A PROJECT REPORT ON

VOLATILITY IN INDIAN STOCK MARKET AND FOREIGN

INSTITUTIONAL INVESTOR

SUBMITTED BY

CHOPADA PRANJAL VASANT

THIRD YEAR BACHELOR OF COMMERCE

(FINANCIAL MARKETS)

SEMESTER-V

2012-13

MODEL COLLEGE, DOMBIVALI

UNIVERSITY OF MUMBAI

OCTOBER-2012

A PROJECT REPORT ON

VOLATILITY IN INDIAN STOCK MARKET AND FOREIGN

INSTITUTIONAL INVESTOR

SUBMITTED TO THE

UNIVERSITY OF MUMBAI

IN PARTIAL FULFILLMENT FOR THE AWARD OF

THE DEGREE OF BACHELOR OF COMMERCE

FINANCIAL MARKETS

SEMESTER V

BY

CHOPADA PRANJAL VASANT

MODEL COLLEGE, DOMBIVALI

UNIVERSITY OF MUMBAI

OCTOBER 2012

TABEL OF CONTENTS

SR NO.

DESCRIPTION PAGE NO.

1. CERTIFICATE I

2. DECLARATION II

3. ACKNOWLEDGEMENT III

4. LIST OF ABBREVATIONS IV

5. LIST OF CHARTS / GRAPHS V

6. CHAPTER. 1

VOLATILITY IN INDAIN STOCK

MARKET AND FOREIGN INSTITUTIONAL

INVESTORS.

1

7. CHAPTER. 2 INDIAN STOCK MARKET – A THEORETICAL VIEW

7

8. CHAPTER. 3

IMPACT OF FIIs ON STOCK MARKET

INSTABILITY

30

9. CHAPTER. 4

CONCLUSION

37

10. ANNEXURE MILESTONES OF FII IN INDIAN STOCK MARKET

41

11. BIBLIOGRAPHY 44

12. WEBLIOGRAPHY 45

DECLARATION

I, PRANJAL CHOPDA STUDENT OF

BACHELOR OF COMMERCE, FINANCIAL

MARKETS, SEMESTER V OF KERALEEYA

SAMAJAM DOMBIVALI‘S MODEL COLLEGE,

HEREBY DECLARE THAT I HAVE

COMPLETED PROJECT REPORT ON

―VOLATILITY IN INDIAN STOCK MARKET

AND FOREIGN INSTITUTIONAL INVESTOR‖

FOR THE ACADEMIC YEAR 2012-13.

THE INFORMATION SUBMITTED IS TRUE

AND ORIGINAL TO THE BEST OF MY

KNOWLEDGE.

PRANJAL CHOPADA

BACHELOR OF COMMERCE

FINANCIAL MARKETS

ACKNOWLEDGEMENT

I would like to extent my sincere gratitude to all

those people who have helped in the successful

completion of my project entitled ―VOLATILITY

IN INDIAN STOCK MARKET AND FOREIGN

INSTITUTIONAL INVESTORS ―

I would also like to express my deep sense of

my gratitude to Mrs. REENA PILLAI, the faculty

member, for her help and untrying efforts

constant inspiration and stimulating guidance to

me in my academics endeavor and in my

project.

I would also like to thank the college for giving

me this opportunity for doing this project. I would

also like to thank my family for giving me the

support to do the same.

I would also like to express my sincere thanks to

all my friends who help me in finding the

information and support for the successful

completion.

PRANJAL CHOPADA

LIST OF ABBREVATION

BSE : Bombay Stock Exchange

CAPM : Capital Asset Pricing Model

CMR : Call Money Rate

EMEs : Emerging market economies

EMEs : Emerging Market Economies

FII : Foreign Institutional Investment

FIIN : Net Foreign Institutional Investment

FIIP : Foreign Institutional Investment-

Purchase

FIIS : Foreign Institutional Investment-Sale

FPI : Foreign Portfolio Investment

GDP : Gross Domestic Product

IIP : Index of Industrial Production

KYC : Know Your Client

NRIs : Non-Resident Indians

NSE : National Stock Exchange

OCBs : Overseas Corporate Bodies

QIPs : Qualified Institutional placements

RBI : Reserve Bank of India

SEBI : Securities and Exchange Board of

India

VAR : Vector Auto Regression

LIST OF TABELS / GRAPHS

Sr No. Table Particular

1. NO. OF REGISTERED FIIs IN INDIA

2.

FIIs INFLOWS AND SENSEX

MOVEMENT

3.

FREQUENCY DISTRIBUTION OF FII

HOLDINGS IN SENSEX COMPANIES

4.

FOREIGN INVESTMENT IN VARIOUS

COUNTRIES IN TERMS OF THE %

OF GLOBAL INVESTMENT IN US$

5.

VOLATILITY OF STOCK MARKET

RETURNS AS PER TRADITIONAL

MEASURES(DAILY DATA)

Sr No. Graph particulars

1. NUMBER OF REGISTERED FIIs 2. Debt and Equity FII flow

CHAPTER 1

Volatility in Indian Stock

Markets and Foreign

Institutional Investors

The safe way to double the money is to fold

it over once and put it in your pocket.

CHAPTER: 1

VOLATILITY IN INDAIN STOCK MARKET

AND FOREIGN INSTITUTIONAL INVESTORS

Many developing countries, including India, restricted the flow of

foreign capital till the early 1990s and depended on external aid and

official development assistance. Later, most of the developing

countries opened up their economies by dismantling capital controls

with a view to attracting foreign capital, supplementing it with

domestic capital to stimulate domestic growth and output.

Since then, portfolio flows from foreign institutional investors (FII)

have emerged as a major source of capital for emerging market

economies (EMEs) such as Brazil, Russia, India, China and South

Africa. Besides, the surge in foreign portfolio flows since 1990s can

be attributed to greater integration among international financial

markets, advancement in information technology and growing interest

in EMEs among FIIs such as private equity funds and hedge funds so

as to achieve international diversification and reduce the risk in their

portfolios.

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

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

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

attract such flows through flexible investment norms/regulations or by

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

on their investments, enabling continuous and sustainable investment

flows.

FII flows into India registered substantial growth from a meager US$4

million in 1992–93 to over US$ 32 billion in 2010–11 (SEBI, 2011:

76). FII inflows underwent a sea-saw movement in India during the

last decade. They registered spectacular growth especially since the

middle of 2003 due to the higher growth rate in Indian GDP, robust

corporate performance and an investment-friendly environment.

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

12 billion) during 2008–09 (ibid.) mainly due to the heightened risk

aversion of foreign investors, emanating from the global financial

meltdown.

Ever since foreign portfolio investors were allowed to invest in Indian

financial markets in September 1992, there have been extensive

deliberations on the impact of such flows. It is said that portfolio flows

from FIIs inject global liquidity into the capital markets, raise the price-

to-earnings ratios, thereby reducing the cost of capital. This, in turn,

leads to further issues of equity capital and stimulates investment

growth in the host economy, apart from bringing in best international

corporate governance practices. Yet, FIIs have been targets of

criticism due to characteristics such as return chasing behaviour,

herd mentality, hot money flows, short-term speculative gains and

their influence on domestic policy-making.

Though numerous research studies have been conducted in respect

of FII flows into India, most of them have been confined to assessing

the impact of such flows on stock markets. Very few studies have

focused on the overall impact of FII flows on all segments of the

Indian financial markets, viz., the capital market, the foreign

exchange market, the money market and other macro-economic

variables, such as inflation, money supply and Index of Industrial

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

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

markets in a holistic manner, by considering various macro-economic

parameters, such as IIP, interest rates, inflation, exchange rates,

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

informed decisions in this regard. The present study examines the

causes and effects of FII net flows into Indian financial markets with

the support of empirical data for the period April 2003–March 2011,

i.e., a time span of eight years, covering the period before, during and

after the eruption of the global financial crisis.

ABOUT THE REPORT

Title of the study:

The present study is titled as A PROJECT REPORT ON ―Volatility in

India n Stock Markets and Foreign Institutional Investors‖. The study

made with special reference to Foreign Institutional Investors.

Objectives of Study:

• To study in depth FDI & FII & its role in Indian stock market.

• To know the changing scenario of Indian stock market after FII

investment and various aspects of FII.

Data and Methodology:

For the purpose of the present study Secondary data were used. The

data is collected from Books , Journals & websites.

Limitations of the Study:

• The study has got all the limitations of using Secondary data

and Inferences were made based on that.

SCOPE OF THE STUDY:

The report examines The Impact of Foreign Institutional Investments

and Foreign Direct Investment on Equity Stock Market in India. The

scope of the research comprises of information derived from

secondary data from various websites. The various information and

statistics were derived from the websites of BSE, NSE, Money

Control, RBI and SEBI. Sensex and Nifty was a natural choice for

inclusion in the study, as it is the most popular market indices and

widely used by market participants for benchmarking.

Chapter Layout:

The Present study is arranged as follows.

Chapter 1 – Gives an Introduction to volatility in Indian stock market

and foreign institutional investors.

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

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

Chapter 4 – Summarizes the result of study.

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

CHAPTER 2

DEALS WITH

INDIAN STOCK MARKET

– A THEORETICAL VIEW

If you want to rear financial blessings, you

have to sow financially.

CHAPTER 2.

INDIAN STOCK MARKET

- A THEORETICAL VIEW

Diversifying globally i.e., holding a well diversified portfolio of

securities from around the globe in proportion to market

capitalizations, irrespective of investor‘s country of residence, has

long been advocated as means to reduce overall portfolio risk and

maximize risk-adjusted returns by the traditional capital asset pricing

model (CAPM). Foreign investment inflow depends on returns in the

stock market, rates of inflation (both home and foreign), and extant

risk. In terms of magnitude, the impact of stock market returns and

the ex-ante risk turned out to be the key determinants of FII inflows.

An investment will always carry the consideration of risk factor in its

risk-return behaviour. In an investment friendly environment the

bullish behaviour dominates the trends and at a given huge volume of

investments, foreign investors may play a role of market makers and

book their profits, i.e., they can buy financial assets when the prices

are declining thereby jacking-up the asset prices and sell when the

asset prices are increasing (Gordon & Gupta, 2003). Hence, there is

a possibility of bi-directional relationship between FII and the equity

returns. Although FII flows help supplement the domestic surplus

resources and augment domestic investments without rising the

foreign debt of the recipient countries, helps to maintain stabilized

balance of payments particularly current account segment. Entry of

FII may also leads to decrease the required rate of return for equity,

and improve stock prices of the host economies / nations. However,

there are uncertainties about the defenselessness of recipient

country‘s capital markets to such flows. FII flows, often referred to as

'hot money' (i.e., short-term and overly tentative), are extremely

unstable in character compared to other forms of capital flows.

Foreign portfolio investors are regarded as 'fair weather friends' who

come in when there is money to be made and leave at the first sign of

impending trouble in the host country thereby destabilizing the

domestic economy of the recipient country. Often, they have been

blamed for exacerbating small economic problems in the host nation

by making large and concerted withdrawals at the slightest hint of

economic weakness. It is also alleged that as they make frequent

marginal adjustments to their portfolios on the basis of a change in

their perceptions of a country's solvency rather than variations in

underlying asset value, they tend to spread crisis even to countries

with strong fundamentals thereby causing 'contagion' in international

financial markets.

Several research studies on FII flows to emerging market economies

(EMEs) over the world have found that financial market infrastructure

like market size, market liquidity, trading cost, extent of informational

dissemination etc., legal mechanisms relating property rights,

harmonization of corporate governance, accounting, listing and other

rules with those followed in developed economies etc., are some of

the important determinants of foreign portfolio investments into

emerging markets. The Securities and Exchange Board of India

(SEBI) and Reserve Bank of India (RBI) have initiated several

measures such as allowing overseas pension funds, mutual funds,

investment trusts and asset management companies, banks,

institutional portfolio managers, universal funds, endowments, easing

the norms for registration of FIIs, reducing procedural delays,

lowering the fees of registration, mandating strict disclosure norms,

improved regulatory mechanisms etc. all these are supported by

strong fundamentals, have made India as one of the attractive

destinations for FIIs. The following table highlights the registered FIIs

in India during the period from 2006 to 2010.

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

number of registered FIIs in India. In the year 2006(January, 2006),

the number of registered FIIs were 833 only. The same number has

been increased to 1697 by the year 2010 (January 2010). The

number has been increased by more than 100 per cent. In spite of

the global financial crisis the number of registered FIIs has shown a

significant increase. Irrespective of the situation in Indian stock

markets these FIIs has earmarked their presence. But the investment

made by FIIs has experienced drastic decline in the recent past. This

is mainly because of the global economic meltdown. Though the

number of registered FIIs increased the net investments were not

increased proportionately. The important reasons for growth in

number of registered FIIs are easing of registration norms, lowering

the registration fees, reducing the procedural delays. The most

important is strong economical foundation of Indian economy.

Though the entire globe affected with the global financial meltdown,

India could face the global financial meltdown effectively. Compared

too many other markets Indian markets are offering attractive returns

on the investments. The growth rates of Gross Domestic Product

(GDP) even during the financial crisis was attractive than many other

economies. This resulted in increased number of registered FIIs in

the last half decade. The following table (Table 2) provides a cross

section of data on the FIIs inflow and stock market movement from

the year 2000 to 2011(31stMay). The FIIs and hedge funds had

pulled out money mainly due to higher interest rates in U.S. after

Federal Reserve increased 7interest rates to 4.5% under their new

governor. Similar changes took place many times in the history since

opening and few times in the study.

Additional indicators and data reflect that movements in the

SENSEX during the two years have clearly been driven by the

behaviour of foreign institutional investors (FIIs), who were

responsible for net equity purchases of as much as $6.6 and $8.5

billion respectively in 2003 and 2004. The Pearson correlation

values indicate positive correlation between the foreign

institutional investments and the movement of Sensex. (The

value of Pearson correlation is 0.570894)

The above table (Table:3) shows the proportion of investment

made by the FIIs in Sensex scrip‘s. It is observed that almost

half of the companies are equipped with FII investment to the

tune of 10% to 20%. Nearly 25% of the companies (Sensex 30

scrip‘s) are having the FII investment between 30% and 40%.

Another important thing is all the thirty scrip‘s are showing the

presence of foreign institutional investment. The pattern of change is

also very minimal in respect of these companies regard to FIIs are

concerned. It can be understood that the FIIs may enter and exit

frequently form the other scrip‘s but not the Sensex scrip‘s. The

above table depicts the consistency of FIIs over a period of time.

From the above table (Table:3) it can be understood that fifty percent

of the companies which are included in BSE SENSEX are having

fifteen to twenty percent of capital from the overseas. This

indicates the level of influence by the foreign institutional investment

on those companies particularly and on the stock market in general.

Any withdrawal of foreign institutional investment may result in

huge volatility in the market as well as share price movements.

Similarly, any increase in the shareholding pattern by the foreign

institutional investors may result huge rally in the market. The

psychology of domestic investors is also affected by the decisions of

foreign institutional investors.

Being an agricultural based economy India has faced large

number of problems while establishing industries. After

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

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

decades. Indian economy has experienced the problem of capital in

many instances. Particularly, to start large scale industries where

capital requirement was more. While planning to start the steel

companies under government control, due to shortage of

resources it has taken the aid of foreign countries. Likewise we

have received aid from Russia, Britain and Germany for establishing

Bhiloy, Rourkela and Durgapur steel plants. The foreign

institutional investment was increased during the years 2006 and

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

were reduced.

ADVANTAGES OF FII IN INDIAN MARKET

• Enhanced flows of equity capital

• FIIs have a greater appetite for equity than debt in their asset

structure. The opening up the economy to FIIs has been in line with

the accepted preference for non-debt creating foreign inflows over

foreign debt. Enhanced flow of equity capital helps improve capital

structures and contributes towards building the investment gap.

• Managing uncertainty and controlling risks.

• FII inflows help in financial innovation and development of

hedging instruments. Also, it not only enhances competition in

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

fundamentals.

• Improving capital markets.

• FIIs as professional bodies of asset managers and financial

analysts enhance competition and efficiency of financial markets.

• Equity market development aids economic development.

• By increasing the availability of riskier long term capital for

projects, and increasing firms‘ incentives to provide more information

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

development.

• Improved corporate governance.

• FIIs constitute professional bodies of asset managers and

financial analysts, who, by contributing to better understanding of

firms‘ operations, improve corporate governance. Bad corporate

governance makes equity finance a costly option. Also,

institutionalization increases dividend payouts, and enhances

productivity growth.

DISADVANTAGES OF FII IN INDAIN MARKET

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

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

amount of Rupee in the market as a result of demand created.

• Problems for small investor: The FIIs profit from investing in

emerging financial stock markets. If the cap on FII is high then they

can bring in huge amounts of funds in the country‘s stock markets

and thus have great influence on the way the stock markets behaves,

going up or down. The FII buying pushes the stocks up and their

selling shows the stock market the downward path. This creates

problems for the small retail investor, whose fortunes get driven by

the actions of the large FIIs.

• Adverse impact on Exports: FII flows leading to appreciation of

the currency may lead to the exports industry becoming

uncompetitive due to the appreciation of the rupee.

• Hot Money: ―Hot money‖ refers to funds that are controlled by

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

the market for short-term, high interest rate investment opportunities.

―Hot money‖ can have economic and financial repercussions on

countries and banks. When money is injected into a country, the

exchange rate for the country gaining the money strengthens, while

the exchange rate for the country losing the money weakens. If

money is withdrawn on short notice, the banking institution will

experience a shortage of funds.

FII and FDI connection:

The relationship between FII and FDI (Foreign Direct Investment) is

intertwined. In 1998 – 1999 a number of reforms were initiated, that

were designed specifically for attracting FDI. In India FDI is allowed

through FII‘s. This is done through private equity, preferential

allotment, joint ventures and capital market operations. The only

industries in which FDI isn‘t allowed are arms, railways, coal, nuclear

and mining. 100% financing by FDI is allowed in infrastructural

projects such as construction of the bridges and the tunnels. In the

financial sector, insurance and banking operations can have foreign

investors.

Differences between FII & FDI:

FDI and FIIs are two important sources of foreign financial flows into

a country. FDI (Foreign Direct Investment) the acquisition abroad of

physical assets such as plant and equipment, with operating control

residing in the parent corporation. It is an investment made to acquire

a lasting management interest (usually 10 percent of voting stock) in

an enterprise operating in a country other than that of the investor,

the investor‘s purpose being an effective voice in the management of

the enterprise. It includes equity capital, reinvestment of earnings,

other long-term capital, and short-term capital. Usually countries

regulate such investments through their periodic policies. In India

such regulation is usually done by the Finance Ministry at the Centre

through the Foreign Investment Promotion Board).

Types of Investments:

FDI typically brings along with the financial investment, access to

modern technologies and export market. The impact of the FDI in

India is far more than that of FII largely because the former would

generally involve setting up of production base - factories, power

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

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

because of further domestic investment in related downstream and

upstream projects and a host of other services. Korean Steel maker

Pasco‘s USD 8 billion steel plants in Orissa would be the largest FDI

in India once it commences. Maruti Suzuki has been an exemplary

case in the India's experience. However, the issue is that it puts

an impact on local entrepreneur as he may not be able to

always successfully compete in the face of superior technology

and financial power of the foreign investor. Therefore, it is often

regulated that Foreign Direct Investments should ensure minimum

level of local content, have export commitment from the investor and

ensure foreign technology transfer to India.FII investments into a

country are usually not associated with the direct benefits in terms of

creating real investments. However, they provide large amounts of

capital through the markets. The indirect benefits of the market

include alignment of local practices to international standards in

trading, risk management, new instruments and equities

research. These enable markets to become more deep, liquid,

feeding in more information into prices resulting in a better

allocation of capital to globally competitive sectors of the

economy. Foreign Institutional Investors Since, these portfolio flows

can technically reverse at any time, the need for adequate and

appropriate economic regulations are imperative.

Government Preference:

FDI is preferred over FII investments since it is considered to be the

most beneficial form of foreign investment for the economy as a

whole. Direct investment targets a specific enterprise, with the aim of

enhancing capacity and productivity or changing its management

control. Direct investment to create or augment capacity ensures

that the capital inflow translates into additional production. In the

case of FII investment that flows into the secondary market, the

effect is to increase capital availability in general, rather than

availability of capital to a particular enterprise. Translating an FII

inflow into additional production depends on production decisions

by someone other than the foreign investor — some local

investor has to draw upon the additional capital made available

via FII inflows to augment production. In the case of FDI that flows

in for acquiring an existing asset, no addition to production capacity

takes place as a direct result of the FDI inflow. Just like in the case of

FII inflows, in this case too, addition to production capacity does not

result from the action of the foreign investor – the domestic seller has

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

capacity or productivity for the foreign capital inflow to boost

domestic production. There is a widespread notion that FII

inflows are hot money — that it comes and goes, creating

volatility in the stock market and exchange rates. While this

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

provided net inflows of capital

Stability:

FDI tends to be much more stable than FII inflows. Moreover, FDI

brings not just capital but also better management and governance

practices and, often, technology transfer. The know-how thus

transferred along with FDI is often more crucial than the capital

per se. No such benefit accrues in the case of FII inflows, although

the search by FIIs for credible investment options has tended to

improve accounting and governance practices among listed

Indian companies.

Types of FIIs:

FII investments in India can be of the TWO types:

1. Normal FIIs: FII allocation of its total investment between

equity and non-equity instruments (including dated government

securities and treasury bills in the Indian capital market) should

not exceed the ratio of 70:30. Equity related instruments would

include fully convertible debentures, convertible portion of

partially convertible debentures and tradable warrants.

2. 100% Debt FIIs: FII that can invest the entire corpus in dated

government securities including treasury bills, non-convertible

debentures/bonds issued by an Indian company subject to limits,

if any. A FII needs to submit a clear statement that it wishes to be

registered as FII/sub-account under 100% debt routes.

Entities which can register as FIIs:

Entities who propose to invest their proprietary funds or on

behalf of "broad based" funds (fund having more than twenty

investors with no single investor holding more than 10 per cent

of the shares or units of the fund) or of foreign corporate and

individuals and belong to any of the under given categories can be

registered for FII.

Pension Funds

Mutual Fund

Investment Trust

Insurance or reinsurance companies

Endowment Funds

University Funds

Foundations or Charitable Trusts

Charitable Societies who propose to in

On their own behalf, and

Asset Management Companies

Nominee Companies

Institutional Portfolio Managers

Trustees

Power of Attorney Holders

Banks

Foreign Government Agency

Foreign Central Bank

International or Multilateral Organization or an Agency

Trends in FIIs:

In 1993, when investments in FII s were introduced, Picket

Umbrella Trust Emerging Markets‘ Fund, an institutional investor

from Switzerland, Indian market. While in 1994, no new registrations

were reported, between 1995 and 2003, an average of 51 new FIIs

began operations in the country each year. The graph below clearly

indicates the steep increase in number of FII to the number of

registered FII‘s at the end of each calendar year). Currently, there are

1,695 registered FIIs and 5,264 registered sub accounts (As on 11th

September, 2009).

Since 1993 when FII‘s were first allowed to enter the India,

there has always been a preference towards investing in equity

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

FII investments through QIPs:

QIPs are private placements or issuances of certain specified

securities by Indian listed companies to qualified institutional

buyers in accordance with the provisions of SEBI guidelines.

Qualified Institutional placements or QIPs were introduced in mid-

2006.

Indian companies that are listed on stock exchanges having

nationwide terminals — the BSE and NSE have been raising capital

through the QIP route. Quarterly Institutional buyers are preferred

primarily because these entities have a large risk appetite,

possess the general expertise and have the experience to make an

informed decision.

In August 2008, SEBI liberalized the pricing conditions for QIPs by

reducing the period of reckoning to an average of two weeks‘

stock price, prior to the relevant date, against the earlier

requirement of taking the higher of the previous six months‘ or 15

days‘ average price. The pre-existing slowdown in the markets led to

attractive valuations for the investors.

Companies have taken advantage of this revision in pricing

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

38.50 per share, and again raised Rs. 2,760 crores in July

2009 at Rs 81 per share. Other companies which successfully

raised capital through QIPs were HDIL, Shobha Developers, Network

18, Dewan Housing and Bajaj Hindustan. Most of the companies

which came out with QIPs were in the real-estate/infrastructure

sector. However, some companies like GMR Infrastructure were

not so successful and had to withdraw their issue and GVK

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

to problems in the valuations. Domestic institutional investors,

especially life insurers kept away from the QIPs on valuation

concerns. However, FIIs which were net sellers had purchased Rs

9,500 crores in the same period.

This led several FIIs to pick up the target stocks via QIP before

the July 6thBudget and offload the same after the budget

session. As per a CRISIL study, 10 out of 13 QIPs are currently

quoting below the offer price. Since most of QIPs were in the

reality and infrastructure sectors, one explanation is that FIIs came in

expecting some quick gains from significant sops to the infrastructure

and housing sectors in the Budget. It is also possible that the rush

for QIPs was driven largely by short-term considerations, where

the FIIs hedged their bets by taking short positions in the issuers‘

stock even as they bought into the offers.

New sources of FII funds:

The Securities and Exchange Board of India is in talks with the

Cayman Islands Monetary Authority (Cima), over allowing funds

based in the Caribbean into the country. Cayman Islands is one

of the world‘s largest tax havens and a lot of global hedge funds are

based out of Cayman Islands Sebi has received numerous

applications from Cayman-based funds since June when Cima was

admitted as a full member of the international body of securities

market regulators, the International Organization of Securities

Commissions (Iosco).

Iosco's constituents regulate more than ninety percent of the world's

securities markets. Funds from Cayman Islands were usually not

favoured by SEBI owning to lack of transparency and difficulty in

establishing the owner base. Consequently, these investments were

viewed unfavorably and any Cayman fund seeking to invest in India

had to be carefully examined.

Post Cayman‘s admission to Iosco, Sebi is now determining

which grades of investment funds can be admitted expeditiously

and which should be examined more carefully. Presently, there are

19 registered foreign institutional investors from Cayman Islands,

taking the total to 19. The two recent additions have been Fir Tree

Capital Opportunity Master Fund and Fir Tree Value Master Fund.

The fund base of Cayman Islands is huge. There are about 9870

funds based there. Indian markets can expect more inflow from

Cayman Island if SEBI agrees to let them come in.

REASONS FOR FDI:

Invest by Companies Overseas

Companies choose to invest in foreign markets for a number of

reasons, often the same reasons for expanding their operations

within their home country. The economist John Dunning has identified

four primary reasons for corporate foreign investments.

Market seeking -

Firms may go overseas to find new buyers for goods and services.

Market-seeking may happen when producers have saturated sales in

their home market, or when they believe investments overseas will

bring higher returns than additional investments at home. This is

often the case with high technology goods.

Resource seeking -

Put simply, a company may find it cheaper to produce its production a

foreign subsidiary- for the purpose of selling it either at home or in

foreign markets. The foreign facility may be able to obtain superior or

less costly access to the inputs of production (land, labor, capital and

natural resources) than at home.

Strategic asset seeking -

Firms may seek to invest in other companies abroad to

help build strategic assets, such as distribution networks or new

technology. This may involve the establishment of partnerships

with other existing foreign firms that specialize in certain aspects of

production.

Efficiency seeking -

Multinational companies may also seek to reorganize their overseas

holdings in response to broader economic changes.

Fluctuations in exchange rates may also change the profit

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

its resources.

ACTS AND RULES:

FII registration and investment are mainly governed by SEBI (FII)

Regulations, 1995.

ELIGIBILITY FOR REGISTRATION AS FII: Following entities / funds

are eligible to get registered as FII:

1. Pension Funds

2. Mutual Funds

3. Insurance Companies

4. Investment Trusts

5. Banks

6. University Funds

7. Endowments

8. Foundations

9. Charitable Trusts / Charitable Societies

Further, following entities proposing to invest on behalf of broad

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

has at least twenty investors with no single individual investor holding

more than 10% shares or units of the fund), are also eligible to be

registered as FIIs:

Asset Management Companies

Institutional Portfolio Managers

Trustees

Power of Attorney Holders

INVESTMENT OPPORTUNITIES FOR FIIs

The following financial instruments are available for FII investments

a) Securities in primary and secondary markets including shares,

debentures and warrants of companies, unlisted, listed or to be listed

on a recognized stock exchange in India;

b) Units of mutual funds;

c) Dated Government Securities;

d) Derivatives traded on a recognized stock exchange;

e) Commercial papers.

Investment limits on equity investments

a) FII, on its own behalf, shall not invest in equity more than 10% of

total issued capital of an Indian company.

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

total issued capital of an India company.

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

Individual category, the investment limit is fixed at 5% of issued

capital. These limits are within overall limit of 24% / 49 % / or the

sectoral caps a prescribed by Government of India / Reserve Bank of

India.

Investment limits on debt investments

The FII investments in debt securities are governed by the policy if

the Government of India. Currently following limits are in effect:

For FII investments in Government debt, currently following limits are

applicable:

For corporate debt the investment limit is fixed at US $ 500 million.

TAXATION:

The taxation norms available to a FII are shown in the table below.

Nature of Income Tax Rate

Long-term capital gains 10%

Short-term capital gains 30%

Dividend Income Nil

Interest Income 20%

Long term capital gain: Capital gain on sale of securities held for a

period of more than one year.

Short term capital gain: Capital gain on sale of securities held for a

period of less than one year.

CHAPTER 3

Impact of FIIs on

Stock Market Instability

The real measure of your wealth is how

much you’d be worth if you lost all your

money.

CHAPTER 3

IMPACT OF FIIS ON

STOCK MARKET INSTABILITY

Investment of FIIs are motivated not only by the domestic and

external economic conditions but also by short run expectations

shaped primarily by what is known as market sentiment. The

element of speculation and high mobility in FII investment can

increase the volatility of stock return in emerging markets. In

fact, a widely held perception among academicians and

practitioners about the emerging equity markets is that price or

return indices in these markets are frequently subject to extended

deviations from fundamental values with subsequent reversals and

that these swings are in large part due to the influence of highly

mobile foreign capital. Volatility is an unattractive feature that has

adverse implications for decisions pertaining to the effective

allocation of resources and therefore investment. Volatility makes

investors averse to holding stock due to increased uncertainty.

Investors in turn demand higher risk premium so as to ensure against

increased uncertainty. A greater risk premium implies higher cost

of capital and consequently lowers physical investment. In

addition, great volatility may increase the ―option to wait‖ thereby

delaying investment. Also weak regulatory system in emerging

market economies (EMEs) reduce the efficiency of market

signals and the processing of information, which further

magnifies the problem of volatility. But some researchers have the

opposite assumption of non-disestablishing hypothesis that says FIIs

have no adverse impact

Trading by FIIs happens on a continuous basis and therefore has a

lasting impact on the local stock market. There is, however,

surprisingly little empirical evidence on the impact of FIIs trading on

the host country‘s stock return volatility, thereby making it imperative

that this aspect of local equity markets, which is important for

both risk analysis and portfolio construction, be examined. This

chapter attempts to fill the gap. Beside the introduction, this chapter is

classified into two parts.

• Part I presents the impact of foreign institutional investors on

the Indian stock market volatility.

• Part II shows the structure of the volatility before and after

introduction of the foreign institutional investors in Indian stock

market.

The scope of the study is limited to the India which has become an

attraction for FIIs in recent years, in fact the emerging markets of

many developing countries have been attracting large inflows of

private capital in recent years. The surge in capital flows occurred

first in Latin America, then South East Asia and is now clearly visible

in South Asia. A significant feature of these capital flows is the

increasing importance of foreign portfolio investment (FPI), whose

buying and selling of stocks on a daily basis determines the

magnitude of such capital flows. A significant improvement has

also taken place in India relating to the flow of foreign capital

during the period of post economic reforms. The major change

in the capital flows particularly in Foreign Institutional Investors

(FIIs) investments has taken place following the changes in

trade and industrial policy. Over the past 15 years or so India

has gradually emerged an important destination of global investors‘

investments in emerging equity markets. In 2006, India had a share

of about 0.55% of global investment which is quite high in comparison

to year 2001 in which India‘s share was only 0.12%. On the other

hand some of the developed countries have shown a downward

trend.

The foreign financial inflows, beside other factors, helped the Indian

stock market to rise at a great height according to financial analysts.

Sensex crossed a new high. It crossed 20000- mark in December

2007, which was 13786.91 in December 2006 and

9397.93 In December 2005. This historical movement is also due to

the other parameters of the economy, which are favorable for the

investment. The returns on investment are also much favorable. The

profit performance of the firms may explain the reasons for

High return on investment. There are other factors such as

favorable tax laws and relaxation on the caps of various kinds

of investments. The policy measures and economic factors are also

the reasons for the investor‘s confidence.

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

higher than those found pre-liberalization period (i.e.1961-80).

Interestingly, return and volatility increase further to 0.074 and 1.92

respectively. In era of first generation reforms financial sector reforms

(i.e. 1991-2000).It is appreciable to see from the table that the

second generation reforms have brought in more cheers for the

capital market as the risk (i.e. Standard Deviation of return)

decreased but the stock return went up in the period. Clearly

the volatility has declined in Indian stock market after year 2000.

Table 5 further reveals that the stock return has remained

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

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

standard deviation which measures the volatility has declined

from 2.1598 percent during 1986-92 to 1.59 percent during

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

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

to 2001 gave a serious setback to stock market performance.

Increase cap on G-Sec Bond Markets:

Currently, the cap on FII investments in the bond market is USD 6

Billion. As per the new budget, proposes to borrow Rs.4.5 lakh

crore in 2009-10 to support its infrastructure and other

developmental projects. This could be opened up to the FIIs so that

they can take part in India‘s hitherto almost closed debt market. The

Indian debt markets are not fully developed and see low volumes.

The lifting of the cap on FIIs will increase the traded volumes

and it will also help in preventing the ‗crowding out‘ of investment for

private enterprises.

Allow dollar settlements in India:

The suggestion by SEBI to permit dollar settlements for FIIs would

revolutionize the way in which they invest in the country. This will help

mitigate risks of currency fluctuations for FIIs, and help in improve the

volume and liquidity of the derivatives market. With dollar

settlements, many participants, who want to take exposure to

Indian markets through index buying, will be able to participate

freely. This, in turn, will give stability to Indian markets as there will

be buying of underlying stocks by the sellers of these contracts to

FIIs.

At present, settlements in India are done in rupee denominations. As

a result, a number of FIIs, who intend to trade in Nifty futures, take

the Singapore route where CNX Nifty index futures are traded on

SGX.

About 50 per cent of the total open interest (OI) build-up in Nifty

futures takes place on the SGX, which allows settlements in US

dollar. This enables different types of FIIs to operate there. Also, low

transaction costs due to the absence of securities transaction tax,

stamp duty and P-note complications have resulted in a gradual

shift of FIIs into offshore markets. Settlements in dollar would

also help in reducing the volatility in dollar-rupee conversion

value caused due to FII flows. Each time a settlement is done, a

seller of futures contracts to an FII would buy an equivalent amount of

underlying stocks to hedge his/her exposure due to the sale. This

would increase the trading volume and liquidity of Indian markets,

once dollar settlement is allowed.

Stricter implementation of regulation to curb p-notes etc.

To prevent the misuse of the participatory notes, there should

be stricter implementation of the regulations. Tough

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

group is of the opinion that registration procedures for FIIs

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

with.

CHAPTER 4

CONCLUSION

Those who start with too little money are

more likely to succeed than those who start

with too much. Energy and imagination are

the springboards to wealth creation.

CHAPTER 4.

CONCLUSION

A number of studies in the past have observed that investments by

FIIs and the movements of Sensex are quite closely correlated in

India and FIIs wield significant influence on the movement of Sensex

(Rangarajan 2000, Samal 1997, Pal 1998). NSE (2001) also

observes that in the Indian stock markets FIIs have a

disproportionately high level of influence on the market sentiments

and price trends. This is so because other market participants

perceive the FIIs to be infallible in their assessment of the market and

tend to follow the decisions taken by FIIs. This ‗herd instinct‘

displayed by other market participants amplifies the importance of

FIIs in the domestic stock market in India.

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

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

when there are positive inflows of FIIs and there were decrease in

Sensex when there were negative FII inflows. It has been perceived

in some quarters that FII flows are major drivers of stock

markets in India and hence a sudden reversal of flows may harm

the stability of its markets. The nature of relationship between FII

flows and Indian stock market returns can be explained in terms of

―cumulative informational disadvantage‖ of foreign portfolio investors

vis-a-vis domestic investors. The theory says that domestic investors

posses better knowledge about Indian financial markets than

foreign investors and this information asymmetry leads to „positive

feedback trading‟ by the foreign portfolio investors. There is no

doubt FIIs are influencing the movement of Sensex to a greater

extent.

The whole process also highlights another disturbing feature. During

the post election period, the sudden volatility in the stock market and

the subsequent decline of Sensex was almost treated as a national

emergency in India by the financial media and to a certain extent, by

the incoming UPA government. It is very difficult to understand why

the government feels so concerned about speculative investors and

the movements in Sensex. Most studies have shown that Sensex is

neither a good barometer of economic fundamentals it is not an

indicator of future growth prospects of the economy. Moreover, this

study also shows that even sharp changes in Sensex do not

necessarily indicate a significant alteration of actual shareholding

pattern of different investor groups even in the Sensex companies. As

far as the real economy is concerned, the stock market has a very

limited role to play. In India, for the year 2002-03, new capital issues

by non- government public limited companies raised a combined

capital of Rs 1,878 crores from ordinary shares, preference share and

debentures. This amount is only 0. 33 percent of gross domestic

capital formation of the economy and about 1. 6 percent of gross

domestic capital formation by private corporate sector for that year.

This is not surprising because even in developed stock market s like

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

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

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

Handbook of Statistics shows, investment in shares and

debentures10 and units of UTI account for only 1.37 percent of total

household financial savings for t h e y ear 2003- 04. In comparison,

bank deposits account for about 42 .8 percent of household financial

savings for the same year. Under this circumstance s, it is not clear

why so much importance is given to the stock market and portfolio

investors by policy makers in India. It is high time to realize that in

spite of the impression given by the financial media, movements of

stock markets and Sensex do not necessarily imply any

fundamental changes in the economy and these movements affect a

very small minority of the country ‘s population. It will be

unfortunate if movements of speculative capital and the resultant

stock market gyrations are allowed to influence macro-economic

policy making in India.

Results of this study show that not only the FIIs are the major players

in the domestic stock market in India, but their influence on the

domestic markets is also growing. Data on trading activity of FIIs and

domestic stock market turnover suggest that FII‘s are becoming more

important at the margin as an increasingly higher share of stock

market turnover is accounted for by FII trading. Moreover, the

findings of this study also indicate that Foreign Institutional Investors

have emerged as the most dominant investor group in the domestic

stock market in India. Particularly, in the companies that constitute

the Bombay Stock Market Sensitivity Index (Sensex) and NSE Nifty,

their level of control is very high. Dominant position of FIIs in the

Sensex companies, it is not surprising that FIIs are in a position to

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

Since FIIs are dominating the Indian Market, individual investors are

forced to accept the dictates of major FIIs and hence join the group

by entering the Mutual Fund group. Many Mutual Funds floated

specific funds for the sectors favored by the FIIs. An implication of

MFs gaining strength in the Indian stock market could be that unlike

individual investors, whose monies they manage, MFs can create

market trends whereas the small individual investors can only follow

the trends. The situation becomes quite difficult if the funds gain a

vested interest in certain sectors by floating sector specific funds.

One can even venture to say that the behaviour of MFs in India has

turned the very logic that mutual funds invest wisely on the basis of

well-researched strategies and individual investors do not have the

time and resources to study and monitor corporate performance,

upside down. Thus, the entry of FIIs has not resulted in greater depth

in Indian stock market; instead it led to focusing on only a few

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

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

CHAPTER 5

ANNEXURE

Fortune knocks once, but misfortune has

much more patience.

ANNEXURE

MILESTONES OF FOREIGN INSTITUTIONAL INVESTMENT IN INDIAN STOCK MARKET

India embarked on a programme of economic reforms in the early

1990s to tie over its balance of payment crisis and also as a step

towards globalisation.

An important milestone in the history of Indian economic reforms

happened on September 14, 1992, when the FIIs (Foreign

Institutional Investors) were allowed to invest in all the securities

traded on the primary and secondary markets, including shares,

debentures and warrants issued by companies which were listed or

were to be listed the stock exchanges in India and in the schemes

floated by domestic mutual funds.

Initially, the holding of a single FII and of all FIIs, NRIs (Non-

Resident Indians) and OCBs (Overseas Corporate Bodies) in any

company was subject to a limit of 5% and 24% of the company's total

issued capital respectively.

( In order to broad base the FII investment and to ensure that such

an investment would not become a camouflage for individual

investment in the nature of FDI (Foreign Direct Investment), a

condition was laid down that the funds invested by FIIs had to have at

least 50 participants with no one holding more than 5%. Ever since

this day, the regulations on FII investment have gone through

enormous changes and have become more liberal over time.

( From November 1996, FIIs were allowed to make 100%

investment in debt securities subject to specific approval from SEBI

as a separate category of FIIs or sub-accounts as 100% debt funds.

Such investments were, of course, subjected to the fund-specific

ceiling prescribed by SEBI and had to be within an overall ceiling of

US $ 1.5 billion. The investments were, however, restricted to the

debt instruments of companies listed or to be listed on the stock

exchanges.

In 1997, the aggregate limit on investment by all FIIs was allowed

to be raised from 24% to 30% by the Board of Directors of individual

companies by passing a resolution in their meeting and by a special

resolution to that effect in the company's General Body meeting.

(From the year 1998, the FII investments were also allowed in the

dated government securities, treasury bills and money market

instruments.

(In 2000, the foreign corporates and high net worth individuals

were also allowed to invest as sub-accounts of SEBI-registered FIIs.

FIIs were also permitted to seek SEBI registration in respect of sub-

accounts. This was made more liberal to include the domestic

portfolio managers or domestic asset management companies.

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

March 2000.

(This was subsequently raised to 49% on March 8, 2001 and to the

specific sectoral cap in September 2001.

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

on March 13, 2002 to identify the sectors in which FIIs portfolio

investments will not be subject to the sectoral limits for FDI.

(Later, on December 27, 2002 the committee was reconstituted

and came out with recommendations in June 2004. The committee

had proposed that, 'In general, FII investment ceilings, if any,

may be reckoned over and above prescribed FDI sectoral

caps. The 24 per cent limit on FII investment imposed in 1992 when

allowing FII inflows was exclusive of the FDI limit. The suggested

measure will be in conformity with this original stipulation.' The

committee also has recommended that the special procedure for

raising FII investments beyond 24 per cent up to the FDI limit in a

company may be dispensed with by amending the relevant

regulations.

(Meanwhile, the increase in investment ceiling for FIIs in debt funds

from US $ 1 billion to US $ 1.75 billion has been notified in 2004. The

SEBI also has reduced the turnaround time for processing of FII

applications for registrations from 13 working days to 7 working days

except in the case of banks and subsidiaries.

All these are indications for the country's continuous efforts to

mobilize more foreign investment through portfolio investment by FIIs.

The FII portfolio flows have also been on the rise since September

1992. Their investments have always been net positive, but for 1998-

99, their sales were more than their purchase.

CHAPTER 6

BIBLIOGRAPHY

No matter how hard you hug your money, it

never hugs back.

BIBLIOGRAPHY

BOOKS: FOREIGN DIRECT INVESTMENT

BY- M. SORNARAJAH

FOREIGN INSTITUTIONAL INVESTORS

BY- VIJAYCHANDRA KUMAR C

MAGAZINE: INDAIN JOURNALS OF MARKETING MARCH 10, MAY

12.

NEWS PAPER: ECONOMICS TIMES

TIMES OF INDIA

DNA

CHAPTER 7

WEBLIOGRAPHY

I don’t think about financial success as the

measurement of my success.

WEBLIOGRAPHY

http://www.moneycontrol.com/

http://www.rbi.org.in/

http://www.sebi.gov.in/

http://www.nseindia.com/