वलुँशन OF SHARES

TABLE OF CONTENTS

1. VALUATION OF COMMON STOCK…………………......................... 3

2. DETERMINANTS OF STOCK PRICES…………………………........... 10

3. EFFICIENT MARKET THEORY AND TESTS.......................... ………………12

4. STOCK MARKET ANOMALIES................................................ ………………17

5. STOCK PRICES AND TRADING VOLUME......................................... 21

6. STOCK MARKET REGULATIONS………………...................................... 23

7. REFERENCES.................................................................………………… 25






























ASSET PRICING: EQUITIES

VALUATION OF COMMON STOCKS

What is Value?
In general, the value of an asset is the price that a willing and able buyer pays to a willing and able seller. The valuation of equity shares is relatively more difficult than the valuation of fixed income securities. This is because: -

1. The payment of dividend is discretionary

2. The earnings and dividend on equity shares are expected to grow.

However the general principle of valuation applies to share valuation, in that, the value of a share today is a function of cash inflows expected by investors and the risk associated with those cash flows. Cash flows from an equity share consist of dividends and capital gain expected on sale of the Share.

THEORIES OF VALUATION

There are three theories of valuation of common shares:

I. Fundamental theory
II. Technical theory
III. Random walk theory

Fundamental theory
This theory states that every security has an implicit value, which is equal to the present value of all cash flows expected from a company. The value of the security should therefore be equal to the present value of dividends expected from the company. The assumption is that the company follows a constant dividend policy.

Technical theory
This holds that the historical price patterns are expected in the future. This price patterns can be sub-divided into;
-Primary movements- that are long term in nature. Trend that represent a period greater than one year.
-Secondary movements- Seasonal variations in the share prices capturing periods covering several weeks.
-Tertiary movements- Referring to the daily changes in stock prices. This theory ignores the tertiary movements and uses the secondary movements to determine changes in primary movements.

Random walk theory
This theory holds that prices of securities depend on factors that affect expected return and expected risk. Information on these factors is released to the markets at different intervals and investors react differently to the information, security prices therefore follow a random walk trend and cannot therefore be predicted. It has the support of the efficient market hypothesis.


Common Stock
A share of common stock represents an ownership position in the firm. Typically, the owners are entitled to vote on important matters regarding the firm, to vote on the membership of the board of directors, and (often) to receive dividends.
In the event of liquidation of the firm, the common shareholders will receive a pro-rata share of the assets remaining after the creditors (including employees) and preferred stockholders have been paid off. If the liquidation is bankruptcy related, the common shareholders typically receive nothing, though it is possible that they may receive some small amount.

Common Stock Valuation
The shareholders may interpret the value of a share of common stock as the present value of an expected stream of future dividends. Finding the present values of these cash flows and adding them together will give us the value. The value of a share of stock should be equal to the present value of all the future cash flows the shareholders expect to receive from that share of stock. When a shareholder purchases a share of common stock, what they pay for should reflect what they expect to receive in future i.e. return on investments .The purchase of a stock represents the exchange of present goods for future goods.

Price of a = 1st periods’dividends + 2nd periods’dividends + 3rd periods’dividends +…
Share of stock (1+discount rate) 1 (1+discount rate) 2 (1+discount rate) 3

Since common stock never matures; then today’s value is the present value of an infinite stream of cash flows. Another complication is that common stock dividends are not fixed. Not knowing the amount of dividends, or even if there will be future dividends, makes it difficult to determine the value of common stock.
For a stock, there are two cash flows:
¡ Future dividend payments
¡ The future selling price
Although in the short run shareholders may be influencing a change in earnings or other variables, the ultimate value of any holding rests with the distribution of earnings in form of dividend payments. Though the stockholder may benefit from retention and re-investment of earnings by the corporation, at some point the earnings may be translated into cash flow for the stockholder.
In valuing the common stock, we have made two assumptions:
¡ We know the dividends that will be paid in the future.
¡ We know how much you will be able to sell the stock for in the future.
Both of these assumptions are unrealistic, especially knowledge of the future selling price. We cannot value common stock without making some simplifying assumptions. These assumptions will define the path of the future cash flows, so that we can derive a present value formula to value the cash flows. If we make the following assumptions, we can derive a simple model for common stock valuation:
Ø The holding period is infinite (i.e. the stockholder will never sell the stock so does not have to worry about forecasting a future selling price).
Ø The dividends will grow at a constant rate forever.
Note that the second assumption allows us to predict every future dividend, as long as we know the most recent dividend and the growth rate.

Valuation Models

1. Dividend Discount Models
A stock valuation model based on future expected dividends, which is termed as dividend valuation model or the Gordon’s valuation model can be stated as:

P0 = D1 + D2 + D3 + … + D∞
(1+Ks) 1 (1+Ks) 2 (1+Ks) 3 (1+Ks) ∞
∞
P0 = ∑ D1
t=1 (1+Ks) t Where
P0 = Price of stock today
Dn = Dividend for each year (n = 1,2,3…∞)
Ks= the required rate of return for common stock (discount rate)

This formula with modifications is usually applied to three different circumstances:
The zero growth model
Normal/Constant growth model
Non-constant or super-normal growth rate

(i) The zero growth model - Assumes dividend remain constant i.e. g = 0

Under the no growth circumstance, common stock pays a constant dividend each year. If the dividend is constant forever, the value of stock is the present value of the dividends per share per period.
The summation of the constant amount (i.e. D1 = D2 = … =D∞ = D) discounted from perpetuity simplifies to:


P0 = D + D + ……. + D
(1 + KS) (1 + KS) (1 + KS) ∞

P0 = D
KS

Where Po =current price
D = Dividend
Ks = required rate of return

A no growth policy for common stock dividends does not hold much appeal for investors and so is seen infrequently in the real world.

(ii) Normal/constant growth model

A firm increases dividends at a constant rate. In other words, the current price of stock is the present value of the future stream of dividends growing at a constant rate. If we anticipate the growth pattern of future dividends and determine the discount rate, we can ascertain the price of the stock.
The general valuation approach is:
P0 = Σ DO(1 + g) = D1
1 + KS KS – g
Where Po =current price
D = Dividend
Ks = required rate of return
g = constant or normal growth rate
If dividends are expected to decline each year, the formula used is the same except the growth rate g is negative

(iii) Non-constant or supernormal growth rate model.

The most common variable growth model is one in which the firm experiences supernormal (very rapid) growth for a number of years and the levels off to more normal, constant growth. The supernormal growth pattern is often experienced by firms in emerging industries such as the early days of electronics or microcomputers.
In evaluating a firm with an initial pattern of supernormal growth, we first take the present value of dividends during the exceptional growth period. We then determine the price of the stock at the end of the supernormal growth period by taking the present value of the normal, constant dividends that follow the supernormal growth period. We discount this price to the present and add it to the present value of the supernormal dividends. This gives us the current price of the stock.
When the pattern of expected growth is not constant, the perpetual growth model can be modified. If the dividends of a firm are expected to grow at a supernormal growth rate gs, for n years and then grow at a normal growth rate gn indefinitely, then price of the share becomes

P0 = Σ D0 (1 + gs)t + D n+1 1
(1 + KS)t Ks - gn (1 + Ks)n
Where: -

D0 = Dividend in year 0
gs = growth rate in supernormal growth period
Dn = Dividend in year n (last supernormal year)
gn = Growth rate in normal growth period
Ks = Cost of equity
The second term on the right hand side of the equation gives the value of a stream of dividends starting from t = n +1 and growing at a constant growth rate perpetually. The first term gives the value of dividends starting from the first year and growing at a supernormal rate for a finite period t = n.

2. Earnings Capitalization Models

Rather than concentrate on dividends alone most investors prefer to estimate the value of common stocks using an earnings multiplier model. This model also uses the reasoning that the value of an investment is the present value of future returns. In the case of equity shares the returns that the investors are entitled to receive are the net earnings of the firm. Therefore investors can determine the value of equity shares by determining how many shillings they are willing to pay for a shilling of expected earnings. For example if investors are willing to pay 10 times the expected earnings, they would value a stock they expect to earn sh.10 a share during the following year at sh.100.

The prevailing earning multiplier or the price earnings ratio can be calculated as follows:

P/E ratio = Current market price
Expected 12 months earnings

The P/E ratio indicates the prevailing attitude of investors towards a stock value. Investors must decide if they agree with the prevailing P/E ratio. To do this the constant dividend growth model can be used



P0 = D1
KS – g
Divide both sides by E
P / E = D1 / E
KS – g

The P/E ratio is a function of:

• Dividend payout ratio

• Growth rate

• Required rate of return

3. Present value of operating cash flows of the firm

V0 = Σ CF1
(1 + WACC) 1
P0 = V0
n

Where
V0 =current value of firm
CFT =Cash flow at time t
WACC =Weighted av. Cost of capital
P0 =Current price of a share
n =Outstanding number of shares

4. Book value

Book value per share is the amount per share of common stock that would be received if all the firm's assets were sold for their exact book (accounting) value and the proceeds remaining after paying all the liabilities (including preferred stocks) were divided among the common stockholders.

Book value = Total assets - Total Liabilities - Preferred stocks
No. of common stocks outstanding


5. Liquidation Value

Liquidation Value per share is the actual amount per share of common stock that would be received if all of the firm's assets were sold for their market value, liabilities (including preferred stocks) were paid and any remaining amount were divided among the common stockholders.

In the valuation of common stock, we have associated value with dividends. This brings us to ask how companies that do not currently pay dividends are valued.
One approach would be to assume that even for a firm that pays no current dividends, at some point in the future, stockholders would be rewarded with cash dividends. We then take the present value of their deferred dividends.
A second approach to valuing a firm that pays no dividend is to take the present value of a future anticipated stock price. The discount applied to future earnings is generally higher than the discount rate applied to future dividends


The valuation of common stock is difficult because you must value a future cash flow stream that is uncertain with respect to both the amount and the timing. However, understanding the stocks’ dividends exhibit patterns that help us manage the valuation of these securities.
Investors are constantly valuing and revaluing common stocks as expectations about cash flows change, whether this is the timing and amount or the uncertainty associated with these expected future cash flows. Though they may not each have the dividend valuation model, or some variation, we assume they are rational and will value a stock according to the best estimates regarding risks and rewards from investing in stock.




















2. Determinants of Stock prices


Definition of Price
The price of a share of stock, like that of any other financial asset, equals the present value of the expected stream of future cash payments to the owner. The cash payments available to a shareholder are uncertain and subject to the earnings of the firm. This uncertainty contrasts sharply with cash payments to bondholders, the value of which is fixed by contractual obligation. Most of the cash payments to stockholders arise from dividends, which are paid out of earnings, and distributions resulting from the sale or liquidation of assets.
Over time most firms pay rising dividends. Rising dividends occur for two reasons. First, firms rarely pay out all their earnings as dividends, so that the difference, called retained earnings, is available to the firm to invest. This, in turn, often produces greater future earnings and hence higher prospective dividends. Second, the earnings of a firm will rise as the price of its output rises with inflation. Firms may also increase their dividends due to growth in the demand for their products and increased efficiencies of operation. These are the firms, of course, that investment advisers seek out when recommending stocks.
The market Mechanism

The value of publicly traded shares is liquidity. Publicly traded companies are worth more than private ones simply because there is greater access to buyers and sellers, and market efficiency can better determine share price. The stock market provides value to any company that chooses to list its shares because the company gains liquidity.

Among the determinants of stock prices are:

New information
Uncertainty
Psychological factors-Fear and Greed
Supply and Demand

Information

Information gives market a reason to value a stock at a particular price level. The market will price a stock based on all information that the public is aware of. As new information come into the public realm, the market will adjust prices up or down based on how the market perceives the information will effect the future earnings capacity of the company. Normally rumor plays a big role in flow of information, particularly today when technology is allows for rapid dissemination of information. Those closed to the company often have access to privileged information that they can act upon by buying and selling in the market.

Technical analysis is very useful because it provides tools that allow investors to identify the signs that new information is being priced into a stock before news is released.

Uncertainty

What a company will make in future is far from certain. For this reason, we should expect stocks to bounce around a little bit because of nervousness of market about the future of the company. The uncertain future of the company will bring some volatility in share prices even during a period in which there is no new information.

Companies that have established performance record will tend to show less volatility as determined by uncertainty. Safaricom (if quoted in NSE) which is well established in its performance in Kenya, will show less volatility than an upstart technology company that has not yet had an opportunity to establish a track record of revenues and earnings. Because of uncertainty, these stocks will trade differently and will present different kinds of trading opportunities.

Psychological Factors

Human are behind the trading of stock market. That means human characteristics are also factors in how share price move. Understanding human psychology is extremely valuable when evaluating investment opportunities because it creates and accentuates many opportunities that investors can capitalize on.

For example greed often causes stocks to go higher than they deserve to go. By deserve, means that they go up higher than present value of its future earnings potential can justify. New information can cause frenzy in the market that makes investors lose sight of rational valuation and simply buy the stock for fear of being left behind. This phenomenon is basis of some great speculative bubbles that we have seen in history.

At the same time, fear motivated by negative information can cause every one to rush for exit door at once and take a stock, or entire market, dramatically lower very quickly. Most of the selling pressure that prevails during market crashes is out of fear, not a rational thought process based on information.

Fear and greed present incorrect valuations in the market that exist for relatively short periods of time but long enough for smart investors to capitalize on. Emotion in the market can be viewed as an amplifier for new information.

Supply and Demand

Established companies trade huge stocks daily in stock markets, while most stocks investors are interested in do not have such huge volumes hence less liquidity. As a result, stocks that trade smaller volumes of shares are subject to fluctuations because of supply and demand. If a larger shareholder wants to sell a large number of shares into a market with weak liquidity, that shareholder can dramatically move share price. The flip side is also true when a large buy order comes in to a market that lacks sellers.

Supply and demand can take the short-term balance out of the stock market and present opportunities for investors who have the patience to see that balance restored. Investors who can anticipate abnormal supply or demand variations can also capitalize.



3. Efficient Markets

An efficient market is one, which security prices adjust rapidly to the arrival of new information, and therefore current prices reflect al information about the security.
Assumptions that imply an Efficient Capital Markets

i. A large number of competing profit-maximizing participants analyze and value securities each independently of one another;
ii. Information regarding the security come into the market in a random manner
iii. The competing investors attempt to adjust security prices rapidly to reflect new information

The efficient market hypothesis implies that it is not generally possible to make above average returns in the stock market by trading (including market timing), except through luck or obtaining and trading on inside information.

There are three common forms in which the efficient markets hypothesis is commonly stated - weak form efficiency, semi-strong form efficiency and strong form efficiency, each of which have different implications for
Weak-form efficiency

Weak form efficiency is where stock prices fully reflect all security-market information, including the historical sequence of prices, rates of return, trading volume data, and other market generated information such as odd lot transactions, block trades and transactions by exchange specialists or other unique groups.

No excess returns can be earned by using investment strategies based on historical share prices or other financial data. Technical analysis will not be able to produce excess returns.

To test for weak-form efficiency it is sufficient to use statistical investigations on time series data of prices. In a weak-form efficient market current share prices are the best, unbiased, estimate of the value of the security. The only factor that affects these prices is the introduction of previously unknown news. News is generally assumed to occur randomly, so share price changes must also therefore be random.


Semi-strong form efficiency

Semi strong form efficiency includes current prices that fully reflect all public information. The semi strong hypothesis encompasses the weak form hypothesis because all market information considered by the weak-form hypothesis such as stock prices; rates of return and trading volume is public. Public information also includes all non-market information such as earnings; dividend announcements; price to earnings ratios; dividend yield; book value-market value; stock splits news about economy and stock splits.

Share prices adjust instantaneously and in an unbiased fashion to publicly available new information, so that no excess returns can be earned by trading on that information.

To test for semi-strong-form efficiency, the adjustments to previously unknown news must be of a reasonable size and must be instantaneous. To test for this, consistent upward or downward adjustments after the initial change must be looked for. If there are any such adjustments it would suggest that investors had interpreted the information in a biased fashion and hence in an inefficient way.
Strong-form efficiency

Share prices reflect all information and no one can earn excess returns. This means that no group(s) of investors can monopolistic access to the information relevant to the formation of prices
To test for strong form efficiency, a market needs to exist where investors cannot consistently earn excess returns over a long period of time. When the topic of insider trading is introduced, where an investor trades on information that is not yet publicly available, the idea of a strong-form efficient market seems impossible. Studies on the US stock market have shown that people do trade on inside information. It was also found though that others monitored the activity of those with inside information and in turn followed, having the effect of reducing any profits that could be made.
Even though many fund managers have consistently beaten the market, this does not necessarily invalidate strong-form efficiency. We need to find out how many managers in fact do beat the market, how many match it, and how many under perform it. The results imply that performance relative to the market is more or less normally distributed, so that a certain percentage of managers can be expected to beat the market. Given that there are tens of thousand of fund managers worldwide, then having a few dozen star performers is perfectly consistent with statistical expectations.
Arguments concerning the validity of the hypothesis

Many observers dispute the assumption that market participants are rational, or that markets behave consistently with the efficient market hypothesis, especially in its stronger forms. Many economists, mathematicians and market practitioners cannot believe that man-made markets are strong-form efficient when there are prima facie reasons for inefficiency including the slow diffusion of information, the relatively great power of some market participants (e.g. financial institutions), and the existence of apparently sophisticated professional investors.

The efficient market hypothesis was introduced in the late 1960s and the prevailing view prior to that time was that markets were inefficient. Inefficiency was commonly believed to exist e.g. in the United States and United Kingdom stock markets. However, earlier work by Kendall (1953) suggested that changes in UK stock market prices were random. Later work by Brealey and Dryden, and also by Cunningham found that there were no significant dependences in price changes suggesting that the UK stock market was weak-form efficient.

Further to this evidence that the UK stock market is weak form efficient, other studies of capital markets have pointed toward them being semi strong-form efficient. Studies by Firth (1976, 1979 and 1980) in the United Kingdom have compared the share prices existing after a takeover announcement with the bid offer. Firth found that the share prices were fully and instantaneously adjusted to their correct levels, thus concluding that the UK stock market was semi strong-form efficient.

It may be that professional and other market participants who have discovered reliable trading rules or stratagems see no reason to divulge them to academic researchers; the academics in any case tend to be intellectually wedded to the efficient markets theory. It might be that there is an information gap between the academics who study the markets and the professionals who work in them. Within the financial markets there is knowledge of features of the markets that can be exploited e.g. seasonal tendencies and divergent returns to assets with various characteristics. E.g. factor analysis and studies of returns to different types of investment strategies suggest that some types of stocks consistently outperform the market (e.g. in the UK, the USA and Japan).
An alternative theory: Behavioural Finance

Opponents of the EMH sometimes cite examples of market movements that seem inexplicable in terms of conventional theories of stock price determination, for example the stock market crash of October 1987 where most stock exchanges crashed at the same time. It is virtually impossible to explain the scale of those market falls by reference to any news event at the time. The correct explanation seems to lie either in the mechanics of the exchanges (e.g. no safety nets to discontinue trading initiated by program sellers) or the peculiarities of human nature.

It is certainly true that "behavioural psychology" approaches to stock market trading are amongst the most promising that there are (and some investment strategies seek to exploit exactly such inefficiencies). A growing field of research called Behavioural finance studies how cognitive or emotional biases, which are individual or collective, create anomalies in market prices and returns and other deviations from the EMH.


ASSUMPTIONS OF MARKET EFFICIENCY

i) Information is available - all investors have costless access to currently available
information about the future.
ii) All investors are capable analysts

iii) All investors pay close attention to market prices and adjust their holdings appropriately

iv) A set of information is fully and immediately reflected in market prices.

v) Fair return- Investors make a fair return on their investors but no more. Technical
analysts (who examine past price behavior of securities) and Fundamental analysts (who examine earnings and dividend forecasts) are not successful since one cannot make abnormal returns unless by chance

vi) Investors believe that the market is not efficient. -Investors spend time analyzing
securities searching for undervalued securities and consequently security prices react
instantaneously to release of information, which in turn makes the market efficient.

vii) Publicly known investment strategies cannot be expected to generate abnormal returns-after the strategy has been released to the public, the investors who know the strategy will try to capitalize on it and in doing so will force prices to equal investment values the moment the strategy indicates a security is mispriced. The action of investors following the strategy will eliminate its effectiveness at identifying mispriced securities.

viii) Professional investors should fare no better in picking securities than ordinary investors. Prices in an efficient market always reflect investment value and hence the search for mispriced securities is futile. Consequently, professional investors do not have an edge on ordinary investors when it comes to identifying mispriced securities and generating abnormally high returns,

ix) Past performance is not an indicator of future performance-Investors who have done
well in the past are no more likely to do better in the future than other investors who
have done poorly in the past. Historical performance records are useless in predicting future performance records since past luck and misfortune do not have a tendency to repeat themselves.

x) Information is released into the market at random and therefore changes in prices of
equity occur randomly. This is referred to as the Random walk theory

IMPLICATIONS OF MARKET EFFICIENCY

Since stock prices do seem to reflect public information, most stocks appear to be valued. This
does not mean that new developments could not cause a stock's price to soar or plummet, but it
does mean that stocks in general are neither overvalued nor undervalued. They are fairly priced
and in equilibrium. However, there are certainly case in which corporate insiders have
information not known to outsiders.

If EMH is correct, it is a waste of time for most of us to analyze stocks by looking for those that
are undervalued. If stock prices already reflect all publicly available information and hence are
fairly priced, one can "beat" the market only by luck and it is difficult if not impossible for
anyone to consistently outperform the market averages.

Empirical tests have shown that EMH is, in its weak and semi strong forms, valid.

However, people such as corporate officers who have inside information can do better than the
averages, and individuals and organizations that are especially good at digging information on
small, new companies seem to do consistently well. In addition, some investors may be able to
analyses and react more quickly than others to release of new information and these investors
may have an advantage over others.

In an efficient market, a security's price will be a good estimate of its investment value, where
investment value is the present value of the security's future prospects estimated by well-
informed and capable analysts. In a well-developed and free market, major disparities between
price and investment value will be noted by alert analysts who will seek to take advantage of their discoveries. Securities priced below investment value (known as overpriced or overvalued
securities) will be sold, creating pressure for price decreases due to the increased supply to sell.
As investors seek to take advantage of opportunities created by temporary inefficiencies, they will cause the inefficiencies to be reduced denying the alert and the less informed a chance to obtain large abnormal profit. As a consequence of the efforts of such highly alert investors, at any time a security's price can be assumed to equal the security's investment value implying that security mispricing will not exist.



4. STOCK MARKET NOMALIES

Anomalies are empirical results that seem to be inconsistent with maintained theories of assets pricing behavior. They indicate either market inefficiency or inadequacies in the underlying asset-pricing model, after their documentation and analysis, they reverse, which raises doubts whether they actually existed and have been arbitraged away or they were simply statistical aberrations that attracted the attentions of academicians and practitioners.

The following represents observed anomalies:

A. Data snooping

In the process of data examination and modeling to gain market information, there is a tendency for researchers to focus attention on surprising and exciting information. To the extent that subsequent authors reiterate or refine the surprising results by examining the same or at least positively correlated data, there is really no additional evidence in favour of the anomaly.

Inferences drawn from such exercises could be misleading to the extent that no additional
evidence has been brought from any new data.

Testing an independent sample, using data from prior periods and use of raw data, can solve such an anomaly.

B. The Turn of the year effect or The January Effect:

This refers to the tendency for securities to register higher prices in the month of January as compared to the other months of the year. Rozeff and Kinney (1976) were the first to document evidence of higher mean returns in January as compared to other months. Using NYSE stocks for the period 1904-1974, they found that the average return for the month of January was 3.48 percent as compared to only .42 percent for the other months. Later studies document the effect to be persistent in more recent years. Like in 1983, Roll hypothesized that the higher volatility of small capitalization stocks caused more of them to experience substantial short-term capital losses that investors might want to realise for income tax purposes before the end of the year. This selling pressure might reduce prices of small cap stocks in December, leading to a rebound in early January as investors repurchase these stocks to reestablish their investment positions. The effect has been found to be present in other countries as well. This anomaly disappeared since the initial publication of the papers that discovered it.

C. The Weekend Effect / Monday Effect:

This is the tendency of stock values and prices to below on Mondays and increase in value in the other days of the week. In a study done by French(1980), which analyzed daily returns of stocks for the period 1953-1977, findings showed that there is a tendency for returns to be negative over the weekend, but gaining value from Mondays, although lower than the other days of the week. He noted that these negative returns are "caused only by the weekend effect as they run parallel to the conventional market efficiency theories, A trading strategy, which would be profitable in this case, would be to buy stocks on Monday and sell them on Friday. Just like the January effect, the weekend effect has been substantially attenuated, or has disappeared since it was first documented in 1980.

D. Other Seasonal Effects:

Holiday and turn of the month effects have been well documented over time and across countries as having considerable influences on securities' values and prices. Several studies have shown that stock returns are significantly higher at the turn of the month, defined as the last and first three trading days of the month. They have also shown that returns tend to be higher on the last day of the month. However, it has been noted to occur in some markets and not in others. Evidence of a turn of month effect has been more observed in eastern economies such as Japan than western economies. These studies recommend that abnormal returns can be earned by exploiting this anomaly. Other studies done by Cadsby and Ratner (1992) all provide evidence to show that returns arc, on average, higher the day before a holiday, than on other trading days. The paper shows this for countries other than the U.S. and describes the pre- holiday effect as one of the oldest and most consistent of all seasonal regularities.

E. The size effect/Small Firm Effect:

Banz (1981) published one of the earliest articles on the'small-firm effect', which is also known as the 'size-effect'. His analysis of the 1936-1975 period revealed that holding stocks of low capitalization companies would have earned excess returns.

Supporting evidence is provided by Reinganum(t981) in his study presented in his article,
'Misspecification of the capital asset pricing: Empirical anomalies based on earnings yields and market values' Journal of Financial Economics 12, 89-104. He established that the risk adjusted annual return of small firms was greater than of big firms. If the market were efficient, one would expect the prices of stocks of these companies to go up to a level where the risk adjusted returns to future investors would be normal. But this did not happen. This effect has also disappeared since the initial publication of the papers that discovered it.

F. P/E Ratio Effect:

Sanjoy Basu (1977) shows that stocks of companies with low P/E ratios earned a premium for investors during the period 1957-1971. An investor who held the low P/E ratio portfolio earned higher returns than an investor who held the entire sample of stocks. These results also contradict the Efficiency Market Hypothesis. Fama and French (1995) found that market and size factors in earnings help explain market and size factors in returns. Short-sellers position themselves in stocks of firms with low earnings to price ratios since they are known to have lower future returns

G. Value-Line Enigma:

The Value-Line organization divides the firm into five groups and ranks them according to their estimated performance based on publicly available information. Over any given period of time, studies have shown that returns to investors correspond to the value rankings given to firms. That is, higher-ranking firms, firms with high dividend yields and those with high book to market ratios earned higher returns. Firms with high earnings to price ratio (E/P) have been observed and noted to have high values relative to those with low ratios. Several researchers (e.g. Stickel, 1985) have found positive risk-adjusted abnormal (above average) returns using value line rankings to form trading strategies, thus challenging the EMH.

H. Over/Under Reaction of Stock Prices to Earnings Announcements:

There-is substantial documented evidence on both over and under-reaction to earnings announcements. DeBondt and Thaler (1985, 1987) present evidence that is consistent with stock prices overreacting to current changes in earnings. They report positive (negative) estimated abnormal stock returns for portfolios that previously generated inferior (superior) stock price and earning performance. This could be construed as the prior period stock price behavior overreacting to earnings developments (Bernard, 1993). Bernard (1993) provides* evidence that is consistent with the initial reaction being too small, and being completed over a period of at least six months. Thus, the evidence suggests that information is not impounded in prices instantaneously as the EMH would predict.

I. The Distressed Securities Market:

White the academic literature largely suggests that stocks
in the distressed securities market are efficiently priced, the popular press has frequently
conjectured that the stock pricing may be inefficient during the bankruptcy period. For example, the shares of Uchumi supermarkets did not register substantial reduction in value at the house as a result of its poor performance although it was in the public knowledge that it was not doing well.
Investors have always sought superior returns in the securities market and 'vulture' investors have attracted a substantial amount of risk-oriented money by offering the possibility of high returns through exploitation of the apparent pricing inefficiencies or anomalies in the market for distressed securities. This fact could have led to the reluctance of investors to dispose of their Uchumi shares. This proves the statement by Philip Schaeffer of Robert Fleming Inc. that put it that; "Returns are attractive because of market's abundant inefficiencies. Investors who find themselves owners of distressed securities do not understand or want to participate in the market and frequently sell at prices substantially below the investments' cost. Distressed investing requires skills involving bankruptcy law,
experience and knowledge of the bankruptcy process, and personal contacts.
Consequently, the relatively small numbers of experienced distressed security
investors have a significant advantage over other investors who do not have such
expertise, knowledge and experience". [Wall Street Journal, 1991].

J. The Weather:

Few would argue that sunshine puts people in a good mood. People in good
moods make more optimistic choices and judgments; Saunders (1993) shows that the New York Stock Exchange index tends to be negative when it is cloudy. More recently, Hirshleifer and Shumway (2001) analyze data for 26 countries from 1982-1997 and find that stock market returns are positively correlated with sunshine in almost all of the countries studied. Interestingly, they found that snow and rain have no predictive power!

These phenomena have been rightly referred to as anomalies because they cannot be explained within the existing paradigm of Efficient Market Hypothesis. It clearly suggests that information alone is not moving the prices. These anomalies have led researchers to question the EMH and to investigate alternate modes of theorizing market behavior. Such a development is consistent with Kuhn's (1970) route for progress in knowledge. As he states, "Discovery commences with the awareness of anomaly, i.e., with the recognition that nature has somehow violated the paradigm induced expectations..." [Kuhn, 52]



5. STOCK PRICES AND TRADING VOLUME

What is trading volume?
Trading volume is the amount of shares traded among parties in a certain period of time. This time is usually a day, but it can be much longer, such as a week or a month.

Institutional investors
Generally only stocks with large trading volumes will be bought by institutional investors, such as large banks with billions of dollars in assets. They need to be able to buy and sell large amounts of stock quickly at any given time, and they are much more likely to do so with a stock that trades in high volumes. Some private investors feel more secure with these stocks because of all the savvy institutional investors that have also chosen to purchase and hold the stock.

Why is it important?
Trading volume is such an important indicator for you because it tells you how significant a price shift is. For example, let's say there are two stocks that are both worth $10, and they both suddenly gain $4 in one day to become $14. If the volume of stock A was 1,000,000 shares whereas the volume of stock B was only 10,000 shares, there is a much bigger shift in stock A. As a result, you can definitely consider stock A to have had a much greater increase in investor confidence.
VOLUME-a basic element for stock trading decisions
In the trading world, it oftentimes is said that when it comes to the stock market, price is king, but volume is queen. One of the considerations that you must bear in mind when you are developing a stock trading strategy is the role that volume must play in your portfolio management thinking process.
When it comes to a workable trading system and overall investment strategy, it is important to remember that high volume stocks tend to have a far better liquidity than there lower volume counterparts. As a result, when it comes to developing a profitable investment strategy, these high volume stocks tend towards having an advantageous entry and exit price for most people involved in stock trading.
Of course, in the final analysis, when it comes to any stock trading system, the ultimate result needs to be to fashion a stratagem that results in you having the ability to buy low and to sell high in the vast, vast majority of instances. (Naturally, due to the nature of the stock market, there will always be incidents in which you will be left having to sell below your purchase price due to an unexpected decline in value. However, and with that said, by adopting an investment strategy that turns towards high volume stocks, you can lessen the likelihood that you will face a devastating loss in the stock market.)
Finally, you do need to bear in mind that more often than not it is the high volume stocks that end up breaking out. In other words, it is these high volume securities that end up increasing dramatically in their value -- that end up breaking away from the pack. As a result, these high volume stocks can be a very profitable acquisition for a thoughtful investor involved in the stock market.
Market Direction
It’s important to have an idea what the general trend of the market seems to be and what the market is telling us about future trends. You can get a good idea of where the market is headed with just two pieces of information: Price and volume. When you put these two together, you get a picture that tells whether there are more sellers in the market or buyers.
Volume tells you whether there is movement in the market and price tells you which direction.
Volume Indicator
The volume indicator comes from the daily sales volume.
If the market has a high-volume day and prices (of the indexes) are up, you are probably looking at mutual funds and institutional investors buying, which is a sign of an up market trend.
On the other hand, a high-volume day with lower prices could mean a downward trend with the big players backing out of the market.
You need to use some common sense when watching these indicators. For example, if you have three or four days of high volume and rising prices, it is not unusual to hit a high-volume day where the prices fall off.
You’ll usually hear the talking heads on television refer to this as “profit taking.”
Change Coming
If you begin to see the down days too frequently in a market that has been moving up, it may be a sign that it is about to reverse course or stall.
Mutual funds and institutional investors are the volume buyers and sellers that move the market. When they began moving in a direction, that’s where the market goes and you can see it in the price and volume numbers.
A market that shows sharp price movements in either direction without corresponding volume increases is sending false messages that should be watched carefully.
What does this mean to you? Don’t swim upstream. The obvious forces of supply and demand (except when something extraordinary occurs) drive the market. When there are more buyers (higher prices on higher volume) than sellers, the market is trending up.
When there are more sellers (lower prices on higher volume) than buyers, the market is trending down.
Watch for signs that the market is changing course (different price and volume than the prevailing trend), if you see more than a few of these, prepare for a change.
Conclusion
Reading the market from one day to the next may not be helpful, but you can watch the general direction of the market and with some study spot the warning signs that a change is coming.
6. STOCK MARKET REGULATIONS

Need for Regulations

To prevent information asymmetry. Listed firms left on their own may not provide all the information that an investor may require or may not provide it in the required frequency.

To enhance investor welfare by providing them with detailed information.

To supplement market forces especially in an imperfect market situation like the NSE

To create confidence in the operations of the NSE to the players

To create a level playing field for all players

To create order by ensuring only players who have value to offer are allowed to be involved in the market.




Disadvantages of regulations

They are not perfect, even upon strict regulations they never perfectly achieve their objectives. I.e. the recent collapse of Francis Thuo & partners despite the existence of Brokers licensing regulations.

They are expensive. Once put in place they require to be monitored for compliance. These costs are eventually borne by the investor. A body is set to monitor the adherence to the set regulations.

They interfere with market forces. In a perfect market, information arrives in the market in a random manner and prices of stocks fluctuate in a response to the market information. All players therefore have access to the same information and arrive at similar decisions. Thus no information asymmetry. In the long run, it will be to the benefit of the quoted companies to provide all and in regular intervals, information needed for those decisions. Regulations only impose requirements that perhaps are not useful to the market.

They can sometime be too many to the extent of stifling initiative.






Types of regulations

They are;

1. NSE Management & Membership Rules
2. NSE Listing Manual
3. NSE ATS Trading Rules
4. Capital Markets (Securities) (Public Offers Listing and Disclosure) Regulations 2002
5. Capital Markets Foreign Investors Regulations 2002
7. Capital Markets (Licensing Requirements) (General) Regulations 2002


CAPITAL MARKETS AUTHORUTY REGULATIONS



1. Capital Markets Authority Act
2. Central Depository System Act
3. Licensing Requirements General Regs 2002
4. Takeovers / Mergers 2002
5. Securities, Public offers and disclosures 2002
6. Foreign Investors Regulations 2002
7. Rating Agencies Guidelines 2002
8. Collective Investments Scheme 2001 Revised
9. The Central Depositories (Capital Markets ) Rules, 2004
10. Corporate Governance Guidelines 2002
11. Registered Venture Capital Companies Regulations 2006 - Exposure Draft February 2006
12. Proposed Statutory and Regulatory Amendments - Registered Venture Capital Companies Regulations 2006
13. Asset - Backed Securities Regulations 2006 - Exposure Draft February 2006
14. Proposed Regulatory Amendments - Asset Backed Securities Regulations 2006
15. Amendments to Facilitate Listing by Introduction
16. Miscellaneous Amendments to the Capital Markets Act – 16th April 2007











REFERENCES

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3. Elroy Dimson and Massoud Mussavian, European Financial Management, Volume 4,
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4. Reem Heakal, October 15, 2002.

5. William F. Sharpe, Gordon J, Alexander and Jeffery V. Bailey. Investments. 6th edition, .
1999 by Prentice-Hall Inc PPg 96-102

6. Brigham, Financial Management

7. G. William Schwert (2002), Anomalies and Market Efficiency, National Bureau of Economic
Research working paper number 9277.

8. Roll, R. [1984] "Orange juice and weather," American Economic Review74, 861-880.

9. Rozeff, M.S., and W.R. Kinney [1976] "Capital market seasonality: The case of stock
returns." Journal of Financial Economics 3, 379-402.

10. French, K.R. [1980] "Stock returns and the weekend effect," Journal of Financial Economics 8, 55-69.

11. Cadsby, B. and M. Ratner [1992] "Turn-of-month and pre-holiday effects on stock returns:
Some international evidence." Journal of Banking and Finance 16, 497-509.

12. Myers Brealey (2003) ‘Principles of Corporate Finance’ Tata McGraw-Hill