Stock and T-Bill Returns: A Comparative analysis from Pakistan

SUBMITTED TO:

SIR NAWAZ AHMED

SUBMITTED BY

AFSHEEN SACHWANI (14503)

JEHAN SHABBIR (13954)

MUJAHID ZAHID (14149)

ZAHAIB HUSSAIN (14186)

ZAINAB MORAWALLA (11516)

1. Introduction Stock A share of a company held by an individual or group. Corporations raise capital by issuing stocks and entitle the stock owners (shareholders) to partial ownership of the corporation. Stocks are bought and sold on what is called an exchange. There are several types of stocks and the two most typical forms are preferred stock and common stock. Holding a company's stock means that you are one of the many owners (shareholders) of a company and, as such, you have a claim (albeit usually very small) to everything the company owns. Yes, this means that technically you own a tiny sliver of every piece of furniture, every trademark, and every contract of the company. As an owner, you are entitled to your share of the company's earnings as well as any voting rights attached to the stock. A stock is represented by a stock certificate. This is a fancy piece of paper that is proof of your ownership. In today's computer age, you won't actually get to see this document because your brokerage keeps these records electronically, which is also known as holding shares "in street name". This is done to make the shares easier to trade. In the past, when a person wanted to sell his or her shares, that person physically took the certificates down to the brokerage. Now, trading with a click of the mouse or a phone call makes life easier for everybody. There are two main types of stocks: common stock and preferred stock.

Common Stock Common stock is, well, common. When people talk about stocks they are usually referring to this type. In fact, the majority of stock is issued is in this form. We basically went over features of common stock in the last section. Common shares represent ownership in a company and a claim (dividends) on a portion of profits. Investors get one vote per share to elect the board members, who oversee the major decisions made by management.

Over the long term, common stock, by means of capital growth, yields higher returns than almost every other investment. This higher return comes at a cost since common stocks entail the most risk. If a company goes bankrupt and liquidates, the common shareholders will not receive money until the creditors, bondholders and preferred shareholders are paid.

Preferred Stock

Preferred stock represents some degree of ownership in a company but usually doesn't come with the same voting rights. (This may vary depending on the company.) With preferred shares, investors are usually guaranteed a fixed dividend forever. This is different than common stock, which has variable dividends that are never guaranteed. Another advantage is that in the event of liquidation, preferred shareholders are paid off before the common shareholder (but still after debt holders). Preferred stock may also be callable, meaning that the company has the option to purchase the shares from shareholders at anytime for any reason (usually for a premium).

Some people consider preferred stock to be more like debt than equity. A good way to think of these kinds of shares is to see them as being in between bonds and common shares.

Treasury Bill - T-Bill' A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations of $1,000 up to a maximum purchase of $5 million and commonly have maturities of one month (four weeks), three months (13 weeks) or six months (26 weeks).

T-bills are issued through a competitive bidding process at a discount from par, which means that rather than paying fixed interest payments like conventional bonds, the appreciation of the bond provides the return to the holder. Treasury bills (or T-Bills) mature in one year or less. Like zero-coupon bonds, they do not pay interest prior to maturity; instead they are sold at a discount of the par value to create a positive yield.[7] Many regard Treasury bills as the least risky investment available to U.S. investors. Regular weekly T-Bills are commonly issued with maturity dates of 28 days (or 4 weeks, about a month), 91 days (or 13 weeks, about 3 months), 182 days (or 26 weeks, about 6 months), and 364 days (or 52 weeks, about 1 year). Treasury bills are sold by single-price auctions held weekly. Offering amounts for 13-week and 26-week bills are announced each Thursday for auction, usually at 11:30 a.m., on the following Monday and settlement, or issuance, on Thursday. Offering amounts for 4-week bills are announced on Monday for auction the next day, Tuesday, usually at 11:30 a.m., and issuance on Thursday. Offering amounts for 52-week bills are announced every fourth Thursday for auction the next Tuesday, usually at 11:30 am, and issuance on Thursday. Purchase orders at Treasury Direct must be entered before 11:00 on the Monday of the auction. The minimum purchase, effective April 7, 2008, is $100. (This amount

formerly had been $1,000.) Mature T-bills are also redeemed on each Thursday. Banks and financial institutions, especially primary dealers, are the largest purchasers of T-bills.

2. Problem Statement and Hypothesis

2.1 Problem Statement To study the Stock and T-Bill Returns: A Comparative analysis from Pakistan

2.2 Hypothesis H: Ho: stock returns and T-bill returns are equal

3. Literature Review:

Treasury securities are incorporated in these studies only through the choice of the risk-free security used tocalculateexcessreturns.2 However, Treasury securities are risk free only if they are held to maturity. Otherwise, they have uncertain returns that, like stock returns, can be evaluated with Sharpe and Treynor ratios. For any risky asset or portfolio, the Sharpe ratio is defined as the ratio of the excess return to the standard deviation of that return. We define the excess return on a risky asset as the difference between the 1-month holding- period return on the risky asset and the return on a U.S. Treasury bill expiring at the end of the month. We report the results of the estimation of the regression systems. There document predictable variation in all bill, bond, and stock portfolio excess returns. For all bills and bonds, the yield spread is statistically significant with a t-statisticof3.96orgreater,while the T BILL Because our Sharpe ratios are based on monthly returns, they are smaller than Sharperatiosbasedonannualreturns.7 is positive and significant only for the bills and bonds with maturities of less than1year. (Pilotte, 2006)

The undertaking known as the '' bond-syndicate contract with the United States government was the most interesting financial episode of I895. Politically and com- mercially, its results were and still are far-reaching. Economic- cally, it was so remarkable an experiment, so absolute a

departure from the beaten track of precedent, that it merits particularly thorough examination. To such examination it is my purpose to subject the episode. I shall take nothing for granted, shall admit no statement of fact unless from the first authority, and shall use no logic which prejudice, economic or political, can reject. (Noyes, 1895) Bond yields are the sum of two components: the averages of expected future risk free short interest rates and risk premiums.1 Thus, a change in risk premiums can be expected to bond yields. However, the recent literature has found the opposite; risk premiums in the Treasury bond market do not appear to a_ect the shapes of yield curves. Many papers in the literature of bond risk premiums have not examined the importance of Treasury bills since their methodology is based on the annual excess returns of holding long-term Treasury bonds over one-year risk-free interest rates. Treasury bills are not considered by construction. Bond risk premiums consist of two factors: one long term and the other short term. The long-term factor raises the slope of a yield curve, while the short-term factor is hidden from Treasury bond yields but pulls down the yields of Treasury bills. The longterm factor is able to predict excess returns over the horizon of even longer than one year, while the short-term factor loses its predictability in one quarter. Treasury bills are special. Their values rise during a financial crisis since they are considered the safest collaterals in the world (Campbell, 1985)

In general, the historical movement of inflation provides evidence that real rates of return on Tbills will revert closer to historical norms rather than what we experienced during the Great Bull Market. With better control over monetary policy and more efficient markets, the likelihood of high unexpected inflation and high risk premium is less likely. However, the value of T-bills as a risk-free benchmark will remain intact - without it, risk premiums can't be calculated and the allocation of capital become less efficient.

We can conclude that monetary variables have a long-run as well as short-run relationship with equity returns. The identification of the impact of monetary variables on stock market behavior facilitates investors in making effective investment decisions as by estimating expected trends in exchange rates, interest rate, and money supply, investors can estimate the future direction of equity prices and thus allocate their resources more efficiently. Architects of monetary policy should keep in mind the impact of changes in interest rates on the capital market in the form of a reduction of prices. The central bank should consider the impact of money supply on capital markets. Under the efficient market hypothesis, capital markets respond to the arrival of new

information, implying that macroeconomic policies should be designed to provide stability to the capital market. (Hasan, 2009)

The purpose of this study is to examine the effects of discount rate, t-bill, and consumer price index (CPI) on KSE-100 index and KSE-30 index trading volumes. It is usually considered that financial markets or trading volumes show response to economic variables such as money supply, unemployment rate; wholesale price index (WPI), consumer price index (CPI), producer price index (PPI), discount rate, and t-bill rates etc

Research has been conducted previously that financial market reacts to these economic variables but our study will be focus to show the relation of discount rate, CPI, and T-bill The study recommends formulating such policies which strengthened the stock market in Pakistan and uphold stock retunes. It should encourage industrial sector for the promotion of Industrial production. The long run positive impact of exchange rate on KSE100 index, and LSE25 index suggested that for the development of stock market in Pakistan, exchange rate should be managed carefully keeping in view the elasticity of exports and elasticity of imports which will lead to stability in stock market. The monetary authorities should take care in executing monetary policies particularly to affect movements in the stock market, because soft monetary policy to elevate stock prices in the short-run will lead to adverse results in the longrun. The study also recommended that three months treasury bills rate should be kept appropriately low so that it cannot affect stock returns adversely (sohail, 2012).

Full Information Maximum Likelihood Estimation procedure was used in establishing the relationship between macroeconomic variables and stock market returns. The empirical results reveal that there is a significant relationship between stock market returns and three macroeconomic variables; consumer price index (inflation rate), exchange rate and Treasury bill rate seem to affect stock market returns. The results of the study show that there is a significant positive relationship between consumer price index (inflation) and stock market return. This means that there is a tradeoff between risk and return by investors in holding stocks and also it serves as a guide for risk management. The findings also points out the inadequacy of hedging role of stock against inflation. That is, Ghana stocks cannot be used as a hedge against inflation,

since the positive regression coefficient implies a higher expected return is required for higher inflation rate. Our empirical result shows a negative link between stock returns and exchange rate and this is consistent with Bilson et al., (2001) conclusion that a devaluation of the domestic currency has a negative relationship with returns. For developing economies like Ghana that depend heavily on imports, currency depreciation may lead to higher import prices causing a fall in firms profit and in turn the price of stocks. The net effect of currency depreciation will depend on which of these factors is more dominant. In addition, currency depreciation may also create expectations in future increase in the exchange rate which consequently leads to a fall in the investment flows to the country (Kuwornu, 2011) Random walk hypothesis state the prices move randomly and the past prices are not helpful in predicting future prices. Many researches so far have been conducted to prove that hypothesis using different models and approaches, because of the nature of stock price movement which is complex. Much empirical work has been done to validate the concept of weak form of market efficiency in various stock markets of the world. Some studies have found results in favor of the random walk hypothesis Karachi stock 100 index (NAQVI, 2004).

Each investor is profit-oriented and wants to gain the highest possible returns and different researches are conducted about beating the market for earning some abnormal return. However, most of the time markets prove efficient against the strategies of the investment gurus and the prices of the market cannot be predicted accurately. Many researchers has agreed to the fact that KSE is an efficient financial market that can adjust any new information very quickly and efficiently and the prices of the securities listed for trading at KSE-100 Index cannot be predicted as KSE cannot be beaten to gain any abnormal return.KSE-100 Index follows the Random Walk Hypothesis (RWH) and Efficient Market Hypothesis (EMH) (Mehmood, 2012).

4. Data and Variables 4.1 Data Collection We used secondary data for our research and the data was taken from KSC 100 Index n T-Bills websites. The rates of KSC 100 index and T-Bills returns are on monthly bases.

4.2 Variables Independent Variable Independent Variable

Stock returns
VS

T-bill returns

As far as the scope of this research is concerned we have total 2 variables, both of these variables are independent variables and are not dependent on each other. The first independent variable is stock returns and second independent variable is T-Bills returns. There are no dependent variables. We have taken the data of last 5 years of stock returns and t-bills returns. All data belongs to Pakistan. 5. Methodology In this research we study the comparison of stock returns and T bills returns we used the Independent-Sample T-Test. Through this test we are able to make our decision. For data analysis purpose Statistical Package for Social Sciences (SPSS) is used. 6. Data Analysis and Findings H: Stock returns and T-bill returns are equal instrument
Group Statistics

VARIABLE

Mean

Std. Deviation

Std. Error Mean

DATA

ksc 100 index

50

.00059726

.000739057

.000104518

Group Statistics

VARIABLE

Mean

Std. Deviation

Std. Error Mean

DATA

ksc 100 index

50

.00059726

.000739057

.000104518

t bill rates

50

.00004114

.000065939

.000009325

In the Group Statistics box, the mean of KSC stock return is 0.00059726. The mean for T bill returns is 0.00004114. The standard deviation of KSC stock return is .000739057 and for T bill returns is .000065939. The number of months is 50 equals to 5years.
Independent Samples Test

Levene's Test for Equality of Variances t-test for Equality of Means 95% Confidence Interval of the Difference Sig. (2F Sig. t df tailed) Mean Difference Std. Error Difference Lower Upper

DATA

Equal variances assumed

24.545

.000

5.300

98

.000

.000556120

.000104934 .000347883 .000764357

Equal variances not assumed

5.300

49.780

.000

.000556120

.000104934 .000345332 .000766908

According to Levenes Test for Equality of Variances, if value of Sig. is less than 0.05 means that the variability in the two rules is different. That the scores in one rule vary too much more than the scores in the second rule. Putting scientifically, it means that the variability in the two rules is not significantly different. On behalf of this, we took the value of test when assuming equal variances because the Sig. value is 0 If the Sig (2-Tailed) value is less than or equal to .05, we can conclude that there is a statistically significant difference between the two rules. The value of Sig. (2-tailed) in the result in 0 and the mean difference is 0.000556120. In all together, the independent-samples t-test was conducted to compare the stock returns and T bills returns There was a significant difference in the scores of stock returns (M=0.00059726, SD=0.000739057) and T bills returns (M=0.00059726, SD=0.000065939) conditions; t (98) =5.3, p =0.000. These results suggest that stock returns and T-bills returns are equal instruments. On the behalf of the result our hypothesis accepted that stock returns and T-bills returns are equal instruments.

7. Conclusion and Future Research 7.1 Conclusion: T-bills are issued through a competitive bidding process at a discount from par, which means that rather than paying fixed interest payments like conventional bonds, the appreciation of the bond provides the return to the holder. Karachi Stock Exchange 100 Index (KSE-100 Index) is a stock index acting as a benchmark to compare prices on the Karachi Stock Exchange (KSE) over a period. In determining representative companies to compute the index on, companies with the highest market capitalization are selected. However, to ensure full market representation, the company with the highest market capitalization from each sector is also included. 7.2 Future Research Researchers can follow up with the same topic but considering other countries. They can opt for comparison between two countries considering the factor of political regime or else can also consider the factors of use of technology, foreign investment, trade, economic condition, etc.

8. References

Gerring, J., Bond, P., Barndt, W. T., & Moreno, a. C. (2005). Democracy and Economical Growth: A historical Perspective.

Ota, T. (2003). Development of Political Regime and Economic Growth in Asia (PART I).

Mahmood, K., Azid, T., & Siddiqui, a. M. (2010). Democracy and Economic Growth in Pakistan. Research Journal of Internatonal Studes - Issue 15 .

Schmitter, P. C. (2005). Democratization and State capacity. X Congreso Internacional del CLAD sobre la Reforma del Estado y de la Administracin Pblica .

Sirowy, L., & Alex, I. (1990). The Effects of Democracy on Economic Growth and Inequality: A Review. Studies in Comparative International Development. 25:126-157.

Subhani, M. I., Lakhiya, Z., & Osman, a. A. (n.d.). The Structure and Performance of Economy of Pakistan (Comparative Study between Democratic and Non-Democratic Governments). International Journal of Business and Social Science Vol. 2 No. 14 .

Williamson, J., & Haggard, a. S. (1994). The Political Conditions for Economic Reform.

John Gerring, Philip Bond, William T. Barndt, and Carola Moreno, " Democracy and Economical Growth: A historical Perspective (2005).

Tatsuyuki Ota, " Development of Political Regime and Economic Growth in Asia (PART I)" (2003)

Khalid Mahmood,Toseef Azid, Masood Mashkoor Siddiqui, "Democracy and Economic Growth in Pakistan (2010)

DATA OF KSC 100 INDEX AND T-BILLS RETURNS:

Data of KSC 100 Index

Date Index Points

1/31/2008 2/29/2008 3/31/2008 4/30/2008 5/31/2008 6/30/2008 7/31/2008 8/31/2008 9/30/2008 10/31/2008 11/30/2008 12/31/2008 1/31/2009 2/28/2009 3/31/2009 4/30/2009 5/31/2009

6.34% 1.27% 0.02% 22.05% 1.30% 14.94% 13.92% 0.32% 0.04% 0.05% 44.88% 8.68% 6.31% 18.05% 4.86% 1.00% 1.55%

6/30/2009 7/31/2009 8/31/2009 9/30/2009 10/31/2009 11/30/2009 12/31/2009 1/31/2010 2/28/2010 3/31/2010 4/30/2010 5/31/2010 6/30/2010 7/31/2010 8/31/2010 9/30/2010 10/31/2010 11/30/2010 12/31/2010 1/31/2011 2/28/2011 3/31/2011 4/30/2011 5/31/2011

7.51% 12.06% 6.99% 1.97% 0.51% 1.94% 2.39% 0.45% 5.25% 2.42% 11.17% 4.15% 7.88% 6.95% 2.02% 5.68% 5.83% 6.78% 2.76% 9.06% 4.51% 2.08% 0.54% 3.03%

6/30/2011 7/31/2011 8/31/2011 9/30/2011 10/31/2011 11/30/2011 12/31/2011 1/31/2012 2/13/2012

2.48% 9.64% 6.06% 0.90% 2.87% 1.62% 4.54% 3.07% 7.94%

Data of T-Bills Rates:

Date

T-Bills Rates

1/1/2008 2/1/2008 3/1/2008 4/1/2008 5/1/2008 6/1/2008 7/1/2008 8/1/2008 9/1/2008 10/1/2008

2.75% 2.12% 1.26% 1.29% 1.73% 1.86% 1.63% 1.72% 1.13% 0.67%

11/1/2008 12/1/2008 1/1/2009 2/1/2009 3/1/2009 4/1/2009 5/1/2009 6/1/2009 7/1/2009 8/1/2009 9/1/2009 10/1/2009 11/1/2009 12/1/2009 1/1/2010 2/1/2010 3/1/2010 4/1/2010 5/1/2010 6/1/2010 7/1/2010 8/1/2010

0.19% 0.03% 0.13% 0.30% 0.21% 0.16% 0.18% 0.18% 0.18% 0.17% 0.12% 0.07% 0.05% 0.05% 0.06% 0.11% 0.15% 0.16% 0.16% 0.12% 0.16% 0.16%

9/1/2010 10/1/2010 11/1/2010 12/1/2010 1/1/2011 2/1/2011 3/1/2011 4/1/2011 5/1/2011 6/1/2011 7/1/2011 8/1/2011 9/1/2011 10/1/2011 11/1/2011 12/1/2011 1/1/2012 2/1/2012 3/1/2012 4/1/2012 5/1/2012 6/1/2012

0.15% 0.13% 0.14% 0.14% 0.15% 0.13% 0.10% 0.06% 0.04% 0.04% 0.04% 0.02% 0.01% 0.02% 0.01% 0.01% 0.03% 0.09% 0.08% 0.08% 0.09% 0.09%

7/1/2012 8/1/2012 9/1/2012 10/1/2012 11/1/2012

0.10% 0.10% 0.11% 0.10% 0.07%