Introduction and Design of the Study
CHAPTER I
INTRODUCTION YDUTS EHT FO NGISED DNA
1.1 INTRODUCTION
Now-a-days, many financial institutions such as commercial banks, financial
firms and individual investors actively participate in Foreign Exchange (FOREX) tekraM
in order to grasp potential profits or to hedge in their financial transactions. sA it is
considered to be the biggest and the most liquid market, a vast majority of investors are
inclined to tsevni their capital in this market for speculation purposes. According to April
2014 (Bank for International Settlements, 2014), 1 Report of the Bank for International
Settlement the average daily turnover in global Foreign Exchange Market is estimated
$5.3 trillion per day with growth in global Foreign Exchange turnover of about 35
percent at current Exchange Rates. The survey results continue the trend of strong
turnover growth evidenced in past Triennial Surveys. Foreign Exchange turnover,
computed at constant Exchange Rates, grew roughly on the same magnitude. The growth
in foreign exchange activity has increased to 20 percent when comparde to the previous
years.
The world economy has experienced Fixed and Flexible Exchange Rate regimes.
Before 1875, the system which was bimetalism of Exchange Rate and follwed by Gold
Standard (1875-1914) during inter-war period (1914-1944) the classical Gold Standard
broke down, and in July 1944 representatives of 44 countries succeeded in establishing
the ‘Bretton Woods’ system. Again, the oil shock in the early 1970s badly that hurt the
system and the world economy shifted to Flexible Exchange Rate. From 1972 to 1990
there was a huge deficit in ‘Balance of Payment’ affected the economy badly. In the year
1990, the gap in the Balance of Payment began to narrow down (Mohammadi, A. 2010). 2 1
The Exchange Rate regime worked sufficiently well in terms of balance of payment,
Inflation, Export and Remittance, etc.
1
Bank of International Settlements (2014), “Foreign Exchange and Derivatives Market Activity in
April,” Triennial Central Bank Survey, Pp.35-47.
2
Mohammadi, A. (2010), “Introduction to Forex Market”, Arad Ketab Publication.Pp.12-16
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Foreign Exchange market has influenced all aspects of the World Economy, and
understanding these dynamics is one of the great challenges of International Economics.
This study provides a novel, comprehensive, and in-depth examination of the latest
research in Exchange Rate economics. Foreign Exchange Market is considered as a
highly volatile market, like stocks, bond and other Capital Markets. Exchange Rate
fluctuation, the driving factor of volatility, is an important indicator of Macro Economic
policies. The related price movement either high/up or down/low. Impeding factors
which affecting the Foreign Exchange Market were the Economic Indicators, such as
reporting variation in GDP, Inflation, International Trade, Interest Rate, Employment,
Unemployment, Factory Order Report, Trade Balance, Payroll, Retail Sale, Personal
Income Report, FII, Reserve Position, etc. There exists an uncertainty about natural
catastrophes such as floods, earthquakes, wars, political disturbances, etc,. That could
direct impact on Foreign Exchange Market trend. The study mainly focuses on dynamic
relationship between Exchange Rate of (INR/USD, INR/EUR, INR/JPY, and INR/GBP)
and Nifty Index on five selected Economic Factors, namely, GDP, FII, Inflation, Forex
Reserves and International Trade.
Macro Economic Variables lead to acute variations in the Exchange Rate of major
currency. India has witnessed the recent episode of excessive volatility leading to sudden
and sharp depreciation of Indian Rupee against US Dollar and other currencies.
In the current year, Indian Rupee breached the sixty one per Dollar mark, its all-time hgih
against Dollar (India Budget, 2014) 3. Macro Economics is a movement and trend in the
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economy as a whole, which is influenced and in turn influences the micro economic
factors found at business and individual levels. The overall Macro Economic framework
plays a vital role in determining the conditions under which these micro level decisions
are made.
Foreign Institutional Investments (FIIs) have also reposed their confidence in the
Indian market, manifested in positive net FII investment, during the last four months of
3
India Budget, (2014), "Macro-economic Framework Statement" published by Indian Government.
2
2014 (Anita Mirchandani, 2014), 4 reversing the earlier trend of net outflow during the
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June-August period in the emas year. The total net FII flows to India in the year 2014 is
US$ 12.13 billion [(+) 20.10 billion in Equity and (-) 7.97 billion in Debt], with
investment sentiments being mainly driven by equity flows.
1.2 STATEMENT OF THE PROBLEM
In the era of globalization and financial liberalization, Exchange Rate plays an
important role in International Trade and finance for an open economy like India.
The movements in Exchange Rates affect the profitability of multinationals, and increase
exchange exposure to enterprises and Financial Institutions. A stable Exchange Rate will
help enterprise and Financial Institutions in evaluating the performance of investments,
financing and hedging, by reducing the operational risks. Fluctuations in the Exchange
Rate will have a significant impact on the Macro Economic fundamentals such as Interest
Rates, Prices, Wages and Unemployment, and the Level of output. This may ultimately
result in a Macro Economic disequilibrium that would lead to real Exchange Rate
devaluation to correct external imbalances (Parikh and Williams, 1998) 5. Increased
demand for a currency is due to, either an increased transaction demand for money or
increased speculative demand for money. The transaction demand for money is highly
correlated to the countries level of busines activity, Gross Domestic Product (GDP),
Employment Levels, FDI, FII, BOP, Exchange Rate, International Trade, Inflation, Stock
Prices, Foreign Exchange Reserves, etc. none of the comprehensive study has focused on
the dynamics of Exchange Rate movements of currencies along with Nifty Index and its
impact on the selected Macro Economic Factors in India. Hence, the researcher has
identified the above disscussed factor as the problem statement of the study.
1.3 RESEARCH QUESTIONS
The research question is the significnat part in the research work, it helps to raise
the quries related to the statement of the problem and suggest to analyse the doubts arised
for select variables.
4
Anita Mirchandani (2014) "Analysis of Macroeconomic Determinants of Exchange Rate Volatility in
India", International Journal of Economics and Financial Issues, Vol. 3, No.1, ISSN: 2146-4138, Pp. 172-179
5
Parikh, A. and Williams G. (1998), “Modeling real Exchange Rate behavior: A cross-country study”,
Applied Financial Economics, Vol. 8, Pp. 577-587.
3
1. The major research question for this study is; how the dynamics exists between major
currencies Exchange Rates and Macro Economic Factors in India.
2. Whether Forex market and Nifty Index has a long run or short-term equilibrium?
3. What are the effects of Macro Economic Factors such as FII, GDP, Inflation, and
Forex Reserves and International Trade on Foreign Exchange Market in India?
4. When will more volatility happens in Exchange Rates, What is the reason for
currency fluctuation in India?
5. Which currency has more volatile?
The following objectives are help the researcher to find the answer for the above
questions.
1.4. OBJECTIVE OF THE STUDY
1. To study the oveall performance of select currencies’ Exchange Rate , Macro
Economic Factors and Nifty Index,
2. To analyze the volatility of the select currencies and Nifty Index ,
3. To explore the impact of Exchange Rate on Macro Economic Variables,
4. To analyse the direct and indirect effects of the Macro Economic Factors on
Exchange Rate and Nifty Index, and
5. To analyze the casual relationship among Exchange Rate, Macro Economic Variables
and Nifty Index.
1.5. HYPOTHESIS OF THE STUDY
H0: There is no significant unit root exists among Exchange Rates during the study period
.
H0: There is no significant unit root exists for Nifty Index during the study period .
H0: There is no significant unit root exists for Macro Economic Factors during the study
period .
H0: There is no significant volatility on Exchange Rate of major currencies (USD, EUR,
JPY and GBP) with respect to Indian Rrupee during the study period .
H0: There is no significant volatility on Nifty Index during the study period .
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H0: There is no significant impact between Exchange Rate and Macro Economic
Factors during the study period.
H0: There is no significant impact between Nifty Index and Macro Economic Factors
during the study period.
H0: There is no significant causality between Exchange Rates and Nifty Index during
the study period.
1.6. SCOPE OF THE STUDY
In the current global scenario, global markets in the nations and their economies
haev become increasingly inter-dependent. The Foreign Exchange Market, Stock Market
and Economic Factors have emerged as a global focal point. The study has been
undertaken to highlight the dynamics of Foreign Exchange Market and its imapct on
Economic Variables in Indian Capital Market. The study also explors the linkage between
Forex movments and real economic events in Nifty Index in Indian Stock Market.
The study prevealing precision of major influencing variables of the Indian Capital
Market in the post reform era. The study also confined to Forex Market and Nifty Index.
The samples are the Exchange Rate of four major traded currencies, Nifty Index in Indian
Capital Market, and selected Macro Economic Factors (FII, GDP, Infaltion, Forex
Reareves and International Trade) in India. As such, there is a scope to examine whether
the dynamics of Forex Market and its impact provide better path to cater to the needs of
various avenues of investments, financial decision, and venture capital investments etc,.
1.7. OPERATIONAL DEFINITIONS
Foreign Exchange
The term Foreign Exchange refers to the process of conversion of currencies and
conversion of currencies themselves, since they cannot function as a legal tender yet
serve the purpose of exchange of values.
Forex tekraM
Forex tekraM is the markets were currencies are bought and sold. It is
distinguished from a financial market, where currencies are borrowed and lend.
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Exchange Rate
The rate at which one currency is converted into another currency is the rate of
exchange between the currencies concerned. The rate of exchange for a currency is
known from the quotation in the Foreign Exchange Market.
Stock
“Stock” is a share in the ownership of a company. A stock represents a claim on
the company's assets and earnings. As more stocks are required , the ownership stake in
the company becomes greater.
Share Market
A Share tekraM or Stock tekraM, is a private or public market for the trading of
company stock and derivatives of company stock at an agreed price; these are securities
listed on a Stock Exchange as well as those only traded privately. The stocks are listed
and traded on Stock Exchanges which is entities, a corporation or mutual organization,
specialized in the business of bringing buyers and sellers of the organizations to a listing
of stocks and securities together.
Foreign Institutional Investment (FII)
FII is defined by the European Union is an investment in a Foreign Stock Market
by the specialized financial intermediaries managing savings collectively on behalf of
investors, especially small investors, towards specific objectives in terms of risk, return,
and maturity of claims. SEBI’s definition of FIIs presently includes foreign Pension
Funds, Mutual Funds, Charitable/Endowment/University Funds, Asset Management
companies and other money managers operating on their behalf in a Foreign Stock
Market.
Gross Domestic Product (GDP)
Gross Domestic Product is the official measure of the economic output, because,
it is the best basis of the well being of the citizens in a given country. GDP is the total
final value of all the goods and services produced in a given country, in a year.
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Inflation
Inflation is defined as “An increase in the amount of currency in circulation, resulting
in a relatively sharp and sudden fall in its value and rise in prices”.
International Trade
International Trade refers to trade between the residents of two different
countries. It occurs when a firm exports and imports goods or services to consumers in
another country.
Forex Reserve
A reserve currency is a currency that is held in significant quantities by many
governments and institutions as a part of their Foreign Exchange Reserves. This permits
the issuing country to purchase the commodities at a marginally lower rate than other
nations, which must exchange their currencies with each purchase and pay a transaction
cost. For major currencies, this transaction cost is negligible with respect to the price of
the commodity.
Stationarity
It exists when mean and variance are constant over time and the value of covariance
between two timeperiods depends only on the distance and not on the actual time.
Heteroscedasticity
A collection of random variables is heteroscedastic if there are sub-populations
that have different variabilities from others. Heteroscedasticity is the absence of
homoscedasticity.In other words it is the sequence of conditional variance that changes
and not the unconditional variance.
Correlogram Analysis
Correlogram means (autocorrelations and partial autocorrelations) the
standardized residuals.
Technical Terms Used for the Study
In theis research there are varrious technical terms are used such as volatility,
movements, fluctutions are has the same meaning “change”.
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Bollerselv-wooldrige robust: is a method to analyse/identify auto coeelation effect on
residual statistics.
1.8. CHAPTER SCHEME
This study is analyzed and presented in five chapters
Chapter-I: - Introduction
The First chapter is introductory in nature and deals with introduction, statement
of the problem, research questions, objectives, hypothesis of the study, scope and
operational definition of the study.
Chapter-II: - Review of Literature and Theoritical Concepts
The second chapter highlights the overview of Forex Market, Nifty Index and
Macro Economic Factors in India and Review of Literature.
Chapter-III: - Research Methodology
This chapter gives a brief overview of the Research Methodology.
Chapter-IV: - Analysis and Interpretations
The fourth chapter disscus the analysis and the interpretations relating to four
major currencies and select Macro Economic Variables which are analysed through
Normality Test, ADF Test, ARCH Test, Multiple Regression Model, finally Pair Wise
Granger Casulaty Tests, to find the dynamics of Forex Market.
Chapter-V: - Findings, Suggestions and Conclusion
The fifth chapter presents the summation of findings and suggestions for
improving investment in Forex Market and most influening factors to investment decsion
and policy making. It further focuses on the brand new methodology for Forex Market
and Nifty Index in the Indian Capital Market.
