1.

Introduction
The Foreign Institutional Investors (FIIs) have emerged as noteworthy players in
the Indian stock market and their growing contribution adds as an important
feature of the development of stock markets in India. To facilitate foreign capital
flows, developing countries have been advised to strengthen their stock markets.
As a result, the Indian Stock Markets have reached new heights and became more
volatile making the researches work in this dimension of establishing the link
between FIIs and Stock Market volatility. Hence, its an interesting topic to
ascertain the role of FIIs in Indian Capital Markets.
Until the 1980s, there was a general reluctance towards foreign investment or
private commercial flows as Indias development strategy was focused on selfreliance and import substitution and current account deficits were financed largely
through debt flows and official development assistance. A major development in
our country, post 1991 has been liberalization of the financial sector, especially that
of capital markets. After the launch of the reforms, foreign institutional investors
(FIIs) from September 14, 1992, with suitable restrictions, were permitted to invest
in all securities traded on the primary and secondary markets, including shares,
debentures and warrants issued by companies which were listed or were to be
listed on the Stock Exchanges in India and in schemes floated by domestic mutual
funds. A positive contribution of the FIIs has been their role in improving the stock
market infrastructure and the SEBI assured its contribution towards its
development.
FII is defined as an institution organized outside of India for the purpose of making
investments into the Indian securities market under the regulations prescribed by

SEBI.FII include Overseas pension funds, mutual funds, investment trust, asset
management company, nominee company, bank, institutional portfolio manager,
university funds, endowments, foundations, charitable trusts, charitable societies, a
trustee or power of attorney holder incorporated or established outside India
proposing to make proprietary investments or investments on behalf of a broadbased fund.
FIIs can invest their own funds as well as invest on behalf of their overseas clients
registered as such with SEBI. These client accounts that the FII manages are
known as sub-accounts. A domestic portfolio manager can also register itself as
an FII to manage the funds of sub-accountsforeign institutional investor means an
entity established or incorporated outside India which proposes to make investment
in India. Positive tidings about the Indian economy combined with a fast-growing
market have made India an attractive destination for foreign institutional investors.
In other words FII is defined as an institution organized outside of India for the
purpose of making investments into the Indian securities market under the
regulations prescribed by SEBI.
1.1 Investment by FIIs
There are generally two methods to invest for Foreign Institutional Investors Equity Investment
100% investments could be in equity related instruments or up to 30% could be
invested in debt instruments i.e.70 (Equity Instruments): 30 (Debt Instruments)

 100% Debt
100% investment has to be made in debt securities only
EQUITY INVESTMENT ROUTE: In case of Equity route the FIIs can invest in
the following instruments:
A. Securities in the primary and secondary market including shares which are
unlisted, listed or to be listed on a recognized stock exchange in India.
B. Units of schemes floated by the Unit Trust of India and other domestic mutual
funds, whether listed or not.
C. Warrants
100% DEBT ROUTE: In case of Debt Route the FIIs can invest in the following
instruments:
a. Debentures (Non Convertible Debentures, Partly Convertible Debentures etc.)
b. Bonds
c. Dated government securities
d. Treasury Bills
e. Other Debt Market Instruments
It should be noted that foreign companies and individuals are not be eligible to
invest through the100 % debt route.
1.2 Scope & Trading Mechanism of Foreign Institutional Investors In India.
The scope and the trading mechanism of Foreign Institutional investors in India is
discussed as follow:

The eligibility criteria for applicant seeking FII registration:

As per Regulation 6 of SEBI (FII) Regulations,1995, Foreign Institutional
Investors are required to fulfill the following conditions to qualify for grant of
registration:

Applicant should have good track record, professional competence, financial

soundness, experience, good reputation of fairness and integrity.
The applicant should be regulated by an appropriate foreign regulatory
authority in the same category where registration is sought from SEBI.
Registration with authorities, which are responsible for incorporation, is not
adequate to qualify as Foreign Institutional Investor.
The applicant is required to have the permission under the provisions of the
FEMA, 1999 from the Reserve Bank of India.
Applicant must be legally permitted to invest in securities outside the
country or its in-corporation / establishment.
The applicant must be a "fit and proper" person& not disqualified by any
law.
The applicant has to appoint a local custodian and enter into an agreement
with the custodian. Along with the above it also has to appoint a designated
bank to route its transactions.
Payment of registration fee of US $ 5,000.00

"Form A" as prescribed in SEBI (FII) Regulations, 1995 is to be filled before

applying for FII registration.
Supporting documents required are:

 Application in Form A duly signed by the authorized signatory of the

applicant.
Certified copy of the relevant clauses or articles of the Memorandum and
Articles of Association or the agreement authorizing the applicant to invest
on behalf of its clients.
Audited financial statements and annual reports for the last one year,
provided that the period covered shall not be less than twelve months.
A declaration by the applicant with registration number and other particulars
in support of its registration or regulation by a Securities Commission or
Self-Regulatory Organization or any other appropriate regulatory authority
with whom the applicant is registered in its home country.
A declaration by the applicant that it has entered into a custodian agreement
with a domestic custodian together with particulars of the domestic
custodian.
A signed declaration statement that appears at the end of the Form.
Declaration regarding fit & proper entity.
The application fee for registration as FII is US $ 5,000. The mode of payment is
Demand Draft in favor of "Securities and Exchange Board of India" payable at
New York.
SEBI generally takes 7 working days in granting FII registration. However, in
cases where the information furnished by the applicants is incomplete or missing,
seven days shall be counted from the days when all necessary information sought,
reaches SEBI.
In cases where the applicant is bank and subsidiary of a bank, SEBI seeks
comments from the Reserve Bank of India (RBI). In such cases, 7 working days
would be counted from the day no objection is received from RBI.

The FII registration is valid for 5 years. After expiry of 5 years, the registration
needs to be renewed.
Same as initial registration, Along with "Form A" and all the relevant documents,
the applicants are required to fill in additional form (Annexure 1) while applying
for renewal. US $ 5,000 needs to be paid for renewal of FII registration.
The application for renewal should be submitted three months before expiry of the
FII registration. 100 % debt FIIs are debt dedicated FIIs which invest in debt
securities only. The procedure for registration of FII/sub-account, under 100% debt
route is similar to that of normal funds besides a clear statement by the applicant
that it wishes to be registered as FII/sub-account under 100% debt route.

2. Literature Review

Foreign institutional investment-a history in India

The remarkable economic growth during the past two decades in most of the
emerging countries had been stimulated by foreign capital inflows from developed
countries. The post 1990s period witnessed sharp augment inflows of foreign
private capital and official development finance lost its predominance in net capital
inflows. Most of the developing countries opened their capital markets to foreign
investors either because of inflationary pressures, widening current account
deficits, exchange depreciation, increase in foreign debt or as a result of economic
policy. There was a surge in capital inflows into India too since 1992 as in India,
the purchase of domestic securities by FIIs was first allowed in September 1992 as
part of the liberalization process that followed the balance of payment crisis in
1990-91 (Gordon and Gupta, 2003).
Now days, a significant portion of Indian corporate sectors securities are held by
Foreign Institutional Investors, such as pension funds, mutual funds and insurance
companies. These investors are often viewed as sophisticated investors as these
institutional investors are better informed and better equipped to process
information than individual investors (Han and Wang, 2004). As the share of
foreign investors in emerging markets has risen, they have influenced the assets
prices considerably. Consequently, policymakers have become increasingly
concerned about the factors determining international investment, the performance
of foreign capital investments, and the impact of foreign investment on local
turnover and on the volatility of stock prices (Tesar and Werner, 1995).
The impact study of FIIs flows on domestic stock market is important from
government as well as investor point of view, for example, does the opening up of
the market for FII increase speculation in the market and thus make the market
more volatile and more vulnerable to foreign shocks (Li, 2002). The immediate

impact of market opening to FIIs is the surge in trading volume and capital inflows
to domestic stock markets, result of which the boom in stock prices. The stock
market boom, typically, does not last for the entire period is of capital inflows. It
usually starts with the initial surge in capital inflows and ends before the episode of
capital inflows completely subsides (Calvo and Mendoza, 2000).
Henry (2000) reports the two possible consequences of market liberalization in the
light of international asset pricing models. First outcome of market liberalization
(because of its impact on the cost of capital) is an increase in a countrys equity
prices because market learns that domestic markets will liberalize more in near
future. The second impact of market liberalization is on physical investment that
will increase because of fall in cost of capital as new entrepreneurs will initiate
more investment projects. The second effect of market liberalization will definitely
increase the rate of economic growth.
Similarly Gompers et al. (2001) prove that institutional investors invested in liquid
and large stocks having low returns during the previous year. So an increase in the
institutional demand in share market will affect stock market prices and returns if
supply and demand curves for that particular share are not perfectly elastic.
Han et al. (2004) also analyze the impact of institutional investors on stock prices
from a different perspective. They studied the impact on stock prices because of
the investment constraints on institutional investors by their unit holders.
Institutional constraints some time refrain from selling or purchasing of stock
about which they have even some good/bad news. So they conclude that higher
institutional investment constraints have strong price momentum on the shares.

Similarly Lin et al. (2006) conclude that the investment performance of FIIs high
holding stocks is significantly better than that of FIIs low holding stocks. They
presented the evidence that FIIs trading behavior has generated better returns and
portfolio performance since the stock markets full liberalization. Li (2002) studies
the impact of market opening to foreign investors on Taiwan stock market behavior
and found no significant changes in stock market return after market opening. But
author agreed that the impact on return should be there because large international
investors tend to study companies more thoroughly. The involvement of foreign
investors disseminates information better hence leads to more efficient market.
Richards (2004) analyze data of six Asian emerging equity markets and found two
interesting findings. The trading behavior of foreign investors was largely
influenced by the return in global market that is positive feedback trading. The
price impact associated with foreign investors trading was much large than
estimated earlier.
2.1 Determinants of FII Investment
2.1.1 Impact cost
One of the pre-requisites for an investor to be able to comfortably trade frequently
in the market (to reconstitute the investment portfolio) is the ability to do so
comfortably in a market without having to suffer a great transaction cost. In other
words, it requires the market to be liquid. Financial foreign shareholders have
financial focus and lay emphasis on liquidity, argue Coffee (1991) and Aguilera
and Jackson (2003). Liquidity, in this context, means the ability of the market to
absorb large quantities of trade without a heavy transaction cost. The transaction

cost, here, would mean not the fixed costs like brokerage, depository chares etc.
but the cost that is attributable to lack of market liquidity. Since these costs are
different in different countries and also vary across the stocks listed in the same
countrys bourses, it could be one of the important considerations for the Foreign
Portfolio Investors.
2.1.2 Market Return
The basic rationale for the international capital flows is the rate of return which is
higher in a foreign market compared to the domestic market. Capital flows across
the geographical boundaries of the countries is mainly to enhance the productivity
and efficiency of capital at the global level. Hence the rate of return should
certainly explain the choice of a particular stock for investment by the FIIs.
Mohanty (1998) has found that the institutional investors as a group have invested
in companies with good financial performance. Clark and Berko (1996) show a
positive contemporaneous relation between equity flows and stock returns using
monthly data for Mexico. The study has used the market return of the Nifty
companies stock as the average of the market return for the 3 months June-August
2004, as it is reported by NSE.

2.1.3 Non-Promoter Shareholding

The shares that are available for trading in the normal course are those that are with
the investors other than the promoters and other interested and special categories of
investors. This is an important variable to be considered in investing in a stock
because the available free-float in most American companies is above 90 per cent
whereas in India promoters have more than 50 per cent stakes in majority of large
companies.(Biswal, 2003) As early as in 1968, Demsetz (1968) has found that one
of the important determinants of secondary market liquidity is the number of
shareholders. As the number of persons currently holding a particular share
increases, the number of market participants interested in trading the asset
increases in direct proportion. Therefore, the number of transactions per unit of
time also increases. One of the findings of his study is that the increase in the
number of shareholders reduces the bid-ask spread. Benston and Hagerman (1974)
also have observed a direct relation between a proxy for insider holdings and bidask spread. These studies show that the number of shareholders and the ratio of
non-promoter shareholders to total shareholders have a bearing on the interest of
the investors in wanting to include that security in their portfolio and also the bidask spread. The ratio of shares held by Non-promoter category to Promoters
category as of September 2004 is used in the model. This is a measure of liquidity
of a stock in the bourses. This is the quantum of shares that an investor can actually
buy and sell. The FIIs investment cap has not been included as one of the
explanatory variables because only 17 out of the 50 Nifty companies studied have
FIIs investment cap different from the generic cap. The balance 33 companies have
stayed with the generic cap only. Hence, FIIs investment cap is not considered for
the model.

2.2 Recent FII trends in India

Bansal And Pasricha (2009), studied the impact of market opening to FIIs, on
Indian stock market behavior. India announced its policy regarding the opening
of stock market to FIIs for investment in equity and related instruments on 14th
September 1992. Using stock market data related to Bombay Stock Exchange,
for both before and after the FIIs policy announcement day, they conducted an
empirical examination to assess the impact of the market opening on the returns
and volatility of stock return. they found that while there is no significant
changes in the Indian stock market average returns, volatility is significantly
reduced after India unlocked its stock market to foreign investors.
P. Krishna Prasanna (2008) has examined the contribution of foreign
institutional investment particularly among companies included in sensitivity
index (Sensex) of Bombay Stock Exchange. Also examined is the relationship
between foreign institutional investment and firm specific characteristics in
terms of ownership structure, financial performance and stock performance. It
is observed that foreign investors invested more in companies with a higher
volume of shares owned by the general public. The promoters holdings and the
foreign investments are inversely related. Foreign investors choose the
companies where family shareholding of promoters is not substantial. Among
the financial performance variables the share returns and earnings per share are
significant factors influencing their investment decision
Prasanna (2008) examined FIIs investment preferences in India. The study has
observed that apart from economic development of the country, firm specific
factors to a large extent determine FIIs investment in a firm. FIIs invested more

in companies with higher volume of shares owned by general public. The

promoters holdings and foreign investment were inversely related and also
foreign investors tend to choose companies where family holding of promoters
is not substantial. Returns and earnings per share were significant factors
influencing the investment decisions by FIIs.
Rai Kulwant et al (2003) held that the present study tries to examine the
determinants of Foreign Institutional Investments in India, which have crossed
almost US$ 12 billion by the end of 2002. Given the huge volume of these
flows and its impact on the other domestic financial markets understanding the
behavior of these flows becomes very important at the time of liberalizing
capital account. In this study, by using monthly data, we found that FII inflow
depends on stock market returns, inflation rate (both domestic and foreign) and
ex-ante risk. In terms of magnitude, the impact of stock market returns and the
ex-ante risk turned out to be major determinants of FII inflow. This study did
not find any causation running from FII inflow to stock returns as it was found
by some studies. Stabilizing the stock market volatility and minimizing the exante risk would help in attracting more FII inflow that has positive impact on
the real economy.
Agarwal, Chakrabarti et al (2003) have found in their research that the equity
return has a significant and positive impact on the FII. But given the huge
volume of investments, foreign investors could play a role of market makers
and book their profits, i.e., they can buy financial assets when the prices are
declining thereby jacking-up the asset prices and sell when the asset prices are
increasing. Hence, there is a possibility of bi-directional relationship between
FII and the equity returns.

Gordon and Gupta (2003) analyzed the factors affecting portfolio equity flows
into India. The analysis has shown that, the magnitude of flows was smaller in
India compared to other emerging markets and also less volatile than other
emerging markets. Portfolio flows were determined by both domestic and
external factors. Among external factors Libor was prominent and in domestic
factors credit ratings and lagged returns were important determinants of
portfolio flows. In quantitative terms both domestic and external factors were
found to be equally important in determining portfolio flows.
Batra (2003) examined FII trading behavior and returns in Indian equity market
based on daily and monthly data. The study has found trend chasing and
positive feedback trading by FIIs on daily basis at an aggregate level. But no
such evidence was found in monthly basis. Based on the impact of trading
imbalance, study concluded that bias of FIIs do not have destabilizing impact
on the equity market.
Chakrabarti (2001) examined the nature and causes of FII flows to India. The
study has found FII inflows were highly correlated with equity returns in India
and argued that FII flows are effects of returns rather than the cause of it. The
study also argued that, FIIs do not seem to have informational disadvantage
compared to local investors. It was found that Asian crisis resulted in a regime
shift and since then domestic equity returns became the single most important
determinant of FII flows to India.
Mukherjee et al. (2002) examined the daily flows of FIIs investment in Indian
stock market. The study has found that domestic equity returns was the most
important factor in influencing the FIIs investment flows into the country and

FIIs investment flows do not have significant impact on returns. FIIs sale and
net flows were significantly affected by the performance of the equity market
whereas FIIs purchase was not responsible for such a performance. The study
has also found that, FIIs investment flows were highly auto correlated.
Stanley Morgan (2002) has examined that FIIs have played a very important
role in building up Indias forex reserves, which have enabled a host of
economic reforms. Secondly, FIIs are now important investors in the countrys
economic growth despite sluggish domestic sentiment. The Morgan Stanley
report notes that FII strongly influence short-term market movements during
bear markets. However, the correlation between returns and flows reduces
during bull markets as other market participants raise their involvement
reducing the influence of FIIs. Research by Morgan Stanley shows that the
correlation between foreign inflows and market returns is high during bear and
weakens with strengthening equity prices due to increased participation by
other players.
Suresh Babu and Prabheesh (2008) examined the causal relationship between
foreign institutional investment and stock returns. The study has found bi
directional causality between FIIs investment and stock returns. FIIs investment
flows were more stock return driven.
Thenmozhi and Kumar (2009) examined the dynamic interaction between
mutual fund flows and security returns and between mutual fund flows and
volatility. They found a positive contemporaneous relationship between stock
market returns and mutual fund flows measured as stock purchases and sales.
The study has found that mutual funds flows are significantly influenced by

returns but returns were not influenced by mutual fund flows. The study has
also identified a strong positive relationship between stock market volatility and
mutual fund flows.
Some of the studies reviewed in this section belong to early part of 2000. They
are the initial periods in the development of institutional investment. It gives
enough justification to have revisit the pattern of institutional investment. The
studies of Suresh Babu and Prabheesh (2008), and Thenmozhi and Kumar
(2009) do belong to the latest period and have addressed the primary objective
of the present study individually i.e. examining the relationship between returns
and institutional investment as represented by FIIs and MFs. But, both studies
have considered only one estimation window. In the present study an attempt is
made to analyze the relationship between institutional investments and market
return over a period of time by dividing the study to cover different phases in
the market.
2.3 Overview of Indian Stock Market
Stock markets refer to a market place where investors can buy and sell stocks. The
price at which each buying and selling transaction takes is determined by the
market forces (i.e. demand and supply for a particular stock. A stock exchange
includes an association of persons or firms to regulate and supervise all
transactions, rules, regulations and standard practices to govern all market
dealings, authorized stock brokers and an exchange floor where stock brokers or
their approved agents meet during fixed business hours to buy and sell securities.
The Securities and Exchange Board of India (SEBI) is the regulatory body of the
stock market. It gives rules and regulation to control the stock exchanges. These

rules and regulation are called the stock market reforms. To study the stock market
reforms in detail, we have to study the concepts of capital market in detail firstly.
The financial securities deal with the capital market, which include primary market
and secondary market. The primary market is that part of capital market that deals
with the issuance of new securities. Primary market issue can be classified in to
initial public offer, right issue and preferential issue. The secondary market is the
financial market for trading of securities that have already been issued in initial
private or public offering. Securities initially issued in the primary market by
companies are traded on the secondary market.
2.3.1. History of Indian Stock Market
The earliest records of security dealings in India are somewhat obscure. The East
India Company was the dominant institution in the countrys economy and it is
presumed that transactions in its loan securities first began in the eighteenth
century. By the 1830's, shares of banks and cotton companies were actively traded
in Bombay. Though the list of tradable securities kept increasing there were only
half a dozen brokers recognized by banks and merchants during the 1840s and
1850s. The number of brokers increased to about 250 shortly thereafter, when a
true 'share mania' took place in India. The stock boom was the result of a
disruption in the cotton supply from the United States to Britain due to the
American Civil War. Later, in 1875, the Stock Exchange of Mumbai (BSE) was
established as "The Native Share and Stockbrokers Association". The BSE is the
oldest exchange in Asia. The BSE has evolved over the years and is currently the
largest stock exchange in the country accounting for one third of trading volume
and the largest share of listings and market capitalization. In the 1980s, the number
of exchanges grew dramatically and today there are 23 recognized stock exchanges
in the country. In addition to the BSE, the National Stock Exchange of India Ltd.

(NSE) and the Inter-connected Stock Exchange of India (ISE) are significant in
terms of market capitalization and trading value. The NSE was incorporated in
1992 and in 1994 began operations in the Wholesale Debt Market (WDM) and the
equities segment. Trading of derivative instruments was introduced on the
exchange in 2000. ISE is a national-level exchange providing trading, clearing,
settlement, risk management and surveillance support to the inter-connected
market system. Fifteen regional stock exchanges are currently linked through ISE
linkage and connectivity to all the participating exchanges to widen their market.
2.3.2National Stock Exchange
On the basis of the recommendations of high powered Pherwani Committee, the
National Stock Exchange was incorporated in 1992 by Industrial Development
Bank of India, Industrial Credit and Investment Corporation of India, Industrial
Finance Corporation of India, all Insurance Corporations, selected commercial
banks and others. NSE provides exposure to investors in two types of markets,
namely: Wholesale debt market and Capital market .Wholesale Debt Market is
similar to money market operations, debt market operations involve institutional
investors and corporate bodies entering into transactions of high value in financial
instruments like treasury bills, government securities, etc. NSE has some positive
points such as fully automated screen-based trading mechanism, Strictly follows
the principle of an order-driven market, trading members are linked through a
communication network, this network allows them to execute trade from their
offices, the prices at which the buyer and seller are willing to transact will appear
on the screen, when the prices match the transaction will be completed and a
confirmation slip will be printed at the office.

2.3.3Bombay stock exchange

Bombay stock exchange is the oldest stock exchange in Asia with a rich heritage,
new spanning three centuries in its 133 years of existence. What is now popularly
known as BSE was established as The Native share & stock Brokers
Association in 1875. BSE is the first stock exchange in the country which
obtained permanent recognition (in1956) from the Govt. of India under the
Securities Contracts (Regulation) Act 1956. BSE pivotal and preeminent role in the
development of the Indian Capital Markets is widely recognized. It changed from
the open outcry system to an outline screen based order driven trading system in
1995. BSE is now a corporatized under the provisions of the Companies Act 1995.
2.3.4Stock Market Reforms about FII IN INDIA:
FII have been allowed to invest in the Indian securities market since September
1992 when the Guidelines for Foreign Institutional Investment were issued by the
Government. The SEBI (Foreign Institutional Investors) Regulations were
enforced in November 1995, largely based on these Guidelines. The regulations
need FIIs to register with SEBI and to obtain approval from the Reserve Bank of
India (RBI) under the Foreign Exchange Regulation Act to buy and sell securities,
release foreign currency and rupee bank accounts, and to forward and repatriate
funds. Once SEBI registration has been obtained, an FII does not require any
further consent to buy or sell securities or to move funds in and out of the country,
subject to compensation of applicable tax. Foreign investors, whether registered as
FIIs or not, may also invest in Indian securities outside the FIIs process. Foreign
financial service institutions have also been allowed to set up joint ventures in

stock broking, asset management companies, merchant banking, and other

financial services firms along with Indian partners. Foreign portfolio investments
in Indian companies are limited to individual foreign ownership at 10 percent of
the total issued capital of any one company and to aggregate foreign ownership at
30 percent of the total issued capital of any one company. When India opened
investment into listed equities through the FIIs framework not all foreign investors
were eligible to register with the Indian securities regulator (SEBI). No FII was
permitted to own more than 5% of a firm and there were restrictions on ownership
by all FIIs taken together. Foreign investors faced many difficulties in
accomplishing transactions in the Indian equity market. For example in 1993, the
settlement system which was based on physical paper share certificates found it
difficult to handle the settlement volume of foreign investors. Similarly, foreign
investors who sent orders to open outcry trading floor of the Bombay stock
exchange found an array of problems including high transactions costs and low
probability of order execution. Thus from 1993 to 2003, the Ministry of Finance
and SEBI led a strong reforms aiming at a fundamental transformation of the
equity market. Presently the ceiling for overall investment for FIIs is 24% of the
paid up capital of the Indian company. The limit is 20% of the paid up capital in
the case of public sector banks, including the State Bank of India. The ceiling can
be raised up to sectoral cap/statutory ceiling, subject to the approval of the board
and the general body of the company passing a special resolution to that effect.
Also the rigid criteria of requiring FIIs and sub-account to register as a 70:30 FII/
sub-account or 100% debt FII/sub-account has recently been done away with.

2.3.5 There are some other reforms and their effects on FIIs also mentioned
below
1. Limit of investment by FIIs increased from 49% to the limit of sectoral cap for
FDI with the approval of the board of directors & the shareholders. FIIs
investments in sectors like hotels and tourism, petroleum, air, roads, highways, port
etc. can be up to 100%. These reforms increase the profit of FIIs.
2. After the year 2007, FIIs are permitted to entering to the short selling
transactions only in accordance with the specified by SEBI. This would prohibit
the market manipulation.
3. Now no transaction could be carried forward and the transaction in securities
would be only through stock broker is granted a certificate by SEBI.
4. After the year 2007 FIIs are permitted to invest US $ 3.2 billion in Govt.
Securities.
5. Internet trading promotes competition and improves investor service.
6. Rolling settlement has a positive impact on the FIIs. This would increase the
flexibility in transacting of the institutional investors. Because of it the speculative
volumes reduce which was very high in India.
7. FIIs are permitted up to 23% in infrastructure companies in the security market
viz. stock exchanges, deposits

3. Research Objective and Hypothesis

Objectives of the Study:

Following are the objectives of the study:

To study the scope and trading mechanism of Foreign Institutional

investors in India.
To find the relationship between the FIIs equity investment pattern and
Indian stock indices.

Hypothesis
Null Hypothesis (Ho): The BSE Index does not rise with the increase in FIIs
investment.
Alternate Hypothesis (Ha): The various BSE Sensex rises with the increase in
FIIs investment.

4. Scope And Need Of Study

Scope of the study is very broader and covers both the values of BSE Sensex and
its comparison with foreign institutional investments. But, study is only going to
cover foreign investments in form of equity. The time period is limited from
January 2008 to December 2011 as it will give exact impact in both the bullish and
bearish trend.

The study will provide a very clear picture of the impact of foreign institutional
investors on BSE Sensex. It will also describe the market trends due to FIIs inflow
and outflow.

The study would be helpful for further descriptive studies on the ideas that will be
explored. Moreover, it would be beneficial to gain knowledge regarding foreign
institutional investments, their process of registration and their impact on BSE
sensex.

5. Research Methodology:
Research methodology is the arrangement of conditions for collection and analysis
of data in a manner that aims to combine relevance to the research purpose with
economy in procedure. Research methodology is the conceptual structure within
which research is conducted. It constitutes the blueprint for the collection
measurement and analysis of the data.

The research methodology here includes:

Research problem
Research design
Sampling design
Sampling technique
Data collection method

5.1 Research Problem:

There is a saying a problem well defined is half solved. The project deals with
the Impact of Foreign Institutional Investors on BSE Sensex . This research
project studies the relationship between FIIs investment and BSE sensex. This
indice, in a way, represent the picture of Indias stock markets. So this project
reveals the impact of FII on the Indian capital market.

There may be many other factors on which a stock index may depend i.e.
Government policies, budgets, bullion market, inflation, economic and political
condition of the country, FDI, Re./Dollar exchange rate etc. But for this study I
have selected only one independent variable i.e. FII. This study uses the concept of
correlation and regression to study the relationship between FII and stock index.
The FII started investing in Indian capital market from September 1992when the
Indian economy was opened up in the same year. Their investments include equity
only. The sample data of FIIs investments consists of monthly average from
January 2008 to December 2011.

5.2 Research Design

Exploratory Research
As an exploratory study is conducted with an objective to gain familiarity with the
phenomenon or to achieve new insight into it, this study aims to find the new
insights in terms of finding the relationship between FIIS and Indian Stock
Indices.

5.3 Sampling Design

Universe
In this study the universe is finite and will take into the consideration related
news and events that have happened in last few years.

 Sampling Unit
As this study revolves around the foreign institutional investment and BSE
Sensex.So for the sampling unit is confined to only the Indian stock market.

5.4 Sampling Technique:Convenient Sampling: Study conducted on the basis of availability of the Data and
requirement of the project. Study requires the events that have impact on the Indian
stock market.

5.5 Data collection Method

Secondary data: For the secondary data various literatures, books, journals,
magazines, web links are used. As there are not possibilities of collecting data
personally so no questionnaire is made.

5.6 Research Analysis Tools

5.6.1 Regression analysis and Correlation analysis:
Regression Analysis: We can analyze how a single dependent variable is affected
by the values of one or more independent variables for example, how an
athlete's performance is affected by such factors as age, height, and weight. We can
apportion shares in the performance measure to each of these three factors, based
on a set of performance data, and then use the results to predict the performance of
a new, untested athlete.

Correlation: This analysis tool and its formulas measure the relationship between
two data sets that are scaled to be independent of the unit of measurement. The
population correlation calculation returns the covariance of two data sets divided
by the product of their standard deviations. We can use the Correlation tool to
determine whether two ranges of data move together that is, whether large
values of one set are associated with large values of the other (positive correlation),
whether small values of one set are associated with large values of the other
(negative correlation), or whether values in both sets are unrelated (correlation near
zero).

6. Analysis
6.1 Correlations

Correlations
SensexVal
Pearson Correlation
SensexVal

Sig. (2-tailed)

Pearson Correlation

.403**
.005

FII

FII

48

48

**

.403

Sig. (2-tailed)
N

.005
48

48

**. Correlation is significant at the 0.01 level (2-tailed).

Inferences:1. As the Pearson correlation coefficient between FII and Sensex Value is
good and positive (.403) and the p value is .005, this implies that null
hypothesis is rejected.
2. So we can infer that Foreign Institutional Investments have significant
correlation with Sensex.

Regression:

Model Summaryb
Model

R Square

.403a

Adjusted R

Std. Error of the

Square

Estimate

.162

.144

2894.337

a. Predictors: (Constant), FII

b. Dependent Variable: SensexVal

Coefficientsa
Model

Unstandardized

Standardized

Coefficients

Coefficients

Std.

Sig.

FII

15412.41

Beta

.100

465.
399
.033

.403

Correlations

Interval for B

Error
(Constant)

95.0% Confidence

33.117

.000

2.985

.005

Lower

Upper

Zero-

Bound

Bound

order

14475.6

16349.21

17

.033

.167

a. Dependent Variable: SensexVal

Regression Equation is Sensex =15412.217+ .100 FII

.403

Partial

.403

Part

.403

Charts

The histogram shows the residuals of the Sensex variable. Residual is what remains after
independent co-efficient have been determined. This curve is not a normal curve which
implies that some part of histogram is outside the normal curve. This implies that residual
is more after carrying out the regression analysis.

The normal p-p plot of regression standardized residual shows the residual values
all hugging the line of least squares or the line of greatest fit. These values must be
close to the line of least squares which is an idealized plot. So in this plot there is
some deviation.

The scatter plot shows the distribution of data which must be randomly distributed.
If the data is not randomly distributed then we have heteroscedasticity present in
our data which implies that we dont have confidence in standard error associated
with our database.

Frequencies
Sensex Values : Statistics
Valid

Missing

Mean

48
0
16024.71

Std. Error of Mean

451.553

Median

16725.50

Std. Deviation

3128.453

Variance
Skewness

9787215.232
-.996

Std. Error of Skewness

.343

Kurtosis

.373

`
Std. Error of Kurtosis
Range

.674
11954

Minimum

8607

Maximum

20561

The mean value of Sensex over the period of 2008-2011 is approx. 16000,
though there is a lot of movement i.e. deviation from the mean (3128.45).

Also the value has varied from a minimum of 8607 to maximum of 20561.

Skewness is the measure of the asymmetry of the probability distribution of

a real-valued random variable. The skewness is negative in the research
study (-.996) indicates that the tail on the left side of the probability density
function is longer than the right side and the bulk of the values (including
the median) lie to the right of the mean.

Foreign Institutional Investment : Statistics

Valid

Missing

Mean

48
0
6135.239583

Std. Error of Mean

Median

1822.6993176
2795.300000

Std. Deviation

12628.0312998

Variance

159467174.509

Skewness
Std. Error of Skewness
Kurtosis

1.071
.343
1.670

Std. Error of Kurtosis

Range

.674
65888.0000

Minimum

-17205.4000

Maximum

48682.6000

According to the research the mean value of FII over the period of 20082011 is approx. Rs. 6135 crores, though there is a lot of movement i.e.
deviation from the mean (12628.3).

Also the value has varied from a minimum of -17205 to maximum of 48682.
The reason for such a movement is because of the economic slowdown
during the period of 2008-09.

Skewness is the measure of the asymmetry of the probability distribution of

a real-valued random variable. The skewness is positive in the research
study (1.071) indicates that the tail on the right side is longer than the left
side and the bulk of the values lie to the left of the mean.

FY - 2008
25000
20000
15000
10000
5000

SensexVal
FII

39479
39539
39600
39661
39722
39783
39448
39508
39569
39630
39692
39753
-5000
-10000
-15000
-20000

Interpretation:
After plotting the values of BSE Sensex of the year 2008 and the values of
respective FIIs, we find that the values of FIIs and Sensex are interrelated
in some manner.
When there is a downfall in FIIs the value of Sensex also comes down and
vice-versa.
But there is some deviations or exceptions to this were found. For ex from
Jan to Feb 2008 the value of FIIs has been increased and Sensex value have
been decreased, which indicates that there has been some other factors
which effects Sensex values.
The period of 2008 has been a period of tremor for the Indian Markets, the
Indian Markets plunged after making high of 18242 in Jan. 2008 to as low as
9903 in Dec. 2008 almost decrease of around 50%.

FY - 2009
60000
50000
40000
30000

#REF!

20000

Sense

#REF!

Sens
ex
FII

10000
0
39814 39845 39873 39904 39934 39965 39995 40026 40057 40087 40118 40148
-10000

Interpretation
After plotting the values of BSE Sensex of the year 2009 and the values of
respective FIIs, we find that the values of FIIs and Sensex are not
following a particularly related to each other.
Sensex in this year has been continuously increased; on the contrary FIIs
values undergo some variations. This indicates that there have been some
other factors which affect Sensex values.
Sensex has shown some recovery from the past recessionary period of 2008.

FII

FY - 2010
35000
30000
25000
20000
15000

#REF!

#REF!

10000

Sens
ex
FII

5000
0
40179 40210 40238 40269 40299 40330 40360 40391 40422 40452 40483 40513
-5000
-10000

Interpretation:
The period of 2010 has showed continuity in uptrend in the markets.
The BSE Sensex has surged to 20561 as on 31 st Dec. 2010 from 16356 in
Jan. 2010 gaining 4195 points and the inflows from the FII's have been
robust during this period.
The total FII inflow during this period has been to the tune of Rs. 179674
crs.

Sen
FII

FY-2011
25000
20000
15000
10000
Axis Title

#REF!

#REF!

5000
0
Nov-10

Jan-11

Feb-11

Apr-11

Jun-11

Jul-11

Sens
ex
FII

Sep-11 Nov-11 Dec-11

-5000
-10000
Axis Title

Interpretation :
The period of 2011 has shown a mix trend in sensex values.
From Jan to March 2011 March it has been decreased and then follow a
continuous downtrend and reached 15454,and the inflows from the FII's
have also been not so good during this period.
The total FII inflow during this period has been to the tune of Rs. 28071 crs.
There had been 2 months in this period where FIIs inflow is maximum
i.e.10652 & 21872 in the months of July and December.

Sen
FII

SensexVal
25000

20000

15000
SensexVal
10000

5000

Interpretation:

Above line chart shows the Sensex values from Jan08 to Dec 2011.

There has been strong downfall in the value of Sensex during the year 2008,
because of the global recession.

In the next year the Sensex has been recovered much from the recessionary
pressures of 2008, in the month of Dec 2010 it has reached the value of
20560 which was its life time high.

Again in the year of 2011 it starts declining and reached the level of 15454
in Dec 2011.

FII
60000
50000
40000
30000
20000
10000
0
-10000
-20000
-30000

Interpretaion:
Above line chart shows different inflows and outflows of Foreign
Institutional Investments in India.
Foreign investors have been continuously investing in India because only in
the year of 2008 outflow of investments were there otherwise there were
inflows in the country.
The highest inflow of foreign capital was in the month of Dec 09 which was
around 48682 crores.

FII

FY 2008-2011
60000
50000
40000
30000
SensexVal
20000

FII

10000
0
-10000
-20000
-30000

Interpretation:
The above chart shows the relative effect of Foreign Institutional
Investments on BSE Sensex from Jan 2007 to Dec 2011 we can see that
how the FII investments have affected the movement in the Indian Markets.
Also the study supports this fact as the correlation between the two is
positive (.403) Thus, FII investments play an important role in our Indian
Markets.
This being an important factor should always be tracked upon. the period of
2008 was a period of pain due to economic crisis in the global economy, this

recessionary period had severe impact on the Indian Markets too as the
global investors sell-off was seen.
The period of 2009 saw simultaneous recovery due to reassurance by the
Government in the form of relief packages and the recovery in the economy
itself.
The period of 2010 has been the continuity of the recovery for the Indian
Markets as we are a growing economy with lots of potential.
The GDP of India is on constant rise, the business prospects and political
stability all are attracting the foreign investors to be a part of the Indian
Markets.

FINDINGS:
After the analysis following are the findings of the study:
1) There is a positive and significant correlation (.403) between Foreign
Institutional Investments and the value of sensex, which states that FIIs inflows
and outflows, has significant impact on BSE Sensex.
2) Determinants of the FIIs are Impact cost, Non promoter holding, Market
return.
3) In bearish trend of 2008 the volatility in Indian Stock indices due to FIIs is more
than in bullish trend of 2009. No doubt FII inflow is more in 2009. The domestic
investors were also playing an important role in 2009 but in 2008 FIIs is
influencing market more as domestic investors are not in the market.

Recommendations:
After the analysis of the project study, following recommendations can be made:
1) Simplifying procedures and relaxing entry barriers for business activities and
providing investor friendly laws and tax system for foreign investors.

2) Allowing foreign investment in more areas. In different industries indices the

FIIs should be encouraged through different patterns like futures, options, etc.
3) Somewhere, a restriction related to the track record of Sub- Accounts is also to
be made on the investors who withdraw money out of the Indian stock market who
have invested with the help of participatory notes.
4) We have to modernize and also have to save our culture. Similarly the laws
should be such that it protects domestic investors and also promote trade in country
through FIIs.
5) Encourage industries to grow to make FIIs an attractive junction to invest.

Limitation:

There are certain limitations in the study which is to be conducted. Some of these
limitations are discussed below:1. There can be some other determinants which may affect the stock market
volatility, but not taken into account in this study.

2. The data to be analyzed will be collected for a period of four years only which is
a short interval when analyzing the impact of FIIs on Indian Stock Exchange.
3. As the data is to be analyzed on monthly basis so it may lead to some error if it
is analyzed on weekly or daily analysis as this analysis provides more data and
hence better analysis can be done.