A PROJECT REPORT ON VOLATILITY IN INDIAN STOCK MARKET AND FOREIGN INSTITUTIONAL INVESTOR

SUBMITTED BY CHOPADA PRANJAL VASANT

THIRD YEAR BACHELOR OF COMMERCE (FINANCIAL MARKETS) SEMESTER-V 2012-13

MODEL COLLEGE, DOMBIVALI UNIVERSITY OF MUMBAI OCTOBER-2012

A PROJECT REPORT ON VOLATILITY IN INDIAN STOCK MARKET AND FOREIGN INSTITUTIONAL INVESTOR

SUBMITTED TO THE UNIVERSITY OF MUMBAI IN PARTIAL FULFILLMENT FOR THE AWARD OF THE DEGREE OF BACHELOR OF COMMERCE FINANCIAL MARKETS SEMESTER V

BY CHOPADA PRANJAL VASANT

MODEL COLLEGE, DOMBIVALI UNIVERSITY OF MUMBAI OCTOBER 2012

TABEL OF CONTENTS
DESCRIPTION SR NO. 1. CERTIFICATE 2. 3. 4. 5. 6. DECLARATION ACKNOWLEDGEMENT LIST OF ABBREVATIONS LIST OF CHARTS / GRAPHS CHAPTER. 1 1 MARKET AND FOREIGN INSTITUTIONAL INVESTORS. 7. CHAPTER. 2 INDIAN STOCK MARKET A THEORETICAL VIEW 8. CHAPTER. 3 IMPACT OF FIIs ON STOCK MARKET INSTABILITY 9. CHAPTER. 4 CONCLUSION 10. ANNEXURE MILESTONES OF FII IN INDIAN STOCK MARKET 11. BIBLIOGRAPHY 12. WEBLIOGRAPHY PAGE NO. I II
III

IV V

30

37 41 44 45

DECLARATION
I, PRANJA CHOPDA STUDENT OF L BACHELOR OF COMMERCE, FINANCIAL MARKETS, SEMESTER V OF KERALEEYA SAMAJAM DOMBIVALIS MODEL COLLEGE, HEREBY DECLARE THAT I HAVE COMPLETED PROJECT REPORT ON VOLATILITY IN INDIAN STOCK MARKET AND FOREIGN INSTITUTIONAL INVESTOR FOR THE ACADEMIC YEAR 2012-13.

THE INFORMATION SUBMITTED IS TRUE AND ORIGINAL TO THE BEST OF MY KNOWLEDGE.

PRANJAL CHOPADA BACHELOR OF COMMERCE FINANCIAL MARKETS

ACKNOWLEDGEMENT
I would like to extent my sincere gratitude to all those people who have helped in the successful completion of my project entitled VOLATILITY IN INDIAN STOCK MARKET AND FOREIGN INSTITUTIONAL INVESTORS
I would also like to express my deep sense of my gratitude to Mrs. REENA PILLAI, the faculty member, for her help and untrying efforts constant inspiration and stimulating guidance to me in my academics endeavor and in my project.

I would also like to thank the college for giving me this opportunity for doing this project. I would also like to thank my family for giving me the support to do the same.
I would also like to express my sincere thanks to all my friends who help me in finding the information and support for the successful completion.

PRANJAL CHOPADA

LIST OF ABBREVATION
BSE : Bombay Stock Exchange CAPM : Capital Asset Pricing Model CMR : Call Money Rate EMEs : Emerging market economies EMEs : Emerging Market Economies FII : Foreign Institutional Investment FIIN : Net Foreign Institutional Investment FIIP : Foreign Institutional InvestmentPurchase FIIS : Foreign Institutional Investment-Sale FPI : Foreign Portfolio Investment GDP : Gross Domestic Product IIP : Index of Industrial Production KYC : Know Your Client NRIs : Non-Resident Indians NSE : National Stock Exchange OCBs : Overseas Corporate Bodies QIPs : Qualified Institutional placements RBI : Reserve Bank of India SEBI : Securities and Exchange Board of India VAR : Vector Auto Regression

LIST OF TABELS / GRAPHS

Sr No. 1. 2. Table Particular NO. OF REGISTERED FIIs IN INDIA FIIs INFLOWS AND SENSEX MOVEMENT FREQUENCY DISTRIBUTION OF FII HOLDINGS IN SENSEX COMPANIES FOREIGN INVESTMENT IN VARIOUS 4. COUNTRIES IN TERMS OF THE % OF GLOBAL INVESTMENT IN US$ VOLATILITY OF STOCK MARKET 5. RETURNS AS PER TRADITIONAL MEASURES(DAILY DATA)

3.

Sr No. 1. 2.

Graph particulars NUMBER OF REGISTERED FIIs Debt and Equity FII flow

CHAPTER 1 Volatility in Indian Stock Markets and Foreign Institutional Investors

The safe way to double the money is to fold it over once and put it in your pocket.

CHAPTER: 1 AND FOREIGN INSTITUTIONAL INVESTORS

Many developing countries, including India, restricted the flow of foreign capital till the early 1990s and depended on external aid and official development assistance. Later, most of the developing countries opened up their economies by dismantling capital controls with a view to attracting foreign capital, supplementing it with domestic capital to stimulate domestic growth and output.

Since then, portfolio flows from foreign institutional investors (FII) have emerged as a major source of capital for emerging market
economies (EMEs) such as Brazil, Russia, India, China and South

Africa. Besides, the surge in foreign portfolio flows since 1990s can be attributed to greater integration among international financial markets, advancement in information technology and growing interest in EMEs among FIIs such as private equity funds and hedge funds so as to achieve international diversification and reduce the risk in their portfolios.

Economic growth is a function of, among other things, capital

formation. As FII flows are a source of non-debt creating capital for

the economy, many EMEs have been competing with each other to

attract such flows through flexible investment norms/regulations or by

offering fiscal sops. Further, FIIs have been assured decent returns

on their investments, enabling continuous and sustainable investment

flows.

FII flows into India registered substantial growth from a meager US$4 million in 199293 to over US$ 32 billion in 201011 (SEBI, 2011:
76). FII inflows underwent a sea-saw movement in India during the last decade. They registered spectacular growth especially since the

middle of 2003 due to the higher growth rate in Indian GDP, robust
corporate performance and an investment-friendly environment.

Portfolio investment flows into India turned negative (outflow of US$

12 billion) during 200809 (ibid.) mainly due to the heightened risk aversion of foreign investors, emanating from the global financial

meltdown.

Ever since foreign portfolio investors were allowed to invest in Indian financial markets in September 1992, there have been extensive deliberations on the impact of such flows. It is said that portfolio flows from FIIs inject global liquidity into the capital markets, raise the priceto-earnings ratios, thereby reducing the cost of capital. This, in turn,
leads to further issues of equity capital and stimulates investment

growth in the host economy, apart from bringing in best international corporate governance practices. Yet, FIIs have been targets of criticism due to characteristics such as return chasing behaviour,

herd mentality, hot money flows, short-term speculative gains and their influence on domestic policy-making.

Though numerous research studies have been conducted in respect

of FII flows into India, most of them have been confined to assessing
the impact of such flows on stock markets. Very few studies have

focused on the overall impact of FII flows on all segments of the Indian financial markets, viz., the capital market, the foreign
exchange market, the money market and other macro-economic variables, such as inflation, money supply and Index of Industrial

Production (IIP). Given this background, it is all the more relevant to

undertake a cause and-effect study of FII flows into Indian financial

markets in a holistic manner, by considering various macro-economic parameters, such as IIP, interest rates, inflation, exchange rates,

apart from the BSE Sensex, so as to enable policymakers to take

informed decisions in this regard. The present study examines the

causes and effects of FII net flows into Indian financial markets with
the support of empirical data for the period April 2003March 2011,

i.e., a time span of eight years, covering the period before, during and after the eruption of the global financial crisis.

ABOUT THE REPORT

Title of the study:

The present study is titled as A PROJECT REPORT ON Volatility in India n Stock Markets and Foreign Institutional Investors. The study made with special reference to Foreign Institutional Investors.

Objectives of Study:

To study in depth FDI & FII & its role in Indian stock market.
To know the changing scenario of Indian stock market after FII

investment and various aspects of FII.

Data and Methodology:

For the purpose of the present study Secondary data were used. The data is collected from Books , Journals & websites.

Limitations of the Study:

The study has got all the limitations of using Secondary data

and Inferences were made based on that.

SCOPE OF THE STUDY:

The report examines The Impact of Foreign Institutional Investments and Foreign Direct Investment on Equity Stock Market in India. The
scope of the research comprises of information derived from secondary data from various websites. The various information and statistics were derived from the websites of BSE, NSE, Money

Control, RBI and SEBI. Sensex and Nifty was a natural choice for
inclusion in the study, as it is the most popular market indices and

widely used by market participants for benchmarking.

Chapter Layout:

The Present study is arranged as follows.

Chapter 1 Gives an Introduction to volatility in Indian stock market and foreign institutional investors.

Chapter 2 Deals with the Theoretical view of Indian Stock Market.

Chapter 3 Deals with the impact of FIIs on stock market instability.

Chapter 4 Summarizes the result of study.

Chapter 5 Annexure - milestones of foreign institutional investment in Indian stock market

CHAPTER 2 DEALS WITH INDIAN STOCK MARKET A THEORETICAL VIEW

If you want to rear financial blessings, you have to sow financially.

CHAPTER 2.
INDIAN STOCK MARKET - A THEORETICAL VIEW
Diversifying globally i.e., holding a well diversified portfolio of securities from around the globe in proportion to market
capitalizations, irrespective of investors country of residence, has

long been advocated as means to reduce overall portfolio risk and maximize risk-adjusted returns by the traditional capital asset pricing model (CAPM). Foreign investment inflow depends on returns in the
stock market, rates of inflation (both home and foreign), and extant risk. In terms of magnitude, the impact of stock market returns and

the ex-ante risk turned out to be the key determinants of FII inflows. An investment will always carry the consideration of risk factor in its risk-return behaviour. In an investment friendly environment the bullish behaviour dominates the trends and at a given huge volume of investments, foreign investors may 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 (Gordon & Gupta, 2003). Hence, there is
a possibility of bi-directional relationship between FII and the equity

returns. Although FII flows help supplement the domestic surplus resources and augment domestic investments without rising the foreign debt of the recipient countries, helps to maintain stabilized
balance of payments particularly current account segment. Entry of

FII may also leads to decrease the required rate of return for equity, and improve stock prices of the host economies / nations. However, there are uncertainties about the defenselessness of recipient countrys capital markets to such flows. FII flows, often referred to as
'hot money' (i.e., short-term and overly tentative), are extremely unstable in character compared to other forms of capital flows.

Foreign portfolio investors are regarded as 'fair weather friends' who come in when there is money to be made and leave at the first sign of
impending trouble in the host country thereby destabilizing the domestic economy of the recipient country. Often, they have been

blamed for exacerbating small economic problems in the host nation by making large and concerted withdrawals at the slightest hint of economic weakness. It is also alleged that as they make frequent marginal adjustments to their portfolios on the basis of a change in their perceptions of a country's solvency rather than variations in underlying asset value, they tend to spread crisis even to countries
with strong fundamentals thereby causing 'contagion' in international

financial markets.

Several research studies on FII flows to emerging market economies

(EMEs) over the world have found that financial market infrastructure like market size, market liquidity, trading cost, extent of informational
dissemination etc., legal mechanisms relating property rights,

harmonization of corporate governance, accounting, listing and other rules with those followed in developed economies etc., are some of
the important determinants of foreign portfolio investments into

emerging markets. The Securities and Exchange Board of India (SEBI) and Reserve Bank of India (RBI) have initiated several measures such as allowing overseas pension funds, mutual funds,
investment trusts and asset management companies, banks, institutional portfolio managers, universal funds, endowments, easing

the norms for registration of FIIs, reducing procedural delays, lowering the fees of registration, mandating strict disclosure norms,
improved regulatory mechanisms etc. all these are supported by

strong fundamentals, have made India as one of the attractive

destinations for FIIs. The following table highlights the registered FIIs

in India during the period from 2006 to 2010.

From the above table it is clear that there is constant growth in the

number of registered FIIs in India. In the year 2006(January, 2006), the number of registered FIIs were 833 only. The same number has
been increased to 1697 by the year 2010 (January 2010). The

number has been increased by more than 100 per cent. In spite of the global financial crisis the number of registered FIIs has shown a significant increase. Irrespective of the situation in Indian stock

markets these FIIs has earmarked their presence. But the investment made by FIIs has experienced drastic decline in the recent past. This is mainly because of the global economic meltdown. Though the number of registered FIIs increased the net investments were not increased proportionately. The important reasons for growth in
number of registered FIIs are easing of registration norms, lowering

the registration fees, reducing the procedural delays. The most important is strong economical foundation of Indian economy. Though the entire globe affected with the global financial meltdown, India could face the global financial meltdown effectively. Compared too many other markets Indian markets are offering attractive returns on the investments. The growth rates of Gross Domestic Product (GDP) even during the financial crisis was attractive than many other economies. This resulted in increased number of registered FIIs in the last half decade. The following table (Table 2) provides a cross
section of data on the FIIs inflow and stock market movement from

the year 2000 to 2011(31stMay).

The FIIs and hedge funds had

pulled out money mainly due to higher interest rates in U.S. after Federal Reserve increased 7interest rates to 4.5% under their new governor. Similar changes took place many times in the history since opening and few times in the study.

Additional the

indicators the

and two

data

reflect

that

movements

in

SENSEX during

years have clearly been driven by the

behaviour of foreign institutional investors (FIIs), who were

responsible for net equity purchases of as much as $6.6 and $8.5 billion respectively in 2003 and 2004. The Pearson correlation

values
(The

indicate

positive
and

correlation
the

between
of

the

foreign

institutional

investments

movement

Sensex.

value of Pearson correlation is 0.570894)

The above table (Table:3) shows the proportion of investment made by the FIIs in Sensex scrips. It is observed that almost

half of the companies are equipped with FII investment to the tune of 10% to 20%. Nearly 25% of the companies (Sensex 30 scrips) are having the FII investment between 30% and 40%. Another important thing is all the thirty scrips are showing the presence of foreign institutional investment. The pattern of change is
also very minimal in respect of these companies regard to FIIs are

concerned. It can be understood that the FIIs may enter and exit
frequently form the other scrips but not the Sensex scrips. The above table depicts the consistency of FIIs over a period of time.

From the above table (Table:3) it can be understood that fifty percent of the companies which are included in BSE SENSEX are having
fifteen to twenty percent of capital from the overseas. This

indicates the level of influence by the foreign institutional investment on those companies particularly and on the stock market in general. Any withdrawal of foreign institutional investment may result in huge volatility in the market as well as share price movements. Similarly, any increase in the shareholding pattern by the foreign institutional investors may result huge rally in the market. The

psychology of domestic investors is also affected by the decisions of foreign institutional investors.

Being

an

agricultural

based

economy

India

has

faced

large

number

of

problems

while establishing industries. After

independence, to establish core industries such as Iron & Steel,

Cement, Electrical and construction of Roads, buildings etc. it took

decades. Indian economy has experienced the problem of capital in many instances. Particularly, to start large scale industries where capital requirement was more. While planning to start the steel
companies under government control, due to shortage of

resources it has taken the aid of foreign countries. Likewise we have received aid from Russia, Britain and Germany for establishing
Bhiloy, Rourkela and Durgapur steel plants. The foreign institutional investment was increased during the years 2006 and

2007. Later on, due to global financial crisis the investments by FIIs were reduced.

ADVANTAGES OF FII IN INDIAN MARKET

Enhanced flows of equity capital FIIs have a greater appetite for equity than debt in their asset

structure. The opening up the economy to FIIs has been in line with the accepted preference for non-debt creating foreign inflows over

foreign debt. Enhanced flow of equity capital helps improve capital structures and contributes towards building the investment gap.

Managing uncertainty and controlling risks. FII inflows help in financial innovation and development of

hedging instruments. Also, it not only enhances competition in

financial markets, but also improves the alignment of asset prices to

fundamentals.

Improving capital markets. FIIs as professional bodies of asset managers and financial

analysts enhance competition and efficiency of financial markets.

Equity market development aids economic development. By increasing the availability of riskier long term capital for

projects, and increasing firms incentives to provide more information

about their operations, FIIs can help in the process of economic

development.

Improved corporate governance. FIIs constitute professional bodies of asset managers and

financial analysts, who, by contributing to better understanding of firms operations, improve corporate governance. Bad corporate
governance makes equity finance a costly option. Also, institutionalization increases dividend payouts, and enhances

productivity growth.

DISADVANTAGES OF FII IN INDAIN MARKET

Problems of Inflation: Huge amounts of FII fund inflow into the

country creates a lot of demand for rupee, and the RBI pumps the

amount of Rupee in the market as a result of demand created. Problems for small investor: The FIIs profit from investing in

emerging financial stock markets. If the cap on FII is high then they can bring in huge amounts of funds in the countrys stock markets and thus have great influence on the way the stock markets behaves, going up or down. The FII buying pushes the stocks up and their selling shows the stock market the downward path. This creates
problems for the small retail investor, whose fortunes get driven by

the actions of the large FIIs. Adverse impact on Exports: FII flows leading to appreciation of

the currency may lead to the exports industry becoming uncompetitive due to the appreciation of the rupee. Hot Money: Hot money refers to funds that are controlled by

investors who actively seek short-term returns. These investors scan

the market for short-term, high interest rate investment opportunities. Hot money can have economic and financial repercussions on countries and banks. When money is injected into a country, the

exchange rate for the country gaining the money strengthens, while the exchange rate for the country losing the money weakens. If money is withdrawn on short notice, the banking institution will experience a shortage of funds.

FII and FDI connection: The relationship between FII and FDI (Foreign Direct Investment) is
intertwined. In 1998 1999 a number of reforms were initiated, that were designed specifically for attracting FDI. In India FDI is allowed

through FIIs. This is done through private equity, preferential allotment, joint ventures and capital market operations. The only industries in which FDI isnt allowed are arms, railways, coal, nuclear
and mining. 100% financing by FDI is allowed in infrastructural

projects such as construction of the bridges and the tunnels. In the financial sector, insurance and banking operations can have foreign investors.

Differences between FII & FDI:

FDI and FIIs are two important sources of foreign financial flows into
a country. FDI (Foreign Direct Investment) the acquisition abroad of

physical assets such as plant and equipment, with operating control residing in the parent corporation. It is an investment made to acquire
a lasting management interest (usually 10 percent of voting stock) in

an enterprise operating in a country other than that of the investor, the investors purpose being an effective voice in the management of the enterprise. It includes equity capital, reinvestment of earnings, other long-term capital, and short-term capital. Usually countries regulate such investments through their periodic policies. through the Foreign Investment Promotion Board). In India such regulation is usually done by the Finance Ministry at the Centre

Types of Investments: FDI typically brings along with the financial investment, access to
modern technologies and export market. The impact of the FDI in

India is far more than that of FII largely because the former generally involve setting up of production base - factories, power

would

plant, telecom networks, etc. that enables direct generation of

employment. There is also multiplier effect on the back of the FDI

because of further domestic investment in related downstream and upstream projects and a host of other services. Korean Steel maker Pascos USD 8 billion steel plants in Orissa would be the largest FDI in India once it commences. Maruti Suzuki has been an exemplary case in the India's experience. However, the issue is that it puts
an to impact on local entrepreneur as he may not be able

always successfully compete in the face of superior technology and financial power of the foreign investor. Therefore, it is often regulated that Foreign Direct Investments should ensure minimum level of local content, have export commitment from the investor and ensure foreign technology transfer to India.FII investments into a country are usually not associated with the direct benefits in terms of creating real investments. However, they provide large amounts of capital through the markets. The indirect benefits of the market include alignment of local practices to international standards in trading, equities research. These enable markets to become more deep, liquid, feeding in more information better into prices resulting in a risk management, new instruments and

allocation

of

capital

to

globally

competitive

sectors

of

the

economy. Foreign Institutional Investors Since, these portfolio flows can technically reverse at any time, the need for adequate and appropriate economic regulations are imperative.

Government Preference: FDI is preferred over FII investments since it is considered to be the most beneficial form of foreign investment for the economy as a whole. Direct investment targets a specific enterprise, with the aim of enhancing capacity and productivity or changing its management
control. Direct investment to create or augment capacity ensures

that the capital inflow translates into additional production. In the case of FII investment that flows into the secondary market, the effect is to increase capital availability in general, rather than availability of capital to a particular enterprise. Translating
by someone other than the foreign investor some

an

FII

inflow into additional production depends on production decisions

local

investor has to draw upon the additional capital made available via FII inflows to augment production. In the case of FDI that flows in for acquiring an existing asset, no addition to production capacity takes place as a direct result of the FDI inflow. Just like in the case of FII inflows, in this case too, addition to production capacity does not
result from the action of the foreign investor the domestic seller has

to invest the proceeds of the sale in a manner that augments

capacity or productivity for the foreign capital inflow to

boost

domestic FII

production.

There

is

a widespread

notion

that

inflows creating volatility

are

hot

money

that

it

comes

and

goes,

in

the

stock

market

and

exchange

rates.

While this

might be true of individual funds, cumulatively, FII inflows have only provided net inflows of capital

Stability: FDI tends to be much more stable than FII inflows. Moreover, FDI brings not just capital but also better management and governance practices and, often, technology transfer. The know-how transferred along with FDI is often more crucial than the capital per se. No such benefit accrues in the case of FII inflows, although
the search by FIIs for credible investment options improve accounting and governance practices has tended listed to among

thus

Indian companies.

Types of FIIs: FII investments in India can be of the TWO types:

1. Normal equity and FIIs: FII allocation of its (including total investment between

non-equity instruments

dated

government

securities and treasury bills in the Indian capital market) should not exceed the ratio of 70:30. Equity related instruments would include fully convertible debentures, convertible portion of partially convertible debentures and tradable warrants.

2. 100% Debt FIIs: FII that

can invest the entire corpus

in dated

government securities including

treasury

bills,

non-convertible

debentures/bonds issued by an Indian company subject to limits, if any. A FII needs to submit a clear statement that it wishes to be registered as FII/sub-account under 100% debt routes.

Entities which can register as FIIs:

Entities on behalf twenty of "broad based" funds (fund having more than who propose to invest their proprietary funds or

investors with no single investor holding more than 10 per cent of the shares or units of the fund) or of foreign corporate and individuals and belong to any of the under given categories can be registered for FII. Pension Funds Mutual Fund Investment Trust Insurance or reinsurance companies Endowment Funds University Funds Foundations or Charitable Trusts Charitable Societies who propose to in On their own behalf, and

Asset Management Companies Nominee Companies Institutional Portfolio Managers Trustees Power of Attorney Holders Banks Foreign Government Agency Foreign Central Bank International or Multilateral Organization or an Agency

Trends in FIIs:
In 1993, when investments in FII s were introduced, Picket

Umbrella Trust Emerging Markets Fund, an institutional investor from Switzerland, Indian market. While in 1994, no new registrations were reported, between 1995 and 2003, an average of 51 new FIIs began operations in the country each year. The graph below clearly indicates the steep increase in number of FII to the number of
registered FIIs at the end of each calendar year). Currently, there are

1,695 registered FIIs and 5,264 registered sub accounts (As on 11th September, 2009).

Since 1993 when FIIs were first allowed to enter the India,
there has always been a preference towards investing in equity

than debt. The following graph shows the debt and equity FII flows.

FII investments through QIPs:

QIPs are private placements or issuances of certain specified securities buyers in by Indian listed companies with the to qualified of institutional SEBI guidelines.

accordance

provisions

Qualified Institutional placements or QIPs were introduced in mid2006.

Indian companies that are listed on stock exchanges having

nationwide terminals the BSE and NSE have been raising capital through the QIP route. primarily because appetite, possess the general expertise and have the experience to make an informed decision. In August 2008, SEBI liberalized the pricing conditions for QIPs by
reducing the period of reckoning stock earlier price, prior to the to an average date, of two weeks the relevant against

Quarterly entities

Institutional buyers are preferred have a large risk

these

requirement of taking the higher of the previous six months or 15 days average price. The pre-existing slowdown in the markets led to
attractive valuations for the investors.
Companies have taken advantage of this revision in pricing

guidelines .Unitech, raised Rs 1,621 cores in April 2009 at Rs

38.50 July 2009 at Rs 81 per share. Other companies which successfully per share, and again raised Rs. 2,760 crores in

raised capital through QIPs were HDIL, Shobha Developers, Network 18, Dewan Housing and Bajaj Hindustan. Most of the companies
which came out with QIPs were in the real-estate/infrastructure sector. However, some companies like GMR Infrastructure were not GVK so successful and had to withdraw their issue and

Power and Infrastructure had to scale down by nearly 60% due

to on problems in the valuations. life Domestic away institutional from the QIPs investors, especially insurers kept

valuation concerns.

However, FIIs which were net sellers had

purchased Rs 9,500 crores in the same period. This led several FIIs to pick up the target stocks via QIP before the July 6thBudget and offload the same after the budget session. As per a CRISIL study, 10 out of 13 QIPs are currently quoting below the offer price. Since most of QIPs were in the

reality and infrastructure sectors, one explanation is that FIIs came in expecting some quick gains from significant sops to the infrastructure and housing sectors in the Budget. It is also possible that the rush
for QIPs was driven largely by short-term considerations, where the FIIs hedged their bets by taking short positions in the issuers

stock even as they bought into the offers.

New sources of FII funds:

The Securities and Exchange Board of India is in talks with the Cayman Islands Monetary Authority (Cima), over allowing funds based in the Caribbean into the country. Cayman Islands is one of the worlds largest tax havens and a lot of global hedge funds are based out of Cayman Islands Sebi has received numerous applications from Cayman-based funds since June when Cima was admitted as a full member of the international body of securities market regulators, the International Organization of Securities Commissions (Iosco). Iosco's constituents regulate more than nine percent of the world'ssecurities markets. Funds from Cayman Islands

were usually not favoured by SEBI owning to lack of transparency and difficulty in establishing the owner base. Consequently, these investments were viewed unfavorably and any Cayman fund seeking to invest in India had to be carefully examined.
Post which Caymans grades of admission to Iosco, Sebi is now

determining investment funds can be admitted expeditiously

and which should be examined more carefully. Presently, there are 19 registered foreign institutional investors from Cayman Islands, taking the total to 19. The two recent additions have been Fir Tree Capital Opportunity Master Fund and Fir Tree Value Master Fund. The fund base of Cayman Islands is huge. There are about 9870 funds based there. Indian markets can expect more inflow from Cayman Island if SEBI agrees to let them come in.

REASONS FOR FDI:

Invest by Companies Overseas Companies choose to invest in foreign markets for a number of reasons, often the same reasons for expanding their operations within their home country. The economist John Dunning has identified four primary reasons for corporate foreign investments.

Market seeking -

Firms may go overseas to find new buyers for goods and services. Market-seeking may happen when producers have saturated sales in

their home market, or when they believe investments overseas will bring higher returns than additional investments at home. This is often the case with high technology goods. Resource seeking Put simply, a company may find it cheaper to produce its production a

foreign subsidiary- for the purpose of selling it either at home or in foreign markets. The foreign facility may be able to obtain superior or less costly access to the inputs of production (land, labor, capital and natural resources) than at home. Strategic asset seeking Firms may seek to invest in other companies abroad to help build strategic assets, such as distribution networks or new
technology. This may involve the establishment of partnerships with other existing foreign firms that specialize in certain aspects of

production. Efficiency seeking Multinational companies may also seek to reorganize their overseas holdings in response to broader economic changes.

Fluctuations in exchange rates may also change the profit

calculations of a firm, leading the firm to shift the allocation of

its resources.

ACTS AND RULES:

FII registration and investment are mainly governed by SEBI (FII) Regulations, 1995.

ELIGIBILITY FOR REGISTRATION AS FII: Following entities / funds are eligible to get registered as FII: 1. Pension Funds 2. Mutual Funds 3. Insurance Companies 4. Investment Trusts 5. Banks 6. University 8. Foundations 9. Charitable Trusts / Charitable Societies
Further, following entities proposing to invest on behalf of broad

Funds

7. Endowments

based funds (a fund established or incorporated outside India, which

has at least twenty investors with no single individual investor holding more than 10% shares or units of the fund), are also eligible to be

registered as FIIs:

Asset Management Companies Institutional Portfolio Managers Trustees Power of Attorney Holders

INVESTMENT OPPORTUNITIES FOR FIIs

The following financial instruments are available for FII investments a) Securities in primary and secondary markets including shares, debentures and warrants of companies, unlisted, listed or to be listed on a recognized stock exchange in India; b) Units of mutual funds; c) Dated Government Securities; d) Derivatives traded on a recognized stock exchange; e) Commercial papers. Investment limits on equity investments
a) FII, on its own behalf, shall not invest in equity more than 10% of

total issued capital of an Indian company.

b) Investment on behalf of each sub-account shall not exceed 10% of

total issued capital of an India company.

c) For the sub-account registered under Foreign Companies/

Individual category, the investment limit is fixed at 5% of issued capital. These limits are within overall limit of 24% / 49 % / or the sectoral caps a prescribed by Government of India / Reserve Bank of India.

Investment limits on debt investments

The FII investments in debt securities are governed by the policy if the Government of India. Currently following limits are in effect: For FII investments in Government debt, currently following limits are applicable: For corporate debt the investment limit is fixed at US $ 500 million.

TAXATION:
The taxation norms available to a FII are shown in the table below. Nature of Income Long-term capital gains Short-term capital gains Dividend Income
Interest Income

Tax Rate 10% 30% Nil

20%

Long term capital gain: Capital gain on sale of securities held for a period of more than one year.
Short term capital gain: Capital gain on sale of securities held for a

period of less than one year.

CHAPTER 3 Impact of FIIs on Stock Market Instability

The real measure of your wealth is how much youd be worth if you lost all your money.

CHAPTER 3 IMPACT OF FIIS ON STOCK MARKET INSTABILITY

Investment of FIIs are motivated not only by the domestic and external economic conditions but also by short run expectations shaped primarily by what is known as market sentiment. The element of speculation and high mobility in FII investment can increase the volatility of stock return in emerging markets. In fact,
or

widely
about

held perception
the emerging

among
equity

academicians
markets

and

practitioners

is that price

return indices in these markets are frequently subject to extended deviations from fundamental values with subsequent reversals and that these swings are in large part due to the influence of highly mobile foreign capital. Volatility is an unattractive feature that has adverse implications for decisions pertaining to the effective allocation of resources and therefore investment. Volatility makes investors averse to holding stock due to increased uncertainty. Investors in turn demand higher risk premium so as to ensure against increased uncertainty. A greater risk premium of In addition, great volatility may increase the option to wait thereby
delaying investment. Also weak regulatory system in emerging

implies physical

higher

cost

capital

and

consequently

lowers

investment.

market

economies

(EMEs)

reduce

the efficiency

of

market signals have the

and

the

processing

of

information, which

further magnifies the problem of volatility. But some researchers opposite assumption of non-disestablishing hypothesis that says FIIs have no adverse impact

Trading by FIIs happens on a continuous basis and therefore has a lasting impact on the local stock market. There is, however, surprisingly little empirical evidence on the impact of FIIs trading on
the host countrys stock return volatility, thereby making it imperative

that this aspect of local equity markets, which is important for both risk analysis and portfolio construction, be examined. This chapter attempts to fill the gap. Beside the introduction, this chapter is classified into two parts.
Part I presents the impact of foreign institutional investors on

the Indian stock market volatility. Part II shows the structure of the volatility before and after

introduction of the foreign institutional investors in Indian stock market.

The scope of the study is limited to the India which has become an attraction for FIIs in recent years, in fact the emerging markets of many developing countries have been attracting large inflows of private capital in recent years. The surge in capital flows occurred first in Latin America, then South East Asia and is now clearly visible

in South Asia. A significant feature of these capital flows is the increasing importance of foreign portfolio investment (FPI), whose buying and selling of stocks on a daily basis determines the magnitude of such capital flows. A significant improvement has
also taken place in India relating to the flow of foreign capital

during the period of post economic reforms. The major change in the capital flows particularly in Foreign Institutional Investors
(FIIs) in investments has taken place following the changes

trade and industrial policy. Over the past 15 years or so India has gradually emerged an important destination of global investors investments in emerging equity markets. In 2006, India had a share of about 0.55% of global investment which is quite high in comparison to year 2001 in which Indias share was only 0.12%. On the other hand some of the developed countries have shown a downward trend.

The foreign financial inflows, beside other factors, helped the Indian stock market to rise at a great height according to financial analysts. Sensex crossed a new high. It crossed 20000- mark in December
2007, which was 13786.91 in December 2006 and

9397.93 In December 2005. This historical movement is also due to the other parameters of the economy, which are favorable for the investment. The returns on investment are also much favorable. The profit performance of the firms High return on investment. may explain the reasons for There are other factors such as

favorable tax laws and relaxation on the caps of various kinds of investments. The policy measures and economic factors are also
the reasons for the investors confidence.

during

1981-90, period of real sector reforms, were significantly

higher than those found pre-liberalization period (i.e.1961-80). Interestingly, return and volatility increase further to 0.074 and 1.92 respectively. In era of first generation reforms financial sector reforms

(i.e. 1991-2000).It is appreciable to see from the table that the second generation reforms have brought in more cheers for the capital market as the risk (i.e. Standard Deviation of return) decreased but the stock return went up in the period. Clearly the volatility has declined in Indian stock market after year 2000.
Table 5 further reveals that the stock return has remained

around
standard

half

(0.06%) after the arrival of FIIs as compared to that

the
declined which measures the volatility has

obtained (0.15%) during 1986 to 1992 period. Simultaneously,

deviation

from 2.1598 during

percent

during

1986-92

to

1.59

percent

1992-2007. Thus, both volatility and return have declined after the

opening up of domestic stock market for FIIs. Time period 1994

to 2001 gave a serious setback to stock market performance.

cap on G-Sec Bond Markets: Currently, the cap on FII investments in the bond market is USD 6 Billion. As per the new budget, proposes to borrow Rs.4.5 lakh crore in 2009-10 to support its infrastructure and other developmental projects. This could be opened up to the FIIs so that they can take part in Indias hitherto almost closed debt market. The Indian debt markets are not fully developed and see low volumes. The lifting of the cap on FIIs will increase the traded volumes and it will also help in preventing the crowding out of investment for private enterprises.

The suggestion by SEBI to permit dollar settlements for FIIs would revolutionize the way in which they invest in the country. This will help

mitigate risks of currency fluctuations for FIIs, and help in improve the volume and liquidity of the derivatives market. With dollar
settlements, many participants, who want to take exposure to Indian markets through index buying, will be able to participate

freely. This, in turn, will give stability to Indian markets as there will be buying of underlying stocks by the sellers of these contracts to FIIs. At present, settlements in India are done in rupee denominations. As a result, a number of FIIs, who intend to trade in Nifty futures, take the Singapore route where CNX Nifty index futures are traded on SGX. About 50 per cent of the total open interest (OI) build-up in Nifty futures takes place on the SGX, which allows settlements in US dollar. This enables different types of FIIs to operate there. Also, low transaction costs due to the absence of securities transaction tax,
stamp duty and P-note complications have resulted in a gradual shift of FIIs into offshore markets. Settlements in dollar would also help in reducing the volatility in dollar-rupee conversion

value caused due to FII flows. Each time a settlement is done, a seller of futures contracts to an FII would buy an equivalent amount of underlying stocks to hedge his/her exposure due to the sale. This

would increase the trading volume and liquidity of Indian markets, once dollar settlement is allowed.

-notes etc.

To prevent the misuse of the participatory notes, there should be

group

stricter
is of

implementation
the opinion

of the
that

regulations.

Tough
for FIIs

implementation of KYC norms should be done. In the long run, the

registration procedures

should be made simpler after which P-Notes should be done away with.

CHAPTER 4 CONCLUSION

Those who start with too little money are more likely to succeed than those who start with too much. Energy and imagination are the springboards to wealth creation.

CHAPTER 4. CONCLUSION
A number of studies in the past have observed that investments by

FIIs and the movements of Sensex are quite closely correlated in India and FIIs wield significant influence on the movement of Sensex (Rangarajan 2000, Samal 1997, Pal 1998). NSE (2001) also observes that in the Indian stock markets FIIs have a disproportionately high level of influence on the market sentiments and price trends. This is so because other market participants perceive the FIIs to be infallible in their assessment of the market and tend to follow the decisions taken by FIIs. This herd instinct
displayed by other market participants amplifies the importance of

FIIs in the domestic stock market in India.

It is clear that the FIIs are influencing the Sensex movement to a

greater extent. Further it is evident that the Sensex has increased

when there are positive inflows of FIIs and there were decrease in Sensex when there were negative FII inflows. It has been perceived
in some quarters that FII flows are major drivers of stock

markets in India and hence a sudden reversal of flows may harm the stability of its markets. The nature of relationship between FII flows and Indian stock market returns can be explained in terms of cumulative informational disadvantage of foreign portfolio investors vis-a-vis domestic investors. The theory says that domestic investors

posses better than

knowledge

about

Indian

financial

markets

foreign investors and this information asymmetry leads to positive

feedback trading by the foreign portfolio investors. There is no

doubt FIIs are influencing the movement of Sensex to a greater extent.

The whole process also highlights another disturbing feature. During the post election period, the sudden volatility in the stock market and
the subsequent decline of Sensex was almost treated as a national

emergency in India by the financial media and to a certain extent, by the incoming UPA government. It is very difficult to understand why the government feels so concerned about speculative investors and the movements in Sensex. Most studies have shown that Sensex is neither a good barometer of economic fundamentals it is not an
indicator of future growth prospects of the economy. Moreover, this

study

also shows that even sharp changes in Sensex do not

necessarily indicate a significant alteration of actual shareholding pattern of different investor groups even in the Sensex companies. As
far as the real economy is concerned, the stock market has a very

limited role to play. In India, for the year 2002-03, new capital issues
by non- government public limited companies raised a combined capital of Rs 1,878 crores from ordinary shares, preference share and

debentures. This amount is only 0. 33 percent of gross domestic capital formation of the economy and about 1. 6 percent of gross domestic capital formation by private corporate sector for that year. This is not surprising because even in developed stock market s like

USA, the stock market has not been a significant source of finance

for new investments. Also, stock markets mobilize a very s mall

fraction of household financial saving in India. As the recent RBI

Handbook

of Statistics shows, investment in shares and

debentures10 and units of UTI account for only 1.37 percent of total
household financial savings for t h e y ear 2003- 04. In comparison,

bank deposits account for about 42 .8 percent of household financial savings for the same year. Under this circumstance s, it is not clear
why so much importance is given to the stock market and portfolio

investors by policy makers in India. It is high time to realize that in spite of the impression given by the financial media, movements of
imply any stock markets and Sensex do not necessarily

fundamental changes in the economy and these movements affect a very small be unfortunate if movements of speculative capital and the resultant stock market gyrations are allowed to influence macro-economic policy making in India. Results of this study show that not only the FIIs are the major players in the domestic stock market in India, but their influence on the domestic markets is also growing. Data on trading activity of FIIs and domestic stock market turnover suggest that FIIs are becoming more important at the margin as an increasingly higher share of stock market turnover is accounted for by FII trading. Moreover, the findings of this study also indicate that Foreign Institutional Investors have emerged as the most dominant investor group in the domestic
stock market in India. Particularly, in the companies that constitute

minority of the country s

population.

It will

the Bombay Stock Market Sensitivity Index (Sensex) and NSE Nifty, their level of control is very high. Dominant position of FIIs in the
Sensex companies, it is not surprising that FIIs are in a position to

influence the movement of Sensex and Nifty in a significant way.

Since FIIs are dominating the Indian Market, individual investors are

forced to accept the dictates of major FIIs and hence join the group
by entering the Mutual Fund group. Many Mutual Funds floated specific funds for the sectors favored by the FIIs. An implication of

MFs gaining strength in the Indian stock market could be that unlike individual investors, whose monies they manage, MFs can create market trends whereas the small individual investors can only follow the trends. The situation becomes quite difficult if the funds gain a vested interest in certain sectors by floating sector specific funds.
One can even venture to say that the behaviour of MFs in India has

turned the very logic that mutual funds invest wisely on the basis of well-researched strategies and individual investors do not have the time and resources to study and monitor corporate performance,
upside down. Thus, the entry of FIIs has not resulted in greater depth in Indian stock market; instead it led to focusing on only a few

sectors. Ultimately to provide a level playing field, even the domestic

investors had to be offered lower rates of capital gains tax.

CHAPTER 5 ANNEXURE

Fortune knocks once, but misfortune has much more patience.

ANNEXURE
MILESTONES OF FOREIGN INSTITUTIONAL INVESTMENT IN INDIAN STOCK MARKET

1990s to tie over its balance of payment crisis and also as a step towards globalisation.
An important milestone in the history of Indian economic reforms

happened on September 14, 1992, when the FIIs (Foreign Institutional Investors) were allowed to invest in all the securities traded on the primary and secondary markets, including shares, debentures and warrants issued by companies which were listed or were to be listed the stock exchanges in India and in the schemes floated by domestic mutual funds. ng of a single FII and of all FIIs, NRIs (NonResident Indians) and OCBs (Overseas Corporate Bodies) in any company was subject to a limit of 5% and 24% of the company's total issued capital respectively.
nvestment and to ensure that such

an investment would not become a camouflage for individual investment in the nature of FDI (Foreign Direct Investment), a condition was laid down that the funds invested by FIIs had to have at least 50 participants with no one holding more than 5%. Ever since

this day, the regulations on FII investment have gone through enormous changes and have become more liberal over time. ere allowed to make 100%
investment in debt securities subject to specific approval from SEBI as a separate category of FIIs or sub-accounts as 100% debt funds. Such investments were, of course, subjected to the fund-specific ceiling prescribed by SEBI and had to be within an overall ceiling of

US $ 1.5 billion. The investments were, however, restricted to the debt instruments of companies listed or to be listed on the stock exchanges.
ent by all FIIs was allowed

to be raised from 24% to 30% by the Board of Directors of individual companies by passing a resolution in their meeting and by a special resolution to that effect in the company's General Body meeting.
(From the year 1998, the FII investments were also allowed in the dated government securities, treasury bills and money market

instruments.

were also allowed to invest as sub-accounts of SEBI-registered FIIs. FIIs were also permitted to seek SEBI registration in respect of subaccounts. This was made more liberal to include domestic portfolio managers or domestic asset management companies. the

(40% became the ceiling on aggregate FII portfolio investment in March 2000.

specific sectoral cap in September 2001.

(As a move towards further liberalization a committee was set up

on March 13, 2002 to identify the sectors in which FIIs portfolio investments will not be subject to the sectoral limits for FDI.

was reconstituted

and came out with recommendations in June 2004. The committee had proposed that, 'In general, FII investment ceilings, if any,
may sectoral be reckoned over and above prescribed FDI

caps. The 24 per cent limit on FII investment imposed in 1992 when allowing FII inflows was exclusive of the FDI limit. The suggested measure will be in conformity with this original stipulation.' The committee also has recommended that the special procedure for raising FII investments beyond 24 per cent up to the FDI limit in a company may be dispensed with by amending the relevant regulations.

from US $ 1 billion to US $ 1.75 billion has been notified in 2004. The SEBI also has reduced the turnaround time for processing of FII applications for registrations from 13 working days to 7 working days except in the case of banks and subsidiaries.

mobilize more foreign investment through portfolio investment by FIIs. The FII portfolio flows have also been on the rise since September 1992. Their investments have always been net positive, but for 199899, their sales were more than their purchase.

CHAPTER 6 BIBLIOGRAPHY

No matter how hard you hug your money, it never hugs back.

BIBLIOGRAPHY

BOOKS: FOREIGN DIRECT INVESTMENT

BY- M. SORNARAJAH FOREIGN INSTITUTIONAL INVESTORS BY- VIJAYCHANDRA KUMAR C

MAGAZINE: INDAIN JOURNALS OF MARKETING MARCH 10, MAY

12.
NEWS PAPER: ECONOMICS TIMES TIMES OF INDIA

DNA

CHAPTER 7 WEBLIOGRAPHY

I dont think about financial success as the measurement of my success.

WEBLIOGRAPHY

http://www.moneycontrol.com/ http://www.rbi.org.in/ http://www.sebi.gov.in/ http://www.nseindia.com/