Posted: October 20th, 2022

KLSE Relationship with Inflation and Exchange Rates

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Capital market is a financial market which is for long term investment funds with the maturities greater than one year. In USA, capital market was controlled by security exchange and it was established in 1934. While in Malaysia, Bank Negara Malaysia (BNM) capital market has been developed since 1980s. It is a market where securities such as common stock, preferred stock and bonds are issued or traded. Companies, government and other organizations use capital market in order to raise funds for their operations. In other words, capital market helps organizations or institutions whether in public and private sector to gain capital. Besides that, capital market also traded an investment funds like debt, equity and mortgage loan. The central bank, Bank Negara Malaysia (BNM) also played a very important role in develop and care of this market.

Kuala Lumpur Stock Exchange or more popular known as KLSE is the only one stock market in this country. All the listed securities in Malaysia are done by KLSE since the KLSE is a self-regulatory. Based on this study, KLSE Composite Index are represented by the stock market, money supply represented by M3, consumer price index represented the inflation rates and exchange rates represented by the Malaysian Ringgit (RM) against the US Dollar. In KLSE it has their own rules where buyers and sellers trade their transaction with each other. Since KLSE was established, there were ups and down movement of KLSE causes by many variables.

To measure the performance of stock market, stock index is used. Besides, it can be used by all investors as a benchmark for them to evaluate the performance of holding shares. KLSE Composite Index is comprised of 100 companies listed on the exchange. The movement of stock prices can be triggered by the movement in financial sector in particular, that is the money supply. From this situation, there might be a relationship between KLSE Composite Index with money supply.

A negative relationship between stock market and inflation in India and by previous study that also comes out with the same result might support the relationship between KLSE Composite Index with inflation rates.

The motivation of this study is to find out whether there is a relationship between KLSE Composite Index with the level of money supply, inflation rates and exchange rates. Thus, if the Malaysian economic are facing with inflation, the stock price will be low and vice versa.

1.2 BACKGROUND OF THE STUDY

Kuala Lumpur Stock Exchange (KLSE) is a formal stock market and it is widely constructed such as the composite index, EMAS index, and the various sector indices of tin, plantation, hotel, services, automobile, industrial and properties. KLSE is a self-regulatory organization and has emerged as one of the top performing bourses in developing countries in 1992.

Based on the previous study, stock index is used to measure the performance of all stock market. KLSE calculate the index for each main sector traded however, mostly it will use the KLSE Composite Index because it will comprise the stocks traded on the KLSE. Since it is the only stock market in Malaysia, the monitoring and supervising do by Minister of Finance (MOF) and by Securities Commission (SC).

KLSE Composite Index has been introduced on 1986 where one stock index was needed which can act to stock market performance and Malaysia economy. All the data that has been calculated electronically by KLSE can be taken by brokers companies and other customers at any time since the index is base on minute to minute.

KLSE are really a well known stock market in the world. In 1970’s and 1980’s, KLSE had major development until it had become one of the largest market capitalization bourses in South-East Asia.

However, when Singapore out from Malaysia in 1965, the Stock Exchange of Malaysia then, known as the Stock Exchange of Malaysia and Singapore. In spite of, in 1973 when the currency exchange between Malaysia and Singapore drop, again it changes the name and become Kuala Lumpur Stock Exchange and Stock Exchange of Singapore.

In 2004, KLSE has changed it name and now it is known as Bursa Malaysia Berhad. This Bursa Malaysia focused to improve the products and services that they conduct. While in year 2005, Bursa Malaysia was listed on the Main Board of Bursa Malaysia Security Berhad.

While in KLSE Composite Index, it has been accepted as a local stock market barometer when it was introduced in 1986. From the investor side, the major factors that determine the stock market are the climate of economic.

This study investigates the impact of inflation rates, exchange rates and money supply towards stock market. Based on the previous study, there are several researches that have been handled to investigate this dependent variable and independent variables.

1.3 PROBLEM STATEMENT

This study is to analyze whether there are significant relationship between KLSE Composite Index as a dependent variables with the money supply (M3), inflation rate and exchange rate as an independent variables.

Malaysia stock market performance nowadays has staged at an encouraging recovery and gain in selected blue chips and this can be proved when in 2007, Malaysia’s economy placed the third largest economy in Southeast Asia. Malaysian stock market is able to provide profitability investment since strong domestic spending give benefit sector trading in Kuala Lumpur Stock Exchange (KLSE).

The movement of KLSE Composite Index Inflation depends on many economic factors. For this study, researcher tries to figure out whether the economic factors could affect the performance of KLSE Composite Index. The economic factors for this study refer to money supply, inflation rates and exchange rates. Researcher also tries to figure out, whether the economic factors could be major elements of stock investments.

Inflation is happen when a country has printed too much money which will increase the rate of consumer price and also will affect the cost of living. Good news for inflation is, the last report of inflation rate in Malaysia is about only two percent which is in November 2010. There was a negative relationship between inflation rate and stock price. This is because during inflation, cost of living and cost of production will increase and investor will not invest as before inflation happen.

Exchange rate refers as a payment or change for person that want to do exchange in currency from one country to currency of other country. While for the study in relationship with exchange rate, it also showed a negative relationship. When there is an increment in level of currency, the charges for each exchange also will be affected. This means they have to change the currency in a large amount and it might affect their money. Therefore, the rational of doing this research is to find out, whether KLSE Composite Index are linked to economic condition in level of money supply, inflation rate and exchange rate?

1.4 OBJECTIVES OF THE STUDY

This study is to figure out the relationship, movement and performance of dependent variable and independent variables. It has divided into two types of objectives. The objectives of this study are:

1.4.1 GENERAL OBJECTIVES

The major objective of this study is to identify the relationship between dependent variable (KLSE-CI) and independent variables which are money supply, inflation rates and exchange rates in order to know whether there is any positive or negative relationship.

1.4.2 SPECIFIC OBJECTIVES

To determine the relationship between inflation rates and KLSE Composite Index

To determine the relationship between exchange rates and KLSE Composite Index

To identify whether changes in variables are significant in affecting the movement of KLSE Composite Index

1.4.3 NULL HYPOTHESES (H0)

There is no significant relationship between KLSE Composite Index (dependent variables) with money supply, inflation rates and exchange rates (independent variables).

1.5 SCOPE OF THE STUDY

This research paper is to examine the relationship between Kuala Lumpur Stock Exchange Composite Index with level of money supply (M3), inflation rates (CPI) and exchange rates (Ringgit against US Dollar). The data for this study are gathered a period for 60 months (5 years) from 2006 to 2010. As been stated, the multiple regression analysis is used to measure the relationship between dependent variable and independent variables with monthly basis issued by Bank Negara Malaysia (Central Bank of Malaysia).

1.6 LIMITATION OF THE STUDY

There are some limitations in conducting this research. The limitations that have been highlighted are as follow:

Limited variables chosen make it difficult to interpret the relationship of dependent variable and independent variables and it been conclude as not really efficient.

The data collected are mostly from internet, journals, newspapers and economic reports. Unreliable collected data will lead to unreliable results.

The data for this study is gathered for monthly collective data which taken from Bank Negara Malaysia.

Only three independent variables (money supply, inflation rates and exchange rates) have been chosen since there are too many internal factors that can classify the relationship and can affect KLSE Composite Index.

This study cover period for 60 months (5 years) 2005 to 2010, are considered quite a short period compare to other research. The finding might not be perfectly accurate.

For this research, only one country is focused which is Malaysia in order to limit the scope of research.

The limitation for this research can be more reliable if the data taken based on weekly basis. Since best research comes with accurate data from weekly or daily basis data.

1.7 SIGNIFICANCE OF THE STUDY

This study provides some useful information about the relationship between KLSE Composite Index with levels of inflation rates, exchange rates and money supply.

The significant of this study is to build better understanding for readers and useful information to investors in making good investment decision.

In addition, this study provides two important aspects in Malaysia economy (exchange rates and inflation rates) which can help companies in Malaysia to make decisions to issue their shares during the period of good economic and during the economic when it face with high inflation.

Studies examining the relationship between money supply, inflation rates and exchange rates under Malaysian experiences are very limited, and it is hope from the available findings from this study, it can be use as a direction or reference for further research.

CHAPTER 2

2.1 LITERATURE REVIEW

According to Ooi Beng Hooi (2011), entitled The Relationship between KLCI and Ringgit Malaysia against US Dollar, he would like to explain the relationship between stock price and currency exchange rate. Researcher had done his research in four years starting from July 2005 until July 2009. Last, he comes out with the conclusion that state that a significance and strong relationship are explained in both KLCI and Ringgit Malaysia against US Dollar. The results of this research are really useful and in can be us as references for future study.

According to Noor Azlinna Azizan and Hasyaliny Sulong (2011), entitled The Preparation Towards Asean Exchange Link between Malaysia Stock Market and Asia Countries Macroeconomics Variables Interdependency, they investigated the interaction between stock prices and macroeconomic variables in Asia countries include Malaysia, Indonesia, Singapore, Thailand, India, China, South Korea, Japan and Taiwan to view the interdependency of our stock market to other Asia countries macroeconomics variables. As a result, the researcher found out that only stock price and exchange rates have the most impact to our stock market.

According to Oguzhan Aydamer (2009), with the topic of The Relationship Between Stock Prices and Exchange Rates Evidence From Turkey, he disclose the relationship between macroeconomics variables such as money supply, inflation rates, exchange rates, interest rates and stock price. This research is done for 8 years from February 2001 to January 2008 which focuses in one country that is Turkey. After all the research has been made, he then concludes that there is a negative relationship between exchange rates and all stock market indices. Besides, he also stated that other variables are also having negative relationship.

According to Aisyah Abdul Rahman, Noor Zahirah Mohd Sidek and Fauziah Hanim Tafri (2009), a research on Macroeconomic Determinants of Malaysian Stock Market, are investigates the relations between selected macroeconomic variables and stock prices for the case of Malaysia. In addition, this research highlights that Malaysian stock market has weak interaction with money supply, exchange rates and interest rates as compared to the industrial production index.

Sara Alataqi and Shokoofeh Fazel (2008), with topic Can Money Supply Predict Stock Price said that, when they refer to other previous researcher, most of them come with the same result which a positive casual relationship between money supply and stock prices is frequently hypothesized by some financial analysis. While for both of these researchers, Sara Alataqi and Shokoofeh Fazel theier belive are against with that statement. From the research they have made, the results that they get are totally different with the previous study. They have proved the reason and all the calculated data in their research. As a result, they strongly explained that there is a negative relationship from money supply to stock price and also a negative relationship from interest rate to stock price.

Paritosh Kumar (2008), Is Indian Stock Market Related with Exchange Rate and Inflation, said that short-term foreign assets are fully exposed to exchange risk and exchange rates movement might affect the domestic companies. He also strongly believes that, a relationship between exchange rates and stock prices do exists but it just does not rule out any relationship between them. The end result for this research is he admit that there is a significance relationship even though it shows a negative sign which means to a negative relationship.

According to Shamail Arzu (2008), Relationship Between Exchange Rates and Stock Prices comes to the conclusion which changes immediately in currency can absolutely affect ups and down in the stock index. Besides, he found that fluctuation in currency rates and movement in stock exchange is negatively will affect imports and exports in a country as well.

Koffie Nassar (2005), Money Demand and Inflation said that by doing an analyzing data on the relationship between money supply, prices, inflation and income in Madagascar, it comes to the result which state that a negative correlation do exist and inflation expectations are largely determined by every past events. By controlling inflation in the short run, most of the broad money growth can be effective. It concludes that the variables are not strongly significance with the dependent variable.

Ramin Cooper Maysami, Lee Chuin Howe and MohamadAtkin Hamzah (2004), Co-integration Evidence From Stock Exchange of Singapore’s All-S Stock Indices said that the objective of their research is to examine the relationship between selected macroeconomic variables with Singapore Exchange Stock Indices. The result highlighted that the majority of the macroeconomic variables includes broad money, exchange rates and other factors are much more seriously have strong casual relationship with Singapore Exchange Stock Indices.

According to Chandran V.G.R and Norazman Shah Abd Rahman (2004), entitled Causality between Money Supply and Stock Prices: A Preliminary Investigation on Malaysian Stock Market, help the researchers in order to observed the relationship between money supply and stock prices. However, based on this study, researchers are using a simple bivariate Granger causality to test the Malaysian stock market. It shows that by predicting the changes in money supply, thus it may afford for better understanding in stock prices.

Ming-Yu Cheng and Hui-Boon Tan (2002), entitled Inflation in Malaysia, sait that the objective of this study is to identify either it contribute to the significance relationship or not. Both researchers come to the same conclusion where based on the variables that they have been discussed, it still significance but it cannot be calssified as strong significance.

According to Professor J.P.Gupta, Professor Alian Chevalier and Fran Sayekt (2000), entitled The Casuality between Interest Rate, Exchange Rate and Stock Price in Emerging Markets: The Case of the Jakarta Stock Exchange highlighted that stock market are very complex and it can be very sensitive to exchange rates and interest rates. Any movement in stock market will totally affect the economy. When interest rate and exchange rates are fluctuating, it will cause a bad effect. Other than that, they agreed that interest rate and stock prices are independent series for most of the time and it a same result found in exchange rates which have strong relationship with stock price. Both variables are significance relationship towards stock price.

CHAPTER THREE

RESEARCH METHODOLOGY

To find the result on this research, there are certain methods that can be used in order to determine the information data of relationship between the given variables. In this study, to determine the relationship between dependent variables (KLSE Composite Index) with independent variables (Inflation Rates, Money Supply and Exchange Rates), an analysis named the Multiple Regression Analysis and Statistical Package of Social Science (SPSS) is applied in order to analyze data and enhance better understanding for the result.

This study covers the period from 2005 to 2010. These methods are the most applicable because it will evaluate the relationship between the variables. SPSS is used to interpret a result in research while Multiple Regression Analysis is used to measure the linear association between dependent variable and independent variables

3.2 DATA SOURCES

Most of the data for this study are come from the secondary data. The closing prices of KLSE Composite Index at the end of each period were gathered and the data were achieved from Quarterly closing prices KLSE Composite Index over the period 2005 to 2010.

Data for the independent variables, which are money supply (M3), inflation rate (CPI) and exchange rate were achieved from Monthly Statistical Bulletin issued by Central Bank of Malaysia (Bank Negara Malaysia) from 2005 until 2010.

3.3 THE DATA

Based on this study, all the relevant data are the secondary data. There are:

KLSE COMPOSITE INDEX

Kuala Lumpur Stock Exchange (KLSE), which now known as Bursa Malaysia Berhad is a place for traders to do trading. It contains many counters where each of the counters is for different companies. Besides, it is a self regulatory organization that administers the conduct of its members and also members of stock broking companies. The data for KLSE were gathered from KLSE Yahoo Finance.

MONEY SUPPLY

Money supply is a total supply of money circulation use in economy. There are several types of measurement in money supply which known as M1, M2 and M3. In this study, researcher focuses more on M3. M3 which refer to broad money are consists of foreign currency deposits, saving deposits, fixed deposits, negotiable certificate deposit (NIDS) and repurchase agreement (Repos). The foreign currency deposits refer to deposit of foreign currencies hold by commercial banks, merchant bank and non-bank Malaysian residents. In this research, the data were taken from Monthly Statistical Bulletin of Bank Negara Malaysia.

INFLATION RATES

In economics, the inflation rate is a measure of inflation. In this study, the data were obtained from Monthly Statistical Bulletin of Bank Negara Malaysia.

EXCHANGE RATES

Exchange rate or also known as foreign exchange rate shows the relationship of currency between one country with others. In this research, researcher focuses on Malaysian (MYR) currency with US currency (USD). Increase in Malaysia ringgit means a decrease in the cost of exchange of Malaysian currency with other currency. The data for exchange rate were taken from Monthly Statistical Bulletin of Bank Negara Malaysia.

THEORETICAL FRAMEWORK

In this study, KLSE Composite Index is chosen as dependent variable and money supply, inflation and exchange rates are classified as the independent variables. This means that the changes in KLSE Composite Index actually depend on the changes in money supply, inflation rates and exchange rates. The diagram of the relationship between both dependent variable and independent variables are being showed below:

Money Supply

Inflation Rates

Kuala Lumpur Stock Exchange Composite Index (KLSE-CI)

Exchange Rates

Dependent Variable

Independent Variable

HYPOTHESES

This study consists of Null Hypotheses (H0) and Alternative Hypotheses (H1). The hypotheses are as showed below:

Hypotheses 1

H0: There is no relationship between money supply and KLSE Composite Index.

H1: There is a relationship between money supply and KLSE Composite Index.

Hypotheses 2

H0: There is no relationship between inflation rate and KLSE Composite Index.

H1: There is a relationship between inflation rate and KLSE Composite Index.

Hypotheses 3

H0: There is no relationship between exchange rate and KLSE Composite Index.

H1: There is a between exchange rate and KLSE Composite Index.

MULTIPLE REGRESSION ANALYSIS

Data for this study were being analyzed by using the Statistical Package of Social Science (SPSS) Software. Hypotheses are used to determine the relationship between dependent variables (KLSE Composite Index) and independent variables (money supply-M3, inflation rate, exchange rate). In order to determine the influential of money supply, interest rate and exchange rate towards KLSE Composite Index, a Multiple Regression Analysis is applied.

This multiple regression analysis used the independent variables to predict the dependent variables.

The Estimated Regression Model as follows:

Y = c + βM + βF + βX + ε

Where:

Y = Dependent Variable (KLSE Composite Index)

c = Constant Term

β = Regression Coefficient (Beta Measurement)

M = Independent Variable (Money Supply-M3)

F = Independent Variable (Inflation Rate)

X = Independent Variable (Exchange Rate)

ε = Error Term

COEFFICIENT RELATIONSHIP

Researcher used R2, T-Statistic and F-Statistic to determine the relationship between money supply, inflation rate and exchange rate towards KLSE Composite Index.

COEFFICIENT OF DETERMINATION (R2)

Coefficient of Determination or known as R2 is the most usually used in linear regression. R2 present how well the regression model describes changes in the value of dependent variable (Y) that can be explained by the independent variables. It shows how the line fits the data.

The value of R2 is range from zero to one. The range indicates whether the correlation is strong or not. If R2 is zero, the equation explains that there is no relationship between the dependent variable and independent variables. While if the R2 is 1, the equation explains the relationship between dependent variable and independent variables are do exist.

The higher the value of R2, the better the regression equation will be. When value of R2 is higher, the exploratory power will increase and be more accurate for forecasting purposes.

An equation of R2:

Total VariationR2 = Total Explain Variation

This equation are used when researcher decide to calculate by manual. However, in this study, researcher has chosen Statistical Package of Social Science (SPSS) in order to calculate all the data that are gathered from Bank Negara Malaysia for the 60 months periods.

The result of this R2 will be shows and explains in analysis and findings. It also will conclude whether all independent variables will explain the dependent variable or it will not.

T – STATISTICS ( T-STAT)

T- Statistic is used to decide whether to accept or reject the null hypotheses and also to analyze the significant relationship between dependent variable and independent variables. The value in t-table will be compared with the calculated t-value.

T is critical value at certain significant

T = (n – k – 1)

n = number of observations / years

k = number of independent variables

If the computed t-statistic is greater than t-critical value at certain significant levels, thus reject H0. If the computed t-statistic is lower than t-critical value at certain significant levels, thus accept H0.

T-Computed > T Critical Value, accept H1 and reject H0

T-Computed < T Critical Value, accept H0 and reject H1

F – STATISTICS (F-STAT)

Researcher is also using F-Statistic in order to know the consistency of overall regression equation. F-Statistic will evaluate the significant of each individual component of entire regression model.

Equation of F-Statistic is as follows:

F = Explained Variation / (k-1) Unexplained Variation / (n-k)

Where:

F = critical value

k = number of independent variable

n = number of observation

If the computed F-Statistic is greater than F-Statistic value at certain significant level, then reject H0. It is a vice versa when the computed F-Statistic is lower than F-Statistic value at certain significant level, then accept H0.

F-Computed > F-Critical Value, accept H1

F-Computed < F-Critical Value, reject H1

DURBIN WATSON STATISTIC

Durbin Watson is used to test the presence of auto correlation. It is appears when time series data are used. Auto correlation gives a downward bias to the standard error of the estimated coefficient (t-value are exaggerated) and hence the estimated coefficient is concluded to be significant when in reality they are not.

There are three possibilities where the auto correlation problem might arise:

When the independent variables are duplicated

When some of the independent variables are miss specified

When some important variables are found missing in the model

When successive residuals are positively auto correlated, the value of D will be approach zero. If the residual are not correlated, the value of D will be closed to zero. If there is a negative auto correlated, the value of D will be greater than two and could even approach its minimum value of four.

Equation of Durbin Watson Statistic (D) is defining as:

D =

PEARSON CORRELATION ANALYSIS

Pearson correlation analysis is a statistical analysis to see the direction and to describe the strength and significance of the relationships between the dependent variables and the independent variables. According to Pearson correlation analysis, the result can be ranked as follows:

Less than 0.30 = Week Relationship

0.30 to 0.49 = Moderate Relationship

0.50 to 0.69 = Strong Relationship

0.70 to 0.99 = Very Strong Relationship

1.0 = Perfect Relationship

CHAPTER FOUR

ANALYSIS AND FINDINGS

This chapter provides the findings which are obtained from the Statistical Package for Social Science (SPSS). Through SPSS, the relationship between Money Supply (M3), Inflation Rate and Exchange Rate with KLSE Composite Index can be identified. The researcher used regression in order to measure the linear relationship between dependent variable and independent variables. Coefficient of determinations (R2), T- statistic and F- statistic are the methodologies that being used by researcher to interpret the multiple regressions.

All the data were calculated on monthly basis for 60 months period (5-year), which are from January 2006 to December 2010.

Table1: Data gathered from monthly statistical bulletin BNM

YEAR

KLSE

M3

INFLATION

EXCHANGE

Jan-06

914.0100

679276.3000

3.2500

3.7510

Feb-06

928.9400

686040.7000

3.2400

3.7135

Mar-06

926.6300

690830.2000

4.7600

3.6860

Apr-06

949.2300

697329.4000

4.5500

3.6255

May-06

927.7800

699037.4000

3.9100

3.6290

Jun-06

914.6900

700537.8000

3.9000

3.6750

Jul-06

935.8500

705585.5000

4.1100

3.6535

Aug-06

958.1200

717140.9000

3.2800

3.6770

Sep-06

967.5500

716265.6000

3.2700

3.6845

Oct-06

988.3000

725351.2000

3.0700

3.6480

Nov-06

1080.6600

737229.6000

2.9600

3.6180

Dec-06

1096.2400

760301.6000

3.0500

3.5315

Jan-07

1189.3500

776100.8000

3.2400

3.5015

Feb-07

1196.4500

789147.0000

3.1400

3.5060

Mar-07

1246.8700

789222.5000

1.5500

3.4560

Apr-07

1322.2500

796487.8000

1.5500

3.4230

May-07

1346.8900

799238.9000

1.4500

3.4045

Jun-07

1354.3800

788610.8000

1.4400

3.4545

Jul-07

1373.7100

799902.2000

1.6300

3.4540

Aug-07

1273.9300

801630.3000

1.9200

3.5035

Sep-07

1336.3000

804248.7000

1.8300

3.4170

Oct-07

1413.6500

807425.8000

1.9200

3.3418

Nov-07

1396.9800

808446.5000

2.3000

3.3585

Dec-07

1445.0300

832737.8000

2.3900

3.3065

Jan-08

1393.2500

867682.2000

2.2800

3.2360

Feb-08

1357.4000

876225.7000

2.6600

3.1890

Mar-08

1247.5200

884372.9000

2.7600

3.1875

Apr-08

1279.8600

893619.3000

3.0500

3.1580

May-08

1276.1000

898652.6000

3.8100

3.2435

Jun-08

1186.5700

899120.0000

7.6900

3.2665

Jul-08

1163.0900

912693.3000

8.5100

3.2630

Aug-08

1100.5000

904562.2000

8.5000

3.3895

Sep-08

1018.6800

912780.0000

8.2100

3.4575

Oct-08

863.6100

900442.6000

7.6300

3.5625

Nov-08

866.1400

909230.6000

5.7100

3.6175

Dec-08

876.7500

931864.7000

4.3900

3.4640

YEAR

KLSE

M3

INFLATION

EXCHANGE

Jan-09

884.4500

946005.1000

3.9100

3.6085

Feb-09

890.6700

944320.5000

3.7100