Stock market prices is recognized as being a very sensitive indicator of the state of any economy. A change in stock price is likely to result a negative impact on the economy and it is because of this that the causal relationship existing between the macroeconomic variables and the stock returns is highly debated topics in finance in the recent past (Ozbay, 2009). The stock market has not only been the attraction to those involved in policy making and the researchers , rather the existing relationship between macroeconomic variables and stock market has been an attraction to the both economist and financial investors.
There are three reasons that are behind this scenario. First, the policy makers will be in a position of predicting the likely outcomes of the present as well as the future policies and regulations. Second, investors are likely to come up with plausible decisions when they have full knowledge regarding the relations between the variables and this would mean reduced exposure to risk level. Third, with the public being fully aware of changes that are likely to be experienced in the financial market, there will be a reduced level in shock factor with the public being in a position of taking precautionary measures (Abu-Libdeh & Harasheh, 2011). Ali (2011) has observed that there has been more attention in developed economies with only a few researches being undertaken in the developing countries.
There has been recognition of how stock market are useful in some of the developing countries as they (stock market0 results to improvement in quality and efficiency in the financial system at the domestic level. The emphasis on the importance of stock market and attraction it has received as the fact that local markets are being exposed to global capital market that is has a reputation systems with flexible rate of exchange as well as financial markets globalization. Aliyu (2009) has linked this to the high attention researchers have given in the investigation of the variables that affect stock market. The effect of macroeconomic factors on the stock market will be different in different stock markets and will show variation from one period to another.
Furthermore, the performance of the market as depicted by the FSTE index may not be a reflection on all the companies in the market. It is with this reasoning that there was inspiration to investigate the relationship between price share of Severn Trent plc, FTSE performance, exchange rates and interest rate. It will be expected that any changes generally affecting the economic conditions, including removal of restrictions on foreign investment, would likely result to changes being experienced the stock market and its interaction with the economic factors. Pramod-Kumar & Puja, (2012) have reiterated that the relationship between stock market and macroeconomic factors are important for investors with dynamics in relationships having changed. Bhunia (2012) has pointed out that even though there have been theoretical and empirical studies that have been undertaken with the aim of establishing the direction in causality in the stock market performance and the macroeconomic variables, the direction has not yet been fully established in both cases.
While in some studies causality have been proofed through empirical evidence, in other studies there has been no causal relationship that has been established and also as seen earlier the behavior will be unique for different economies. The high impact that the macro economic variables has on the stock market the vital role played by the capital market in economy by virtue of the effect it has on its major factors and in return affecting the investment decisions. This is the reason that a keen investor need to be knowledgeable of the dynamics the macroeconomic variables and stock market performance as this will put the investor in a position of managing the investment with high efficiency (Osamwonyi & Evbayiro-Osagie, 2012).
This study aims at exploring the relationship between the shares of servant, the stock market performance, the exchange rates and interest rates. The fluctuation in stock market has been said to be well explained well by the exchange rates, interest rates, inflation and money supply (Graham & Harvey, 2001; Adrangi et al., 2011).
The rest of this paper is organized as follows; section two reviews papers examining the relationship between macroeconomic variables and stock market. Section three defines the research variables, methodology, and hypothesis and research strategy. Section four presents’ results of the paper and finally section five concludes the research and gives recommendation for future work.
Methodology
Research Variables
This study aims at exploring the relationship between the shares of servant, the stock market performance, the exchange rates and interest rates. The variable that will be under investigation are GN/US$ proxy for exchange rate, FSTE index proxy for stock market, yield level proxy for and the share price of server company. The details of the variables are given below in much more details.
Market index FTSE: as a step of helping those who have interest in stock market be it the government, investors or those who have are pursuing academics, the FTSE is a tool for evaluation useful for portfolio managers and investment advisors. As Strong (2005) puts it an index is compost of a collection of what are regarded as major companies in the economy and Rafiqueet al. (2013), points out that movement of the index is a measure of the performance of the stock market. The things that makes the index to fluctuate are social, macroeconomics, political , international variable and variables specific in companies.
Interest rate: according to the definition given by Reilly and Brown (2003) interest is the rate of exchange between future and the prevailing consumption at present. A person accepting to pay for the difference when borrowing money or receiving this interest when they have saved the money in different forms including bonds, then we have interest rate referred to as “pure time value moneyâ€. But where there is uncertainity, an interest rate that is higher than the “pure time value money†will be demanded by the investor in addition to incorporation of inflation rate that is expected to counterweigh uncertainity. In a study by Uddin and Alam (2007) there was use of interest on deposit as a proxy for interest rate. The argument that was put forward was that in theory interest rate will exhibit a negative relationship with stock prices. When there is an increase in the banks, there will be a tendancy of people redirecting their money from the capital market towards the banks thus leading to a drop in share demand with the vise versa being true.
Additionally, when interest on deposit increases, lending rate also increases, which will have a negative impact on investment in the economy and hence the stock prices and vice versa.
Exchange rate: Gunasekarage et al. (2004) and Adam and Tweneboah (2008) used national currency per United States dollar (USD) as a proxy for exchange rate. As exchange rate is the price of a currency in terms of another currency, it will affect net exports (Osamwonyi, 2003 cited in Osamwonyi & Evbayiro-Osagie, 2012). IT was established by Vejzagic and Zarafat (2013) that changes in exchange rates would impact a company’s competitiveness due to the fact that this affects price of foreign currency, and this eventually leads to changes in the firm’s profits and equity, which in return will lead to price adjustments in the stock market. According to the portfolio adjustment approach, any inflow or outflow of foreign capital will be a result of a change in stock prices. That is, when stock prices increase, they will attract foreign capital and when prices decrease, they will be less appealing to foreign investors, which will lead to a reduction in corporate wealth and as a result a reduction in the country’s wealth (Vejzagic & Zarafat, 2013).
3.2 Hypothesis
This research involved the following hypothesis
H1: Yield level is not negatively correlated to FSTE
H2: the share value of Severn and FTSE are not related
H3: There is a negative relationship between exchange rate and the share of the company
H4: There is no causal relationship between stock market index and inflation.
H5: Exchange rate does not affect stock market index in the long run.
H6: There is no causal relationship between stock market index and exchange rate.
3.3 Research Strategy
In this research there was a quantitative approach where empirical analysis is performed where correlation of the variables was performed. The data used in the research was secondary, which had been published by official websites. The data used was from 2nd January 2015 to 14th December 20 16. The FTSE was used to indicate the performance of the stock market while yield level was used as a measure of interest rate, 10 year Gilt interest rate for that matter.
Results
Descriptive statistics
Table 1 below gives the results of the descriptive statistics. From the table it can be seen that in the study period under consideration the US$/GB£ range between 1.21 to 1.59 with a mean of 1.4461. The share price of Severn Trent plc a maximum of 2471 to a low of 1804.62. on the other hand FTSE had a mean of 6476.76 with a minimum of 5499.51 and a maximum of 7061.36.
Descriptive Statistics
N
Minimum
Maximum
Mean
Std. Deviation
US$/GB£
495
1.21
1.59
1.4461
.10409
Share
495
1804.62
2471.60
2107.0180
152.67749
FTSE
495
5499.510
7061.360
6476.76780
378.727310
Valid N (listwise)
495
Relationship between variables
Table 2 below gives a summary of the relationship between the variables. From the table it can be seen that the there is a strong negative correlation between share price of Severn Trent Plc and the US$/GB£ r(495)=-0.738(p<0.05). The correlation between FTSE and share price of US$/GB£ seen to be positive and statistically significant r(495)=0.148(p<0.05). The table also reveal that there is a negative significant correlation between FTSE and US$/GB£ r(495)=-0.215(p<0.05).
Correlations
US$/GB£
share
ftse
US$/GB£
Pearson Correlation
1
-.738**
-.215**
Sig. (2-tailed)
.000
.000
N
495
495
495
share
Pearson Correlation
-.738**
1
.148**
Sig. (2-tailed)
.000
.001
N
495
495
495
ftse
Pearson Correlation
-.215**
.148**
1
Sig. (2-tailed)
.000
.001
N
495
495
495
**. Correlation is significant at the 0.01 level (2-tailed).
Discussion and conclusion
From the result it was seen that both FTSE and the price share of Severn Trent plc were negatively correlated to exchange rate (US$/GB£). This was in agreement with observation made by Osamwonyi(2003) that exchange rate will affect the FTSE and share prices of individual companies as a result of exportation. Low exchange rate will benefit companies that export there products while if a company imports material for use then a high exchange rate will affect them negatively. It can also be seen that the correlation is stronger for Severn Trent plc price share with exchange rate than for FTSE with exchange rate. This means that as much as the general market index will show a trend that depends on whether the exchange rate is increasing of reducing the individual companies will affected differently. In conclusion this research was in agreement with what was expected.