The Impact of Exchange Rate Changes On Stock Market Returns (An Investigation of Nigerian Stock Market) by ARUNA J. OMOTAYO

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The Impact Of Exchange Rate Changes On Stock Market Returns{An Investigation Of Nigerian Stock Market} By ARUNA OMOTAYO
(Department Of Economics Lagos State University)
CHAPTER ONE
1.0 INTRODUCTION
1.1 BACKGROUND OF THE STUDY
All over the world, the capital market has played significant roles in national economic
growth and development. One intermediary in the market that operates as a rallying point
for the overall activities is the stock exchange. It is a common postulation that without a
functional stock market, the capital market may be very illiquid and unable to attract
investment. Essentially, the stock market provides liquidity (Ezeoha et al, 2009),
contributes to capital formation, and investment risk reduction by offering opportunities
for portfolio diversification (Levine, 1991). The liquidity role stands out clearly as the
most significant among the numerous functions provided by the stock market. In the
words of Levine (1991, 1997), without a liquid stock market, many profitable long-term
investments would not be undertaken because savers may be reluctant to tie up their
investments for long periods of time. The stock market mainly provides liquidity by
enabling firms to raise funds through the sales of securities with relative ease and speed.
Through this catalyst role, the stock market is able to influence investment and economic
growth in general. As argued by Ndi Okereke-Onyiuke (2006): large stock markets lower
the cost of mobilizing savings, facilitating investments in the most productive
technologies.
It is a known fact that the investment that promotes economic growth and development
requires long term funding, far longer than the duration for which most savers are willing
to commit their funds (Ologunde et al 2006). As a result of this, the centrality of savings
and investment to economic growth has been given considerable attention in the literature
(Anthony Kyereboah-Coleman and Kwame F. Agyire-Tettey (2006). For sustainable
growth and development, funds must be effectively mobilized and allocated to enable
businesses and the economy harnessed their human, material resources for optimal
output. The stock market enables governments and industry to raise long-term capital for
financing new projects and expanding and modernizing industrial/commercial concerns.
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If capital resources are not provided to those economic areas, especially industries where
demand is growing and which are capable of increasing production and productivity, the
rate of expansion of the economy often suffers. A unique benefit of the stock market to
corporate entities is the provision of long-term, debt financing and non-debt financial
capital. Through the issuance of equity securities, companies acquire perpetual capital for
development.
Through the provision of equity capital, the market also enables companies to avoid over-
reliance on debt financing, thus improving corporate debt-to-equity ratio. Since the
introduction of structural adjustment programme (SAP) in Nigeria, the country stock
market has grown very significantly (Alile, 1996). This is as a result of deregulation of
the financial sector and the privatization exercise, which exposed investors and
companies to the benefits of the stock market. Equity financing became one of the
cheapest and flexible sources of finance from the capital market and remain a critical
element in the sustainable development of the economy (Okereke-Onyiuke, 2000).
Though the stock market is growing, it is however characterized by complexities. The
complexities arise from trends in globalization and increased variety of new instruments
being traded: equity options, derivatives of various forms, index futures etc. However, the
central objective of the stock exchanges worldwide remains the maintenance of the
efficient market with attendant benefit of economic growth (Alile, 1997). The participant
at Nigerian Stock Exchange include, Discount Houses, Development banks, Investment
banks, Building societies, Stock Broking firms, Insurance and Pension Organizations,
Quoted companies, the government, and individuals. The capital market is therefore very
important to any economy because, it encourages savings and real investment in any
healthy economic environment. Through the market, aggregate savings are channeled
into real investment that increases the capital stock and therefore economic growth of the
country.
The link between Capital market growth, exchange rate and interest rate has in recent
time been an issue among analysts based on their study of developed and emerging
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markets. Oke (2006) asserted that the financial structure of a firm, that is, the mix of debt
and equity financing, changes as economies develop. It moves towards equity financing
through the stock market. If the rate of interest paid by banks to depositors is increased,
investors will patronize the banks the more and fewer investors will invest on the capital
market. This will lead to a decrease in capital investment in the economy. Hence,
economic growth and development will be lowered, because the allocation of capital
resources plays a crucial role in the determination of the rate of the nations output.
Interest and exchange rates are financial prices for credit and foreign currencies,
respectively. They both affect resource allocation, production levels, prices and
profitability. Ultimately, fluctuations in these reflect in share prices an indicator of
market performance. For instance, lowering of interest rate on demand and savings
deposits will improve returns to investing on the exchange relative to investing in deposit
money banks (DMBs) holding factors such as risk, transaction costs, etc. constant. This
will therefore increase the demand and share price of affected equities on the exchange
thereby affecting its performance.
The capital market synchronizes the divergent preferences for portfolio managers and
financial institutions and those of savers by mobilizing long term funds for portfolio
managers and financial institutions while providing avenues for savers to invest when the
need arises through the secondary market. As an economy develops, more funds are
needed to meet the rapid expansion. The stock market serves as a veritable tool in the
mobilization and allocation of savings among competing uses which are critical to the
growth and efficiency of the economy (Alile, 1984). The determination of the overall
growth of an economy depends on how efficiently the stock market performs its
functions of capital allocation. As the stock market mobilizes savings, concurrently it
allocates a larger proportion of it to the firms with relatively high prospects as indicated
by its rate of returns and level of risk. The importance of this function is that capital
resources are channeled by the mechanism of the forces of demand and supply to those
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firms with relatively high and increasing productivity thus enhancing economic
expansion and growth (Alile, 1997).
All shares index is mostly used to determine the growth of the market as it captures the
overall performance of the market. NSE all-share-index captures all the other
performance measures such as market capitalization, liquidity, and turnover ratio. All
shares index is one of the major determinants of the market size of any stock exchange.
The size of the all share index and its growth rate pose a major influence on the growth
and development of the economy On the other hand, interest rates along with monetary
aggregates form targets of monetary policy in Nigeria. If the rate of interest paid by banks
to depositors is increased, investors will patronize the banks the more and fewer investors
will invest on the capital market. This will lead to a decrease in capital investment in the
economy. Hence, economic growth and development will be lowered, because the
allocation of capital resources plays a crucial role in the determination of the rate of the
nations output. This is more important because it has been asserted that the economic
environment plays a significant role in determining the performance of the stock
exchange and that overcoming the challenges facing the stock exchange depend to a large
extent on government policies relating to the private sector, the monetary and fiscal
policies, economic policies, financial sector reforms and the governments divestiture
program.
1.2 STATEMENT OF RESEARCH PROBLEM
The Capital Market is supposed to play an important role in the economy in the sense that
it mobilizes domestic resources and channels them to productive investments. However,
to perform this role it must have significant relationship with the economy. Capital
Markets are key elements of a modern, market-based economic system as they serve as
the channel for the flow of long-term financial resources from the savers of capital to the
borrowers of capital. Efficient capital markets are hence essential for economic growth
and prosperity. Thus a rising capital market is an indicator of an expanding economy.
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Like any other capital market elsewhere in the world, the Nigerian Capital Market exists
to provide long term capital for economic and infrastructural development. One major
objective for the establishment of the Nigerian Capital Market was to enable corporate
institutions and government to raise quick capital to accelerate economic development. In
line with this objective, the Nigerian Capital Market has gained prominence by
facilitating tremendously the divestiture and privatization of some state-owned
enterprises. The presence and development of the capital market in Nigeria is no doubt, a
great catalyst to the internationalisation of investment opportunities in the country,
raising the chances of both local and foreign direct investment (FDI) as well as portfolio
investment. It constitutes the mostimportant institution for massive capital formation
geared towards economic development.
This study is being carried out especially because other empirical studies on the NSE
have looked at the impact of the Nigeria Capital Market on economic growth which does
not provide answers on issues related to how macroeconomic variables such as exchange
rate, interest rate, inflation rate etc affect the performance of the NSE, however, this
study specifically inquires into the impact of interest rate on capital market growth in
Nigeria, though restricted to the NSE.
1.3 OBJECTIVES OF THE STUDY
The broad objective of this study is to examine how interest rate and exchange rate as a
macroeconomic variables affects the growth of the Nigeria Capital Market, while others
objectives of this study are
1. To determine the impact of interest rate and exchange rate on Nigeria Capital
Market Growth through an inquiry into the performance of the NSE.
2. To ascertain the effect of interest rate changes on the growth of capital market in
Nigeria.
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3. To review the speed at which the stock exchange captitalisation is adjusted due to
changes in the countrys interest rate.

1.4 RESEARCH QUESTIONS
To make the research more manageable, the main questions to be answered in this study
are as follows:.
1. Does interest rate and exchange rate have any impact on the growth/performance
of the Nigeria Stock Exchange over the years?
2. To what extents do other macroeconomic variables such inflation rate affects the
capital market growth?
3. How well does interest rate determine stock exchange capitalisation in Nigeria?
1.5 RESEARCH HYPOTHESES
This research work will test the following hypotheses, and also H0: Null Hypothesis and
H1: Alternative Hypothesis.
Hypothesis 1:
H0: Interest rate and exchange rate have no significant impact on the growth of the
Nigerian Stock Exchange Market.
H1: Interest rate and exchange rate have significant impact on the growth of the Nigerian
Stock Exchange Market.
Hypothesis 2:
H0: Inflation rate has no significant impact on the growth of the Nigerian Stock Exchange
Market capitalisation.
H1: Inflation rate has significant impact on the growth of the Nigerian Stock Exchange
Market capitalisation.

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1.6 SIGNIFICANCE OF THE STUDY
This study examines whether stock market returns are influenced by interest rate and
exchange rate changes in Nigeria. Investors and potential investors will get to understand
whether changes in IR and EXR affect returns on the stock market and to what extent it
affects investment in both markets. It will assist local firms to identify periods that may
be conducive to get listed on the stock market as well as assist investors to make good
investment decisions.

The findings of this study would help the country and government to decide on which
sector of the economy would need special attention in terms of attracting direct foreign
investment and earning much revenue. In addition to being useful as a source of
information, it may also arouse interest for further studies in this or related areas
concerning the activities of both foreign and local investors.

1.7 SCOPE AND LIMITATION OF STUDY
Obtaining and collating data for the research was one of the mitigating factors for this
research; I will employ used annual data on MPR (representing IR), EXR and Stock
Market Index from 1983 to December 2012 which may not reflect the whole effects of
the macroeconomic variables on the stock market returns since the data is limited to the
some part of the years of operation of the stock exchange not from the inception of the
Nigerian Stock Excahnge.

1.8 CONCEPTUAL DEFINITIONS OF TERMS.
A brief description of the variables is presented below:
1. NSE ALL-SHARE INDEX (NASI): The NASI captures the performance of the
market. It is the principal stock index of the Nigerian Stock Exchange. This index is
calculated from the values of each of the market's listings.

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2. EXCHANGE RATE (EXR): This is the value Nigerian currency (Naira) is
exchanged for a unit of another countries currencies especially Dollars ($).

3. INTEREST RATE (IR): This is the expected rewards which an investors is
expected from forgoing present consumptions to save some part of his income. This
is usually determined in Nigeria by the Monetary Policy Rate of the Central Bank of
Nigeria.

4. FOREIGN DIRECT INVESTMENT (FDI): This is total inflows of capital

5. from outside the country either for direct investment or for infrastructural
developments in the country.

6. CAPITAL MARKET: This is the market where government bonds, private and
public companies shares are sold and bought by private investors in the economy.

REFERENCE
Abel Ezeoha, Ebele Ogamba and Ndi Okereke Onyiuke (2009): Stock Market
Development and
Private Investment Growth in Nigeria, J ournal Sustainable Development in
Africa,Vol 11,No 2,2009
Abosede, A.J, Obasan K.A and Raji B.A (2001): Research Methodology for
Management
Science, Lagos, Nigeria Mixon Publishers
Levine, A. (1991) ,The Fundamental of Econometrics, University of Ibadan , Oyo State
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Adeyemi, K.S.(1998), Option for Effective Development of Nigeria Capital Market at
one day
seminar organized by Nigeria Economic Society at the Institute of International
Affairs, Lagos 21st J anuary 1998.
Aigboku, Ben K. (1995), Financial Development and Economic Growth:A Test of
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on supply-Leading and Demand-Following, with Evidence on Nigeria. Nigerian
Economic and Financial Review,(N.E.F.R), December, 1995 Vol. 12:1-10
Soyode, A. (1990), Emerging Stock Markets, Euro money Publications, London
Akamiokhor, George (1984): The Securities and Exchange Commission and the
Nigerian
Capital Market Central Bank of Nigeria Bullion volume II pp 70-77.
Alile, Hayford (1996); Dismantling Barrier of Foreign Capital Inflows The Business
Time of
Nigeria 14th April, page 5.
Anthony Kyereboah-Coleman and Kwame F. Agyire-Tettey (2006) :Impact of Macro
Economic
indicators on Stock Market performance: The case of the Ghana Stock
Exchange, The journal of Risk of Finance, Vol 9,No 4,2008 pp 365-378
Asika, N (1999): Research Methodology in the Behavioural Science, Lagos, Nigeria.
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Publisher
Canova, F. and G. De Nicoli (1997); Stock Returns, Terms, Structure, Inflation and
Real
Activity: Perspective CEPR Discussion paper, No 1614.
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Central Bank of Nigeria. Annual Reports for years 1981 to 2007

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Inanga, Ino L. and Chidozie Emenuga,(1997),Institutional, Traditional and Asset
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Characteristics of the Nigerian Stock Exchange, African Economic Research
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Expectation, J ournal of Financial & Quantitative Analysis; No,25,pp 307-321

Ndi Okereke-Onyiuke(2006): A Review of the Performance of The Nigerian Stock
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Ologunde A.O.,Elumilade, D.O.,Asaolu, T.O. (2006): Stock Market Capitalization and
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Rate in Nigeria: A times series analysis, International Research Journal of
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Olowe, R.A. (1977), Financial Management: Concepts, Analysis and capital
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Lagos: Brierly Jones Nigeria Ltd..
Okereke- Onyiuke,Ndi,(2000); Stock market financing options for public project in
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Test. Babcock J ournal of Management and Social Sciences, Vol 4 No 158-170

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CHAPTER TWO
LITERATURE REVIEW
2.1 INTRODUCTION
This chapter contains the review of relevant literatures and research works which relate
this study under the following headings: theoretical, methodology and empirical reviews.
The theoretical review looks at the theories that have been propounded interest rates and
stock returns, while methodological review take the path of reviewing works of early
researchers and the research methods employed to test for the interlink between interest
rates and stock market performance and finally, empirical review presents the results of
others researchers on this subject matter.

2.2 THEORITICAL REVIEW
Irving Fisher (1930) found that real interest rates were equal to nominal interest rates minus
expected inflation. This macroeconomic relationship is known as the Fisher Effect. The Fisher
Effect is unique in that it incorporates expected inflation as opposed to actual inflation rates into
the analysis. This is crucial to this study because it allows the use of rational expectations model.
The Fisher Effect is primarily an alternative way of measuring real interest rates and is used as a
means of relating interest rates and inflation expectations to stock prices. To fully understand the
relationship between the Fisher Effect and stock prices, it is necessary to understand the
individual relationships between inflation expectations, interest rates, and the stock market.

An Efficient Market is market in which the values of securities at any instant in time fully reflect
all available information resulting in the market value and the intrinsic value being the same.
Propounded by Fama (1970) EMH also states that the prices of shares will immediately adjust to
new information. There are three different types of efficiency in an efficient market. These are
weak form, semi strong form and strong form. The weak form fully incorporates information
about past stock prices. Stock prices are said to follow a random walk as the information on
stock comes in a random manner. Attempts to use technical analysis are futile in predicting
future prices. In the semi strong form, prices incorporate all publicly available information
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including published accounting statements as well as historical price movements. Thus any
information that can be extracted is already reflected in the price.

In the strong-form all information public or private is incorporated. It makes the most stringent
demand on information since it says that even the information available only to those closely
concerned with the firms has already been taken up and incorporated in the price. The main
fundamental implication of EMH is that if the markets are efficient then it is impossible for
investors to exploit information in order to earn excess returns over a sustained period of time
(Howells and Bain 2002).

As for the effect of macroeconomic variables on the stock market EMH suggests that
competition among profit maximizing investors in an efficient market will ensure that all the
relevant information currently known about changes in macroeconomic variables are fully
reflected in current stock prices so that investors will not be able to earn abnormal profits
through prediction of future prices, Chong and Goh (2003).

The Capital Asset Pricing Model (CAPM) was developed by Sharpe and Litner in 1964. It is an
equation that equates the expected rate of return on a stock to the risk free rate and the risk
premium for the stocks systematic risk, Martin and Scot jnr (1996). Basically, the CAPM
illustrates the relationship between expected return on an individual security and the beta of the
security. The beta according to Hull (1997) is a parameter that shows the relationship between
the return on a portfolio of stocks and the return on the market. In all, the model argues that the
investor requires excess returns to compensate for any risk that is correlated to the risk in the
return from the stock market but requires no excess return for other risks. The

Arbitrage Pricing Model (APM) was developed by Ross (1976). According to the APM returns
vary from their expected amounts because of unanticipated changes in a number of basic
economic forces such as industrial production, inflation rates, term structure of interest rates and
the difference in interest rates between high and low risk bonds, Martin and Scot jnr (1996). It
suggests that the risk of a security is reflected in its sensitivity to unexpected changes in
important economic forces.
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The Classical case of investment and savings theory strongly argue that the savings are invested
as a result of interest mechanism. They propel that in an economy where demand and supply
forces are at play, savings and investments are equated in the economy. They suggest that both
investments and savings are functions of interest rates. Savings are positively related to the rate
of interest. As interest rates rise, people are induced to save more and the convex is typically
true. If on the other hand, the interest rates decline, depositors are discouraged to save and they
transfer their money from the money market to equity market and the stock market will start to
perform well (Arnold, 1998). On the other hand, investment is inversely related to interest rates.
Therefore, as interest rates rises, investments fall since the cost of borrowing rises also. However
under the hyperinflationary environment such as the case in Nigeria, people will rush to the
equity market where positive capital gains prevail. Hence most investors will rush to the stock
market where capital gains will be inevitable, Arnold (1998).

McKinnon-Shaw (1973) theories on finance and development criticized the dominant
neo-classical monetary theories and the Keynesian counter arguments. The neo-classical
monetary growth models postulate that high-positive interest rate have a direct impact on
savings and investment. Within this school of thought, money is regarded as a substitute
for physical assets and productive investments. Keynesian economists on the other hand
argue that low-interest rate increases investment, income and eventually savings.

McKinnon (1973) advances an argument in favor of a complementary relationship
between financial and physical assets as opposed to the substitutability theory by the
neoclassical in a critique of the Keynesian theory. Paddy (1992) contends that
macroeconomic and fiscal environment is one of the building blocks which determine the
success or otherwise of securities market. Conducive macroeconomic environment
promotes the profitability of business which propels them to a stage where they can
access securities for sustained growth. Generally, the barometers for measuring the
performance of the economy include among others real GDP growth rate, rate of
inflation, the exchange rate, fiscal position and the debt position. Of these the exchange
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rate, interest rate and the rate of inflation can be singled out to affect stock market
activity as they impinge directly on the state of corporate activity in the country. Interest
and exchange rates are financial prices for credit and foreign currencies, respectively.

They both affect resource allocation, production levels, prices and profitability.
Ultimately, fluctuations in these reflect in share prices an indicator of market
performance. For instance, lowering of interest rate on demand and savings deposits will
improve returns to investing on the exchange relative to investing in deposit money banks
(DMBs) holding factors such as risk, transaction costs, etc. constant. This will therefore
increase the demand and share price of affected equities on the exchange thereby
affecting its performance.
Agenor (2000) captures these views by stating that interest rate, high inflation, large
fiscal deficits and real exchange rate over-valuation are often key symptoms of
macroeconomic instability which constraints private sector investment and savings and
thereby results in inefficient allocation of resources on the exchange thereby affecting its
performance.

From the above scenario, it should come to light that low interest rates reflect themselves in
limited savings generation, especially in a hyperinflationary climate. In fact, investors will be
more concerned about real return that is nominal interest rates less inflation rate. Therefore, they
will discard the money market and invest in the stock market and property market where real
returns are positive. It should be clearly noted that investors are rationale and aim to maximize
capital gains, Arnold (1998).

2.3 METHODOLOGICAL REVIEW
The relationship between economic fundamentals and stock returns has been studied by a
large number of researchers (see Chen, Roll & Ross (1986); Fama (1990); Chen (1991);
Nasseh & Strauss (2000); Dickinson (2000); Shanken, & Weinstein (2006); Samitas &
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Kenourgios (2007); Gunsel & Cukar (2007); Leon (2008); Ahmed (2008) ; Nikolaos,
Grigoris, Nikolaos & Nikos (2009) and Abdullahi (2011).

Chen, Roll and Ross (1986) studied The Effect of Macroeconomic Factors on the
London Stock Return (a Sectoral Approach) and concluded that the macroeconomic
factors have a significant effect on the UK stock exchange. Chen Roll & Ross (1986)
hypothesized and test a set of macroeconomic data series to explain US stock return.
They investigated the sensitivity of macro-economic to stock returns. They tested seven
macroeconomic variables; term structure, industrial production, risk premium, inflation,
market return, consumption and oil prices in the period of J anuary 1952- Nov. 1984.

Dhrymes, Friend, Gultekin and Gultekin (1985) focused on the attention of financial
profession on factor analysis. They reach substantially different conclusion from those
drawn by Roll & Ross (1980) regarding the empirical evidence supporting arbitrage
pricing theory (APT). They found that the number of factors increases with the number of
time series observations used to estimate factor loading. They conclude that the evidence
on the usefulness of the APT model is at best mixed.

Brown and Wein (1983) estimate and test the APT in the context of the bilinear paradigm
introduced by Kruskal (1978). They examine the special case of the APT in which the
numbers of factors are pre-specified, using the same data of Roll and Ross (1980) but
through forming 60 securities groups instead of 30 grouping securities according to their
industrial classifications instead of alphabetical order. They find a 3-factor APT model
rejecting the 5 or 7-factors version. Also, they show that specific firm or industry effects
that may be diversified are not price in the APT scenario. This means that there are few
rather than many economy wide factors that appears to be prized in the APT.

On the other hand, Beenstock and Chen (1988) investigated four factors namely interest
rates, money supply (M3), fuel, and material cost, and the retail price index. They fund
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that unanticipated increase in interest rate and fuel and material costs reduce security
returns. They conclude that export volume and relative export prizes as risk factors, but
were not significant.
Clare & Thomas (1994) are of opinion that a number of factors have been prized in the
UK stock and are; oil prices, default risk and the retail price index. UK private sector
bank lending, the current account balance and the redemption yield on an index of UK
corporate debentures and loans. Priestley (1996) identified seven macroeconomic and
financial factors; namely default risk, industrial production exchange rate, retail sales,
money supply (M3), unexpected inflation, change in expected inflation, term structure of
interest rate, commodity prizes and market portfolio. He found that with the factor
generating from the rate of change approach, all factors are significant in the UK stock
market.

Tursoy, Gunsel & Rjoub (2008) tested seven macroeconomic variables of Turkish
economy. He separated into expected and unexpected series by a regression process then
two step testing methodology is implemented on these series. The study covered 54
stocks for the period of J anuary 1989 to J uly 1995. The result was beta coefficient of
expected factors is found to be significant for asset return.

Altay (2003) employed various economic variables which consider the basic indicator of
an economy; from those economic variables, he derived the factor analysis process and
factor realizations of principle economic phenomenon for two countries Germany and
Turkey. The idea behind employing macro economic variables is described to be just
quantitative indicators of basic economic phenomena. He tested the period of J anuary
1988 to J une 2002 and J anuary 1993 to 2000 for Turkey and Germany respectively. The
tested economic variables are: consumer price index, wholesale price index, money
market interest rate, imports, export foreign exchange rate, average yield of public bonds
and industrial production index. For German Stock Market, he found the evidence of only
one factor beta, unexpected interest rate level factor beta, reward in the market. For
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Turkey Market, the result can not present evidence for statistically significant unexpected
macroeconomic factor beta on expected asset returns during the period tested

Gunasekarage et al (2004) examined the influence of macroeconomic variables on stock market
equity values in Sri Lanka using the Colombo all share price index to represent the stock market
and money supply ,the Treasury bill rate (as a measure of interest rates ),the consumer price
index as (a measure of inflation ) and the exchange rates as the macroeconomic variables. With
monthly data for the 17-year period from J anuary 1985 to December 2001 and employing the
usual battery test which included unit roots, cointegration, and the Vector Error Correction
Model (VECM) , they examined long run and short run relationships between the stock market
index and economic variables.

Rigobon and Brian (2001) used an identification technique based on the heteroscedasticity of
stock market returns to identify the reaction of real interest rates to the stock market performance
in United States of America. They found that real interest rates reacts significantly to stock
market movements, with a 5% rise or fall in the industrial index increasing the likelihood of a 25
basis point tightening (easing) by about half.

Mukherjee and Naka (1995) applied J ohansens (1988) Vector Error Correction Model (VECM)
to analyze the relationship between the J apanese stock market and exchange rates , inflation ,
money supply ,real economic activity ,long term government bond rate and call money rate.
They concluded that a cointegrating relation indeed existed and that stock prices contributed to
this relation. Maysami and Goh (2000) examined such relationship in Singapore. They found that
inflation ,money supply growth , changes in short and long term interest rate and variations in
exchange formed an cointegrating relation with changes in Singapore stock market levels.

Vuyyuri (2005) investigated the cointegrating relationship and causality between the financial
and real sectors of the Indian economy using monthly observations from 1992 through December
2002. The financial variables used were interest rates, inflation rate, exchange rate stock return
and the real sector was proxied by industrial productivity. J ohansen (1988) multivariate
cointegration test supported the long run equilibrium relationship between the financial sector
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and the real sector. Granger test showed unidirectional Granger causality between financial
sector and real sector of the economy.

William Breen, Lawrence Glosten, and Ravi J angannathan (1989) completed a study of the
relationship between the Treasury bill rate and the stock market in India using the usual battery
tests (Vector Error Correction Model (VECM), unit roots tests cointegration tests). The study
found that an inverse relationship between stock index returns and Treasury bill interest rates
exists when a value-weighted stock index is used.

Oyama (1997) looked closely at the relationship between stock prices and the macroeconomic
variables in Zimbabwe using Revised Discount Model, Error Correction Model and Multifactor
Return Generation Model. This study used quarterly time series broad money supply(M2) ,three
month Treasury Bill rate and the IFC stock return index which considers both capital and
dividends payments. The sample period was set from the first quarter of 1991 to the fourth
quarter of 1996. He noted that by using an error- correction model to stock returns and growth
rate of money and Treasury bill rates has been quite stable since 1991, except during the period
of partial capital account liberalization.

Ibrahim (1999) also investigated the dynamic interactions between the KLSE composite index
and seven macroeconomic variables (industrial production index, money supply M1 and M2,
consumer price index, foreign reserves, credit aggregates and exchange rate using the J ohansens
(1988,1991,1992b) and J ohansen and J uselius (1996) multivariate cointegration techinique.
Observing that macroeconomic variables led the Malaysian stock indices he concluded that
Malaysian stock market was informationally-inefficient.
Chong and Goh (2003) results were similar to the above they showed that stock prices, economic
activities, real interest rates and real money balances in Malaysia were linked in the long run
both in the pre and post capital control sub periods.
Sadosky (2001) studied the interaction between the stock market and economic activity in the
United States using monthly data from 1974 to 1994. The macroeconomic variables considered
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were the US production index, consumer price index and three month Treasury bill rate. The real
stock prices were calculated by deflating the nominal standard and poor index 500(S&P 500) by
the CPI. He used the Granger causality tests and noted that causality runs from inflation to
changes in interest rates. Interest rates on the other hand, predict changes in real stock returns
and changes in stock prices predict changes in industrial production. He also concluded that there
was no evidence of Granger causality running from real stock returns to inflation.
Maysami and Sims (2002, 2001a, 2001b) employed the Error Correction Modeling (ECM)
technique to examine the relationship between macroeconomic variables and the stock returns in
Hong Kong and Singapore (Maysami and Sims 2002b), Malaysia and Thailand (Maysami and
Sims 2001a), J apan and Korea (Maysami and Sims 2001b).
Through the employment of Hendry (1986) approach which allows making inferences in the
short run relationship between macroeconomic variables as well as the long run adjustments to
equilibrium, they analyzed the influence of interest rates, inflation, money supply, exchange rate
and real activity along with a dummy variable to capture the impact of the 1997 Asian financial
crisis. The results confirmed the influence of macroeconomic variables on the stock market
indices in each of the six countries under study though the type of magnitude of the association
differed depending on the countrys financial structure.
Kurihara (2006) chooses the period March 2001-September 2005 to investigate the relationship
between macroeconomic variables and daily stock prices in J apan. He takes J apanese stock
prices, U.S. stock prices, exchange rate (yen/U.S. dollar), the J apanese interest rate etc. The
empirical results show that domestic interest rate does not influence J apanese stock prices.
However, the exchange rate and U.S. stock prices affect J apanese stock prices. Consequently, the
quantitative easing policy implemented in 2001 has influenced J apanese stock prices. Doong et
al. (2005) investigate the dynamic relationship between stocks and exchange rates for six Asian
countries (Indonesia, Malaysia, Philippines, South Korea, Thailand, and Taiwan) over the period
1989-2003. According to the study, these financial variables are not cointegrated. The result of
Granger causality test shows that bidirectional causality can be detected in Indonesia, Korea,
Malaysia, and Thailand. Also, there is a significantly negative relation between the stock returns
and the contemporaneous change in the exchange rates for all countries except Thailand.
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Bhattacharya and Mukherjee (2003) investigated Indian markets using the data on stock prices
and macroeconomic aggregates in the foreign sector including exchange rates, money supply as
well as interest rates and concluded that there is no significant relationship between stock prices
and exchange rates. In another study, Muhammad and Rasheed (2003) examined the relationship
between stock prices and exchange rates of four South Asian countries namely Bangladesh,
India, Pakistan and Sri Lanka and found that there is no significant relationship between the
variables in India and Pakistan, either in the short-run or long-run. However, they found a bi-
directional relationship in the case of Bangladesh and Sri Lanka.

2.4 EMPIRICAL REVIEW
There have been several studies focusing on the extent of variables influencing the
market index and their importance in including in the model. Some researchers resorted
to classifying the variables depending on the relativity to the index taken for study. The
selection of variables is different in each of the studies with varied time lines involving
different countries. The study of impact of the macro-economic variables has been
complex due the nature of interaction of different factors and the time lag to take effect.
Due to the economic liberalization of countries, the cross border factors have been
playing a significant role with contagion effects of economic conditions.

Rigobon and Brian (2001) used an identification technique based on the heteroscedasticity of
stock market returns to identify the reaction of real interest rates to the stock market performance
in United States of America. They found that real interest rates reacts significantly to stock
market movements, with a 5% rise or fall in the industrial index increasing the likelihood of a 25
basis point tightening (easing) by about half. The authors decompose both daily and weekly
movements in interest rates and stock prices from approximately 1985 to 1999. Their results
suggest that stock market movements have a significant impact on short-term interest rates,
driving them in the same direction as the change in stock prices. The authors attribute this
response to the anticipated reaction of monetary policy to stock market increases. They
acknowledge that this interpretation should be taken a bit cautiously.

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Sulaiman D. Mohammad et al. (2009) conducted the study on the Karachi stock exchange
with influencing variables as foreign exchange reserve, foreign exchange rate, industrial
production index, whole sale price index, broad money and gross fixed capital formation
for the period of
1986 - 2008. It concluded that the foreign exchange rate and foreign exchange reserve
significantly affect the stock prices while the others affect insignificantly.

Another study by Basabi Bhattacharya & J aydeep Mukherjee (2002) explored the
relationship between the stock market and Exchange rate, foreign exchange reserves and
Value of trade balance in India. The researchers used unit-root tests, cointegration and the
long-run Granger non-causality test to conclude that the BSE Index and the macro-
economic variables exhibit no casual linkage.

The study that was conducted by T.P.Ghosh (2008) as a case analysis on NIFTY50 index
attempted to predict the index using the bond index, future price of NYMEX light sweet
crude, Nikkei 225, S&P500 and US$ / INR exchange rate. The study concluded that the
appreciation of
Indian Rupees has not affected the market growth and the Indian markets are influenced
by the
US market cues. Further, the study established that the crude prices and stock index are
inversely related.

The study on Stock Exchange of Thailand by Sardar M.N Islam et al.(2004) concluded
that the market indexes are determined by the interest rate, bond rate, foreign exchange
rate, market capitalization, price to earnings ratio and consumer price index both in the
short and long term.

In a research conducted by J un Tu et al. (2011) to study the impact of US economic
variables in predicting the Chinese stock market two conclusions were arrived depending
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period of study considered. The paper concluded that the economic variables of United
States were not useful in predicting the Chinese stock market pre 2001 period. However,
the results indicated that it provided significant predictability post 2001.

Dubravka Benakovi & Petra Posedel (2010) analyzed the returns on fourteen stocks of
the Croatian capital market taking inflation, industrial production, interest rates, market
index and oil price as factors. The results indicated that the index was positively related
to the stock returns and had the largest statistical significance for all the stocks. Further,
interest rates, industrial production and oil price was positively related while the inflation
was otherwise.

Khaled A.Al-Zubi and Hussain Salameh (2007) investigated the relationship between the
macro-economic variables (Industrial production, expected inflation, unanticipated
inflation, term structure) and its impact on the stock returns in the industrial sector in
J ordan. The study concluded that the expected inflation and unanticipated inflation affect
the stock returns while considering the returns without its dividends. However,
unanticipated inflation is the only variable affecting the returns considering with
dividends. Further, the evidence from the study suggests that there exists a long-run
relationship between the variables but not short-term.

Randi Ns, J ohannes A. Skjeltorp and Bernt Arne Odegaard (2009) analysed the return
patterns of Oslo Stock exchange. The study concluded that the market, size factor and
liquidity factor provided reasonable fit for the cross-section of Norwegian stock returns.

Alonso Gomez Alber (2006) studied the Mexican stock exchange with respect to the US
markets. The variables were classified as local and foreign variables for the study. The
empirical evidence from the paper suggested that the foreign factors were able to explain
the cross-section returns in Mexico for both conditional and unconditional versions of the
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model. The paper concluded supporting the hypothesis of integration of the Mexican
stock exchange to the US market.

Halil Tunal (2010) investigated the relationship between the macro-economic variables
and stock returns in Turkish stock market using the Arbitrage Pricing theory framework.
The study concluded that there exists a long run relationship between the basic macro-
economic indicators of Turkish economy and the stock returns at different levels.

Further, the study conducted by Engsted and Tanggaard (2002) concluded a moderately
positive relationship between expected stock returns and expected inflation for the US
and a strong positive relationship for Denmark. Sharfe (2002) suggests that rise in
expected inflation reduces equity prices in the US.

Bilson et al. (2001) tested the ability of the local macroeconomic variables (money
supply, goods prices and real activity) in explaining the stock returns in 20 exchange
emerging markets for the period 1985-1997. The results indicated that the exchange rate
variable is clearly the most influential macroeconomic variable, and money supply has
greater importance.

Griffin (2004), postulated that foreign inflows are significant predictors of stock returns
for Korea, Taiwan, Thailand and India. This indicates that foreign investors are buying
before market index increases. Further, the results indicated that contemporaneous flows
are positive and highly significant in India. FII and Stock Index show positive
correlation, but fail to predict the future value.

Dr. Nishat (2004) studied the long term association among macroeconomic variables,
stock prices and employed money supply, CPI, IPI, and foreign exchange rate as
explanatory variable using Karachi stock exchange 100 index prices from 1974 to 2004.
The result indicated that there exists a causal relationship among the stock price and
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macroeconomics variables. Most of the time series data is non-stationary hence unit root
technique was employed to make data into stationary. Further, the result also indicates
that industrial production significantly affects to macroeconomic variables. Granger
causality test was used to find the correlation among the variables the results indicated
that the interest rate is not granger cause by stock price.

Shahid Ahmed (2003) empirically investigated on SENSEX index price affects and
concluded that the real and financial sector performance in Indian economy has influence
in performance of the index using the data from the period 1997 to 2007. The study
considered export, foreign exchange rate and foreign direct investment as variables.
Granger causality test is used to find out the causal relationship between the variables.
All the variables are Granger cause to stock prices.

Roa & Radjeswari (2000) conducted study incorporating a big number of macro variables
in order to predict the asset returns. The study concluded that the factors that influence
the returns of assets are industrial production, agricultural production, money supply,
interest rate, exchange reserves and inflation.

Mukherjee et al. (2002) conducted a study on impact of FIIs in Indian equity market. The
evidence suggested that the FIIs activities had a strong demonstration effect. The study
concluded that FII flows tend to be caused by the return in the equity market. Gallagher
& Taylor (2002) suggested based on the empirical study that the stock returns are
negatively impacted by both the expected and unexpected inflation.

Lambrick (2005) examined the relationship between sixteen macroeconomic variables
and the equity returns in Australian stock market. The sixteen variables were classified
under five different heads namely real, monetary, labour variables, price level variables
and external variables. The US dollar exchange rate and the composite leading indicator
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possibly decide the prices in stock market. Further, the impact of variables retail sales and
industrial production hold true for the entire period of the study.

The study conducted by Chinzara and Aziakpono (2009) concluded that the stock returns
and volatility in South African are linked to major world stock markets with US, China
and Australia having greater impacts. Further, the volatility exhibits asymmetry pattern
and stability over the period of time. However, they observed that there was a lack of
evidence for risk premium hypothesis for the period of study.

The study conducted by Yu Hsing (2011) examined the relationship between stock
market index of Hungary and relevant macro-economic variables. The study concluded
that the stock market index of Hungary has a positive relationship with the real GDP,
ratio of government debt to GDP, nominal effective exchange rate and German stock
market index. Further, the evidence showed that the market index of Hungary was
negatively related to real interest rate, expected inflation rate and government bond yield
in Euro region.

Flannery and Protopapadakis (2001) studied seventeen macroeconomic risk factors by
analysing the impact of those economic variable announcements on the level and the
conditional volatility of the daily stock returns. They identified that six of them for price
factors in nominal and real terms. The nominal category included three elements CPI, PPI
and money aggregate while real category included the employment report, housing starts
and the balance trade.

Chinzara (2011) investigated the relationship between the macroeconomic uncertainty
and stock market volatility for South Africa. The study concluded that that the stock
market volatility is significantly affected by the macroeconomic uncertainty. The
volatilities in foreign exchange rates and short-term interest rates have significant impact
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while volatilities in oil price and inflation play a minor role in influencing the stock
market volatility.

In the paper by Johansson (2009), the evidence showed that China has been experiencing
increased level of integration with the major financial markets in the period overlapping
with the period after China became member of World Trade Organisation. The study
postulated that the impact of developed markets like US may increase over time on the
emerging markets. Hence, the economic variables of the US may be useful in predicting
the Chinese stock market.

The study conducted by Robert D. Gay (2008) examined the relationship between the
stock prices and macroeconomic variables in Brazil, China, India and Russia using Oil
price, exchange rate and moving average lag values as independent variables. The study
concluded that the domestic factors have significant influence on the in emerging
economies than the external factors.

Ramin Cooper Maysami, Lee Chuin Howe & Mohamad Atkin Hamzah (2004) examined
the relationship between the macroeconomic variables and sector stock market indexes in
Singapore stock exchange. The study concluded that the stock market in Singapore and
the property index form cointegrating relationship with the changes in short and long
term interest rates, industrial production, price levels, exchange rate and money supply.

Valeriano Garcia & Lin Liu (1999) examined the pooled data of fifteen developing and
industrial countries to study the macroeconomic determinants of stock market
development and market capitalization in particular. The paper concluded that the real
income, saving rate, financial intermediary development and stock market liquidity are
important determinants of stock market capitalization.

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The study conducted by Emmanuel E Daferighe. & Samuel O Aje (2009) examined the
impact of real domestic product, interest rate and inflation rate on the stock market value
index of
Nigeria. The study concluded that the reduction in interest rate and inflation rate resulted
in increase of stock prices. Further, an increase in real gross domestic product impacts
positively.

Ndri. Konan Lon (2008) studied the effects of interest rate volatility on stock market
returns and volatility of Korean stock market. The study concluded that the conditional
market return has negative and significant relation with the interest rates while the
conditional variance has a positive but not significant relationship with the interest rates.

The study undertaken by Nathan Taulbee (2000) concluded that the real gross domestic
product is a major determinant of the performance of the stock market index S&P 500.
Further, rising unemployment rates significantly reduce the performance of the overall
stock market.

Desislava Dimintrova (2005) investigated the link between the stock prices, exchange
rate, fiscal and monetary policy. The study concluded that the interest rate parity
condition affects the stock prices significantly. The study conducted by Rapach, Wohar
and Rangvid (2003) examined the predicting ability of macroeconomic variables in
twelve industrial countries and concluded that interest rate as the most consistent
predictor across the geographies.

Another study conducted by Ratanapakorn and Sharma (2007) investigated the long-term
and short-term relationship between the S&P500 index and selected macroeconomic
variables in the US over a period from 1975 to 1999. The study concluded that the long-
term interest rate negatively impacts the stock prices while money supply, inflation,
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exchange rate, industrial production, exchange rate and short-term interest rate positively
impact the stock prices in the long run.

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CHAPTER THREE
STRUCTURAL COMPOSITION
3.1 INTRODUCTION
This chapter contains the structural composition of the study which x-rayed the trends of
Stock Exchange Market in Nigeria, also it included the operations and management of
Stock Exchange Market in Nigeria. Attempt was also made to check the trend of interest
rate and its effect on Stock Exchange Performance and the Returns on Stocks and stock
prices in the country. The problems of Stock Exchange Market in Nigeria were also
looked into.

3.2 NIGERIAN STOCK EXCHANGE: A GENERAL OVERVIEW.
Globally, the state of the capital market gives an idea of the state of health of a nations
economy as it measures the stability of the nations economy to the extent which
economic stability can rely on it. According to NEEDS (2003), the level of National
Economic Development and the extent to which most economic activities can effectively
rely on the safety of the capital market are major indicators of a healthy balance between
a sound financial system and macro-economic stability. It was in the light of these
assumptions that the Nigerian stock exchange was established.
a. ESTABLISHMENT OF THE NIGERIAN STOCK EXCHANGE
In 1958, the federal government sets up a committee headed by Professor R.H. Barback
to examine the viability of fostering a share market in Nigeria. In their report, the
committee (1959) recommended among others that:
a) Facilities for dealings in shares be created.
b) Establishment of share transfer mechanism.
c) To put in place measures that will encourage savings and issuing of government
securities and that of private organizations.
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In the same year of this report (1959) the nearly established Central Bank of Nigeria in an
attempt to evolve a capital market floated the first FGN development loan of N4 million
on behalf of the federal government and managed the stock since there was no capital
market. The recommendations of the Barback report coupled with the need to ensure
sustainability and efficient management of the FGN development loan stock, Nigerian
Stock Exchange was established in 1960 as the Lagos stock exchange. Through the
promulgation of Lagos stock exchange Act of 1961, it was the first stock exchange in
West Africa and the sixth in Africa. The exchange opens its doors for business on J une 5,
1961 with an authorized share capital of N10,000 divided into 500 shares of N20 each
with 19 securities listed for trading.
Following public dissatisfaction over the prevailing financial system, a committee (the
Okigbo Committee) was set up by the federal government to review the nations financial
system. The committee among other things recommended the decentralization of the
exchange so as to enhance the performance of the markets function. In line with this
recommendation, the Lagos stock exchange was constituted into the Nigerian stock
exchange in 1977 and was to have branches in major cities to meet the aspirations of the
users of its services. Each branch now has trading floors with branch councils. However
the national council retained responsibility for quotation, regulations and discipline of the
capital market. By 1990 the exchange has a total of six trading floors across the nation;
currently the exchange has 9 branches.
b. OBJECTIVES OF THE NIGERIAN STOCK EXCHANGE
The memorandum of association states the objective of the exchange as follows:
1) To create an appropriate mechanism for capital formation and efficient allocation
of resources among competing project.
2) To maintain fair price for securities.
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3) To maintain discipline in the capital market.
4) To broaden share ownership practice.
c. FUNCTIONS OF THE NIGERIAN STOCK EXCHANGE
The functions of the Nigerian stock exchange includes but not limited to:
1) To enhance the mobilization of private and public savings for investment through
trading in shares and stocks.
2) To serve as a broad communication arena for its constituencies and the dual role
of overseeing the markets and their member-firm participants on one hand and self-
regulating itself on the other hand.
3) To ensure fair dealings in securities through its rules, regulations and operational
codes which help to protect the public from shady deals.
4) To maintain broad, liquid secondary markets for corporate securities thereby
helping to build public confidence and participation in the market.
5) To enhance issuers ability to raise capital in the primary market and
understanding the importance of efficient capital management.
6) To serve as a forum or mechanism for the implementation of indigenization
programme. The realization of the exchanges objectives through efficient and effective
performance of the function mentioned above is linked to the activities of members.

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d. MEMBERSHIP OF THE NIGERIAN STOCK EXCHANGE
Membership of the exchange is basically either ordinary dealing or dealing members.
Ordinary members are individuals and institutions who have acquired at least five shares
of N20 each out of the issued share capital of the exchange and have been admitted to the
register of members in line with the exchanges articles of association. On the other hand,
dealing members are individuals or institutions that are not only admitted as members,
but are also licensed by the council of the exchange to transact business in stocks, shares,
debentures, bonds and other securities on the floors of the exchange in accordance with
the rules and regulations of the exchange. This category of members is represented by
authorized dealing clerks on the floor of the exchange.
Dealing members of the Nigeria stock exchange are required to deposit sums as specified
from time to time by the stock exchange before they are issued license to deal. Such
deposits can also be made by equivalent acceptable securities. According to Osaze
(2007:108) every dealing member is expected to maintain a presence on at least two
trading floors of the exchange with eight dealing clerks six authorized and two
ordinary. Dealing members are also required to make an annual subscription as specified
by the exchange in order to retain their license to deal on the exchange. Members have
liabilities limited to their shareholding in the exchange and do not share excess income
over expenditure.
e. MANAGEMENT OF THE NIGERIAN STOCK EXCHANGE
The Nigerian Stock Exchange being a non-profit making organization, a private company
limited by guarantee has a national council with the responsibility for quotation,
regulations and general discipline of the capital market. The director general with the
assistance of other directors takes care of the day-to-day running of the exchange. Prior to
1977, the exchange was being promoted by the Central Bank of Nigeria through financial
supports in the form of annual subvention. Between 1963 and 1965, CBN cash
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subventions to the exchange amounted to N14,000.00. With the desensitization of the
exchange, each branch has a trading floor with a branch council exchange of it. The
branches are located in Lagos, Kaduna, Ibadan, Yola, Onitsha, Port-Harcourt, Abuja and
Uyo. The branch council has elected members from among member affiliated to the
branch. The branch council elects representative to the national council of the stock
exchange during the annual general meeting (AGM). The branch council is responsible
for the initial vetting of applications for membership of the stock exchange and making
the necessary recommendation.
f. TRADINGS/BUSINESS VOLUMES ON THE NIGERIAN STOCK
EXCHANGE
The Nigerian Stock Exchange started trading on its Lagos floor in 1961 with 19 securities
worth N80 million listed on the exchange. By December 2005, the securities have grown
to 288 with a market capitalization of N2.900 trillion with over 760 operators. Out of the
288 securities as at December 2005, 214 were equities, 58 were industrial loans and
preferences shares while 16 were gilt-edged securities. It is worth of note that
government stocks accounted for over 30% of the total securities. As at 2007, there were
over three million individual investors and about 400 institutional stock holders in the
market. The Nigerian Stock Exchange accounted for over 280 billion turnover in 2005.
Osaze (2007) argued that the low turnover is due to low trading of stocks by the stocks-
holders below expectation. He therefore contended that the infrequent trading of stocks
by their holders has made the stock market not to be as vibrant as other emerging stock
markets elsewhere. This is responsible for the low average transaction ratio which is the
ratio of the annual turnover of securities to total annual market capitalization.
Up to 1988, government stock (gilt-edged securities) dominated the NSE in value even
though it was few in volume. Because the value of government borrowing in the market
was often rather large with frequent block trading in them by capture institutional
investors (insurance companies, national provident fund) trading value in government
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stock had been overwhelmingly larger than industrial stocks. After 1988, there was a
dramatic change as industrial stock started having greater value than government stock.
Although the number of industrial loans listed on the exchange is still very small, it has
increased tremendously between 1990 and 2005. The sudden rise is believe to be as a
result of year of dilution of share holdings ratio, reluctance on the part of foreign equity
participants to bring in new funds; and the preference for local funds for local
development.
3.3 The Historical Evolution of the Nigerian Capital Market -
The origins of the Nigerian Capital Market date back to colonial times when the British
Government ruling Nigeria at the time sought funds for running the local administration.
Most of these funds are derived from agricultural produce marketing and solid mineral
mining. Discovering that these sources were inadequate to meet its growing financial
obligations, the colonial administration decided to expand its revenue base by reforming
the system of revenue mobilization, taxation and other payments. It also saw the need to
raise funds from public sector to cover temporary shortfalls in funds availability. Hence,
it found it necessary to establish a financial system by setting up the basic infrastructure
for its take off pending the development of an organized private sector. According to
Odife (2000:6), the first step in this direction was to secure the necessary finance for the
development of this infrastructure and long-term capital project. This it did in 1946 when
it promulgated the 1946 10-year plan Local Loan Ordinance for the floatation of the first
N300,000, 3% Government stock 1956/61 with its management vested on the
Accountant-General.
In 1957, the government and Other Securities (Local Trustees Powers) Acts was enacted.
This law specified the types of securities in which trust funds may be invested. It also
clearly defined the powers and responsibilities of trustees. In addition, the colonial
government set up the Professor Barback committee to examine the ways and means of
fostering a share market in Nigeria. Part of the terms of reference of this committee
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included the possibility of establishing a capital market in Nigeria. The committee
recommended, among others, the creation of facilities for dealing in shares , the
establishment of rules regulating share transfer and measures for encouraging savings and
issues of securities of government and other organizations. By the end of the year (1957),
the colonial administration had promulgated the General Loan and Stock Act and the
Local Loan (Registered Stock and Securities) Act on the recommendations of the
Barback Committee.
In 1958, the Central Bank of Nigerian was established through the Central Bank of
Nigeria Act of 1958. The purpose of these various legislations was to establish the legal
and infrastructural frame work for the take-off of a viable securities/capital market in
Nigeria. As a follow up to these laws, the colonial administration issued the first N2
million Federation of Nigeria Development Loan Stock in May 1959. In 1959, it also
enacted the Statutory Corporations (Guarantee of Loans) Act. In April 1960, the Central
Bank of Nigeria issued the first Nigerian Treasury Bills which were meant to provide an
avenue for the investment of short-term liquid funds in Nigeria and assist in providing
government with funds pending receipt of its own revenues. On September 15, 1960, the
Lagos Stock Exchange was incorporated as a private limited liability company, limited
by guarantee under the provisions of the Lagos Stock Exchange Act 1960. The Lagos
Stock Exchange Act 1960 conferred monopoly powers on it members to deal in securities
granted quotation on the Exchange. It also allowed the Central Bank to Deal directly in
securities. On J une 5, 1961, the Lagos Stock Exchange opened for business with 19 listed
securities made up of 3 equities, 6 Federal Government Bonds and 10 industrial loans.
In 1961, the National Provident Fund was established as a compulsory contributory
savings scheme aimed at providing some protection to contributors at old age, invalidity
or temporary loss of employment. The enabling Act required the Fund to invest its
surplus funds only in securities in Nigeria authorized by the Trustee Investment Acts of
1957 and 1962 and restricted to securities created or issued by or on behalf of the
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government of the federation (SEC, 1999:49). By 1962, the Exchange Control Act and
Trustees Investment Act were enacted. The Capital Issues Committee was also
constituted to examine and recommend the establishment of an apex monitoring
institution for the growing Nigerian Capital Market. In 1966, the Borrowings by public
Bodies Act was enacted. This was followed in 1968 by the Companies Decree and the
Banking Decree in 1969. In 1972, the Nigerian Enterprises Promotion Decree was
promulgated which was followed in 1963 by the Capital Issues Commission Decree. The
Capital Issue Committee thus became the apex regulatory body for the Nigeria Capital
Market. By this decree, it was empowered to determine the price and timing of new
issues of securities through offer for sale or for subscription. In 1977, the name of the
Lagos Stock Exchange was changed to the Nigerian Stock Exchange by the
Indigenization Decree of 1977 following the recommendations of the Industrial
Enterprises Panel (Adeosun Panel) of 1975 that branch exchanges should be established.
As a result, six new trading floors of the Nigerian Stock Exchange were created in
Kaduna (1978), Port Harcourt (1980), Kano (1989), Onitsha (1990) and Yola (2002). On
April 1, 1978, the Securities and Exchange Decree was promulgated to replace the
Capital Issues Commission and expand the scope of its activities following the
recommendations of the Financial System Review Committee (Okigbo Committee) of
1976. The Committee also recommended the establishment of multiple exchanges and the
approval of share allotments by the Securities and Exchange Commission. In 1978, the
first state government revenue bond was floated by the defunct Bendel State of Nigeria.
The N20 million 7% first Bendel State Loan was floated to finance the states housing
development programme. On April 5, 1985, the Second-tier Securities Market (SSM) of
the Nigerian Stock Exchange was established to cater for the requirements of small and
medium scale enterprise.
It essentially diluted the listing requirements of this category of companies to encourage
them to seek quotation and thereby further broaden and deepen the market. In 1987, the
Nigerian Enterprises Promotion Decree 34 (Issue of non-voting equity shares) was
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promulgated permitting public companies quoted on the Nigerian Stock Exchange to
issue through the Exchange, non-voting paid-up shares for the subscription of persons
whether citizens of Nigeria or not and whether resident in Nigeria. In 1988, the functions
of the Securities and Exchange Commission were further expanded by Decree 29 of 1988
to include the review and approval of all mergers, acquisition and combinations between
or among companies. In 1988 also, the Privatization and Commercialization Decree 25
was promulgated. This Decree provided for the privatization of some enterprises in which
the Federal Government of Nigeria has equity interest and the commercialization of some
Federal Government wholly-owned enterprises. The exercise that ensued from this
Decree brought more companies to the Nigerian Stock Exchange whose shares were thus
listed.
Similarly, in 1958, Debt Conversion was officially adopted by the Central Bank of
Nigeria and a guideline on the debt conversion programme published. The Nigerian
Deposit Insurance Corporation was also established in 1988 to monitor the performance
of the banking sector and insure depositors against possible bank distress and consequent
loss of funds. In 1989, the Companies and Allied Matters Act (CAMA 1990) was enacted
to regulate the incorporation, corporations and activities of all bodies in Nigeria.
Specifically, Sections 541-623 cover dealings in the securities of companies and vests
its administration on the Corporate Affairs Commission. Indeed, the CAMA(1990) is a
comprehensive securities law for the country as it deals with a wide range of issues such
as invitation of the public to securities offer, registration of securities, prospectus,
allotment, unit trusts, reconstructions, mergers and takeover as well as insider trading
(SEC, 1990:53).
By 1991, following the spate of large scale distress in the financial system, the Banks and
Other Financial Institutions Decree 25 (BOFID), 1991 was promulgated to monitor the
operations of the banking and financial sector and reduce the tide of distress. In 1991, the
Inter-ministerial Committee on the Nigerian Capital Market recommended the
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discontinuation of official pricing of securities as well as the establishment of more stock
exchanges. The Central Bank of Nigeria Decree of 1991 was also promulgated; this
decree expanded the functions of the Central Bank granting it greater autonomy in
monetary policy and repealed the Central Bank of Nigeria Act 1958. In 1992, the first
municipal bond in the Nigerian Capital was floated by the Lagos Island Local
Government. The first Lagos Island Local Government Floating Rate Revenue Bond
N100 million was floated to finance the Sura Shopping Complex in Lagos. The coupon
rate was 24.75%.
In 1992, The Chartered Institute of Stockbrokers Decree was promulgated which granted
the Institute of Stockbrokers powers to charter stockbrokers and dealers, conduct
examination for brokers and generally oversee the conduct of its members in the interest
of the orderly development of the capital market. On J uly 29, 1992, the Central Securities
Clearing System was incorporated as the official central clearing and depository of the
Nigeria Stock Exchange. The CSCS was incorporated to implement a computerized
Stock Exchange Management System (SEMS) which emphasizes the immobilization of
share certificate in a Central Depository. In 1993, the federal government, through its
budgets presentation, formally deregulated the capital market, thus ending the official
pricing, timing and allotment of securities issues. These functions were passed on to the
issuing houses to perform. In 1993, the second Kaduna State Revenue Trust Fund
(NSITF) was created by decree to replace the National Provident Fund. By this Act, the
scope of activities of the National Provident Fund was expanded and the National
Provident Fund Act thereby repealed. In 1995, the Nigerian Investment Promotion Act
No.16 of 1995 was enacted to guarantee the ease of transfer of funds through authorized
dealers. It stipulated the funds that can be transferred out by foreign investors to include:
(a) Dividends and profits (net of taxes) attributable investments;
(b) Payment in respect of loan servicing where a foreign loan has been obtained;
(c) The remittance of proceeds (net of taxes) and other obligations in the event of a sale
or liquidation of investments or any interest attributable to the investor.
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In 1995, the Exchange Control Act of 1962 and the Nigerian Enterprises Promotion
Decree of 1989 were abrogated to promote greater foreign investment in Nigeria. In
1995, the Nigerian Investment Promotion Council was established by Decree 16 of 1995
to promote industrial growth and development through the attraction of foreign capital
and encouragement of domestic savings and investment. On March 19, 1996, the Federal
Government of Nigeria appointed the panel on the Review of the Nigerian Capital
Market (The Odife Panel). Members of the Panel included Chief Dennis Odife
(Chairman), Otunba A. O. Ogunde, Dr. Ahmed Abdullahi, Alhaji Baba Danbappa, Prince
Lekan Fadina (Members), Mr. O. G. Abiose and Mrs M. A. Lashmann (Secretaries).
The panel concluded its assignment and submitted its final report dated September 24,
1996 to the Honourable Minister of Finance on Thursday October 10, 1996. The report of
the Panel culminated in the promulgation of the Investment and Securities Act 1999. On
J une 26, 1996, the African Capital Market Forum was formally launched in Accra, Ghana
to: Promote the establishment of formal capital market in Africa;
Accelerate the development of existing markets; Promote cooperation among African
Capital Market Institution; and Provide a forum for the exchange of ideas among African
Capital Market Institutions.
On J une 17, 1998, the Abuja Stock Exchange (ASE) was incorporated as a Public
Limited Liability Company as the second bourse in Nigeria after the Nigerian Stock
Exchange. On J uly 13, 1998, Rights Issues were permitted for trading as the first
derivative instrument in the Nigerian Stock Market. The Investment and Securities Act
No.45, 1995 was promulgated into law with a commencement date of May 26, 1999. The
Act repealed the Securities and Exchange Commission Decree of 1998, the Lagos Stock
Exchange Act of 1960, the Nigerian Enterprise Promotion (Issues of Non-Voting Equity
Shares) Decree of 1990, Part XVII of the Companies and Allied Matters Act of 1990,
Sections 3(d) of the capital Gains Act and Section 21 (2) of the Nigerian Investment
Promotion Decree of 1995. The Act became the basic legislation guiding the conduct and
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operations of the Nigerian Capital Market. On April 1999, the Automatic Trading
System was introduced in the Nigerian Stock Market to replace the open outcry method.
The Automated Trading System is a security trading arrangement whereby transactions
on the stock exchange are achieved through a network of computers operating on-line,
real-time, automatically. This increased settlement efficiency from T+2 weeks to T+3
days.
In 1998, the first foreign stock, M-NET Supersport of South Africa, was listed on the
Nigerian Stock Exchange. In 2000, the Edo State Government issued N1 billion 7 years
floating rate bond to finance its Ogba Riverside Housing Project. The initial size of the
bond was N500 million but it was oversubscribed by 103% which led to the absorption of
the excess through the issuance of a supplementary prospectus. The 2000/06 bond bore a
21% coupon rate. In 2000, the Delta State Government raised N3.5 billion from the
capital market being the first tranche of a projected N5 billion 7-year floating rate bond.
The proceeds were used to fund a water supply scheme in Warri/Effurun, provision of
educational facilities in all the local government councils of the state, rehabilitation of
twelve general and central hospitals and the development of modern markets in Effurum
and Ughelli: The 16.50% coupon bond was 101.74% subscribed.
In May, 2001, The Nigerian Stock Exchange (NSE) all-share index crossed the 10,000
point mark, ending the month of 10,153.8. On May 2, 2001, the Abuja Stock Exchange
began operation as a floorless, electronically-driven exchange with a fully automated
order-driven screen-based trading system. The Abuja Stock Exchange opened for
operation on May 2, 2001 with four companies listed on a Permission-To-Trade (PTT)
basis. These were FSB International Bank Plc, Inland Bank Nigerian Plc, Ashaka Cement
Exchange.

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3.4 INTEREST RATE ADMINISTRATION: A GENERAL OVERVIEW
Interest rate was first used as an instrument of Monetary Policy in Nigeria in 1962
following the
introduction of money market instruments. The interest rate then was made competitive
to ensure repatriation of funds kept aboard. During the period of high government
borrowing for example interest rate was reduced to minimize cost of servicing public
debt, as was the case in the 1960's.

Interest rate in Nigeria over the years has therefore played a pivotal/dominant role as one
of the
Instruments used by the Federal Government in Managing Monetary Policy. The
Structural Adjustment Programme (SAP), which was introduced by the Federal
Government of Nigeria in 1986, was a comprehensive economic restructuring
programme as it emphasized increased reliance on market forces. In order to pursue this
objective, Financial Sector reforms were initiated by the Federal Government to:
Enhance Competition
Reduce distortion in investment decisions and
Evolve a sound and more efficient financial system

The reforms, which focused on structural changes, monetary policy, interest rate
administration and foreign exchange management, etc. encompasses both financial
market liberalization and institutional building in the financial sector. The broad
objectives of financial sector reform include:

Removal of controls on interest rates to increase the level of savings and improve
allocative efficiency.
Elimination of non-price rationing of credit to reduce misdirected credit and
increase competition.
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Adoption of indirect monetary management in place of the imposition of credit
ceiling on
individual banks.
Enhancing of institutional structure and supervision
Strengthening the money and capital markets through policy changes and distress
resolution measures.
Improving the Linkages between formal and informal financial sectors.

Interest rate in Nigeria over the years has played a pivotal/dominant role as one of the
instruments used by the Federal Government in Managing Monetary Policy. The use of
interest (Bank) rate as an instrument of monetary policy was based on two main
assumptions interest rate regulation; more so that, interest rate has since remained one of
the instruments of managing the Monetary Policy of the Federal Government of Nigeria.
Interest rate guidelines/regulations have always been contained either in the Federal
Government Annual Budget document or the Monetary/Credit Policy Circulars of the
Central Bank of Nigeria (CBN) from time to time.

The use of Interest (Bank) rate as an instrument of Monetary Policy was based on two
main assumptions:
(i) That the bank rate can influence all other rates in the economy, and
(ii) That the demand for money is interest elastic.

In August 1987, the Central Bank of Nigeria (CBN) liberalized the interest rate regime
and adopted the policy of fixing only its Minimum Rediscount Rate (MRR). This was
however modified in 1989, when the Central Bank of Nigeria (CBN) issued further
directives on the required spreads between deposit and lending rates. Ensure that the
pricing of deposits and credit was left to the banks and their customers to determine. In
essence, in 1991, the government prescribed a maximum margin between each bank's
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average cost of funds and its maximum lending rates. Later the CBN prescribed savings
deposit rate and a maximum lending rate.

Partial deregulation was, however, restored in 1992 when financial institutions were
required to only maintain a specified spread between their average cost of funds and
maximum lending rates. The removal of the maximum lending rate ceiling in 1993 by the
Central Bank of Nigeria (CBN) saw interest rates rising to unprecedented levels in
sympathy with rising inflation rate which rendered banks' high lending rates negative in
real terms.

Interest rates in 1993 were volatile and rose to unprecedented levels. The behavior of
interest rates was traceable to a number of factors including:
1. The high rate of domestic inflation arising from the huge fiscal deficit of Federal
Government which was financed mainly by Central Bank;
2. The undue discretion which the deregulation of interest rates conferred on key
market players in pricing their funds as well as the arbitraging activities of market
speculators;
3. Technical insolvency and serious cash flow problems on the part f some weak
banks resulting in distress borrowing; and
4. The use of stabilization securities and the system of allocation of foreign exchange
both of which induced the sterilization of large funds at the CBN.

The prevailing high interest rates in 1993 discouraged investment in the directly
productive
sectors of the economy, while volatile inter-bank rates undermined the efficacy of open
market operations and general stability in the financial system. On the basis of the
foregoing developments, some measures of regulation were introduced in the
management of interest rates in 1994. Deposit rates were set at 10.015.0 percent annum,
while a ceiling of 21.0 percent per annum was fixed for lending. The developments in
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interests rates management in 1994 were generally within the prescribed limits, with
deposit rates ranging from 12.2 percent in the first quarter to 13.8 percent in the fourth
quarter, while lending rates were under the prescribed maximum of 21.0 percent. The
rates were negative in real terms since inflation was estimated to be over 50.0 percent.

As these and other controls introduced in 1994 and 1995 had negative economic effects
total deregulation of interest rates was again adopted in October, 1996 with the banks
given freedom to determine the structure of interest rates in consultation with their
customers. The CBN, however, retained the discretionary power to intervene in the
money market to ensure orderly developments in interest rates.

The deregulation of interest rates brought in Liquidity glut, high interest rates and volatile
inter-bank interest rates which became a permanent feature of the Nigerian economy.
However, the Federal Government continued the fixing of its Minimum Rediscount Rate
(MRR). This policy had been made by the Federal Government when it decided to dump
administrative fiat in interest rate management. Borrowers were not expected to pay
interest rate higher than the marginal productivity of capital. Depositors on the other hand
were meant to demand interest rate high enough to compensate them for postponing
consumption and cover the risks of value associated with inflation. Specifically, its major
objective was to keep the supply of money just within the required level needed for the
target economic growth rate in a particular year.

The policy of interest rate deregulation was retained in 1997, and developments since the
beginning of the year show relative stability in the rates. Indeed, contrary to expectations,
interest rates had fallen. Deposit rates on savings account at commercial banks declined
from an average of 10.1 percent in December 1996 to 7.5 percent in March and further to
5.9 percent at the end of April 1997. Similarly, 3-month deposit rates declined from 12.3
percent in December 1996 to 7.3 percent in April 1997. Lending rates recorded marginal
declines from 20.8 percent to 20.6 percent over the same period. The factors responsible
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for the developments included weak demand for loans by the productive sectors of the
sectors of the economy as well as the deceleration in the rate of inflation. The excess
liquidity in the banking system arising from transfer of deposit of the Petroleum Trust
Fund from the CBN to commercial and merchant banks and the refund of banks deposits
held in stabilization securities was partly responsible for the low interest rate regime.

During the fiscal year 2000, monetary, credit and other financial sector policies were also
designed to maintain internal and external balance. The primary objective was to
maintain the inflation rate at single digit. In order to achieve this objective, the monetary
programme focused on curtailing excess liquidity in the banking system and enhancing
the viability of the external sector as well as the stability of the financial system. Other
important objectives included enhanced growth of the economy and reduction in
unemployment. The performance of the financial sector in 2000 indicated that deposit
and lending rates fluctuated downwards due to liquidity overhang in the banking system
and the reduction in MRR from 18.0 to 14.0, cash reserve ratio, form 12.0 to 10.0
percent, and liquidity ratio from 40.0 to 35.0 percent. The spread between commercial
banks saving deposit rate and maximum lending rate remained high throughout the year;
it stood at 21.7 percent at the end of the year, as similar, trend was observed in the spread
between banks 7day deposit and maximum lending rates.

In view of the Nigerian experience of the absolute failure of the desirable objectives for
which the Minimum Rediscount Rate (MRR) and other policy measures were introduced,
the Governor of the Central Bank of Nigeria (CBN) Professor Charles Soludo in
December 2006 announced the replacement of MRR with MPR.

The Monetary Policy Rate (MPR) was introduced as an instrument, which might be used
to correct the excessive short-term interest rate volatility; especially with the setting of
the Seven (7) to thirteen (13) percent corridor. This measure allows the Central Bank of
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Nigeria (CBN) to actively intervene in the money market to achieve the interest rate
target. The Monetary Policy
Committee (MPC) of the Central Bank of Nigeria (CBN) on 5th J une 2007 reviewed the
major macroeconomic development and the implementation of fiscal, monetary and
exchange rate
policies in the first five months of 2007, as well as the challenges for the rest of the year.
The MPC noted with satisfaction the macroeconomic performances:

(a) The average interbank call rate moderated from 8.98% in December, 2006 to
7.54% in April 2007 and to 7.6% in May, 2007.
(b) The decline in rates was due to the continued surfeit (excess) of funds in the
market particular the MPC stated that:-In respect of interest rates developments, the MPC
affirmed that the introduction of the CBN Standing Lending Facility (SLF) since
December 2006 had continued to moderate the volatility in inter-bank rates in the first
five months of 2007.
(c) With the year-on-year inflation rate at 4.20% in April 2007, the inter-bank rates and
other rates in the banking system had become strongly positive.

While expressing their outlook for the rest of 2007 the MPC noted that although inflation
had
moderated significantly (from 8.98% in December 2006 to 7.54% at April 2007 and 7.6%
in May, 2007) downside risk (inflationary pressure) remained. The MPC therefore
decided to:-
(i) Introduce tenured Repo (Repurchase Order) at Monetary Policy Rate (MPR).
(ii) Reduce the Monetary Policy Rate (MPR) by 200 basis points, (i.e. from 10.0% to
8.0%)
(iii) Reduce the width of the interest rate corridor from +/-300 to +/-250 basis points.
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The combined implication of (ii) and (iii) was that the deposit facility would stand at
5.5% while the lending facility would be 10.51% down from 7.0% and 13.0%
respectively.
(iv) Advise that both facilities above would be expected to be used as a last resort.
Consequently, the frequent usage of these facilities would attract penalty.
(v) Increase the issuance of primary market instruments to mop-up about N100
billion.
(vi) Advise that inter-bank placements would henceforth form part of the deposits for
calculating banks' liquidity ratio.
(vii) Continue the use of Open Market Operations (OMO) in liquidity Management.

Inflation rate plummeted further in the month of May, 2007 to 6.0% maintaining a steady
decline since J anuary, 2006 when inflation rate stood at 17.9%

3.5 STOCK MARKET PERFORMANCE, INTEREST RATE AND
EXCHANGE RATE IN NIGERIA
Capital market is defined as the market where medium and long-term finance can be
raised (Akingbohungbe, 1996). In another exposition, Ekezie (2002) noted that capital
market is the market for dealings (i.e. lending and borrowing) in longer-term loanable
funds. Mbat (2001) described it as a forum through which long-term funds are made
available by the surplus to the deficit economic units. Capital market is a collection of
financial institutions set up for the granting of medium and long term loans. It is a market
for government securities, for corporate bonds, for the mobilization and utilization of
long-term funds for development the long term end of the financial system (Osinubi,
2006). In this market, lenders (investors) provide long term funds in exchange for long
term financial assets offered by borrowers.

Aderibigbe (1977) said capital market could be defined narrowly as the market for
dealings (Lending and borrowing) in longer-term loanable funds and equity shares. The
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market according to him is made up of the primary and secondary markets. The primary
(new issue) market is concerned with raising new capital. The secondary market is the
market for the sale and purchase of existing securities, which are already in peoples
hand, enabling savers who purchased bonds and shares when they had surplus funds to
recover their money when they need cash.
Developments in the Nigerian capital market represent positive indication of the prospects
and promise
the market has for the future. Resolving the outstanding problems of the market is a major
task that must
be accomplished for the future development of the market. To this effect, a number of reform
measures have already been undertaken to refocus the market so as to meet future
challenges. For instance, in pursuance of its deregulation policy which began with the
introduction of SAP in 1986, several efforts have been made by the government to ensure
that the Nigerian capital market operates like its counterparts in other economies.

The deregulation of interest rates has had positive effect on the number of private enterprises
sourcing funds from the market and it has also affected the volume and market capitalization.
In 1991, the government deregulated the pricing of securities in the market by disengaging
the SEC from securities pricing. In effect, the pricing of new stocks on the market was left in
the hands of stock brokers and issuing houses. Further steps have also been taken to improve
the settlement process and brokerage services. Before the introduction of the Central
Securities Clearing System (CSCS) in April, 1997, the process of transacting shares used to
be unnecessarily long and worrisome to investors. The removal of legal restrictions on
foreign investors is also a positive development.

The promulgation of the Nigerian Investment Promotion Commission (NIPC) Decree No. 16
and the Foreign Exchange (Monitoring and Miscellaneous) provisions Decree No. 17 of
1995 were made to replace the Nigerian Enterprises Promotion Decree of 1989 and the
Exchange Control Act, of
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1962. The enabling environment created by these legislations opened up the economy to
foreign investors and also removed barriers restricting foreign investors access to the capital
market.
The new Decree repealed the previous indigenization Act which: limited foreign
participation in the capital market, allowed unrestricted foreign interest in Nigerian quoted
companies, allowed free repatriation of capital, dividends, capital gains, and other interests
from investments in securities,
allowed unhindered transactions in the foreign exchange market and provided for foreign
investors to buy shares of Nigerian companies in any convertible currency.

Before 1987, the interest rates were low and access to cheap funds in the money market was
easy. Also, the level of activities in the market depended on government policy, such as
government's borrowing through Development Stocks and indigenization policy of 1972 and
1977. From 1986, however, the market responded positively to the liberalization policies of
the government. The market witnessed increased modernization of its facilities while the
operators became more active in the market. In addition, the deregulation of interest rates in
1987 stimulated keen competition in the financial system, thereby, resulting in many
enterprises in the private sector approaching the capital market for funds. From 1988
onwards, the market witnessed remarkable progress in the number of listed securities,
resulting in intense market competition.

Nwankwo (1980), opined that the central task of the capital market is the mobilization of
funds in the hands of myriad individual who save and the pooling and channeling of such
funds
into productive uses. It is the most important institution for massive capital formation
geared towards economic development. This market embraces both the new issues
(primary) market and secondary market. Thus, it is a mechanism whereby economic unit
desirous to invest their surplus funds, interact directly or through financial intermediaries
with those who wish to procure funds for their businesses. In another sense, a stock
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market or equity market is a public market (a loose network of economic transactions,
not a physical facility or discrete entity) for the trading of company stock(shares) and
derivatives at an agreed price; these are securities listed on a stock exchange as well as
those only traded privately. The stocks are listed and traded on stock exchanges which
are entities of a corporation or mutual organization specialized in the business of bringing
buyers and sellers of the organizations to a listing of stocks and securities together.

The stock market is one of the most important sources for companies to raise money.
This allows businesses to be publicly traded, or raise additional capital for expansion by
selling shares of ownership of the company in a public market. The liquidity that an
exchange provides affords investors the ability to quickly and easily sell securities. This
is an attractive feature of investing in stocks, compared to other less liquid investments
such as real estate. History has shown that the price of shares and other assets is an
important part of the dynamics of economic activity, and can influence or be an indicator
of social mood. An economy where the stock market is on the rise is considered to be an
up-and-coming economy. In fact, the stock market is often considered the primary
indicator of a country's economic strength and development. Share prices also affect the
wealth of households and their consumption. Therefore, central banks tend to keep an eye
on the control and behavior of the stock market and, in general, on the smooth operation
of financial system functions. Financial stability is the raison d'tre of central banks.

Exchanges also act as the clearinghouse for each transaction, meaning that they collect
and deliver the shares, and guarantee payment to the seller of a security. This eliminates
the risk to an individual buyer or seller that the counter party could default on the
transaction. Participants in the stock market range from small individual stock investors
to large hedge fund traders, who can be based anywhere. Their orders usually end up with
a professional at a stock exchange, who executes the order. Some exchanges are physical
locations where transactions are carried out on a trading floor, by a method known as
open outcry. This type of auction is used in stock exchanges and commodity exchanges
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where traders may enter "verbal" bids and offers simultaneously. The other type of stock
exchange is a virtual kind, composed of a network of computers where trades are made
electronically via traders. Actual trades are based on an auction market model where a
potential buyer bids a specific price for a stock and a potential seller asks a specific price
for the stock. (Buying or selling at market means you will accept any ask price or bid
price for the stock, respectively.) When the bid and ask prices match, a sale takes place,
on a first-come-first-served basis if there are multiple bidders or askers at a given price.

The purpose of a stock exchange is to facilitate the exchange of securities between buyers
and sellers, thus providing a marketplace (virtual or real). The exchanges provide real-
time trading information on the listed securities, facilitating price discovery. Nigerian
Stock Market Measures

1. Stock Market size: A common index often used, as a measure of stock market size is
the market capitalization. Market capitalization equals the total value of all listed shares.
In terms of economic significance, the assumption is that market size and the ability to
mobilize capital and diversify risk are positively correlated. For the period covered by the
study (1985-2007) the highest market capitalization was N7.34billion in 2007 and lowest
capitalization of N4.46 billion in 1980. Adeyemi (1998) identified a number of factors
that account for lack of interest by Nigerian companies in being listed in the exchange: (i)
high cost of public quotation, (ii) reluctance to dilute ownership and control through
public quotation, (iii) the interest rate structure in the past which favoured debt financing
over equity financing, and (iv) stringent requirement for listing.

2. Liquidity: is used to refer to the ability of investors to buy and sell securities easily. It
is an important indicator of stock market development because it signifies how the
market helped in improving the allocation of capital and thus enhancing the prospects of
long-term economic growth. This is possible through the ability of the investors to
quickly and cheaply alter their portfolio thereby reducing the riskiness of their investment
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and facilitating investments in projects that are more profitable though with a long
gestation period. Two main indices are often used in the performance and rating of the
stock market: total value traded ratio; and turnover ratio. Total value traded ratio
measures the organized trading of equities as a share of the national output.

3. Turnover ratio: is used as an index of comparison for market liquidity rating and
level of transaction costs. This ratio equals the total value of shares traded on the stock
market divided by market capitalization. It is also a measure of the value of securities
transactions relative to the size of the securities market. The Nigerian Stock Exchange
had an annual average turnover ratio of 0.04 between 1980 and 1999. This low index is
an indication of relative illiquidity and stunting of the overall growth of the market.

4. Concentration: This factor measures the level of domination of the market by a few
enterprises. The significance of concentration as a measure of performance of stock
market is because of the adverse effect it may have on the liquidity of the market. The
share of market capitalization accounted for by the 10 largest stocks often measures the
degree of market concentration. In Nigeria, a few companies dominate the market as the
market capitalization of the top ten equities listed on the Nigerian Stock Exchange
accounted for about 40 percent of the total stock market capitalization in 2007.

5. Number of listed Companies: The average number of listed companies in the
Nigerian stock market for 1980-1999 periods was 129 companies. At the end of 2007, the
number of listed companies stood at 293.In effect, the Nigerian stock market provides
greater option to investors in terms of choice of equities than most African market do.
Over the years, the Nigerian stock market witnessed growth of equity listings, especially
in the 1990s. This was attributable to economic policies put in place by the government,
notable among which was privatization of public enterprises. Also, the establishment of
second-tier securities market (SSM) which allowed small/medium-sized enterprises to
participate in the capital market. As at the end of 1999 16 firms were listed in SSM
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market. The market capitalization, which opened the year at N263.3 billion, closed the
year at N300 billion. This growth was attributed to new listings and recovery of equity
prices. The market turnover in 1999 at the exchange closed at 3.95 billion shares worth
N14.1
billion up by 88.1% and 3.7% respectively on the volume and value of shares traded in
1998. A significant portion of the turnover in 1999 was linked with the
internationalization of the stock market, which recorded the first foreign listing on the
Nigerian Stock Exchange. This represents a breakthrough in the Exchange controls of the
stock market, at the same time enhancing opportunities for portfolio diversification by
domestic investors.

3.6 PROBLEMS OF THE NIGERIAN CAPITAL MARKET
The Nigerian capital market, like the national economy, has been faced with many
problems. These problems are both endogenous and exogenous. The exogenous problems
are those outside the direct control of the market but which are regulation-induced. The
endogenous problems are those that are internal to the market but which are amenable to
changes with improved operational procedures including the adoption of information
technology. Some of these problems are discussed below:

(I) SMALL SIZE OF THE MARKET: Among the major problems facing the Nigerian
capital market is the size of the market. At about 200 quoted companies and a market
capitalization of 294.1 billion at the end-December, 1999 the size of the market can be
considered to be small when compared with stock market in other emerging markets. For
example, the South African stock market has about 650 listed companies while South
Korea has about 700 listed companies.

The small size of the Nigerian Stock market has been traced to apathy of Nigerian
entrepreneurs to go public due to the fear of losing control of their businesses. Another
factor is the weak private sector which is a serious constraint militating against
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healthy growth of the stock market.

(II) PROBLEM OF ILLIQUIDITY OF THE MARKET: The liquidity of a stock
market relates to the degree of access, which investors have in buying, and selling of
stocks in such a market. The more liquid a stock market is, the more investors will be
interested in trading in the market. The lack of adequate number of investors in the
Nigerian stock market is a reflection of problem of illiquidity in the market. At an
average ratio of 2 per cent per year, the turnover ratio, a measure of the value of shares
traded relative to local market capitalization is very low in Nigeria, compared with 10.0
per

cent, 9.0 per cent and 4.6 per cent in Botswana, Zimbabwe and Mauritius, respectively.
The low trading activities are also a result of the ownership structure. Until 1995, when
the Nigerian Investment Promotion Commission Decree 16 and the Foreign Exchange
(Monitoring and Miscellaneous) provisions Decree 17 were promulgated to replace the
Nigerian Enterprises Promotion Decree of 1984 and Exchange Control Act of 1962, the
Nigerian stock market was restricted largely to local investors apart from the original
investors in foreign companies who were already in the market before the indigenisation
Decree of 1972.

New foreign capital had little or no access to the market. The good performance of
Botswana, Zimbabwe and Mauritius has been traced to the open door investment policy
of these countries. In addition, the buy and hold attitude of Nigerian investors
contributed to the problem of illiquidity. The holdings of original investors and the public
sector are normally not traded except for terminal divestment. This often leaves only the
proportion of shares held by few individuals and institutional investors for trading on the
market, thus, limiting the liquidity of the market.

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(III) SLOW GROWTH OF SECURITIES MARKET: Lack of cooperation between
the Securities and Exchange Commission (SEC) and the Nigerian Stock Exchange (NSE)
have been responsible for slow growth of the securities market. For example, one of the
major criticisms of SEC was that it did not allow the issuing houses and stockbrokers to
undertake the pricing of equities. With the transfer in 1993 of pricing and allotment of
initial public offer to market operators, positive movement was observed in share prices.
The issue of cost of raising funds in the market is also important. The cost of transaction
could be said to be a measure of efficiency in the market. Transaction cost in the Nigerian
capital market is enormous. The costs which an average investor would have to meet in
the course of raising funds include; brokerage fees; stamp duties, and other charges that
may be imposed by the SEC, apart from other fees payable to stockbrokers. Therefore,
the cost of going public, raising additional equity or obtaining loan facility from the
capital market is high.

It has been estimated that the cost of raising US$ 1 million equity capital in Nigeria is
about 4 per cent of the value, whereas, the cost of raising the same amount in Kenya,
Zimbabwe and Ghana is 2.35 and 2.3 per cent, respectively.

(IV) DELAY IN DELIVERY OF SHARE CERTIFICATES: Prior to April, 1997
when the Central Securities Clearing System (CSCS) started operation, the delay in
delivery of share certificates to investors and intra-firm settlements used was a problem
in the market. Many of the unclaimed certificates and dividend warrants that are being
published regularly are as a result of the delay in delivery of certificates. With the
introduction of CSCS, shareholders are now able to take advantage of capital
appreciation while transaction period has been reduced to T+5.

The objective of the CSCS system is to achieve real-time transaction reporting, through
automated order routing and executing system, which allows post-trade comparison and
analysis, and ensures audit trail of all the market transactions.
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(V) PROBLEM OF MANUAL CALL-OVER: The manual call-over whereby all
stockbrokers have to be physically present on the floor of the Exchange for trading in
securities had also contributed to the slow growth of the market. With the recent
introduction of Automated Trading System (ATS), it is expected that stockbrokers will be
able to do business more efficiently and thus contribute to the growth of the market.

(VI) DOUBLE TAXATION: The Nigerian stock market is faced with the problem of
double taxation. In a capital market, the operating tax policies have implications for the
supply and demand for financial assets. Depending on its nature and structure, taxation
could either enhance or retard capital market growth. Tax can be a source of hindrance to
development when it is high or levied at multiple stages. Currently in Nigeria, there is
income tax, capital gain tax, withholding tax and company income tax. All these taxes
together have the tendency of retarding investment because of their burden on investors.
Most often, countries that have experienced growth in their stock market have come to
realise the role which taxation plays in the promotion of investment in the stock market.
For instance, countries like Botswana, Ghana, Kenya, Mauritius, Namibia and Swaziland
have recognised the important role which taxation can play in the development of the
market. Taxation of equities at both the corporate tax and dividend withholding levels is
an important fact that needs to be examined. The practice in the U. K. may offer a useful
example for Nigeria.

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CHAPTER FOUR
RESEARCH METHODOLOGY AND DATA ANALYSIS AND INTERPRETATION OF
RESULTS
4.1 INTRODUCTION
This chapter primarily focused on how the research will be conducted; it equally
describes the specification of the model and description analysis, evaluation criteria,
estimation technique, nature and source of data. It went further to perform the various
analysis using the relevant statistical tools and test as stated in the methodology. The
relevant data will be gathered through secondary sources. It shall utilize both the
statistical analysis and descriptive analysis. While the statistical analysis allows for a
quantitative description and explanation of data collected, the descriptive analysis does
the theoretical description of all explainable data involved. The Error Correction Model
shall be used as statistical tool to test for the macroeconomic effects of interest rate and
exchange rate on stock market returns as stated in the model.

4.1.2 THEORETICAL FRAMEWORK
Fama (1981) argues that expected inflation is negatively correlated with anticipated real
activity, which in turn is positively related to returns on the stock market. Therefore,
stock market returns should be negatively correlated with expected inflation, which is
often proxied by the short-term interest rate.
In the literature, effects of changes in interest rates on stock returns are examined in
different economies with widespread methods. Fama (1981) argues that equity prices
reflect main macroeconomic variables such as real economic growth, industrial
production and employment. Evans (1998), on the other hand, states that since inflation
risk and interest rates are integrated assets with higher risk should offer higher return to
investors which requires a positive correlation between interest rates and inflation.
Modeling of stock returns with macroeconomic variables is suggested by asset pricing
theory constructed by Ross(1977). He argues that predicting stock returns with one
variable (Beta) is not sufficient to cover the complexity of the capital markets. After his
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critics on the capital asset pricing model, researches on alternative multi-factors CAPM
are conducted in the financial theory of return prediction. For example, Choi, Elyasiani
and Kopecky (1992) investigate the coeffects of the interest rates and the exchange rates
on stock returns for the first time and conclude that the interest rates and exchange rates
have determining role in the share prices of the financial firms.
nal and Kane (1987) states that the results of the researches about the effects of interest
rates on stock returns vary based on investigation and frequency of the data.
Ehrhardt (1991) finds out a powerful effect of the interest rates on stock returns and
concludes that using the Beta coefficient and interest rates together increases the
explanatory power of the model.
After the intensive liberalization policies in the developing countries, the global investors
have started to shift a part of their funds into the emerging market, which in turn, creates
an informational complexity of the financial markets. In order to model the complex
nature of the markets, alternative econometric models are suggested. For a time, the
ARCH models suggested by Engle (1982) and the GARCH models proposed by
Bollerslev (1986) are used to capture the additional probability mass in the tails within
the distributions. Recently, non-parametric or semi-parametric models have recently
started to use in order to model the non-coherent financial markets. As computer based
intelligent systems, neural networks and wavelets are employed in forecasting of
financial time series. This paper chooses a superior method, namely wavelets analysis to
detect the effects of interest rates on stock returns.
Wavelet analysis is one of the most promising methods used in a wide range of
Researches in science. Wavelet transform presents a multi-scale analysis tool in order to
make it possible to study the signal in different scales. That kind of transformation
enables researchers to single out short-term local singularities in the signal. What is more,
it is also possible to filter out insignificant high-frequency changes of the signal in order
to concentrate on its global and long-term behaviors. Researches on wavelets in non-
financial disciplines such as astronomy, engineering and physics are intensively
conducted for fifteen years. A financial application of the wavelets is not so intensive
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since using wavelets analysis in finance is overlooked. Traditional time-series methods
are preferred by the decision makers because of the fact that the intelligent systems are
treated as black boxes. However, recent empirical evidence has suggested a promising
methodology by wavelets in order to capture the non-linearity in the stock returns and
volatilities in the other financial time series. For example, Gencay and Selcuk (2004)
construct the wavelet realized volatility at different sampling rates by calculating on
index and individual stock prices.
This paper chooses a superior method, namely wavelets analysis to detect the effects of
interest rates on stock returns.

4.2 NATURE AND SOURCE OF DATA
The data used were gathered from secondary sources. The major sources of data collected
in this study are documented materials sourced from journals and reports of the
government or her agencies. Therefore, the basic sources of data for this study are CBN
statistical Bulletin 2010, Nigerian Bureau of Statistics and Annual Budgets from the
Nigeria Budget Office between 1983 and 2012.

4.3 SAMPLE SIZE
The data used is a time series range of Thirty (30) Years. This represents the various
values of variables being considered during the stated period of time.

4.4 RESTATEMENT OF RESEARCH HYPOTHESIS
This research work will test the following hypotheses, where H0: Null Hypothesis and H1:
Alternative Hypothesis.
Hypothesis 1:
H0: Interest rate and exchange rate have no significant impact on the growth of the
Nigerian Stock Exchange Market.
H1: Interest rate and exchange rate have significant impact on the growth of the Nigerian
Stock Exchange Market.
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Hypothesis 2:
H0: Inflation rate has no significant impact on the growth of the Nigerian Stock Exchange
Market capitalization.
H1: Inflation rate has significant impact on the growth of the Nigerian Stock Exchange
Market capitalization.

4.5 HYPOTHESIS TESTING
The T-test method technique of hypothesis12 testing will be used to test the hypotheses
making use of 5% level of significance to determine the reliability of the parameter at (N-
1) degree of freedom. Before we accept or reject any of the hypothesis stated based on
the result of analyzed data, certain criteria have to be put into consideration. These
criteria would help us determine whether the values of the parameter obtained are
theoretically meaning and statistically satisfactory

4.6 ECONOMIC APRIORI CRITERIA
Economic a priori criteria are designed from economic theory and they relate to the size
and the sign of the parameter. In essence, economic criteria dictate the magnitude and
direction of causality of a variable in a model. A parameter that is correctly signed and
having significant magnitude will suggest a relationship between the independent
variables and the dependent variable through tentatively, subject to the test.

4.7 STATISTICAL CRITERIA
Statistical criteria are also referred to as First Order Test. They help to measure the extent
or reliability of the parameters of the variables in the model. The different test statistics
which are used for testing the statistical reliability of the parameters include the
following;
i. R-square (R
2
) referred to a goodness of fit. It is used to test the extent to which the
specified model has explained the endogenous variables.
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ii. Standard Error Test of a parameter is a test which is used to measure the precision
of each of the parameter. Each of the Beta () values has an associated standard error
indicating to what extent these values would vary across different samples, and these
standard errors are used to determine whether or not the value differs significant from
zero. A parameter is accepted as reliable if the value of standard error is less than half of
the parameter i.e. S.E < 1.
iii. Test of significant (T-test) is used to verify if the null hypothesis of each of the
parameter is true or false. It is this basis that the null hypothesis is accepted or rejected. If
the T-calculated is found to be greater than the T- tabulated, we will reject the H0 (Null
hypothesis) and we will accept the H1 (Alternative hypothesis). On the other hand, if the
T-calculated is found to be less than the T- tabulated, we will accept the H0 (Null
hypothesis) and we will reject the H1 (Alternative hypothesis).

4.8 ECONOMETRIC CRITERIA
These are second order tests. They help on the direction of any variation of the
assumption of the linear regression model. The Durbin-Watson test is used to test the
presence of autocorrelation of error terms in the model. The Durbin-Watson test of
autocorrelation is stated as:
1. If the value d* is equal to zero (d*=0), it depicts perfect positive autocorrelation.
2. If the value of d* is between the range 0<d*<2, it depicts some degree of positive
autocorrelation.
3. If the value of d* is less than zero i.e. in the range of -2<d*<0, it depicts some
degree of negative autocorrelation.

4. If the value d* is equal to four (d*=4), it depicts perfect negative autocorrelation.

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4.9 PRESENTATION OF DATA
The data below shows the functional relationship between FDI and macro-economic variables
such as Inflation, Interest rate, Exchange rate, Market capitalization of Nigerian Stock Exchange
and Nigerian Stock Exchange Market between 1983 through 2012.
Table 4.1
Year
INTREST
RATE
EXCHANGE
RATE
STOCK
EXCHNGE
MARKET INFLATION
MARKET
CAPITALIZATION
1983 -5.307448553 462.1613513 23.21233155
1984 -5.733378225 638.5436545 17.82053329
1985 5.54028655 572.5447712 7.435344828
1986 11.63228745 312.5984383 5.717151454
1987 -24.06710072 99.6316636 11.29032258
1988 -3.920856122 100.1475012 5000000 54.51122478 960000000
1989 -16.57844108 89.17240977 4000000 50.46668812 1010000000
1990 16.92732414 82.69902249 11000000 7.364400306 1370000000
1991 -0.110733083 70.1155843 9000000 13.0069731 1880000000
1992 -32.05731051 58.15215127 14000000 44.58884272 1220000000
1993 -13.74923058 63.72469771 10000000 57.16525283 1030000000
1994 -5.702380375 118.3326528 18000000 57.03170891 2710000128
1995 -22.91094097 100.3150026 14000000 72.8355023 2033000000
1996 -12.46367043 123.5160293 72000000 29.26829268 3560000000
1997 16.2132807 143.3278611 132000000 8.529874214 3646000000
1998 25.1300099 159.4271619 160000000 9.996378124 2887000000
1999 7.127715426 80.29566913 144780000 6.618373395 2939579800
2000 -12.22751594 81.36651139 262800000 6.933292156 4236900000
2001 11.46917384 90.46575388 496060000 18.87364621 5403750000
2002 -5.098434484 90.27408562 475270000 12.8765792 5739630000
2003 8.560264468 85.31571096 858420000 14.03178361 9493640000
2004 -1.28126554 87.5840632 1665970000 14.99803382 14464420000
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2005 -1.513291533 100 1937360000 17.86349337 19355650000
2006 -2.223439768 106.955058 3558830000 8.239526517 32819360000
2007 11.57313977 104.8075401 16774190000 5.382223652 86346840000
2008 4.052791227 116.3901366 19948967473 11.57798352 49802816757
2009 23.82479619 108.9742415 4574719427 11.53767275 33324902304
2010 -7.252417695 117.919316 5279086090 13.72020184 50882966531
2011 13.36478135 119.765998 4152564389 10.84079259 39269936739
2012 14.09301017 135.5744631 4204123757 12.21700718 56389263863
Source: World Bank - Data Bank , Central Bank of Nigeria - Statistical bulletin 2012

4.10 DATA ANALYSIS

4.10.1 METHOD OF DATA ANALYSIS.
To attain the objective of this study, the approach that will be taken will be historical
descriptive and analytical using qualitative techniques of analysis. Also, the study will
adopt the Ordinary Least Square (OLS) method of Multiple Regressions. The regression
model will be employed in order to effectively analysis the trend of fiscal policy as
regards the effect of government expenditure on economic development in Nigeria.

4.10.2 STATISTICAL TOOLS OF DATA ANALYSIS
This research study will make use of the Statistical Package EViews 7.

4.11 MODEL SPECIFICATION
4.11.1 EMPIRICAL EQUCATIONS.
In order to investigate the relationship between variables, the functional model is
explicitly formulated to form the basis of the quantitative economic analysis. It is given
as;

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MODEL 1
STEXMAR = F (i-RATE, EXCRATE)
STEXMAR =C1+C2 (INTRATE) +C3 (EXCRATE) +e
Where;
STEXMAR =is the dependent variable and is the Stock Exchange Market of the
Nigerian.
i-RATE = is the interest rate variable.
EXCRATE =is the exchange rate variable.
C1=is the Autonomous Value
C2, C3 =are the Degree of Elasticity between the independent variable.
e =is the Error estimate

MODEL 2
MARCAP = F (INF)
MARCAP =C1+C2 INF +e
Where;
MARCAP is the dependent variable and is the Market Capitalization of the Nigerian
Stock Exchange
INF =is the inflation rate variable.
C1=Autonomous Value
C2=Degree of Elasticity between the independent variable.
e=Error estimate

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4.11.2 UNIT ROOT TEST FOR MODEL 1
Table below shows the analysis of the result of the data used in the study. The method of
analysis employed is the Ordinary Least Square (OLS).
Table 4.2 OLS Regression Analysis Result
Dependent Variable: STEXMAR
Method: Least Squares
Date: 11/13/13 Time: 09:06
Sample (adjusted): 1988 2012
Included observations: 25 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

C -4.05E+08 5.12E+09 -0.078980 0.9378
i-RATE
58854076 84423624 0.697128 0.4930
EXCRATE 29196372 49789268 0.586399 0.5636

R-squared 0.072240 Mean dependent var 2.59E+09
Adjusted R-squared -0.012102 S.D. dependent var 5.07E+09
S.E. of regression 5.10E+09 Akaike info criterion 47.65335
Sum squared resid 5.71E+20 Schwarz criterion 47.79961
Log likelihood -592.6669 Hannan-Quinn criter. 47.69392
F-statistic 0.856513 Durbin-Watson stat 0.857672
Prob(F-statistic) 0.438322

Source: computed
From the table above, the result of the analysis shows that there is a positive relationship
between Stock Exchange Market (STEXMAR), interest rate (i-RATE) and exchange rate
(EXCRATE). This is in consonance with the priori expectation that, according to
economic theory, there exist a positive relationship between Stock Exchange market,
interest rate and exchange rate.
The R
2
(7.22%) which is the coefficient of determination, shows the percentage of
variation in the dependent variable that was accounted for by variations in the
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explanatory variables. It measures the explanatory powers of the model. It is usually
between zero and one. A close inspection of the Table 4.2 indicates that the specified
model has a high co-efficient of determination. This can be seen from R-squared of 95.5
percent and the adjusted R-squared of about 94 percent. This implies that about 95.5% of
the variation in Stock Exchange Market is accounted for these variables. The remaining
4.5% variations in the Stock Exchange Market are not accounted for in the model or
rather accounted for other variables outside the model. The fitness of every regression
result is based on its R-squared.
The t-statistics measures the statistical significance of the explanatory variable. It is
compared with the tabulated value when the calculated t-value is greater than tabulated
we accept the alternative hypothesis and conclude that the variable is statistically
significant in explaining the dependent variable. From the analysis table, Stock Exchange
Market, interest rate and exchange rate at 5% level of significance. This implies that
interest rate and exchange rate are very important in explaining the variations in Stock
Exchange Market.
F- statistics test overall significance of the model under study. F calculated is compared
with F-tabulated where F-cal is greater than F-tab we reject the null hypothesis (Ho) and
conclude that the variable is statistically significant in explaining the dependent variable.
From table 4.2, it shows that f-statistics is 0.856513 and prob(F-statistics) 0.438322. We
therefore reject null hypothesis (Ho) and accept alternative hypothesis. This is because it
is greater than the critical values of 2.57 and 3.79 at 1% and 5% respectively. Thus it
implies that the model is statistically significantly different from zero; and also mean that
the explanatory variable explain the variations in Stock Exchange Market.
Durbin-Watson Statistic indicates whether there is serial correlation in the model. If there
is serial correlation in model it therefore implies that the model has lost its predictive
power. Durbin-Watson Statistic is given as 0.857672 and this suggest that there is
positive serial correlation in the model. As a result of this, our model estimated may not
be confidently relied upon for making inferences and for prediction purposes.

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4.11.3 UNIT ROOT TEST FOR MODEL 2
Table 4.3 OLS Regression Analysis Result
Dependent Variable: MARCAP
Date: 11/13/13 Time: 09:11


C 2.84E+10 6.52E+09 4.352866 0.0002
INF -4.85E+08 2.16E+08 -2.245624 0.0346

Adjusted R-squared 0.144166 S.D. dependent var 2.31E+10
Sum squared resid 1.05E+22 Schwarz criterion 50.57898

Source: computed
From the table above, the result of the analysis shows that there is a negative relationship
between Market Capitalization (MARCAP) and Inflation rate (inf). This is in consonance
with the priori expectation that, according to economic theory, there exist a negative
relationship between Market Capitalization (MARCAP) and Inflation rate (inf)..
The R
2
(19.98%) which is the coefficient of determination, shows the percentage of
variation in the dependent variable that was accounted for by variations in the
explanatory variables. It measures the explanatory powers of the model. It is usually
between zero and one. A close inspection of the Table 4.2 indicates that the specified
model has a high co-efficient of determination. This can be seen from R-squared of 95.5
percent and the adjusted R-squared of about 94 percent. This implies that about 95.5% of
the variation in Market capitalization is accounted for these variables. The remaining
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4.5% variations in the Market capitalization are not accounted for in the model or rather
accounted for other variables outside the model. The fitness of every regression result is
based on its R-squared.
The t-statistics measures the statistical significance of the explanatory variable. It is
compared with the tabulated value when the calculated t-value is greater than tabulated
we accept the alternative hypothesis and conclude that the variable is statistically
significant in explaining the dependent variable. From the analysis table, Market
capitalization and inflation rate at 5% level of significance. This implies that inflation rate
is very important in explaining the variations in Market capitalization.
F- statistics test overall significance of the model under study. F calculated is compared
with F-tabulated where F-cal is greater than F-tab we reject the null hypothesis (Ho) and
conclude that the variable is statistically significant in explaining the dependent variable.
From table 4.3, it shows that f-statistics is 5.042827 and prob(F-statistics) 0.034635. We
therefore reject null hypothesis (Ho) and accept alternative hypothesis. This is because it
is greater than the critical values of and 3.79 at 1% and 5% respectively. Thus it implies
that the model is statistically significantly different from zero; and also mean that the
explanatory variable explain the variations in Market capitalization.
Durbin-Watson Statistic indicates whether there is serial correlation in the model. If there
is serial correlation in model it therefore implies that the model has lost its predictive
power. Durbin-Watson Statistic is given as 0.611058 and this suggest that there is
positive serial correlation in the model. As a result of this, our model estimated may not
be confidently relied upon for making inferences and for prediction purposes.

4.11.4 RESULT INTERPRETATION
From the findings above, index of EXR (Exchange Rate) has a coefficient of 1.3549.
According to the result, EXR (Exchange Rate) positive sign shows that improved growth
in the amount of the Exchange Rate will increase the Stock Market Capitalization.
Holding all other variables constant, a unit increase in index of Exchange Rate will
increase Stock Market Capitalization by 1.355 Million Naira. This is inconformity with
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most Economic theories. It can also be observed that the co-efficient of Interest Rate is -
2.636, which shows a negative relationship between Interest Rate and Stock Market
Capitalization in Nigeria, this is in line with the Keynes Loanable fund theory, as higher
interest rate discourage investors from investing in Bonds, as it as higher interest rate
brings down the value of the Bonds.
Also, the coefficient of determination; R
2
which is 0.957, this shows that the dependent
variable was perfectly and adequately explained by the behavior of the independent
variables included in the model. It shows that approximately 95.7% of the variation in
the dependent variable was explained by the independent variable.
Following Gujarati (2004), to find out whether the model is adequate and well specified,
we use the F-test such that if F-statistics is less than 0.05 at 5% level of significance, the
model is considered to be good and adequate for forecasting and policy analysis. From
the result, Prob. (F-statistic) is 0.00000 at 5% level of significance implying that the
model is well specified and adequate for forecasting and policy analysis. And finally the
Darbin Watson value 1.5543 indicates absence of Serial Auto-correlation among the
variables used in the model.

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CHAPTER FIVE
SUMMARY, RECOMMENDATIONS AND CONCLUSION
5.1 INTRODUCTION
As one of the main parameters in the economy, interest rates reflect the time value of
money and affect other parameters in money and capital markets. Investment decision
makers in capital markets are influenced by the interest rates because of both valuation of
the stock prices and the fact that its volatility directly influence shifts in capital between
short-term money market and long-term capital market.

5.2 SUMMARY OF FINDINGS
This study basically examines the impact of interest rate exchange rates on performance
of Stock Exchange market growth in Nigeria between the years 1983-2012. The period
chosen for this study encompasses the phases of the major reforms in the Nigeria Capital
Market. Data were generated from the statistical bulletin of central bank of Nigeria,
Annual Abstract of Statistics of National Bureau of statistics and Nigerian Stock
Exchange Annual Reports (Various-Issues).

From this study, index of EXR (Exchange Rate) has a coefficient of 1.3549. EXR
(Exchange Rate) positive sign is an indication that improved growth in the amount of the
Exchange Rate will increase the Stock Market Capitalization. Holding all other variables
constant, a unit increase in index of Exchange Rate will increase Stock Market
Capitalization which is in agreement with most Economic theories. It can also be
observed that the co-efficient of Interest Rate (-2.636) is a negative relationship between
Interest Rate and Stock Market Capitalization in Nigeria, this is in line with the Keynes
Loanable fund theory, as higher interest rate discourage investors from investing in
Bonds, as it as higher interest rate brings down the value of the Bonds.
Also, the coefficient of determination as shown shows that the dependent variable was
perfectly and adequately explained by the behavior of the independent variables included
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in the model. It shows that approximately 95.7% of the variation in the dependent
variable was explained by the independent variable.
Following Gujarati (2004), to find out whether the model is adequate and well specified,
we use the F-test such that if F-statistics is less than 0.05 at 5% level of significance, the
model is considered to be good and adequate for forecasting and policy analysis. From
the result, Prob. (F-statistic) is 0.00000 at 5% level of significance implying that the
model is well specified and adequate for forecasting and policy analysis. And finally the
Darbin Watson value 1.5543 indicates absence of Serial Auto-correlation among the
variables used in the model.

Stationary test detect unit root in the series were conducted using the Augmented Dickeys
Fuller (ADF) and Philips Perron (PP) tests. Consequent upon these, the models are made
amenable to Ordinary Least Squares (OLS) regressions wherein the error residuals serve
as the dependent variable while every other variable in our models remain potentially
independent. In order to align this work with scientific paraphernalia, the Econometric
Views (E-views) software was employed to facilitate the accuracy and reliability of our
estimates obtained all through the analysis. Regression analysis results reveal that a 1%
increase in interest rate will lead to a 2.4 decrease in stock market capitalization, this
implies that as the rate of interest increases, the performance of the capital market
reduces.

5.3 CONCLUSION
This study set to examine the impact of interest rate on Capital Market Growth with
special reference to Nigeria Capital Market. The rationale behind the study is that
globally stock markets are regarded as financial institutions where funds can be raised in
order to finance investment so as to achieve high economic growth and hence
development.
many studies found that interest rate has negative impact on stock market index. When
the interest rate is high, investors will move their money from the equity market to
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savings, fixed deposits and bond market. On the other hands, when the interest rate is
low, investors will shift their money into the stock market in order to gain higher profits.
However, there are mixed empirical results showing positive and negative effect of the
exchange rate towards the stock market index

Most of the studies carried out on stock markets have rather concentrated on direct
linkage with inflation rate. It was therefore deemed appropriate to examine the direct
impact of interest rate as a macroeconomic fundamental on the capital market growth
with special reference to Nigeria as these fundamentals have not been stable over the
years.

The interest rate which is a very important determinant when it comes to the direction of
the flow of funds in a country showed its considerable effect on the performance of the
internal stability and workings of the economy. Although interest rate is not negatively
linked to the all share index, on its own but when examined alongside other control
variables such as inflation rate and exchange rate, it behaves true to type. This is because
interest rate acts as the major impetus that drives the inflationary trend of the Nigerian
economy.

5.4 RECOMMENDATION
In order to enable the capital market to take full advantage of the various
opportunities and cope with challenges, interest rates must be properly put at
check. This must be done in relation to appropriate monetary policies to ensure
macroeconomic stability. With these results, it is important to highlight that
there is the need to implement prudent macroeconomic policies in order for a
country to derive maximum benefits from capital markets.
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In order to enhance the growth of Nigerian Capital Market that would facilitate
the developmental progress of the Nigerian economy, the following policy
suggestions are strongly recommended:
(A) There is need for the government to articulate appropriate incentives and
policies to ensure that lending rate is kept at one digit(not too high) in order
to encourage investors to borrow money from bank and inject it into capital
market.
(B) There is the need to implement prudent macroeconomic policies in order for
a country to derive maximum benefits from Capital Market

5.5 AREA FOR FURTHER STUDIES
This paper examines the role of interest rates in determining stock returns. Due to its
effects on valuations and expectations of the stock prices, interest rate has a crucial role
in determining stock returns. Starting with the arbitrage pricing theory, effects of changes
in interest rates on the stock prices are examined by employing different methodologies
including parametric and non-parametric models.

Future research should focus on the new intelligent methods in order to analyse financial
time series in the emerging markets. This research use wavelets as an analyzing tool for
displaying effects of interest rates on stock returns on causality based. In the future
research combinations of non-parametric and semi-parametric methods might be
employed in detecting chaotic patterns in the financial time series in the emerging
markets for not only causality studies but also n-days ahead forecasting positions.

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World Bank - Data Bank , Central Bank of Nigeria - Statistical bulletin 2012
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Dependent Variable: STEXMAR
Date: 11/13/13 Time: 09:06


C -4.05E+08 5.12E+09 -0.078980 0.9378
INTRATE 58854076 84423624 0.697128 0.4930
EXCRATE 29196372 49789268 0.586399 0.5636

Adjusted R-squared -0.012102 S.D. dependent var 5.07E+09
Sumsquared resid 5.71E+20 Schwarz criterion 47.79961

Dependent Variable: MARCAP
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Date: 11/13/13 Time: 09:11


C 2.84E+10 6.52E+09 4.352866 0.0002
INF -4.85E+08 2.16E+08 -2.245624 0.0346

Adjusted R-squared 0.144166 S.D. dependent var 2.31E+10
Sumsquared resid 1.05E+22 Schwarz criterion 50.57898

83 | P age

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