Description
In the last two decades, globalization, interlinkages of the capital markets, gradual eradication of capital inflow barriers and the implementation of more flexible exchange rate mechanism in developed as well as transition economies, created a systematic interdependency between and within the stock and foreign exchange markets.
1.) RESEARCH METHODOLOGY
Problem Statement
In the last two decades, globalization, interlinkages of the capital markets, gradual
eradication of capital inflow barriers and the implementation of more flexible exchange
rate mechanism in developed as well as transition economies, created a systematic
interdependency between and within the stock and foreign exchange markets. The
individual have very vague idea about such relationship between two markets. Thus,
investigating the relationship between stock prices and exchange rates has received
unprecedented attention in the literature. A number of studies have empirically examined
the relationship between the stock and foreign exchange markets. This study explores the
evidence of relationship between exchange rates and stock prices and also lead lag
relationship between exchange rates and stock prices. We use a threestep
framework for examining dynamic relationships between exchange rates and stock index.
Literature Review
Apte !"##$% investigated the relationship between the volatility of the stock market and
the nominal exchange rate of India by using the &'A()* specifications on the daily
closing +,-.I/( exchange rate, 0,& 1# !,ensex% and /I2T34# over the period $55$ to
"###. The study suggests that there appears to be a spillover from the foreign exchange
market to the stock market but not the reverse.
0hattacharya and 6ukhar7ee !"##"% studied the nature of causal relation between the
stock market, exchange rate, foreign exchange reserves and value of trade balance in
India from $55# to "##$ by applying the cointegration and longrun 'ranger /on
causality tests. The study suggests that there is no causal linkage between stock prices
and the three variables under consideration.
1
To examine the dynamic linkages between the foreign exchange and stock markets for
India, /ath and ,amanta !"##1% employed the 'ranger causality test on daily data during
the period 6arch $551 to -ecember "##". The empirical findings of the study suggest
that these two markets did not have any causal relationship. When the study extended its
analysis to verify if liberalization in both the markets brought them together, it found no
significant causal relationship between the exchange rate and stock price movements,
except for the years $551, "##$ and "##" during when a unidirectional causal influence
from stock index return to return in forex market is detected and a very mild causal
influence in the reverse direction is found in some years such as $558 and "##".
3amini 9armarkar and ' 9awadia tried to investigate the relationship between (,.:
exchange rate and Indian stock markets. 2ive composite indices and five sectoral indices
were studied over the period of one year; "###. the results indicated that exchange rate
has high correlation with the movement of stock markets.
Reear!" Ob#e!tive
The present study is being contemplated with the following specific ob7ectives;
i% Investigating the relationship between the foreign exchange market and stock market
in India. To see that weather there is a significant relationship or dynamic linkage
between the two markets.
ii% To find out which variable is leading and which variable is lagging. The lead-lag
relationship illustrates how well the two markets are linked, and how
fast one market refects new information from the other. If relation
between foreign exchange market and stock market exist, then it is possible
that investor may use this information to predict the exchange rate
movement or indices movement.
H$%ot"ei
*#; There is no significant relation between stock prices and exchange rates
*$; There is significant relation between stock prices and exchange rates
Reear!" Dei&n
The study type is -escriptive because this research helps to find out the meaning out of
the secondary data, but not the causeandeffect !causal% linkages among its different
elements.
T"e Sam%le
The sample population of the study comprises of daily closing price, for of 0,& ,ensex,
)/< /ifty and exchange rates of (upee.-ollar are considered for analyzing.
Sour!e o' Data
=rimary -atanil
,econdary sources The study is based on the secondary data collected from the official
website of 0,&, /,& and &xchange (ate data from exchangeate.com.
Perio( o' t"e Stu($
-aily closing values of 0,& ,ensex, )/< /ifty and exchange rates of (upee.-ollar are
considered from $$"##$ to 1$1"##5.
!
Statiti!al Tool ue( in t"e tu($
• Augmented -ickey2uller test !+nit (oot Test for stationarity of data%
• >ohnson co integration test !Test for long run relationship%
• )ross )orrelation !Test for short run relationship%
S!o%e o' t"e tu($
The study includes only one currency pair i.e. I/(.+,- for the representation of the
forex market while the two ma7or stock markets of India are covered. Thus the relation
and effects of other currencies is out of the preview of the research.
)ene'it
The determination of relationship between the foreign exchange market and stock market
would help the students to increase their understanding about these markets. It would also
provide a platform for participants to enhance their views about the relationship between
the two markets.
Limitation
• +navailability of intraday minute to minute data of both the markets.
• The study is limited to period of eight years.
• ?nly one pair of +,-.I/( is used.
Data an( Met"o(olo&$
"
The data set comprises of daily closing price of ,ensex, /ifty and I/(.+,- exchange
rates obtained from the respective ,tock &xchange and (eserve 0ank of India websites.
The series span the period from $st >anuary "##$ to 1$st 6arch "##5. The daily stock
index and I/(.+,- returns are continuously compounded rate of return, computed as the
first difference of the natural logarithm of the daily stock index and I/(.+,- exchange
rate value.
The stationary status of series should be tested when investigating the relationship
between exchange rate and stock market price. In order to test the unit roots i.e.
stationarity in the ,ensex, /ifty and I/(.+,- exchange rates, the study employ
augmented -ickey and 2uller !A-2% test. If the findings of A-2 test suggests that the
series are integrated of order one, >ohansen co integration tests methodologies would be
used to determine whether any co integration between stock and exchange market
variables exists or not.
2urther )ross )orrelation method would be used on fragmented data, each of size six
months, from "##@ to "##5 to determine any lead or lag relation. The analysis has been
performed using 6,&xcel and &view.
*.) +ntro(u!tion
#
'lobalization and financial liberalization in India have brought about battery of changes
in the financial functioning of the economy, as a result of which, the resultant gain of the
global integration of domestic and foreign financial markets has thrown open new
opportunities but at the same time exposed the financial system to significant risks.
)onseAuently, it is important to understand the mutual relationship between the financial
markets from the standpoint of financial stability. Though the inception of the financial
sector reforms has taken place initiated in the beginning of the $55#s, particularly since
$558, there has been a dramatic change in the functioning of the financial sector of the
economy.
The recent emergence of new capital markets, the relaxation of foreign capital controls
and the adoption of more flexible exchange rate regimes have increased the interest of
academics and practitioners in studying the interactions between the stock and foreign
exchange markets. The gradual abolition of foreign exchange controls in emerging
economies like India has opened the possibility of international investment and portfolio
diversification. At the same time, the adoption of more flexible exchange rate regimes by
these countries in the late $5B#Cs and early $55#Cs has increased the volatility of foreign
exchange markets and the risk associated with such investments.
The advent of floating exchange rates, opening up of current account, Diberalization of
capital account, reduction of customs duties, the development of "@hour screen based
global trading, the increased use of national currencies outside the country of issue and
innovations in internationally traded financial products have led to the cross )ountry
linkages of capital markets and international integration of domestic economy.
Altogether, the whole gamut of institutional reforms, introduction of new instruments,
change in procedures, widening of network of participants, call for a reexamination of the
relationship between the stock market and the foreign sector of India.
The process of economic liberalization and thrust on reforms in the financial sector and
the foreign exchange market in particular that was initiated in India in early nineties has
resulted into increasing integration of the Indian 2< market with that of the global
$
markets. With a large number of foreign funds and foreign institutional investors now
actively participating in the Indian financial markets !foreign exchange reserves standing
at about +,-$$B bn%, the style of functioning of the market itself has undergone a lot of
change and result of microstructure changes are visible. Today the Indian 2< market,
which was insulated from outside impacts, has been getting integrated with the world
markets.
In the present scenario, interesting results are emerging particularly for the developing
countries where the markets are experiencing new relationships between money markets,
forex markets, capital markets, international events, oil prices, WT? agreements etc
which were not perceived earlier. The analysis on stock markets is important as it is
considered as the most sensitive segment of the economy and through this segment the
countryCs exposure to the outer world is most readily felt. The impact of fluctuation in
exchange rate on domestic companies, companies importing or exporting and on multi
national corporations with the degree of exposure is increasing in each case respectively.
The movements in exchange rate indirectly affect the value and hence the stock prices of
these companies. The value of the company is affected due to the forex exposures namely
Transaction exposures, translation exposure and economic exposure.
An exchange rate has two effects on stock prices, a direct effect through 6ulti /ational
2irms and an indirect effect through domestic firms. In case of 6ulti /ational 2irms
involved in exports, a change in rate will change the demand of itCs product in the
international market, which ultimately reflects in its 0., as profit or loss. ?nce the profit
or loss is declared, the stock price will also change for a domestic firm.
?n the other hand, currency devaluation could either raise or decrease a firmCs stock
prices. This depends on the nature of the firmCs operations. A domestic firm that exports
part of its output will benefit directly from devaluation due to an increase in demand for
%
its output. As higher sales result in higher profits, local currency devaluation will cause
firm stock price to rise in general.
?n the other hand, if the firm is a user of imported inputs, currency devaluation will raise
cost and lower profits. Thus, it will decrease the firmCs stock price.
,.) -orei&n E.!"an&e Mar/et0
&
The foreign exchange market exists wherever one currency is traded for another. It is by
far the largest market in the world, in terms of cash value traded, and includes trading
between large banks, central banks, currency speculators, multinational corporations,
governments, and other financial markets and institutions. The trade happening in the
forex markets across the globe currently exceeds +,:$.5 trillion.day !on average%. (etail
traders !individuals% are currently a very small part of this market and may only
participate indirectly through brokers or banks.
The foreign exchange market provides the physical and institutional structure through
which the money of one country is exchanged for that of another country, the rate of
exchange between currencies is determined, and foreign exchange transactions are
physically completed.
The retail market for foreign exchange deals with transactions involving travelers and
tourists exchanging one currency for another in the form of currency notes or travelersC
cheAues. The wholesale market often referred to as the interbank market is entirely
different and the participants in this market are commercial banks, corporations and
central banks.
Curren!$ E.!"an&e Rate0
The &xchange rate or 2< rate is the rate between two currencies specifies how much one
currency is worth in terms of the other. 2or example an exchange rate of 11 Indian
(upees !I/-, (s.% to the +nited ,tates -ollar !+,-, :% means that I/- 11 is worth the
same as +,- $. The foreign exchange market is one of the largest markets in the world.
0y some estimates, about " trillion +,- worth of currency changes hands every day.
The S%ot exchange rate refers to the current exchange rate. The 'orwar( exchange rate
refers to an exchange rate that is Auoted and traded today but for delivery and payment on
a specific future date.
1uotation
'
An exchange rate Auotation is given by stating the number of units of a %ri!e !urren!$
that can be bought in terms of $ unit !urren!$ !also called base currency%. In a Auotation
that says the >=/.+,- exchange rate is $"# !+,- per >=/%, the price currency is +,-
and the unit currency is >=/.
1uote
Direct quote is a Auote using a countryCs home currency as the price currency !e.g.,(s.11
E : $ in India% and is used by most countries.
Indirect quote is a Auote using a countryCs home currency as the unit currency !e.g, :
#.#1 E (s. $ in India% and is used in 0ritish newspapers and are also common in
Australia, /ew Fealand and )anada.
A%%re!iation2(e%re!iation o' !urren!$0
While using direct Auotation, if the home currency is strengthening !i.e., appreciating, or
becoming more valuable% then the exchange rate number decreases. )onversely if the
foreign currency is strengthening, the exchange rate number increases and the home
currency is depreciating.
E.!"an&e rate re&ime0
The exchange rate regime is the way a country manages its currency in respect to foreign
currencies and the foreign exchange market. It is closely related to monetary policy and
the two are generally dependent.
A floating exchange rate or a flexible exchange rate is a type of exchange rate regime
wherein a currencyCs value is allowed to fluctuate according to the foreign exchange
market. A currency that uses a floating exchange rate is known as a floating currency.
A pegged float is pegged to some band or value, either fixed or periodically ad7usted.
=egged floats are )rawling bands, )rawling pegs and =egged with horizontal bands.
1(
A fixed rate is that rate that has direct convertibility towards another currency. *ere, the
currency is backed one to one by foreign reserves.
-un!tion o' 'orei&n e.!"an&e mar/et0
The foreign exchange market is the mechanism by which participants
• Transfer purchasing power between countries,
• ?btain or provide credit for international trade transactions, and
• 6inimize exposure to the risks of exchange rate changes
-orei&n E.!"an&e Mar/et %arti!i%ant0
The foreign exchange market consists of two tiers;
• the interbank or wholesale market and
• The client or retail market.
-ive broa( !ate&orie o' %arti!i%ant o%erate wit"in t"ee two tier0
• 0ank and nonblank foreign exchange dealers;
0anks and a few nonblank foreign exchange dealers operate in both the interbank and
client markets. They profit from buying foreign exchange at a GbidC price and reselling it
at a slightly higher GaskC price. -ealers in the foreign exchange departments of large
international banks often function as market makers.
)urrency trading is Auite profitable for commercial and investment banks. ,mall to
medium sized banks are likely to participate but not as market makers in the interbank
market. Instead of maintaining significant inventory positions, they buy from and sell to
large banks to offset retail transactions with their own customers.
11
• Individuals and firms conducting commercial or investment Transactions;
Importers and exporters, international portfolio investors, 6ulti /ational &nterprises,
tourists, and others use the foreign exchange market to facilitate execution of commercial
or investment transactions. ,ome of these participants use the market to GhedgeC foreign
exchange risk.
• ,peculators and arbitragers;
,peculators and arbitragers seek to profit from trading in the market itself. They operate
in their own interest, without a need or obligation to serve clients or to ensure a
continuous market. A large proportion of speculation and arbitrage is conducted on behalf
of ma7or banks by traders employed by those banks. Thus banks act both as exchange
dealers and as speculators and arbitrages.
• )entral banks and treasuries;
)entral bank and treasuries use the market to acAuire or spend their countryCs foreign
exchange reserves as well as to influence the price at which their own currency is traded.
They may act to support the value of their own currency because of policies adopted at
the national level or because of commitments entered into through membership in 7oint
float agreements.
• 2oreign exchange brokers;
2oreign exchange brokers are agents who facilitate trading between dealers. 0rokers
charge small commission for the service provided to dealers. They maintain instant
access to hundreds of dealers world wide via open telephone lines.
-orei&n e.!"an&e trana!tion
Transactions within the foreign exchange market are executed either on a spot basis,
reAuiring settlement two days after the transaction, or on a forward or swap basis, which
reAuires settlement at some designated future date.
1
To be successful in the foreign exchange markets, one has to anticipate price changes by
keeping a close eye on world events and currency fluctuations.
Global 'orei&n e.!"an&e mar/et turnover0
According to the 0ank for International ,ettlements, average daily turnover in global
foreign exchange markets is estimated at :1.5B trillion as of April "##8. Trading in the
worldCs main financial markets accounted for :1."$ trillion of this. This approximately
:1."$ trillion in main foreign exchange market turnover was broken down as follows;
Components are:
• :H"$ billion in spot
• :$."H trillion in derivatives
• :"#B billion in outright forwards
• :5@@ billion in forex swaps
• :$#8 billion in 2< options
?f the :1.5B trillion daily global turnover, trading in Dondon accounted for around :$.1H
trillion, or 1@.$I of the total, making Dondon by far the global center for foreign
exchange. In second and third places respectively, trading in /ew 3ork accounted for
$H.HI, and Tokyo accounted for H.#I.J@K In addition to LtraditionalM turnover, :".$
trillion was traded in derivatives.
&xchangetraded 2< futures contracts were introduced in $58" at the )hicago 6ercantile
&xchange and are actively traded relative to most other futures contracts.
,everal other developed countries also permit the trading of 2< derivative products !like
currency futures and options on currency futures% on their exchanges. All these developed
countries already have fully convertible capital accounts. 6ost emerging countries do not
permit 2< derivative products on their exchanges in view of prevalent controls on the
1!
capital accounts. *owever, a few select emerging countries !e.g., 9orea, ,outh Africa,
and India% have already successfully experimented with the currency futures exchanges,
despite having some controls on the capital account.
1"
,ource; 0I, Triennial ,urvey "##8
,ource; 0I, Triennial ,urvey "##8
1#
Stru!ture
• -ecentralized GinterbankC market
• 6ain participants; )entral 0anks, commercial and investment banks, hedge funds,
corporations N private speculators
• The freefloating currency system arose from the collapse of the 0retton Woods
agreement in $58$
• ?nline trading began in the mid to late $55#Cs
Tra(in& Hour
• "@ hour market
• ,unday 4pm &,T through 2riday @pm &,T.
• Trading begins in the Asia=acific region followed by the 6iddle &ast, &urope,
and America
Si3e
• ?ne of the largest financial markets in the world
• :1." trillion average daily turnover, eAuivalent to;
o 6ore than $# times the average daily turnover of global eAuity markets
$
o 6ore than 14 times the average daily turnover of the /3,&
"
o /early :4## a day for every man, woman, and child on earth
1
o An annual turnover more than $# times world '-=
@
• The spot market accounts for 7ust under onethird of daily turnover
1$
$. About :"B# billion World 2ederation of &xchanges aggregate "##H
". About :B8 billion World 2ederation of &xchanges "##H
1. 0ased on world population of H.H billion +, )ensus 0ureau
@. About
B trillion World 0ank "##H.
Ma#or Mar/et
• The +, N +9 markets account for 7ust over 4#I of turnover
• 6a7or markets; Dondon, /ew 3ork, Tokyo
• Trading activity is heaviest when ma7or markets overlap
• /early twothirds of /3 activity occurs in the morning hours while &uropean
markets are open
Avera&e Dail$ Turnover b$ Geo&ra%"i! Lo!ation
,ource; 0I, Triennial ,urvey "##8
Con!entration in t"e )an/in& +n(utr$
• $" banks account for 84I of turnover in the +.9.
• $# banks account for 84I of turnover in the +.,.
1%
• 1 banks account for 84I of turnover in ,witzerland
• 5 banks account for 84I of turnover in >apan
,ource; 0I, Triennial ,urvey "##8
Curren!ie
• The +, dollar is involved in over B#I of all foreign exchange transactions,
eAuivalent to over +,:".8 trillion per day
Curren!$ Co(e
• +,- E +, -ollar
• &+( E &uro
• >=3 E >apanese 3en
• '0= E 0ritish =ound
• )A- E )anadian -ollar
• A+- E Australian -ollar
• /F- E /ew Fealand -ollar
Avera&e Dail$ Turnover b$ Curren!$
1&
/.0. 0ecause two currencies are involved in each transaction, the sum of the percentage
shares of individual currencies totals "##I instead of $##I.
,ource; 0I, Triennial ,urvey "##8
Curren!$ Pair
• 6a7ors; &+(.+,- !&uro-ollar%, +,-.>=3, '0=.+,- !commonly referred to
as the L)ableM%, +,-.)*2
• -ollar bloc; +,-.)A-, A+-.+,-, /F-.+,-
• 6a7or crosses; &+(.>=3, &+(.'0=, &+(.)*2
Avera&e Dail$ Turnover b$ Curren!$ Pair
1'
,ource; 0I, Triennial ,urvey "##8
-a!tor a''e!tin& E.!"an&e rate0
The prime factor that affects currency prices are supply and demand forces. The three
factors include;
E!onomi! 'a!tor0
• 'overnment budget deficits or surpluses
• 0alance of trade levels and trends
• Inflation levels and trends
• &conomic growth and health
Politi!al !on(ition0
• =olitical upheaval and political instability
• (elation between two countries
Mar/et %$!"olo&$0
• 2lights to Auality
• &conomic numbers
• Dongterm trends
(
4.) +n(ian -5 Mar/et
1
India foreign exchange reserve is at : "8B.8 0illion +,- !2eb 4, "#$#%
/,& has witnessed healthy growth in the turnover and open interest positions during its
first completed month of currency futures trading in India. /,& commenced currency
futures trading in India on "5
th
August.
)-< !)urrency -erivative &xchange%, currency derivative segment of 0,& !0ombay
,tock &xchange% commenced currency futures trading from $
st
?ctober. 0,& on its very
first day of trading in currency futures clocked a turn over of about H4,### contracts,
which is approximately (s. 1## )rores.
With evergrowing global financial crisis, exchange rates are fluctuating widely. I/(
exchange rate has touched @8 against +,-. )urrency futures trading in India has
generated huge interest among Indian retail investors and traders. There is a strong
demand for information gathering about the intricacies of currency futures from small
investors and enterprises.
After over a year of introduction of exchangetraded currency futures in the +,-I/(
pair on the stock exchanges in the country, the market regulators have now permitted
trading of &uroI/(, >apanese 3enI/( and =ound ,terlingI/( on the exchange
platform. This is a move that the market had been demanding for a long time. This is an
apt time to review how the exchangetraded currency market has fared so far and what
lies ahead as it ventures further into new currency pairs.
The currency derivatives segment on the /,& and 6)< has witnessed consistent growth
both in traded value and open interest since its inception. The total turnover in the
segment has increased incredibly from :1.@bn in ?ctober "##B to :B@bn in -ecember
"##5. The average daily turnover reachedbn in -ecember "##5. ?pen interest in the
segment on the /,& and 6)< stood at around @ lakh contracts till end-ecember "##5.
India already has an active overthecounter !?T)% market in currency derivatives where
the average daily turnover was :"5bn in "##B and :"$bn in "##5 !till ,eptember "##5%.
This market is being driven by its ability to meet the respective needs of participants. 2or
example, it is used by importers.exporters to hedge their payables.receivablesO foreign
institutional investors !2IIs% and /(Is use it to hedge their investments in IndiaO
borrowers find it an effective way to hedge their foreign currency loans and resident
Indians find it an effective tool to hedge their investments offshore. 2urther, for
arbitrageurs it presents an opportunity to arbitrage between onshore and nondeliverable
forward !/-2% markets.
!
The exchangetraded currency futures market is an extension of this already available
?T) market, but with added benefits of greater accessibility to potential participantsO
high price transparencyO high liAuidityO standardised contractsO counterparty risk
management through clearing corporation and no reAuirement of underlying exposure in
the currency. As the market participants are realising these benefits of exchangetraded
market in currency, they are choosing this market over ?T).
*owever, it is too early to see a ma7or shift in activity from ?T) to exchangetraded
market as it has created a niche for itself and it would perhaps take some time for the
currency futures market to create one for itself. 'lobally, too, the foreign exchange
market is largely ?T) in character. While the notional amount outstanding of ?T)
derivatives was as high as :H1trn in >une "##B, the exchangetraded market is rather non
existent with notional amount outstanding as end>une "##5 being only #.4I of that in
the ?T) segment.
*owever, there is a renewed debate on the level of transparency and counterparty risk in
the ?T) market kindled by the subprime mortgage crisis in the +, and the need to
regulate ?T) transactions effectively. This throws up certain important issues which, at
best, may need to be handled separately.
"
India has, in this light, embarked upon an experiment by attempting to make the
exchangetraded currency market popular and a first choice for investors. Though the
market has not been able to evince the kind of activity that the ?T) market has witnessed
as yet, the recent phenomenal growth is a pointer towards better days ahead for this
market. ,ome of the issues plaguing the market at present include the fact that many
corporates using currency derivatives for hedging their foreign currency exposure find
the reAuirement of margin and settlement of daily marktomarket differences
cumbersome, especially since there is no such reAuirement for ?T) trades. It would
conceivably take some time for them to realise the concomitant benefits of these risk
containment measures. Also, there is a perceived resistance to change and switchover
from ?T) to exchangetraded framework following a level of comfortability reached by
market players with the ?T) market framework.
2urther, the market has been restricted in a number of ways. Till recently only +,-I/(
futures contracts were permitted. ?ne hopes to see more activity in the segment with
more currency pairs being added. Also to start with, 2IIs have not been permitted to
participate in this market. This has in effect restricted the liAuidity that 2IIs could have
otherwise created. 2IIs are already active in -ubai 'old and )ommodity &xchange
!-')uly, "##5. 0,& reaches to over @## cities and town nationwide and has around @,518
listed companies, with over 88@4 scrips being traded as on 1$
st
>uly #5.
The 0,& Index, ,&/,&une "### )ommencement of -erivatives Trading !Index 2utures%
>une "##$ )ommencement of trading in Index ?ptions
>uly "##$ )ommencement of trading in ?ptions on Individual ,ecurities
/ovember "##$ )ommencement of trading in 2utures on Individual ,ecurities
August "##B Daunch of )urrency -erivatives
August "##5 Daunch of Interest (ate 2utures
/ovember "##5 Daunch of 6utual 2und ,ervice ,ystem
"!
S?P C75 7i't$
,N= )/< /ifty is a well diversified 4# stock index accounting for "" sectors of the
economy. It is used for a variety of purposes such as benchmarking fund portfolios, index
based derivatives and index funds.
,N= )/< /ifty is owned and managed by India Index ,ervices and =roducts Dtd.
!II,D%, which is a 7oint venture between /,& and )(I,ID. II,D is IndiaCs first specialized
company focused upon the index as a core product. II,D has a 6arketing and licensing
agreement with ,tandard N =oorCs !,N=%, who are world leaders in index services.
The total traded value for the last six months of all /ifty stocks is approximately 4"I of
the traded value of all stocks on the /,&
/ifty stocks represent about H1I of the 2ree 2loat 6arket )apitalization as on -ec 1$,
"##5.
Impact cost of the ,N= )/< /ifty for a portfolio size of (s." crore is #.$#I
,N= )/< /ifty is professionally maintained and is ideal for derivatives trading
2rom >une "H, "##5, ,N= )/< /ifty is computed based on free float methodology.
""
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"$ 0a7a7 auto @H *indalco
"" 'AID @8 /ational Alu
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@.) Tet an( Reult
Tet 'or Stationarit$9
A time series is said to be stationary if its mean and variance are constant over time and
the value of the covariance between the two time periods depends only on the distance or
gap or lag between the two time periods and not the actual time at which the covariance
is computed. Tests for stationarity are routinely applied to highly persistent time series.
2ollowing 9wiatkowski, =hillips, ,chmidt and ,hin !$55"%, standard stationarity
employs a rescaling by an estimator of the longrun variance of the !potentially%
stationary series. Test for stationarity is important in case of time series data because a
"$
nonstationary time series will have time varying mean or a timevarying variance or both.
*ence the results cannot be extrapolated for the entire population.
The test for stationarity can be done using +nit (oot Test. It is due to the fact that V E $.
If however, WVW X $, that is if the absolute value of V is less than one, then it can be shown
that the time series is stationary.
'iven that in most situations only one observation is available at a given time,
stationarity ensures that all parts of the series are like the other parts, which allows us to
estimate the needed parameters. Therefore, the mean, the variance and the covariance of
the series are not functions of time and depend rather on the lag between the observations
!the difference between the times at which two observations were recorded%. To
summarize, if
In the last two decades, globalization, interlinkages of the capital markets, gradual eradication of capital inflow barriers and the implementation of more flexible exchange rate mechanism in developed as well as transition economies, created a systematic interdependency between and within the stock and foreign exchange markets.
1.) RESEARCH METHODOLOGY
Problem Statement
In the last two decades, globalization, interlinkages of the capital markets, gradual
eradication of capital inflow barriers and the implementation of more flexible exchange
rate mechanism in developed as well as transition economies, created a systematic
interdependency between and within the stock and foreign exchange markets. The
individual have very vague idea about such relationship between two markets. Thus,
investigating the relationship between stock prices and exchange rates has received
unprecedented attention in the literature. A number of studies have empirically examined
the relationship between the stock and foreign exchange markets. This study explores the
evidence of relationship between exchange rates and stock prices and also lead lag
relationship between exchange rates and stock prices. We use a threestep
framework for examining dynamic relationships between exchange rates and stock index.
Literature Review
Apte !"##$% investigated the relationship between the volatility of the stock market and
the nominal exchange rate of India by using the &'A()* specifications on the daily
closing +,-.I/( exchange rate, 0,& 1# !,ensex% and /I2T34# over the period $55$ to
"###. The study suggests that there appears to be a spillover from the foreign exchange
market to the stock market but not the reverse.
0hattacharya and 6ukhar7ee !"##"% studied the nature of causal relation between the
stock market, exchange rate, foreign exchange reserves and value of trade balance in
India from $55# to "##$ by applying the cointegration and longrun 'ranger /on
causality tests. The study suggests that there is no causal linkage between stock prices
and the three variables under consideration.
1
To examine the dynamic linkages between the foreign exchange and stock markets for
India, /ath and ,amanta !"##1% employed the 'ranger causality test on daily data during
the period 6arch $551 to -ecember "##". The empirical findings of the study suggest
that these two markets did not have any causal relationship. When the study extended its
analysis to verify if liberalization in both the markets brought them together, it found no
significant causal relationship between the exchange rate and stock price movements,
except for the years $551, "##$ and "##" during when a unidirectional causal influence
from stock index return to return in forex market is detected and a very mild causal
influence in the reverse direction is found in some years such as $558 and "##".
3amini 9armarkar and ' 9awadia tried to investigate the relationship between (,.:
exchange rate and Indian stock markets. 2ive composite indices and five sectoral indices
were studied over the period of one year; "###. the results indicated that exchange rate
has high correlation with the movement of stock markets.
Reear!" Ob#e!tive
The present study is being contemplated with the following specific ob7ectives;
i% Investigating the relationship between the foreign exchange market and stock market
in India. To see that weather there is a significant relationship or dynamic linkage
between the two markets.
ii% To find out which variable is leading and which variable is lagging. The lead-lag
relationship illustrates how well the two markets are linked, and how
fast one market refects new information from the other. If relation
between foreign exchange market and stock market exist, then it is possible
that investor may use this information to predict the exchange rate
movement or indices movement.
H$%ot"ei
*#; There is no significant relation between stock prices and exchange rates
*$; There is significant relation between stock prices and exchange rates
Reear!" Dei&n
The study type is -escriptive because this research helps to find out the meaning out of
the secondary data, but not the causeandeffect !causal% linkages among its different
elements.
T"e Sam%le
The sample population of the study comprises of daily closing price, for of 0,& ,ensex,
)/< /ifty and exchange rates of (upee.-ollar are considered for analyzing.
Sour!e o' Data
=rimary -atanil
,econdary sources The study is based on the secondary data collected from the official
website of 0,&, /,& and &xchange (ate data from exchangeate.com.
Perio( o' t"e Stu($
-aily closing values of 0,& ,ensex, )/< /ifty and exchange rates of (upee.-ollar are
considered from $$"##$ to 1$1"##5.
!
Statiti!al Tool ue( in t"e tu($
• Augmented -ickey2uller test !+nit (oot Test for stationarity of data%
• >ohnson co integration test !Test for long run relationship%
• )ross )orrelation !Test for short run relationship%
S!o%e o' t"e tu($
The study includes only one currency pair i.e. I/(.+,- for the representation of the
forex market while the two ma7or stock markets of India are covered. Thus the relation
and effects of other currencies is out of the preview of the research.
)ene'it
The determination of relationship between the foreign exchange market and stock market
would help the students to increase their understanding about these markets. It would also
provide a platform for participants to enhance their views about the relationship between
the two markets.
Limitation
• +navailability of intraday minute to minute data of both the markets.
• The study is limited to period of eight years.
• ?nly one pair of +,-.I/( is used.
Data an( Met"o(olo&$
"
The data set comprises of daily closing price of ,ensex, /ifty and I/(.+,- exchange
rates obtained from the respective ,tock &xchange and (eserve 0ank of India websites.
The series span the period from $st >anuary "##$ to 1$st 6arch "##5. The daily stock
index and I/(.+,- returns are continuously compounded rate of return, computed as the
first difference of the natural logarithm of the daily stock index and I/(.+,- exchange
rate value.
The stationary status of series should be tested when investigating the relationship
between exchange rate and stock market price. In order to test the unit roots i.e.
stationarity in the ,ensex, /ifty and I/(.+,- exchange rates, the study employ
augmented -ickey and 2uller !A-2% test. If the findings of A-2 test suggests that the
series are integrated of order one, >ohansen co integration tests methodologies would be
used to determine whether any co integration between stock and exchange market
variables exists or not.
2urther )ross )orrelation method would be used on fragmented data, each of size six
months, from "##@ to "##5 to determine any lead or lag relation. The analysis has been
performed using 6,&xcel and &view.
*.) +ntro(u!tion
#
'lobalization and financial liberalization in India have brought about battery of changes
in the financial functioning of the economy, as a result of which, the resultant gain of the
global integration of domestic and foreign financial markets has thrown open new
opportunities but at the same time exposed the financial system to significant risks.
)onseAuently, it is important to understand the mutual relationship between the financial
markets from the standpoint of financial stability. Though the inception of the financial
sector reforms has taken place initiated in the beginning of the $55#s, particularly since
$558, there has been a dramatic change in the functioning of the financial sector of the
economy.
The recent emergence of new capital markets, the relaxation of foreign capital controls
and the adoption of more flexible exchange rate regimes have increased the interest of
academics and practitioners in studying the interactions between the stock and foreign
exchange markets. The gradual abolition of foreign exchange controls in emerging
economies like India has opened the possibility of international investment and portfolio
diversification. At the same time, the adoption of more flexible exchange rate regimes by
these countries in the late $5B#Cs and early $55#Cs has increased the volatility of foreign
exchange markets and the risk associated with such investments.
The advent of floating exchange rates, opening up of current account, Diberalization of
capital account, reduction of customs duties, the development of "@hour screen based
global trading, the increased use of national currencies outside the country of issue and
innovations in internationally traded financial products have led to the cross )ountry
linkages of capital markets and international integration of domestic economy.
Altogether, the whole gamut of institutional reforms, introduction of new instruments,
change in procedures, widening of network of participants, call for a reexamination of the
relationship between the stock market and the foreign sector of India.
The process of economic liberalization and thrust on reforms in the financial sector and
the foreign exchange market in particular that was initiated in India in early nineties has
resulted into increasing integration of the Indian 2< market with that of the global
$
markets. With a large number of foreign funds and foreign institutional investors now
actively participating in the Indian financial markets !foreign exchange reserves standing
at about +,-$$B bn%, the style of functioning of the market itself has undergone a lot of
change and result of microstructure changes are visible. Today the Indian 2< market,
which was insulated from outside impacts, has been getting integrated with the world
markets.
In the present scenario, interesting results are emerging particularly for the developing
countries where the markets are experiencing new relationships between money markets,
forex markets, capital markets, international events, oil prices, WT? agreements etc
which were not perceived earlier. The analysis on stock markets is important as it is
considered as the most sensitive segment of the economy and through this segment the
countryCs exposure to the outer world is most readily felt. The impact of fluctuation in
exchange rate on domestic companies, companies importing or exporting and on multi
national corporations with the degree of exposure is increasing in each case respectively.
The movements in exchange rate indirectly affect the value and hence the stock prices of
these companies. The value of the company is affected due to the forex exposures namely
Transaction exposures, translation exposure and economic exposure.
An exchange rate has two effects on stock prices, a direct effect through 6ulti /ational
2irms and an indirect effect through domestic firms. In case of 6ulti /ational 2irms
involved in exports, a change in rate will change the demand of itCs product in the
international market, which ultimately reflects in its 0., as profit or loss. ?nce the profit
or loss is declared, the stock price will also change for a domestic firm.
?n the other hand, currency devaluation could either raise or decrease a firmCs stock
prices. This depends on the nature of the firmCs operations. A domestic firm that exports
part of its output will benefit directly from devaluation due to an increase in demand for
%
its output. As higher sales result in higher profits, local currency devaluation will cause
firm stock price to rise in general.
?n the other hand, if the firm is a user of imported inputs, currency devaluation will raise
cost and lower profits. Thus, it will decrease the firmCs stock price.
,.) -orei&n E.!"an&e Mar/et0
&
The foreign exchange market exists wherever one currency is traded for another. It is by
far the largest market in the world, in terms of cash value traded, and includes trading
between large banks, central banks, currency speculators, multinational corporations,
governments, and other financial markets and institutions. The trade happening in the
forex markets across the globe currently exceeds +,:$.5 trillion.day !on average%. (etail
traders !individuals% are currently a very small part of this market and may only
participate indirectly through brokers or banks.
The foreign exchange market provides the physical and institutional structure through
which the money of one country is exchanged for that of another country, the rate of
exchange between currencies is determined, and foreign exchange transactions are
physically completed.
The retail market for foreign exchange deals with transactions involving travelers and
tourists exchanging one currency for another in the form of currency notes or travelersC
cheAues. The wholesale market often referred to as the interbank market is entirely
different and the participants in this market are commercial banks, corporations and
central banks.
Curren!$ E.!"an&e Rate0
The &xchange rate or 2< rate is the rate between two currencies specifies how much one
currency is worth in terms of the other. 2or example an exchange rate of 11 Indian
(upees !I/-, (s.% to the +nited ,tates -ollar !+,-, :% means that I/- 11 is worth the
same as +,- $. The foreign exchange market is one of the largest markets in the world.
0y some estimates, about " trillion +,- worth of currency changes hands every day.
The S%ot exchange rate refers to the current exchange rate. The 'orwar( exchange rate
refers to an exchange rate that is Auoted and traded today but for delivery and payment on
a specific future date.
1uotation
'
An exchange rate Auotation is given by stating the number of units of a %ri!e !urren!$
that can be bought in terms of $ unit !urren!$ !also called base currency%. In a Auotation
that says the >=/.+,- exchange rate is $"# !+,- per >=/%, the price currency is +,-
and the unit currency is >=/.
1uote
Direct quote is a Auote using a countryCs home currency as the price currency !e.g.,(s.11
E : $ in India% and is used by most countries.
Indirect quote is a Auote using a countryCs home currency as the unit currency !e.g, :
#.#1 E (s. $ in India% and is used in 0ritish newspapers and are also common in
Australia, /ew Fealand and )anada.
A%%re!iation2(e%re!iation o' !urren!$0
While using direct Auotation, if the home currency is strengthening !i.e., appreciating, or
becoming more valuable% then the exchange rate number decreases. )onversely if the
foreign currency is strengthening, the exchange rate number increases and the home
currency is depreciating.
E.!"an&e rate re&ime0
The exchange rate regime is the way a country manages its currency in respect to foreign
currencies and the foreign exchange market. It is closely related to monetary policy and
the two are generally dependent.
A floating exchange rate or a flexible exchange rate is a type of exchange rate regime
wherein a currencyCs value is allowed to fluctuate according to the foreign exchange
market. A currency that uses a floating exchange rate is known as a floating currency.
A pegged float is pegged to some band or value, either fixed or periodically ad7usted.
=egged floats are )rawling bands, )rawling pegs and =egged with horizontal bands.
1(
A fixed rate is that rate that has direct convertibility towards another currency. *ere, the
currency is backed one to one by foreign reserves.
-un!tion o' 'orei&n e.!"an&e mar/et0
The foreign exchange market is the mechanism by which participants
• Transfer purchasing power between countries,
• ?btain or provide credit for international trade transactions, and
• 6inimize exposure to the risks of exchange rate changes
-orei&n E.!"an&e Mar/et %arti!i%ant0
The foreign exchange market consists of two tiers;
• the interbank or wholesale market and
• The client or retail market.
-ive broa( !ate&orie o' %arti!i%ant o%erate wit"in t"ee two tier0
• 0ank and nonblank foreign exchange dealers;
0anks and a few nonblank foreign exchange dealers operate in both the interbank and
client markets. They profit from buying foreign exchange at a GbidC price and reselling it
at a slightly higher GaskC price. -ealers in the foreign exchange departments of large
international banks often function as market makers.
)urrency trading is Auite profitable for commercial and investment banks. ,mall to
medium sized banks are likely to participate but not as market makers in the interbank
market. Instead of maintaining significant inventory positions, they buy from and sell to
large banks to offset retail transactions with their own customers.
11
• Individuals and firms conducting commercial or investment Transactions;
Importers and exporters, international portfolio investors, 6ulti /ational &nterprises,
tourists, and others use the foreign exchange market to facilitate execution of commercial
or investment transactions. ,ome of these participants use the market to GhedgeC foreign
exchange risk.
• ,peculators and arbitragers;
,peculators and arbitragers seek to profit from trading in the market itself. They operate
in their own interest, without a need or obligation to serve clients or to ensure a
continuous market. A large proportion of speculation and arbitrage is conducted on behalf
of ma7or banks by traders employed by those banks. Thus banks act both as exchange
dealers and as speculators and arbitrages.
• )entral banks and treasuries;
)entral bank and treasuries use the market to acAuire or spend their countryCs foreign
exchange reserves as well as to influence the price at which their own currency is traded.
They may act to support the value of their own currency because of policies adopted at
the national level or because of commitments entered into through membership in 7oint
float agreements.
• 2oreign exchange brokers;
2oreign exchange brokers are agents who facilitate trading between dealers. 0rokers
charge small commission for the service provided to dealers. They maintain instant
access to hundreds of dealers world wide via open telephone lines.
-orei&n e.!"an&e trana!tion
Transactions within the foreign exchange market are executed either on a spot basis,
reAuiring settlement two days after the transaction, or on a forward or swap basis, which
reAuires settlement at some designated future date.
1
To be successful in the foreign exchange markets, one has to anticipate price changes by
keeping a close eye on world events and currency fluctuations.
Global 'orei&n e.!"an&e mar/et turnover0
According to the 0ank for International ,ettlements, average daily turnover in global
foreign exchange markets is estimated at :1.5B trillion as of April "##8. Trading in the
worldCs main financial markets accounted for :1."$ trillion of this. This approximately
:1."$ trillion in main foreign exchange market turnover was broken down as follows;
Components are:
• :H"$ billion in spot
• :$."H trillion in derivatives
• :"#B billion in outright forwards
• :5@@ billion in forex swaps
• :$#8 billion in 2< options
?f the :1.5B trillion daily global turnover, trading in Dondon accounted for around :$.1H
trillion, or 1@.$I of the total, making Dondon by far the global center for foreign
exchange. In second and third places respectively, trading in /ew 3ork accounted for
$H.HI, and Tokyo accounted for H.#I.J@K In addition to LtraditionalM turnover, :".$
trillion was traded in derivatives.
&xchangetraded 2< futures contracts were introduced in $58" at the )hicago 6ercantile
&xchange and are actively traded relative to most other futures contracts.
,everal other developed countries also permit the trading of 2< derivative products !like
currency futures and options on currency futures% on their exchanges. All these developed
countries already have fully convertible capital accounts. 6ost emerging countries do not
permit 2< derivative products on their exchanges in view of prevalent controls on the
1!
capital accounts. *owever, a few select emerging countries !e.g., 9orea, ,outh Africa,
and India% have already successfully experimented with the currency futures exchanges,
despite having some controls on the capital account.
1"
,ource; 0I, Triennial ,urvey "##8
,ource; 0I, Triennial ,urvey "##8
1#
Stru!ture
• -ecentralized GinterbankC market
• 6ain participants; )entral 0anks, commercial and investment banks, hedge funds,
corporations N private speculators
• The freefloating currency system arose from the collapse of the 0retton Woods
agreement in $58$
• ?nline trading began in the mid to late $55#Cs
Tra(in& Hour
• "@ hour market
• ,unday 4pm &,T through 2riday @pm &,T.
• Trading begins in the Asia=acific region followed by the 6iddle &ast, &urope,
and America
Si3e
• ?ne of the largest financial markets in the world
• :1." trillion average daily turnover, eAuivalent to;
o 6ore than $# times the average daily turnover of global eAuity markets
$
o 6ore than 14 times the average daily turnover of the /3,&
"
o /early :4## a day for every man, woman, and child on earth
1
o An annual turnover more than $# times world '-=
@
• The spot market accounts for 7ust under onethird of daily turnover
1$
$. About :"B# billion World 2ederation of &xchanges aggregate "##H
". About :B8 billion World 2ederation of &xchanges "##H
1. 0ased on world population of H.H billion +, )ensus 0ureau
@. About
B trillion World 0ank "##H.Ma#or Mar/et
• The +, N +9 markets account for 7ust over 4#I of turnover
• 6a7or markets; Dondon, /ew 3ork, Tokyo
• Trading activity is heaviest when ma7or markets overlap
• /early twothirds of /3 activity occurs in the morning hours while &uropean
markets are open
Avera&e Dail$ Turnover b$ Geo&ra%"i! Lo!ation
,ource; 0I, Triennial ,urvey "##8
Con!entration in t"e )an/in& +n(utr$
• $" banks account for 84I of turnover in the +.9.
• $# banks account for 84I of turnover in the +.,.
1%
• 1 banks account for 84I of turnover in ,witzerland
• 5 banks account for 84I of turnover in >apan
,ource; 0I, Triennial ,urvey "##8
Curren!ie
• The +, dollar is involved in over B#I of all foreign exchange transactions,
eAuivalent to over +,:".8 trillion per day
Curren!$ Co(e
• +,- E +, -ollar
• &+( E &uro
• >=3 E >apanese 3en
• '0= E 0ritish =ound
• )A- E )anadian -ollar
• A+- E Australian -ollar
• /F- E /ew Fealand -ollar
Avera&e Dail$ Turnover b$ Curren!$
1&
/.0. 0ecause two currencies are involved in each transaction, the sum of the percentage
shares of individual currencies totals "##I instead of $##I.
,ource; 0I, Triennial ,urvey "##8
Curren!$ Pair
• 6a7ors; &+(.+,- !&uro-ollar%, +,-.>=3, '0=.+,- !commonly referred to
as the L)ableM%, +,-.)*2
• -ollar bloc; +,-.)A-, A+-.+,-, /F-.+,-
• 6a7or crosses; &+(.>=3, &+(.'0=, &+(.)*2
Avera&e Dail$ Turnover b$ Curren!$ Pair
1'
,ource; 0I, Triennial ,urvey "##8
-a!tor a''e!tin& E.!"an&e rate0
The prime factor that affects currency prices are supply and demand forces. The three
factors include;
E!onomi! 'a!tor0
• 'overnment budget deficits or surpluses
• 0alance of trade levels and trends
• Inflation levels and trends
• &conomic growth and health
Politi!al !on(ition0
• =olitical upheaval and political instability
• (elation between two countries
Mar/et %$!"olo&$0
• 2lights to Auality
• &conomic numbers
• Dongterm trends
(
4.) +n(ian -5 Mar/et
1
India foreign exchange reserve is at : "8B.8 0illion +,- !2eb 4, "#$#%
/,& has witnessed healthy growth in the turnover and open interest positions during its
first completed month of currency futures trading in India. /,& commenced currency
futures trading in India on "5
th
August.
)-< !)urrency -erivative &xchange%, currency derivative segment of 0,& !0ombay
,tock &xchange% commenced currency futures trading from $
st
?ctober. 0,& on its very
first day of trading in currency futures clocked a turn over of about H4,### contracts,
which is approximately (s. 1## )rores.
With evergrowing global financial crisis, exchange rates are fluctuating widely. I/(
exchange rate has touched @8 against +,-. )urrency futures trading in India has
generated huge interest among Indian retail investors and traders. There is a strong
demand for information gathering about the intricacies of currency futures from small
investors and enterprises.
After over a year of introduction of exchangetraded currency futures in the +,-I/(
pair on the stock exchanges in the country, the market regulators have now permitted
trading of &uroI/(, >apanese 3enI/( and =ound ,terlingI/( on the exchange
platform. This is a move that the market had been demanding for a long time. This is an
apt time to review how the exchangetraded currency market has fared so far and what
lies ahead as it ventures further into new currency pairs.
The currency derivatives segment on the /,& and 6)< has witnessed consistent growth
both in traded value and open interest since its inception. The total turnover in the
segment has increased incredibly from :1.@bn in ?ctober "##B to :B@bn in -ecember
"##5. The average daily turnover reached
bn in -ecember "##5. ?pen interest in thesegment on the /,& and 6)< stood at around @ lakh contracts till end-ecember "##5.
India already has an active overthecounter !?T)% market in currency derivatives where
the average daily turnover was :"5bn in "##B and :"$bn in "##5 !till ,eptember "##5%.
This market is being driven by its ability to meet the respective needs of participants. 2or
example, it is used by importers.exporters to hedge their payables.receivablesO foreign
institutional investors !2IIs% and /(Is use it to hedge their investments in IndiaO
borrowers find it an effective way to hedge their foreign currency loans and resident
Indians find it an effective tool to hedge their investments offshore. 2urther, for
arbitrageurs it presents an opportunity to arbitrage between onshore and nondeliverable
forward !/-2% markets.
!
The exchangetraded currency futures market is an extension of this already available
?T) market, but with added benefits of greater accessibility to potential participantsO
high price transparencyO high liAuidityO standardised contractsO counterparty risk
management through clearing corporation and no reAuirement of underlying exposure in
the currency. As the market participants are realising these benefits of exchangetraded
market in currency, they are choosing this market over ?T).
*owever, it is too early to see a ma7or shift in activity from ?T) to exchangetraded
market as it has created a niche for itself and it would perhaps take some time for the
currency futures market to create one for itself. 'lobally, too, the foreign exchange
market is largely ?T) in character. While the notional amount outstanding of ?T)
derivatives was as high as :H1trn in >une "##B, the exchangetraded market is rather non
existent with notional amount outstanding as end>une "##5 being only #.4I of that in
the ?T) segment.
*owever, there is a renewed debate on the level of transparency and counterparty risk in
the ?T) market kindled by the subprime mortgage crisis in the +, and the need to
regulate ?T) transactions effectively. This throws up certain important issues which, at
best, may need to be handled separately.
"
India has, in this light, embarked upon an experiment by attempting to make the
exchangetraded currency market popular and a first choice for investors. Though the
market has not been able to evince the kind of activity that the ?T) market has witnessed
as yet, the recent phenomenal growth is a pointer towards better days ahead for this
market. ,ome of the issues plaguing the market at present include the fact that many
corporates using currency derivatives for hedging their foreign currency exposure find
the reAuirement of margin and settlement of daily marktomarket differences
cumbersome, especially since there is no such reAuirement for ?T) trades. It would
conceivably take some time for them to realise the concomitant benefits of these risk
containment measures. Also, there is a perceived resistance to change and switchover
from ?T) to exchangetraded framework following a level of comfortability reached by
market players with the ?T) market framework.
2urther, the market has been restricted in a number of ways. Till recently only +,-I/(
futures contracts were permitted. ?ne hopes to see more activity in the segment with
more currency pairs being added. Also to start with, 2IIs have not been permitted to
participate in this market. This has in effect restricted the liAuidity that 2IIs could have
otherwise created. 2IIs are already active in -ubai 'old and )ommodity &xchange
!-')uly, "##5. 0,& reaches to over @## cities and town nationwide and has around @,518
listed companies, with over 88@4 scrips being traded as on 1$
st
>uly #5.
The 0,& Index, ,&/,&une "### )ommencement of -erivatives Trading !Index 2utures%
>une "##$ )ommencement of trading in Index ?ptions
>uly "##$ )ommencement of trading in ?ptions on Individual ,ecurities
/ovember "##$ )ommencement of trading in 2utures on Individual ,ecurities
August "##B Daunch of )urrency -erivatives
August "##5 Daunch of Interest (ate 2utures
/ovember "##5 Daunch of 6utual 2und ,ervice ,ystem
"!
S?P C75 7i't$
,N= )/< /ifty is a well diversified 4# stock index accounting for "" sectors of the
economy. It is used for a variety of purposes such as benchmarking fund portfolios, index
based derivatives and index funds.
,N= )/< /ifty is owned and managed by India Index ,ervices and =roducts Dtd.
!II,D%, which is a 7oint venture between /,& and )(I,ID. II,D is IndiaCs first specialized
company focused upon the index as a core product. II,D has a 6arketing and licensing
agreement with ,tandard N =oorCs !,N=%, who are world leaders in index services.
The total traded value for the last six months of all /ifty stocks is approximately 4"I of
the traded value of all stocks on the /,&
/ifty stocks represent about H1I of the 2ree 2loat 6arket )apitalization as on -ec 1$,
"##5.
Impact cost of the ,N= )/< /ifty for a portfolio size of (s." crore is #.$#I
,N= )/< /ifty is professionally maintained and is ideal for derivatives trading
2rom >une "H, "##5, ,N= )/< /ifty is computed based on free float methodology.
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"# Tata steel @4 A00
"$ 0a7a7 auto @H *indalco
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"1 6aruti udyog @B 6N6
"@ ,un pharma @5 ,eagrams
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@.) Tet an( Reult
Tet 'or Stationarit$9
A time series is said to be stationary if its mean and variance are constant over time and
the value of the covariance between the two time periods depends only on the distance or
gap or lag between the two time periods and not the actual time at which the covariance
is computed. Tests for stationarity are routinely applied to highly persistent time series.
2ollowing 9wiatkowski, =hillips, ,chmidt and ,hin !$55"%, standard stationarity
employs a rescaling by an estimator of the longrun variance of the !potentially%
stationary series. Test for stationarity is important in case of time series data because a
"$
nonstationary time series will have time varying mean or a timevarying variance or both.
*ence the results cannot be extrapolated for the entire population.
The test for stationarity can be done using +nit (oot Test. It is due to the fact that V E $.
If however, WVW X $, that is if the absolute value of V is less than one, then it can be shown
that the time series is stationary.
'iven that in most situations only one observation is available at a given time,
stationarity ensures that all parts of the series are like the other parts, which allows us to
estimate the needed parameters. Therefore, the mean, the variance and the covariance of
the series are not functions of time and depend rather on the lag between the observations
!the difference between the times at which two observations were recorded%. To
summarize, if