The Australian Securities Exchange and Interest Rates - Case Study Example

RUNNING HEAD: The Australian Securities Exchange and interest rates Your Name Goes Here: Name of University: Executive Summary In financial economics, interest rates and the stock exchange are two important factors that determine the economic growth of a country. Ideally, the effects of interest rate on a country’s stock exchange present significant implications for hedging and other risk management practices, stock market securities valuation, the monetary policy, and other government policies towards financial markets. This research aims at presenting supporting evidence on the existence of negative relationship between stock prices and interest rates based on the monthly data of two ASX200 companies (Suncorp-Metway Ltd and CSL Ltd) from January 2000 to December 2010. In order the relationship between share price of Suncorp-Metway Ltd and CSL Ltd and interest rate, changes of the two companies share price and the changes of interest rate were obtained from time series data. The research conducts a correlation analysis between the firms’ stock prices. For both companies it is found that interest rate has a noteworthy negative relationship with stock price. The correlation between interest rates and SUN corp’s share price is positive (0.55) indicating that there is a positive relationship between interest rates and the company’s share price. On the other hand, the correlation coefficient between interest rates and CSL’s share price is 0.026. This indicates that there exists a positive relationship between the company share price and interest rates but the relationship is weaker compared to that of SUN corp.Therefore, it is concluded that if interest rate is significantly controlled by the Australian government, it will yield great benefits for the Australian Securities Exchange by creating a demand pull effect of potential investors in share market, and also by triggering a supply push effect whereby more investment will be made by companies listed on the ASX. Introduction An Overview of the Australian Securities Exchange (ASX) The Australian Securities Exchange (ASX) was formed on July 2006 as a result of a merger of the Australian Stock Exchange with the Sydney Futures Exchange. The ASX is the main stock exchange group in Australia. In terms of market capitalization, the ASX is ranked top ten among stock exchanges in the world. ASX’s domestic market capitalization is approximated to be over AUS$1.6 trillion. The leading sectors by market capitalisation are financial, metal and mining and consumer which take about 36%, 22% and13% respectively. The main market index is the ASX 200, an index consisting of the top 200 shares in the ASX. The role of the Australian Securities Exchange (ASX) is to: serve as a market operator, supervise, be the central counterparty clearer, and to facilitate the payments system. Its varied domestic and supranational customer base consists of issuers of a variety of listed securities, investment banks, traders, fund managers, commodity trading analysts, and retail traders. In order to safeguard the market’s, ASX has stipulated standards that govern the behaviour of listed companies. ASX’s Issuers business unit is responsible for making daily decisions regarding the application of the ASX Listing Rules. To ensure compliance, guidance notes are published to help listed companies together with their advisers to gain full understanding of listing rules and procedures. ASX assumes the role of overseeing compliance of firms with its operating rules, besides promoting standards of corporate governance among the listed firms. In addition, it has a role of educating retail investors, provision of educational resources relating to its products including free online resources. ASX products and services include shares; derivatives, warrants, exchange traded funds, investment trusts, and interest rate securities among others (NASDAQ OMX, 2008). Interest rate market The ASX interest rate market consists of corporate bonds, commercial papers, floating rate notes, and bond related preference shares listed on the ASX. Interest rate securities are traded and settled in a manner similar to that of ordinary shares (Richard, (n.d). Nonetheless, the ASX provides information such as the maturity of these securities, their effective interest rate, yield etc., for purposes of comparison. In the current economy, interest rates are very unpredictable: rates a year (or even a month) ago are very dissimilar from those observed today in the financial markets. The reason behind this is that interest rates move with the rise and fall of general economic performance. In addition, interest rates move in response to borrowers’ and lenders’ expectations on future price levels. Policy makers will always try to strike a balance is struck between the demand and supply of funds by continuously adjusting interest rate levels (Jefferis & Okeahalam, 2000). Therefore, interest rate is one of the crucial macroeconomic variables that directly affect economic growth. In general, interest rate is understood to be the cost of capital, i.e., the price paid for using someone else money for a given period of time. Looking at it from the borrower’s, interest rate is simple the cost of borrowing. On the other hand, from a lender’s viewpoint, interest rate is the cost of lending money. Prudent investors will always seek investment opportunities where markets are efficient. Ideally, in cases where the market is inefficient, where only few investors make extra ordinary profits, the confidence of general people about the market is lost. Where this exists, if the interest rate paid by banks to depositors rises, people will naturally switch their money from the share market to banks. As a result, the demand for share will decrease, leading to decreased share price and vice versa (Uddin, 2009). On the other side, an increase in the interest rate paid by banks to depositors will also mean increased lending interest rate leading to decreased investments in the economy. Data Analysis An overview of Suncorp-Metaway Suncorp-Metway (also known as Suncorp Group) is a vanguard company in Australia’s insurance and banking sectors. Suncorp Group is involved in insurance business through Suncorp Insurance, which operates one of the largest general insurance business in Australia, as well as a young but maturing life insurance and fund management dealings. Suncorp’s general insurance business is carried out by brands such as Shannons, AAMI, Suncorp, Vero, and GIO that major in personal and commercial property and casualty business. In addition, Suncorp also runs Suncorp Bank, which operates about 170 branches in eastern part of Australia. Suncorp bank offers a variety of products including personal and commercial deposit accounts, wealth management and financial planning services, as well as loans to retail customers and small- medium businesses. An overview of CSL Limited CSL Limited (CSL) is a key supranational biopharmaceutical company that is involved in the development, manufacturing, marketing and distribution of biopharmaceutical and allied products in the global market. CSL’s significant geographic segments include the Australia, North America, Germany, and Switzerland among other countries. The main business operations include CSL Biotherapies and CSL Behring (including CSL Plasma). Correlation analysis When two variables vary together, it is said that there is correlation between the variables. The correlation coefficient, r, is used to quantify the direction and magnitude of the relationship. The correlation coefficient, r, ranges from -1 to +1. From table-1, the correlation between interest rates and SUN corp’s share price is positive (0.55) indicating that there is a positive relationship between interest rates and the company’s share price. Perhaps in order to interpret the value of r (coefficient of correlation), it is important to square it to calculate the coefficient of determination (r2). The coefficient of determination ranges from zero to one, and is ideally the fraction of the variance in the correlated variables that is common. In this study, r2=0.3030, implying that 30% of the variance in interest rates can be explained by variation in SUN Corp’s share price.  Likewise, 30% of the variance in share price goes along with variation in interest rate. More simply, 30% of the variance is shared between interest rates and SUN corp.’s share price. Table-1: Correlation results   Interest rates SUN Corp CSL Close Interest rates 1  0.550464117  0.02595778 SUN Corp 0.550464117 1  -0.077458486 CSL Close 0.02595778 -0.077458486 1 On the other hand, the correlation coefficient between interest rates and CSL’s share price is 0.026. This indicates that there exists a positive relationship between the company share price and interest rates but the relationship is weaker compared to that of SUN corp. In this study, r2=0.000674, implying that only 0.07% of the variance in interest rates can be explained by variation in CSL’s share price. From the figure above, it is clear that the movement of SUN corp.’s share price mimics the movement of interest rates. On the contrary the movement of CSL’s share price does is contrary to the movement of interest rates. The argument here is that SUN corp. is a financial services company hence it is more likely that interest rates have a significant impact on companies in the financial sector relative to those in the pharmaceuticals. However, the general thesis is that interest rates have a positive relationship with stock price. Conclusion From the analysis, the level of interest rates affects and is affected by the general condition of any given economy. The correlation between interest rates and SUN corp.’s share price is positive (0.55) indicating that there is a positive relationship between interest rates and the company’s share price. On the other hand, the correlation coefficient between interest rates and CSL’s share price is 0.026. This indicates that there exists a positive relationship between the company share price and interest rates but the relationship is weaker compared to that of SUN corp. Funds supplied from savers characterize the amount available to finance investments and spending by borrowers. If the supply of savings exceeds the demand for funds, a fall in interest rates is generally expected and vice versa. The changes in the quantity of money together with the rise and fall of interest rates affect the economic health of a country. This is in terms of the GNP (Gross National Product), income levels, even price levels. The changes that take place in the economy, on the other hand, influence the activities in the financial markets, i.e., the amount of funds supplied and demanded as well as the level of interest rates. From the research, the effects of interest rate on share price of two companies are empirically examined. It is assumed that the Efficient Market Hypothesis applies in the ASX, but in reality this assumption is violated. In general, the theoretical assumption of negative relationship between stock price and interest rate is confirmed by correlating share prices of both companies (individually) with the prevailing interest rates. References Jefferis, K. R. and Okeahalam, C. C. (2000). The Impact of Economic Fundamentals on Stock Markets in Southern Africa. Development Southern Africa, 17(1), 23-51. NASDAQ OMX (2008). “ ASX Case Study.” Retrieved from http://www.nasdaqomx.com/digitalAssets/54/54085_ASX_Nov_2008.pdf Richard, D.C. (n.d). “Basics of Interest Rates.” Retrieved from http://ecedweb.unomaha.edu/ve/library/boir.pdf Uddin, G. S. (2009). Relationship between Interest Rate and Stock Price: Empirical Evidence from Developed and Developing Countries. International Journal of Business and Management 3(4), 1-9 Appendix Table-1: Interest rates and SUN Close and CSL Close Date Interest Rates SUN Close Price CSL Close price Jan-2000 5.00 7.46 7.70 Feb-2000 5.48 7.05 7.27 Mar-2000 5.50 6.94 6.83 Apr-2000 5.72 7.55 6.87 May-2000 5.98 7.54 7.90 Jun-2000 6.00 7.87 11.01 Jul-2000 6.00 7.99 11.03 Aug-2000 6.24 8.11 11.84 Sep-2000 6.25 8.18 11.57 Oct-2000 6.25 8.95 11.44 Nov-2000 6.25 9.64 11.44 Dec-2000 6.25 9.84 13.02 Jan-2001 6.25 10.42 11.54 Feb-2001 5.85 10.73 12.13 Mar-2001 5.55 10.21 11.93 Apr-2001 5.06 11.42 12.27 May-2001 5.00 12.24 13.03 Jun-2001 5.00 13.70 15.90 Jul-2001 5.00 13.24 15.63 Aug-2001 5.00 12.12 15.35 Sep-2001 4.78 11.29 14.98 Oct-2001 4.52 12.23 16.77 Nov-2001 4.50 12.05 15.98 Dec-2001 4.28 12.81 17.16 Jan-2002 4.25 13.63 15.76 Feb-2002 4.25 12.15 14.27 Mar-2002 4.25 11.42 13.77 Apr-2002 4.25 11.48 13.02 May-2002 4.45 11.42 12.33 Jun-2002 4.72 11.24 10.73 Jul-2002 4.75 11.40 9.50 Aug-2002 4.75 11.45 7.67 Sep-2002 4.75 10.59 7.35 Oct-2002 4.75 11.08 5.90 Nov-2002 4.75 10.73 7.13 Dec-2002 4.75 10.18 7.20 Jan-2003 4.75 9.84 5.92 Feb-2003 4.75 9.31 4.66 Mar-2003 4.75 9.29 5.21 Apr-2003 4.75 10.38 5.21 May-2003 4.75 10.25 3.97 Jun-2003 4.75 10.59 3.98 Jul-2003 4.75 11.14 4.55 Aug-2003 4.75 11.14 5.63 Sep-2003 4.75 10.89 5.35 Oct-2003 4.75 11.84 5.67 Nov-2003 4.98 11.37 5.40 Dec-2003 5.23 11.31 5.95 Jan-2004 5.25 11.49 5.82 Feb-2004 5.25 12.40 6.67 Mar-2004 5.25 12.95 6.99 Apr-2004 5.25 12.24 7.35 May-2004 5.25 12.73 7.71 Jun-2004 5.25 12.97 7.43 Jul-2004 5.25 12.69 8.50 Aug-2004 5.25 13.61 8.62 Sep-2004 5.25 13.97 9.47 Oct-2004 5.25 15.63 9.60 Nov-2004 5.25 15.75 8.87 Dec-2004 5.25 15.87 9.75 Jan-2005 5.25 17.03 10.32 Feb-2005 5.25 17.04 10.68 Mar-2005 5.49 17.74 11.39 Apr-2005 5.50 18.01 10.53 May-2005 5.50 17.90 9.63 Jun-2005 5.50 18.36 11.24 Jul-2005 5.50 18.64 11.63 Aug-2005 5.50 17.99 11.42 Sep-2005 5.50 18.00 12.80 Oct-2005 5.50 17.60 12.50 Nov-2005 5.50 18.08 13.20 Dec-2005 5.50 18.31 14.17 Jan-2006 5.50 20.18 14.50 Feb-2006 5.50 18.68 17.56 Mar-2006 5.50 17.75 18.23 Apr-2006 5.50 18.57 19.23 May-2006 5.73 17.03 17.16 Jun-2006 5.75 17.67 17.91 Jul-2006 5.75 17.67 17.58 Aug-2006 5.99 18.72 16.95 Sep-2006 6.00 20.04 18.01 Oct-2006 6.00 18.99 18.69 Nov-2006 6.19 18.68 19.76 Dec-2006 6.25 18.58 21.79 Jan-2007 6.25 19.73 23.14 Feb-2007 6.25 19.73 23.14 Mar-2007 6.25 19.88 25.88 Apr-2007 6.25 19.62 27.45 May-2007 6.25 20.23 29.09 Jun-2007 6.25 19.96 29.72 Jul-2007 6.25 19.02 29.33 Aug-2007 6.45 18.30 29.55 Sep-2007 6.50 18.96 32.73 Oct-2007 6.50 19.15 35.76 Nov-2007 6.70 19.13 36.50 Dec-2007 6.75 17.62 34.87 Jan-2008 6.75 15.96 36.36 Feb-2008 6.96 14.47 34.16 Mar-2008 7.22 13.12 36.50 Apr-2008 7.25 12.14 36.91 May-2008 7.25 12.87 39.79 Jun-2008 7.25 13.61 39.80 Jul-2008 7.25 12.30 35.70 Aug-2008 7.25 12.62 34.60 Sep-2008 7.02 10.77 41.05 Oct-2008 6.18 8.77 37.30 Nov-2008 5.33 7.56 36.40 Dec-2008 4.35 7.40 34.70 Jan-2009 4.25 7.92 33.70 Feb-2009 3.35 7.07 37.50 Mar-2009 3.25 5.26 36.66 Apr-2009 3.06 6.00 32.49 May-2009 3.00 5.90 34.42 Jun-2009 3.00 5.90 29.20 Jul-2009 3.00 6.70 32.15 Aug-2009 3.00 7.10 30.55 Sep-2009 3.00 7.83 32.21 Oct-2009 3.21 8.88 33.46 Nov-2009 3.48 8.86 31.50 Dec-2009 3.74 8.78 31.54 Jan-2010 3.75 8.69 32.49 Feb-2010 3.75 8.90 31.18 Mar-2010 3.98 8.54 34.39 Apr-2010 4.22 8.54 36.43 May-2010 4.48 9.03 32.39 Jun-2010 4.50 8.14 31.63 Jul-2010 4.50 8.04 32.58 Aug-2010 4.50 8.37 33.14 Sep-2010 4.50 8.35 32.96 Oct-2010 4.50 9.00 33.05 Nov-2010 4.73 9.20 32.83 Dec-2010 4.75 9.03 34.91 Read More