33341798 role of financial institutional investors in capital market in india

8/13/2019 33341798 Role of Financial Institutional Investors in Capital Market in India

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A PROJECT REPORT ON

ROLE OF FINANCIAL INSTITUTION IN CAPITAL

MARKET IN INDIA

SUBMITTED BY

NEHA BHADRA

SUBMITTED IN PARTIAL FULFILLMENT OF THEREQURIEMENT FOR

POST GRADUATE DIPLOMA IN FINANCIAL SERVICES

(PGDFS)

OF

UNIVERSITY OF PUNE

UNDER THE GUIDANCE OF

Ms. RACHANA PHADKE

SINHGAD BUSINESS SCHOOL, PUNE CITY

SESSION- 2009-10


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BONAFIED CERTIFICATE

This is to certify that Mr. ROHAN MESHRAM

Studying in the second semester of Post Graduate Diploma in

Financial services of University of Pune is a Bonafide student of

Sinhgad Business School, Pune City.

Director

Sinhgad Business School

Pune City


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D E C L A R A T I O N

I, the undersigned, hereby declare that the Project Report entitled ROLE OF

FINANCIAL INSTITUTION IN CAPITAL MARKET IN INDIA written and

submitted by me to the University of Pune, in partial fulfillment of the

requirements for the award of degree of Post Graduate Diploma In Financial

Services under the guidance of Ms. RachanaPhadke is my original work and

does not form earlier the basis for the award of any degree or similar title of this

or any other University or examining body. In addition, the conclusions drawn

therein are based on the material collected by myself.

Place: Pune RohanJ.Meshram

Date: Research Student


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APPROVAL CERTIFICATE

The project report of

Mr. ROHAN MESHRAM

ROLE OF FINANCIAL INSTITUTION IN CAPITALMARKET IN INDIA

is approved and is acceptable in quality and form.

Internal Examiner External Examiner

Signature: Signature:

Name: Name:


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GUIDES CERTIFICATE

This is to certify that the Project Report entitled ROLE OF FINANCIALINSTITUTION IN CAPITAL MARKET IN INDIA which is being

submitted herewith for the award of the degree of Post Graduate Diploma In

Financial Services of University of Pune, is the result of the original research

work completed by Mr. ROHAN MESHRAM under my supervision and

guidance and to the best of my knowledge and belief the work embodied in

this Project Report has not formed earlier the basis for the award of any

degree or similar title of this or any other University or examining body.

CERTIFIED

Ms. RachanaPhadke

Guides Name & Signature


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TABLE OF CONTENTS

CONTENTS PPAGE NOSDASD

ABSTRACT 8

1.INTRODUCTION 11

2.OBJECTIVE 13

3.METHODOLOGY 13

4.INSTITUTIONALINVESTORS 14

5.TYPES OF INSTITUTIONALINVESTOR 14

5.1DOMESTICINSTITUTIONALINVESTORS 14

5.1.1DOMESTICFINANACIALINSTITUTION 14

5.1.2INSURANCECOMPANIES 15

5.1.3BANKS 15

5.1.4ASSETMANAGEMENT COMPANY 15

5.2FOREIGN INSTITUTIONALINVESTORS 16

5.2.1SOURCESOF FII IN INDIA 17

6.CAPITALMARKETIN INDIA 18

7.INSTITUTIONALINVESTORS REGISTEREDIN INDIA 20

7.1MUTUALFUND REGISTEREDIN INDIA 20

7.2FII REGISTEREDIN INDIA 21

8.MAJOR INSTITUTIONALINVESTORS IN INDIA 22

8.1DOMESTICINSTITUTIONALINVESTORS 23

8.1.1 LIFEINSURANCE CORPORATION 23


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8.1.2RELIANCEMUTUALFUND 24

8.1.3ICICI PRUDENTIAL 24

8.1.4UTI MUTUALFUND 25

8.1.5HDFC MUTUALFUND 25

8.2FII 26

8.2.1DEUTSCHEGROUP 26

8.2.2CITIGROUPGROUP 27

8.2.3HSBC GLOBALINVESTMENT 27

8.2.4MORGAN STANLEY&CO INTERNATIONALLTD 27

8.2.5DSPMERRILLLYNCH 28

9.INVESTMENTTRENDS OF INSTITUTIONALINVESTORS IN INDIA 28

9.1INVESTMENTTRENDS OF INDIAN MUTUALFUND INDUSTRY 28

9.2FOREIGN INSTITUTIONALINVESTMENT 29

9.2.1REASONS FOR GROWTHIN FII INVESTMENT 30

10. FII: COST BENEFIT ANALYSIS 31

11. DETERMINATION OF FII 34

12. COMPARISION BETWEEN FIIS & MUTUAL FUND INVESTMENT 36

13. ROLE OF INSTITUTIONAL INVESTORS IN CAPITAL MARKET 36

14. A STUDY OF MAJOR EPISODES OF VOLATILITY 40

15. STATISTICAL ANALYSIS 45

RECOMMENDATION 50

CONCLUSION 51

REFERENCES 52

ANEXURE 53


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ABSTRACT:

" Thewholeis much more than justthe sumof the parts"Aristotle

Aneconomy,apartfromeverythingelse,isahighlyfluidtransmissionmechanism.Itsbeautylies

inhowthe smallestofchangeshavethemostcomplextrickle-downeffects.Aparadigmatic

exampleofhowseeminglyminorpolicychangescanjumpstarttheeconomycanbeillustrated by

examiningthe effects liberalization on capital market in India.

Globalization had led to widespread liberalization and implementation of financial market

reformsinmanycountries,mainlyfocusingonintegratingthefinancialmarketswiththeglobal

markets.IndianCapitalMarkethasalsoundergonemetamorphicreformsinthepastfewyears. Every

segment of Indian Capital Market vizprimary and secondary markets, derivatives, institutional

investment and market intermediation has experienced impact of these changeswhichhassignificantlyimprovedthetransparency,efficiencyand integration ofIndianmarket withthe

global markets.

Thisisoneoftheprimereasonswhytheforeignportfolioinvestmentshavebeenincreasingly

flowingintotheIndianmarkets.AsignificantpartoftheseportfolioflowstoIndiacomesinthe

formofForeignInstitutional Investors(FIIs)investments,mostlyinequities.Eversincethe openingof

the Indian equitymarkets to foreigners,FII netinvestments havesteadilygrown.Thus, we cansee that

there has been a consistent rise inthe FII inflows intothe country.

WhiletheconcernssuchasFIIpullingbacktheirinvestmentsandthekindofdestabilizingeffect

onthecapitalmarketinIndiaareallwell-placed,comparativelylessattentionhavebeenpaidso

fartoanalyzingtheFIIflowsdataandunderstandingtheirkeyfeatures.Aproperunderstanding

ofthenatureanddeterminantsoftheseflows,however,isessentialforameaningfuldebateabout

theireffectsaswellaspredictingtheirchancesoftheirsuddenreversals.Thusthisprojectaimsat

studyingtheroleofthese InstitutionalinvestorsanditsimpactonthecapitalmarketsinIndia.Thisalsoaimstofindoutthevariousfactorsanddeterminantsfortheirinvestmentsandalsocite

outscenarioswhereintheseinvestmentswhenpulledbackbytheseFIIcouldreallyeffectthe capital

markets in India.


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Institutionalinvestorsareapermanentfeatureofthefinanciallandscape,andtheirgrowthwill continue

at a similar and perhaps fasterpace.The factorsthatunderpin their development are far

fromtransitoryandinmany caseshaveonlyjuststartedhavinganimpact.Thebehavioral

characteristicsofinstitutionalinvestors,therefore,willbeanincreasinglyimportantdeterminant

ofdomesticandinternationalfinancialmarketconditions,andthe implicationsforfinancial

marketstability warrantserious consideration"

Bankfor InternationalSettlements,AnnualReport1998, p95.


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EXECUTIVE SUMMARY:

Theobjectiveoftheprojectistofindthedifferentroleofinstitutionalinvestorsinthecapital

marketinindiaandthentofindtheroleofinstittutionalinvestorsin themajorvolatileepisodein

thecapitalmarketinindia.FinalytofindtherelationshipbetweentheSensexvariationwiththevariationoftheinvestmentsmadebytheinstitutionalinvestors.Indiaopeneditsstockmarketsto foreign

investors in September 1992 and has, since 1993, received considerable amount of portfolio

investment from foreigners in the form of Foreign Institutional Investors (FII)

investmentinequities.Whileitisgenerallyheldthatportfolioflowsbenefittheeconomiesof recipient

countries,policymakersworldwidehavebeenmorethanalittleuneasyaboutsuch

investments.Portfolioflows-oftenreferredashotmoney-arenotoriouslyvolatilecomparedto

othertypesofcapitalinflows.Investors areknowntopullbackportfolioinvestmentsatthe slightest hint of

trouble in the host countryoften leading to disastrous consequences to its

economy.Theyhavebeenblamedforexacerbatingsmalleconomicproblems inacountryby

makinglargeandconcertedwithdrawalsatthefirst signof economicweakness.Themethodology

usedtoisregressionanalysis.Thedegreeofassociationhelpsustoquantifytherelationship between the

variation in sensexdue to the variation in the net investments made by the institutionalinvestors.

AftercompleteingtheprojectIcould recommendthatGovernmentshouldcertainlyencourage

foreigninstitutionalinvestmentbutshouldkeepacheckonthevolatilityfactor.Longtermfunds should

begiven priorityand encouraged someof the actions that couldbe taken to ensure stability

are

Strengtheningdomestic institutional investors

Operational flexibilityto impartstabilityto the market

Knowledgeactivitiesand researchprograms

ToconcludewithIwouldsaythethattheforeignfundsiscertainlyoneofthemostimportant

causeofvolatilityintheIndianstockmarketandhashadaconsiderableinfluenceonit.Although

itwouldnotbefairenoughtocometoanyconclusionastherearealotofotherfactorsbeyond

thescopeofthestudythateffect returnsandrisks.itisnoteasytopredictthenatureofthe

macroeconomicfactorsandtheirbehaviorbutithasagreatsignificanceonanyeconomyandits

elements.Althoughgenerallyapositiverelationhasbeenseenbetweenthestockmarketreturns andthe

FII inflows itis not easyto saywhichis the cause n whichis the effect.

1. INTRODUCTION:


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Financialmarketsarethecatalystsandenginesofgrowthforanynation.Indiasfinancialmarket

beganitstransformationpathintheearly 1990s.Thebankingsectorwitnessedsweepingchanges,

includingtheeliminationofinterestratecontrols,reductionsinreserveandliquidityrequirements andan

overhaul in prioritysectorlending. Persistent efforts bytheReserveBank of India(RBI) to

putinplaceeffectivesupervisionandprudentialnormssincethenhaveliftedthecountry closerto

globalstandards.Aroundthesametime,Indiascapitalmarketsalsobegan tostageextensive

changes.TheSecuritiesandExchangeBoardofIndia(SEBI)wasestablishedin1992witha

mandatetoprotectinvestorsandusherimprovementsintothemicrostructureofcapitalmarkets, while the

repeal of the Controller of Capital Issues (CCI) in the same year removed the

administrativecontrolsoverthepricingofnewequityissues.Indiasfinancialmarketsalsobegan to

embracetechnology. Competition in the markets increased with the establishment of the National

Stock Exchange (NSE) in 1994, leading to a significant rise in the volume of transactionsandto the

emergence of new important instruments infinancial intermediation.

Indianinvestorshavebeenabletoinvestthroughmutualfundssince1964,whenUTIwas

established.IndianmutualfundshavebeenorganizedthroughtheIndianTrustActs,underwhich

theyhave enjoyed certain tax benefits. Between 1987 and 1992, public sectorbanks andinsurance

companiessetupmutualfunds.Since1993, privatesectormutualfundshavebeenallowed,whichbroughtcompetitiontothemutualfundindustry.Thishasresultedintheintroductionof new

productsand improvement of services. The notificationof the SEBI (Mutual Fund)

Regulationsof1993broughtaboutarestructuringofthemutualfundindustry.Anarmslength

relationshipisrequiredbetweenthefundsponsor,trustees,custodian,andassetManagement Company.

This is in contrast to the previous practice where all three functions, namely trusteeship,

custodianship, and asset management, were often performedbyone body,

Usually the fund sponsor or its subsidiary. The regulations prescribed disclosure and

advertisementnormsformutualfunds,and,forthefirsttime,permittedtheentryofprivatesector

mutualfunds.FIIsregisteredwithSEBImayinvestindomesticmutualfunds,whetherlistedor

unlisted.The1993Regulationshavebeen revisedonthebasisoftherecommendationsofthe

MutualFunds2000ReportpreparedbySEBI.Therevisedregulationsstronglyemphasizethe


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governanceof mutualfundsandincreasetheresponsibilityofthetrusteesinoverseeingthe

functionsoftheassetmanagementcompany.Mutualfundsarenowrequiredtoobtaintheconsent of

investorsfor anychange in the fundamental attributesof a scheme, on thebasis of whichunit

holders haveinvested. The revisedregulations require disclosures in terms of portfolio

composition,transactionsbyschemesofmutualfundswithsponsorsor affiliatesofsponsors,

withtheassetManagementCompanyandtrustees,andalsowithrespecttopersonaltransactions of

keypersonnel of asset management companiesandof trustees.

IndiaopeneditsstockmarketstoforeigninvestorsinSeptember1992andhas,since1993, received

considerableamountofportfolioinvestmentfromforeignersintheformofForeign

InstitutionalInvestors(FII)investmentinequities.Thishasbecomeoneofthemainchannelsof

portfolioinvestmentinIndiaforforeigners.In ordertotradeinIndianequitymarkets,foreigncorporations need to register with the SEBI as Foreign Institutional Investor (FII). SEBIs

definition of FIIs presently includes foreign pension funds, mutual funds,

charitable/endowment/universityfundsetc.aswellasassetmanagement companiesandother

moneymanagersoperating on their behalf

ThesourcesoftheseFIIflowsarevaried.TheFIIsregisteredwithSEBIcomefromasmanyas

28countries(includingmoneymanagementcompaniesoperatinginIndiaonbehalfofforeign

investors).USbasedinstitutionsaccountedforslightlyover41%thosefromtheU.Kconstitute about20%

with otherWesternEuropean countrieshosting another 17% of the FIIs.

Portfolioinvestmentflowsfromindustrialcountrieshavebecomeincreasinglyimportantfor

developingcountriesinrecentyears.TheIndiansituationhasbeennodifferent.Asignificantpart

oftheseportfolioflowstoIndiacomesintheformofFIIsinvestments,mostlyinequities.Ever

sincetheopeningoftheIndianequitymarketstoforeigners,FIIinvestmentshavesteadilygrown

fromabout Rs.2600 crores in 1993 toover Rs.272165 crores till the end of Feb 2008.

Whileitisgenerallyheldthatportfolioflowsbenefittheeconomiesofrecipientcountries,policy

makersworldwidehavebeenmorethanalittleuneasyaboutsuchinvestments.Portfolioflows-

oftenreferredashotmoney-arenotoriouslyvolatilecomparedtoothertypesofcapitalinflows.

Investorsareknowntopullbackportfolioinvestmentsattheslightesthintoftroubleinthehost

countryoftenleadingtodisastrousconsequences toitseconomy.Theyhavebeenblamedfor


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exacerbatingsmall economicproblems in acountrybymaking largeand concerted withdrawalsat

thefirstsignof economicweakness.Theyhavealsobeenresponsibleforspreadingfinancial crisis

causingcontagion ininternational financial markets.

Internationalcapitalflowsandcapitalcontrolshaveemergedasanimportantpolicyissuesinthe

Indiancontextaswell.ThedangerofabruptandsuddenoutflowsinherentwithFIIflowsand their

destabilizing effect on equityand foreignexchange markets have been stressed.

ThefinancialmarketinIndiahaveexpandedanddeepenedrapidlyoverthelasttenyears.The Indiancapital

marketshavewitnessedadramaticincreaseininstitutionalactivityandmore specifically that of FIIs. This

changein market environment has made the market more

innovativeandcompetitiveenablingtheissuersofsecuritiesandintermediariestogrow.InIndia

theinstitutionalizationofthecapitalmarketshasincreasedwith FIIsbecomingthedominant

ownerofthefreefloatofmostbluechipIndianstocks.Institutionsoftentradelargeblocksof

sharesandinstitutionalorderscanhaveamajorimpactonmarketvolatility.Insmallermarkets,

institutionaltradescanpotentiallydestabilizethemarkets.Moreover,institutionsalsohaveto designandtime

theirtradingstrategiescarefullysothattheirtradeshavemaximumpossible returnsand

minimumpossibleimpact costs.

2. OBJECTIVEOFTHE PROJECT:

ToStudytheImpactofInstitutionalInvestorsespeciallytheFIIonthecapitalmarketin

India.

Tostudy themajorEpisodesofvolatilityinIndiaandanalyzingtheimpactofInstitutional investorsin

theseepisodes.

ToquantifytherelationbetweenFIIflowsandtheirrelationshipwitheconomicvariables,

particularlywithNIFTY.

3. METHODOLOGY:

ForcoveringtheTheoreticalpartIshallbegoingthroughalotofliteratureincludingbookson

FII&CapitalMarket.BeyondthisIshallbetrackingtheperformanceofFIIthroughthehelpof internet.

ToStudythemajorepisodesofvolatilityinIndia,Iwouldbereadingthroughalotofliterature, articles, and

magazinesandvisiting various sitesfor their comments during that period.


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Forthestudypurpose,IwilltakeonlyNIFTYthatistheNationalStockExchange(NSE)

benchmarkIndexisconsidered.ThisisbecausethelargerchunkofFIIactivityinIndiahappens

ontheNSE.NSEisthedominantexchangeinIndiawithcloseto75%ofcashmarketturnover

andwellover90%ofderivativesturnoverinIndia happeningontheNSE.Thedailyindex

volatilityandvolatilityindailyFIIcashflowswerestudiedanddailyFIIvolatilityontheNifty

volatility.OntheinformationsogatheredIwillberunningSPSSanalysis&reachingontothe conclusion.

Thusthroughoutthe projectI shall bemaking use of secondarydata.

4. INSTITUTIONALINVESTOR:

Aninstitutional investor is an investor,suchas a bank, insurance company,retirementfund, hedge

fund,ormutualfundthatisfinanciallysophisticatedandmakeslargeinvestments,oftenheldin

verylargeportfoliosofinvestments.Becauseoftheirsophistication,institutionalinvestorsmay

oftenparticipateinprivateplacementsofsecurities,inwhichcertainaspectsofthesecuritieslaws maybe

inapplicable.

5. TYPESOFINSTITUTIONALINVESTOR

5.1.DOMESTICINSTITUTIONALINVESTOR

isusedtodenoteaninvestor-mostlyoftheformofaninstitutionorentity,whichinvests

moneyinthe financialmarketsofitsowncountrywheretheinstitutionorentitywas

originallyincorporated. In India, there are broadlyfour types of institutional investors.

5.1.1 DEVELOPMENTALFINANCIALINSTITUTIONSlikeIndustrialFinance

CorporationofIndia(IFCI),IndustrialCreditandInvestmentCorporationof
http://en.wikipedia.org/wiki/Mutual_fundhttp://en.wikipedia.org/wiki/Mutual_fundhttp://en.wikipedia.org/wiki/Mutual_fundhttp://en.wikipedia.org/wiki/Investorhttp://en.wikipedia.org/wiki/Investorhttp://en.wikipedia.org/wiki/Institutional_investorhttp://en.wikipedia.org/wiki/Institutional_investorhttp://en.wikipedia.org/wiki/Financial_marketshttp://en.wikipedia.org/wiki/Financial_marketshttp://en.wikipedia.org/wiki/Financial_marketshttp://en.wikipedia.org/wiki/Institutional_investorhttp://en.wikipedia.org/wiki/Investorhttp://en.wikipedia.org/wiki/Mutual_fund


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India (ICICI), Industrial Development Bank of India (IDBI), the State Financial Corporations,

etc.Theroleplayed bythese financialinstitutions(FIs) istoextendfundstothe

companiesforbothlongtermfinancingand(more

recently)workingcapitalfinancing.Thefinancialinstitutionsextendbothdebt andequityfinancing to

their nominee directors in the companies.

5.1.2 INSURANCE COMPANIESlike the Life Insurance Corporation (LIC), General

InsuranceCorporation (GIC), and their subsidiaries.

5.1.3 BANKS: Earlier banks used to finance only the working capital of the companies.

But now theyare also extending long-term finance to the companies.

5.1.4 ASSETMANAGEMENTCOMPANIESallthemutualfundsincludingUnit

TrustofIndia(UTI).Themutualfundscollectfundsfrombothindividualsand

corporatetoinvestinthe financialassetsofothercompanies.InIndia,the

mutualfundsparticipatelargelyinthe equitycapitalofthecompanies.The

mutualfundindustrywhichisthemajorinstitutionalinvestorsinIndiastarted

in1963withtheformationofUnitTrustofIndia,atthe initiativeofthe Government of

India and ReserveBank.

ThehistoryofmutualfundsinIndiacanbebroadlydividedintofourdistinct phases

FirstPhase:1964-1987,UnitTrustofIndia(UTI)wasestablishedon

1963byanAct of Parliament.

SecondPhase:1987-1993,EntryofPublicSectorFunds.1987marked

theentryofnon- UTI,public sectormutualfunds set up bypublicsector banks

and Life Insurance Corporation of India (LIC) and General

InsuranceCorporation of India (GIC).

ThirdPhase:1993-2003,EntryofPrivateSectorFundsin1993.Kothari Pioneer

(now mergedwithFranklinTempleton)wasthe firstprivate

sectormutualfundregisteredinJuly1993.AsattheendofJanuary2003;

therewere33mutualfundswithtotalassetsofRs.1,21,805crores.The

UnitTrustofIndiawithRs.44,541croresofassetsundermanagementwas wayahead


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of othermutual funds.

FourthPhase:2003-2007InFeb2003theUnitTrustofIndiaAct1963

UTIwasbifurcatedintotwoseparateentities.TheSpecifiedUndertaking ofUnitTrust

ofIndia,functioningunderanadministratorandunderthe

rulesframedbyGovernmentofIndia.ThesecondistheUTIMutualFund

Ltd,sponsoredbySBI,PNB,BOBandLIC.ItisregisteredwithSEBIand functions

under theMutual Fund Regulations.

5.2FOREIGNINSTITUTIONALINVESTOR (FII)

isusedtodenoteaninvestor-mostlyofthe formofaninstitutionorentity,whichinvestsmoneyinthefinancialmarketsofacountrydifferentfromtheonewhereinthe

institutionorentitywasoriginallyincorporated.FIIinvestmentisfrequentlyreferredto

ashotmoneyforthereasonthatitcanleavethecountryatthesamespeedatwhichit comesin. In

countries likeIndia, statutoryagencies likeSEBI have prescribed norms to register FIIs and

also to regulate suchinvestments flowing inthrough FIIs.

PensionFunds

MutualFunds

InvestmentTrust

Insuranceor reinsurance companies

Endowment Funds

UniversityFunds

Foundationsor CharitableTrusts or Charitable Societies

AssetManagement Companies

Nominee Companies InstitutionalPortfolio Managers Trustees

PowerofAttorneyHolders

Bank
http://en.wikipedia.org/wiki/Investorhttp://en.wikipedia.org/wiki/Investorhttp://en.wikipedia.org/wiki/Institutional_investorhttp://en.wikipedia.org/wiki/Institutional_investorhttp://en.wikipedia.org/wiki/Financial_marketshttp://en.wikipedia.org/wiki/Financial_marketshttp://en.wikipedia.org/wiki/Financial_marketshttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/SEBIhttp://en.wikipedia.org/wiki/SEBIhttp://en.wikipedia.org/wiki/SEBIhttp://en.wikipedia.org/wiki/SEBIhttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Financial_marketshttp://en.wikipedia.org/wiki/Institutional_investorhttp://en.wikipedia.org/wiki/Investor


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5.2.1 SOURCES OFFII IN INDIA:

ThesourcesoftheseFIIflowsarevaried.TheFIIsregisteredwithSEBIcome from as many

as 28 countries (including money management companies operating in India on

behalf of foreign investors). US-based institutionsaccountedforslightlyover41%;thosefromtheUKconstituteabout20%with other

Western European countries hosting another 17% of the FIIs. It is,

however,instructivetobearinmindthatthesenational affiliations donot

necessarilymeanthattheactualinvestorfundscomefromthese particular

countries.Giventhesignificantfinancialflowsamongtheindustrialcountries, national

affiliations are very rough indicators of the home of the FII investments.In

particularinstitutionsoperatingfromLuxembourg,Cayman

IslandsorChannelIslands,oreventhosebasedatSingaporeorHongKongare

likelytobeinvestingfundslargelyon behalfofresidentsinothercountries.

Nevertheless,theregionalbreakdownoftheFIIsdoesprovideanideaoftherelative

importance of different regions of the world in the FII flows.

6. CAPITALMARKETIN INDIA


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TheBombay StockExchange(BSE),whichbeganformaltradingin1875,isoneoftheoldest

inAsia.Overthelastdecade,therehasbeenarapidchangeintheIndiansecuritiesmarket,

bothinprimaryaswellasthe secondarymarket.Advancedtechnologyandonline-based transactions

have modernized

thestockexchanges.Intermsof

thenumberofcompanieslisted

andtotal marketcapitalization,

the Indian equity market is

consideredlarge relativetothe

countrys stage of economic

development.Currently,thereare40mutualfunds,outofwhich33areintheprivatesector

and7areinthepublicsector.Mutualfundswereopenedtotheprivatesectorin1992.Earlier, in1987,

banks wereallowed to enter this business, breakingthe monopolyof the UnitTrust of

India(UTI),whichmaintainsadominantposition.Before1992,manyfactorsobstructedthe


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expansionofequitytrading.FreshcapitalissueswerecontrolledthroughtheCapitalIssues

ControlAct.Tradingpracticeswerenottransparent,andtherewasalargeamountofinsider

trading.Recognizingtheimportanceofincreasinginvestorprotection,severalmeasureswere

enactedtoimprovethefairnessofthecapitalmarket.TheSecuritiesandExchangeBoardof

India(SEBI)wasestablishedin1988.Therehavebeensignificantreforms intheregulationof

thesecuritiesmarketsince1992inconjunctionwithoveralleconomicandfinancialreforms.

In1992,theSEBIActwasenactedgivingSEBIstatutorystatusasanapexregulatorybody.

Andaseriesofreformswasintroducedtoimproveinvestorprotection,automationofstock

trading,integrationofnationalmarkets,andefficiencyofmarketoperations.Indiahasseena

tremendous changein the secondarymarket for equity.

Amongtheprocessesthathavealreadystartedandaresoontobefullyimplementedare electronic

settlementtradeandexchange-tradedderivatives.Before1995,marketsinIndia

usedopenoutcry,atradingprocessinwhichtradersshoutedandhandsignaledfromwithina

pit.OnemajorpolicyinitiatedbySEBI from1993involvedtheshiftofallexchangesto screen-

basedtrading,motivatedprimarilybytheneedfor greatertransparency.Thefirst exchangetobe

basedonan openelectroniclimitorder bookwas theNationalStockExchange

(NSE),whichstartedtradingdebtinstrumentsinJune1994andequityinNovember1994.In

March1995,BSEshiftedfromopenoutcrytoalimitorderbookmarket.Before1994,Indias

stockmarketsweredominatedby BSE.Inotherpartsofthecountry,thefinancialindustry did

nothaveequalaccesstomarketsandwasunabletoparticipateinformingpricescompared

withmarketparticipantsinMumbai (Bombay).Asaresult,thepricesinmarketsoutside

MumbaiwereoftendifferentfrompricesinMumbai.Thesepricingerrorslimitedorderflow

tothesemarkets.Explicitnationwideconnectivity and implicitmovementtowardonenational

markethaschangedthissituation.NSEhasestablishedsatellitecommunicationswhichgive

alltradingmembersofNSEequalaccesstothemarket.Similarly,BSEandtheDelhiStock

Exchangearebothexpandingthenumberoftradingterminalslocatedalloverthecountry.

Thearbitrages are eliminating pricing discrepancies between markets.

TheIndiancapitalmarketstillfaces manychallenges ifit is topromote more efficient allocation

and mobilization of capital in the economy.


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First,marketinfrastructurehastobeimprovedasithinderstheefficientflowof

informationand effective corporate governance.

Second,the trading systemhas tobe mademore transparent.

Third,Indiamayneedfurtherintegrationofthenationalcapitalmarketthrough

consolidation of stock exchanges.

Fourth,the payment system has to be improved to better link the banking and

securitiesindustries.

Thecapitalmarketcannotthrivealone;ithastobeintegratedwiththeothersegmentsofthe

financialsystem.Theglobaltrendisfortheeliminationofthetraditionalwallbetweenbanks andthesecurities market. Securities market development has to be supported byoverall

macroeconomic and financial sector environments. Further liberalization of interest rates,

reduced fiscal deficits,fullymarket-based issuanceof Governmentsecuritiesand a more

competitivebankingsectorwillhelpinthedevelopmentofasounderand amoreefficient capital

market inIndia.

7. INSTITUTIONALINVESTORS REGISTEREDIN INDIA:

7.1MUTUALFUNDS REGISTEREDIN INDIA:

Fromthebarchartaboveitisclearlyevidentthatthemutualfundindustryisstillata


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nascentstageascomparedtotheFIIs.Sinceitsinceptionin1964whenthefirstmutual fundi.e.UTI

hadthemonopolyfor25 years.Itwasthus intheyearafter1989 thatpublic

sectorbanksandfinancialinstitutionstartedtheirAMC.Finallyinthethirdphasewhen

privateplayersenteredthearena,itleadtoafiercebattletoholdthetopslotintheIndian

mutualfundindustry.Thegrowingnumberofmutualfundcompaniescorroboratesthe

factthatIndianpublicarenowlookingfordifferentavenuestoinvesttheirearningsand

areconfidentontheworkingofcapitalmarketinIndia.ThisshowsthatSEBIhasina

wayrestoredthefaithoftheseinvestorsinspiteofthedifferentscamsthatrockedthe capital market

inIndia.

7.2FII REGISTEREDIN INDIA:

Lets lookat some of the data to get an idea about the trendof FIIs in India,and also

tosee thefuture direction of their movement.

Indiahad528FIIswereregisteredwithSEBIbyendof2001andbyendofFeb-2008the

numberincreasedto1303.ThetrendinthenumberofregisteredFIIshasbeenconsistently

ontheriseascanbeseenfromthetable;showingthesignificantamountofconfidence that

Indian Capital market has developed in the last few years.

Notonlyhasbeenthenumberincreasingonaconsistentbasis,buttheamountofinflow

intoIndianmarkethasalsoseenamanifoldincreased.Thegrosspurchase,salesandnet

investmentfigureonan annualbasisgivesafairideaabouttheconsistencyoftheir investments

inour country.


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Aswecanseeintheinvestmenttrendstable,exceptfor1998,thenetinvestmentbythe

FIIsinthe Indianmarkethasalwaysbeenpositivesinceliberalizationwhichtoalarge

extenttellsabouttheconsistencyoftheirpresenceinIndianmarket.Thisisalsoevident

fromthefactthatthenumberofFIIregisteringinIndiaisincreasinginspiteofthefact

thatSEBIhasdeclinedtoissueany furtherPNnotesandalsoaskedthemtogetregistered.

ThisshowsthatIndiastillremainsthehotspotfortheforeign investorsinthecoming years.

8.MAJOR INSTITUTIONALINVESTORS IN INDIA

Thetotal number of Domestic institutionalinvestors speciallythemutual funds is 40 in

number. Similarlyinsurance companies and otherbanks are verylargein number. Butout of

thesethere are some heavyweightswhich solelybytheir investments areamong thetop 5

domestic institutional investorsin india.Among thetotal FII registered i.e. 1303 bythe end

of feb2008 the top 5 FII interms of their investmentin India are listed below.

8.1.DOMESTICINSTITUTIONALINVESTORS


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8.1.1.LIFEINSURANCE CORPORATION OFINDIA.

LifeInsuranceinitsmodernformcametoIndiafromEnglandintheyear1818.

Thefirsttwo decadesofthetwentiethcenturysawlotofgrowthininsurance

business.From44companieswithtotalbusiness-in-forceasRs.22.44crore,itrose

to176companieswithtotalbusiness-in-forceasRs.298crorein1938.Duringthe

mushroomingofinsurancecompaniesmanyfinancially unsoundconcernswere

alsofloatedwhichfailedmiserably.However,itwasmuchlateronthe 19thof

January,1956,thatlifeinsuranceinIndiawasnationalized.About154Indian

insurancecompanies,16non-Indiancompanies and75provident wereoperating in

India atthe timeof nationalization. Nationalization wasaccomplished in two

stages;initiallythemanagementofthecompanieswastakenoverbymeansofan

Ordinance,andlater,the ownership toobymeansofacomprehensivebill.The

ParliamentofIndiapassedtheLifeInsuranceCorporationActonthe19thofJune

1956,andtheLifeInsuranceCorporationofIndiawascreatedon1stSeptember,

1956,withtheobjectiveofspreadinglifeinsurancemuchmorewidelyandin particularto

the ruralareaswithaviewtoreachallinsurablepersonsinthe

country,providingthemadequatefinancial cover at a reasonable cost.

LICsemergenceasthebiggestinvestorinthecountryshouldnotsurpriseanyone. The state-owned

company is 51 years old and enjoyed a state-sanctioned monopolyoverthe

lifeinsurancebusinesstill2000.Thefirmhasissued220 millionpolicies and earned total

premiumincomeof Rs39, 541 crorein 2006-07. It is allowed to invest 35% of its funds in

equities.

ThelargestchunkinLICsportfolioisthestakeitownsinlistedengineeringgiant

LarsenandToubroLtd.The15.7%stakeinL&T isvaluedatmorethanRs19,642

crore.Othermajorinvestmentsincludea4.14%stakeinRelianceIndustriesLtd,

thelargestIndiancompanyby marketcapitalization,7.2%inICICIBankLtd,

13.4%inITC Ltd and 4.2 % in Reliance Communications Ltd.


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8.1.2 RELIANCE MUTUALFUNDS:

Reliance Mutual Fund (RMF) is one of Indias leading Mutual Funds, with

AverageAssetsUnderManagement(AAUM)ofRs.90,938Crores(AAUMfor

Mar08)andaninvestorbaseofover66.87Lakhs.RelianceMutualFund,apartof

theReliance-AnilDhirubhaiAmbaniGroup,isoneofthefastestgrowingmutual

fundsinthecountry.RelianceCapitalLtd. is oneofIndiasleadingandfastest

growingprivatesectorfinancialservicescompanies,and ranksamongthetop3

privatesectorfinancialservicesandbankingcompanies,intermsofnet worth. Reliance

Capital Ltd.has interests inassetmanagement, lifeandgeneral insurance, private

equityand proprietary investments, stock broking and other financial services.

8.1.3 ICICI PRUDENTIALFUNDS:

ICICI PrudentialAsset Management Company enjoysthe strong parentage of

prudentialplc,oneofUK'slargestplayersintheinsurance&fundmanagement sectorsand

ICICIBank,awell-knownandtrustednameinfinancialservicesin

India.ICICIPrudentialAssetManagementCompany,inaspanofjustovereight

years,hasforgedapositionofpre-eminenceintheIndianMutualFundindustry

asoneofthelargestassetmanagementcompaniesinthecountrywithassetsunder

management ofRs. 37,906.24 crore(as of March 31, 2007). The

Companymanagesacomprehensiverangeofschemestomeetthevaryinginvestmentnee

ds ofitsinvestorsspreadacross68citiesinthecountry.UponitsinceptioninMay

1998itmanages2fundsofRs160Crandhasgrowntomanage35Fundsworth

Rs62,008.95 Cr.


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8.1.4 UTI MUTUALFUNDS:

UTIMutualFundcameintoexistenceon1stFebruary2003.BankofBaroda (BOB),PunjabNationalBank(PNB)andStateBankofIndia(SBI)andLife InsuranceCorporationofIndia

(LIC)arethesponsorsoftheUTIMutualFund. UTI Mutual Fund is managed by UTI

Asset Management Company Private Limited (AMC). UTIAMCis

aregisteredportfoliomanager under theSEBI (Portfolio Managers) Regulations,

1993 for undertaking portfolio management

servicesandalsoactsasthemanagerandmarketertooffshorefunds.UTIMutual

Fundhasanationwidenetworkconsisting70UTIFinancialCenters(UFCs)and UTI

InternationalofficesinLondon,DubaiandBahrain.Thefundhasatrack

recordofmanagingavarietyofschemescateringtotheneedsofeveryclassof citizenry.

8.1.5 HDFC MUTUALFUND:

HDFC (Housing Development Finance Corporation Limited) is one of the dominant

playersin the Indian mutualfund space. HDFC was incorporated in 1977 as the first

specialized MortgageCompany in India. HDFC MutualFunds are handled by HDFC

AssetManagementCompanyLimited.HDFCAssetManagementCompany

wasincorporatedundertheCompaniesAct,1956,onDecember10,1999,andwas

approvedto act as anAsset Management Companyfor theMutual Fund bySEBI on

July3, 2000.Thecompanyalso provides portfolio management/ advisoryservices.

8.2FOREIGNINSTITUTIONALINVESTORS:


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8.2.1 DEUTSCHE GROUP:

DWSInvestmentspartofDeutscheAssetManagement,wasfoundedin1956in

Frankfurt/Main.Withfundassetsundermanagementofeuro267bn,thecompany

isoneoftheTop10companiesworldwide.InEurope,DWSisoneoftheleadingmutualfundcompaniesandcurrently manageseuro173 bn.In excessof morethan

euro147bnassetsundermanagement,DWSrepresents22,3%ofthefundmarket

inGermany, making it theunchallenged numberone.

TheInternationalnatureofitsbusinessdifferentiatesDWSsignificantlyfromits

domesticandinternationalcompetitors.DWSInvestmentsactivitiesspanallthe

keyEuropeanmarkets.Inthe USA,DWSisrepresentedbyDWSScudderand

managesassetsofeuro86bn.Inspring2006,itlauncheditsfirstfundsaswellas

theDWSbrandinSingaporeandIndia,continuingitssuccessfulexpansioninthe


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Asia-Pacificregion.Thereafter,morefundswereregisteredinothercountriesin

Asia-Pacific.

8.2.2 CITIGROUP:TheformationofCitigroupin1998createdanewmodeloffinancialservices organization

toserveitsclientsfinancialneeds.Asthecompany continues togrow and evolve, its

increasingly evident that such a large, complex grouping of

businessescanindeedsucceed.With275,000employeesworkinginmorethan100 countries

andterritories, Citigroups globalityand diversity contribute to its continued success.

8.2.3 HSBC GLOBALINVESTMENTS:

HSBC Investments is one of the world's premier fund management

organizations.Ithasestablishedastrongreputationwithinstitutionalinvestors

includingcorporations,governments,insurancecompaniesandcharitiestheworld over for

delivering consistently superior returns. In Indiawe offer fund

managementservicesforinstitutional aswellasretailinvestors.Ourarrayof

productsincludesEquityFunds Income/DebtFunds.

8.2.4 MORGANSTANLEY&COINTERNATIONALLTD:

Morgan Stanleyis a global financial servicesfirmand a marketleader in securities,

investment managementandcreditservices.Ithasmorethan600officesin27

countriesandmanages$421billioninassetsforinstitutionalandindividualclients around

theworld. Stanley Investment Management (MSIM), the asset

management company of Morgan Stanley was established in 1975. Morgan

StanleyenteredIndianmarketin1989withthelaunchofIndiaMagnumFund.In

1994,MorganStanleylaunchedMorganStanleyGrowthFund(MSGF).Itisone of

thelargestprivate sectorschemesinvesting in equities.

8.2.5 DSPMERRILLLYNCH :


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DSP Merrill Lynch Mutual Funds are managed by DSPMerrill Lynch Fund

Managers. DSP MerrillLynch Ltd. (DSPML) is a premier financial services

provider and Merrill Lynch (ML) holds 90% stake in DSPML. DSPMLwas

originallycalled DSPFinancialConsultantsLtd.Thefirmtraces itsoriginstoD.S.

Purbhoodas&Co., a securities and brokerage firm with over 140 years of

experienceintheIndianmarket.MerrillLynchisoneoftheworld'sleadingwealth

management,capitalmarketsandadvisorycompanieswithofficesin37countries

andterritories and totalclient assetsof approximately$1.5 trillion.

9. INVESTMENTTRENDS OFINSTITUTIONALINVESTORS:

9.1INVESTMENTTRENDS OFINDIAN MUTUALFUND INDUSTRY:

TheAssetsunderManagementofUTIwasRs.4563Crbytheendof1987.Letme concentrate

abouttheperformanceofmutualfundsinIndiathroughfigures.FromRs.

4563Cr.theAssets under Managementrose toRs. 32977 Cr inMarch 1993

Thenetassetvalue(NAV)ofmutualfundsinIndiadeclinedwhenstockpricesstarted

fallingintheyear1992.Thosedays,themarketregulationsdidnotallowportfolioshifts

intoalternativeinvestments.Therewasrathernochoiceapartfromholdingthecashorto

furthercontinue investing in shares.

AloneUTIwithjustoneschemein1964nowcompeteswithasmanyas400odd

productsand34playersinthemarket.Inspiteofthestiffcompetitionandlosingmarket

share,Lastsixyearshavebeenthemostturbulentaswellasexitingonesfortheindustry.

Newplayershavecomein,whileothershavedecidedtocloseshopbyeithersellingoff

ormergingwithothers. Productinnovationisnowpass withthegameshiftingto

performancedeliveryinfundmanagementaswellasservice.Theindustryisalsohaving

aprofoundimpactonfinancialmarkets.WhileUTIhasalwaysbeenadominantplayer


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ontheboursesaswellasthedebtmarkets,thenewgenerationsofprivatefunds,which havegained

substantialmass,arenowflexingtheirmuscles.Fundmanagers,bytheir

selectioncriteriaforstockshaveforcedcorporategovernanceontheindustry.Rewarding

honestandtransparentmanagementwithhighervaluationshascreatedasystemofrisk- reward

created wherethecorporate sectoris moretransparent then before.

Fundscollectionhasbeenincreasinginlast5yearswhichcanbeattributedtothefactof

soundeconomicgrowthandtheconfidenceoftheretailinvestorsonthecapitalmarketof India.

9.2FOREIGNINSTITUTIONALINVESTMENT

(FII)isoneofthemainchannelsofforeigninvestmentinIndia.Foreigninstitutional

investors(FIIs)werepermittedtoinvestinIndiansecuritiesmarketin1993.Sincethen,theirinvestmentsintoIndian equitymarkethavegrownbyleapsandbounds.Infact,

FIIs,asaclassofinstitutionalinvestors, haveassumedamajorroleinmatureand

emergingmarketeconomies,inrecentyears.TheFIIinthe Indianequitymarketshas

risensteadilysince2003-04.Thegrosspurchasesofdebtandequitytogether byFIIs

increasedby50.0percenttoRs.5,20,508crorein2006-07fromRs.3,46,978crorein

2005-06.

INVESTMENTSBYFOREIGN INSTITUTIONALINVESTORS

ThegrosssalesbyFIIsalsoroseby60.3percenttoRs.4,89,667crorefromRs.3,

05,512croreduringthesameperiod.However,thenetinvestmentbyFIIsin2006-07


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declinedby25.6percenttoRs.30,840crorein2006-07fromRs.41,467crorein2005-

06mainlyduetolargenetoutflowsfromtheequitysegment.Butthecumulativenet

investmentbyFIIsinIndianstockmarket(since1993)crossedUSD50billionattheend

ofMarch2007.AsonMarch31,2007,thecumulativenetinvestmentbyFIIswasUSD

52billion.ThecumulativenetinvestmentbyFIIsatacquisitioncost,whichwasUSD

15.8 billionattheendofMarch2003,hadrisentoUSD45.3billionattheendofMarch

2006.TheFIIinequity,whichwashighinthepreviousyears,declinedin2006-07. During2006-

07,FIIsreducedtheirinvestment,inbothequitiesaswellasdebtsecurities.

ThenetFIIinvestmentinequityduring2006-07wasRs.25,236crore,atitslowestin

pastthreeyears.Thiswas mainlydueto largenet salesinsome months of 2006-07.

NETINVESTMENTBYFII

INVESTMENTTRENDS BYFII

AsfarastheinvestmenttrendsofFIIareconsideredwecanseethatthetrendandthe actual

investmentgohandinhandexceptin98-99and2003-2004.Thenetinvestment flowsbyFIIswere

negativeduring1998-99primarilybecauseoftheuncertaintythat

prevailedafterIndiatestedaseriesofnuclearbombsinMay1998andtheimpositionof

economicsanctionsbytheUS,Japanandother industrializedcountriesbuttheFIIs

portfolioflowsquicklyrecoveredandhavebecomeapositivenetinvestmentfromthe

subsequentyearsonwards.

9.2.1REASONS FOR GROWTH INFII INVESTMENTS

Globalliquidityis, of course,the primarycauseof the recent surge inAsianmarkets

includingIndia.Alsolowinterestrateregimehasledforeigninvestorstolookfor

freshavenuestoinvest.Thishasresultedinmostemergingmarketsseeingheavy inflows.

FIIsseeIndiaasagooddestinationtoinvestinandmakemoney.Theyarehappy withthe

Indiangovernment'scommitmenttoeconomicreforms.Theyarealso

lookingcloselyatsectors(andcompanieswithinthesesectors)which theythink


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havepotential. Infact,thegrowingcompetitivenessofIndiancompaniesisan enticing

factor.

Long-TermCapitalGainsTax:whichisthetaxaninvestorpayswhenhesellshis

sharesafter morethanayear--hasbeenabolished;thusonecansellhisshares

withouthavingto paythegovernmentanykind of tax.

Rupee Appreciation: The dollar has been falling in value vis--vis other

currencies.Asaresult,FIIsdontfindthethoughtofinvestingintheUSmarketall that

attractive.Theyknow theywillmakemore moneyif theyinvestelsewhere.

EconomicGrowth:AsmentionedearlierwewitnessedaGDPgrowthrateofabout

8.5%lastyear.OurindustrieslikeTelecom,Bankingetcaredoingrelativelywell. Allthese

makeour countryveryattractive to invest in.

ThesheersizeofIndiaandtherelativestabilitythecountryoffersareotherobvious

pluspoints. Whateverthecasemaybe,aperceptionisgainingmomentumthat

foreigninvestorsarehere to stayat least in the short-term.

10.FOREIGNINSTITUTIONALINVESTMENT:ACOSTBENEFITANALYSIS

Theroleofforeigninvestmentovertheyearscantbeignored.Itcertainlyhashadanimpacton

theIndianstockmarketwithalotofbenefitsbutalongwiththesebenefitsthereareafewcosts

attachedwithit.ThereforeitisusefultosummarizethebenefitsandcostsforIndiaofhaving

foreigninflows.

BENIFITS

a)Reducedcostofequity

FIIinflowsaugmentthesourcesoffundsintheIndiancapitalmarkets.FIIinvestment

reducestherequiredrateofreturnforequity,enhancesstockprices,andfostersinvestmentby

Indianfirmsinthecountry. TheimpactofFIIsuponthecostofequitycapitalmaybe visualized

byasking what stock prices would be iftherewereno FIIs operating in India.


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b) Stabilityin the balanceofpayment

ForpromotinggrowthinadevelopingcountrysuchasIndia,thereisneedtoaugment

domesticinvestment,overandbeyonddomesticsaving,throughcapitalflows.Theexcessof

domesticinvestmentoverdomesticsavingsresultinacurrentaccountdeficitandthisdeficit

isfinancedbycapitalflowsinthebalanceofpayments.Priorto1991,debtflowsandofficial

developmentassistancedominatedthesecapitalflows.Thismechanismoffundingthecurrent

accountdeficitiswidelybelievedtohaveplayedaroleintheemergence ofbalanceof

paymentsdifficultiesin1981and1991.Portfolioflowsintheequitymarkets,andFDI,as

opposedtodebt-creatingflows,areimportantassaferandmoresustainablemechanismsfor

fundingthe current account deficit.

c) Knowledgeflows

TheactivitiesofinternationalinstitutionalinvestorshelpstrengthenIndianfinance.FIIs

advocatemodernideasinmarketdesign,promoteinnovation,developmentofsophisticated

productssuchasfinancialderivatives,enhancecompetitioninfinancialintermediation,and lead to

spillovers of human capital by exposing Indian participants to modern financial

techniques,andinternational best practices and systems.

d) Strengtheningcorporategovernance

Domesticinstitutionalandindividualinvestors,usedastheyaretotheongoingpracticesof

Indiancorporate, oftenacceptsuchpractices,evenwhenthesedonotmeasureuptothe

internationalbenchmarksof best practices. FIIs,withtheirvastexperience withmodern

corporategovernancepractices,arelesstolerantof malpracticebycorporatemanagersand

owners(dominantshareholder).FIIparticipationindomesticcapital marketsoftenleadto

vigorousadvocacyofsoundcorporategovernancepractices,improvedefficiencyandbetter

shareholder value.


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e) Improving market efficiency

AsignificantpresenceofFIIsinIndiacanimprovemarketefficiencythroughtwochannels.

First,whenadversemacroeconomicnews,suchasabadmonsoon,unsettlesmanydomestic

investors, it may be easier for a globally diversified portfolio manager to be moredispassionateaboutIndia'sprospects,andengageinstabilizingtrades.Second,atthelevelof

individualstocksandindustries,FIIsmayactasachannel throughwhichknowledgeand

ideasaboutvaluationofafirmoranindustrycanmorerapidlypropagate into India.For

example,foreigninvestorswererapidlyabletoassessthepotentialoffirmslikeInfosys,

whichareprimarilyexport-oriented,applyingvaluationprinciplesthatprevailedoutsideIndia

for softwareservices companies.

COSTS

a)Hedgingandpositivefeedbacktraining

There areconcernsthat foreign investors are chronicallyill informedabout india, andthis

lack ofsoundinformationmay

generateherding(alargenumberofFIIsbuyingorsellingtogether) andpositivefeedback

(buyingafterpositivereturns,sellingafternegativereturns).These Kinds of behaviorcan

exacerbate volatility,andpush prices awayfrom fairvalues.

b) Balanceof payment

vulnerability

Thereareconcernsthatinanextremeevent,therecanbeamassiveflightofforeigncapital

outofIndia,triggeringdifficultiesinthebalanceofpaymentsfront.India'sexperiencewith

FIIssofar,however,suggeststhatacrossepisodeslikethePokhranblasts,orthe2001stock

marketscandal,nocapitalflighthastakenplace.AbillionormoreofUSdollarsofportfolio

capitalhasneverleftIndiawithintheperiodofonemonth. WhenjuxtaposedwithIndia's

enormous current account and capital account flows, this suggests that there is little

vulnerabilityso far.

c)Possibility


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oftakeovers

WhileFIIsarenormallyseenaspureportfolioinvestors,withoutinterestincontrol,portfolio

investorscanoccasionallybehavelikeFDIinvestors,andseekcontrolofcompaniesthatthey

haveasubstantialshareholdingin.Suchoutcomes,however,maynotbeinconsistentwith

India's questfor greater FDI. Furthermore, SEBI'stakeover code is in place, and has

functioned fairlywell,ensuring that all investorsbenefit equallyin the eventof a takeover.

11.DETERMINANTS OFFOREIGN INSTITUTIONALINVESTMENT

After theinitiationofeconomicreformsintheearly1990s,themovementofforeigncapitalflow

increasedvery substantially.Therearealotoffactorsthatdeterminethenatureandcauseof

foreigninstitutionalinvestmentinacountryafewofthembeinginflationexchangerateequity

returns,governmentpolicies,priceearringratioandrisk.Nowifwetrytoanalyzetherelationof

eachofthesefactorswiththelevelofforeigninflowinthecountry, wemighthaveabetter

understanding.letusbroadlyclassifythefactorsintoinflation,riskandstockmarketreturnsand

understandthe basic principle behind theinflows.

a) Equityreturns-Anincreaseinthereturnintheforeignmarketwillinduceinvestorsto

withdrawfromtheIndian(domestic)stockmarkettoinvestintheforeignmarket.Investorsarebelieved tofollowahigherreturn,hence when thereturnin thedomestic marketincreases,

FIIflowstothedomesticmarket.Whiletheflowsarehighlycorrelatedwithequityreturnsin

India,theyaremorelikelytobetheeffectthanthecauseofthesereturns..Itisassumedthat

theequityreturnshaveapositiveimpactontheFIIinflowbutforeigninvestorscanalsoget

involvedinprofitbooking.Theycanbuyfinancialassetswhenthepricesaredeclining,

therebyjacking-uptheassetpricesandsellwhentheassetpricesareincreasingandhencebe

thecauseof such returns so making it more of abi-directional relationship.

b) Risk-Investorsareconsideredtoberiskaverse,hencewhenriskinthedomesticmarket

increasestheywill withdrawfromthedomesticmarket,whenriskintheforeignmarket

increases,investorswillwithdrawfromtheforeignmarketandinvestintheIndian(domestic)

market.Investments,eitherdomesticorforeign,dependheavilyonriskfactors.Hence,while


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studyingthebehaviorofFII,itisimportanttoconsidertheriskvariable.Riskcanbedivided

intoex-anteandunexpectedrisk.Whiletheex-anteriskcertainlyhasaninverserelationwith

theforeign investmentnothingcan be clearlysaid aboutthe unexpectedrisk.

c) Inflation- Theinflationnodoubthasaninverserelationwiththeforeigninvestmentinflowas

theinvestorwouldkeepinmindthepurchasingpowerofthefundsinvestedandasinflation

increasei.e.thepurchasingpowerdeclinestheinvestorismostlikelytowithdrawhismoney.

Wheninflationinthedomesticcountryincreases,thepurchasingpowerofthefundsinvested

declines,hence investorswill withdrawfromthe domestic market.Similarly,when inflation in

theforeigncountryincreases,thepurchasingpoweroffundsinvestedintheforeigncountry declines,

causing institutional investors to withdraw from the foreign market and make investmentin

the domestic (Indian) market.

d) ExchangerateWhenthevalueofthehomecurrencyisstrongertheFIIinvestmentswill

alsoincrease as the percentage of returns the FII getautomaticallyincreasesandvisa versa

Soitcanbesaidthattheinflationandriskinthedomesticcountryandreturnintheforeign

countryadverselyaffecttheFIIflowingtothedomesticcountry,whereasinflationandriskinthe

foreigncountryandreturn inthe domestic countryhave afavorable effect on the flow of FII.

12.COMPARISON BETWEEN FIISAND MUTUALFUNDS INVESTMENTS

ThecomparisonbetweentheFIIpurchasesandnetinvestmentwithMutualfundsfortheperiod reveals

some interesting information.As canbe seen from thefigure,

Theamountofmutualfundinvestmentinourcountryisverymeagerascomparedtothat of FIIs.

It meansthatIndian public is still not putting itsbet on mutual funds and.


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FIIsaremuchmoreaggressiveinnaturethanmutualfunds,whoseemtohave beenvery constant

in there approach to the Indianequitymarket.

SinceMay04,whenthestockmarketcrashedby800pointsinaday,themarkethas

recoveredsmartlyandtheFIIshavebeenabletocashontothegainsbybuyingValue

stocksduringtheleanperiods,orbuyingonthedips. Whilethemutualfundshaveseems

totakenadifferentroutealtogetherandhavebeennetsellersformostoftheperiodsince May04.

Butaftertheyear2004mutualFundinvestment havealsoatremendousincrease.There

activityistheproofoftheconditionthathasprevailedinthecapitalmarketrecentlythat has

created a lot of faith amongtheretail investorsalso.

Alsointheyear2007hassofarbeenthebestyearformutualfundindustryasithasshownatremendousgrowthintermsofnetinvestment.Thiscorroboratesthefactthatnow

Indianpublichasstarted recognizingmutualfundastoolforinvestinginthecapital market in

india.

13.ROLEOFINSTITUTIONALINVESTORS IN CAPITALMARKETIN INDIA:

AstheIndiancapitalmarketopeneditsgatesfortheforeigninstitutionalinvestors.with time

therehasbeen an increasingtrendsofthereparticipatinginthecapitalmarket.Withthere

increasingparticipationtherehasbeenalotof effectonmany parametesoftheindiaNcapital

market.Themajoreffectoftheincreasingparticipationoftheinstitutionalinvestorshasbeen

observed inthe following areas.

Liquidity:Marketliquidityisabusiness,economicsorinvestmenttermthatreferstoan

asset'sabilitytobeeasilyconvertedthroughanactofbuyingorsellingwithoutcausinga

significantmovementinthepriceandwithminimumlossofvalue.Anactofexchangeof

alessliquidassetwithamoreliquidassetiscalledliquidation.Liquidityalsorefersboth

tothatqualityofabusinesswhichenablesittomeetitspaymentobligations,intermsof

possessingsufficientliquid assets;and to such assetsthemselves.

Aliquid asset has someor more of thefollowingfeatures.Itcan be sold (1) rapidly,(2)

withminimalloss of value, (3) anytimewithin market hours.The essential characteristic

of aliquid marketis that thereare readyandwilling buyersand sellersat all times.An
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elegant definition of liquidityis also theprobabilitythat the next trade is executed at a

price equal to the lastone.Amarket maybe considered deeplyliquid if there are ready

andwilling buyers andsellersinlarge quantities.This is related toamarketdepth,where

sometimes orders cannot stronglyinfluenceprices.The liquidityof a product can be

measured as how often itis bought and sold;this is known as

volume.Ofteninvestmentsinliquid markets such as thestock exchange orfuturesmarkets

areconsidered to be more liquid than investments such asreal estate,based on their

abilitytobe converted quickly. Someassets withliquid secondarymarkets maybe more

advantageoustoown, arewilling topaya higher price for the assetthan for comparableassets

without a liquid secondary market.

Pricebuildingmechanism:Withtheincreasingparticipationoftheinstitutionalinvestors

inthecapitalmarket,ithasalsohelpedthedifferentcompaniestoraisefundsforthereuse

throughthecapitalmarketin india.earlierthecompaniesusetogofordebtfinancing

whichhasacostattachdtoitandalsointhosedaysthecostofissuinganIPOwashigher

ascomparedtothefundsthatwerebeinggeneratedbythecompanies.WiththehelpofFII themarket

has become morecompetitive. fairvalueof their.

Roleofspeculation:Generallypeopletransactforthreereasonshedgingspeculatingand

arbitragingHedgersarethosetointendtohedgetheirrisk.Speculationmaybedefinedas

thepurchaseorsaleofagoodwithaviewtoresaleorrepurchaseata laterdate, wherethe motivebehind

such action is the expectation of changesinthe prices.

Speculationisoneofthemostwatchedactivityinany capitalmarketitsimportancevaries indifferent

countriesincountrieslikeinUSitformsanintegralpartofthemarket whereasindeveloping

countrieslikeIndiaitstakenasathreat.Itisoftenbelievethat speculators even out the price

fluctuation by due to change in demand and supply condition but the concerns about the

adverse effects of speculation come from two

sources.First,thepossibilitythatspeculation,insteadofevening outpricefluctuations, may end up

exacerbating such fluctuations. Second, is the problem of speculation destabilizing rather than

stabilizing prices and hence affecting resource allocation.
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Throughspeculation,futureexpectedpricenotonly dependson,butalsohasanimpacton thespot

price.

Themarketforsharesissubjecttomuchlargerfluctuationsthanthemarketforbondsor

evencommodities.Sharesrepresentashareintheexpectedfutureprofitsofacompany.

Whenfortunesofcompaniesbothintheshortrunaswellasinthemediumtolongrun

fluctuate,sodoshareprices.Uncertaintyregardingthefutureleadstoheavydiscounting

offutureprofits,andtofocusonshort-periodexpectationsaboutcapitalvalueratherthan long-period

prospectsof the company.

The effect of foreign speculative activity in emerging markets can be particularly beneficial if

in the emerging market, liquidity is poor First, the potential of market

manipulationisacuteinsmall emergingmarketsandliquidityisoftenpoor.Although

therearemanypolicyinitiativesthatcould increaseliquidityandreducethedegreeof

collusionamonglargetraders,theremaynotbeasufficientmassofdomesticspeculators to ensure

market liquidity and efficiency. Second, openingthe market to foreign

speculatorsmayincreasethevaluationoflocalcompanies,therebyreducingthecostof equitycapital.

Volatilty: Volatilitymostfrequentlyreferstothestandarddeviationofthechangein

valueofafinancialinstrumentwithaspecifictimehorizon.Itisoftenusedtoquantifythe

riskoftheinstrumentoverthattimeperiod.Volatilityistypicallyexpressedinannualized

terms,anditmayeitherbeanabsolute number($5)orafractionofthemean(5%).

Volatilityisoftenviewedasanegativeinthatitrepresentsuncertaintyandrisk.However,

volatilitycanbegoodinthatifoneshortsonthepeaks,andbuysonthelowsonecan

makemoney,withgreater moneycomingwithgreater volatility.Thepossibilityformoney

tobemadeviavolatilemarketsishowshorttermmarketplayerslikedaytradershopeto

makemoney,and isincontrasttothelongterminvestmentviewofbuyandhold.In

today'smarkets,itisalsopossibletotradevolatilitydirectly,throughtheuseofderivative

securitiessuchasoptionsandvarianceswaps.Foreigninstitutionalinvestmentiscertainly

volatileinnatureanditsvolatilityhascertainlyposedsomethreatsto theIndianstock
http://en.wikipedia.org/wiki/Standard_deviationhttp://en.wikipedia.org/wiki/Standard_deviationhttp://en.wikipedia.org/wiki/Financial_instrumenthttp://en.wikipedia.org/wiki/Financial_instrumenthttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Short_sellinghttp://en.wikipedia.org/wiki/Short_sellinghttp://en.wikipedia.org/wiki/Day_tradershttp://en.wikipedia.org/wiki/Day_tradershttp://en.wikipedia.org/wiki/Day_tradershttp://en.wikipedia.org/wiki/Investmenthttp://en.wikipedia.org/wiki/Investmenthttp://en.wikipedia.org/wiki/Buy_and_holdhttp://en.wikipedia.org/wiki/Buy_and_holdhttp://en.wikipedia.org/wiki/Buy_and_holdhttp://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Buy_and_holdhttp://en.wikipedia.org/wiki/Investmenthttp://en.wikipedia.org/wiki/Day_tradershttp://en.wikipedia.org/wiki/Short_sellinghttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Financial_instrumenthttp://en.wikipedia.org/wiki/Standard_deviation


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marketconsideringitsinfluenceonthemarket.Giventhepresenceofforeigninstitutional

investorsinSensexcompaniesandtheiractivetradingbehavior,smallandperiodicshifts

intheirbehavior leadtomarketvolatility.Suchvolatilityisaninevitableresultofthe

structureofIndiasfinancialmarketsaswell.MarketsindevelopingcountrieslikeIndia arethinor

shallowinatleastthreesenses.First,onlystocksofafewcompaniesare

activelytradedinthemarket.Thus,althoughtherearemorethan8,000companieslisted

onthestockexchange,theBSESensexincorporatesjust30companies,tradinginwhose

sharesisseenasindicativeofmarketactivity.Second,ofthesestocksthereisonlyasmall

proportionthatis routinelyavailablefor trading,with the restbeingheldbypromoters,the

financialinstitutionsandothersinterestedincorporatecontrolorinfluence.And,thirdthe numberof

players trading these stocks is also small.

Insuchascenarioinvestmentbytheforeigninstitutionalinvestorsleadstoasharpprice

increasethisprovidesincentivestoFIIinvestmentandenhancesinvestmentandwhenthe correction

in the stock pricesbeginsit would have to be apull out bythe FII and can result

insharpdeclineintheprices.Theotherreasonfor volatilityisthat theforeigninstitutional

investorsareattractedtoamarketbytheexpectationofprice increasethattendtobe

automaticallyrealized,theinflowofforeigncapitalcanresultinanappreciation ofthe rupeevis--

visthedollarThisincreases thereturnearnedinforeignexchange,whenrupee assetsare

soldandtherevenueconvertedintodollars.Asaresult,theinvestmentsturn

evenmoreattractivetriggeringaninvestmentspiralthatwouldimplyasharperfallwhen

anycorrectionbegins.ApartfromthatthegrowingrealizationbytheFIIsofthepower

theywieldinwhatareshallowmarkets, encouragesspeculativeinvestmentaimed at

pushingthemarketupandchoosinganappropriatemomenttoexit.Thismanipulationof the market

would certainly enhance the volatility and in volatile markets even the

domesticinvestorstrytomanipulatethemarketwhenthepricesarereallyhigh.Overall

theforeigninstitutional investorshavebeenbullish ontheIndianstocks buttheproblemis

thatthisbullishnaturemightbearesultoftheactivitiesoutsidetheIndianmarketitmight beduetothe

performanceoftheirequitymarketortheirnonequityreturns.Therefore

theyseekoutforbestreturnsanddiversifiedgeographicalportfolioinordertohedgetheir

riskandwhentheymakesomeadjustmentsintheirportfolioandmakeshiftsinfavoror against a


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countryitborings about sharp changes.

14.ASTUDYOFMAJOR EPISODES OFVOLATILITY

14.1AsianMajor EpisodesofVolatility

Excessvolatilityinducedbytheforeigninvestmentisoftentakenasanargumentagainst

liberalization withsuchincidenceshappeninginthepast.Letusnowtrytofindout

whethertheforeigninvestorsinparticulardestabilizethecapitalmarketbeyondalevel.

The two most common examples of such destabilization caused by the portfolio

investmentparticularlythehedgefundsaretheAsiancrisisof1997andtheERMcrisis

of 1992.

I. ERMcrisisThehigh-profileERMcrisisof1992camewithspeculatorsbetting

that the member countries of the European Monetary System (EMS) were

convergingtotheEuropeanMonetaryUnion(EMU),andhigh-

inflationcountries

wouldhavetorealigntheirexchangerates,buttheextentofdepreciationwouldbe

lessthantheinterestratedifferentialbetweenthehigh-inflationandlow-inflation

countries.Theexpectationregardingtheextentofexchangerateadjustmentledto

carrytradeborrowingfromthelowinterestERMcountriesandlendingtothe

highinterestcountries,orintheforwardcurrencymarket,takingalongpositionin

thehigheryieldingcurrencyandshortingthelower-yieldingcurrency.Inspiteof

thematerialimpactofhedgefundactivitiesintheERMcrisis,theroleofthehedge

fundsinthecrisiswaslimited.Thepracticeofextendinglinesofcredittooffshore

entitiesonanon-recoursebasisagainstcollateralwasnotwidelyacceptedbymost

banks, and foreign exchange trading was primarilyan inter-bank activity.

EastAsiancrisisAftertenyears(198697)ofpeggingoftheThaibahttotheU.S.

dollar,onJuly2,1997,thepeghadtobeabandoned,andthiscreatedpressure


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onother Asiancurrencies,andeventually

broughtdowntheMalaysianringgit,theIndonesian

rupiah,thePhilippinepeso,andtheKoreanwon.Byend-1997,thesecurrencieshadlost

between44and56percentoftheirvalueagainsttheU.S.dollar,bankruptingmanyAsian

corporations and banks that had borrowed in foreign currencies, and leading to a

significantcontractionoftheeconomies.ThisepisodeisknownastheEastAsiancrisis

orAsian crisis.Foreigninvestorswereoftenblamedforthedramaticdifficultiesofthe

EastAsiancountriesatthetimesofthe1997crisis.Itwasbelievedthatthedeveloping

countriesweremorevulnerabletovacillationsininternationalflowsthaneverbeforeA

varietyofreasonsareadducedtoexplainwhyforeigninvestorscanhaveadestabilizing

effect on capital markets in emerging economies. Foremostamong themarethe pursuit

of apositivefeedbackstrategythatisbuyingwhenpricesarerisingandsellingwhenprices

arefalling,therebyexacerbatingboththeupswingsanddownswings.Positivefeedback

leads tobubbleswhenpricesdepartfromfundamentalsandtocrasheswhenbubbles

burst.ItisalsobelievedthattheAsianfinancialcrisiswastheresultofapaniccreatedin

themarketPrimeMinister MahathirMohammedofMalaysiaaccusedhedgefundsof being

the modern equivalent of highwaymen in breaking the Asian currencies.

AggressiveflowofthecarrytradedownthecreditspectruminAsiaduringthe1990s

fromsovereigncredit,totop-tierdomesticcommercialbanks,tolower-tiercommercial

banksandfinancecompanies,andfinallytofirms.Theexcessivebuild-upof foreign

debt,theyattributetotheconfidenceofdomesticcompaniesandbanksinthefixed

officialexchangerate.FIIinvestmentinequitieshadlittleroletoplayinthecrisis.Fung,

Hsieh, and Stsatsaronis(2000) report At the height of the episode, some Asian

governmentofficialsaccusedspeculatorsandhedgefundsofattackingthecurrenciesand

causingtheirdownfall.Apublicdebateensued,andthe InternationalMonetaryFund

(IMF)respondedbyexaminingtheroleofhedgefundsintheAsiancurrencycrisis.The

resulting studybyEichengreen, Mathieson,Chadha, Jansen,Kodres, and

DuringthestockmarketscamwhichshookthecapitalmarketinindiatheFII

werealsooneofthemajorfactorswhichexacerbatesthefallinthesensex.During

theBlackMondayepisode theFIIwerealsoonaheavysellingspreewhich


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ultimatelylead to some major fall in the sensex value.

FIIinvestmentbehaviorduringthesefourspecificeventsindicatesthattheseeventsdid

affect the behavior of the foreign portfolio investors.But, theseeventsdidaffect

domestic investorsbehavioras well.

TheseexperiencesshowthatFIIoutflowofasmuchasabilliondollarsinamonth

whichcorrespondstoanaverageof$40millionorRs.170croreperday hasneverbeen

observed.ThesevaluesRs.170croreperdayaresmallwhencomparedwithequity

turnoverinIndia.Incalendar2004,grossturnoverontheequitymarketofRs.88lakh

crorecontainedRs.5lakhcroreofgrossturnoverbyFIIs.Thissuggeststhatasyet,FIIs

areasmallpartoftheIndianequitymarket.TransactionsbyFIIsofRs.5lakhcroreinayearmighthavebeenlargein1993,butthesuccessofaradicalnewmarketdesigninthe

Indianequitymarkethaveledtoenormousgrowthofliquidityandmarketefficiencyon

theequitymarket.Throughthis,Indiasabilitytoabsorbsubstantialtransactionsonthe

equitymarket appears to be inplace.

Thenet FII inflows into India have been less volatile compared to other emerging markets

this stability could be attributed to several factors: Strong economic

fundamentalsandattractivevaluationofcompanies.Improvedregulatorystandards,high quality

of disclosure and corporate governance requirement, accounting standards,

shorteningofsettlementcycles,efficiencyofclearing andsettlementsystemsandrisk management

mechanisms. Product diversificationand introduction of derivatives. Strengtheningof the

rupee dollar exchange rateand low interest ratesinthe US.

I. Post 2004 MajorVolatile Episodes:

Asfromtheabove graph it is clear that in the monthof jan 2008 the BSE sensexwas

alreadymoving down due to the weak global cues and US recessionand similarlythe FII

investmentfelldrasticallyduringthatperiod running panickamongthe investors

andfurther exacerbating the fall. But in the caseof mutual fund investmentwent up


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duringthe time shows that the thedomestic institutional investorscash on thefall of

sensex because of the strong fundamentals of the Indian capital market.

Bylookingatthe above graph we can verywell saythat this timearound the fall of BSE

sensex was majorlydue tothe FII which wenton a selling spreewhich lead to thefall of

the marketduring this Crash.FII acted in thisfashion because of the weak global cues

i.e atthatpoint of time other emergingmarkets were also down .

Thefall of 769 points bysensex on Dec 17,2007 was attributed to the fact mainlydue

tothe subprimelosses and also was exacerbated dueto the withdrawl of investments

bytheFII.Asthesubprimelossesmainlyhit the US economyand the majorityof FII

participating in the Indian capital market are from US .To coverthere losses in US

theystarted selling in india which lead to the fall of sensexon that particular dayand

subsequentdays.

DuringthemonthofOstober2007 indiangovttooksomestrictmeasuretocontrol the

usageofthe Participatorynotes.TherestrictionsproposedbySEBIinregulating

participatorynotesinasuddenannouncementwroughthavocintheoperationsofthe

sharemarketcausingafallofover1,700pointsintheSensexonWednesday.SEBI

should have used some pragmatic caution by avoiding the announcement and

introducing regulatorystepsina phasedmanner.Theshare marketis extremely

vulnerable to the sentiments created bytheutterances of those inregulatoryauthority.

Thislead theFIItowithdrawfromtheIndianmarketas theywerenotsure ofhow the

measuretakenbythegovtwillbeimplemented.Thisisclearlyvivblefromtheabove

graphthatthistimearoundtheFIIwerethemaincauseofthecrashofthesensexon

18thoct.Butalsotherecomesaninterestingfactthattherewasalsoaheavyselling on

22ndOctoberbut thistime the FIIWithdrawl effect was offset bythe Huge

investmentmadeby domesticinstitutionalinvestorspeciallyLIC,whichsavedthe market


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froma heavymeltdown.

Thereasons being given for the crash are the sale of Rs7300 crore(Rs73

Billion)sharwesby FIIsinthepast1week,anexpectedincreaseininterestratesby

theUSFeds,a crashintheinternationalcommodityprices,andthestrawwhich

brokeitsbackseemstobeagovernmentcircularwhichwasinterpretedthatFIIs

shouldbetaxed.PChidambaram,thecountrysFinanceMinister,issuedaneveningpress

releasedenying thelatter.

15.STATISTICALANALYSIS

ForthepurposeofstatisticalanalysisIhaveconsidered7yrsdataofFIINetInvestments,

MutualFundsNet Invesments,NSES&PCNXNiftyandBSESensexIndices.Statistical

AnalysisiscarriedouttofindthedegreeofassociationbetweentheNetinvestmentsbythe

institutionalinvestorswiththecapitalmarketi.e(Sensex&Niftyindices).Since7yearsdata

isaverycomprehensivedataandtheinternalandtheextraneousfactorshavebeenchanging

overthetimewhichdoeshaveimpactontheIndiancapitalmarket.Soinordertohave

appropriatedataIcalculatedthevolatilityofBSESensexforeachyearandthendividedthem into 3

periods i.e2001-2003,2004-2005,2006-Feb 2008. Then Ihave applied regression

analysistofindoutthedegreeofassociationamongtheFIINetInvestments,theSensexandMutualFundInvestments,theSensex.Similarlythedegreeofassociationisbeencalculated for

Niftyindex with FII andMutual funds net investments.

TocalculatethevolatilityoftheBSEIndex andtofindoutthedegreeofassociation,the formula and the

methodologyis givenbelow.

I. Volatility
http://economictimes.indiatimes.com/articleshowcnews/1537982.cmshttp://economictimes.indiatimes.com/articleshowcnews/1537982.cmshttp://economictimes.indiatimes.com/articleshowcnews/1537982.cmshttp://economictimes.indiatimes.com/articleshowcnews/1537982.cmshttp://economictimes.indiatimes.com/articleshowcnews/1537982.cms


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Volatilityisameasureoftherangeofanassetpriceaboutitsmeanleveloverafixed

amountoftime.Itfollowsthatvolatilityislinkedtothevarianceofanassetprice. Ifa

stockislabeledasvolatilethenthepricewillvariesgreatlyovertime. Conversely,aless

volatilestockwillhaveapricethatwilldeviaterelativelylittleovertime.Sincevolatility

isassociatedwithrisk,themorevolatilethatastockis,themoreriskyitis.Consequently,

themoreriskyastockis,theharderitistosaywithanycertaintywhatthefuturepriceof thestock will

be.

Computing theVolatility

Theestimationofvolatilitycomesfromamathematicalmodelofstockprices. The

mathematicalmodel we will use is based on three assumptions about stock pricesand their

movements.Thefirstassumptionthatwewillbeusingisthatvolatilityisconstant. The

nextassumptionisthatstockpricescannotbenegative;onceastockpricereaches$0it

cannotgoanylower. Thethirdassumptionisthatthepriceofastockisanormalrandom variable.

Thusvolatilityiscalculatedasstandarddeviationasitisthestandardmeasurementdevice used

worldwidetocalculate the volatility.

Standarddeviationisastatisticaltermthatprovidesagoodindicationofvolatility.It

measureshowwidelyvalues(closingpricesforinstance)aredispersedfromtheaverage.

Dispersionisdifferencebetweentheactualvalue(closingprice)andtheaveragevalue

(meanclosingprice).Thelargerthedifferencebetweentheclosingpricesandtheaverage

price,thehigherthestandarddeviationwillbeandthehigherthevolatility.Thecloserthe

closingpricesaretotheaverageprice,thelowerthestandarddeviationandthelowerthe volatility.

StandardDeviation =(Xi-X)2

nWhere

nNumberof observations,_

Xbar - mean of observations,Xiithobservation.


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II. RegressionAnalysis:

RegressionAnalysisisanotherstatisticaltoolformeasuringtheassociationbetweentwo variables.

It is a technique used to predict the nature and closeness of relationships

betweentwoormorevariables.Thisanalysishelpstheresearcherstoevaluatethecausal

effectofonevariableonanothervariable.Itis usedtopredictthevariabilityinthe dependent

variable based on the information of one or more independent

variable.Regressionanalysis that involves two variable is termed as bivariate linear

regressionanalysis.It is expressedas followingequation.

Y=a+b*X

Where

Yis the dependent variable (Sensexand NiftyIndices)

Xis theindependentvariable (FII Investments and Mutual Funds Investments). a&

b are two constants which areknown as regressioncoefficients.

b istheslopecoefficienti.ethevalueofbisthechangeinvalueofYwithcorresponding change in

oneunit of X.

Theconstant b can be calculated usingfollowingformula:

b = n(XY)- XY

n(X)2(-X)2

arepresentsYintercepts when X=0.

a=Y-bX

whereY=themeanof valuesof dependent variable.

X=themean of valuesof independentvariable.


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We now developthe estimated regressionequation

=a+bX

representstheestimatedvalue of dependent variable for a given value of X.

StrengthofAssociation - R2

Theabove developed estimated regression equation can only explain the nature of

relationshipbetween two variables.However,if the researcher wants toknow how strong or

weakthe relationshipisi.etowhatdegreethatthevariationinYcanbeexplainedby

X.thecoefficient of determination denoted by R2 isused. R2 whichis measuredin

percentage willexplain how muchof thetotal variation inYis explained byX variable.

R2=explainedVariance/TotalVariance

TotalVariance=ExplainedVarianceUnexplainedVariance

R2=(TotalVariance- UnexplainedVariance)/TotalVariance.

UnexplainedVariance= (Yi-)2

Total variance=(Yi-Y)2

Tablesbelow give the resultsof theregressionanalysisdone on the data abovementioned.

Theabovetablewhichshowstheresultoftheregressionanalysisdonewithssensexasthe

dependentvariableandFIIastheindependentvariable.Volatilityiscalculatedforsensex

andthetableshowsthatthesensexvolatilityhasbeenincreasingovertheyears.Thevalue ofR2

impliesthattheintheyear20012003,thetotalvariationofsensexnearly27%is

explainedbythevariationofFIIinvestments.Overthe yearsithasbeenfollowinga

decreasingtrendwhichisgoodfortheIndiancapitalmarket asthisshowsthatFII isnot theonlycriteria

on which thevolatilityof sensex is dependent.

Theabovetableshowstheanalysisranbetweenthesensexandthemutualfundsin

india.Asweknowmutualfundsinindiaareat anascentstage.theresultofR2 tellsus that the


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dependencyof sensexvariation on the mutual fund investment has beenincreasing overthe years.

TheAbovegraphshowsusthevolatilityofNiftyovertheperiodofsevenyearsandthe

resultstellusthatthevolatilityhasbeenincreasedovertheyears.TheValueofR2 also

tellsusthatthetotalvariationofniftyindex,nearly26%isexplainedbythevariationin FII

netinvestment in the year2001-2003 and has been decreasing over theyears.

Interpretation of theAnalysis.

Nowlookingattheresulttableaboveitisclearlyvisiblethatvolatilityhasincreased

tremendouslyduringtheyears.VolatilityhasincreasedsixtimesinthecaseofSensexand

forniftyithasincreasedninetimesascomparedtowhatitwasthereintheyears2001-

2003.Also the value of the constant ain the regression equation is following an

increasingtrend whichtellstheeffectonthedependentvariablewhentheindependent

variableiszero.Similarlytheconstantbwhichtellsthemagnitudinalchangewithone

unitchangeintheindependentvariableisalsofollowingadecreasingtrendinthecaseof

FIIinvestmentsbutinthecaseofmutualfundsitisshowinganincreasingtrendwhich

tellsusthatdomesticinstitutionalinvestorsarealsorestoringfaithinthe marketand

subsequentlytheyhaveincreasedthereparticipationinthecapitalmarket.Thedegreeof

associationi.eRsquaretellsusanimportantfactthatslowlyandsteadilythedegreeof

associationofFIIinvestmentswiththeSensexisdecreasing.Ittellsusthefactthatinthe year2001-

2003around27%ofthetotalvarianceshownbysensexcouldbeexplainedby

FIIinvestmentsinboththeleadingstockexchangesinindia.Alsointhesubsequentyears

thevalueorRsquareisdecreasingincaseofFIIinvestmentsleadingtothefactthatthe

volatilityeffectofFIIonthecapitalmarketisonthedecreasingtrend,whichisbeneficial

fortheIndianstockmarket.AlsotheincreasingvalueofRsquareincaseofmutualfunds

isalsoapositivesignfortheIndianstockmarketasittellsusthatthedomesticinvestors

overtheyearshasshownincreasedparticipationandhelpedthemarkettostabliseinspite of such

highvolatility.


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Recommendations

Afteranalyzingthenatureandbehavioroftheforeigninstitutionalinvestmentinthepastandits

influenceontheIndianstockmarketitwouldbesafeenoughtosaythatforeignfundsareoneof themost

volatile instruments floating inthe market andneeds to be handled cautiously.

Governmentshouldcertainlyencourageforeigninstitutionalinvestmentbutshouldkeepacheck

onthevolatility factor.Longtermfundsshouldbegivenpriorityandencouragedsomeofthe actions that

could be taken to ensure stabilityare

Strengtheningdomestic institutional investors

Theparticipationofdomesticpensionfundsintheequitymarketwouldaugmentthediversityof views on

themarketand hence thedomestic pension funds must be encouraged .

Broadbasingof eligible entities

Inordertoaddressthemarketintegrityconcernsarisingoutofallowingsomeentities,whichdo nothave

reputationalriskorareunregulated,thereismeritinprohibitingsuchentitiesfrom gettingregistered.

Operational flexibilityto impartstabilityto the market

ThestabilityofforeigninvestmentinIndiawillbeenhancedifFIIsareabletoswitchbetween

equityanddebtinvestmentsinIndia,dependingontheirviewaboutfutureequityreturns.SEBI

canmakesuchpolicies.

Knowledgeactivitiesand researchprograms

There must be a lot of research programs and studies conducted by the economic affairs regulators

in India

Conclusion


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After analyzingthenatureofFIIinthepastitwouldbesafeenoughtosaythattheforeignfunds

iscertainlyoneofthemostimportantcauseofvolatilityintheIndianstockmarketandhashada

considerableinfluenceonit.Althoughitwouldnotbefairenoughtocometoanyconclusionas

therearealotofotherfactorsbeyondthescopeofthestudythateffectreturnsandrisks.itisnot

easytopredictthenatureofthemacroeconomicfactorsand their behaviorbutithasagreat

significanceonanyeconomyanditselements.Althoughgenerallyapositiverelationhasbeen seen

betweenthe stock market returns andthe FII inflows itis not easytosaywhichis the cause n whichis

the effect and strange behavior has also been noticed inthe past.

Foreigninvestment certainly are influencing the Indian stock market but the extent of this

influencecannot bedetermined orrathertheextentof Indias dependenceon theFIIs isa

subjectiveissueasonnocleargroundscanweseeapermanentrelationshipbetweenthestockmarketreturnsandtheForeigninflows. Buttogeneralizetheyhaveshownapositiverelation

mostofthetimeapartfromafewoccasionswherethebehavioroftheirrelationwasdifficultto explain.


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REFERENCES:

WEPSITE:

www.nseindia.com

www.finmin.nic.in

www.bseindia.com

www.investopedia.com

www.indiainfoline.com

www.amfiindia.com

www.livemint.com

www.sebi.gov.in

www.capitaline.com
http://www.nseindia.com/http://www.finmin.nic.in/http://www.bseindia.com/http://www.investopedia.com/http://www.indiainfoline/http://www.amfiindia.com/http://www.livemint.com/http://www.sebi.gov.in/http://www.capitaline.com/http://www.capitaline.com/http://www.sebi.gov.in/http://www.livemint.com/http://www.amfiindia.com/http://www.indiainfoline/http://www.investopedia.com/http://www.bseindia.com/http://www.finmin.nic.in/http://www.nseindia.com/

8/13/2019 33341798 Role of Fi

33341798 role of financial institutional investors in capital market in india

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