Body

A Study On Impact of Foreign Institutional Investors On Indian
Stock Market

CHAPTER 1

INTRODUCTION

1.1 FOREIGN INSTITUTIONAL INVESTORS

FII is defined as an institution organized outside of India for the purpose of making
investments into the Indian securities market under the regulations prescribed by SEBI.

‗FII‘ include ―Overseas pension funds, mutual funds, investment trust, asset management
company, nominee company, bank, institutional portfolio manager, university funds, endowments,
foundations, charitable trusts, charitable societies, a trustee or power of attorney holder
incorporated or established outside India proposing to make proprietary investments or
investments on behalf of a broad-based fund. FIIs can invest their own funds as well as invest on
behalf of their overseas clients registered as such with SEBI. These client accounts that the FII
manages are known as ‗sub-accounts‘. A domestic portfolio manager can also register itself as an
FII to manage the funds of sub-accounts

Foreign institutional investor means an entity established or incorporated outside India
which proposes to make investment in India. Positive tidings about the Indian economy combined
with a fast-growing market have made India an attractive destination for foreign institutional
investors. FII is defined as an institution organized outside of India for the purpose of making
investments into the Indian securities market under the regulations prescribed by SEBI.

Entry Options for FII

A foreign company planning to set up business operations in India has the following options:

Incorporated Entity

By incorporating a company under the Companies Act,1956 through

• Joint Ventures; or

CANARA BANK SCHOOL OF MANAGEMENT STUDIES Page 1

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• Wholly Owned Subsidiaries

Foreign equity in such Indian companies can be up to 100% depending on the requirements of the
investor, subject to equity caps in respect of the area of activities under the Foreign Direct
Investment (FDI) policy.

1.1.1 Important terms to know about FIIs:

Sub-account:

Sub-account includes those foreign corporations, foreign individuals, and institutions, funds or
portfolios established or incorporated outside India on whose behalf investments are proposed to
be made in India by a FII.

Designated Bank:

Designated Bank means any bank in India which has been authorized by the Reserve Bank of
India to act as a banker to FII.

Domestic Custodian:

Domestic Custodian means any entity registered with SEBI to carry on the activity of providing
custodial services in respect of securities.

Broad Based Fund:

Broad Based Fund means 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. Provided that if the fund has institutional investor(s) it shall not be necessary for the fund to
have twenty investors.

If the fund has an institutional investor holding more than 10% of shares or units in the fund, then
the institutional investor must itself be broad based fund.


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1.1.2 Foreign Institutional Investors Registration

Following entities / funds are eligible to get registered as FII:

• Pension Funds

• Mutual Funds

• Investment Trust

• Insurance or reinsurance companies

• Investment Trusts

• Banks

• Endowments

• University Funds

• Foundations

• Charitable Trusts or Charitable Societies

Further, following entities proposing to invest on behalf of broad based funds, are also eligible to be
registered as FIIs:

• Asset Management Companies

• Institutional Portfolio Managers

• Trustees

• Power of Attorney Holders.

The eligibility criteria for applicant seeking FII registration

As per Regulation 6 of SEBI (FII) Regulations,1995, Foreign Institutional Investors are required to
fulfill the following conditions to qualify for grant of registration:


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• Applicant should have track record, professional competence, financial soundness,
experience, general reputation of fairness and integrity.

• The applicant should be regulated by an appropriate foreign regulatory authority in the
same capacity/category where registration is sought from SEBI. Registration with authorities, which
are responsible for incorporation, is not adequate to qualify as Foreign Institutional Investor.

• The applicant is required to have the permission under the provisions of the Foreign
Exchange Management Act, 1999 from the Reserve Bank of India.

• Applicant must be legally permitted to invest in securities outside the country or its in-
corporation / establishment.

• The applicant must be a "fit and proper" person.

• The applicant has to appoint a local custodian and enter into an agreement with the
custodian. Besides it also has to appoint a designated bank to route its transactions.

• Payment of registration fee of US $ 5,000.00

"Form A" as prescribed in SEBI (FII) Regulations, 1995 is to be filled before applying for FII
registration.

Supporting documents required are:

• Application in Form A duly signed by the authorized signatory of the applicant.

• Certified copy of the relevant clauses or articles of the Memorandum and Articles of
Association or the agreement authorizing the applicant to invest on behalf of its clients

• Audited financial statements and annual reports for the last one year , provided that the
period covered shall not be less than twelve months.


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• A declaration by the applicant with registration number and other particulars in support of
its registration or regulation by a Securities Commission or Self Regulatory Organisation or any
other appropriate regulatory authority with whom the applicant is registered in its home country.

• A declaration by the applicant that it has entered into a custodian agreement with a
domestic custodian together with particulatrs of the domestic custodian.

• A signed declaration statement that appears at the end of the Form.

• Declaration regarding fit & proper entity.

The fee for registration as FII is US $ 5,000. The mode of payment is Demand Draft in favour of
"Securities and Exchange Board of India" payable at New York‖.

SEBI generally takes 7 working days in granting FII registration. However, in cases where the
information furnished by the applicants is incomplete, seven days shall be counted from the days
when all necessary information sought, reaches SEBI.

In cases where the applicant is bank and subsidiary of a bank, SEBI seeks comments from the
Reserve Bank of India (RBI). In such cases, 7 working days would be counted from the day no
objection is received from RBI.

The FII registration is valid for 5 years. After expiry of 5 years, the registration needs to be
renewed.

Same as initial registration, Along with "Form A" and all the relevant documents, the
applicants are required to fill in additional form (Annexure 1) while applying for renewal. US $ 5,000
needs to be paid for renewal of FII registration.

The application for renewal should be submitted three months before expiry of the FII
registration. 100 % debt FIIs are debt dedicated FIIs which invest in debt securities only. The
procedure for registration of FII/sub-account, under 100% debt route is similar to that of normal
funds besides a clear statement by the applicant that it wishes to be registered as FII/sub-account
under 100% debt route.


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The FII registration application should be sent to:

Securities and Exchange Board of India

Division of FII & Custodian

Mittal Court "B" Wing, First Floor

224, Nariman Point

Mumbai 400 021

India.


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Chart 1.1- showing FII registration Process:


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1.1.3 Sub-Account Registration

a) Institution or funds or portfolios established outside India, whether incorporated or not.

b) Proprietary fund of FII.

c) Foreign Corporates

d) Foreign Individuals.

The FII should apply on the behalf of the Sub-account. Both the FII and the Sub-account are
required to sign the Sub-account application form.

"Annexure B" to "Form A" (FII application form) needs to be filled when applying for sub-
account registration. No document is needed to be sent with annexure B. The fee for sub-account
registration is US$ 1,000. The fee is to be submitted at the time of submitting the application. The
mode of payment is Demand Draft in the name of "Securities and Exchange Board of India"
payable at New York. SEBI generally takes three working days in granting FII registration.
However, in cases where the information furnished by the applicants is incomplete, three days
shall be counted from the days when all necessary information sought, reaches SEBI. The validity
of sub-account registration is co-terminus with the FII registration under which it is registered. The
process of renewal of sub-account is same as initial registration. Renewal fee in this case is US $
1,000. OCBs / NRIs are not permitted to get registered as FII/sub-account.

1.1.4 Post-Registration Process

If a registered FII/sub-account undergoes name change, then the FII need to promptly
inform SEBI about the change. It should also mention the reasons for the name change and give
an undertaking that there has been no change in beneficiary ownership.

In case of name change of FII, the request should be accompanied with documents from
home regulator and registrar of the company evidencing approval of name change, and the original
FII registration certificate issued by SEBI should be sent back for necessary amendment.

Procedure for transferring a sub-account from one FII to another:


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The FII to whom the Sub-account is proposed to be transferred has to send a request
along with a declaration that it is authorized to invest on behalf of the Sub-account. The transferor
FII should also submit a No-objection certificate.

The FII should send a request, along with no-objection certificate from existing domestic custodian,
for change in domestic custodian.

The FII would be required to send a request for cancellation of its registration or registration of its
Sub-account/s clearly mentioning the name and registration number of the entity. The FII should
ensure that it / Sub-account has nil cash / securities holdings.

Procedure for change of local custodian:

In case of change of the local custodian of the FII / sub-account, the change should be
intimated to SEBI by the FII. On receipt of no objection from the existing custodian and acceptance
from the proposed custodian, the change of custodian would be approved - by SEBI.

Procedure for registration as FII/sub account under 100% debt route:

The procedure for registration of FII/sub account under 100% debt route is similar to that of
normal funds besides a clear statement by the applicant that it wishes to be registered as FII/sub
account under 100% debt route. However, Government of India allocates the overall investment
limit for 100% debt funds annually. The grant of investment limit for individual 100% debt funds is
within this overall limit. The funds have to seek further investment limit in case the limit allotted to
them is exhausted and they wish to invest further.

A Foreign Institutional Investor having an account with one custodian can open accounts
with different custodians for its different sub-accounts. However, one sub-account cannot be
custodial with more than one custodian.

Procedure if an existing sub-account wants to get registered as a Foreign Institutional Investor:

In case if a registered sub-account wishes to get itself registered as a Foreign Institutional Investor,
then it will have to apply in Form A to SEBI for the same and has to satisfy all the eligibility criteria


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norms mentioned in SEBI (Foreign Institutional Investor) Regulations, 1995. It should also submit a
letter from the old FII indicating its 'No-objection' to such registration.

Procedure for renewal of FII/Sub-Account registration:

They have to apply before 3 months of the expiry of registration in Form A. Circular No
FITTC/CUST/09/2000 dated September 21, 2000 may be referred.

If the FII does not renew its/sub-account‘s registration:

The registration of the FII / Sub-account would get expired at due date and it would not be
allowed to trade in Indian securities markets. If it is not interested in renewal but has certain
residual assets, it can apply for disinvestment in terms of Circular No. FITTC/CUST/12/2001 dated
June 04, 2001 and abides by the guidelines specified in this regard.

1.1.5 Scope of Investments under the Portfolio Investment Scheme.

FIIs, under the Portfolio Investment Scheme, are permitted to make both primary and
secondary investments in the India capital markets. Unlike an investor which relies solely on FDI
regulations, a foreign investor which registers as a FII would be allowed to buy and sell securities
over Indian stock exchanges. In addition, FIIs are entitled to effect transactions in a broader
category of securities than an investor relying on FDI regulations alone. FIIs are permitted to
purchase equity securities (both listed and unlisted), units of schemes floated by the Unit Trust of
India and other domestic municipal funds, warrants, debentures, bonds, governmental securities
and derivative instruments which are traded on a recognized stock exchange. There is no limit on
the amount that FIIs may invest in the Indian market, and no lock-up periods apply to investments
made by FIIs.


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Exchange Controls

FIIs are required to open up one or more bank accounts with certain designated banks and must
also appoint a domestic custodian for custody of investment made by the FII. Through the
designated accounts, FIIs are authorized to freely transfer funds from foreign currency accounts to
Rupee accounts and vice versa; make Rupee denominated investments in Indian companies;
freely transfer after-tax proceeds from Rupee accounts to foreign currency accounts, and repatriate
capital, capital gain, dividends interest income and other gains, subject to deduction for applicable
withholding taxes. So long as FIIs execute purchases and sales on a recognized Indian stock
exchange, they are not required to obtain transaction specific approval from the Reserve Bank. FIIs
are also entitled to effect transactions using their own proprietary funds, or the funds of their sub
accounts.

Investment Restrictions

Certain limitations apply to investments by FIIs into India. First, FIIs‘ and their sub-
accounts‘ investment in an Indian company cannot exceed ten percent (10%) of the total issued
share capital of the Indian company (five percent if the subaccount is a foreign corporation or
individual). In addition, the aggregate investment of all FIIs in an Indian company may not exceed
twenty four percent (24%) of its total issued share capital, without the express approval of its board
of directors and shareholders. Even with board of director and shareholder approval, the same
sectoral limits which apply to foreign direct investment would continue to apply. FIIs may register
with SEBI as a debt fund or an equity fund. FIIs which are registered as equity funds are required
to invest at least seventy percent (70%) of their funds in equity and equity-related securities. A FII
registered as a debt fund, on the other hand, must invest one hundred percent (100%) of its funds
in debt instruments. Foreign corporations and individuals are not eligible subaccounts of a FII that
is registered as a debt fund. FIIs are not permitted to engage in short selling, other than in respect
of derivative securities traded over a recognized exchange, and must effect transactions through a
registered stock broker. Sector investment prohibitions and caps which apply to foreign direct
investment also apply to investments by FIIs, and FII investments must also comply with the pricing


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requirements applicable to foreign direct investment. In addition, FIIs are not permitted to invest in
print media.


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1.2 TREND OF FIIS WITH THE HELP OF ECONOMIC FIGURES

• In 2004, FII investments crossed $9 billion, the highest in the history of Indian capital
markets.

• The total net investment for the year up to December 29 stood at US$9,072 million while
foreign investors pumped in about US$2,113 million in December.

• Korea and Taiwan have always been the biggest recipients of FII money. It was only in
2004 that India managed to receive the second highest FII inflow at over $8.5bn.

• In 2005 FIIs invested more in Indian equities than in Korean or Taiwanese equities.

• On 9th March 2009, India's exceptional growth story and its booming economy have made
the country a favourite destination with foreign institutional investors (FIIs). It has continued to
attract investment despite the Satyam non-governance issue and the global economic contagion
impact on Indian markets.

• According to Mr Gautam Chand, CEO of Instanex, said FIIs are the largest institutional
investors in India with holdings valued at over US$ 751.14 billion as on December 31, 2008.

• They are also the most successful portfolio investors in India with 102 per cent
appreciation since September 30, 2003.

• As per SEBI, number of registered FIIs stood at 1626 and number of registered sub-
accounts stood at 4972 as on March 17, 2009.

Future Prospects of Foreign Institutional Investments:

Sustaining the growth momentum and achieving an annual average growth of 9-10 % in
the next five years.
Simplifying procedures and relaxing entry barriers for business activities and Providing
investor friendly laws and tax system.
Checking the growth of population; India is the second highest populated country in the
world after China. However in terms of density India exceeds China, as India's land area is


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almost half of China's total land. Due to a high population growth, GNI per capita remains
very poor. It was only $ 2880 in 2003 (World Bank figures).
Boosting agricultural growth through diversification and development of agro processing.
Expanding industry fast, by at least 10% per year to integrate not only the surplus labour in
agriculture but also the unprecedented number of women and teenagers joining the labour
force every year.
Developing world-class infrastructure for sustaining growth in all the sectors of the
economy
Allowing foreign investment in more areas.
Effecting fiscal consolidation and eliminating the revenue deficit through revenue
enhancement and expenditure management.
Global corporations are responsible for global warming, the depletion of natural resources,
and the production of harmful chemicals and the destruction of organic agriculture.
The government should reduce its budget deficit through proper pricing mechanisms and
better direction of subsidies. It should develop infrastructure with what Finance Minister P
Chidambaram International Research Journal of Finance and Economics - Issue 5 (2006)
171 of India called ―ruthless efficiency‖ and reduce bureaucracy by streamlining
government procedures to make them more transparent and effective.
Empowering the population through universal education and health care, India must
maximize the benefits of its youthful demographics and turn itself into the knowledge hub
of the world through the application of information and communications technology (ICT) in
all aspects of Indian life although, the government is committed to furthering economic
reforms and developing basic infrastructure to improve lives of the rural poor and boost
economic performance. Government had reduced its controls on foreign trade and
investment in some areas and has indicated more liberalization in civil aviation, telecom
and insurance sector in the future.


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Chart 1.2- Investment structure of FII


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Chart 1.3- FII and THE FINANCIAL SYSTEM


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Table 1.1- Number of registered FIIs in India

As of March 2011 there were 1722 FIIs registered with SEBI, as against 1711 in March 2010

SEBI Registered FIIs in India End of March
1992-93 0
1993-94 3
1994-95 156
1995-96 353
1996-97 439
1997-98 496
1998-99 450
1999-00 506
2000-01 527
2001-02 490
2002-03 502
2003-04 540
2004-05 685
2005-06 882
2006-07 997
2007-08 1319
2008-09 1618
2010-11 1711

Till March 2011 1722


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Table 1.2- FII share in different sectors of companies listed on NSE

Sectors Percentage of Foreign Institutional Investors
Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Sep-11
Banks 18.41 19.15 14.27 16.02 17.62 18.17
Engineering 11.45 10.63 7.34 8.28 9.36 9.30
Finance 18.18 17.44 13.01 16.53 23.35 19.20
FMCG 11.91 14.07 12.72 14.09 16.34 17.00
Information 14.53 16.00 12.44 11.68 21.16 17.07
Technology
Infrastructure 7.15 8.86 7.31 8.90 7.87 7.50
Manufacturing 9.57 9.46 7.28 8.79 9.41 9.60
Media & 15.20 11.71 11.42 7.06 10.97 11.63
Entertainment
Petrochemicals 5.83 4.73 4.77 6.08 6.52 6.49
Pharmaceuticals 11.17 10.69 7.88 8.78 10.19 10.13
Services 13.09 10.70 8.39 8.05 7.41 9.50
Telecommunication 11.17 9.12 6.85 8.64 8.44 8.46
Miscellaneous 8.19 9.30 8.39 8.10 13.65 13.37
Total stake of FIIs in 10.78 10.62 8.40 9.58 10.32 10.45
all sectors


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Table 1.3- Foreign Investment Inflows

FOREIGN INVESTMENT INFLOWS
YEAR A. Direct Investment B. Portfolio Investment Total(A+B)
Rs. US $ RS. US $ Rs. US $
crore Million Crore Million Crore Million
1992-93 965 315 748 244 1713 559
1993-94 1838 586 11188 3567 13026 4153
1994-95 4126 1314 12007 3824 16133 5138
1995-96 7172 2144 9192 2748 16364 4892
1996-97 10015 2821 11758 3312 21773 6133
1997-98 13220 3557 6794 1828 20014 5385
1998-99 10358 2462 -257 -61 10101 2401

1999-00 9338 2155 13112 3026 22450 5181

2000-01 18406 4029 12609 2760 31015 6789

2001-02 29235 6130 9639 2021 38874 8151

2002-03 24367 5035 4738 979 29105 6014

2003-04 19860 4322 52279 11377 72139 15699

2004-05 27188 6051 41854 9315 69042 15366

2005-06 39674 8961 55307 12492 94981 21453

2006-07 103367 22826 31713 7003 135080 29829

2007-08 140180 34835 109741 27271 249921 62106

2008-09 173741 37838 -63618 -13855 110123 23983

2009-10 179059 37763 153516 32376 332575 70139

2010-11 138462 30380 143435 31471 281897 61851

(Sources RBI, Statistics on Indian Economy)


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1.3 PORTFOLIO INVESTMENT

With greater openness in the emerging market economies and developing countries,
portfolio investment flows became net outflows in four out of the last years ending 2008. According
to the WEO, private net portfolio flows to these economies, after being overall outflows in the
period 2002-05, recorded modest levels of positive inflows of US $ 2.1 billion and US $ 23.3 billion
in 2005, respectively. The year 2006 witnessed a great reversal with a massive net outflow of us $
111.9 billion. The reversal in emerging Asia was the highest with an outflow of US $ 120.8 billion in
2006. There was no such outflow from India in 2006, Though the level of portfolio inflows was
lower than in 2005.

With heightened volatility in Asian and global financial markets in 2006-07, net portfolio
inflows into India amounted to US $ 7.1 billion for 2006-07. Portfolio net inflows after being
negative in the initial months (May-July 2006) picked up momentum in August-November 2006
only to slow down again in March 2008. Euro equities, which were relatively a very small
component of portfolio flows (less than US $ 1 billion in the period 1997-98 to 2004-05), have risen
in 2006-07 and 2007-08 to reach US $ 2.6 billion and US $ 3.* billion, respectively. IN 2007-08,
Euro equities constituted 54.3 percent of the total portfolio net flows. However this composition was
more due to lower net inflows under FII. Portfolio investment inflows in the first six months was
US $ 83.4 billion and outflows was US $ 65 billion leaving a net inflow of US $ 18.3 billion, which
implies a growth of 1,015.2 percent, year on year.

In the scheme of classification based on duration, portfolio investment flows fall under
short term variety. The proportion of net portfolio outflows to total portfolio flows under this head
indicates the nature of such flows. In the seven year period from 2000-01, the proportion of net
flows to total gross flows (inflows plus outflows) were below 13 percent, with the exception of 2003-
04 when it was higher at 25.2 percent. IN 2006-08, the proportion was by abysmally low at 3.3
percent.


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Table 1.4- FII Sale and Purchase activity for the past years on annual basis:

Equity Debt
YEAR Gross Gross Net Gross Gross Net
Purch. Sales Invest. Purch. Sales Invest.
(Rs. Cr) (Rs. Cr) (Rs.Cr) (Rs. Cr) (Rs. Cr) (Rs. Cr)

2011 608086.40 611728.80 -3642.40 288365.70 245767.90 42597.80
2010 768402.60 634110.70 140497 213849.20 161749 54442.80
2009 624237.5 540813.69 83423.9 111772.1 107208.91 4563.3
2008 719536.8 772378.7 -52841.9 46296.4 33964 12332.4
2007 811621.8 741276.4 70345.6 31176 21989.7 9186.4
2006 475622.5 439082.8 36539.7 11060.9 7011.7 4049.2
2005 284354.10 237642.20 46711.90 6890.90 12418.00 -5527.10
2004 184608.40 146396.00 38212.40 12478.70 10572.10 1906.70
2003 94122.20 63385.10 30737.10 10956.90 6363.90 4593.00
2002 46854.10 43272.80 3581.30 2970.60 2540.83 429.77
2001 47340.60 34558.30 12752.90 5346.90 4828.30 518.80
2000 74791.50 68421.60 6509.90 2834.80 2735.40 106.00
1999 36395.50 29817.10 6578.10 817.70 698.80 118.60
Source: Securities and Exchange Board of India

According to data released by the market regulator Securities and Exchange Board of
India (SEBI), FIIs transferred a record US $ 17.46 billion in domestic equities during the calendar
year 2009. This FII investment in 2009 proved to be the highest ever inflow in the country in rupee
terms in a single year, breaking the previous high of US $ 14.96 billion parked by foreign fund
houses in domestic equities in 2007. FIIs infused a net US $ 1.05 billion in debt instruments during
the above said period.


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CHART 1.4- GROSS PURCHASES & SALES OF EQUITY (RS. CR)

900000

800000

700000

600000

500000
Gross Purchases
400000
Gross Sales
300000

200000

100000

0
2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999

Inference:

From the above graph it‘s clear that FIIs reached its peak in equity in 2007 period and
because of the recession the investments came down in year 2008. In 2011 also the FII
investments are at good levels. It would depend upon the various government policies which would
support the foreign investors. If the registration and Investment processes become easier then we
could see more investments in the further near future.


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CHART 1.5- GROSS PURCHASES & SALES OF DEBT (RS. CR)

350000

300000

250000

200000
Gross Purchase
150000 Gross sales

100000

50000

0
2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999

Inference:

From above graph we can say that the trend in the investment in debts suddenly raised
since 2008 as there is a steep ascent in the graph. Due to economical policies of our country and
good market conditions the debt investments has increased.


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CHAPTER 2

REVIEW OF LITERATURE & DESIGN OF THE STUDY

2.1 Introduction to the problem

The term Foreign Institutional Investor is defined by SEBI as under:

―Means an institution established or incorporated outside India to make investment in
Indian securities. Provided that a domestic asset management company or domestic portfolio
managers who manages funds raised or collected or brought from outside India for Investment in
India on behalf of a sub-account, shall be deemed to be Foreign Institutional Investor.‖

The study attempts understand the behavioral pattern of FII during the period from March-
2007 to February-2012 and examine the volatility of BSE Sense and S&P CNX NIFTY due to FII.
THE data for the study uses the information obtained from the secondary sources like websites of
BSE sensex.We have attempted to explain the impact of foreign institutional investment on stock
market and Indian economy. Also attempts to present the correlation between FII and BSE sensex
and S&P CNX NIFTY by Karl Pearson‘s CO-efficient of correlation and Regression analysis.

2.2 Review of Literature

1. Richard W.Sias (1996) has found that a trader-intensified transactions database is
employed to investigate: (1) the relation between order-flow imbalance closed-end funds share
prices and discounts (2) the role of institutional investors in closed-end funds. Empirical results are
consistent with the hypothesis that buyers (sellers) of closed-end funds face upward (downward)
sloping supply (demand) curves. The results also demonstrate that ownership statistics fail to
accurately reflect institutional investors‘ importance in closed-end funds market. The results failed
to provide the evidence that institutional investors offset the position of individual investors or that
institutional investors face systematic ―noise trader risk‖.

2. Ilangovan Prof. D. et al (1997) held that Steps are taken to gain extra mileage as regards
the level of foreign investment receipts is concerned. Foreign direct investment is proven to have


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well-known positive effect through technology spillovers and stable investments tied to plant and
equipment, but portfolio capital is associated more closely with volatility and its capacity to be
triggered by both domestic as well as exogenous factors, making it extremely difficult to manage
and control.

3. Arshanapalli Bala et al (1997) has examined the nature and extent of linkage between the
U.S. and the Indian stock markets. The study uses the theory of co-integration to study
interdependence between the BSE, NYSE and NASDAQ. The sample data consisted of daily
closing prices for the three indices from January 1991 to December 1998 with 2338 observations.
The results were in support of the intuitive hypothesis that the Indian stock market was not
interrelated to the US stock markets for the entire sample period. It should be noted that stock
markets of many countries became increasingly interdependent with the US stock markets during
the same time period. India was late in effecting the liberalization policy and when it implanted
these policies it did so in a careful and slow manner. However, as the effect of economic
liberalizations started to take place, the BSE became more integrated with the NASDAQ and the
NYSE, particularly after 1998. It must be noted that though BSE stock market is integrated with US
stock markets, it does not influence the NASDAQ and NYSE markets.

4. Michael Mosebach et al (2000) have examined the long run equilibrium relation between
the net flow of funds into equity MF and the S&P 500 index. Applying the Engel and Granger
correction methodology followed by a state space procedure, we find that the levels of the stock
market are influenced by the net flow of funds into equity MFs. Their findings indicate that the US
equity market appears to be rationally adjusting to a structural change in the behaviour of the US
investing public.

5. Chakrabarti (2001) has examined in his research that following the Asian crisis and the
bust of info-tech bubble internationally in 1998-99 the net FII has declined by US$ 61 million. But


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there was not much effect on the equity returns. This negative investment would possibly disturb
the long-term relationship between FII and the other variables like equity returns, inflation, etc. has
marked a regime shift in the determinants of FII after Asian crisis. The study found that in the pre-
Asian crisis period any change in FII found to have a positive impact on the equity returns. But in
the post-Asian crisis period it was found the reverse relation that change in FII is mainly due to
change in equity returns. Hence, any empirical exercise on FII has to take care of this fact.

6. Richard A.Ajayi et al (2001) have studied recent advances in the time-series analysis to
examine the inter-temporal relation between stock indices and exchange rates for a sample of
eight advanced economies. An error correction model (ECM) of two variables employed to
simultaneously estimate short-run and long-run dynamics of variables. The ECM result revealed
significant short-run and long-run relationship between two financial markets. Specifically, the
results show that increase in aggregate stock prices has negative short-run effect on domestic
currency value. In the long-run, however, stock prices have positive effect on domestic currency
value. On the other hand currency depreciation has negative short-run and long-run effects on
stock market.

7. Stanley Morgan (2002) has examined that FIIs have played a very important role in
building up India‘s forex reserves, which have enabled a host of economic reforms. Secondly, FIIs
are now important investors in the country‘s economic growth despite sluggish domestic sentiment.
The Morgan Stanley report notes that FII strongly influence short-term market movements during
bear markets. However, the correlation between returns and flows reduces during bull markets as
other market participants raise their involvement reducing the influence of FIIs. Research by
Morgan Stanley shows that the correlation between foreign inflows and market returns is high
during bear and weakens with strengthening equity prices due to increased participation by other
players.


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8. Sivakumar S (2003) has analysed the net flows of foreign institutional investment over the
years, it also briefly analyses the nature of FII flows based on research, explores some
determinants of FII flows and examines if the overall experience has been stabilising or
destabilising for the Indian capital market.

9. Rai Kulwant et al (2003) heldf that the present study tries to examine the determinants of
Foreign Institutional Investments in India, which have crossed almost US$ 12 billions by the end of
2002. Given the huge volume of these flows and its impact on the other domestic financial markets
understanding the behavior of these flows becomes very important at the time of liberalizing capital
account. In this study, by using monthly data, we found that FII inflow depends on stock market
returns, inflation rate (both domestic and foreign) and ex-ante risk. In terms of magnitude, the
impact of stock market returns and the ex-ante risk turned out to be major determinants of FII
inflow. This study did not find any causation running from FII inflow to stock returns as it was found
by some studies. Stabilizing the stock market volatility and minimizing the ex-ante risk would help
in attracting more FII inflow that has positive impact on the real economy.

10. Agarwal, Chakrabarti et al (2003) have found in their research that the equity return has a
significant and positive impact on the FII. But given the huge volume of investments, foreign
investors could 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. Hence, there is a possibility of bi-directional relationship between FII and the
equity returns.

11. Raju M.T, Ghosh Anirban (2004) held that volatility estimation is important for several
reasons and for different people in the market. Pricing of securities is supposed to be dependent
on volatility of each asset. In this paper we not only extend the study period of the earlier paper but
also expand coverage in terms of number of countries and statistical techniques. Mature markets /


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Developed markets continue to provide over long period of time high return with low volatility.
Amongst emerging markets except India and China, all other countries exhibited low returns
(sometimes negative returns with high volatility). India with long history and China with short
history, both provide as high a return as the US and the UK market could provide but the volatility
in both countries is higher. The third and fourth order moments exhibit large asymmetry in some of
the developed markets. Comparatively, Indian market show less of skewness and Kurtosis. Indian
markets have started becoming informationaly more efficient. Contrary to the popular perception in
the recent past, volatility has not gone up. Intra day volatility is also very much under control and
has came down compared to past years.

12. Sandhya Ananthanarayanan (2004) held that as part of its initiative to liberalize its financial
markets, India opened her doors to foreign institutional investors in September, 1992. This event
represents a landmark event since it resulted in effectively globalizing its financial services
industry. We study the impact of trading of Foreign Institutional Investors on the major stock indices
of India. Our major findings are as follows. First, we find that unexpected flows have a greater
impact than expected flows on stock indices. Second, we find strong evidence consistent with the
base broadening hypothesis. Third, we do not detect any evidence regarding momentum or
contrarian strategies being employed by foreign institutional investors. Fourth, our findings support
the price pressure hypothesis. Finally, we do not find any substantiation to the claim that
foreigners‘ destabilize the market.

13. Kwangsoo Ko et al (2004) have examined the characteristics of institutional and foreign
investor stock ownership, and the stock price performance according to their ownership for two
major Asian markets, Japan and Korea. The differences in abnormal returns are more evident for
foreign ownership portfolios than for institutional ownership portfolios, especially in Korea. If we
consider either institutional or foreign investors, the differences in abnormal returns remain still
significant in Korea, but not in Japan. Both institutional investors‘ incentive for stock holding and


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the extent of stock market efficiency would be the possible explanations for the different results
between Japan and Korea.

14. David A. Carpenter et al (2005) has examined that the Indian government has established
a regulatory framework for three separate investment avenues: foreign direct investment;
investment by foreign institutional investors; and investment by foreign venture capital investors.
While these investment alternatives have created clear avenues for foreign investment in India,
they remain subject to many conditions and restrictions which continue to hamper foreign
investment in India.

15. Bose Suchismita et al (2005) has examined the impact of reforms of the foreign
institutional investors' (FIIs) investment policy, on FII portfolio flows to the Indian stock markets, an
aspect, studies on determinants of FII flows to India so far have not taken into consideration. FIIs
have been allowed to invest in the domestic financial market since 1992; the decision to open up
the Indian financial market to FII portfolio flows was influenced by several factors such as the
disarray in India's external finances in 1991 and a disorder in the country's capital market. Aimed
primarily at ensuring non-debt creating capital inflows at a time of an extreme balance of payment
crisis and at developing and disciplining the nascent capital market, foreign investment funds were
welcomed to the country. Analysis also helps to evaluate the impact of liberalization policies as well
as measures for strengthening of policy framework for FII flows, in the post-Asian crisis period

16. Samy Dr. P. Chella et al (2006) held that Investors can pick up stocks at these levels for a
growth story for long term i.e. for equities a 5 years holding period is reasonable to give a very
above average return. Caution may be exercised to buy only good, well established market movers
and never, to buy on margins or play intraday or dabble in derivatives market, which is high risk.


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17. Sikdar Soumyen (2006) held that the surge in inflows has not been matched by a
corresponding growth in the absorptive capacity of the Indian economy. The major reason is the
persistent slowdown of industrial activity since 1997. At the same time, the Reserve Bank of India
(RBI) has been reluctant to let the rupee find its market-clearing level under the circumstances.
This has resulted in steady accretion to our foreign exchange reserves (FER) over the last few
years. Problems of Foreign Capital are widening of current account deficit, monetization,
appreciation of real exchange, etc.

18. Andy Lin Chih-Yuan Chen (2006) has explored the relationship between qualified foreign
institutional investors (QFIIs) and Taiwan‘s stock market and evaluates the effect of QFIIs‘
investment transactions on Taiwan‘s stock market. By taking the date of easing regulatory
restrictions on foreigners‘ stock investment holdings as a cutoff point, the research uses the
highest and lowest 10 stocks of QFII holdings in three industry sectors as sample portfolios to
study the prior- and post-event returns.

19. Dhamija Nidhi (2007) held that the increase in the volume of foreign institutional
investment (FII) inflows in recent years has led to concerns regarding the volatility of these flows,
threat of capital flight, its impact on the stock markets and influence of changes in regulatory
regimes. The determinants and destinations of these flows and how are they influencing economic
development in the country have also been debated. This paper examines the role of various
factors relating to individual firm-level characteristics and macroeconomic-level conditions
influencing FII investment. The regulatory environment of the host country has an important impact
on FII inflows. As the pace of foreign investment began to accelerate, regulatory policies have
changed to keep up with changed domestic scenarios. The paper also provides a review of these
changes.


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20. P. Krishna Prasanna (2008) has examined the contribution of foreign institutional
investment particularly among companies included in sensitivity index (Sensex) of Bombay Stock
Exchange. Also examined is the relationship between foreign institutional investment and firm
specific characteristics in terms of ownership structure, financial performance and stock
performance. It is observed that foreign investors invested more in companies with a higher volume
of shares owned by the general public. The promoters‘ holdings and the foreign investments are
inversely related. Foreign investors choose the companies where family shareholding of promoters
is not substantial. Among the financial performance variables the share returns and earnings per
share are significant factors influencing their investment decision

2.3 Statement of the problem

An adage says ―a problem well defined is half solved‖. The project deals with the ―Impact
of Foreign Institutional Investors on Indian Stock Market‖. This research project studies the
relationship between FIIs investment and stock indices. For this purpose India‘s two major indices
i.e. BSE Sensex and S&P CNX Nifty are selected. These two indices, in a way, represent the
picture of India‘s stock markets. So this project reveals the impact of FII on the Indian capital
market.

There may be many other factors on which a stock index may depend i.e. Government
policies, budgets, bullion market, inflation, economic and political condition of the country, FDI,
Re./Dollar exchange rate etc. But for this study I have selected only one independent variable i.e.
FII. This study uses the concept of correlation and regression to study the relationship between FII
and stock index. The FII started investing in Indian capital market from September 1992 when the
Indian economy was opened up in the same year. Their investments include equity only. The
sample data of FIIs investments consists of monthly average from March 2007 to February 2012.


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2.4 Scope of the study

Scope of the study is very broader and covers both the stock indices and its comparison
with foreign institutional investments. But, study is only going to cover foreign investments in form
of equity. The time period is limited from March 2007 to February 2012 as it will give good idea
about FII trend.

The study will provide a very clear picture of the impact of foreign institutional investors on
Indian stock indices. It will also describe the market trends due to FIIs inflow and outflow.

The study would be helpful for further descriptive studies on the ideas that will be explored.
Moreover, it would be beneficial to gain knowledge regarding foreign institutional investments, their
process of registration and their impact on Indian stock market.

2.5 Objectives of the study

Following are the objectives of the study:

• To study the scope and trading mechanism of Foreign Instititutional investors in India.

• To find the impact of net investments made by foreign institutional investors on S&P CNX
NIFTY.

• To find the impact of net investments made by foreign institutional investors on BSE
Sensex.

• To find the trend of foreign institutional investment


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2.6 Hypothesis

A hypothesis describes the relationship between or among variables. A good hypothesis is one that
can explain what it claims to explain, is testable and has greater range, probability and simplicity
than its rivals

Null Hypothesis (Ho): The BSE Sensex and S&P CNX Nifty indices do not vary with the variation in
Foreign Institutional Investments

Alternate Hypothesis (Ha): The BSE Sensex and S&P CNX Nifty indices vary with the variation in
Foreign Institutional Investments.

2.7. Research Methodology

Research methodology is the arrangement of conditions for collection and analysis of data
in a manner that aims to combine relevance to the research purpose with economy in procedure.
Research methodology is the conceptual structure within which research is conducted. It
constitutes the blueprint for the collection measurement and analysis of the data.

The research methodology here includes:

• Research design

• Sampling design

• Sampling technique

• Data collection method


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2.7.1 Research Design

Exploratory Research

As an exploratory study is conducted with an objective to gain familiarity with the
phenomenon or to achieve new insight into it, this study aims to find the new insights in terms of
finding the relationship between FII‘S and Indian Stock Indices.

2.7.2 Sampling Design

• Universe

In this study the universe is finite and will take into the consideration related news and
events that have happened in last few year.

• Sampling Unit: -

As this study revolves around the foreign institutional investment and Indian stock market.
So for the sampling unit is confined to only the Indian stock market.

2.7.3 Sampling Technique

Convenient Sampling: Study conducted on the basis of availability of the Data and
requirement of the project. Study requires the events that have impact on the Indian stock market.

Data collection Method:

Secondary data: For the secondary data various literatures, books, journals, magazines,
web links are used. As there are not possibilities of collecting data personally so no questionnaire
is made.


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2.7.4 RESEARCH ANALYSIS TOOLS

Correlation and Regression Analysis:

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: 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.

2.8 Limitations of the study

1. The project has been prepared in two months, so due to time limitations depth analysis of such a
wide concept may contain some lacuna. IN this report impact of FII on the stock market has been
analyzed considering BSE Sensex ans S&P CNX NIFTY. But only these two may not depict exact
picture of the entire stock market.

2. The data for calculation is taken on monthly basis. The data on daily basis can give more
positive results.

3. The secondary data that I have used in this study may not give true picture of the concern.

4. For calculation purpose I have used only Correlation and Regression methods. Only these two
methods may not give accurate information about the impact of FII on stock market


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2.9 Chapter Scheme

CHAPTER 1 - INTRODUCTION

1.1 Foreign Institutional Investors
1.2 Trend of FIIs with the help of economic figures
1.3 Portfolio Investment

CHAPTER 2 - REVIEW OF LITERATURE AND RESEARCH DESIGN

2.1 Introduction to the Problem

2.2 Review of Literature

2.3 Statement of the Problem

2.4 Scope of the Study

2.5 Objectives of the Study

2.6 Hypothesis

2.7 Research Methodology

2.8 Limitations of the Study

2.9 Chapter Scheme

CHAPTER 3 - PROFILE OF THE INDUSTRY

3.1 Overview of Indian Stock Market

3.2 Trading Pattern of Indian Stock Market

3.3 S&P CNX NIFTY

3.4 Issues Studied


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CHAPTER 4 - RESULTS, ANALYSIS AND DISCUSSIONS

4.1 FII Flows and Volatility of BSE Sensex and S&P CNX NIFTY

4.2 Correlation and Regression Analysis

4.3 Correlation and Regression with determinants of FII and Indian Stock Market

CHAPTER 5 – SUMMARY OF FINDINGS, CONCLUSIONS & SUGGESTIONS

5.1 Summary of Findings

5.2 Conclusion

5.3 Suggestions


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CHAPTER 3

PROFILE OF THE INDUSTRY

3.1 OVERVIEW OF INDIAN STOCK MARKET

The working of stock exchanges in India started in 1875. BSE is the oldest stock market in
India. The history of Indian stock trading starts with 318 persons taking membership in Native
Share and Stock Brokers Association, which we now know by the name Bombay Stock Exchange
or BSE in short. In 1965, BSE got permanent recognition from the Government of India. National
Stock Exchange comes second to BSE in terms of popularity. BSE and NSE represent themselves
as synonyms of Indian stock market. The history of Indian stock market is almost the same as the
history of BSE.

The 30 stock sensitive index or Sensex was first compiled in 1986. The Sensex is
compiled based on the performance of the stocks of 30 financially sound benchmark companies. In
1990 the BSE crossed the 1000 mark for the first time. It crossed 2000, 3000 and 4000 figures in
1992. The reason for such huge surge in the stock market was the liberal financial policies
announced by the then financial minister Dr. Man Mohan Singh.

The up-beat mood of the market was suddenly lost with Harshad Mehta scam. It came to
public knowledge that Mr. Mehta, also known as the big-bull of Indian stock market diverted huge
funds from banks through fraudulent means. He played with 270 million shares of about 90
companies. Millions of small-scale investors became victims to the fraud as the Sensex fell flat
shedding 570 points.

To prevent such frauds, the Government formed The Securities and Exchange Board of
India, through an Act in 1992. SEBI is the statutory body that controls and regulates the functioning
of stock exchanges, brokers, sub-brokers, portfolio managers, investment advisors etc. SEBI
oblige several rigid measures to protect the interest of investors. Now with the inception of online
trading and daily settlements the chances for a fraud is nil, says top officials of SEBI.


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Sensex crossed the 5000 mark in 1999 and the 6000 mark in 2000. The 7000 mark was
crossed in June and the 8000 mark on September 8 in 2005. Many foreign institutional investors
(FII) are investing in Indian stock markets on a very large scale. The liberal economic policies
pursued by successive Governments attracted foreign institutional investors to a large scale.
Experts now believe the sensex can soar past 14000 mark before 2010.

The unpredictable behavior of the market gave it a tag – ‗a volatile market.‘ The factors
that affected the market in the past were good monsoon, Bharatiya Janatha Party‘s rise to power
etc. The result of a cricket match between India and Pakistan also affected the movements in
Indian stock market. The National Democratic Alliance led by BJP, during 2004 public elections
unsuccessfully tried to ride on the market sentiments to power. NDA was voted out of power and
the sensex recorded the biggest fall in a day amidst fears that the Congress-Communist coalition
would stall economic reforms. Later prime minister Man Mohan Singh‘s assurance of ‗reforms with
a human face‘ cast off the fears and market reacted sharply to touch the highest ever mark of
8500.

India, after United States hosts the largest number of listed companies. Global investors
now ardently seek India as their preferred location for investment. Once viewed with skepticism,
stock market now appeals to middle class Indians also. Many Indians working in foreign countries
now divert their savings to stocks. This recent phenomenon is the result of opening up of online
trading and diminished interest rates from banks. The stockbrokers based in India are opening
offices in different countries mainly to cater the needs of Non Resident Indians. The time factor
also works for the NRIs. They can buy or sell stock online after returning from their work places.

The recent incidents that led to growing interest among Indian middle class are the initial
public offers announced by Tata Consultancy Services, Maruti Udyog Limited, ONGC and big
names like that. Good monsoons always raise the market sentiments. A good monsoon means
improved agricultural produce and more spending capacity among rural folk.

The bullish run of the stock market can be associated with a steady growth of around 6%
in GDP, the growth of Indian companies to MNCs, large potential of growth in the fields of


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telecommunication, mass media, education, tourism and IT sectors backed by economic reforms
ensure that Indian stock market continues its bull run.

3.1.1 History of the Indian Stock Market - The Origin

Stock markets refer to a market place where investors can buy and sell stocks. The price
at which each buying and selling transaction takes is determined by the market forces (i.e. demand
and supply for a particular stock.

Let us take an example for a better understanding of how market forces determine stock
prices. ABC Co. Ltd. enjoys high investor confidence and there is an anticipation of an upward
movement in its stock price. More and more people would want to buy this stock (i.e. high demand)
and very few people will want to sell this stock at current market price (i.e. less supply). Therefore,
buyers will have to bid a higher price for this stock to match the ask price from the seller which will
increase the stock price of ABC Co. Ltd. On the contrary, if there are more sellers than buyers (i.e.
high supply and low demand) for the stock of ABC Co. Ltd. in the market, its price will fall down.

In earlier times, buyers and sellers used to assemble at stock exchanges to make a
transaction but now with the dawn of IT, most of the operations are done electronically and the
stock markets have become almost paperless. Now investors don‘t have to gather at the
Exchanges, and can trade freely from their home or office over the phone or through Internet.

One of the oldest stock markets in Asia, the Indian Stock Markets has a 200 years old history.

18th Century East India Company was the dominant institution and by end of the century,
busuness in its loan securities gained full momentum

1830's Business on corporate stocks and shares in Bank and Cotton presses started in Bombay.
Trading list by the end of 1839 got broader

1840's Recognition from banks and merchants to about half a dozen brokers


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1850's Rapid development of commercial enterprise saw brokerage business attracting more
people into the business

1860's The number of brokers increased to 60

1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United
States of America; marking the beginning of the "Share Mania" in India

1862-63 The number of brokers increased to about 200 to 250

1865 A disastrous slump began at the end of the American Civil War (as an example, Bank of
Bombay Share which had touched Rs. 2850 could only be sold at Rs. 87)

3.1.2 Achievements and Milestones

Pre-Independence Scenario - Establishment of Different Stock Exchanges

1874 With the rapidly developing share trading business, brokers used to gather at a street (now
well known as "Dalal Street") for the purpose of transacting business.

1875 "The Native Share and Stock Brokers' Association" (also known as "The Bombay Stock
Exchange") was established in Bombay

1880's Development of cotton mills industry and set up of many others

1894 Establishment of "The Ahmedabad Share and Stock Brokers' Association"

1880 - 90's Sharp increase in share prices of jute industries in 1870's was followed by a boom
in tea stocks and coal

1908 "The Calcutta Stock Exchange Association" was formed

1920 Madras witnessed boom and business at "The Madras Stock Exchange" was transacted
with 100 brokers.


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1923 When recession followed, number of brokers came down to 3 and the Exchange was
closed down

1934 Establishment of the Lahore Stock Exchange

1936 Merger of the Lahoe Stock Exchange with the Punjab Stock Exchange

1937 Re-organisation and set up of the Madras Stock Exchange Limited (Pvt.) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies

1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was
established

1944 Establishment of "The Hyderabad Stock Exchange Limited"

1947 "Delhi Stock and Share Brokers' Association Limited" and "The Delhi Stocks and Shares
Exchange Limited" were established and later on merged into "The Delhi Stock Exchange
Association Limited"

Post Independence Scenario

The depression witnessed after the Independence led to closure of a lot of exchanges in the
country. Lahore Estock Exchange was closed down after the partition of India, and later on merged
with the Delhi Stock Exchange. Bangalore Stock Exchange Limited was registered in 1957 and got
recognition only by 1963. Most of the other Exchanges were in a miserable state till 1957 when
they applied for recognition under Securities Contracts (Regulations) Act, 1956. The Exchanges
that were recognized under the Act were:

1. Bombay

2. Calcutta

3. Madras


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4. Ahmedabad

5. Delhi

6. Hyderabad

7. Bangalore

8. Indore

Many more stock exchanges were established during 1980's, namely:

• Cochin Stock Exchange (1980)

• Uttar Pradesh Stock Exchange Association Limited (at Kanpur, 1982)

• Pune Stock Exchange Limited (1982)

• Ludhiana Stock Exchange Association Limited (1983)

• Gauhati Stock Exchange Limited (1984)

• Kanara Stock Exchange Limited (at Mangalore, 1985)

• Magadh Stock Exchange Association (at Patna, 1986)

• Jaipur Stock Exchange Limited (1989)

• Bhubaneswar Stock Exchange Association Limited (1989)

• Saurashtra Kutch Stock Exchange Limited (at Rajkot, 1989)

• Vadodara Stock Exchange Limited (at Baroda, 1990)

• Coimbatore Stock Exchange

• Meerut Stock Exchange


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3.1.3 Performance of Indian Stock Market Over Few Years

At present, there are twenty one recognized stock exchanges in India which does not include the
Over The Counter Exchange of India Limited (OTCEI) and the National Stock Exchange of India
Limited (NSEIL).

Government policies during 1980's also played a vital role in the development of the Indian Stock
Markets. There was a sharp increase in number of Exchanges, listed companies as well as their
capital, which is visible from the table:


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TABLE 3.1-NO. OF STOCK EXCHANGES YEAR WISE

Sl. As on 31st 1946 1961 1971 1981 1991 1995 2001 2005
No. December
1 No. of Stock 7 7 8 8 9 14 20 23
Exchanges

2 No. of Listed 1125 1203 1599 1552 2265 4344 6229 8593
Cos.

3 No. of Stock 1506 2111 2838 3230 3697 6174 8967 11784
issues of
Listed Cos.

4 Capital of 270 753 1812 2614 3973 9723 32041 59583
Listed
Cos.(Cr. Rs.)

5 Market Value 971 1292 2675 3273 6750 25302 110279 478121
of Capital of
Listed Cos.
(Cr. Rs.)

6 Capital per 24 63 113 168 175 224 514 693
Listed
Cos.(4/2)
(Lakh Rs)
7 Market Value 86 107 167 211 298 582 1770 5564
of capital per
Listed Cos.
(Lakh Rs.)
(5/2)


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3.2 TRADING PATTERN OF THE INDIAN STOCK MARKET

Indian Stock Exchanges allow trading of securities of only those public limited companies that are
listed on the Exchange(s).

Indian stock exchange allows a member broker to perform following activities:

• Act as an agent,

• Buy and sell securities for his clients and charge commission for the same,

• Act as a trader or dealer as a principal, Buy and sell securities on his own account and
risk.

Over The Counter Exchange of India (OTCEI)

Traditionally, trading in Stock Exchanges in India followed a conventional style where
people used to gather at the Exchange and bids and offers were made by open outcry.

This age-old trading mechanism in the Indian stock markets used to create many
functional inefficiencies. Lack of liquidity and transparency, long settlement periods and benami
transactions are a few examples that adversely affected investors. In order to overcome these
inefficiencies, OTCEI was incorporated in 1990 under the Companies Act 1956. OTCEI is the first
screen based nationwide stock exchange in India created by Unit Trust of India, Industrial Credit
and Investment Corporation of India, Industrial Development Bank of India, SBI Capital Markets,
Industrial Finance Corporation of India, General Insurance Corporation and its subsidiaries and
CanBank Financial Services.

Advantages of OTCEI

• Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India

• The screen-based scripless trading ensures transparency and accuracy of prices


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• Faster settlement and transfer process as compared to other exchanges

• Shorter allotment procedure (in case of a new issue) than other exchanges

NATIONAL STOCK EXCHANGE

In order to lift the Indian stock market trading system on par with the international standards. On
the basis of the recommendations of high powered Pherwani Committee, the National Stock
Exchange was incorporated in 1992 by Industrial Development Bank of India, Industrial Credit and
Investment Corporation of India, Industrial Finance Corporation of India, all Insurance
Corporations, selected commercial banks and others.

NSE provides exposure to investors in two types of markets, namely:

1. Wholesale debt market

2. Capital market

Wholesale Debt Market - Similar to money market operations, debt market operations involve
institutional investors and corporate bodies entering into transactions of high value in financial
instrumets like treasury bills, government securities, etc.

Trading at NSE

• Fully automated screen-based trading mechanism

• Strictly follows the principle of an order-driven market

• Trading members are linked through a communication network

• This network allows them to execute trade from their offices

• The prices at which the buyer and seller are willing to transact will appear on the screen.

• When the prices match the transaction will be completed , a confirmation slip will be
printed at the office of the trading member.


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Advantages of trading at NSE

• Integrated network for trading in stock market of India

• Fully automated screen based system that provides higher degree of transparency

• Investors can transact from any part of the country at uniform prices

• Greater functional efficiency supported by totally computerized network


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3.3 S&P CNX Nifty:

Nifty Fifty was an informal term used to refer to 50 popular large cap stocks on the New York Stock
Exchange in the 1960s and 1970s that were widely regarded as solid buy and hold growth stocks.

The fifty are credited with propelling the bull market of the early 1970s. Most are still solid
performers, although a few are now defunct or otherwise worthless.

The long bear market of the 1970s that lasted until 1982 caused valuations of the nifty fifty to fall to
low levels along with the rest of the market, with most of these stocks under-performing the
broader market averages. A notable exception was Wal-Mart, the best performing stock on the list,
with a 29.65% compounded annualized return over a 29 year period.

Because of the under-performance of most of the nifty fifty list, it is often cited as an example of
unrealistic investor expectations for growth stocks. However, those who held on until the late 1990s
bull market saw many of the stocks return to market valuations.[2]

Characteristics

The stocks were often described as "one-decision", as they were viewed as extremely stable, even
over long periods of time.

The most common characteristic by the constituents were solid earnings growth for which these
stocks were assigned extraordinary high price-earnings ratios. Fifty times earnings was not
uncommon.

NIFTY means National Index for Fifty

S&P CNX Nifty is a well diversified 50 stock index accounting for 21 sectors of the economy. It is
used for a variety of purposes such as benchmarking fund portfolios, index based derivatives and
index funds.

S&P CNX Nifty is owned and managed by India Index Services and Products Ltd. (IISL), which is a
joint venture between NSE and CRISIL. IISL is India's first specialised company focused upon the


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index as a core product. IISL has a marketing and licensing agreement with Standard & Poor's
(S&P), who are world leaders in index services.

The traded value for the last six months of all Nifty stocks is approximately 44.89% of the
traded value of all stocks on the NSE
Nifty stocks represent about 58.64% of the total market capitalization as on March 31,
2008.
Impact cost of the S&P CNX Nifty for a portfolio size of Rs.2 crore is 0.15%
S&P CNX Nifty is professionally maintained and is ideal for derivatives trading


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3.4 ISSUE STUDIED

To study the scope and trading mechanisms of Foreign Institutional Investors in India.

The scope and the trading mechanism of Foreign Institutional investors in India is discussed as
follows:

The eligibility criteria for applicant seeking FII registration

As per Regulation 6 of SEBI (FII) Regulations,1995, Foreign Institutional Investors are required to
fulfill the following conditions to qualify for grant of registration:

• Applicant should have track record, professional competence, financial soundness,
experience, general reputation of fairness and integrity.

• The applicant should be regulated by an appropriate foreign regulatory authority in the
same capacity/category where registration is sought from SEBI. Registration with authorities, which
are responsible for incorporation, is not adequate to qualify as Foreign Institutional Investor.

• The applicant is required to have the permission under the provisions of the Foreign
Exchange Management Act, 1999 from the Reserve Bank of India.

• Applicant must be legally permitted to invest in securities outside the country or its in-
corporation / establishment.

• The applicant must be a "fit and proper" person.

• The applicant has to appoint a local custodian and enter into an agreement with the
custodian. Besides it also has to appoint a designated bank to route its transactions.

• Payment of registration fee of US $ 5,000.00

"Form A" as prescribed in SEBI (FII) Regulations, 1995 is to be filled before applying for FII
registration.


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Supporting documents required are:

• Application in Form A duly signed by the authorized signatory of the applicant.

• Certified copy of the relevant clauses or articles of the Memorandum and Articles of
Association or the agreement authorizing the applicant to invest on behalf of its clients

• Audited financial statements and annual reports for the last one year, provided that the
period covered shall not be less than twelve months.

• A declaration by the applicant with registration number and other particulars in support of
its registration or regulation by a Securities Commission or Self Regulatory Organisation or any
other appropriate regulatory authority with whom the applicant is registered in its home country.

• A declaration by the applicant that it has entered into a custodian agreement with a
domestic custodian together with particulars of the domestic custodian.

• A signed declaration statement that appears at the end of the Form.

• Declaration regarding fit & proper entity.

The fee for registration as FII is US $ 5,000. The mode of payment is Demand Draft in favour of
"Securities and Exchange Board of India" payable at New York‖.

SEBI generally takes 7 working days in granting FII registration. However, in cases where the
information furnished by the applicants is incomplete, seven days shall be counted from the days
when all necessary information sought, reaches SEBI.

In cases where the applicant is bank and subsidiary of a bank, SEBI seeks comments from the
Reserve Bank of India (RBI). In such cases, 7 working days would be counted from the day no
objection is received from RBI.

The FII registration is valid for 5 years. After expiry of 5 years, the registration needs to be
renewed.


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Same as initial registration, Along with "Form A" and all the relevant documents, the applicants are
required to fill in additional form (Annexure 1) while applying for renewal. US $ 5,000 needs to be
paid for renewal of FII registration.

The application for renewal should be submitted three months before expiry of the FII registration.
100 % debt FIIs are debt dedicated FIIs which invest in debt securities only. The procedure for
registration of FII/sub-account, under 100% debt route is similar to that of normal funds besides a
clear statement by the applicant that it wishes to be registered as FII/sub-account under 100% debt
route.

Sub-Account Registration

e) Institution or funds or portfolios established outside India, whether incorporated or not.

f) Proprietary fund of FII.

g) Foreign Corporates

h) Foreign Individuals.

The FII should apply on the behalf of the Sub-account. Both the FII and the Sub-account are
required to sign the Sub-account application form.

"Annexure B" to "Form A" (FII application form) needs to be filled when applying for sub-account
registration. No document is needed to be sent with annexure B. The fee for sub-account
registration is US$ 1,000. The fee is to be submitted at the time of submitting the application. The
mode of payment is Demand Draft in the name of "Securities and Exchange Board of India"
payable at New York. SEBI generally takes three working days in granting FII registration.
However, in cases where the information furnished by the applicants is incomplete, three days
shall be counted from the days when all necessary information sought, reaches SEBI. The validity
of sub-account registration is co-terminus with the FII registration under which it is registered. The
process of renewal of sub-account is same as initial registration. Renewal fee in this case is US $
1,000. OCBs / NRIs are not permitted to get registered as FII/sub-account.


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Post-Registration Process

If a registered FII/sub-account undergoes name change, then the FII need to promptly inform SEBI
about the change. It should also mention the reasons for the name change and give an
undertaking that there has been no change in beneficiary ownership.

In case of name change of FII, the request should be accompanied with documents from home
regulator and registrar of the company evidencing approval of name change, and the original FII
registration certificate issued by SEBI should be sent back for necessary amendment.

Procedure for transferring a sub-account from one FII to another:

The FII to whom the Sub-account is proposed to be transferred has to send a request along with a
declaration that it is authorized to invest on behalf of the Sub-account. The transferor FII should
also submit a No-objection certificate.

The FII should send a request, along with no-objection certificate from existing domestic custodian,
for change in domestic custodian.

The FII would be required to send a request for cancellation of its registration or registration of its
Sub-account/s clearly mentioning the name and registration number of the entity. The FII should
ensure that it / Sub-account has nil cash / securities holdings.

Procedure for change of local custodian:

In case of change of the local custodian of the FII / sub-account, the change should be intimated to
SEBI by the FII. On receipt of no objection from the existing custodian and acceptance from the
proposed custodian, the change of custodian would be approved - by SEBI.

Procedure for registration as FII/sub account under 100% debt route:

The procedure for registration of FII/sub account under 100% debt route is similar to that of normal
funds besides a clear statement by the applicant that it wishes to be registered as FII/sub account
under 100% debt route. However, Government of India allocates the overall investment limit for


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100% debt funds annually. The grant of investment limit for individual 100% debt funds is within
this overall limit. The funds have to seek further investment limit in case the limit allotted to them is
exhausted and they wish to invest further.

A Foreign Institutional Investor having an account with one custodian can open accounts with
different custodians for its different sub-accounts. However, one sub-account cannot be custodial
with more than one custodian.

Procedure if an existing sub-account wants to get registered as a Foreign Institutional Investor:

In case if a registered sub-account wishes to get itself registered as a Foreign Institutional Investor,
then it will have to apply in Form A to SEBI for the same and has to satisfy all the eligibility criteria
norms mentioned in SEBI (Foreign Institutional Investor) Regulations, 1995. It should also submit a
letter from the old FII indicating its 'No-objection' to such registration.

Procedure for renewal of FII/Sub-Account registration:

They have to apply before 3 months of the expiry of registration in Form A. Circular No
FITTC/CUST/09/2000 dated September 21, 2000 may be referred.

If the FII does not renew its/sub-account‘s registration:

The registration of the FII / Sub-account would get expired at due date and it would not be allowed
to trade in Indian securities markets. If it is not interested in renewal but has certain residual
assets, it can apply for disinvestment in terms of Circular No. FITTC/CUST/12/2001 dated June 04,
2001 and abide by the guidelines specified in this regard.

INVESTMENT OPPORTUNITIES

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;


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c. Dated Government Securities;

d. Derivatives traded on a recognized stock exchange;

e. Commercial papers.

Investment limits on equity investments by FII/sub-account:

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 prescribed by Government
of India / Reserve Bank of India.

Investment limits on debt investments by FII/sub-account:

The FII investments in debt securities are governed by the policy if the Government for FII
investments in Government debt, currently of India. Currently following limits are in effect:

100 % Debt Route US $ 1.55 billion

70 : 30 Route US $ 200 million

Total Limit US $ 1.75 billion

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

Other investment limits:

Normal FII (70:30 Route) 100% Debt FII


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Total investment in equity and equity related instruments shall not be less than 70% of aggregate
of all investments. 100% investment shall be made in debt security only.

Securities to be registered in name of:

a. In the name of FII when making investments on its own behalf

b. In the name of sub-account when making investments on behalf of Sub-account

DERIVATIVES POSITION LIMITS

a. The FII position limits in a derivative contracts (Individual Stocks)

The FII position limits in a derivative contract on a particular underlying stock i.e. stock option
contracts and single stock futures contracts are:

i. For stocks in which the market wide position limit is less than or equal to Rs. 250 Cr, the
FII position limit in such stock shall be 20% of the market wide limit.

ii. For stocks in which the market wide position limit is greater than Rs. 250 Cr, the FII
position limit in such stock shall be Rs. 50 Cr.

b. FII Position limits in Index options contracts

FII position limit in all index options contracts on a particular underlying index shall be Rs. 250
Crores or 15 % of the total open interest of the market in index options, whichever is higher, per
exchange.

This limit would be applicable on open positions in all option contracts on a particular underlying
index.

c. FII Position limits in Index futures contracts:

FII position limit in all index futures contracts on a particular underlying index shall be Rs. 250
Crore or 15 % of the total open interest of the market in index futures, whichever is higher, per
exchange.


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This limit would be applicable on open positions in all futures contracts on a particular underlying
index.

In addition to the above, FIIs shall take exposure in equity index derivatives subject to the following
limits:

i. Short positions in index derivatives (short futures, short calls and long puts) not exceeding
(in notional value) the FII‘s holding of stocks.

ii. Long positions in index derivatives (long futures, long calls and short puts) not exceeding
(in notional value) the FII‘s holding of cash, government securities, T-Bills and similar instruments.

d. FII Position Limits in Interest rate derivative contracts

At the level of the FII

The notional value of gross open position of a FII in exchange traded interest rate derivative
contracts shall be:

i. US $ 100 million.

ii. In addition to the above, the FII may take exposure in exchange traded in interest rate
derivative contracts to the extent of the book value of their cash market exposure in Government
Securities.

At the level of the sub-account

The position limits for a Sub-account in near month exchange traded interest rate derivative
contracts shall be higher of:

i. Rs. 100 Cr or

ii. 15% of total open interest in the market in exchange traded interest rate derivative
contracts.


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