“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

CHAPTER-1

RESEARCH EXTRACT

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RESEARCH EXTRACT
The unusual rise and fall in of Bombay Stock Exchange (BSE) Sensitive Index (SENSEX) has received a lot of media attention over last couple of decades in India. Even some policy analyst has designated it as an “indicator” of India’s inevitable growth and development. In this research, attempt has been made to explore the relation especially the causal relation between BSE SENSEX and some economic indicators. Annual data has been used from 2005 to 2009 for all the variables like, SENSEX, gross domestic product (GDP), Money supply, Labor report, inflation. Efficiency of the stock markets is one of the most researched topics in financial economics. This project attempts to empirically study the relationship between economic indicators with the stock market. Since all the firms operate in a macro economy, the influence of the economic factor in determining the investment performance cannot be ignored. The interaction among the economic variables and stock market activities has been a busy area of research over a long period of time. In the Indian context there is no dearth of studies regarding determinants of share prices in terms of economic activities. This project in this regard tries to find the possible nexus between market liquidity of Bombay Stock Exchange (BSE) with some very important economic variables namely consumer price index(CPI), inflation, GDP, money supply (MY).

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CHAPTER-2

INTRODUCTION

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INTRODUCTION
The stock market is something that is greatly influenced by the state of the economy. After all, it acts as a gauge to the economy. When a nation’s economy is doing well, its stock market usually mirrors its economic growth. With this in mind, understanding the economy, or at least the basics, is important. g An economic indicator is in simple terms, the official statistical data of a certain economic factor that are published periodically by the government agencies, which an investor can use to gauge the economic situation. It allows conomic investors to analyze the past and current situation and to project the future prospects of the economy. During a recession, when there are lots of unemployed workers and idle manufacturing capacity, inflation was less of a concern. Thus, measures such as the consumer price index, which gauges inflation and the retail level, do not have the same impact on the financial markets as they would if the economy were operating at full speed. During recessionary periods, indicators that grab the headlines are housing starts, that automobile sales, and the major stock indices because they often provide the earliest clues that an economic recovery is imminent. Once business activities is in full swing, inflation measures like the CPI take centre stage again while other indicators centre receive a bit to the background background.

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There are certain times when the release of certain economic indicators is awaited with great anticipation. However, those same indicators barely get noticed at some other conditions. We have observed the relationship between stock markets and different categories of economic indicators such as: Inflation is an increase in the price of a basket of goods and services that is representative of the economy as a whole. GDP: It’s a measure of Total Income, Output and Spending of the economy. Labor market: The unemployment rate as a percentage of the total labour force will basically indicate the country’s economic state. Money Supply: The money supply is the amount of money floating around the economy and available for spending. All these economic indicators are pro-cyclic or Counter cyclic economic indicators. A counter cyclic (or countercyclical) economic indicator is one that moves in the opposite direction as the economy. A pro-cyclic indicator is one that moves in the same direction as the economy. So, if the economy is doing well, this number is usually increasing, whereas if we’re in a recession, this indicator is decreasing.

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PROFILE OF CAPITAL MARKET
The capital market is the market for securities, where companies and governments can raise long term funds. Selling stock and selling bonds are two ways to generate capital and long term funds. Thus bond markets and stock markets are considered capital markets. The capital . markets consist of the primary market, where new issues are distributed to investors, and the secondary market, where existing securities are traded. The Indian Equity Markets and the Indian Debt markets together form the Indian Capital markets Indian ts Equity Market at present is a lucrative field for investors. Indian stocks are profitable not only for long and medium-term investors but also the position traders, short term swing traders and term short-term also very short term intra intra-day traders. In India as on December 30 2007, market capitalisation (BSE 500) at US$ 1638 billion was 150 per cent of GDP, matching well with other emerging economies and selected matured markets. For a developing economy like India, debt markets are crucial sources of capital fun funds. The debt market in India is amongst the largest in Asia. It includes government securities, public sector undertakings, other government bodies, financial institutions, banks and companies. The Indian Capital Market is one of the oldest capital markets in Asia which evolved around 200 years ago.

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FEATURES OF CAPITAL MARKET
Channelization of Funds: The primal role of the capital market is to channelize investments from investors who have surplus funds to the ones who are running a deficit. The capital market offers both long term and overnight funds. Trading Platform: The primary role of the capital market is to raise longterm funds for governments, banks, and corporations while providing a platform for the trading of securities. Ready & Continuous Market: Fund-raising in the capital market is regulated by the performance of the stock and bond markets within the capital market. The member organizations of the capital market may issue stocks and bonds in order to raise funds. Investors can then invest in the capital market by purchasing those stocks and bonds. Regulation of the Capital Market: Every capital market in the world is monitored by financial regulators and their respective governance organization. The purpose of such regulation is to protect investors from fraud and deception. Financial regulatory bodies are also charged with minimizing financial losses, issuing licenses to financial service providers, and enforcing applicable laws. The Capital Market’s Influence on International Trade: Capital market investment is no longer confined to the boundaries of a single nation. Today’s corporations and individuals are able, under some regulation, to invest in the capital market of any country in the world. Investment in foreign capital markets has caused substantial enhancement to the business of international trade.

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RISK INVOLVED IN CAPITAL MARK MARKET

The capital market, however, is not without risk. It is important for investors to understand market trends before fully investing in the capital market. Any investor should consider the following factors of risk while investing in the Capital nvesting Markets: 1. VOLATILITY RISK AND RISK

OF CONTAGIONS: High volatility is the characteristic of any capital market, especially in emerging markets. They are immature and sometimes vulnerable to scandal. They often lack legal and judicial infrastructure to enforce the law. Accounting disclosure, trading and settlement practices may at he times seem overly arbitrary and naïve. Against this backdrop, many emerging markets have had to cope with unprecedented inflows and outflows of capital. The sudden withdrawal of highly speculative, short-term capital has the potential of term taking with it much of a market's price support. Such sudden flights of capital triggered by events in one emerging market can spread instantly to other markets through contagion effects even when those markets have quite different conditions. 2. LIQUIDITY RISK: Many emerging markets are small and illiquid.

Volumes of trade are quite low. This kind of thin trading often leads to higher costs because large transactions have a significant impact on the market. Thus, buyers of market. large blocks of shares may have to pay more to complete the transaction, and sellers may receive a lower price.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

3.

CLEARANCE AND SETTLEMENT RISK: Inadequate settlement

procedures still exist in many of the emerging markets. They lead to high FAIL rates. A Fail occurs when a trade fails to settle on the settlement date. 4. POLITICAL RISK: In most of the developing countries the political

systems are less stable comparative to the developed countries. This scenario does not give the political system to concentrate more on the capital market happenings and restrict any kind of malfunctions or practices. 5. CURRENCY RISK: The trade in capital markets will be highly

impacted by the fluctuations in the foreign exchange rates. The currencies of the emerging countries are not stable enough to compete with those of the developed countries. This leads towards unexpected losses for the investors in the markets. 6. LIMITED DISCLOSURE AND INSUFFICIENT LEGAL

INFRASTRUCTURE: As it is already mentioned earlier that disclosure levels will not be up to the required extent in emerging markets, the investors will not have a bright picture of the company in which they are investing, and this may lead towards losses.

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INDIAN CAPITAL MARKET
Financial regulators, such as the Reserve Bank of India & Securities & Exchange Board of India {SEBI}, oversee the capital markets in their designated jurisdictions to ensure that investors are protected against fraud, among other duties. The Prime Minister of India Dr. Manmohan Singh, on the occasion of 125 years celebrations of Bombay Stock Exchange {BSE} said, "Capital Markets are the prerequisites to the health of the economy. Indian Capital Market has now begun to transform rapidly in the past five years to offer world-class services to the investors". A capital market can provide huge impetus to the development of any economy, so it can be said that the growth and sustainability of capital markets plays an important role towards the development of the economy. It is being observed that huge fluctuations are happening in Indian Capital Market in recent past, but with the help of proper mechanism, which is being observed in India and after examining various risk factors involved in capital markets, we attempt to say that the growth which has been observed in Indian Capital Market in recent past is a realty, but not a myth. Right from the independence, thanks to steps initiated by the Indian government especially after the post liberalization era. A huge growth has been observed in the aspects of quality and quantity. Huge increase has been observed in the volumes of trade. A steady and growing market size, reliable business community, high levels of intellectual manpower, technological expertise and a dedicated reform process that has brought about impressive economic liberalization, has made India a very attractive destination for investments in capital markets. Emerging Capital Markets are financial markets that reside in the low or middle income economies or where the ratio of investable market capitalization to GNP is low. Such parameters to classify the financial market are set by the International Finance Corporation.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

The emerging capital markets are characterized by derivative markets that are small but organized. There are organized exchanges where both options and . futures contracts are traded for agricultural products, metals, local foreign currency and interest rate products. The Emerging Capital Markets are segmented from the rest of the world. This implies that different interest rates exist for the same level of risk. exist The net private capital flows to the emerging capital markets r reached 3.5% of GDP in 1995, remained strong till 1996 but witnessed a sharp fall by 1997. Structure of Indian capital market

Equity market in India: India:Stock is the type of equity security with which most people are familiar. When investors (savers) buy stock, they become owners of a "share" of a company's assets and earnings. If a company is successful, the price that investors are willing to pay for its stock will often rise and shareholders who bought stock at a lower

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

price then stand to make a capital profit. If a company does not do well, however, its stock may decrease in value and shareholders can lose money. Stock prices are also subject to both general economic and industry-specific market factors. The equity market is classified as:(a) Primary market (b) Secondary market (a) Primary market:The primary market provides the channel for creation of new securities through the issuance of financial instruments by public companies as well as government companies, bodies and agencies. (b) Secondary market:Secondary market is the market for buying and selling securities of the existing companies. Under this, securities are traded after being initially offered to the public in the primary market and/or listed on the stock exchange. The stock exchanges are the exclusive centres for trading of securities. It is a sensitive barometer and reflects the trends in the economy through fluctuations in the prices of various securities. It been defined as, "a body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating and controlling the business of buying, selling and dealing in securities". There are 23 stock exchanges in India. Listing on stock exchanges enables the shareholders to monitor the movement of the share prices in an effective manner. This assists those to take prudent decisions on whether to retain their holdings or sell off or even accumulate further. However, to list the securities on a stock exchange, the issuing company has to go through set norms and procedures.

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Debt Market in India:For a developing economy like India, debt markets are crucial sources of capital funds. The debt market in India is amongst the largest in Asia. It includes government securities, public sector undertakings, other government bodies, financial institutions, banks and companies. The debt market in India is divided into three segments, viz., Government Securities, Public Sector Units (PSU) bonds, and corporate securities. The market for Government Securities comprises the Centre, State and State-sponsored securities. Government securities (G-secs) or gilts are sovereign securities, which are issued by the Reserve Bank of India (RBI) on behalf of the Government of India (GOI). The GOI uses these funds to meet its expenditure commitments. The PSU bonds are generally treated as surrogates of sovereign paper, sometimes due to explicit guarantee and often due to the comfort of public ownership. Some of the PSU bonds are tax free, while most bonds including government securities are not tax free. The RBI also issues tax-free bonds, called the 6.5% RBI relief bonds, which is a popular category of tax-free bonds in the market. Corporate bond markets comprise of commercial paper and bonds. These bonds typically are structured to suit the requirements of investors and the issuing corporate, and include a variety of tailor- made features with respect to interest payments and redemption.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

List of Stock Exchanges in India
Bombay Stock Exchange National Stock Exchange

Regional Stock Exchanges
Ahmadabad Stock Exchange Bangalore Stock Exchange Bhubaneswar Stock Exchange Calcutta Stock Exchange Cochin Stock Exchange Coimbatore Stock Exchange Delhi Stock Exchange Guwahati Stock Exchange Hyderabad Stock Exchange Jaipur Stock Exchange Ludhiana Stock Exchange Madhya Pradesh Stock Exchange Madras Stock Exchange Magadh Stock Exchange Mangalore Stock Exchange Meerut Stock Exchange OTC Exchange Of India Pune Stock Exchange Saurashtra Kutch Stock Exchange Uttar Pradesh Stock Exchange Vadodara Stock Exchange

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Thus in a nutshell the following diagram explains what all is discussed above

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Chronology of the Indian capital markets
1830s: Trading of corporate shares and stocks in Bank and cotton Presses in Bombay. 1850s: Sharp increase in the capital market brokers owing to the rapid development of commercial enterprise. 1860-61: Outbreak of the American Civil War and ' Share Mania ' in India. 1894: Formation of the Ahmadabad Shares and Stock Brokers Association. 1908: Formation of the Calcutta Stock Exchange Association.

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The pattern of growth in the Indian capital markets in the post independence regime can be analyzed from the following graphs.

Trend in the No: of Stock Exchanges in India
25

20

No: of Stock Exchanges

15

10

5

0 1946 1961 1971 1976 1981 1986 1991 1996

Years
From the above graph we find that the number of stock exchanges in India increased at a crawling pace till 1980 but witnessed a sharp rise thereafter till 1995.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

The following diagram shows the trend in the no. of listed companies participating in the Indian Capital Market. Here again we register a sharp rise after 1980.

Trend in the No: of Listed Companies in the Indian Capital Market
9000 8000

No: of listed Companies

7000 6000 5000 4000 3000 2000 1000 0 1951 1961 1971 1975 1980 1985 1991 1995

Years

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Trading Pattern in the Indian Capital Market
There are mainly two types of transactions that are carried out in the Indian Capital Market, one is the spot delivery transactions and the other is the forward delivery transactions. The role of the broker in the Indian Capital Market is to facilitate the purchase or sale of securities and earn commission on each transaction. (a) spot delivery transactions

For delivery and payment within the time or on the date stipulated when entering into the contract which shall not be more than 14 days following the date of the contract. (b) Forward delivery transactions

Delivery and payment can be extended by further period of 14 days each so that the overall period does not exceed 90 days from the date of the contract. The latter is permitted only in the case of specified shares. The brokers who carry over the outstanding pay carry over charges which are usually determined by the rates of interest prevailing.

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The National Stock Exchange

To inject an international standard to the Indian Stock Market the National Stock Exchange was started in 1992 by the Industrial Development Bank of India, Industrial Credit and Investment Corporation of India, Industrial Finance Corporation in India, all Insurance Corporations and the selected commercial banks. The trading members and the participants constitute the players in the national Stock Exchange. The following are the advantages of the National Stock Exchange over the traditional exchanges:
• •

The NSE basically integrates the stock market trading network across the nation. The investors have the freedom to trade from any part of the nation at the same price.

Greater operational efficiency and informational efficiency can wipe out the delays in communication, late payments and the malpractices that are common in the traditional trading grounds.

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The Bombay Stock Exchange Limited
It is the oldest stock exchange in Asia and has the third largest number of listed companies in the world, with 4700 listed as of August 2007. It is located at Dalal Street, Mumbai, India. On 31 December 2007, the equity market capitalization of the companies listed on the BSE was US$ 1.79 trillion, making it the largest stock exchange in South Asia and the 12th largest in the world. With over 4700 Indian companies listed & over 7700 scripts on the stock exchange, it has a significant trading volume. The BSE SENSEX (SENSitive indEX), also called the "BSE 30", is a widely used market index in India and Asia. Though many other exchanges exist, BSE and the National Stock Exchange of India account for most of the trading in shares in India.

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Hours of operation
Session Timing

Beginning of the Day Session 8:00 - 9:00 Trading Session Position Transfer Session Closing Session Option Exercise Session Margin Session Query Session End of Day Session 9:00 - 15:30 15:30 - 15:50 15:50 - 16:05 16:05 - 16:35 16:35 - 16:50 16:50 - 17:35 17:30

The hours of operation for the BSE quoted above are stated in terms of the local time (i.e. GMT +5:30) in Mumbai (Bombay), India. BSE's normal trading sessions are on all days of the week except Saturdays, Sundays and holidays declared by the Exchange in advance.

History of BSE
The Bombay Stock Exchange is known as the oldest exchange in Asia. It traces its history to the 1850s, when stockbrokers would gather under banyan trees in front of Mumbai's Town Hall. The location of these meetings changed many times, as the number of brokers constantly increased. The group eventually moved to Dalal Street in 1874 and in 1875 became an official organization known as 'The Native Share & Stock Brokers Association'. In 1956, the BSE became the first stock exchange to be recognized by the Indian Government under the Securities Contracts Regulation Act.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

The Bombay Stock Exchange developed the BSE Sensex in 1986, giving the BSE a means to measure overall performance of the exchange. In 2000 the BSE used this index to open its derivatives market, trading Sensex futures contracts. The development of Sensex options along with equity derivatives followed in 2001 and 2002, expanding the BSE's trading platform. Historically an open-cry floor trading exchange, the Bombay Stock Exchange switched to an electronic trading system in 1995. It took the exchange only fifty days to make this transition.

BSE indices
For the premier stock exchange that pioneered the securities transaction business in India, over a century of experience is a proud achievement. A lot has changed since 1875 when 318 persons by paying a then princely amount of Re. 1, became members of what today is called Bombay Stock Exchange Limited (BSE). Over the decades, the stock market in the country has passed through good and bad periods. The journey in the 20th century has not been an easy one. Till the decade of eighties, there was no measure or scale that could precisely measure the various ups and downs in the Indian stock market. BSE, in 1986, came out with a Stock Index-SENSEX- that subsequently became the barometer of the Indian stock market. The launch of SENSEX in 1986 was later followed up in January 1989 by introduction of BSE National Index (Base: 1983-84 = 100). It comprised 100 stocks listed at five major stock exchanges in India - Mumbai, Calcutta, Delhi, Ahmadabad and Madras. The BSE National Index was renamed BSE-100 Index from October 14, 1996 and since then, it is being calculated taking into consideration only the prices of stocks listed at BSE. BSE launched the dollar-linked version of BSE-100 index on May 22, 2006.

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With a view to provide a better representation of the increasing number of listed companies, larger market capitalization and the new industry sectors, BSE launched on 27th May, 1994 two new index series viz., the 'BSE-200' and the 'DOLLEX-200'. Since then, BSE has come a long way in attuning itself to the varied needs of investors and market participants. In order to fulfil the need for still broader, segment-specific and sector-specific indices, BSE has continuously been increasing the range of its indices. BSE-500 Index and 5 sectorial indices were launched in 1999. In 2001, BSE launched BSE-PSU Index, DOLLEX-30 and the country's first free-float based index - the BSE TECk Index. Over the years, BSE shifted all its indices to the free-float methodology (except BSE-PSU index). BSE disseminates information on the Price-Earnings Ratio, the Price to Book Value Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices. The values of all BSE indices are updated on real time basis during market hours and displayed through the BOLT system, BSE website and news wire agencies. All BSE Indices are reviewed periodically by the BSE Index Committee. This Committee which comprises eminent independent finance professionals frames the broad policy guidelines for the development and maintenance of all BSE indices. The BSE Index Cell carries out the day-to-day maintenance of all indices and conducts research on development of new indices.

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Awards
• The World Council of Corporate Governance has awarded the Golden Peacock Global CSR Award for BSE's initiatives in Corporate Social Responsibility (CSR).

The Annual Reports and Accounts of BSE for the year ended March 31, 2006 and March 31 2007 have been awarded the ICAI awards for excellence in financial reporting.

The Human Resource Management at BSE has won the Asia - Pacific HRM awards for its efforts in employer branding through talent management at work, health management at work and excellence in HR through technology

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SENSEX
The Sensex is supposed to be an indicator of the stocks in the BSE. Sensex is calculated taking into consideration stock prices of 30 different companies quoted in BSE. It is calculated using the “free-float market capitalization” method. SENSEX Launched on full market capitalization method and September 01, 2003, calculation method shifted to free-float market capitalization.

Market capitalization
Market cap or market capitalization is simply the worth of a company in terms of its shares! To put it in a simple way, if you were to buy all the shares of a particular company, what is the amount you would have to pay? That amount is called the “market capitalization”. To calculate the market cap of a particular company, simply multiply the “current share price” by the “number of shares issued by the company”! Just to give an idea, ONGC, has a market cap of “Rs: 252386.96 Cr” (11/06/2010) Depending on the value of the market cap, the company will either be a “mid-cap” or “large-cap” or “small-cap” company

Free-float market capitalization
Many different types of investors hold the shares of a company. The Govt. may hold some of the shares. Some of the shares may be held by the “founders” or “directors” of the company. Some of the shares may be held by the FDI’s etc. only the “open market” shares that are free for trading by anyone; these are called the “free-float” shares. When we are calculating the Sensex, we are interested in these “free-float” shares. A particular company may have certain shares in the open market and certain shares that are not available for trading in the open market.

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According the BSE, any shares that DO NOT fall under the following criteria, can be considered to be open market shares:
• • • • • • • •

Holdings by founders/directors/ acquirers which has control element Holdings by persons/ bodies with "controlling interest" Government holding as promoter/acquirer Holdings through the FDI Route Strategic stakes by private corporate bodies/ individuals Equity held by associate/group companies (cross-holdings) Equity held by employee welfare trusts Locked-in shares and shares which would not be sold in the open market in normal course.

A company has to submit a complete report about “who has how many of the company’s shares” to the BSE. On the basis of this, the BSE will decide the “freefloat factor” of the company. The “free-float factor” is a very valuable number! If you multiply the "free-float factor" with the “market cap” of that company, you will get the “free-float market cap” which is the value of the shares of the company in the open market.

Steps to calculate the SENSEX
First: Find out the “free-float market cap” of all the 30 companies that make up the Sensex. Second: Add all the free-float market caps’ of all the 30 companies. Third: Make all this relative to the Sensex base. The value you get is the Sensex value.

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Suppose, for a “free-float market cap” of Rs.100,000 Cr... The Sensex point is 4000… Then, for a “free-float market cap” of Rs.150,000 Cr... The Sensex value will be...

100,000 4000

=

150,000 cr 6000

So, the Sensex point will be 6000 if the “free-float market cap” comes to Rs.150,000 Cr. The Sensex was 17064.95point when free-float market capitalization 1,329,153.10 Cr (11/06/2010).

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The table showing five years Opening, High, Low, Closing SENSEX Points
Year 2005 2006 2007 2008 2009 Open 5,872.48 9,422.49 13,827.77 20,325.27 9,720.55 High 6,617.15 14,035.30 20,498.11 21,206.77 17,493.17 Low 4,227.50 8,799.01 12,316.10 7,697.39 8047.17 Closing 6,602.69 13,786.91 20,286.99 9,647.31 17,464. 81

Graph showing that movements of Sensex in five years period

Candle Stick Chart
25,000.00

20,000.00

15,000.00

SENSEX Points

10,000.00

5,000.00

0.00

2005 Open High Low Closing 5,872.48 6,617.15 4,227.50 6,602.69

2006 9,422.49 14,035.30 8,799.01 13,786.91

2007 13,827.77 20,498.11 12,316.10 20,286.99

2008 20,325.27 21,206.77 7,697.39 9,647.31

2009 9,720.55 17,493 8047.17 14493.84

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The SENSEX includes the following 30 companies. Beta and Returns of SENSEX (May 2010)
Free-float Adj.Factor as on 31/05/10 0.55 0.7 0.25 0.7 0.6 0.45 0.65 1 0.35 0.75 0.45 0.45 0.9 0.55 0.9 0.55 0.35 0.7 0.5 0.3 0.2 0.2 0.8 0.7 0.85 0.5 0.2 0.35 0.5 0.65

Sl No: 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Company JAIPRAKASH ASSOCIATES LIMITED HINDALCO INDUSTRIES LTD DLF LIMITED TATA STEEL LIMITED. RELIANCE INFRASTRUCTURE LTD STERLITE INDUSTRIES. TATA MOTORS LTD. ICICI BANK LTD. RELIANCE COMMUNICATIONS LTD. MAHINDRA & MAHINDRA LTD JINDAL STEEL & POWER LTD STATE BANK OF INDIA LARSEN & TOUBRO LTD. RELIANCE INDUSTRIES LTD. HOUSING DEVELOPMENT FIN. CORPN. LTD ACC LTD. BHARAT HEAVY ELECTRICALS LTD. TATA POWER CO. LTD. MARUTI SUZUKI INDIA LIMITED TATA CONSULTANCY SERVICES LIMITED WIPRO LTD. ONGC CORPN HDFC BANK LTD ITC LTD. INFOSYS TECHNOLOGIES LTD. HERO HONDA MOTORS LTD. NTPC LTD. BHARTI AIRTEL LTD. HINDUSTAN UNILEVER LTD. CIPLA LTD

Beta Values 1.84 1.74 1.72 1.68 1.48 1.47 1.47 1.43 1.29 1.22 1.16 1.16 1.14 1.1 0.98 0.92 0.8 0.8 0.79 0.78 0.77 0.7 0.69 0.68 0.67 0.66 0.61 0.6 0.42 0.4

Market Value as on 22/06/2010 130.4 151.35 287.85 494.25 1,173.65 178.75 798.05 893.15 186 632.9 671.95 2,354.85 1,821.20 1,063.65 2,981.70 860.8 2,433.95 1,319.60 1,369.35 779.8 407.1 1,197.90 1,987.70 301.95 2,768.10 2,019.80 199.5 261.95 262 336.45

Allied Management College, Ottappalam

By: Shuhaib PP 30

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Profile of Economic Indicators
An economic indicator is a statistic about the economy. Economic indicators allow analysis of economic performance and predictions of future performance. One application of economic indicator is the study of business cycle. Economic indicators include various indices, earnings reports, and economic summaries. Examples: unemployment rate, quits rate, housing starts, Consumer Price Index (a measure for inflation), Consumer Leverage Ratio, industrial production, bankruptcies, Gross Domestic Product, broadband internet penetration, retail sales, stock market prices, money supply changes. An economic indicator is simply any economic statistic, such as the unemployment rate, GDP, or the inflation rate, which indicate how well the economy is doing and how well the economy is going to do in the future. "How Markets Use Information to Set Prices?" investors use all the information at their disposal to make decisions. If a set of economic indicators suggest that the economy is going to do better or worse in the future than they had previously expected, they may decide to change their investing strategy. An economic indicator is in simple terms, the official statistical data of a certain economic factor that are published periodically by the government agencies, which an investor can use to gauge the economic situation. It allows investors to analyze the past and current situation and to project the future prospects of the economy.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Three Attributes of Economic Indicators
1. Relation to the Business Cycle / Economy Economic Indicators can have one of three different relationships to the economy: 1. Pro cyclic: A pro-cyclic (or pro-cyclical) economic indicator is one that moves in the same direction as the economy. So if the economy is doing well, this number is usually increasing, whereas if we're in a recession this indicator is decreasing. The Gross Domestic Product (GDP) is an example of a pro-cyclic economic indicator. 2. Counter cyclic: A counter-cyclic (or countercyclical) economic indicator is one that moves in the opposite direction as the economy. The unemployment rate gets larger as the economy gets worse so it is a counter-cyclic economic indicator. 3. Acyclic: These indicators are those with little or no correlation to the business cycle: they may rise or fall when the general economy is doing well, and may rise or fall when it is not doing well. The number of home runs the Montreal Expos hit in a year generally has no relationship to the health of the economy, so we could say it is an acyclic economic indicator. 2. Frequency of the Data
In most countries GDP figures are released quarterly (every three months) while the unemployment rate is released monthly. Some economic indicators, such as the Dow Jones Index, are available immediately and change every minute.

3. Timing
Economic Indicators can be leading, lagging, or coincident which indicates the timing of their changes relative to how the economy as a whole changes.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Three Timing Types of Economic Indicators

Leading indicators are indicators that usually change before the economy as a whole changes. They are therefore useful as short-term predictors of the economy. Stock market returns are a leading indicator: the stock market usually begins to decline before the economy as a whole declines and usually begins to improve before the general economy begins to recover from a slump.

Lagging indicators are indicators that usually change after the economy as a whole does. Typically the lag is a few quarters of a year. The unemployment rate is a lagging indicator: employment tends to increase two or three quarters after an upturn in the general economy.

Coincident indicators are those which change at approximately the same time as the whole economy, thereby providing information about the current state of the economy. Personal income, GDP, industrial production and retail sales are coincident indicators. A coincident index may be used to identify, after the fact, the dates of peaks and troughs in the business cycle. Economic indicators can have a huge impact on the market;

therefore, knowing how to interpret and analyze them is important for all investors. India economic indicators are important as they provide an accurate account of state Indian economy at various points of time. There are various types of Indian economic indicators that deal with different periods of time and there are others that deal with separate administrative divisions like states for example. They are important in context of analyzing Indian economy.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

ECONOMIC INDICATORS
Gross Domestic Product of India The growth of an economy is measured in terms of an increase in the size of a nation’s economy. A broad measure of an economy’s size is its output. The most widely-used measure of economic output is the Gross Domestic Product, abbreviated GDP. GDP is generally defined as the market value of the goods and services produced by a country. It is one of the primary indicators used to gauge the health of a country’s economy. Strictly defined, GDP is the sum of the market values, or prices, of all final goods and services produced in an economy during a period of time. In short, everything produced by all the companies and all the people in a given country There are three important concepts to note with regard to this definition: • GDP is a number that expresses the worth of the output of a country in local currency. • GDP tries to capture all final goods and services as long as they are produced within the country, thereby assuring that the final monetary value of everything that is created in the country is represented in the GDP. • GDP is calculated for a specific period of time, usually a year or a quarter of a year. While there are many ways to calculate GDP, the most common approach to measuring and understanding GDP is the expenditure method: GDP = consumption + investment + (government spending) + (exports – imports)

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By: Shuhaib PP 34

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Usually, GDP is expressed as a comparison to the previous quarter or year. For example, if the year-to-year GDP is up 3%, this is thought to mean that the economy has grown by 3% over the last year. As you can imagine, economic production and growth, what GDP represents, has a large impact on nearly everyone within that economy. For example, when the economy is healthy, you will typically see low unemployment and wage increases as businesses demand labor to meet the growing economy. A significant change in GDP, whether up or down, usually has a significant effect on the stock market: a bad economy usually means lower profits for companies, which in turn means lower stock prices. Investors really worry about negative GDP growth, which is one of the factors economists use to determine whether an economy is in a recession. When compared to the previous year's reading, the difference between these two readings indicates whether a country's economy is growing or contracting. GDP is usually published quarterly. It is measured by either adding all of the income earned in an economy, or by all the spending in an economy. Both measures should be roughly equal. When the GDP is positive, the overall stock market will react positively as there will be a boost in investor confidence, encouraging them to invest more in the stock market. This will in turn boost the performances of companies. When the GDP contracts, consumers tread cautiously and reduce their spending. This in turn will affect the performance of companies negatively, thus exerting more downward pressure on the stock market. Gross domestic income includes wages and salaries, corporate profits, interest collected by lenders, and taxes collected by governments. GDP domestic expenditures includes consumer spending, housing investment, government

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

spending, business spending (investment in factories, equipment, and inventory), as well as foreign spending on our exports minus our spending on their imports. With so many individual components affecting GDP (and through the output gap, inflation) you can see how easy it is for the number of economic reports to mushroom. GDP affects the stock market through its effect on inflation, as well as through its use a key indicator of economic activity and future economic prospects by investors. Any significant change in the GDP, either up or down, can have a major effect on investing sentiment. If investors believe the economy is improving (and corporate earnings along with it) they are more likely to pay more for a given stock. If there is a decline in GDP (or investors expect a decline) they would be willing to pay less for a given stock, leading to a decline in the stock market. The stock market itself exerts a reverse effect on economic activity, the socalled “wealth effect”. This theory says that a fall in the stock market makes individual’s personal wealth (or perceived wealth) fall. They consequently stop spending as much, and since consumer spending represents around two-thirds of GDP, a small change in consumption exerts a significant effect on GDP. This means that as the stock market falls, GDP also falls, which just further intensifies the downward pressure on the stock market. According to official information of financial year 2007, gross domestic product of India, with regard to purchasing power parity, was $2.996 trillion and, with regard to official exchange rate, it was $1.099 trillion. In financial year 2007, gross domestic product of India had experienced a real growth rate of 9 percent. In financial year 2007, per capita gross domestic product of India, with respect to purchasing power parity, was $2,600. As of financial year 2007, 17.8 percent of India's gross domestic product was contributed by agricultural sector and

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

29.4 percent came from industrial sector. Services sector made maximum contribution of 52.8 percent in that financial year. Strengths: • GDP is considered the broadest indicator of economic output and growth. • Real GDP takes inflation into account, allowing for comparisons against other historical time periods. • The Bureau of Economic Analysis issues its own analysis document with each GDP release, which is a great investor tool for analyzing figures and trends, and reading highlights of the very lengthy full release. Weaknesses: • Data is not very timely - it is only released quarterly. • Revisions can change historical figures measurably (the difference between 3% and 3.5% GDP growth is a big one in terms of monetary policy)

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Inflation
Inflation is an increase in the price of a basket of goods and services that is representative of the economy as a whole. Inflation is important for all investments, simply because it determines the real rate of return that you get from your investment. For instance, if the inflation rate is 5 per cent and the nominal return is 8 per cent, this means that your real rate of return is 3 per cent as the 5 per cent has been eaten by inflation. Inflation's impact on the stock market is even more complicated. A company's profit will be affected by higher inflation. Its input cost will increase and the impact of the increase will depend on how much of the incremental cost the company is able to pass on to its consumers. The amount that the company will have to absorb will reduce its profits, assuming all else being equal. The stock market will suffer further negative impact if it is accompanied by increased interest rates as the bond market is seen as a cheaper investment vehicle compared to stocks. When this happens, investors will sell off their stocks to invest in bonds instead. The most commonly used indicator for the measurement of inflation is consumer price index (CPI). It consists of a basket of goods and services commonly purchased by consumers, such as food, housing, clothes, transportation, medical care and entertainment. The total value of this basket of goods and services will be compared with the value of the previous year and the percentage increase will be the inflation rate. On the other hand, where the value drops, it will be a deflation rate. A steady or decreasing trend will be favorable to the overall stock market performance.

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By: Shuhaib PP 38

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Inflation is a significant indicator for securities markets because it determines how much of the real value of an investment is being lost, and the rate of return you need to compensate for that erosion. For example, if inflation is at 3% this year, and your investment also increases by 3%, in real terms you have just managed to stay even. And to take on market risk, most individuals require a “risk premium” above and beyond the inflation rate. So investors who buy stocks do so expecting they will get a return equal to (or better than) that risk premium adjusted by the inflation rate. So the higher the inflation rate, the higher nominal return is needed for a stock price to remain the same. But the effect inflation has on the stock market is even more complicated than that. The main impact of inflation on stock prices actually comes from the effect it has on a company’s earnings. Low inflation keeps a company’s costs down, and increases profits. So all other things being equal, (a favorite phrase of all economists), low inflation is better for the market than high inflation. There are many causes of inflation. From a supply-demand standpoint, it can be due to increased demand for a particular product, from an increase in a company’s cost of supplies, or from limited supplies (like OPEC members restricting oil supplies), or even just due to fear that supplies might be limited at some point in the future. But the single most important determinant of inflation is the output gap, which is the balance between supply and demand in the economy. The output gap measures the difference between the economy’s potential, where all capital and labor resources are in use, and the actual level of output. When actual output is below its potential, inflation should be low because excess workers and unused plant and equipment are available. The actual level of output is easy to get, and is measured by GDP. But potential output is harder to get, requiring estimates to determine its value. So while the output gap is important to

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

always keep in mind when interpreting economic data, its exact amount is never known. For that reason it is not a realistic indicator for investors to use, and why a proxy is required, with the Consumer Price Index (CPI) the most widely followed measure of inflation. The Labor Department issues a CPI figure every month, measuring the increase in the price of a given "basket" of goods and services purchased by the average consumer. That basket supposedly includes a number of items commonly purchased by all or most consumers, such as food, housing, clothes, transportation, medical care, and entertainment. The total value of that basket is then compared to the same basket of goods a year later. The percentage increase in the price for these goods in one year is the inflation rate (or if the value drops, like in Japan recently, the deflation rate). That measured percentage, for instance 3%, means that in general the basic necessities of life cost 3% more today than they did last year. There are of course some problems with this measure as well. For one thing, the products rarely remain exactly the same, and it is difficult to strip out how much of an increase is due to inflation, and how much is due to other factors such as improvements in quality. Also, the composition of what people buy changes over time. In fact, many of the goods now included were not even invented 20 or 30 years ago. Still, it is the best proxy currently available, and at least in the short- to medium-term, is the number that investors focus on when making their decisions. Rate of inflation in India is an important economic indicator. As of financial year 2008, projected rate of inflation in India is lower than financial year 2007, when an inflation rate of 5.77 percent had been predicted. As per wholesale price index, rate of inflation in India was 8.75 percent in 2007.

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By: Shuhaib PP 40

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Inflation: The Real Culprit… and Its Effect on the Stock Market
There have been many times in the past when strong economic performance propelled higher stock prices. The 1920s, the 1950s and the 1980s are classic examples. In the Reagan years, stocks and bonds rallied sharply in response to higher economic growth rates and job creation. In principle, the stock market should do well under conditions of strong economic growth and low inflation. Ah, and there’s the rub: inflation! If inflation is a growing problem, investment analysts become suspicious of high economic growth or good job reports. Why? Because they fear that it reflects an inflationary boom, an artificial recovery created primarily by “easy credit” by the government, due to high federal deficits and an expanding money supply. Under inflationary conditions, analysts do not think strong job creation and economic growth are sustainable, and the stock market falls in price because they think that the Fed will need to tighten in the future. Or if economic growth falls, they think the Fed will ease in the future, and stocks rally. To a large extent, the issue hinges on the relevance of the Fed in the economy, whether the Federal Reserve engages in “easy” or “tight” money. Strengths: • Gives most insight into future Fed rate moves • Highly watched and analyzed in the media • Good regional and industry breakdowns for investor research

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By: Shuhaib PP 41

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Weaknesses: • Volatile month to month • Fixed CPI has certain biases (new product, substitution), which can distort results • Exclusion of food and energy is only good for so long - these costs should be considered when assessing inflation

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By: Shuhaib PP 42

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Labor market
The unemployment rate as a percentage of the total labor force will basically indicate the country’s economic state. During an economic meltdown, most companies will either freeze hiring or, in more severe cases downsize, by alleviating cost and reducing capacity. When this happens, the unemployment rate will increase, which in turn, creates a negative impact on the market sentiment. The final major factor influencing the economy is the labor market. The key indicators most investors focus on are total employment and the unemployment rate. US citizens who are already working represent the employed, while those who are actively looking for work, but haven’t found it yet, are the unemployed. The unemployment rate does not include people without jobs who are not looking for jobs, such a retirees or just people who are discouraged and have given up trying to find a job. The Employment Report provides both the employment and unemployment numbers. There is always some unemployment. As the allocation of resources change in the economy, based on what people are buying, some companies go out of business while others that produce the things now in demand will be expanding. This causes a flow of labor from losing to winning industries, and it is not an instantaneous process. Others may leave their jobs by choice. This means there is always some amount of unemployment built into our economic structure, what is often termed the “natural” level of unemployment. The natural level of unemployment is that point where any drop below that figure creates conditions that will drive up inflation. There is always some disagreement as to what the “natural” level of unemployment is for the US economy. For one thing, it changes over time as the nature of the economy

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

changes. For most of the 1980’s, it was often estimated at about 6%, although most economists now feel it is probably around 5%, or even the high 4’s. What might cause this kind of change? A paper a couple years ago from the Brookings Institute cited some factors that they estimated have reduced the natural rate by about 1%. Accounting for about 0.4% is the aging of the population; older people tend to be more fully employed. The growth of temporary staffing firms that rapidly match job-seekers with employers could account for 0.2-0.4%. Finally, the doubling of the prison population probably accounts for about 0.2%, by removing from the labor force people who are less likely to be employed. Strengths As one of the most widely watched reports, the Employment Situation Report gets a lot of press and can move the markets. • Summary analysis provided by the BLS (top link on the site) on the toplevel release of an already detail-rich report. • Relates to investors on a personal level; everyone understands having a job or looking for work. • Services industries are covered here - it is hard to find good indicator coverage of service-based businesses. Weaknesses • Summer and other seasonal employment tends to skew the results. • Only measures whether people are working; it does not take into account whether these are jobs the people wish to have, or whether they are well-suited to workers' skills.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

• Volatile; revisions can be quite large, and updates should always be viewed in the most recent report. • Unemployment and payroll figures can seem to be out of alignment, as they are derived from two different surveys. • Compensation costs portion is considered inferior to the Employment Cost Index.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Money supply
The Reserve Bank of India defines the monetary aggregates as: • Reserve Money (M0): Currency in circulation + Bankers’ deposits with the RBI + ‘Other’ deposits with the RBI = Net RBI credit to the Government + RBI credit to the commercial sector + RBI’s claims on banks + RBI’s net foreign assets + Government’s currency liabilities to the public – RBI’s net non-monetary liabilities. • M1: Currency with the public + Deposit money of the public (Demand deposits with the banking system + ‘Other’ deposits with the RBI). • M2: M1 + Savings deposits with Post office savings banks. • M3: M1+ Time deposits with the banking system = Net bank credit to the Government + Bank credit to the commercial sector + Net foreign exchange assets of the banking sector + Government’s currency liabilities to the public – Net non-monetary liabilities of the banking sector (Other than Time Deposits). • M4: M3 + All deposits with post office savings banks (excluding National Savings Certificates). Businesses are prone to the forces of the economy and business cycles are unavoidable. However, as our understanding of economics improves the severity of business cycles has been reduced by taking steps to counter the downturn in the economy. Of the many steps taken the one that is of the most interest to the stock markets is the change in monetary policy. In this project we look at the impact of the change in money supply (as a proxy for change in monetary policy) on the stock markets.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Few basics The central bank’s job in a country is to ensure the stability of the currency and ensure the right kind of an environment for economic growth. For example, the Reserve Bank of India’s objective is: "…to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage." Source: RBI website. Households keep their saving with a bank and this money is made available to the industry through a banking system of a country, with the central bank at the helm. Thus, the banks act as financial intermediaries. A part of the money that is deposited has to be kept as a reserve with the central bank, RBI in India’s case. The remaining part is given out as loans or is parked in other financial instruments. The central bank using the reserves as input prints currency notes i.e. supplies money. The process of creation of money using the deposits is known as multiple expansions of bank deposits. Suppose an investor deposits Rs 100 in a savings account. Of this Rs 10 (10%) has to be kept as reserve with the central bank and the remaining Rs 90 can be given out as loans. The bank loans the amount to a company wanting to start an industrial venture. The company receiving the loan puts the money into another bank account. The second bank has to keep Rs 9 as reserve and give out Rs 91. This process continues. Thus, we find that at a reserve requirement of 10% every rupee deposited can support demand deposits of Rs 10. The ratio of the new deposit to the increase in reserve is known as the money supply multiplier. The central banks print currency accordingly. If a deposit creates money, withdrawal of deposits has the reverse effect that is to remove money from the system.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

The central banks control the flow of money in the financial system through the monetary policy. The tools used for implementing the monetary policy are: a. Open market operations b. Interest rates c. Reserve ratio The higher the reserve ratio, higher amount of money, the commercial banks will have to hold with the central bank and thus, the money available to the industry will be lower. Also, the central bank buys and sells government securities (G-secs), which are known as the open market operations. If the central bank sells G-secs, deposits will be withdrawn from the banking system to buy these instruments and this will in turn reduce the liquidity. On the other hand, if it buys back G-secs, it will increase the liquidity in the system. Finally the banks borrow from the central bank when they face shortage of reserves. By altering the rate at which the central bank lends out the liquidity in the systems can be controlled. If banks can borrow at lower rates then they can lend out to industries at lower rates also. Thus, the cost of capital becomes cheaper. Depending on the economic environment central banks follow tight money or cheap money policy. When the economy is growing a multiplier effect comes into play. Expectations of future growth propel investments, which in turn drive employment and higher employment results into increased spending. However, increased spending could cause the risk of inflation. Thus, by limiting the availability of money or making it dearer, the central bank steers the economy away from inflation. The central bank of a country tries to counter the weak economy by reducing the cost of one of the most important inputs for business - money. By effectively increasing the money supply into a country’s financial system, the availability of

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

capital is made cheaper with the hope that investments in business becomes more lucrative and investments begin to take place. Strengths: • A timely and consistent indicator, released weekly and with a long operating history. • It is often misunderstood by investors, creating opportunities for those who know how to use it. • There is a lot of existing research on the relationship between money supply and GDP growth as well as inflation. Weaknesses: • Rarely a mover of the markets in the short term. • Limited breakdowns available in the weekly release; the quarterly Flow of Funds report provides a broader view. • Lack of economic consensus on how to best compare money supply levels to inflationary outlook and future spending patterns

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Chapter 3 Statement of the Problem

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Statement of the problem
This study is carried primarily to find the impact of economic indicators on BSE. The investor’s perception towards investments in stock markets is in increasing trend and to understand the role of economic indicators on the variables of stock market, the study is being carried out.

Review of literature
A study conducted by Chen (1986) finds that industrial production changes in risk premium, etc., are positively related to the expected stock return while inflation is negatively related to the same. Solnic (1983) and Marshall (1992) report a significant positive relationship between share prices and some money variables. Several researches have been carried out in this context in different stock exchanges all over the world. These studies reveal a mixed bag of results. In another study, Omran (2003) investigates the relationship between real interest rate and stock market activity and finds a positive linkage between real interest rate and stock market liquidity. Need and importance of the study The stock market in India existed for a well over a century now; its importance in the mobilization, allocation and efficient use of scarce investment recourses has not been recognized until the last decade. Volatility of security price has important implications for firm’s investment and financial decisions, valuations and investors sentiments. This fluctuation is caused by many factors of them are economic indicators. Hence analysis of economic indicators and its impact on stock market is the topic of this dissertation.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Objectives Primary objectives
• Analysis of the economic indicators and relating its impact on Sensex.

Secondary objectives
To analyze the performance of shares in SENSEX. To understand the various types of economic indicators. To measure the popularity of leading stocks. To get in depth, to know how the economic indicators impact on BSE. To summarize and conclude on the study.

Limitations of the study
The following are the limitations of the study. • • • • The study covers only few economic indicators and their impact on BSE. The data available for the study may be subject to changes in future. The study is limited only to BSE. The study is considered only the yearly closing indexes from BSE.

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

CHAPTER-4

METHODOLOGY

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

RESEARCH METHODOLOGY Title of the study:
“An analysis of economic indicators and its impact on stock market”

Methodology
Methodology refers to the systematic procedure carried out in any work or research study. It shows the suitable classifications and sequence of the different stages of the study. This study is basically an exploratory research. Exploratory research is a study undertaken to define nature of problem and opportunity and to gain a better understanding of the environment within which the problem and opportunity has occurred.

Type of research
The respondents forming the part of the primary data are the agents who work in the company. The research plan calls for gathering secondary data, primary data or both

Secondary data
Secondary data consists of information that already exists somewhere having been collected for other purpose. on the other hand include those data, which are collected for some earlier research work and are used in the study researcher was presently undertaken sources of secondary data. Sources of secondary data Magazines News Papers Journals Website

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Text books Other articles

Research design:
“A research design is the arrangements of conditions for collection and analysis of data in a manner that aims to combine relevance to the research purpose with economy in procedure.” A Research design is a method and procedure for acquiring information is needed to solve the problem. A research design is the basic plan that helps in the data collection or analysis. It specifies the type of information to be collected the sources and data collection procedure. It is similar to architect’s blue print to build a house.

Data collection
Information has been collected in an unstructured manner. Data collection was done through interviews of the expert opinion, educationists, stock broker dealers and other related persons.

Plan of analysis
Analysis will be conducted on the five years data of the economic indicators namely consumer price index gross domestic product unemployment rate money supply Stock market price (Sensex). We use graphic method to analyze the impact of above indicators on capital market

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

CHAPTER-5

Presentation, Analysis of Data and Interpretation

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“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Presentation, Analysis of data and Interpretation
Hypothesis
There is a positive relationship between the economic indicators and the stock markets.

Analysis Gross Domestic Product (GDP)
The gross domestic product (GDP) is the godfather of the indicator world. As an aggregate measure of total economic production for a country, GDP represents the market value of all goods and services produced by the economy during the period measured, including personal consumption, government purchases, private inventories, paid-in construction costs and the foreign trade balance (exports are added, imports are subtracted). Presented only quarterly, GDP is most often presented on an annualized percent basis. Most of the individual data sets will also be given in real terms, meaning that the data is adjusted for price changes, and is therefore net of inflation. The GDP is an extremely comprehensive and detailed report. As GDP incorporates many of them, retail sales, personal consumption and wholesale inventories are all used to help calculate the gross domestic product.

Allied Management College, Ottappalam

By: Shuhaib PP 57

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Table showing Index of BSE and the GDP of six years

YEAR 2004-2005 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

SENSEX 6,602.69 9,397.93 13,786.91 20,286.99 9,647.31 14493.84

GDP (%) 7.5 9.5 9.6 9.0 6.7 6.8
(Table 5.1)

Sensex: it consists of the closing prices of the every year end GDP: this consists of the GDP @ factor cost at constant price.

Graph showing the relationship of the stock prices of BSE and GDP 5.1
25,000.00 20,000.00 15,000.00 10,000.00 5,000.00 0.00 BSE GDP

There is a positive relationship between the GDP and the stock market prices. Whenever there is a increase in the GDP there is an increase in the stock an prices.

Allied Management College, Ottappalam

By: Shuhaib PP 58

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Impact on the market
If we trace the period between 1995 -2004, the CAGR (Compounded Annual Growth Rate) of real GDP and the BSE sensex shows a high degree of correlation, while real GDP has grown at 6.1 per cent, sensex has also posted similar gains. However, if we analyze the data more deeply, year-on-year examination gives a different picture. The outcome of this examination shows that though real GDP has shown a steady growth under the period of study, BSE sensex has been very volatile during the entire period. On year-on-year basis there seems to be no sync between the two factors. However, if one tends to consider growth in nominal GDP and corporate performance at the top-level, there it seems to be high degree of correlation. This is on account of the fact that GDP is aggregate of output of agriculture, industrial and services sector. If we look at the trend, stock markets are not always guided by fundamentals but also by sentiments. For instance, lowering of interest rates by the RBI (like until 2004) typically has an impact on the economy with a lag. But the signal that the RBI is reducing interest rates may prop up stock markets immediately and stock prices may react much faster. However, in the present period there is a change in the trend, due to the fact that Indian economy is now more integrated with global world than before. At worldwide level capital markets evince attributes of perfect market with no or acceptable entry barriers, large number of buyers and sellers, absence of, or very low, transaction costs, tax parity and free trading.

Allied Management College, Ottappalam

By: Shuhaib PP 59

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Labor Report The Employment Situation Report, also known as the Labor Report, is an extremely broad-based indicator released by the Bureau of Labor Statistics (BLS). It is made up two separate and equally important surveys. The first, the "establishment survey", is a sampling of more than 400,000 businesses across the country. It is the most comprehensive labor report available, covering about one-third of all non-farm workers nationwide, and presents final statistics including non-farm payrolls, hours worked and hourly earnings. The data sample is both large and deep, with breakouts covering more than 500 industries and hundreds of metropolitan areas. The second survey, referred to as the "household survey", measures results from more than 60,000 households and produces a figure representing the total number of individuals out of work, and from that the national unemployment rate. Both sets of survey results will show the change from the previous month, and also year over year, as tendencies are very important with this often volatile statistic. The payroll figures from the establishment report are considered a coincident indicator. The establishment report is larger, and theoretically more accurate, but excludes private households, the self-employed and the agricultural, as people tend to be out of work when problems in the economy have already manifested themselves in falling economic output (less workers, less GDP) sector. The household report runs on a smaller sample and may be more subjective, but the inclusion of self-employed workers, for example, can make this figure more valuable in a time when many people are starting their own business (as often happens in the beginning of a new business cycle) Average weekly hours for the manufacturing sector, as presented in the establishment report, is a leading indicator. The unemployment figures from the household report (which is probably the most watched metric of the release after non-farm payrolls) are considered a lagging indicator.

Allied Management College, Ottappalam

By: Shuhaib PP 60

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Table showing the SENSEX and the Unemployment rate of six years le employment
Year 2004-2005 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010 SENSEX 6,602.69 9,397.93 13,786.91 20,286.99 9,647.31 14493.84 UNEMPLOMENT RATE (%) 9.5 9.2 8.9 7.8 7.2 6.8
(Table 5.2)

BSE: it consists of the closing prices of the every year end Unemployment Rate: this consists of the unemployment rate in the each year

Graph showing the relationship of the stock prices of BSE and Unemployment rate of six years 5.2
25,000.00 20,000.00 15,000.00 10,000.00 5,000.00 0.00 BSE

UNEMPLOMENT RATE

There is an inverse relationship between the two variables. Whenever the unemployment is decrease there is a increase in the stock prices. an

Allied Management College, Ottappalam

By: Shuhaib PP 61

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Impact on the markets:
Interest Rates: Larger-than-expected monthly fall in the unemployment rate is considered inflationary causing interest rates to rise. The bond market views an increase unemployment rate favorably especially when the economy is close to full capacity and the unemployment rate is close to its "natural rate". A falling unemployment rate also makes it more likely that the Fed will increase the Fed Funds rate that is also bearish for the bond market. Stock Prices: Ambiguous. First, lower unemployment rate signals a strong economy, higher potential profits and that's good for the stock market. Second, lower unemployment may increase expected inflation and lead to higher interest rates that are bad for the stock market. Third, lower unemployment rate may lead to higher wage inflation that is bearish for the stock market. The first effect dominates in recessions and early stages of economic recovery while the second and third dominate when the economy is close to full capacity and the unemployment rate is low Exchange Rates: Lower than expected unemployment rate will tend to appreciate the exchange rate as it is expected to lead to higher interest rates. Ability to Affect Markets: Moderate. Unlike the payroll jobs data, which is a coincident indicator of economic activity (it changes direction at the same time as the economy); the unemployment rate is a lagging indicator. Consequently, it is less likely to move the market than the employment number. However, as the economy get close to the "natural rate of unemployment" unexpected change in the unemployment rate may become bigger market movers. A strong jobs report signifies accelerating inflation, as now more people have money to spend. However the impact of the report also depends at which phase of the business cycle the economy happens to be in. If the US economy has just managed to climb out of recession, a jump in employment report will only have modest effect on the commodity markets.

Allied Management College, Ottappalam

By: Shuhaib PP 62

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Money Supply
The money supply is just that: the amount of money floating around the economy and available for spending. In economics, money supply or money stock is the total amount of money available in an economy at a particular point in time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits. Money supply data are recorded and published, usually by the government or the central bank of the country. Public and private-sector analysts have long monitored changes in money supply because of its possible effects on the price level, inflation and the business cycle.

Allied Management College, Ottappalam

By: Shuhaib PP 63

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Table showing the BSE Index and the MONEY SUPPLY of six years d YEAR 2004-2005 2005 2005-2006 2006 2006-2007 2007 2007-2008 2008 2008-2009 2009 2009-2010 2010 SENSEX 6,602.69 9,397.93 13,786.91 20,286.99 9,647.31 14493.84 M3 (%) 12.00 16.90 21.70 21.40 18.60 16.50
(Table 5.3)

BSE: it consists of the closing prices of the every year end M3: it consists of the percentage change over the years. Graph showing the relationship of the stock prices of BSE and MONEY SUPPLY of six years 5.3 .3
25,000.00 20,000.00 15,000.00 10,000.00 5,000.00 0.00 BSE M3

There is a direct relationship between the two variables. Whenever there is an increase in the money supply there is an increase in the stock prices.

Allied Management College, Ottappalam

By: Shuhaib PP 64

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Impact on the market
Lower interest rates are good for the stock markets. This is due to the fact that lower interest rates make the other asset classes that compete with equities like fixed deposits become relatively less attractive. Also, lower interest rates mean that the interest burden on corporate’ that have a raised a significant part of their capital through debt reduces. Consequently, earnings tend to grow at a faster pace and therefore, stock markets are again benefited in the long run. There seems to be not much of a correlation, the stock market indices seem to mirror the growth in money supply with a lag effect. Higher growth rates have been followed by stock market indices gaining significantly in subsequent years. However, more prominent is the fact that a lower growth rate in money supply has caused index to decline more often than not.

Allied Management College, Ottappalam

By: Shuhaib PP 65

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Inflation
Inflation pared down to the essentials means a rise in an index consisting of many goods that have weights attached to them. The index always has a base year. If a particular item has a higher weight and its price rises, it will have a greater effect on the inflation rate. At the end of the day it depends on how much weight a particular item is assigned. Most countries use a consumer price index (CPI) while India has a wholesale price index (WPI). As their names suggest, the CPI pertains to a set of items that a consumer consumes while the WPI is a basket particular to the wholesale market. Therefore, if the inflation for a particular week is, say, 10 per cent, it means the index is 10 per cent higher than it was the same week the previous year. Then there is core-inflation, which means the inflation rate without taking into account food and fuel. Milton Friedman once said: "Inflation is always and everywhere a monetary phenomenon." It essentially means that inflation is always caused because of too much money in the system. In other words, inflation in a country is always caused because the supply of money is much greater than the demand for it.

Allied Management College, Ottappalam

By: Shuhaib PP 66

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Table is showing the stock prices of BSE and the Inflation rate of six years. nflation
YEAR 2004-2005 2005 2005-2006 2006 2006-2007 2007 2007-2008 2008 2008-2009 2009 2009-2010 2010 SENSEX 6,602.69 9,397.93 13,786.91 20,286.99 9,647.31 14493.84 INFLATION (%) 6.5 4.4 5.4 4.7 8.4 1.6
(Table 5.4)

BSE: it consists of the closing prices of the every year end Inflation: this consists of the WPI 52 week average percentage change over the years. Graph showing the stock prices of BSE and the INFLATION RATE of six years.
25,000.00 20,000.00 15,000.00 10,000.00 5,000.00 0.00 BSE INFLATION

There is an inverse relationship between the inflation between the two variables. Whenever there is an increase in the inflation there is decrease in the stock prices and vice versa.

Allied Management College, Ottappalam

By: Shuhaib PP 67

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Impact on market
The stock market has steadily increased over the years, with minor setbacks during economic downturns. One reason that people invest in the stock market is that over a longer period, stocks outpace the increase in costs due to inflation. This isn't necessarily true every year, particularly in a poor economy.

Supply and Demand
1. During inflationary times, the economy is normally healthy. In these times, people have expendable income, which they either invest or purchase goods with. If they invest, it tends to drive stock prices upward.

Size
2. The amount of growth a stock exhibits due primarily to inflationary factors is proportionate to the cost of the stock.

Benefits
3. Because the stock market increases with inflation, stocks tend to be better for long-term investments when you consider buying power.

Dividends
4. During times of inflation, dividends increase because the costs of goods and services increase. This causes undue optimism in the market.

Warning
5. Even though the stock you own might increase because of inflation, it doesn't mean that the increase keeps up with buying power. You need to calculate the growth percentage and see if it keeps up with inflation.
CONCLUSION

It is proved that the indicators like Gross Domestic Product (GDP), Labor Market, Inflation; Money supply has a positive impact on the stock market movement.

Allied Management College, Ottappalam

By: Shuhaib PP 68

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

CHAPTER-6 SUMMARY AND CONCLUSION

Allied Management College, Ottappalam

By: Shuhaib PP 69

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

SUMMARY AND CONCLUSION
Summary of the study
The study is being carried out to understand the impact of economic indicators on BSE.

FINDINGS Gross domestic product
Real GDP is the one indicator that says the most about the health of the economy and the advance release will almost always move markets. The "corporate profits" and "inventory" data in the GDP report are a great resource for equity investors, as both categories show total growth during the period; corporate profits data also displays pre-tax profits, operating cash flows and breakdowns for all major sectors of the economy.
INFLATION

When the CPI AND WPI release arrives, many questions will be answered in the markets. This report will often move equity and fixed-income markets, both the day of the release and on an ongoing basis. It may even set a new course in the markets for upcoming months.

Labor report
Economists have settled on the number of 150,000 jobs as the level that defines economic growth. Gains of roughly 150,000 jobs or more indicate expansion of the labor force, while anything below indicates a weak job market. Investors study the labor report to look for trends in disposable income, wage inflation and employment statistics, many studying industries of personal interest to them. If payrolls are increasing and wages are rising, that personal consumption

Allied Management College, Ottappalam

By: Shuhaib PP 70

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

stats like retail sales will advance as well, as more money will be in the pockets of consumers. A key to look for is whether wages are keeping pace with inflation; if not, the real purchasing power of consumers will drop.
MONEY SUPPLY

The changes in monetary policy strongly influence the changes in security prices. Supply of money affects industrial security prices through several ways. The demand to hold money varies according to the variations in the money supply. Imbalance in portfolio is caused due to an increase in money supply. Since investors like to retain the proportion of money constant in their portfolio, they allocate their excess money balances to other uses, such as buying more commodities or to acquire more financial assets. Thus, when demand for stocks increases, the stock prices will raise. Interest rates, also, have an impact on stock prices. If commercial banks' rate of interest on deposit accounts (time deposits) or lending rate is lower, implying a loose money policy, then money supply will raise which, in turn, will give rise to increase in stock prices and vice versa. Thus, interest rates and stock prices have an inverse relationship.

Allied Management College, Ottappalam

By: Shuhaib PP 71

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Conclusion
While quarter-to-quarter figures can show some volatility, long-term trends in GDP growth remain the single most conclusive piece of information on the economy as a whole. This indicator is a must-know for investors in all asset classes. The Employment Situation Report is a very powerful indicator that is able to move the markets dramatically. Heavily analyzed, the report is the single best way to understand the state of the labor force at any point in time. The lesser the unemployment rate, the more workers earn, the more they buy and propel the economy forward. If fewer people are working, spending drops off and business suffers. Because household spending accounts for two thirds of the economy’s total output, the investment community pays close attention to the employment report. The evaluation of money supply figures has become a progressive story, one that savvy investors will take into consideration when contemplating future levels of economic growth as well as inflation. Investors who put their money mainly into fixed income investments have to make a conscious attempt to seek out those that offer high double-digit returns. Or they should add riskier investments to beat inflation. Financial planners usually assume a 5 per cent inflation rate (based on the WPI) to compute targets for long-term financial goals in Indian context. But the recent CPI-WPI divergence suggests that they should actually be assuming a much higher number. As mentioned above, CPI in India over the last five years has grown by nearly 7 per cent annually. An investor may also need to have some margin of safety against factors that may drive inflation up by one or two percentage points in a particular year.

Allied Management College, Ottappalam

By: Shuhaib PP 72

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

Suggestions
The above study has inadvertently proved that there is a positive relationship between the economic indicators the BSE. It is a known fact that no one can time the market. Hence a practical suggestion to maximize your returns would be: Depending on the risk profile, 50% of portfolio should constitute equities. "To make the most, invest in banking and infrastructure sectors as also gold mining funds”. Note that at least 10% of portfolio should constitute debt in order to cushion the ups and downs of the market. Fixed-income investors should always be aware of the rate of inflation against which they judge their investments; it is imperative to keep current yields ahead of inflation, or real wealth will fall.

Allied Management College, Ottappalam

By: Shuhaib PP 73

“AN ANALYSIS OF ECONOMIC INDICATORS AND ITS IMPACT ON STOCKS IN SENSEX”

BIBLIOGRAPHY

Economic surveys
1. Economic surveys of 2004-2005 2. Economic surveys of 2005-2006 3. Economic surveys of 2006-2007 4. Economic surveys of 2007-2008 5. Economic surveys of 2008-2009 6. Economic surveys of 2009-2010 Journals 1. Som Sankar Sen and Santanu Kumar Ghosh (2008), “Association Between Stock Market Liquidity and Some Selected Macroeconomic variables”, Icfai University Journal of Economics, Vol.VI, No.3, pp53-70 2. Securities and portfolio management (2009-2010) Sikkim Manipal University. 3. Anver Sadath and B Kamaiah (2009), “Liquidity Effect of Single Stock Futures on the Underlying Stock”, Icfai University Journal of Applied Economics, Vol.VIII, No.5, pp142. Websites www.bseindia.com www.nseindia.com www.scribd.com www.altavista.com www.indianeconomy.com www.wikipedia.com www.indiahowto.com

Allied Management College, Ottappalam

By: Shuhaib PP 74

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