Dependence On The Federal

RESEARCH STUDY)

MIBOR, BSE SENSEX AND S&P CNX NIFTY: DEPENDENCE ON THE FEDERAL RESERVES PRIME RATES RITESH SHARMA IM-98-049 INTERNATIONAL INSTITUTE OF PROFESSIONAL STUDIES, DAVV, INDORE

(A

ABSTRACT This paper tries to observe and find a relationship between the changes in Federal Reserves’ lending rates to its “best” customers and MIBOR1, BSE Sensex and S&P CNX Nifty. Assuming that there are no other factors present and the dependent variables changes with any change in the value of the independent variables, I have tried to find this relationship. Moreover the paper also tries to find out the other factors, which affect the value of MIBOR1, BSE Sensex and S&P CNX Nifty. 1- Mumbai Inter Bank Offered Rate

The findings, interpretations, and conclusions expressed in this paper are entirely those of the author. They may differ from the views of some other researcher.

INDEX

- Abstract

2

- Index

3

- Acknowledgement

4

- Introduction

5

- Main Objectives

8

- Hypothesis

8

- Research Design

9

- Hypothesis Testing

11

- Results of Hypothesis

15

- Conclusion

16

- Epilogue

17

- References

17

- Graphs

18

ACKNOWLEDGEMENT Any accomplishment requires the effort and this work is no different. I am extremely grateful to Ms. Yamini Karmarkar (HOD MMS-5Yrs., IIPS), for providing me an opportunity to undertake this research project on “MIBOR, BSE Sensex and S&P CNX Nifty: Dependence on Federal Reserve Prime Interest Rates”. Her invaluable support, teaching and guidance helped me to complete this project successfully. I express my sincere thanks to all my friends who helped me in completing this project.

Ritesh Sharma IM- 98- 049

INTRODUCTION With the opening up of the Indian economy and the Indian markets becoming a good playground for the global players, the need to study the impact of the factors affecting the Indian markets becomes a useful area to study. This paper studies the relationship between changes in the lending interest rates on the Indian capital markets as well as the Indian Inter bank rates. To represent the Indian Capital Market, I have taken BSE Sensex and S&P CNX Nifty and to represent the Inter bank interest rates I have taken MIBOR. There may be many other factors on which a stock index may depend on i.e. Government policies, budgets, bullion market, inflation, economic and political condition of the country, FDI, Re./Dollar exchange rate etc. But for my study I have

selected only one independent variable i.e. Federal Reserves Prime interest rates. This study uses the concept of T-test and correlation and regression to study the relationship between FII and stock index. The Indian economy opened up for the world from the year 1992. And thus my study includes the data from the year 1991 to year 2001 so as to analyze the dependence of the stock market before and after the opening up of the economy. Federal Reserve Bank is the central bank in the United States Of America (US). The bank controls and monitors the interest rates on the retail deposits kept with the banks in US. It also controls the interest rates at which the banks lends funds to their prime customers, other banks, and the interest rates at which the general commercial banks asks for funds from the Federal Reserve Bank. With the control of these interest rates the Federal Reserve Bank controls over the economy operations in US. And as with the globalization the Indian markets are more and more becoming affected with any change coming in the other economies of the world, the dependency of Indian Stock Markets and Inter Bank rates on Federal

Reserves’ interest rates needs to be determined. The different kinds of interest rates offered by Federal Reserve Bank are as follows 1. Prime Rate : Prime Rate is the interest rate that a bank charges its "best" customers. There is no single prime rate or there is no compulsions on the interest rates to be offered by any bank to different customers, but the commercial banks generally offer the same prime rate. The Federal Reserve Bank adjust a bank's prime rate directly, or indirectly. The change in discount rates will affect the prime rate. As of 30th September, 2001 the prime rate is 6.00%. The Prime Rate is a 7-day rate with weekends and holidays containing the prior business day's value. The daily Prime Rate is therefore more suitable for many purposes. 2. The Discount Rate : The Discount Rate is the interest rate charged by the Federal Reserve when banks borrow "overnight" from the Federal Reserve. The discount rate is under the direct control of the Federal Reserve. The discount rate is always lower than the Federal Funds Rate. Generally only large banks borrow directly from the Federal

Reserve, and thus get the benefit of being able to borrow at the lower discount rate. As of 28th September, 2001, the discount rate was 2.52%. 3. The Federal Funds Rate : Federal Funds Rate is the interest rate charged by banks when banks borrow "overnight" from each other. The funds rate fluctuates according to supply and demand and is not under the direct control of the Federal Reserve, but is strongly influenced by the Federal Reserve's actions. . As of 30th September 2001, the discount rate was 2.750%, the actual rate varies above and below that figure.

Here I am trying to work out a relationship between the changes in the Prime Rate offered by Federal Reserve on the BSE Sensex, S&P CNX Nifty and MIBOR. So before going further let us understand the other terms used in the study.

1. MIBOR: MIBOR stands for Mumbai Inter Bank Offered Rate. The various banks, to fulfill the internal cash requirements. Thus MIBOR is the rate of interest at which these various commercial banks offer funds to the other commercial banks so that the bank in need can fulfill its requirements.

2. BSE Sensex : BSE Sensex is the index created according to the method of weighted averages. It consists of 30 scrips, which are very actively traded in the Bombay Stock Exchange (BSE). The weighted average takes into consideration of the volume of the scrips traded and the price of each share to calculate the Index.

3. S&P CNX Nifty: S&P CNX Nifty is the index at the National Stock Exchange (New Delhi).

MAIN OBJECTIVES The main objective behind the study is to find a relationship between the changes in the Federal Reserve Prime interest rate and MIBOR, BSE Sensex and S&P CNX Nifty. SUB OBJECTIVES 1. To find a relationship between changes in Federal Reserve prime interest rates and MIBOR.

2. To find a relationship between changes in Federal Reserve prime interest rates and BSE Sensex.

3. To find a relationship between changes in Federal Reserve prime interest rates and S&PCNX Nifty.

ASSUMPTIONS REGARDING THE OBJECTIVES 1. There is no other factor which affects the BSE Sensex, MIBOR and S&P CNX Nifty, individually, then the ones considered in the study.

HYPOTHESIS 1. There is no significant relationship between the changes in the Federal Reserve Prime interest rate and the MIBOR. SUB HYPOTHESIS : MIBOR is not affected by change in Federal Reserve Prime interest rate.

2. There is no significant relationship between the changes in the Federal Reserve Prime interest rate and movement of BSE Sensex. SUB HYPOTHESIS: BSE Sensex is not affected by change in Federal Reserve Prime interest rate.

3. There is no significant relationship between the changes in the Federal Reserve

Prime interest rate and S&P CNX Nifty. SUB HYPOTHESIS : S&P CNX Nifty is not affected by change in Federal Reserve Prime interest rate.

RESEARCH DESIGN

TYPE OF RESEARCH The research is done to find out what is the impact of changes in Fedreral Reserves prime interest rates on MIBOR, BSE Sensex, S&P CNX Nifty. SOURCE OF DATA The data about the Prime interest rates of Federal Reserve has been collected from the H15 release: by Federal Reserve Board of Governors and is downloaded from the official website. This data is a secondary data, and is already being collected by the Federal Reserve board of Governors. The time period of the interest rates being considered is from 1st January 1990 to 30th September 2001.

The data regarding the BSE Sensex and S&P CNX Nifty has been collected from the economic times websites, www.bseindia.com and www.etintelligence.com respectively and is freely downloadable. This again is a seconary data earlier collected by the websites. The time period of the BSE Sensex and S&P CNX Nifty being considered is from 1st January 1991 to 30th September 2001. The data regarding MIBOR is collected from the Reuters website. This is also the secondary data collected earlier by the Reuters news agency. The time period of the interest rates being considered is from 4th September 1998 to 4th September 2000. PROCESSING OF DATAThe Federal Reserve prime interest rates, MIBOR, BSE Sensex, S&P CNX Nifty are taken for the purpose of the study, and whereever if the data is not present that date and the corresponding interest rate value has been erased from the data set. This has helped in creating a consistent data set and thus helping in finding out the relative value. Moreover a relative study is also done and with every change in the federal reserve

prime interest rate the respective change in MIBOR, BSE Sensex, and S&P CNX Nifty in the next three working days has been observed.

MODELS: Correlation: This analysis tool and its formulas measure the relationship between two data sets that are scaled to be independent of the unit of measurement. The population correlation calculation returns the covariance of two data sets divided by the product of their standard deviations. We can use the Correlation tool to determine whether two ranges of data move together — that is, whether large values of one set are associated with large values of the other (positive correlation), whether small values of one set are associated with large values of the other (negative correlation), or whether values in both sets are unrelated (correlation near zero). Regression Analysis: This analysis tool performs linear regression analysis by using the "least squares" method to fit a line through a set of observations. We can analyze how a single dependent variable is affected by the values of one or more independent variables — for example, how an athlete's performance is affected by such factors as

age, height, and weight. We can apportion shares in the performance measure to each of these three factors, based on a set of performance data, and then use the results to predict the performance of a new, untested athlete.

NULL HYPOTHESIS and ALTERNATIVE HYPOTHESIS Part A H0: MIBOR is not affected by change in Federal Reserve Prime interest rate. H1: MIBOR is affected by change in Federal Reserve Prime interest rate. The calculated value of the correlation comes out to be = 0.1464 The student’s T test value comes out to be = 4.2827 E-11 Level of Significance= 90% Since the value of correlation coefficient is coming near to zero ie 0.1464, thus we find that there is no signifiacant relationship between change in Federal Reserve Prime interest rate and MIBOR.

Moreover as the Tcalculated(=4.2827 E-11) is less than Ttable( = 1.65), thus we can accept the null hypothesis H0 , and can say that there is no significant relationship between change in prime interest rates and MIBOR.

But when the Differential statistics was applied and the relative change in MIBOR was observed with respect to the changes in the Federal Reserve prime interest rate, it was found that a positive correlation of +0.8912 is found out. This shows that with every change in Federal Reserve prime interest rate there is a significant change in the value of MIBOR within the next 4 days. For calculation of the differential statistics for every change in Federal Reserve prime interest rate the respective change in MIBOR over the next 4 days is observed. The data for MIBOR was available for only 2 years thus the sample size here is only of 9 observations. Part B H0: BSE Sensex is not affected by change in Federal Reserve Prime interest rate.

H1: BSE Sensex is affected by change in Federal Reserve Prime interest rate. The calculated value of the correlation comes out to be = 0.2839 The student’s T test value comes out to be = 0 Level of Significance= 90% Since the value of correlation coefficient is coming near to zero ie 0.2839, thus we find that there is no signifiacant relationship between change in Federal Reserve Prime interest rate and BSE Sensex. Moreover as the Tcalculated(=0) is less than Ttable( = 1.65), thus we can accept the null hypothesis H0 , and can say that there is no significant relationship between change in prime interest rates and BSE Sensex.

But when the Differential statistics was applied and the relative change in BSE Sensex was observed with respect to the changes in the Federal Reserve prime interest rate, it

was found that a negative correlation of - 0.1763 is found out. And as the value of correlation is quite low this shows that with every change in Federal Reserve prime interest rate there is no significant change in the value of BSE Sensex within the next 3 days. For calculation of the differential statistics for every change in Federal Reserve prime interest rate the respective change in BSE Sensex over the next 3 days is observed. As the Indian capital markets started getting affected after the opening up of the economy thus the data analyzed is for 11 years starting from January 1991 to September 2001.

Part C H0: S&P CNX Nifty is not affected by change in Federal Reserve Prime interest rate. H1: S&P CNX Nifty is affected by change in Federal Reserve Prime interest rate. The calculated value of the correlation comes out ot be = 0.2728

The student’s T test value comes out to be = 0 Level of Significance= 90% Since the value of correlation coefficient is coming near to zero ie 0.2728, thus we find that there is no signifiacant relationship between change in Federal Reserve Prime interest rate and S&P CNX Nifty. Moreover as the Tcalculated(=0) is less than Ttable( = 1.65), thus we can accept the null hypothesis H0 , and can say that there is no significant relationship between change in prime interest rates and S&P CNX Nifty.

On doing the Differential statistics and finding the relative change in S&P CNX Nifty was observed with respect to the changes in the Federal Reserve prime interest rate, it was found that a negative correlation of – 0.2814 is found out. As this value of correlation coefficient is quite low thus it can be said that with every change in Federal Reserve prime interest rate there is no significant change in the value of S&P CNX Nifty within the next 3 days.

For calculation of the differential statistics for every change in Federal Reserve prime interest rate the respective change in S&P CNX Nifty over the next 3 days is observed. The data for MIBOR was available for only 2 years thus the sample size here is only of 35 observations. The data analyzed here is for 11 years starting from January 1991 to September 2001.

Other results INFERENTIAL STATISTICS

DIFFERENTIAL

STATISTICS

Correlation with Federal Multiple Reserve R prime interest rates MIBOR 0.1464

0.1464

R2

Correlation with Federal Standard Multiple Standard 2 Reserve R Error R Error prime interest rates

0.0214 2.12

0.8921

0.6907

0.477 104.03

BSE 0.2839 Sensex

0.2839

0.0806 863.72

-0.1763

0.199

0.039 103.13

S&P 0.2728 CNX Nifty

0.2728

0.0744 264.46

-0.2814

0.2814

0.079 32.26

RESULT OF THE HYPOTHESIS 1. Relationship between Prime interest rates and MIBOR: The impact of prime interest rate is positive. This means that with the increase in Prime interest rates, MIBOR also increases. But as the coefficient of correlation is quite low (0.1464), it can be said that there is no definite relationship existing between the two variables under consideration. Moreover the standard error is high being 2.12 showing that there is no perfect linear relationship between the two variables. But there is a significant positive relationship between the immediate effect of change in Federal Reserve prime interest rate and the MIBOR in the next four days of the change in prime interest rates. This is being proved by the value of correlation coefficient being +0.8921.

2. Relationship between Prime interest rates and BSE Sensex : Again the impact of prime lending rates on the BSE Sensex is positive. But again the coefficient of correlation is having a very low value, being 0.2839, due to which it can be said that there is again no linear relationship between the two variables under consideration. The differential statistics also shows that there is no significant relationship between any change in the value of BSE Sensex in the next three days from the day of change of prime interest rates. The coefficient of correlation between the variables is also quite low being –0.1763.

3. Relationship between Prime interest rates and S&P CNX Nifty : The impact of prime interest rate is again positive. And once again the coefficient of correlation is low being 0.2728, and thus there is no linear relationship between the two variables. The differential statistics also shows that there is no significant relationship between any change in the value of S&P CNX Nifty in the next three days from the day of change of prime interest rates.

CONCLUSION As statistically found, it can be said that there is no linear significant relationship existing-

Between the changes in the Federal Reserve Interest Rates and MIBOR.

-

Between the changes in the Federal Reserve Interest Rates and BSE Sensex.

-

Between the changes in the Federal Reserve Interest Rates and S&P CNX Nifty.

But it was found that there is a significant impact of change in prime interest rates of Federal Reserve Bank in the next three days from the day of change in the prime interest rates. The major reason associated with the no significant can be that alone Federal Reserve Prime Interest rate may not be having any direct relationship with MIBOR, BSE Sensex or S&P CNX Nifty. The other factors which can affect the stock markets and interbank rates can be Government policies, budgets, bullion market, inflation, economic and political condition of the country, FDI, Re./Dollar exchange rate etc. Thus on considering various other factors along with it may be a significant relationship can be found out. And this I believe opens up the way for new things to learn.

EPILOGUE “No study is fully complete in itself.”- said the elders. Even then, not taking opportunistic shelter in this proverbial saying, we are fully aware of many lacunas in this piece of survey, presented in the foregoing pages. Firstly the sample size should have been much larger in each category of persons sampled. Secondly many other factors are also present which affect the changes in the values of the dependent variables, but presently I have considered them to be not significant. Had these deficiencies been not there, the outcome of this study should have been more interesting and fruitful than what it is in the present form. Alas! The master factor for these deficiencies was paucity of time. As this is only the start on the knowledge highway, I will try to include more factors in the future. As the ‘proof of pudding is in eating’, I sincerely hope and wish that this pudding will prove tasteful and informative to the reader.

REFERENCES

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www.bseindia.com

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www.nseindia.com

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www.rbi.org.in

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www.equitymaster.com

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www.etintelligence.com

●

Basic Econometrics

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Fundamentals of Mathematical Statistics

by S.C.Gupta

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Research methodology and statistical techniques

by Santosh Gupta

by Damodar Gujrati