Naveed Report

Final Project Report
Foreign currency remittance and its impact
Submitted By:
Naveed
MBA Finance
Roll : 17018
Registeration no: 2113657
DEDICATED TO:
Holy Prophet
HAZRAT
MUHAMMAD
(P.B.U.H.)
&
My Beloved Parents
MR. & MRS. Khursheed
Abstract:
This paper reviews the main policy and analytical issues related to currency
substitution in developing countries. The paper discusses, first, whether
currency substitution should be encouraged or not; second, how the
presence of currency substitution affects the choice of nominal anchors in
inflation stabilization programs; third, the effects of changes in the rate of
growth of the money supply on the real exchange rate; fourth, the interaction
between inflationary finance and currency substitution; and, finally, issues
related to the empirical verification of the currency substitution hypothesis.
ACKNOWLEDGEMENT:
I owe my gratitude to Almighty Allah for His blessings and kindness that I
was able to accomplish the challenging task successfully and
enthusiastically.
I am very lucky for having a brother whose critical evaluations have a great
importance during the documentation of this thesis.
And finally I would like to thank all those persons who prayed for me and
helped me in any context to fulfill the challenge to bring my experience into
the words of internship.
Foreign Currency
Introduction
Foreign exchange is the conversion of one country's currency into that of
another. In a free economy, a country's currency is valued according to
factors of supply and demand. In other words, a currency's value can
be pegged to another country's currency, such as the U.S. dollar, or even to
a basket of currencies. A country's currency value also may be fixed by the
country's government. However, most countries float their currencies freely
against those of other countries, which keeps them in constant fluctuation.
The value of any particular currency is determined by market forces based
on trade, investment, tourism, and geo-political risk. Every time a tourist
visits a country, for example, he or she must pay for goods and services
using the currency of the host country. Therefore, a tourist must exchange
the currency of his or her home country for the local currency. Currency
exchange of this kind is one of the demand factors for a particular currency.
Introduction
The Foreign Exchange market is truly the largest exchange in the world.
The amount of dollars traded on the Forex market on a daily basis is in the
trillions. Most of this currency trading takes place between between large
banks, central banks, currency speculators, multinational corporations,
governments, and other financial markets and institutions. However,
individual traders are starting to get in the mix, using internet discount
brokers such as Etrade to participate in the currency exchange market.
There is no central exchange or meeting place for the Forex. All trading is
done over computer networks between traders in different parts of the world.
Also, unlike the stock market, the foreign exchange market is open 24 hours
per day, because it is a global market. A trader in Hong Kong may be
exchanging currency with a trader in Australia while an American trader is
sleeping.
There are several different markets within the Forex exchange system. First,
there is the spot market. The spot market deals with trades that are based
on the current values of currencies. One person trades a certain amount of
currency with another trader in exchange for an equivalent amount of a

different foreign currency. Spot trades take two days for settlement.
The other two types of foreign exchange markets are the forward and
futures markets. In the forward market, the buyer and seller agree on an
exchange rate and a transaction date is set for a specific time in the future,
at which point the trade is executed regardless of what the rates are at that
time. On the futures market, futures contracts are bought and sold based
upon a standard contract size and maturity date. Futures trades take place
on public commodities markets.
A currency quote is listed differently from a stock quote. Stocks are quoted
in terms of price per share. Currency exchange prices are listed as either a
direct quote or an indirect quote. A direct quote uses the domestic currency
as the base and the foreign currency as the quote. An indirect quote works
the exact opposite way.
1. Inward Remittance - No Restrictions.
2. Outward Remittances.
3. Mode of Remittances.
4. Prescribed Application Forms.
5. Applications by Letters.
6. Applications to be submitted to the State Bank only through an
Authorized Dealer.
7. Forwarding Applications to the State Bank.
8. Processing of Approved Form etc.
9. Permits for Recurring Remittances.
10. Effecting Remittances against Permits.
11. Period of validity of approval by the State Bank.
12. Release of Foreign Exchange for Travel Abroad.

13. Processing of Approvals given on one Authorized Dealer's Form by
another Authorized Dealer.
14. Reporting of Remittances.
15. Cancellation of Outward Remittances.
16. Cancellation of Inward Remittances.
17. Utilization of Exchange for the purpose it is obtained.
1.
Inward Remittances.
The term 'inward remittance" means purchase of foreign currencies in

whatever form and includes not only remittances by M.T., T.T., draft etc., but
also purchase of travelers cheques, drafts under travelers letters of credit,
bills of exchange, currency notes and coins etc. Debit to banks' non-resident
Rupee accounts also constitutes an inward remittance. This chapter,
however, does not cover purchase of foreign currency notes and coins
which is dealt with in Chapter XI.
2.
Inward Remittance No Restrictions.
There is no restriction on receipt of remittances from abroad either in foreign

currency or by debit to non-resident Rupee accounts of banks' overseas
branches or correspondents. Authorized Dealers may freely purchase T.Ts,
M.Ts, drafts, bills etc., expressed and payable in foreign currencies or drawn
in Rupees on banks' non-resident Rupee accounts. There is also no
objection to their obtaining reimbursement in foreign currency from their
overseas branches and correspondents in respect of Rupee bills and drafts
which are purchased by them under letters of credit opened by non-resident
banks or under other arrangements.
3.
Outward Remittances.
The term "outward remittance" means sale of foreign exchange in any form
and includes not only remittances by T.Ts, M.Ts, drafts etc., but also sale of
travelers cheques, travelers letters of credit, foreign currency notes and

coins etc. Outward remittance can be made either by sale of foreign
exchange or by credit to non-resident Rupee account of banks' overseas
branches or correspondents. Authorized Dealers may sell foreign exchange
for approved transactions only in accordance with the procedure outlined in
this chapter. This chapter does not cover sale of foreign currency notes and
coins which is dealt with in Chapter XI.
4.
Mode of Remittances.
Authorized Dealers should normally avoid issuing drafts in cover of outward

remittances whenever remittance can be made by T.Ts, or M.Ts, etc. Where,
however, the normal means of transfer is likely to result in unnecessary
hardship or inconvenience to the remitter, drafts may be issued in the name
of the beneficiaries of the remittance but such drafts should be crossed by
the issuing bank as "Account Payee only".
5.
Prescribed Application Forms.
(i)
There are three types of application forms for outward remittances:

(a) Form 'I' is to cover remittance against imports (Appendix V-30 )
(b) Form 'T-1' is to cover sale of exchange for travel (Appendix V-64)
(c) Form 'M' is to cover all other remittances (Appendix V-8)
(ii)
Any person who wishes to purchase foreign exchange must lodge an
application with an Authorized Dealer on the appropriate prescribed form
duly supported by the requisite documents. On receipt, the application
should be examined by the Authorized Dealer and if the Authorized Dealer is
satisfied that the application is covered by the regulations and it is
empowered to approve the remittance on behalf of the State Bank, it may
effect the sale of foreign exchange. If the transaction requires prior approval
of the State Bank, the application should be forwarded by the Authorized
Dealer to the State Bank for consideration with comments under its stamp
and signature.
6.
Applications by Letters.
In some cases, applications are made by letters as it becomes difficult for

the applicants to fully describe on the prescribed application form the
purpose of purchase of foreign exchange particularly for travel abroad and
for purposes other than import. In all such cases, letters should be
accompanied by Form 'T-1' or 'M' as the case may be, duly filled in. If the
remittance is permissible, the State Bank will return the form duly approved.
In cases where remittance is required to be made in installments at
periodical intervals, the State Bank may issue special permits authorizing
remittances in the desired manner.
7.
Applications to be submitted to the State Bank only through an
Authorized Dealer.
All applications for foreign exchange should be forwarded to the State Bank
through Authorized Dealers who should arrange their delivery to the State
Bank through their own messengers or through post. All applicants who
present their applications directly to the State Bank will be asked to resubmit
them through an Authorized Dealer.
8.
Forwarding Applications to the State Bank.
When submitting applications to the State Bank, Authorized Dealers should

take all reasonable precautions to satisfy themselves as to the bonfires of
the applicants. They should verify that the application form has been duly
completed and signed by the applicant and then affix their stamp and
signature thereon in token of their having examined the application and of
having satisfied themselves that to the best of their knowledge and belief,
the statements made in the form are correct and that full documentary
evidence as required has been submitted. The applicant should also be
advised that under Section 22 of the Act, it is an offence to give any
information or make any statement which he knows or has reasonable
cause to believe to be false or not true in any material particular.
9.
Processing of Approved Form etc.
After receipt of approved forms or permits etc., from the State Bank,
Authorized Dealers should see that the forms etc., have been approved by
the authorized officers of the State Bank and that they bear its embossing
seal. Authorizations which are signed by officers whose specimen
signatures are not available with the Authorized Dealer, should be presented
to the nearest office of the State Bank for authentication. It is also important
that once a form has been approved by or on behalf of the State Bank, the
Authorized Dealer should effect remittance only on behalf of the original
applicant for whom the form has been approved and in favour of the
beneficiary whose name appears in the approval. They must in no case

accept instructions from third parties. In those cases where Authorised
Dealers are empowered under the instructions laid down in this Manual to
approve applications on behalf of the State Bank, they should ensure while
approving the form that the applications are complete in all respects and that
all the necessary documentary or other evidence as required has been
submitted to and examined by them and that they have satisfied themselves
as to the genuineness of the transaction.
10. Permits for Recurring Remittances.
(i)
Permits (Appendix V-9) issued by the State Bank are of three types.
In the first type of permits, the State Bank authorizes remittances up to a
stated amount within a stated period which an Authorized Dealer may make
on behalf of the permit holder. Remittances under such permits may be
made during the period of validity of the permit in amounts as required by
the applicant provided that the total of such remittances under the permit
does not exceed the overall limit laid down in the permit.
(ii)
The second type of permits covers remittances on a periodical
(monthly) basis but the periodical (monthly) limits are not cumulative and
remittances in all during any one period (month) must not exceed the
prescribed rate laid down in the permit. If remittances are not made up to the
full extent of the limit in any period (month), it is not permissible to carry
forward unutilized balance in order to make larger remittances in
subsequent periods.
(iii)
The third type of permits allows remittances on a periodical (monthly)
basis but the periodical (monthly) amount is sanctioned on a cumulative
basis so that unutilized amounts for earlier periods (months) can be remitted
in subsequent periods (months). Unutilized amounts may, however, be
accumulated only within the validity of the permit and the entire unutilized
balance of such permits will lapse after the last day of the validity of the
permit. In such cases it is not permissible to make remittances in advance of
the entitlements of the subsequent periods (months).
(iv)
Requests for utilization of lapsed quotas should be forwarded by
Authorized Dealers to the State Bank giving full reasons for non-utilization
on due dates supported by suitable documentary evidence, wherever
available.
11.
Effecting Remittances against Permits.
In all cases where permits are issued by the State Bank, it will be in order for
the Authorized Dealers to effect remittances against the permits subject to
report on form 'M'. Authorized Dealers must state inform the number of the
permit against which the remittance has been made and also certify that the
remittance has been endorsed on the permit. The remittance must be
endorsed on the reverse of the permit giving the amount and date of
remittance under their stamp and signature. When the permit is exhausted,
it should be returned to the State Bank by the Authorized Dealers along with
the form 'M' on which the last remittance is reported. In all cases where the
purpose for which the permit was granted ceases to exist and no further
remittances are required or are permissible, the unutilized permit should be
returned to the State Bank with an advice that the permit should be
cancelled.
12. Period of validity of approval by the State Bank.
All Authorizations given by the State Bank are valid for a period not
exceeding 30 days from the date of approval unless they are expressly
approved as valid for a specified longer period or unless they have been
revalidated for a further period. Similarly, permits issued by the State Bank is
also valid for specified periods as stated on the permit. Authorized Dealers
should not effect any remittance against approved forms, permits etc., which
have been lapsed unless they have been duly revalidated.
13. Release of Foreign Exchange for Travel Abroad.
Foreign exchange is issued to the travelers against specific or general
approval given by the State Bank. It may be drawn in any foreign currency
equivalent to the sanctioned amount exclusively in the forms specified in
paragraph 44 of Chapter XVII. In cases where a traveler desires to draw
foreign exchange partly in foreign currency instruments and partly in foreign
currency notes, Authorized Dealers will prepare two separate 'T-1' forms. In
the portion meant for their certificate, the Authorized Dealers will give on
both the 'T-1' forms a suitable indication as to the amounts of foreign
exchange released in foreign currency instruments and notes. The 'T-1'
forms will be attached with Schedules E-3 annexed to Summary Statements
S-1 and S-6. In the case of sale of foreign exchange partly in foreign
currency instruments and partly in foreign currency notes against specific
approval issued by the State Bank, a photocopy of the State Bank's sanction
will also be made. Authorized Dealers will give a suitable indication to this
effect, both on the original sanction as well as its photocopy which will be
attached with the relative 'T-1' forms and surrendered to the State Bank
along with the monthly returns of foreign exchange transactions.
14. Processing of Approvals given on one Authorized Dealers Form
by another Authorized Dealer.
There may be instances where a traveler or a remitter might approach an
Authorized Dealer for issue/remittance of foreign exchange against
approved form 'T-1' or 'M' bearing the identifying prefix and serial number of
another Authorized Dealer. While releasing/remitting foreign exchange
against such form 'T-1' or 'M', Authorized Dealers should insert their own
identifying prefix and serial number borne on one of the blank 'T-1' or 'M'
forms in their possession, and score out the prefix and serial number
already appearing on approved form 'T-1' or 'M' under proper authentication.
The Authorized Dealers should, however, destroy that blank form 'T-1' or 'M'
whose serial number is so inserted by them.
15.
Reporting of Remittances.
Authorized Dealers should submit to the State Bank along with the
appropriate returns as laid down inChapter XXII, forms M, T-1 and 'I' as
the case may be, in cover of each remittance effected by them. Where
remittances are approved by the State Bank, the approved forms should be
submitted in original. Where approval is given by the State Bank by letter or
through issue of permit, particulars of the letter or of the permit should be
given on the appropriate form before submitting it to the State Bank with the
returns.
16.
Cancellation of Outward Remittances.
In the event of any outward remittance which has already been reported to
the State Bank being subsequently cancelled, either in full or in part,
Authorized Dealers must report the cancellation of the outward remittance
as an inward remittance. The return in which the reversal of the transaction
is reported should be supported by a letter giving the following particulars:
(a)
The date of the return in which the outward remittance was

reported.
(b)
The name and address of the applicant.
(c)
The amount of the sale as effected originally.
(d)
The amount cancelled.
(e)
Reasons for cancellation.
17.
Cancellation of Inward Remittances.
In the event of any inward remittance which has already been reported to
the State Bank, being subsequently cancelled either in full or in part,
because of non-availability of the beneficiary, Authorized Dealers must
report the cancellation of the inward remittance as an outward remittance on
form 'M'. The return in which the reversal of the transaction is reported
should be supported by a letter giving the following particulars:
18.
(a)
The date of the return in which the inward remittance was

reported.
(b)
The name and address of the beneficiary.
(c)
The amount of the purchase as effected originally.
(d)
The amount cancelled.
(e)
Reasons for cancellation.

Utilization of Exchange for the purpose it is obtained.
Where any foreign exchange is acquired by any person other than an

Authorized Dealer for any particular purpose or where any person has been
permitted conditionally to acquire foreign exchange, the said person will not
use the foreign exchange so acquired otherwise than for that purpose or fail
to comply with the prescribed conditions. In cases where the foreign
exchange so acquired cannot be used in full or in part for the purpose for
which it was acquired or any of the conditions subject to which the foreign
exchange was released cannot be complied with, the foreign exchange
should immediately be surrendered to an Authorized Dealer.
Impact of Monetary Policy on the Volatility of Stock Market in Pakistan

Impact of Monetary Policy on the Volatility of Stock Market in Pakistan
This paper addresses the linkages between the monetary
policy and the stock market in Pakistan. The estimation
technique employed includes Engle Granger two step
procedure and the bivariate EGARCH method. The results
indicate that any change in the monetary policy stance
have a significant impact on the volatility of the stock
market. Thus contributing to the ongoing debate in the
monetary policy rule literature regarding the proactive and
reactive approach1.
JEL code: G120, E430.
Keywords: Interest Rate, Stock Market, Monetary Policy.
1.
Introduction
Financial sector in Pakistan has been experiencing the process of reforms

since eighties. The two important outcomes of the financial sector reforms in
Pakistan has been the opening up of the stock markets for foreign investors
and adoption of market based instruments, such as interest rate, of
monetary policy. Opening up of the stock markets resulted in a sharp
increase in the inflows of portfolio investment [Fazal and Qayyum (2007)].
On one side such an investment helps in raising the investable funds and on
other side it produced wild swings in the stock market. For example, the
Karachi Stock (KSE)-100 Index increased to 2600 in 1995 but declined
sharply to just 878 in 1998. From this low level it crossed 10 thousand marks
in early 2005 and by May 2005 it had declined to around 7 thousand mark
[Fazal and Qayyum (2007)]. It is argued that the volatility is high in the
bullish market than in the bear market. The Repo rate as indicator of
monetary policy these years has also shown volatility. Since 1995 the Repo
rates have been fluctuating between 23.5 to 0.21.
1
The authors are thankful to Saghir Pervaiz, Umad Mazhar and Ejaz Bajwa for the data.
Theoretically, monetary policy affects the stock prices through the wealth
effect channel and the balance sheet channel as pointed out by Bernanke,
Gertler and Gilchrist (1996), Bernanke and Gertler (1999) and Goodhart
and Hofmann (2000). The traditional interest rate channel which implies that
a tighter monetary policy leads to an increase in the interest rate that at
which the firms future cash flows are capitalized causing stock prices to
decline. While the easing of the monetary policy increases the overall level
of economic activity and stock price responds in a positive manner as
indicated by Cassola and Morana (2004). The traditional interest rate
channel was also investigated by Bernanke and Blinder (1992), Thorbecke
(1997) and Rigobon and Sack (2003). One third of the changes in the equity
prices are associated with news on monetary policy (Fair, 2002).
However, there is no study available in Pakistan that has investigated the
relationship between the stock prices and the monetary policy. The core
objective of the study, therefore, is to explore the impact of monetary policy
on the returns to stock market.
The study is arranged as follows. After this introductory part, section II
overviews the stock market and the monetary policy developments in
Pakistan. The section III elaborates the methodological framework. The data
availability and preliminary data analysis is discussed in section IV. The
cointegration analysis and EGARCH model results are presented in section
V. The VI section concludes the study.
2.
Overview of the Stock Market and the Monetary Policy

Developments
The capital market in Pakistan is regulated by the Security and Exchange

Commission of Pakistan (SECP) established in 1997 by replacing the
Corporate Law Authority. There are three stock exchanges in Pakistan,
namely the Karachi Stock Exchange (KSE), the Lahore Stock Exchange
(LSE) and the Islamabad Stock Exchange (ISE). These are established on
1947, 1974, and 1997, respectively. The Karachi Stock Exchange (KSE) is
the main and leading stock Exchange. The growth of the equity market
during the decade of 1960s was due to industrialization policies pursued by

the government of Pakistan. The decade of 1970s started with political
turmoil and unrest in the eastern part of the country. The worsening
domestic situation in the East Pakistan and war with India disaggregated
Pakistan. The out come was the separation of former East Pakistan and
emergence of new country Bangladesh. The Government of Pakistan has
adopted the policy of nationalization of all types of private sector industries
and financial institutions in 1973-74, which had completely eliminated private
sector out of the country. The new government reversed and formulated the
policy of denationalization of industries and financial institutions in 1985-86.
The decade of 1990s witnessed changes in the policies and functioning of
the stock market. In the beginning of 1991 significant measures were taken
including the opening of the market to international investors; removal of
constraints to repatriation on investment proceeds, gains, and dividend;
deregulation of economy and allowing commercial banks in the private
sector; liberalization of foreign exchange restrictions and allowing Pakistanis
to have foreign currency accounts. The market responded positively to
liberalization measure and unprecedented increase in all indicators was
observed in the first year of the opening of the market. The bullish trends
were observed in the first year. In terms of its performance, the market was
ranked third in 1991 [Husain and Qayyum (2006)]. Nevertheless in terms of
listings the market deepened. The new companies (i.e., 86) were listed
during the year that helped to increase the turnover of shares and market
capitalization. The market improved significantly in terms of size and activity.
As a result, the ratio of market capitalization to GDP increased from 7% to
almost 18% in the first year of liberalization and further to 26% after two
years.
In 1995 Pakistani equities market collapsed due to domestic political crisis
and a discouraging economic outlook. KSE established a `Defaulting
Companies Counter in August 1997 for those companies which had
committed various defaults under listing regulations of the Exchange. The
KSE has shown improvement during 1997-98. Further, the Karachi Stock
Exchange introduced a computerized trading system i.e. a KATS (Karachi
Automated Trading System). Due to different measures the number of listed
companies rose to 762 in 2000. In addition the listed capital and market
capitalization are 229,314.8 million and 394,445.7 million respectively. On
the other hand, the growth in activity indicated by trading value and turnover
ratio was tremendous. Since late 90s the turnover ratio has been
phenomenal and increased to almost 500% in 2003. As a result Pakistan

ranks first in the world in terms of turnover ratio. The KSE has been among
the best performing markets for the last two years.
Monetary Policy Developments
The State Bank of Pakistan has been established on July 1, 1948 as a
central bank. The banking system had collapsed at the time of partition; SBP
at first very carefully took measures to rehabilitate and expand the existent
banking structure. These included the declination of the foreign banks offer
to open branches in the interior of the country on the grounds that the local
dominance of the most powerful financial sector of the economy is in the
best interest of the new born country. The National Bank of Pakistan was
thus established in 1949. To encourage the local banks to spread their
branches into the interior of the country, the SBP provided clearing and
cheap remittance facilities. A number of other specialized banks and were
also set up namely Agricultural Development Finance Corporation in 1952
and Asian Development Bank in 1959 later merged into Agricultural
Development Bank in 1961, Pakistan Industrial Finance Corporation in 1957
later on converted into Industrial Development Bank, Pakistan Industrial
Credit and Investment Corporation in 1957, House Building Finance
Corporation in 1952, National Investment Trust, Investment Corporation of
Pakistan etc.
SBP has been using a selective credit control measures like the imposition
of minimum margin requirements as an instrument of monetary policy. The
interest rate was kept low during 19480-70 to contain rise in the public debt
and to encourage larger expansion of the banking credit for financing the
public and private investment. The SBP in addition to the use of moral
suasion with the banks to encourage lending to the small parties used
margin requirement as a tool. To restraint the growth of money supply the
reserve ratios were used 1965. In addition a Quota System was introduced
in August 1963, in respect of its advances to the scheduled banks against
government securities. Under this agreement banks were assigned a quota
every quarter equal to half of its statutory reserves with the state bank in the
preceding quarter. The borrowing beyond this quota was subject to
progressively high higher rates. In 1965 the quota was made more stringent
by reducing the amount from 50 to 25 percent of the average statutory
reserves and making it applicable it for all types of borrowing of the banks
from SBP.
A comprehensive banking reforms was introduced in 1972 by the
government with consultation of the new governor SBP. The emphasis was
on the flow of the bank credit to priority sectors and small businessman in
agriculture and industry through the creation of the National Credit
Consultative Council. However, owing to the ineffectiveness of the reforms
the SBP was nationalized in 1974. The system of the ceilings on the credit
by the individual banks to private sector remained a really potent weapon to

restrain growth of money and credit. Thus the monetary and credit policies
were directed towards providing adequate credit to productive sectors in
general and priority sectors in particular
As a result of Islamization of the economy, a compulsory zakat deduction of
2.5 percent was levied on saving accounts and other financial assets. The
elimination of riba (interest) led to the switch of the NIT, ICP and SBFC to
interest free operations. In 1981, profit loss sharing accounts were opened
in commercial banks alongside the interest-bearing accounts. The capital
was provided on the basis of profit and loss sharing (modarba) and mark-up
(murahaba) basis in place of interest.
The beginning of the 90s witnessed the Banking Reforms II comprising of

the market based policies of system and credit management. In 1992 the
Prudential Regulations were introduced. This included introduction of public
debt auctioning, abolition of credit ceiling and credit deposit ratio (CDR),
phasing out of directed, concessionary credit and finally removal of cap on
interest rates [Ashraf Janjua]. On February 1, 1992, the SBP extended a 3
day Repo facility for the Treasury Bills. The OMO, which SBP started on ad
hoc basis in October 1991, supplemented by the changes in the discount
rates and cash reserve requirements and issuance of T bills of different
maturity in June 1998, facilitated in the management of the monetary and
credit expansion. In 1999 the multiple exchange rate system was replaced
by unified exchange rate by the SBP. From July 1, 2000, the integration of
the exchange rate and the monetary policies took place.
The SBP gained autonomy in 90s with the reforms. In 2002, to strengthen
the SBP autonomy, the State Bank of Pakistan Act, 1956, was amended. A
section 9B was introduced which further clarified the role of Monetary and
Fiscal Policies Coordination Board. To strengthen the SBP core banking
capabilities and for creation of SBP Banking Services Corporation. The
restructuring led to the formation of two subsidiaries. The SBP Banking
Services Corporation in January 2002 and The National Institute of Banking
and Finance (NIBAF) in January 1997. During the 19892000 period,
monetary and credit policies mainly operated within the Annual Credit Plan
(ACP). In December 2000, the Federal Investment Bonds were
complemented with Pakistan Investment Bond.
During FY01, the monetary policy was initially tightened by increasing the
discount rate twice from 11 to 12 percent and from 12 to 13 percent in
September and October 2000 respectively and increasing the cash reserve
requirement by 2 percent to effectively curb the depreciation of the rupee.
Monetary policy witnessed an important transition in 2005, the focus of the
monetary policy shifted on controlling inflation rather then reviving growth in
the economy. The monetary policy was aggressively tightened in the second
half of the fiscal year. In order to curb cost push inflation, SBP raised the
discount rate (for the first time after June 2001) during April 2005, by 150
basis points. This rise in interest rates was supported by high liquidity
absorptions through OMOs and a slow down in reserve money growth. This
coupled with higher acceptance ratio in T-bill auctions during these months
compared with initial nine months of the fiscal year, further drained inter
bank liquidity and resulted in an increase in discounting activities.
3. Methodology
The study is based on time series econometrics. The financial time series,
particularly stock market return, are not distributed normally; they generally
are assumed to be highly Kurtic. The tests of skewness, Kurtosis and
Jarque-Bera test of normality are used to analyse the non normality of the
data. The Augmented Dickey Fuller (ADF) test of unit roots is used to test
stationarity of the data (Dickey and Fuller, 1979, 1981). The volatility of the
stock returns and the repo rate is also seen by plotting the data.
Engle and Granger (1987) two step method is used to test the existence of
cointegrating relationship between the stock market prices and the money
market rate. The first step estimates the long run equation and in the second
step ADF test is applied on the residual from the cointegrating equation.
The Engle-Granger two step method is
LRSt = + LRRt + t
t = t-1 +1t-1 + 2t-2 + + pt-p + t
(1a)
(1b)
where LSPIt is log of stock price index, LREPt is log of Repo rate, t is
residual from cointegrating equation and t is residual from the equation of
ADF unit root test which is assumed to be white noise.
Because the tendency of stock prices to be negatively correlated with

changes in the stock volatility, therefore, the relationship between the two
markets, i.e., stock market and Repo market is estimated by utilizing ARCHGARCH methods proposed by Engle (1982). The simple GARCH (p, q)
model cannot capture the leverage effect. Keeping in view the importance of
leverage effect in stock assets returns Bollerslev (1986) and Nelson (1991),
amongst others, have developed the Exponential Generalised
Autoregressive Conditional Heteroskedecity (EGARCH) model. Braun et al
(1995), Kroners and Ng (1996, 1998), Henry and Sherma (1999) and Engle
and Cho (1999) have extended Exponential Generalised Autoregressive
Conditional Heterosckedecity (EGARCH) model into bivariate version. The
model helps us in the estimation both static as well as dynamic forecast of
the mean, forecast standard error and the conditional variance.
This paper applies a bivariate VAR-EGARCH model to investigate the

relationship between the stock market and Repo rate. The VAR-EGARCH (p,
q) model for the stock market is given in the following two equations;
n
i 1
j 0
rst 0 i rst i j rrt j ecst 1 t
(2a)
ln rst2 s ln rst21 s zrst 1 s zrst 1 E zrst 1

ln rrt ln rrt 1
(2b)
Where i = 1, 2, .. , n and j = 0, 1, ..,m

t
)]
t t-1 ~ N[ 0, (s
The equation (2a) is vector autoregressive (VAR) model of the conditional

mean equation of returns on stock market assets (rs t). It indicates that rst
depends on the past values of stock returns (rs t-i), the current and past
values of Repo rate (rr t-j), the error correction term (ecs t-1) representing the
cointegrating relationship between the stock market prices and Repo rate,
and the random variable. The random variable (i.e., t) is assumed to have
zero mean and conditional variance. Hence the second equation of the
model (i.e., 2b) represents the conditional variance of the stock market
returns.
The exponential conditional variance of stock market returns (i.e., equation
2b) is dependent on the lagged value of innovation of the stock returns and
the Repo rate returns, lag of conditional variance of stock market and the
terms to capture asymmetric effect. The parameters s and s capture the
last period forecast variance and stock market news effects, respectively.
Further, the s allow asymmetry in effects of news from the stock market.
The estimated parameter of GARCH term that is s indicates persistence of
volatility in the stock market asset returns.
4.
Preliminary Data analysis
For the analysis we use weekly data from 1 st July 1998 to 27 May 2008. The
data on stock index (i.e. KSE-index 100) are obtained from the Karachi
Stock Exchange and the data on Repo rate is obtained from State Bank of
Pakistan. The short run interest rate i.e. repo rate is used as the monetary
policy instrument. The data on KSE-index 100 and repo rates is presented in
fig 1. The figure 2 and 3 show volatility in the stock market returns and repo
rates respectively.
Figure. 1. Stock Price Returns and Repo Rates (July 1998 May 2008)
Figure. 2. Volatility in Stock Price Returns (July 1998 May 2008)

0.2
0.1
0.0
-0.1
-0.2
-0.3
50
100
150
200
250
300
350
400
DINDEX
Figure. 3. Volatility in Repo Rates (July 1998 May 2008)
450
500
-2
-4
50
100
150
2 00
2 50
3 00
3 50
400
45 0
5 00
DRR
The Fig. 1 traces the movements in the stock price index and the Repo rates
over the period under analysis. As long as the Repo rates were declining the
stock price index remained low. However, the upward movement of the
Repo rates led to a sharp increase in the stock market returns.
The summary statistics from preliminary analysis are presented in Table 1.
As can be seen in the table, the data are not normally distributed. Moreover,
both the series show skewness. The ADF test of stationarity indicates that
the series are not stationary and have a unit root problem. However, the first
difference of both the stock market prices index and repo rate series are
stationary. The ARCH test on the stock market prices index and the repo
rate series confirms the existence of Autoregressive Conditional
Heteroscedasticity (ARCH) in both the series. The Ljung Box Q statistics
supports the null hypothesis of randomness in the data.
Table 1: Preliminary Data Analysis: Summary Statistics.
Mean
Median
Maximum
Minimum
Std. Dev
Skewness
Kurtosis
INDEX
5224.516
3105.160
15654.79
774.7400
4467.987
0.804339
2.241914
RR
6.718686
7.815000
17.84000
0.2
4.033927
-0.022105
2.184752
RS
0.005347
0.009741
0.152012
-0.238895
0.042180
-0.803208
7.014817
Jarque - Bera
Probability
ADF Test
Ljung Box
Observations
67.20394
0
-1.878484
14677.1355
510
14.16489
0.000840
-8.538676
2284.55548
510
397.3608
0
-22.39739
49.195208
510
5. Empirical Results
Cointegration Analysis
The possibility of a long run relationship between the two series is
investigated by applying Engle-Granger (1987) two step method. This helps
us to determine whether an error correction term should be included in the
EGARCH model or not. In the first step the stock prices are regressed on
the repo rates. The results are presented below (t-statistics in parenthesis).
LRS = 6.612589 + 0.006121 T - 0.016951 LRR
(286.14) (95.92)
(-1.82)
R-squared 0.95
F-statistics 4607.38
ADF -2.791505
In the second step, the presence of cointegration between the two variables
is tested by applying the ADF test of unit roots on the residual obtained from
the cointegration equation 1a. The Engle-Granger five percent critical value
is (3.17). The results thus indicate the existence of a unit root test in the
residual series, implying that the two series are not cointegrated for the
period under analysis. This leads to the estimation of the EGARCH model
without error correction term in the conditional mean equations.
EGARCH Model of Stock Returns
The bivariate EGARCH model is estimated by the Maximum Likelihood
Method proposed by Bollerlov and Wooldridge (1992). The results are
presented in the following equations.
rst 0.010021 0.080740 rst 1 0.000731 rrt 1

(3.421304) (1.871928)
(-1.87918)
(3a)
ln rs t2 0.5793636 0.943131 ln rs t21 0.061934 zrs t 1
- 7.25028
87.42408
0.199633 zrs t 1 E zrs t 1
5.656768
2.575004
0.006783 ln rr
1.928632
t 1
(3b)
The mean equation (3a) reveals that the returns to the stock market are not
only affected significantly by its lag but the monetary policy in terms of the
repo rates also plays a significant role in determining the returns to the stock
market. Thus any increase (decrease) in the repo rates, indicating a
monetary policy tightening (expansioning), decreases (increases) the
returns to the stock market. The same is true for the variance equation (3b)
whereby any increase (decrease) in the repo rates, indicating a monetary
policy tightening (expansioning), enhances the volatility of the stock market
with one week lag. Implying thereby that the monetary policy has a positive
impact on the volatility of the stock market.
The parameter , indicate asymmetric impact of news on the stock market
return. If it is negative, a negative innovation tends to reinforce the size
effect, while a positive innovation tends to partial out. In case of Pakistan, it
is positive and statistically significant. The positive and significant value
implies that positive news tends to amplify the interest rate volatility more
than the negative news.
The relative importance of the negative innovation to the positive innovation
is 0.88, measured by the ratio -1+ / (1+ ). This ratio also considers
the differing impact of a markets own innovation on the current conditional
variance [Yang and Doong (2004)]. It reveals that the positive innovation in
the stock market have a one time larger impact on volatility of the stock
market returns than the impact of negative innovations in the stock market.
The sum of ARCH and GARCH coefficients is 1. If it is close to one, it
reflects the persistence in the volatility shocks. The sum of ARCH and
GARCH coefficients in case of Pakistan shows that the volatility shocks in
the stock market returns have been very persistent and they die out rather
slowly.
Based on the half-life of a shock, the life of volatility is measured as ln (0.5)/
ln (). It turns out to be almost 12 weeks. This implies that it takes almost
twelve weeks for the stock market to regress halfway back to its steady
state value [Mari G. Reyes (1996)].
The leverage effect is statistically significant in case of Pakistan. This
implies that the past negative shocks increase current volatility more than do
past positive shocks.
The monetary policy with one week lag enhances the volatility of the stock
market returns.
News Impact Curve of Stock Market Returns
3000
2500
SIG 2
2000
1500
1000
500
0
-10
-5
0
Z
Given information up to current time, the news impact curve examines the
relationship between the news and future volatility. The news impact curve
plots news scenarios on the horizontal axis against the resulting volatility on
the vertical axis. The curve shows that the conditional variance of the stock
market returns reacts differently to equal magnitudes of negative and
positive shocks. An increase in the stock market returns leads to more
uncertainty when compared to a decrease of equal magnitude.
6.
Conclusion
In an economy there are several paths and channels through which

monetary policy can effect the real activity of the economy. The traditional
transmission mechanisms of the monetary policy i.e. the credit and the
money channel, have one thing common that they operate through the
financial market. Most economists agree that the stock market price index,
being one of the leading indicators in the developed economies, is affected
by the monetary policy rules. Thus indicating that identifying the link
between the monetary policy and the stock market is highly important to
gain useful insight of the transmission mechanism of the monetary policy.
This paper addresses the linkages between the monetary policy and the
stock market in Pakistan. The estimation technique employed includes
Engle Granger two step procedure and the bivariate EGARCH method. The
results indicate that in case of Pakistan the stock market is sensitive to the
changes in the monetary policy.
References
Bernanke, B. and Kuttner, N. (2005) What Explains the Stock Markets
Reaction to the
Federal Reserve Policy?, The Journal of Finance, Vol.
LX, 1221-1257
Bollerslev, T. (1986) Generalized Autoregressive
Heteroscedasticity, Journal of
Econometrics, 31
Conditional
Cassola, N. and Morana, C. (2004) Monetary Policy nad Stock Market in the
Euro Area. Jouirnal of Policy Modelling 26, 387 399.
Engle, R. F., and Granger, C. W. (1987) Cointegration and Error Correction:
Representation, Estimating and Testing, Econometrica, 55, 251, 76
Engle, R. F. (1982) Autoregressive Conditional Heteroskedasticity and

Estimates of the
Variance of UK Inflation, Econometrica, Vol. 50, 9871008
Fair, Ray C. (2002) Events that Shook the Market. Journal of Business,
75,713 731.
Goodhart, C., and Hofmann, B. (2000) Financial Variables and the conduct
of Monetary Policy, Sveriges Riskbank Working Paper, No. 12.
Ioannidis, C. and Kontonikas, A. (2006) Monetary Policy and the Stock
Market: Some
International Evidence, University of Glasgow Working
Paper, No. 2006_12.
Janjua, Asharf (2003), History of the State Bank of Pakistan 1977-1988,
SBP.
Janjua, Asharf (2004), History of the State Bank of Pakistan 1988-2003,
SBP.
Nelson, D. B. (1991) Conditional Heteroscedasticity in Asset Returns: A New

Approach, Econometrica, Vol. 59, 347-370
Niazi, A. K. (2005) Monetary Policy in Historical Perspective (Pakistan
Experience, 1978- 2005), Pakistan Business Review, Vol. 8 (3), 3-43.
Niazi, A. K. (2007) Monetary Policy in Historical Perspective (Pakistan
Experience, 1970- 1978), Pakistan Business Review, Vol. 8 (4), 3-40.
Patelis, Alex. D. (1997) Stock Return Predictability and the Role of Monetary
Policy, The Journal of Finance, Vol. 52(5), 1951-1972.
Currency fluctuations are a natural outcome of the floating exchange rate

system that is the norm for most major economies. The exchange rate of
one currency versus the other is influenced by numerous fundamental and
technical factors. These include relative supply and demand of the two
currencies, economic performance, outlook for inflation, interest rate
differentials, capital flows, technical support and resistance levels, and so
on. As these factors are generally in a state of perpetual flux, currency
values fluctuate from one moment to the next. But although a currencys
level is largely supposed to be determined by the underlying economy, the
tables are often turned, as huge movements in a currency can dictate the
economys fortunes. In this situation, a currency becomes the tail that wags
the dog, in a manner of speaking.
STATE BANK OF PAKISTAN

Statistics & DWH Department
COUNTRY-WISE WORKERS' REMITTANCES
(Provisional)
(Million US Dollar)
Jul-Apr
April
Item
Amount
April
YoY growth (percent)
2015
2.
3.
FY14
1,845.30
4,565.42
2015
U.K.
Saudi
Arabia
4.
UAE
Dubai
245.95
Abu Dhabi 144.44
Sharjah
5.16
Other
0.14
5.
Other
GCC
Countrie
s
Bahrain
35.98
Kuwait
63.76
Qatar
32.68
Oman
58.17
6.
EU
Countrie
s
Germany
6.03
France
1.74
Netherland 0.42
Spain
3.08
Italy
2.30
Greece
0.95
Sweden
0.98
Denmark
0.65
Ireland
10.40
Belgium
0.32
7.
2.02
8.
Switzerla
nd
9.
14.72
2014
174.47
164.28
519.68
489.70
FY15
166.07
415.09
FY13
1,798.37
3,806.41
March
FY15
1,611.11
2.61
3,371.59
19.94
FY14
11.62
12.90
395.69
411.24
233.97
3,384.30
2,522.98
2,312.01
228.04
107.00
1,853.76
1,247.82
1,015.85
1,640.58
1,577.46
1,311.85
14,969.66
12,897.91
1.
USA
233.85
199.69
206.15
0.08
0.12
1.06
1.26
1.37
190.59
196.07
169.67
1,751.22
1,527.40
1,331.67
34.14
48.56
11,569.72
2,105.49
-15.87
14.65
9.12
22.84
16.06
2,028.47
-8.03
14.70
36.59
62.17
36.05
61.26
26.87
35.60
56.57
28.50
49.00
25.98
4.92
1.61
0.27
2.79
2.18
0.82
0.77
1.16
11.07
0.39
1.66
1.86
7.03
2.83
0.42
5.74
2.66
1.27
1.14
1.89
13.09
0.30
2.07
1.89
13.33
14.18
308.32
617.35
283.05
542.50
266.22
558.29
274.60
428.29
298.89
355.36
236.08
511.08
267.13
317.38
297.69
15.81
10.58
3.08
26.67
-15.89
12.77
9.24
2.80
34.95
19.37
64.78
20.83
2.86
39.18
25.82
11.88
9.87
10.89
108.99
3.79
22.98
2.29
70.58
29.03
3.60
65.87
27.34
12.05
12.67
20.10
111.39
2.73
25.16
31.91
25.56
24.91
71.51
30.33
4.61
43.84
29.31
8.92
11.25
20.76
74.46
2.70
-8.66
25.62
-8.22
-28.25
-20.56
-40.52
-5.56
-1.41
-22.10
-45.82
-2.15
38.83
-21.15
2.61
-1.30
-4.29
-21.91
50.25
-6.72
35.09
12.62
-3.18
49.60
1.11
Norway
-2.77
144.73
130.09
36.37
129.62
11.25
0.36
Australia
1
1
10.
11.
12.
II.
Canada
Japan
Other
Countrie
s
0.00
10.98
0.75
69.10
10.49
0.71
62.42
11.72
0.65
53.62
134.72
6.27
684.78
134.86
5.33
538.57
150.66
4.47
483.52
-0.10
17.64
27.15
0.00
0.00
0.00
0.00
0.09
0.00
0.00
1,640.58
1,577.46
1,311.85
14,969.66
12,897.91
11,569.81
(Provisional)
MONTH-WISE WORKERS' REMITTANCES
(Million US Dollar)
Monthly Cash Inflow
FY15
FY14
FY13
(including FEBCs &
FCBCs)
FY15
FY14
1,649.39
1,404.69
1,204.71
17.42
1,328.71
1,240.14
1,258.98
7.14
1,716.59
1,284.22
1,135.42
33.67
1,383.13
1,348.00
1,365.10
2.61
1,320.62
1,130.41
1,017.83
16.83
1,583.23
1,384.94
1,134.70
14.32
1,378.19
1,245.97
1,089.64
10.61
1,391.76
1,209.77
1,028.38
15.04
1,577.46
1,337.89
1,119.15
17.91
1,640.58
1,311.85
1,215.90
25.06
14,969.66
12,897.88
11,569.82
16.06
1,496.97
1,289.79
1,156.98
16.06
16.06
11.48
-10.49
19.24
11.39
Encashm
ent and
Profit in
Pak.Rs.
of
Foreign
Exchang
e Bearer
Certificat
es
(FEBCs)
&
Foreign
Currency
Bearer
Certificat
es
(FCBCs)
TOTAL
YoY growth (percent)
16.60
-1.50
13.11
-1.25
11.06
22.05
14.35
17.64
19.55
7.89
11.48
11.48
July
August
September
October
November
December
January
February
March
April
Jul-Apr
Monthly average
for period JulyApr
Watch
Embed
Actual
Previous
Highest
Lowest
Dates
Unit
Frequency
4346.00
4287.00
4695.00
906.00
2002 - 2015
USD Million
Quarterly
This page provides - Pakistan Remittances - actual values, historical data,

forecast, chart, statistics, economic calendar and news. Content for Pakistan Remittances - was last refreshed on Sunday, May 31, 2015.
Pakistan Trade
Last
Previous
Highest
Lowest
Unit
Balance of Trade
-188772.00
-161481.00
6457.00
-280964.00
PKR Million
Exports
202874.00
196553.00
275483.00
51.00
PKR Million
Pakistan Trade
Last
Previous
Highest
Lowest
Unit
Imports
391646.00
358034.00
472228.00
96.00
PKR Million
Current Account
778.00
-770.00
1418.00
-4213.00
USD Million
Current Account to GDP
-1.10
-2.10
4.90
-8.50
percent
External Debt
62649.00
63960.00
66490.00
33172.00
USD Million
Terms of Trade
54.41
52.24
94.83
49.17
Index Points
Remittances
4346.00
4287.00
4695.00
906.00
USD Million
Gold Reserves
64.47
64.43
65.43
64.39
Tonnes
Crude Oil Production
96.00
98.00
98.00
50.00
BBL/D/1K
Foreign Direct Investment
2816.40
2665.30
3184.30
2099.10
USD Million
Remittances
Reference
Previous
Highest
Lowest
Unit
Brazil
1909.90
Dec/14
1943.90
6411.00
1909.90
USD Million
France
39.00
Feb/15
45.00
87.00
22.00
EUR Million
Germany
-881.00
Feb/15
-863.00
-601.00
-1228.00
EUR Million
India
12293.40
Nov/14
11673.51
12293.40
5999.10
USD Million
Indonesia
2147.00
Nov/14
2103.00
2194.00
1202.00
USD Million
Italy
131.00
Nov/14
153.00
203.00
97.00
EUR Million
Mexico
2257.86
Mar/15
1842.51
2637.71
248.06
USD Million
Netherlands
48.00
Feb/14
48.00
171.00
0.00
EUR Million
Russia
5081.00
Nov/14
4790.00
5728.00
1359.00
Million USD
Spain
1271.00
Feb/14
1349.00
1610.00
252.00
EUR Million
Turkey
66.00
Mar/15
46.00
574.00
43.00
USD Million
Impact of Foreign Exchange rate on stock prices

1(Management Sciences, Foundation University Institute of Engineering &
Management Sciences, Pakistan)
Abstract: Foreign exchange fluctuations have been found in the literature
review to have an impact on the
stock market return and the fluctuations in the stock prices. This research
uses the cointegration technique to
analyze the impact of USD to PKR exchange rate on the stock return
market in Pakistan. The stock market
return has been studied by KSE 100 Index. The results show that a
relationship between the two variables exists
in the short run in Pakistan.
Keywords Exchange Markets, stock prices, Pakistan
I. Introduction
Stock market return is one of the most relevant and most important metric
for the management and the
shareholders of the organizations. The study on the factors that impact the
share prices is flocking the research
databases mostly because the theorist and the applicants want to optimize
the management processes and thus
provide a guaranteed and stabilized performance of the stock. One factor
that impacts the return on stocks and
the interest of investors in the stock is the foreign exchange rate.
Foreign exchange return is also important in the context of macroeconomic
management of a country
meaning to say that if a relationship between the foreign exchange rate and
the stock market return is found to
exist, then the government has the opportunity to manage the exchange rate
and thus the return on the stock
market. Moreover, through the establishment of this relationship, the
investors will be able to get another
element of predictability in the fluctuations of stock market returns.
II. Literature Review
As far as the existence of literature on market returns and forecasting stock
returns is concerned, the
amount is found to be considerably high (Ferreira and Santa-Clara, 2011). A
number of factors have been of
interest when it comes to forecasting stock market return for example the
macroeconomic variables, the
corporate actions and finally the measure of risk and the studies find that
there is a predictable component in
stock market return that the investors can find and use to stabilize their
returns to a greater extent. Certain
critique however exists to the researches and the forecasting models that
exist. For example Goyal and Welch
(2008) studied the out of sample performance of a list of apparent predictors
of stock market return and find the
historical mean to have a better out of sample performance in predicting the

stock market returns than the
traditional regressions used for forecasting purposes. So what Goyal and
Welch (2008) are saying is that the use
of traditional predictive regression models would not have helped the
investor in either attaining valuable
information regarding the stock return patterns or to make profits on time.
Bermer and Hiraki (1999) say that there has been a lot of interest shown by
interest to know whether
there exists a predictable component in the short term stock return or not.
One of the reasons for this interest is
that the researchers want to either confirm or reject the assumed rationality
of individual investors and the
efficiency of the stock market. Those who do have faith in the rationality of
investors and efficiency of the
market, seek to study the short term return patterns of the stock in order to
give evidence on the subtle market
microstructure issues.
For the purpose of assessing the expected returns, uncertain changes in the
investment opportunity have
been found to play a strong role in ascertaining the demand of the asset by
the potential investors (Cox, Ingersoll
and Ross, 1985). In this regards, Chiang and Doong (1999) says that
financial volatility is a factor that needs to
be considered significantly for exaplining the stock returns.
III. Exchange Rate
As far as quantifying the expectation of the exchange rate are concerned,
Marey (2004) says on the
basis of a survey data that long term expectations are not only
heterogeneous but are also not effectively
described by the rational expectations. In his own research, Marey (2004)
tried to investigate the level of
plausibility of standard exchange rate expectations mechanism which in an
artificial economy are found to be
favored by heterogeneous traders, the research concludes that adaptive
expectations market exhibits more serial
correlation because it bandwagons the expectations market. Secondly, the
extrapolative expectations market
The perceived impact of corporate social responsibility on credit rating
company
www.iosrjournals.org 46 | Page
sometimes generates extreme returns and thus cannot be empirically
plausible and finally, the regressive
expectations market reproduces stylized facts of empirical quarterly
exchange rates.
Tsen (2011) says that the real exchange rate has been found to play an
important role in the investment
determination and the international trade systems as the appreciation of real
exchange rate can lead to retarded
exports, a change in the amount of debt payment that needs to be done and
a growth of inflow of foreign direct
investment. The economies overall can be affected by the changes in the
exchange rate.
For this research however, the impact of exchange rate changes on the
stock returns has been considered.
IV. The Impact of Exchange Rate Changes on the Stock Returns
The relationship with the US dollar and the Stock Exchange Index has been
studied by Wu et al (2012)
who have focused their research on the Philippine Stock Exchange.
According to the authors, such a research
can actually help in guiding the government of countries to macro manage
the investor returns on the stocks and
thus in effect control the inflow of foreign direct investment into the country.
Focusing further on the issue,
Bahani-Oskooee and Sohrabian (2006) use the granger causality technique
along with the co integration
technique to analyze the results of exchange rates and stock prices by using
the S&P 500 index. The results
show that not only the relationship exists only in the short run, it is also
bidirectional. Moving on, Branson
(1983) discusses his stock oriented model of exchange rates and
emphasizes on the fact that the exchange rates
serve to equate the supply and demand for assets including the stocks and
the bonds. Yau and Nieh (2008) note
that even though the existence of a relationship is often signified by the
researchers between the stock exchange
returns and the exchange rates, the length and the direction of the
relationship is often an element of further
debate. Interestingly, using the granger causality and the relationship
between the financial assets and exchange
rates of USA and Japan, Yau and Nieh (2008) find that there is no short term
causal relationship between the
two however in the long run a positive relationship has been found to exist.
Kim (2003) uses the error correction technique and the co integrating
system to investigate whether a
long term relationship exists between the exchange rates and the stock
prices in the United States. The data set
used is the S&P 500 which yields that there is a negative relationship that
exists for the stock returns in USA
with the value of the dollar. Finally, Lin (2012, p. 161) analyzes the
comovement of the exchange rates and the
stock prices in the Asian markets and finds that
Results have suggested that the comovement between exchange rates and
stock prices becomes
stronger during crisis periods than during tranquil ones, in terms of long-run
co-integration and short-run
causality, which is consistent with contagion or spillover between exchange
rates and stock prices during the
former type of period.
This means that the government when trying to control the crisis period
should try to stimulate growth
and keep investment attractive.
V. Methodology
In order to test our hypothesis monthly KSE 100 index data from Karachi
Stock Exchange (KSE) was
obtained from 1998 to 2009. Returns of index were calculated by using
following formula:
(1)
Further monthly Real exchange rates (EXT) were obtained from IFS CD
Rom from 1998 to 2009.
Real exchange rate was proffered in order to investigate change that is
purely due to exchange rate itself and not
contaminated by inflation. The analysis period was confined from 1998 to
2009 primarily due to nonavailability
of the former prior to 1998. Further the IFS CD ROM was updated to give
exchange rate
information till June 2010. Since we wanted to obtain data yearly, six months
data in 2010 was unavailable.
Thus we decided to calculate variables from 1998 to 2009, where complete
yearly information was available.
Our sample was time series and it has inherent problems of non-stationarity
that leads to spurious
regression. Thus we conducted stationarity tests using Phillip Peron(PP)
tests for stationarity. The results of PP
are more robust than Augmented Decke fuller test for stationarity (Gujrati,
2003). Thus after we were confirmed
that data is stationary, we will check for co integration and also vector error
correction test cannot be conducted
until there is a long term affiliation between variables. The co integration
tests will reveal whether there exist a
long term relationship between stock market returns and real exchange
rates. Once the co integration tests
confirm long term relationship, we will conduct vector error correction model.
After that we will run ordinary
least square regression using following equation to see if short term impact
exist or not.
(2) D(MRET) = C(1)*( MRET(-1) + 1*EXT(-1) + 2*@TREND(1) + C ) +
C(2)*D(MRET(-1)) +
C(3)*D(EXT(-1)) + C(4)*D(MRET(-2)) + C(5)*D(EXT(-2)) + C(6)
The portion of the model in parenthesis is co integrating while the rest of the
equation is comprised of error
correction term. Our variable of interest are C(3) and C(5). These are error
correction terms representing
company
previous months change in exchange rates. Thus we will check if they have
impact on returns by using Wald
Test under following hypothesis;
H0: Exchange rate change has no impact on Market returns in short term.
H1: Exchange rate change has impact on Market Returns in short term.
Significant p-values of less than .05 will indicate that we will accept H1. This
acceptance will lead us to
believe that in short term exchange rate fluctuations will impact stock market
returns.
VI. Results and Discussion:
Unit root test was conducted using Phillip Peron test for stationarity. The test
was conducted under all
assumptions i.e. with intercept, without intercept but trend and without
intercept and trend. The results for both
variables are summarized in tables 1.1 and 1.2.

Table 1.1: Unit Root Test for Market Returns
ASSUMPTIONS PHILIPS PERRON TEST
STATISIC
CRITICAL VALUES
1% 5% 10%
Intercept -11.3802 -3.477 -2.8817 -2.5774
Trend and intercept -5.107754 -4.263 -3.4426 -3.1457
NO intercept and No trend -4.826372 -2.5804 -1.9422 -1.6169
Table 1.2: Unit Root Test for Change in Exchange Rate
STATISIC
CRITICAL VALUES
1% 5% 10%
Intercept -7.840877 -3.477 -2.8817 -2.5774
The results indicate that both variables are stationary under all three
assumptions at level. This indicates that
problem of non stationarity does not exist in our series and our series has
constant variance. This helps us in
predicting out of sample relationship and robustness is ensured. Further,
since our variables are stationary at
same level, we can safely check our variables for long term relationship.
Thus after unit root we will carry out
co integration tests to check for long term relationship.
company
6.1 Co integration Test
Co integration test was conducted under all assumption. The result are
summarized in table 1.4
The results indicate that Akiake information criteria is lower in case of
assumption which indicates that
equations are quadratic in nature and have trend and intercept. Further
Schwarz criterion is also indicating that
results of the former are correct. Thus we will carry the co integration test
assuming trend and intercept in
quadratic form for establishing long term relationship. The test result under
this assumption is as follows:
6.2 Johansen Co integration Test Summary

Table 1.5
company
The results indicate that Null hypothesis that indicates no long term
relationship exists is rejected by significant
p-value of 0.000. Thus the results clearly indicate that long term relationship
exists in between exchange rate
and market returns. Thus after establishing long term relationship, we will
see whether exchange rate has short
term impact on market returns. Thus we will use the co integrating equation
and check it for Vector Error
Correction.
6.3 Vector Error Correction Model (VECM)
The results of VECM are summarized in table 1.6
Table 1.6
The results indicate that the intercept of co integrating equation is negative
and significant. This validates the
long term relationship. The coefficients of exchange rates with lag 1 and 2
are significant that indicates the
impact of short run exchange rate movements of previous 1 and 2 months
respectively has significant impact on
Pakistani stock market returns. However we have t-values of the error
correction terms and no p-values. Thus to
obtain p-values and to further confirm short run impact of exchange rate on
market return, we will following
VECM equation and conduct Ordinary Least square Analysis at 95%
confidence interval:
(3) D(MRET) = C(1)*( MRET(-1) + 13.3428963975*EXT(-1) 5.38602779704e-05*@TREND(1) 0.0229364536928 ) + C(2)*D(MRET(-1)) + C(3)*D(EXT(-1)) +
C(4)*D(MRET(-2)) + C(5)*D(EXT(2)) + C(6) + C(7)*@TREND(1)
6.4 OLS Results:
The OLS results are summarized as follows;
company
Table 1.7 (VECM regression)
The results of OLS regression indicates that C(3) and C(5) which are the coefficient of short term change in
exchange rate has significant impact on change in market return where C(6)
is the co-efficient of the system
equation. However, to further test the existence of impact of exchange rate
change, we will conduct Wald test
using following hypothesis:
C(3) = C(5) = 0 , the null hypothesis assumes that short term exchange
rates have no significant impact on
market returns.
Table: 1.8
The p-values of .000 indicate that we will reject null hypothesis and accept
the alternate. Thus we can safely say
that exchange rates have short term impact on market returns.
VII. Conclusion
The study was conducted in an effort to understand the impact of exchange
rate on stock market
returns. The primary purpose of the study was to understand short run
sensitivity of returns to changes in
exchange rate. The reason for this is because in Pakistan, investments in
stock exchanges are short term and
most of investors liquidate their stocks within year. VECM analysis was
conducted that indicates that exchange
rates have significant impact on stock market returns. The results indicate
that in the short run, market correct
itself to the changes in exchange rate to be in equilibrium. This finding has
implications for government and
industry. An appreciation of Pakistani rupee will cause the returns to rise and
vice versa. Thus if there is,
fluctuations in rupee, the exchange rate will adversely affect the change in
market returns. Thus for a stable
stock market, exchange rate has to be maintained in a favorably territory.
company
Impact of Foreign Exchange rate on stock prices
Abstract: Foreign exchange fluctuations have been found in the literature
review to have an impact on the
stock market return and the fluctuations in the stock prices. This research
uses the cointegration technique to
analyze the impact of USD to PKR exchange rate on the stock return
market in Pakistan. The stock market
return has been studied by KSE 100 Index. The results show that a
relationship between the two variables exists
in the short run in Pakistan.
Keywords Exchange Markets, stock prices, Pakistan
I. Introduction
Stock market return is one of the most relevant and most important metric
for the management and the
shareholders of the organizations. The study on the factors that impact the
share prices is flocking the research
databases mostly because the theorist and the applicants want to optimize
the management processes and thus
provide a guaranteed and stabilized performance of the stock. One factor
that impacts the return on stocks and
the interest of investors in the stock is the foreign exchange rate.
Foreign exchange return is also important in the context of macroeconomic
management of a country
meaning to say that if a relationship between the foreign exchange rate and
the stock market return is found to
exist, then the government has the opportunity to manage the exchange rate
and thus the return on the stock
market. Moreover, through the establishment of this relationship, the
investors will be able to get another
element of predictability in the fluctuations of stock market returns.
II. Literature Review
As far as the existence of literature on market returns and forecasting stock
returns is concerned, the
amount is found to be considerably high (Ferreira and Santa-Clara, 2011). A
number of factors have been of
interest when it comes to forecasting stock market return for example the
macroeconomic variables, the
corporate actions and finally the measure of risk and the studies find that
there is a predictable component in
stock market return that the investors can find and use to stabilize their
returns to a greater extent. Certain
critique however exists to the researches and the forecasting models that
exist. For example Goyal and Welch
(2008) studied the out of sample performance of a list of apparent predictors

of stock market return and find the
historical mean to have a better out of sample performance in predicting the
stock market returns than the
traditional regressions used for forecasting purposes. So what Goyal and
Welch (2008) are saying is that the use
of traditional predictive regression models would not have helped the
investor in either attaining valuable
information regarding the stock return patterns or to make profits on time.
Bermer and Hiraki (1999) say that there has been a lot of interest shown by
interest to know whether
there exists a predictable component in the short term stock return or not.
One of the reasons for this interest is
that the researchers want to either confirm or reject the assumed rationality
of individual investors and the
efficiency of the stock market. Those who do have faith in the rationality of
investors and efficiency of the
market, seek to study the short term return patterns of the stock in order to
give evidence on the subtle market
microstructure issues.
For the purpose of assessing the expected returns, uncertain changes in the
investment opportunity have
been found to play a strong role in ascertaining the demand of the asset by
the potential investors (Cox, Ingersoll
and Ross, 1985). In this regards, Chiang and Doong (1999) says that
financial volatility is a factor that needs to
be considered significantly for exaplining the stock returns.
III. Exchange Rate
As far as quantifying the expectation of the exchange rate are concerned,
Marey (2004) says on the
basis of a survey data that long term expectations are not only
heterogeneous but are also not effectively
described by the rational expectations. In his own research, Marey (2004)
tried to investigate the level of
plausibility of standard exchange rate expectations mechanism which in an
artificial economy are found to be
favored by heterogeneous traders, the research concludes that adaptive
expectations market exhibits more serial
correlation because it bandwagons the expectations market. Secondly, the
extrapolative expectations market

company
sometimes generates extreme returns and thus cannot be empirically
plausible and finally, the regressive
expectations market reproduces stylized facts of empirical quarterly
exchange rates.
Tsen (2011) says that the real exchange rate has been found to play an
important role in the investment
determination and the international trade systems as the appreciation of real
exchange rate can lead to retarded
exports, a change in the amount of debt payment that needs to be done and
a growth of inflow of foreign direct
investment. The economies overall can be affected by the changes in the
exchange rate.
For this research however, the impact of exchange rate changes on the
stock returns has been considered.
IV. The Impact of Exchange Rate Changes on the Stock Returns
The relationship with the US dollar and the Stock Exchange Index has been
studied by Wu et al (2012)
who have focused their research on the Philippine Stock Exchange.
According to the authors, such a research
can actually help in guiding the government of countries to macro manage
the investor returns on the stocks and
thus in effect control the inflow of foreign direct investment into the country.
Focusing further on the issue,
Bahani-Oskooee and Sohrabian (2006) use the granger causality technique
along with the co integration
technique to analyze the results of exchange rates and stock prices by using
the S&P 500 index. The results
show that not only the relationship exists only in the short run, it is also
bidirectional. Moving on, Branson
(1983) discusses his stock oriented model of exchange rates and
emphasizes on the fact that the exchange rates
serve to equate the supply and demand for assets including the stocks and
the bonds.
that even though the existence of a relationship is often signified by the
researchers between the stock exchange
returns and the exchange rates, the length and the direction of the
relationship is often an element of further
debate. Interestingly, using the granger causality and the relationship

between the financial assets and exchange
rates of USA and Japan, Yau and Nieh (2008) find that there is no short term
causal relationship between the
two however in the long run a positive relationship has been found to exist.
Kim (2003) uses the error correction technique and the co integrating
system to investigate whether a
long term relationship exists between the exchange rates and the stock
prices in the United States. The data set
used is the S&P 500 which yields that there is a negative relationship that
exists for the stock returns in USA
with the value of the dollar. Finally, Lin (2012, p. 161) analyzes the
comovement of the exchange rates and the
stock prices in the Asian markets and finds that
Results have suggested that the comovement between exchange rates and
stock prices becomes
stronger during crisis periods than during tranquil ones, in terms of long-run
co-integration and short-run
causality, which is consistent with contagion or spillover between exchange
rates and stock prices during the
former type of period.
This means that the government when trying to control the crisis period
should try to stimulate growth
and keep investment attractive.
V. Methodology
In order to test our hypothesis monthly KSE 100 index data from Karachi
Stock Exchange (KSE) was
obtained from 1998 to 2009. Returns of index were calculated by using
following formula:
(1)
Further monthly Real exchange rates (EXT) were obtained from IFS CD
Rom from 1998 to 2009.
Real exchange rate was proffered in order to investigate change that is
purely due to exchange rate itself and not
contaminated by inflation. The analysis period was confined from 1998 to
2009 primarily due to nonavailability
of the former prior to 1998. Further the IFS CD ROM was updated to give
exchange rate
information till June 2010. Since we wanted to obtain data yearly, six months
data in 2010 was unavailable.
Thus we decided to calculate variables from 1998 to 2009, where complete

yearly information was available.
Our sample was time series and it has inherent problems of non-stationarity
that leads to spurious
regression. Thus we conducted stationarity tests using Phillip Peron(PP)
tests for stationarity. The results of PP
are more robust than Augmented Decke fuller test for stationarity (Gujrati,
2003). Thus after we were confirmed
that data is stationary, we will check for co integration and also vector error
correction test cannot be conducted
until there is a long term affiliation between variables. The co integration
tests will reveal whether there exist a
long term relationship between stock market returns and real exchange
rates. Once the co integration tests
confirm long term relationship, we will conduct vector error correction model.
After that we will run ordinary
least square regression using following equation to see if short term impact
exist or not.
(2) D(MRET) = C(1)*( MRET(-1) + 1*EXT(-1) + 2*@TREND(1) + C ) +
C(2)*D(MRET(-1)) +
C(3)*D(EXT(-1)) + C(4)*D(MRET(-2)) + C(5)*D(EXT(-2)) + C(6)
The portion of the model in parenthesis is co integrating while the rest of the
equation is comprised of error
correction term. Our variable of interest are C(3) and C(5). These are error
correction terms representing
company
previous months change in exchange rates. Thus we will check if they have
impact on returns by using Wald
Test under following hypothesis;
H0: Exchange rate change has no impact on Market returns in short term.
H1: Exchange rate change has impact on Market Returns in short term.
Significant p-values of less than .05 will indicate that we will accept H1. This
acceptance will lead us to
believe that in short term exchange rate fluctuations will impact stock market
returns.
VI. Results and Discussion:
Unit root test was conducted using Phillip Peron test for stationarity. The test
was conducted under all
assumptions i.e. with intercept, without intercept but trend and without
intercept and trend. The results for both
variables are summarized in tables 1.1 and 1.2.
Table 1.1: Unit Root Test for Market Returns
STATISIC
CRITICAL VALUES
1% 5% 10%
Intercept -11.3802 -3.477 -2.8817 -2.5774
Table 1.2: Unit Root Test for Change in Exchange Rate
STATISIC
CRITICAL VALUES
1% 5% 10%
Intercept -7.840877 -3.477 -2.8817 -2.5774
The results indicate that both variables are stationary under all three
assumptions at level. This indicates that
problem of non stationarity does not exist in our series and our series has
constant variance. This helps us in
predicting out of sample relationship and robustness is ensured. Further,
since our variables are stationary at
same level, we can safely check our variables for long term relationship.
Thus after unit root we will carry out
co integration tests to check for long term relationship.
company
6.1 Co integration Test
Co integration test was conducted under all assumption. The result are
summarized in table 1.4
The results indicate that Akiake information criteria is lower in case of
assumption which indicates that
equations are quadratic in nature and have trend and intercept. Further
Schwarz criterion is also indicating that
results of the former are correct. Thus we will carry the co integration test
assuming trend and intercept in
quadratic form for establishing long term relationship. The test result under
this assumption is as follows:
6.2 Johansen Co integration Test Summary
Table 1.5
company
The results indicate that Null hypothesis that indicates no long term
relationship exists is rejected by significant
p-value of 0.000. Thus the results clearly indicate that long term relationship
exists in between exchange rate
and market returns. Thus after establishing long term relationship, we will
see whether exchange rate has short
term impact on market returns. Thus we will use the co integrating equation
and check it for Vector Error
Correction.
6.3 Vector Error Correction Model (VECM)
The results of VECM are summarized in table 1.6
Table 1.6
The results indicate that the intercept of co integrating equation is negative
and significant. This validates the
long term relationship. The coefficients of exchange rates with lag 1 and 2
are significant that indicates the
impact of short run exchange rate movements of previous 1 and 2 months
respectively has significant impact on
Pakistani stock market returns. However we have t-values of the error
correction terms and no p-values. Thus to
obtain p-values and to further confirm short run impact of exchange rate on
market return, we will following
VECM equation and conduct Ordinary Least square Analysis at 95%
confidence interval:
(3) D(MRET) = C(1)*( MRET(-1) + 13.3428963975*EXT(-1) 5.38602779704e-05*@TREND(1) 0.0229364536928 ) + C(2)*D(MRET(-1)) + C(3)*D(EXT(-1)) +
C(4)*D(MRET(-2)) + C(5)*D(EXT(2)) + C(6) + C(7)*@TREND(1)
6.4 OLS Results:
The OLS results are summarized as follows;
company
Table 1.7 (VECM regression)
The results of OLS regression indicates that C(3) and C(5) which are the coefficient of short term change in
exchange rate has significant impact on change in market return where C(6)
is the co-efficient of the system
equation. However, to further test the existence of impact of exchange rate
change, we will conduct Wald test
using following hypothesis:
C(3) = C(5) = 0 , the null hypothesis assumes that short term exchange
rates have no significant impact on
market returns.
Table: 1.8
The p-values of .000 indicate that we will reject null hypothesis and accept
the alternate. Thus we can safely say
that exchange rates have short term impact on market returns.
VII. Conclusion
The study was conducted in an effort to understand the impact of exchange
rate on stock market
returns. The primary purpose of the study was to understand short run
sensitivity of returns to changes in
exchange rate. The reason for this is because in Pakistan, investments in
stock exchanges are short term and
most of investors liquidate their stocks within year. VECM analysis was
conducted that indicates that exchange
rates have significant impact on stock market returns. The results indicate
that in the short run, market correct
itself to the changes in exchange rate to be in equilibrium. This finding has
implications for government and
industry. An appreciation of Pakistani rupee will cause the returns to rise a
[1] Bahmani-Oskooee, R. and Sohrabian, A. (1992). Stock prices and the
effective exchange rate of the dollar. Applied Economics,
Vol. 24 (4), pp. 193-207
[2] Bremer, M. and Hiraki, T. (1999). Volume and individual security returns
on the Tokyo Stock Exchange, Pacific Basin Finance
Journal, Vol. 7 (3-4) pp. 351 370.
[3] Chiang, T. and Doong, S. (1999). Empirical analysis of real and financial
volatilities on stock excess returns: evidence from Taiwan
industrial data, Global Finance Journal, Vol. 10 (2), pp. 187 200.
[4] Cos, J., Ingersoll, J. and Ross, S. (2985). An intertemporal general

equilibrium model of asset prices, Econometrica, Vol. 53, pp.
363 384.
[5] Ferriera, M. and Santa-Clara, P. (2011). Forecasting stock market
returns: The sum of the parts is more than the whole, Journal of

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Final Project Report

Foreign currency remittance and its impact

currency with another trader in exchange for an equivalent amount of a

12. Release of Foreign Exchange for Travel Abroad.

The term 'inward remittance" means purchase of foreign currencies in

Inward Remittance No Restrictions.

There is no restriction on receipt of remittances from abroad either in foreign

travelers cheques, travelers letters of credit, foreign currency notes and

Authorized Dealers should normally avoid issuing drafts in cover of outward

Prescribed Application Forms.

There are three types of application forms for outward remittances:

In some cases, applications are made by letters as it becomes difficult for

Forwarding Applications to the State Bank.

When submitting applications to the State Bank, Authorized Dealers should

Processing of Approved Form etc.

beneficiary whose name appears in the approval. They must in no case

Effecting Remittances against Permits.

Cancellation of Outward Remittances.

The date of the return in which the outward remittance was

The name and address of the applicant.

The amount of the sale as effected originally.

The amount cancelled.

Reasons for cancellation.

Cancellation of Inward Remittances.

The date of the return in which the inward remittance was

The name and address of the beneficiary.

The amount of the purchase as effected originally.

The amount cancelled.

Reasons for cancellation.

Where any foreign exchange is acquired by any person other than an

Impact of Monetary Policy on the Volatility of Stock Market in Pakistan

Financial sector in Pakistan has been experiencing the process of reforms

Overview of the Stock Market and the Monetary Policy

The capital market in Pakistan is regulated by the Security and Exchange

during the decade of 1960s was due to industrialization policies pursued by

phenomenal and increased to almost 500% in 2003. As a result Pakistan

by the individual banks to private sector remained a really potent weapon to

The beginning of the 90s witnessed the Banking Reforms II comprising of

Because the tendency of stock prices to be negatively correlated with

This paper applies a bivariate VAR-EGARCH model to investigate the

rst 0 i rst i j rrt j ecst 1 t

ln rst2 s ln rst21 s zrst 1 s zrst 1 E zrst 1

Where i = 1, 2, .. , n and j = 0, 1, ..,m

The equation (2a) is vector autoregressive (VAR) model of the conditional

Preliminary Data analysis

Figure. 2. Volatility in Stock Price Returns (July 1998 May 2008)

Figure. 3. Volatility in Repo Rates (July 1998 May 2008)

rst 0.010021 0.080740 rst 1 0.000731 rrt 1

0.199633 zrs t 1 E zrs t 1

In an economy there are several paths and channels through which

Engle, R. F. (1982) Autoregressive Conditional Heteroskedasticity and

Nelson, D. B. (1991) Conditional Heteroscedasticity in Asset Returns: A New

Currency fluctuations are a natural outcome of the floating exchange rate

STATE BANK OF PAKISTAN

YoY growth (percent)

This page provides - Pakistan Remittances - actual values, historical data,

Current Account to GDP

Crude Oil Production

Foreign Direct Investment

Impact of Foreign Exchange rate on stock prices

historical mean to have a better out of sample performance in predicting the

variables are summarized in tables 1.1 and 1.2.