ABSTRACT
This study examined the effect of exchange rate on stock prices in Nigeria from the period of 2002 to 2016 using secondary data collected from CBN statistical bulletin. To analyze data collected, Ordinary Least Square (OLS) multiple regression technique was used to determine the effects of exchange rate on stock prices in Nigeria using E-views statistical software version 9.0. The study reveals that real exchange rate has a positive insignificant effect on stock prices and the macro -economic variable-interest rate which was also included in the study has a negative significant effect on stock prices. The study therefore concluded that exchange rate has a significant effect on stock prices in Nigeria and recommended that the government should strengthen its macro- economic policies and work toward achieving a single digit interest rate to reduce the effects of fluctuating exchange rate and interest rate on stock market prices in Nigeria.
TABLE OF CONTENTS
Declaration
Certification
Dedication
Acknowledgements
List of tables
Table of contents
Abstract
CHAPTER
ONE:
INTRODUCTION
1.1 Background
To The Study
1.2 Statement
of Problem
1.3 Objectives
of The Study
1.4 Research
Question
1.5 Research
Hypothesis
1.6 Significance
of Study
1.7 Scope
of Study
1.8 Limitation
of Study
CHAPTER TWO:
Literature Review
2.1 Conceptual Frame Work
2.1.1 The Concept of Exchange Rate
2.1.2 Types of Exchange Rate
2.1.3 Exchange Rate Regimes
2.1.4 Impact of Exchange Rate on an
Economy
2.1.5 The Concept of Stock Prices
2.1.6 Important Factors Affecting Stock
Prices
2.1.7 The Concept of Interest Rate
2.1.8 Causes of Differences in Rates of
Interest
2.2 Theoretical Frame Work
2.2.1 Purchasing Power Parity Theory
2.2.2 The Keynesian Theory
2.2.3 Portfolio Balance Theory
2.3 Empirical Review
CHAPTER
THREE:
3.1 Research Design
3.2 Source of Data
3.3 Population of Study
3.4 Research Area
3.5 Model Specification
3.5.1 Description of Model Variables
3.6 Analytical Techniques
CHAPTER
FOUR
DATA PRESENTATION, ANALYSIS AND DISCUSSON
4.1 Data Presentation
4.2 Data Analysis
4.3 Test of Hypothesis
4.4 Discussion of Findings
CHAPTER
FIVE
SUMMARY OF FINDINGS, CONCLUSION AND
RECOMMENDATIONS
5.1 Summary of Findings
5.2 Conclusion
5.3 Recommendations
References
Appendices
LIST OF TABLES
Table 4 .1: Nigerian data set on All Share Index, Real Exchange Rate and Interest Rate (2002-2016).
Table 4 .2: Ordinary Least Squares (OLS) Result
CHAPTER ONE
INTRODUCTION
1.1
BACKGROUND
TO STUDY
The
link between exchange rate and stock prices has preoccupied the minds of both
academic and professional players of the stock market as both exchange rate and
stock prices play an important role in influencing the overall mechanism and
development of any economy and they are an important sign of an economy’s health.
Exchange rate and stock prices play a major role in fostering financial sector
development. The relationship between exchange rate and stock prices varies
with different countries and different periods of time. In a stable financial
system the link between the exchange rate and stock prices could be explained
both in short and long run. In the former an upward trend in stock market may
cause currency depreciation where as in the later may cause a decline in stock
market (Odoyo, 2014).
Although, economic theory suggests that changes
in exchange rate can have an important impact on the stock price by affecting
cash flow, investment and profitability of firms, there is no consensus about
these relationship and the empirical studies of the relationship are
inconclusive (Joseph, 2002; Vygodina, 2006). However, the linkage between these
financial variables can be established through the instruments of wealth,
demand for money, interest rates etc. (Mishra,2004). According to traditional
approach, exchange rates lead stock prices. On the other hand, portfolio
balance approach states that exchange rates are determined by Administration
and market mechanism. In other words, changes in stock prices might have impact
on exchange rate movements. This approach states that stock price is expected
to lead exchange rate with a negative correlation since a decrease in stock
prices reduces domestic wealth, which leads to lower domestic money demand and
interest rates (Odoyo, 2014). Also, the decrease in domestic stock prices leads
foreign investors to lower demand for domestic assets and domestic currency.
These shifts in demand and supply of currencies cause capital outflows and the
depreciation of domestic currency. On the other hand, when stock prices rise,
foreign investors become willing to invest in a country’s equity securities.
Thus, they will get benefit from international diversification. This situation
will lead to capital inflows and a currency appreciation (Granger, Huang and
Yang, 2000).
Exchange rate changes affect the
competitiveness of firms through their impact on input and output price
(Joseph, 2002).When the Exchange rate appreciates, since exporters will lose
their competitiveness in international market, the sales and profits of
exporters will shrink and the stock prices will decline. On the other hand,
importers will increase their competitiveness in domestic markets. Therefore,
their profit and stock prices will increase. The depreciation of exchange rate
will make adverse effects on exporters and importers. Exporters will have advantage
against other countries’ exporters and increase their sales and their stock
prices will be higher (Yau and Nieh, 2006).That is, currency appreciation has
both a negative and a positive effect on the domestic stock market for an
export-dominant and an import-dominated country, respectively (Ma and Kao,
1990).
Jorion (1990) points out that exchange
rate is four times as volatile as interest rates and ten times as volatile as
inflation rates. For the investor, changes in exchange rate poses a foreign
exchange risk. High fluctuations in exchange rates can lead to big losses in an
investor’s portfolio of investments due to uncertainty of return on
investments. This is due to the fact that movements in foreign exchange rates
affect the prices of goods on the international markets and this in turn
affects the profit margin of exporting and importing companies (Asaolu, 2011).
Exchange rates can affect stock prices not
only for multinational and export oriented firms but also for domestic firms.
For a multinational company, changes in exchange rates will result in both an
immediate change in value of its foreign operations and a continuing change in
the profitability of its foreign operations reflected in successive income
statements. Therefore, the changes in economic value of firm’s foreign
operations may influence stock prices.
Domestic firms can also be influenced by
changes in exchange rates since they may import a part of their inputs and
export their outputs. For example, a devaluation of its currency makes imported
inputs more expensive and exported outputs cheaper for a firm. Thus,
devaluation will make positive effect for export firms (Aggarwal, 1981) and
increase the income of these firms, consequently, boosting the average level of
stock prices (Wu, 2000).
According to real interest rate
disturbance, when the real interest rate rises, capital inflow increases and
the exchange rate fall. However, since higher real interest rate reduces the
present value of future cash flows, stock prices will decline. An inflationary
disturbance may explain negative relationship between exchange rate and stock
price. That is, when inflation increases, the exchange rate rises and because
of high inflation expectations, investors will demand a higher risk premium and
high rate of return. As a result, stock prices will decrease (Wu, 2000).
On the other hand, the asset market
approach to exchange rate determination states a weak or no association between
exchange rates and stock prices and treats exchange rate to be the price of an
asset (price of one unit of foreign currency). That is, expected future
exchange rates determine the exchange rates and factors affecting exchange
rates and stock price may be different(Muhammad and Rasheed, 2002). Consequently
this research attempts to examine how exchange rate affects stock prices in
Nigeria over the period of 2002 to 2016 .
1.2 STATEMENT OF PROBLEM
Exchange rate and stock market price are
interconnected directly or indirectly, because today’s world is turning into a
global village due to trade liberalization and globalization. For instance,
foreign investors are busy investing
their capital in the stock markets world over. In this process international
investment is booming rapidly and capital is moving across all over the world.
The benefits of these investors are being determined by foreign exchange rate. Moreover,
instability in the exchange rate may bring about uncertainty or otherwise in
these investors. Thus, exchange rate is an important determinant of stock
market fluctuations. In Nigeria, the value of naira experienced high degree of
volatility recently. For example, statistical records have shown that due to
the global financial crisis, from 2006 to 2008 the value of naira to US$ was
₦125, but further depreciated from ₦150.3 in 2010 to average of ₦153.90,
₦156.81 and ₦305.25 per US$ dollar in 2011, 2013 and 2017, respectively. In the
same vain the stock market moves so strongly on the same direction with the
currency exchange rate. Statistically, stock market collapsed by about 70%
between 2008-2009. Additionally, the All Share Index (ASI) as measure of stock
market performance has persistently declined from 65,652.38 in 2008 to less
than 30,000.00 points in 2012. It however, increased from 31,853.19 to
41,210.10 points between 2013 and 2014, after which it continuously declined to
less than 31,853.19 points from 2015 to date. In 2016 due to the decline
in foreign exchange reserve, the Central Bank of Nigeria reintroduced a
floating
exchange rate regime and this has led to variations in the stock market
behavior. The implication is that the price of naira against dollar becomes
volatile to the forces of demand and supply. This means that if inflation for
instance takes place you will have a scenario where more Naira is chasing stock
i.e stock prices rise and fall with changes in exchange rate. Effect of this
policy as to either increased market efficiency or not is
debatable. This study will contribute to this debate by examining the predictability
of stock prices via exchange rate changes in Nigeria. Furthermore, the
inconsistent results and direction of causality between exchange rates and
stock prices is both theoretically and
empirically inconclusive .Therefore, there is need to conduct similar research
and establish the direction and magnitude of the interaction between exchange
rates and stock prices in Nigeria.
1.3
RESEARCH OBJECTIVE
The main objective of the study is to
investigate the effect of exchange rate on stock prices .The specific objectives
of this study are
1. To
determine the effect of real exchange rate on All share index.
2. To
investigate the effect of interest rate on All share index.
1.4 RESEARCH QUESTIONS
In line with the specific objective of the
study, the following question is asked to guide the study and enhance proper
assessment of the work.
1.
In what way does real
exchange rate have effect on All share index?
2.
In what way does interest
rate have effect on All share index?
1.5 RESEARCH HYPOTHESIS
In order to find an answer to the research
questions, the following hypothesis are tested in null form:
Ho: Real exchange rate has no significant
effect on All share index.
Hı: Interest rate has no significant
effect on All share index.
1.6 SIGNIFICANCE OF STUDY
1.To Investors and Policy Makers:
The results generated will provide additional information to investors and
policy makers in forecasting and monitoring stock market performance and
exchange rate. Awareness of the relationship
between exchange rate and stock prices will help domestic as well as
international investors for hedging and diversifying their portfolio.
2.
The study will provide an empirical proof of the effects of real exchange rate
on All share index.
3.
To Monetary Authorities: It may affect decisions
about monetary policies. A booming stock market has a positive effect on
aggregate demand. If this is large enough, expansionary monetary policies that
target the real exchange rate will be neutralized. Sometimes policy makers
advocate less expensive currency in order to boost the export sector. This
study will help them be aware of whether such a policy might depress the stock
market.
4.To
Future Researchers: Also this study will
serve as a reference material and aid future researches on the effect or
relationship between exchange rate and stock prices.
1.7 SCOPE OF STUDY
This research focuses on the activities of
the Nigerian stock exchange and the price of Nigerian currency (Naira) in terms
of the U.S Dollar between the period of 2002 to 2016.
1.8 LIMITATIONS OF STUDY
With the view of carrying out such a study
in an academic environment, some constraints were identified which affected the
extent to which the research work should have been carried out. These
constraints include inadequate finance to access materials needed for the
research study .Also time was not available enough to carry out the research
work as it was difficult combining academic demands, personal routine and the
research p
1.8 DEFINITION OF TERMS
·
FOREIGN
EXCHANGE: Foreign exchange is the exchange of one
currency for another by governments, businesses and residents of two different
countries.
·
STOCK
MARKET: The stock market is the segment of the
financial market where securities are traded at a price determined by the
forces of demand and supply.
·
EXCHANGE
RATE: An exchange rate is the price of a
nation’s currency in terms of another country. It is the price for which the
currency of a country can be exchanged for another country’s currency.
·
STOCK
PRICE: The stock price is the cost of purchasing
a security on an exchange. In layman’s terms , it is the highest amount someone
is willing to pay for the stock or the lowest amount it can be bought for.
·
CURRENCY:
Currency is a generally accepted form of money Including coins and paper notes,
which is issued by a government and circulated within an economy used as a
medium of exchange for goods and services.
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