in the central bank. While it may be a difficult and controversial exercise to weigh up the pros and cons of the two solutions at a general level, without making allowances for the specific environment, in the particular context of the Euro system, the balance of the arguments leans in favor of
  • 16. Page | 15 maintaining a strong role for National Central Banks in prudential supervision. The reasons for this are twofold. First, the conflict of interest regarding monetary policy and concentration of power is no longer relevant given the structure of the Euro system, since the introduction of the Euro has implied an institutional separation between the monetary jurisdictions – the Euro area – and the supervisory jurisdiction – domestically chartered institutions in individual countries. Second, in a single currency area in which financial markets are increasingly integrated, swift and open communications among supervisors are of vital importance for crisis prevention and management. The dual nature of National Central Banks, which are at the same time both national institutions and part of the Euro system, might be a valuable asset when dealing with cross-border or area-wide issues. 2.8 International Financial Market Instruments Funds are raised from the international financial market also through the sale of securities, such as international equities or Euro equities, Euro bonds, medium term and short term Euro notes and Euro commercial papers. 2.8.1 International Equities: International equities or the Euro equities do not represent debt, nor do they represent foreign direct investment. They are comparatively a new instrument representing foreign portfolio equity investment. In this case, the investor gets the divided and not the interest as in case of debt instruments. On the other hand, it does not have the same pattern of voting right that it does have in the case of foreign direct investment. In fact, international equities are a compromise between the debt and the foreign direct investment. They are the instruments that are presently on the preference list of the investors as well as the issuers. 2.8.1.1 Benefit to Issuer/ Investor The issuers issue international equities under certain conditions and with certain objectives. 1. When the domestic capital market is already flooded with its shares, the issuing company does not like to add further stress to the domestic stock of shares since such additions will cause
  • 17. Page | 16 a fall in the share prices. In order to maintain the share prices, the company issues international equities. 2. The presence of restriction on the issue of shares in the domestic market facilitates the issue of Euro equities. 3. The company issues international equities also for the sake of gaining international recognition among the public. 4. International equities bring in foreign exchange which is vital for a firm in a developing country. 5. International capital is available at lower cost though the Euro equities. 6. The funds raised through such an instrument do not add to the foreign exchange exposure. From the viewpoint of the investors, international equities bring in diversification benefits and raise return with a given risk or lower the risk with a given return. If investment is made in international equalities along with international bonds, diversification benefits are still greater. 2.8.2 International Bonds International bonds are a debt instrument. They are issued by international agencies, governments and companies for borrowing foreign currency for a specified period of time. The issuer pays interest to the creditor and makes repayment of capital. There are different types of such bonds. The procedure of issue is very specific. International bonds are classified as foreign bonds and Euro bonds. There is a difference between the two, primarily on four counts. 1. In the case of foreign bond, the issuer selects a foreign financial market where the bonds are issued in the currency of that very country. 2. Foreign bonds are underwritten normally by the underwriters of the country where they are issued. But the Euro bonds are underwritten by the underwriters of multi nationality. 3. The maturity of a foreign bond is determined keeping in mind the investors of a particular country where it is issued. On the other hand, the Euro bonds are tailored to the needs of the multinational investors. In the beginning, the Euro bond market was dominated by individuals who had generally a choice for shorter maturity, but now the institutional investors dominate the scenes who do not seek Euro bond maturity necessarily to march their liabilities.
  • 18. Page | 17 4. Foreign bonds are normally subjected to governmental regulations in the country where they are issued. 2.8.3 Global Bonds It is the World Bank which issued the global bonds for the first time in 1989 and 1990. Since 1992, such bonds are being issued also be companies. Presently, there are seven currencies in which such bonds are denominated namely, the Australian dollar, Canadian dollar, Japanese yen, DM, Finnish markka, Swedish krona and Euro. The special features of the global bonds are: 1. They carry high ratings 2. They are normally large in size 3. They are offered for simultaneous placement in different countries 4. They are traded on “home market” basis in different regions. 2.8.3 Straight Bonds The straight bonds are the traditional type of bonds, wherein the interest rate (coupon rate) is fixed. It is fixed with reference to rates on treasury bonds for comparable maturity. The credit standing of the borrower is also taken into consideration for fixing the coupon rate. Straight bonds are of many varieties. 1. Bullet redemption bond where the repayment of principal is made at the end of the maturity and not in installments every year. 2. A rising coupon bond where coupon rate rises over time. The benefit is that the borrower has to pay small amount of interest payment during early years of debt. 3. Zero coupon bonds whereby it carries no interest payment. Since there is no interest payment, it is issued at discount. 4. Bond with currency options, the investor has the right to receive payments in a currency other than the currency of the issue. 5. The bull and bear bonds are indexed to some specific benchmark and are issued in two trenches. The bull bonds are those where the amount of redemption rises with a rise in the indeed. The bear bonds are those where the amount of redemption falls with a fall in the index. 6. Debt warrant bonds have a call warrant attached with them. (Warrants are zero coupon bonds.) The creditors have the right to purchase another bond at a given price.
  • 19. Page | 18 2.8.4 Floating Rate Notes Bonds, which do not carry fixed rate of interest, are known as Floating Rate Notes (FRNs). Such bonds were issued for the first time in Italy during 1970 and they have become common in recent times. The interest rate is quoted as a premium or discount to a reference rate which is invariably LIBOR. The interest rate is revised periodically, say, at every three month or every six month period, depending upon the period to which the interest rate is referenced to. FRNs are available in different forms. In the case of perpetual FRNs, the principal amount is never repaid. This means they are like equity shares. They were popular during mid-1980s, but when the investors began to ask for higher rate of interest, many issuers could not afford paying higher rates of interest. Such bonds lost their popularity. 2.8.5 Convertible Bonds Some of the convertible bonds have detachable warrants involving acquisition rights. In other cases, there is automatic convertibility into a specified number of shares. Convertible bonds command a comparatively high market value because of the convertibility privilege. The value is the sum of the naked value existing in the absence of conversion and the conversion value. The conversion price per share is computed by dividing the bonds face value by the conversion factor, where the conversion factor represents the number of shares into which each bond could be exchanged. 2.8.6 Euro Notes Euro Notes similar to promissory notes are issued by companies for obtaining short term funds. They emerged in early 1980s with growing securitization in the international financial market. They are denominated in any currency other than the currency of the country where they are issued. They represent low cost funding route. Documentation facilities are the minimum. They can be easily tailored to suit the requirements of different kinds of borrowers. Investors too prefer them in view of short maturity. When the issuer plans to issue Euro notes, it hires the services of facility agents or the lead arranger. On the advice of the lead arranger, it issues the notes, gets them underwritten and sells them through the placement agents. After the selling period is over the underwriter buys the unsold issues. The Euro notes carry three main cost components: 1. Underwriting fee;
  • 20. Page | 19 2. One time management fee for structuring, pricing and documentation; and 3. Margin on the notes themselves. The margin is either in the form of spread above/below LIBOR or built into the note price itself. The documentation is standardized. The documents accompanying notes are usually underwriting agreement, paying agency agreement, and information memorandum showing, among other things, the financial position of the issuer. The notes are settled either through physical delivery or through clearing. 2.8.7 Euro Commercial Papers Another attractive form of short term debt instrument that emerged during mid – 1980s is Euro commercial paper (ECP). It is a promissory note like the short term Euro notes although it is different from Euro notes in some ways. It is not underwritten, while the Euro notes are underwritten. The reason is that ECP is issued only by those companies that possess a high degree of rating. Again, the ECP route for raising funds is normally investor driven, while the Euro notes is said to be borrower driven. ECP came up on the pattern of domestic market commercial papers that had a beginning in the USA and then in Canada as back as in 1950s. The prefix “Euro” means that the ECP is issued outside the country in the currency in which it is denominated. Most of the ECPs are denominated in US dollars, but they are different from the US commercial papers on the sense that the ECPs have longer maturity going up to one year. Moreover, ECPs are structured on the basis of all in costs, whereas in US commercial papers, various charges, such as front end fee and commission are collected separately 2.8.8 Medium- Term Euro Notes Medium term Euro notes are just an extension of short term Euro notes as they fill the gap existing in the maturity structure of international financial market instruments. They are a compromise between short term Euro notes and long term Euro bonds as their maturity ranges from one year to seven years. The short term Euro notes are allowed to roll over repeatedly over five to seven years. Every three or six months, the short term Euro notes are redeemed and a fresh issue is made. Alternatively, a medium term Euro note is issued to get medium term funds in foreign currency without any need for redemption and fresh issue. Medium term Euro notes are not underwritten,
  • 21. Page | 20 yet there is provision for underwriting. This is for ensuring the borrowers that they get the funds even if they lack sufficient creditworthiness. They are issued broadly on the pattern of US medium term notes that are found there since early 1970s. Medium term Euro notes carry fixed rate of interest, although floating rates are also there. In recent years, multicurrency structure has come up. The issuers are mainly banks, sovereigns and international agencies. 2.9 Capital Market Structure in India The term capital market is a wide term, encompassing all long-term claims of money-lending’s and borrowings. It thus includes all term lending’s by banks and financial institutions and long- term borrowings from foreign markets and new issues by companies and raising of all resources from public through issue of new securities, deposits, loans etc. Capital market includes issues of two major categories- marketable and non-marketable. Whether marketable or not, these are issued by government and government departments, companies, public sector units, mutual funds, UTI etc. LIC and GIC sell policies and collects savings from public, which are not marketable, the other non-marketable securities or claims are issued by the post offices as savings certificates, deposit receipts etc., non-securitized loans and advances of banks and financial institutions, deposits with banks and companies and securities of private limited companies and finance company deposits/loans, chit funds etc. the marketable securities are issued through the new issues market and are traded through the stock market. The contributors to new issue are promoters, collaborators, if any, employees, NRIs, banks, FIs, mutual funds are mainly merchant bankers, registrars, brokers, mutual funds etc. the ancillary functions and complementary to the above is those of underwriters, collecting bankers, printers, advertising agents etc. The main players in the stock market, namely, brokers, investment consultant, portfolio managers, investment managers etc. 2.9.1 Nature of Secondary Market Secondary markets, also known as stock market, is a market where the trade of previously issued securities of governments, semi-governments and firms is made under a code of rule and regulations. It is a two-way market in which the investors and stakeholders are just as likely
  • 22. Page | 21 to be seller as buyers. As per Section 2(3) of the Security Contract (Regulation) Act 1956, the following securities can be traded at a stock market. 1. Shares, scrips, stocks, bonds, debenture stocks or other marketable securities of a like nature or of any incorporated company or other body corporate. 2. Government securities; and 3. Rights or interest in securities. 2.9.1.1 Features of secondary markets are: 1. A secondary market is a market for existing long-term securities of governments, semi- governments and corporate enterprise. There are two types of market creators-dealers and brokers. Dealers stands ready to buy and sell at quoted prices. They hold on to the securities until someone else comes along wishing to buy them. In contracts, brokers do not themselves buy or sell securities. They, instead of buying the securities, would find someone willing to buy them. 2. The secondary market can be wholesale and retail. The wholesale market is the market in which professionals, including institutional investors trade with one another. Transactions in the market are usually large. The retail market is the market in which the individual investors buy and sell securities. 3. Exchanges in the wholesale secondary market for capital securities may take places in either of the two market viz., over-the counter market (OTC) and organized exchange market where the organization is more structured and communication is often face to face, market is known as an organized exchange. Generally, the secondary market for government securities is an OTC market, and that the secondary market for corporate equities consists of both the OTC markets and exchanges. The wholesale market for bonds in the USA is principally an OTC market; fewer than 10% of all issue are traded in the stock exchanges. Thus, an organized exchange is characterized as auction market that uses floor traders who specialize in particular stocks. Exchange rule govern trading to ensure the efficient and legal operation of the exchange and the exchange board constantly reviews these rules to ensure that they result in competitive trading. In about 90% of trades, the specialist matches buyers with sellers. In other 10%, the specialist may intervene by taking ownership of the stock themselves or by selling stock from inventory.
  • 23. Page | 22 Unlike organized exchanges, OTC markets have market makers. Rather than trading stocks in an auction format, they trade on an electronic network where bid and ask prices are set by market makers. 4. In the secondary market, only those securities, which are listed in the stock exchanges, are traded. Unlisted securities are not permitted to be dealt in the market. 5. Transactions in the secondary market must accord to the rules and by laws framed by the stock exchanges to regulate its day-to-day operations. 2.9.2 Importance of Secondary Market Secondary market plays crucial role in economic and industrial development of a country through promoting capital formation and efficient allocation of capital. Secondary market promotes capital formation by assisting in the effective mobilization of savings and channelizing them to appropriate source of investment. The opportunity of constant evaluation of returns on one’s investment compared to others, the liquidity that is important to investment in fixed capital and price continuity that it ensures, instill confidence in the minds of savers. On the other hand, by creating conditions which reasonably ensure availability of financial resources for creating real capital, whether in private or public sector, they give impetus to development. A secondary market increases economic efficiency. Moreover, it also helps in directing flow of savings into promising industries and checks the flow of capital in uneconomic and less profitable ventures. Thus, the secondary market seeks to achieve through keeping an eye on the exchanges. A permanent to surge in share price of a particular industry suggest that more capital can also absorbed by the industry with the advantage. On the contrary, if share price in an industry registers continued fall, it suggest that the industry cannot absorb the capital profitably. Through price mechanism the secondary market prevents gluts and scarcities of capital as between different industries and avoids misalignments between supply of capital and the demands of industry and effects economies in the use of capital. The secondary market also facilitates an investor to shift from one type of investment to another according to his investment priorities without any significant depreciation in its real value. Accordingly, an investor does not get tied for the better or for the worse, to the particular enterprise whose shares he buys. It is this assurance that he does not have to sink or swim with it that makes him willing to venture into investment. Further, by widening the opportunities for investment, a secondary market enables investors to spread their risk by acquiring securities
  • 24. Page | 23 for different industries, and in varying proportions, which is an essential concomitant to modern investment. A secondary market helps to promote ‘democratic capitalism’. By distributing the ownership of securities more widely among the public, a securities market ensures that the ownership of business is not confined to a small number of wealthy families or to big industrial financial conglomerates. Thus, secondary markets serve the nation in several ways through their multifarious services. However, to many people the secondary market is in-separately associated with speculation with a word that carries with it a cluster of anti-social in applications and monstrously pervert its functions and advantages. There is no denying fact that unscrupulous and unbridled speculations breed all sorts of misfortunes. But genuine speculations, which enable the stock exchange to render the services, stated above, need not be discouraged. As such, while the significance of the secondary market need not belittled, it must always be subject to the maintenance of normally conductive conditions and effective check over unscrupulous speculation. In summary it can be stated that, both the segments of the capital market are equally important while not being mutually exclusive. Only when a country’s primary market is alive, it is possible to ensure a good deal of activity in the secondary market, more so in developing economies. Looking from the other angle, if country’s secondary market is only active but not transparent and disciplined the cult of equity and related investment in the primary market will be difficult to be continuously developed and sustained because the liquidity which the secondary market imparts to such investment in the hands of the investors will be adversely affected. 2.9.3 Procedure for Securities Trading in Stock Market in India Trading in securities in a stock market is permitted through members of the stock market. Anyone intending to deal in securities has to approach brokers who are members of the stock market. National Stock Exchange of India (NSE) has laid down the following procedure for trading in securities in the exchange:
  • 25. Page | 24 1. Registration of client A firm intending to buy securities has to approach the broker and execute client registration form wherein all details about the buyer are furnished. Likewise, the seller has also to execute the registration form. This forms the basis for trading in the exchange through the broker. 2. Agreement An agreement between the buyer and broker as specified by the exchange concerned is entered into. This agreement is known as the client member agreements. 3. Placing an order Buyer places the order in writing with the broker for the purchase of certain number of scrips at a certain specified price. In this respect, the broker guides the client about the type of securities to be purchased and the proper time for it. If a client is to sell the securities, then the broker tells him about the most appropriate time for sale. While placing an order, sometimes a definite price is given on which the purchase is to be made, sometimes the tentative price is given and sometimes the maximum price is given. The broker tries to make purchase as far as possible to the nearest price offered by the client. The broker is given some choice for bargaining. The same type of choice is given to the broker for selling the securities. 4. Order confirmation After collecting the order from the client, the broker places the order in his computer system, which is, in turn, transmitted to the computer system of the NSE at Mumbai. The order confirmation slip is obtained by the broker from the exchange. 5. Trade confirmation A trade confirmation slip is generated as soon as the order is matched by the computer against the price generated by the matching algorithm (price-time priority). The trade confirmation slip contains details of the trade executed. The buyer then makes payment of requisite margin money to the broker. 6. Contract note The broker issues a contract note to the buyer in respect of all the orders that are executed during the day. Such a note specifies the obligation of the parties concerned, for the buyers to make payment and the broker to make delivery of scrips. Accordingly, the buyer makes the payment and the broker delivers the scrips to the former. And thus, the contract is concluded.
  • 26. Page | 25 2.9.4 Mechanism of Trade Settlement in India The spot dealings are settled in the market itself in full. The selling broker hands over the transfer form and share certificates to the buying broker after receiving the price. In the NSE, settlement of trade in stock takes a certain cycle. At present, there are there are two kinds of settlement in the NSE, viz., Rolling Settlement and Account Settlement. 1. Rolling Settlement System In this system, the trade is executed on a certain day has to be settled after a certain number of days depending on the nature of settlement cycle practiced by the exchange. Thus, if a settlement cycle is specified as T+2, it signifies the trade executed on the first day (say Monday) has to be settled on the third day (on Wednesday) i.e. after a gap of three days. 2. Accounting Period System Under this method, trading is allowed to continue for a certain period mutually agreed upon by the parties and is possible for the client to buy or sell for a certain number of days, and thereby accumulate a certain position during the period. At the end of the period, his obligation in terms of shares purchased or sold and the amount to be paid by him is figured out and communicated to him. The obligations of a broker are calculated after netting the trades. Table 2.1 – Settlement Cycle at NSE Day 1 Monday Commencement of trade cycle Day 2 Tuesday End of trade cycle Day 3 Thursday Work out of obligations and its communications to brokers Day 4 Friday Delivery of shares by selling broker to the clearing house Day 5 Monday Payment by buying broker for purchases made Day 6 Tuesday Receipt of amount by the selling broker and receipt of shares by the buying broker
  • 27. Page | 26 Thus, it is evident that the investor has liberty to trade in any pattern of his choice during a period between Monday and Tuesday (Table 2.1). Once the period expires, the obligation of each broker in terms of the shares sold/ purchased and the money to be received/ paid is figured out and duly communicated to the broker. The broker is expected to deliver the share that he has sold on next Thursday and pay the amount due on Tuesday next. 2.9.5 Mechanism for Guaranteed Settlement At times, either or both the parties of the trading transaction commit default in honoring their respective commitments at the end of the settlement period. Such a situation, known as ‘counterparty default’ is likely to destabilize the functioning of the stock exchange and threaten the sanctity and integrity of the stock market. So as to avert the occurrence of such a situation, the NSE introduced a system called ‘Settlement Guaranteed Mechanism’. According to this system settlement of trade is undertaken by a separate statutory agency known as ‘Clearing Corporation’. The NSE has set up a separate fully owned subsidiary to undertake this task. The modus operandi of settlement guarantee mechanism is that the Clearing Corporation act as a counter party in respect of every transaction. In that capacity it ensures and verifies that the deliveries of proceeds and shares are made and passes them on to the respective brokers. In case a broker defaults, the clearing corporation ensure that the trade is carried out unhindered by making payment delivery of scrips on behalf of the defaulting brokers, who is thereafter dealt with by the corporation. Thus this mechanism help both the brokers and thereby their investors who are assured of prompt settlement irrespective of the fulfillment of obligations by the other party. Besides, minimizing market risk, the mechanism saves the sanctity and integrity of the stock market. However, success of the settlement guarantee mechanism is very much dependent upon the following factors viz., 1. Automated trading and settlement processes 2. Robust risk management processes 3. Well-articulated settlement schedule 4. Clearance of all securities through clearing house 5. Multilateral netting (netting across locations) 6. Funds settlement through clearing house 7. Well- defined procedures for post-settlement issues. 2.9.6 Settlement of Dematerialized Securities
  • 28. Page | 27 In the traditional method of trading i.e. physical movement of scrips, investors experience several problems such as time-consuming process, involvement of heavy paper work, risks due to transiting through postal system and high percentage of bad deliveries due to the vulnerability of physical certificates to forgery, theft mutilation, etc. The unprecedented growth in the number of investors and volume of transactions here sent the entire settlement system haywire. To overcome the above problem, the Government of India enacted the Depositories Act in 1996 to institute Depository System. In depository system, the transfer and settlement of scrips take place through the system of effecting transfer of ownership of securities by means of book entry on the ledger of the depository without the physical movement of scrips. The depository system, thus, eliminates paper work, facilitates automatic and transparent trading in scrips, shortens the settlement period and ultimately contributes to the liquidity of the investment in securities. This system is also known as ‘Scrip less Trading System’. Securities through depository system are called ‘dematerialized securities’. A depository is a firm wherein the securities of an investor are held in electronic form in the same way a bank holds money. It carries out the transactions of securities by means of book entry without physical movement of securities. The depository based settlement system is called ‘book entry transfer settlement’. The depository acts as a defacto owner of the securities lodged with it for the limited purpose of transfer of ownership it operates as a custodian of securities of its clients. At present, there are two depositories in India, viz, 1. National Securities Depository Ltd. (NSDL) 2. Central Depository Services India Ltd. (CDSIL) An investor intending to avail of the depository has to open an account with a depository participant (DP) also known as an agent of the depository. The procedure for selling dematerialized securities in a stock exchange except one followed in physical securities is outlined below: 1. Investors sells securities in any of the stock exchanges linked to depository through a broker. 2. Investor instructs his DP to debit his demat account with the number of securities sold and credit the broker’s clearing account. 3. The broker transfers the securities to clearing corporation before the pay in day. 4. The broker receives payment from the stock exchange.
  • 29. Page | 28 5. The investor receive payment from the broker for the sale of securities. 2.10 Capital Market Instruments The following instruments are being used for raising capital 1. Equity shares 2. Preference shares 3. Non-voting equity shares 4. Cumulative convertible preference shares 5. Company fixed deposits 6. Warrants 7. Debentures/bonds 8. Secured premium notes (SPNs) 9. Euro Convertible Bonds (ECBs)/ Global Depository Receipts (GDRs) 2.11 New Initiatives and Capital Market Reform Measures Though the capital markets in India have evolved over a long-period, they gathered considerably only after various initiatives undertaken by the Government/securities and Exchange Board of India (SEBI) beginning the early 1990s. The activity in the market picked up from 2003-04 significantly reflecting effectiveness of the measures initiated to develop the market and restore investor confidence. Various reforms initiated in the financial markets since the early 1990s have focused on: 1. Removing the restrictions on pricing of assets 2. Building of institutional and technological infrastructure 3. Strengthening the risk management practices 4. Fine-testing of the market microstructure 5. Changes in the legal framework to remove structural rigidities and 6. Widening and deepening of the market with new participants and instruments The Indian capital market dealt in scrips of a large number of listed companies with a wide geographical outreach, providing a world class trading and settlement system, a wide range of product availability with a fast growing derivatives market and well laid down corporate governance and investor protection. The reforms in the capital market are aimed at enhancing
  • 30. Page | 29 the efficiency safety, integrity and transparency of the market. The key reform measures for the capital market are given below. 1. Establishment of SEBI The Securities and Exchange Board of India (SEBI) was established in 1988. It got a legal status in 1992. SEBI was primarily set up to regulate the activities of the merchant banks, to control the operations of mutual funds, to work as a promoter of the stock exchange activities and to act as a regulatory authority of new issue activities of companies. The SEBI was set up with the fundamental objective, "to protect the interest of investors in securities market and for matters connected therewith or incidental thereto." The main functions of SEBI are  To regulate the business of the stock market and other securities market.  To promote and regulate the self-regulatory organizations.  To prohibit fraudulent and unfair trade practices in securities market.  To promote awareness among investors and training of intermediaries about safety of market.  To prohibit insider trading in securities market.  To regulate huge acquisition of shares and takeover of companies. 2. Establishment of Creditors Rating Agencies Three creditors rating agencies viz. The Credit Rating Information Services of India Limited (CRISIL - 1988), the Investment Information and Credit Rating Agency of India Limited (ICRA -1991) and Credit Analysis and Research Limited (CARE) were set up in order to assess the financial health of different financial institutions and agencies related to the stock market activities. It acts as a guide for the investors also in evaluating the risk of their investments. 3. Increasing of Merchant Banking Activities Many Indian and foreign commercial banks have set up their merchant banking divisions in the last few years. These divisions provide financial services such as underwriting facilities, issue organizing, consultancy services, etc. It has proved as a helping hand to factors related to the capital market. 4. Candid Performance of Indian Economy In the last few years, Indian economy is growing at a good speed. It has attracted a huge inflow of Foreign Institutional Investments (FII). The massive entry of FIIs in the Indian capital
  • 31. Page | 30 market has given good appreciation for the Indian investors in recent times. Similarly many new companies are emerging on the horizon of the Indian capital market to raise capital for their expansions. 5. Rising Electronic Transactions With the rapid growth in technology, the physical transaction with more paperwork is almost nil. Now paperless transactions are increasing at a rapid rate. It saves money, time and energy of investors. Thus it has made investing safer and hassle free encouraging more people to join the capital market. 6. Growing Mutual Fund Industry The growing of mutual funds in India has certainly helped the capital market to grow. Public sector banks, foreign banks, financial institutions and joint mutual funds between the Indian and foreign firms have launched many new funds. A big diversification in terms of schemes, maturity, etc. has taken place in mutual funds in India. It has given a wide choice for the common investors to enter the capital market. 7. Growing Stock Exchanges The number of Stock Exchange in India are increasing. Initially the BSE was the main exchange, but now after the setting up of the NSE and the OTCEI, stock exchanges have spread across the country. Recently a new Inter-connected Stock Exchange of India has joined the existing stock exchanges. 8. Investor's Protection Under the purview of the SEBI the Central Government of India has set up the Investors Education and Protection Fund (IEPF) in 2001. It works in educating and guiding investors. It tries to protect the interest of the small investors from frauds and malpractices in the capital market. 9. Growth of Derivative Transactions Since June 2000, the NSE has introduced the derivatives trading in the equities. In November 2001 it also introduced the future and options transactions. These innovative products have given variety for the investment leading to the expansion of the capital market. 10. Insurance Sector Reforms
  • 32. Page | 31 Indian insurance sector has also witnessed massive reforms in last few years. The Insurance Regulatory and Development Authority (IRDA) was set up in 2000. It paved the entry of the private insurance firms in India. As many insurance companies invest their money in the capital market, it has expanded. 11. Commodity Trading Along with the trading of ordinary securities, the trading in commodities is also recently encouraged. The Multi Commodity Exchange (MCX) is set up. The volume of such transactions is growing at a splendid rate. Apart from these reforms the setting up of Clearing Corporation of India Limited (CCIL), Venture Funds, etc., have resulted into the tremendous growth of Indian capital market. SEBI vide its press release dated March 6, 2010 has announced the decisions of the board meeting of SEBI held on the same day. The following is an analysis of the above said decisions. The impact of various reform measures could be seen in the primary as well as secondary segments of the capital market. The reform in the Indian capital market would gain added significance in the context of a measure of international of Indian capital markets. For the Indian system to derive the full benefits and avert risks involved in the process, a structured and sequenced integration would be needed. The great interaction of Indian and international market would necessarily involve further improving procedures and practices. Foreign investors are used to open trading systems within the framework of prudential regulation. Their markets are also characterized by adequate disclosure and research based information and severe penalties for insider trading. Our markets would need, both for their own development and to promote fruitful linkages with foreign capital market, to conform to these principles. 2.12 The Way Forward The Indian financial system in India has become more market-oriented in recent years. There has been a significant increase in financial institutions’ market activities and exposures, as well as participation by non-financial corporations and households in the markets. Hence, market- based risks are becoming more relevant for financial stability.
  • 33. Page | 32 The Reserve Bank closely monitors financial market developments considering their critical role, while simultaneously taking measures to further develop the various segments of the financial market under its purview, viz. the money market, the Government securities market and the foreign exchange market. The SEBI regulates the capital market. Various reforms initiated in the financial markets since the early 1990s have focused on (1) removing the restrictions on pricing of assets; (2) building of institutions and technological infrastructure; (3) strengthening the risk management practices; (4) fine tuning of the market microstructure; (5) changes in the legal framework to remove structural rigidities; and (6) widening and deepening of the market with new participants and instruments. The Reserve Bank set up a separate Financial Market Department (FMD) for exclusively monitoring the developments in the financial markets. 2.13 PESTEL Analysis of Capital Market PESTEL is a mnemonic which in its expanded form denotes P for Political, E for Economic, S for Social, T for Technological, L for Legal and E for Environmental. All the aspects of this technique are crucial for any kind for any industry. The analysis of capital market is as follows: Political The capital market of India is very vulnerable. India has been politically instable in the past but it is a little politically stable now-a-days. The political instability of the country has a very strong impact on the capital market. The share market of India changes as the political changes took place. The BSE Index, SENSEX goes up and down with any kind of small and big political news, like, if there is news that a particular political party has withdrawn its support from the ruling party, and then the capital market will go down with a bang. The capital market of India is too weak and is based on speculations. The political stability of the country is very important for the stability and growth of capital market in India. The political imbalance or balance of the country is the major factor in deciding the capital market of India. The political factors include:  Employment laws  Tax policy  Trade restrictions; and
  • 34. Page | 33  Tariffs political stability Economical: Whenever the annual budget is announced the capital market goes up and down with the economic policies of the government .If the policies are supportive to the companies then the capital market takes it positively and if there is any other policy that is not supportive and it is not welcomed then the capital market goes down. Like, in the case of allocation of 4-G spectrum, those companies that got the license for 4-G, they witnessed sharp growth in their share values so the economic policies play a major part in the growth and decline of the capital market and again if there is relaxation on any kind of taxes on items of automobile industry then the share of automobile sector goes up and virtually strengthen the capital market. The policy of Government of India like demonetization and GST introduction made dramatic changes in the stock market. The economic factors include:  Inflation rate  Economic growth  Exchange rates  Interest rates Social: India is a country of unity in diversity .India is socially rich but the capital market is not very attached with the social factors .Yes, there is some relation between the social factors with the capital market. If there is any big social factor then to some extent it affects the capital market but small social factors don’t impact at all. The social factors include:  Emphasis on safety  Career attitudes  Population growth rate  Age distribution  Health consciousness Technological: The technological factors have not that much effect on the capital market. India is technological backward country. Same as social factors, technological factor can have an effect on an
  • 35. Page | 34 individual form but it cannot have a big impact on a whole of capital market. The technological factors include:  R&D activity  Technology incentives  Rate of technological change  Automation Environmental: Initially the environmental factors don’t play a vital role in the capital market. But the time has changed and people are more eco-friendly. This is really bothering them that if any firm or industry is environment friendly or not. An increasing number of people, investors, and corporate executives are paying importance to these facts, the capital markets still see the environment as a liability. The environmental performance is even under-valued by the markets. Legal: Legal factors play an important role in the development and sustain the capital market. Legal issues relating to any industry or firm decides the fate of the capital market. Like after the Hardhat Mehta scam, new rules and regulations were introduced like PAN card and ADHAR was made necessary for trading, if any investor was investing too much money in a small firm, then the investors were questioned etc. These regulations were meant to maintain transparency in the capital market, but at that time, investment was discouraged. Legal factors are necessary for the improvement and stability of the capital market.
  • 36. Page | 35 CHAPTER 3 LITERATURE REVIEW 3.1 Theoretical Concept Investment is the employment of funds with the aim of achieving additional income or growth in value. The essential quality of an investment is that it involves ‘waiting’ for a reward. It involves the commitment of resources which have been saved or put away from current consumption in the hope that some benefits will accrue in future. The term ‘Investment’ does not appear to be as simple as it has been defined. Investment has been further categorized by financial experts and economists. It has also often been confused with the term speculation. The following discussion will give an explanation of the various ways in which investment is related or differentiated from the financial and economic sense and how speculation differs from investment. The objective of risk and return analysis is to maximize the return by creating a balance of risk. For example, in case of working capital management, the less inventory you keep, the higher the expected return as less of your money is locked as asset; but you also have an increased risk of running out of raw material when you actually need it for production or maintenance.
  • 37. Page | 36 Which means you lose sale. Thus all companies tries very hard to maintain minimum inventory as possible without effecting smooth production. This is a very common example of risk return trade-off. In case of an investment in shares/stocks, an investor accept to get a better return than fixed deposits but he also ready to take risk of losing his money in stock market. Hence important is to understand how much risk one can take and invest accordingly. Risk and return are the two key determinants of share prices. Greater the risk assumed higher will be the return. Investment which carry low risk such as government securities will offer a low rate of return. Any rational investor would analyze the risk associated with the particular stock and a thorough knowledge of risk helps him to plan his portfolio so as to minimize the risk associated with the investment. Return on investment may be because of income, capital appreciation or a positive hedge against inflation. The degree of risk depends upon the features of asset, investment instruments, mode of investment etc. Wider the range of possible outcomes, the greater the risk. The degree of risk in a particular situation is not absolute. It depends on the level of information available with the entity facing the risk. When the complete information is available, the perception of the entity differs. Two different entities may interpret the same information differently or different expectations for the future which would lead to two different sets of probability distribution. Hence the same set of circumstances may translate in to different levels of risk for different people. Further people do not make any distinction between risk and uncertainty. Though risk and uncertainty go together, but they differ in perception. The concept of security analysis is based on risk and return. To earn return on investment, investment has to be made for some period which in turn implies passage of time. Dealing with the return to be achieved requires estimate of the return on investment on investment over the time period. Risk denotes deviation of actual return from the estimated return. The fact that the investors do not hold a single security which they consider most profitable is enough to say that they are interested not only in maximization of return but also minimization of risk. In fact, there is a positive relationship between the amount of risk and expected return, greater the risk, larger the return. One of the most difficult problems for an investor is to estimate the highest level of risk he is able to assume. 3.1.1 Risk Return Relationship The relationship between risk and return is a fundamental financial relationship that affects expected rates of return on every existing asset investment. The Risk-Return relationship is
  • 38. Page | 37 characterized as being a "positive" or "direct" relationship meaning that if there are expectations of higher levels of risk associated with a particular investment then greater returns are required as compensation for that higher expected risk. Alternatively, if an investment has relatively lower levels of expected risk, then investors are satisfied with relatively lower returns. This risk-return relationship holds for individual investors and business managers. Greater degrees of risk must be compensated for with greater returns on investment. Since investment returns reflects the degree of risk involved with the investment, investors need to be able to determine how much of a return is appropriate for a given level of risk. This process is referred to as "pricing the risk". The risk and return constitute the framework for taking investment decision. Return from equity comprises dividend and capital appreciation. To earn return on investment, i.e., to earn dividend and to get capital appreciation, investment has to be made for some period which in turn implies passage of time. Dealing with the return to be achieved requires estimated of the return on investment over the time period. Risk denotes deviation of actual return from the estimated return. This deviation of actual return from expected return may be on either side – both above and below the expected return. The risk from holding a security can arise because of internal and external factors. That part of the risk which is internal that in unique and related to the firm and industry is called ‘unsystematic risk’. That part of the risk which is external and which affects all securities and is broad in its effect is called ‘systematic risk’. The fact that investors do not hold a single security which they consider most profitable is enough to say that they are not only interested in the maximization of return, but also minimization of risks. The unsystematic risk is eliminated through holding more diversified securities. Systematic risk is also known as non- diversifiable risk as this cannot be eliminated through more securities and is also called ‘market risk’. Therefore, diversification leads to risk reduction but only to the minimum level of market risk. The investors increase their required return as perceived uncertainty increases. The rate of return differs substantially among alternative investments, and because the required return on specific investments change over time, the factors that influence the required rate of return must be considered.
  • 39. Page | 38 Fig 3.1 Risk Return Relationship 3.1.2 Measurement of Risk and Return The risk associated with a single asset is assessed both from a behavioral and a quantitative/ statistical point of view. The behavioral view of risk can be obtained by using (1) sensitivity analysis and (2) probability (distribution). The statistical measures of risk of an asset or security are (1) Standard Deviation (2) Beta 3.1.3 Sensitivity Analysis It takes into account a number of possible outcomes/ returns estimates while evaluating an asset/ assessing risk. In order to have a sense of the volatility among return estimates, a possible approach is to estimates the worst (pessimistic), the expected (most likely) and the best (optimistic) return associated with the asset. Alternatively, the level of outcomes may be related to the state of the economy, namely, recession, normal and boom conditions. The difference between the optimistic and the pessimistic outcomes is the range which, according to the sensitivity analysis, is the basic measure of risk. The greater the range, the more variability (risk) the asset is said to have. 3.1.4 The Probability Distribution As compared to sensitive analysis, the risk associated with an asset can be assessed more accurately with the help of probability distribution. The probability of an event represents the likelihood/ percentage chance of its occurrence. Return Low Risk, Low Return High Risk, High Potential Return Standard Deviation (Risk)
  • 40. Page | 39 For instance, if the expectation is that a given outcome (return) will occur seven out of ten times, it can be said to have a seventy per cent (0.70) chance of happening; if it is certain to happen, the probability of happening is 100 per cent (1). An outcome which has a probability of zero will never occur. Based on the probability assigned (probability distribution of) to the rate of return, the expected value of the return can be computed. The expected rate of return is the weighted average of all possible returns multiplied by their respective probabilities. Thus, probabilities of the various outcomes are used as weights. The expected return, R= ∑Ri × Pri (i) Where Ri = return for the ith possible outcome Pri = probability associated with its return N= number of outcomes considered. 3.1.5 Standard Deviation of Return Risk refers to the dispersion of returns around an expected value. The most common statistical measure of risk of an asset is the standard deviation from the mean/ expected value of return. It represents the square root of the average squared deviations of the individual return from the expected returns. Symbolically, the standard deviation, 𝜎𝑟𝑥 = √∑(𝑅𝑖 − 𝑅)^2 × 𝑃𝑟𝑖 (ii) The greater the standard deviation of returns, the greater the variability/ dispersion of returns and the greater the risk of the asset/ investment. However, standard deviation is an absolute measure of dispersion and does not consider variability of return in relation to the expected value. 3.1.6 Beta as a Measure of Volatility Beta is a numeric value that measures the fluctuations of a stock to changes in the overall stock market. Beta measures the responsiveness of a stock's price to changes in the overall stock market. This helps the investor to decide whether he wants to go for the riskier stock that is highly correlated with the market (beta above 1), or with a less volatile one (beta below 1). Beta is the key factor used in the Capital Asset Price Model (CAPM) which is a model that measures the return of a stock. The volatility of the stock and systematic risk can be judged by
  • 41. Page | 40 calculating beta. A positive beta value indicates that stocks generally move in the same direction with that of the market and the vice versa. 3.1.7 GARCH model Generalized autoregressive conditional heteroscedasticity model (henceforth GARCH model) is a successful model for modeling and forecasting the volatility of financial market. GARCH is probably the most commonly used financial time series model and has inspired dozens of more sophisticated models. The basis properties are:  Uniqueness and stationarity  Mean Zero  Lack of serial correlation  Unconditional variance 3.1.8 Jensen's Alpha – Measurement of Return Performance Jensen's Alpha, or just "Alpha", is used to measure the risk-adjusted performance of a security or portfolio in relation to the expected market return (which is based on the capital asset pricing model (CAPM). The higher the alpha, the more a portfolio has earned above the level predicted. Jensen's Alpha is also known as "Jensen's Performance Index" and "Jensen's Measure". As for investors, they need to look not only at the total return of a security or a portfolio, but also at the extent of risk that is inherent in the security and/or the portfolio. In a normal scenario, an investors would like to attain highest possible return at the least possible risk. Jensen's Alpha can help determine if the average return generated is acceptable based on the amount of risk involved. If the return is higher than that predicted by the CAPM, the security or portfolio is said to have a positive alpha (or an abnormal return). Investors are always looking for opportunities where a positive alpha is involved. r = Rf + beta x (Rm - Rf) + Jensen's measure (alpha)…… (iii) Where: r = the security's or portfolio's return Rf = the risk-free rate of return Beta = the security's or portfolio's price volatility relative to the overall market Rm = the market return
  • 42. Page | 41 3.2 Literature Review As state earlier, this study tries to examine the extent of risk and return relationship between Nifty sectoral indices. More over this study also focuses on analyzing the volatility of stock market return. Accordingly in this section a detailed review of literature is described. 3.2.1 Conditional Volatility Models The generalized autoregressive conditional heteroscedasticity (GARCH) model given by Bollerslev (1986) has been extensively used to study high-frequency financial time series data. Most studies find high persistence in volatility shocks, implying that "current information remains important for the forecasts of the conditional variances for all horizons." [See Engle and Bollerslev (1986), p. 27.] Using nominal exchange rates, Lastrapes (1989) found that there is a considerable reduction in the estimated persistence of volatility when monetary regime shifts are incorporated in the standard ARCH model. Hamilton and Susmel (1994) reached similar conclusions using a Markov switching ARCH model to account for structural/regime changes. Unlike Lastrapes (1989), the structural breaks were determined endogenously. Karmakar (2005) estimated conditional volatility models in an effort to capture the salient features of stock market volatility in India. Because of the high growth of the economy and increasing interest of foreign investors towards the country, it is important to understand the pattern of stock market volatility to India which is time varying persistent and predictable. It was observed that GARCH model has been fitted for almost all companies. The various GARCH models provided good forecasts of volatility and are useful for portfolio allocation, performance measurement, option valuation etc. Banerjee and Sarkar (2006) attempted to model the volatility in the Indian stock market. It was found that the Indian stock market experiences volatility clustering and hence GARCH type models predict the market volatility better than simple volatility models, like historical average, moving average etc. Finally, it was seen that the change in volume of trade in the market directly affects the volatility of assets returns. (Karmakar, 2005 ) Kumar (2006) evaluated the ability of ten different statistical and econometric volatility forecasting models to the context of Indian stock and forex markets. These competing models were evaluated on the basis of two categories of evaluation measures – symmetric and
  • 43. Page | 42 asymmetric error statistics. All the measures indicated historical mean model as the worst performing model in the forex market and in the stock market. Karmakar (2007) investigated the heteroscedastic behavior of the Indian stock market using different GARCH models. First, the standard GARCH approach was used to investigate whether stock return volatility changes over time and if so, whether it was predictable. Then, the E-GARCH models were applied to investigate whether there is asymmetric volatility. It was found that the volatility is an asymmetric function of past innovation, rising proportionately more during market decline. Bordoloi and Shankar (2010) explored to develop alternative models from the Autoregressive Conditional Heteroskedasticity (ARCH) or its Generalization, the Generalized ARCH (GARCH) family, to estimate volatility in the Indian equity market return. It was found that these indicators contain information in explaining the stock returns. The Threshold GARCH (T-GARCH) models explained the volatilities better for both the BSE Indices and S&P-CNX 500, while Exponential GARCH (EGARCH) models for the S&P CNX-NIFTY. Srinivasan and Ibrahim (2010) attempted to model and forecast the volatility of the SENSEX Index returns of Indian stock market. Results showed that the symmetric GARCH model performed better in forecasting conditional variance of the SENSEX Index return rather than the asymmetric GARCH models, despite the presence of leverage effect. Few are against conditional volatility models. Pandey (2005) believed that there have been quite a few extensions of the basic conditional volatility models to incorporate observed characteristics of stock returns. It was found that for estimating the volatility, the extreme value estimators perform better on efficiency criteria than conditional volatility models. In terms of bias conditional volatility models performed better than the extreme value estimators. (Srinivasan, 2010) Lakshmi (2013) measured the volatility pattern in various Sectoral Indices in Indian stock market using Autoregressive Conditional Heteroscedasticity. A study was conducted for the period starting 2008 till 2012. All eleven Sectoral Indices from MSE (CNX Auto, CNX Bank, CNX Energy, CNX Finance, CNX FMCG, CNX IT, CNX Media, CNX Metal, CNX Pharma, CNX PSU Bank, CNX Realty) was considered for research. At the end researcher concluded that the reality sector has highest volatility than any other sector what accounts to around 80% whereas Nifty measured around 20%. Whereas the banking sector has lowest volatility for test period which struggled around 12%.
  • 44. Page | 43 Mohandass & Renukadevi, (2013) had modeled volatility of BSE Sectoral Indices. Their study involved data ranging from January 2001 to June 2012 from Bombay stock Index thirteen sector Indices. Normality test, Stationary & Heteroscedasticity of data was carried out and their result was positive. Later they summarized by using the Box-Jenkinson methodology for modeling. ARMA (1,1) was found suitable, since it has ARCH effect also GARCH (1,1) model was also carried out and was found out the best model to predict the volatility of the return. 3.2.2 Relationship between Return and Volatility Volatility is a measure of deviation from the mean return of a security. Volatility is measured by standard deviation. When the fluctuation in prices is large, standard deviation would be high and vice-versa. Generally, higher the risk, higher is the chances of less than expected return. If volatility increases return decreases. Stock returns are uncertain because there is volatility in stock prices. Mahajan and Singh (2008) examined the empirical relationship between volume and return, and volume and volatility in the light of competing hypothesis about market structure by using daily data of Sensitive Index of the Bombay Stock Exchange. Consistent with mixture of distribution hypothesis, positive contemporaneous relationship between volume and volatility was observed. Yakob, Beal and Delpachitra (2005) examined seasonal effects of ten Asian Pacific stock markets, including the Indian stock market, for the period January 2000 to March 2005. They stated that this is a period of stability and therefore ideal for examining seasonality as it was not influenced by the Asian financial crisis of the late nineties. They concluded that the Indian stock market exhibited a month-of-the-year effect in that statistically significant negative returns were found in March and April whereas statistically significant positive returns were found in May, November and December. Of these five statistically significant monthly returns, November generated the highest positive returns whereas April generated the lowest negative returns. Rawashdeh & Squalli (2005) studied the sectoral efficiency of Amman Stock Exchange. Data ranging from 1992 to 2004 was taken on a daily basis. Variance Ratio, Run test was carried out for all the four sectors. Their finding suggested that random walk hypothesis and weak-form of efficiency was rejected. Mubarik & Javid (2009) investigated the relationship between trading volume and returns and volatility of Pakistani market. The findings suggested that there was significance effect of
  • 45. Page | 44 the previous day trading volume on the current return. This implied that previous day returns and volume has explanatory power in explaining the current market returns. Pandian & Jeyanthi (2009) made an attempt to analyze the return and volatility. It was found that the outlook for India is remarkably good. Bank, corporate and personal balance sheets are strong. Corporations are experiencing high profits. The stock market is at a record high. Commodity markets are at their strongest. Rakesh & Dhankar (2011) examined the normality of return and risk of daily, weekly, monthly and annual returns in Indian stock market. They used parametric and non-parametric test to prove these objectives. They have selected Sensex, BSE 100 and BSE 500 indices from Bombay Stock Exchange (BSE) for the period 1996 to 2006. The results show that, the returns are negatively skewed for all the indices over the period. Asymmetry is found in risk and return in case of daily and weekly returns i.e., risk and return relationship seems inconsistent in case of daily and weekly returns. Monthly and annual return, however are found normally distributed for all three indices over the period of time. The study shows the importance of time horizon in investment strategy for the Indian stock market. Durai & Bhadurai (2011) analyzed the correlation structure of the Indian equity markets with that of world markets. The indices considered for the study are NASDAQ composite (USA), S & P 500 (USA), FTSE 100 (UK) and DAX 30 (Germany) classified as developed markets. KLSE composite (Malaysia), Jakarta composite (Indonesia), Straits times (Singapore), Seoul composite (South Korea), Nikkei (Japan), Taiwan weighted index (Taiwan) and the S & P CNX Nifty (India) are classified as Asian market, for the period 1997 to 2006. The logistic smooth transition regression (LSTR) model results for the conditional time varying correlation of S & P CNX Nifty with six Asian market and S & P CNX Nifty with four developed markets show that there is a significant regime shift in the year 2000 and there is a considerable increase in integration in the second regime. This indicates that the S & P CNX Nifty index is moving towards a better integration with other world markets but not at a very noteworthy phase. Abdalla (2012) discussed stock return volatility in the Saudi stock market. Results provided evidence of the existence of a positive risk premium, which supported the positive correlation hypothesis between volatility and the expected stock returns.
  • 46. Page | 45 Nawazish & Sara (2012) examined the volatility patterns in Karachi Stock Exchange. They proposed that higher order moments of returns should be considered for prudent risk assessment. While there are some who believe that there is not much significant relationship between returns and volatility. Shanmugasundram & Benedict (2013) conducted a study on the volatility of the sectoral indices with reference to NSE. In this study the risk relationship in different time intervals of the CNX NIFTY index and five sectoral indices including Auto index, Bank index, FMCG index, Infrastructure index and IT index was examined. The results of the study did not support any significant difference across the risk of sectoral indices and NIFTY. Cao, Long & Yang (2013) analyze correlation between the sectoral indices on the China Stock market. For their study two stage analysis were done. The period 2007 & 2008 was categorized as drastic shock period and other as general ups and downs periods. Their finding suggests that in the first stage sectors in the study were highly correlated but in other period the sector shows less correlation. Madhavi (2014) proved that stock market plays a very important role in the Indian economy. The economy directions can be measured by how the volatility index moves. Although financial industry affected by the financial crisis so stock market is perceived to be very risky place. But still, CAPM, Portfolio Diversification and APT always proved to be effective to manage the risk of market. Rajamohan & Muthukamu (2014) compared the performance of the sectoral indices of NSE. Their main objective was to measure the influence of banking sector vis-à-vis the other sectors. They concluded that there is a positive correlation of influence of the banking sector with other sectors. Bora & Adhikary (2015) conducted an empirical study on the risk-return relationship using BSE Sensex companies. The monthly closing prices of the 30 companies was used to analyze the risk and returns for the period between 2010 and 2013. The findings revealed positive relation between security returns and market returns and betas were found to be unstable. 3.3 Literature Gap Therefore, to sum up, the study mainly focused on the analysis of mean return and volatility of sectoral indices. The articles related to risk and return analysis of sectoral indices were taken for the reference. The literature for the study classified into (i) conditional volatility model and
  • 47. Page | 46 (ii) risk and return relationship. The articles from different authors were taken for the study. But the literature on this research paper only focused on conditional volatility model and risk return relationship. GARCH forecasted volatility estimation was one of the model used in this study. References related to particular model was not included in this literature. Researchers were recommended to take articles related to volatility forecasting using GARCH model for their further studies. CHAPTER 4 DATA ANALYSIS AND INTERPRETATION 4.1 Introduction As mentioned earlier the main aim of the study is to examine the return and volatility of the different sectoral indices listed in NSE. Accordingly four objective has been identified. • To analyze the mean return of CNX Nifty and its sectoral indices. • To analyze and rank the performance of sectoral indices using Jensen's Measure • To study the extend of relationship among the sectoral indices during the study period. • To examine the level of volatility among the sectorial indices using GARCH 4.2 Mean Return of CNX Nifty and its Sectoral Indices In this chapter the data is analyzed and result for each of the objective are reported. As for the first objective i.e., to analyze the mean return of CNX Nifty and its sectoral indices, mean return has been computed and results are given below.