The purpose of this study was to investigate the effect of Monetary Policy Instruments on Capital mobility in Nigeria specifically at The Nigeria Stock Exchange Market using annual data from 1986 to 2020. Causal Research Design was used to analyze data using Statistical Product and Service Solutions (SPSS). The software was run using three monetary policy variables including treasury bill rate, Money Supply(M1) and consumer price index (proxy for inflation) on the Capital market Returns (proxied by NSE 20 share price index).

The general result of the analysis showed a strong correlation between monetary variables and Capital market Returns. All the explanatory variables are positively related to Capital market returns except treasury bill rate which has a negative relationship with capital market returns. Increase in CPI and Money Supply M1 causes a corresponding increase in Capital market returns whereas an increase in Treasury Bill Rate causes a decrease in Capital market Returns. The study has revealed that monetary policy has made significant influence over the prices of ordinary equities in Nigeria and thus effectively on the returns. This implies that the equities market has significantly absorbed the monetary policy impulses and therefore the project confirms earlier studies done on the same topic regarding effect of Monetary policy on Capital mobility.

It would be important therefore to consider monetary variables as an important factor in determining capital market movements. Utmost care should be taken in designing monetary policies as it has a direct impact on cash inflows into the capital market and on the stability of the capital market and as such policy makers need to be aware of the need to encourage investors.

1.1Background of the study
Monetary policy can be defined broadly as any policy relating to the supply of money. The Central Bank of Nigeria has been trying to ease financial market by means of massive monetary policy interventions. Identifying the link between monetary policy and financial asset prices is highly important to gain a better insight in the transmission mechanism of monetary policy, since changes in asset prices play a key role in several channels (Amihud& Mendelson (1986). The Central Bank of Nigeria’s monetary committee defines monetary policy as the measures taken by the monetary authorities to influence the quantity of money with a view to achieving stable prices, full employment and economic growth. The ultimate objective of monetary policymakers is to promote the health of their economy by pursuing their mandated goals of price stability and maximum sustainable output and employment. Hence, monetary policy can also be defined in terms of formulation and execution of policies by the Central Bank, aimed at guiding bank lending rates to levels consistent with aggregate supply elasticity, all of which are set on the attainment of low inflation and high sustainable economic growth (Bernanke, 2003).

Monetary policy is a type of stabilization policy adopted by countries to deal with different economic imbalances. Monetary policy covers the monetary aspect of the general economic policy which requires that a high level of co-ordination between monetary policy and other instruments of economic policy be maintained at all times (Akhtar, 2006). The effectiveness of monetary policy and its relative importance as a tool of economic stabilization varies from one economy to another, due to differences among economic structures, divergence in degrees of development in money and capital markets resulting in differing degree of economic progress, and differences in prevailing economic conditions (Bernanke, 2005).

The effects of the policy instruments such as the short-term interest rate, on the goal variables are indirect at best. Monetary policy actions have their most direct and immediate effects on the broader financial markets, including the capital market, government and corporate bond markets, mortgage markets, markets for consumer credit, foreign exchange markets, and many others (Mishkin, 2000). If all works out as planned, the changes in financial asset prices and returns induced by the actions of monetary policymakers lead to the changes in economic behaviour that the policy attempted to achieve. Thus, understanding how monetary policy affects the broader economy necessarily entails understanding both how policy actions affect key financial markets, as well as how changes in asset prices and returns in these markets in turn affect the behaviour of households, firms and other decision makers (Ioannidis and Kontonikas, 2006).

Capital market or stock exchange is an institution through which company shares and government stocks are traded. According to Anyanwu et al (1997), the stock exchange is a market where those who wish to buy or sell shares, stocks, government bonds, debentures, and other securities can do so only through its members (stock brokers). It is a capital market institution and is essentially a secondary market in that only existing securities, as opposed to new issues, could be traded on. The impact of the capital market on the macroeconomy comes primarily through two channels. Firstly, as suggested by Greenspan (1996) is that movements in stock prices influence aggregate consumption through the wealth channel. Secondly, stock price movements also affect the cost of financing to businesses. A number of macroeconomic and financial variables that influence Capital mobility have been documented in the empirical literature without a consensus on their appropriateness as regressors. These works include Lanne (2002), Campbell and Yogo (2003), Jansen and Moreira (2004), Donaldson and Maddaloni (2002), Goyal (2004), and Ang and Maddaloni (2005). Frequently cited macroeconomic variables are GDP, price level, industrial production rate, interest rate, exchange rate, current account balance, unemployment rate, fiscal balance, etc.

De Long and Olney (2009) asserted that ever since capital markets came into existence in the world, economists have been saddled with the arduous task of making these financial intermediaries work efficiently and effectively. This is because stock prices are among the most closely watched asset prices in the economy and are viewed as being highly sensitive to economic conditions The level of the capital market is a key variable which indicates the pulse of economic activity in a country and together with other variables such as the real Gross Domestic Product, the unemployment rate, the inflation rate, the interest rate and the exchange rate give a summary of the macroeconomy. Stock prices have also been known to swing rather widely, leading to concerns about possible "bubbles" or other deviations of stock prices from fundamental values that may have adverse implications for the economy.

Durban (2000) claimed that many financial crises in the past have been traced to a crash in the capital markets and one of the consequences of financial crises are decline in the level of the capital markets. In fact, capital markets are so important in any economy that the level of the capital markets is the key economic indicator which is heard about most often. Capital market indicators such as market capitalization, all-shares index, value and volume of stocks traded in the stock exchange are announced on the news daily. This shows the great importance of the capital markets to any economy in the world. Capital markets play a vital role in boosting long-run economic growth and as such governments the world over have instituted measures aimed at enhancing capital market operations. However, if any capital market is to play its allocative role properly, a lot more needs to be done on the macroeconomic policy framework front.

Most economists believe that monetary policy has a strong influence on the behaviour of households and firms. In the recent past considerable interest has been shown on the relationship between monetary policy and capital market returns in both developed and developing countries (Cassola and Morana, 2004, Bjornland and Lietemo, 2009 and Bernanke and Kuttner, 2005). Greatly motivated, in part, by the important role given to monetary policy in macroeconomic management in recent years. The other reasons include advances in econometrics techniques and availability of good quality data.

Stock prices which determine capital market volatility and returns may be influenced by variation in future earnings, discount rates of future dividends, risk preferences of investors and taxes. As Bernanke and Kuttner (2005) point out, when establishing the link between monetary policy changes and stock returns one should account for the possibility that anticipated policy actions may have already been incorporated by market participants into their investment decisions. Bernanke and Kuttner (2005) use Kuttner’s (2001) futures methodology to decompose the federal funds rate changes into expected and unexpected and find that an unanticipated monetary policy tightening exerts a negative impact on the US capital market. Bredin et al. (2007) adopt a similar empirical approach using UK data and find that unanticipated policy changes have a significant impact on both aggregate and the majority of the sixteen sectoral stock returns that they employ.

According to the Efficient Market Hypothesis (EMH), the prices of securities fully reflect available information. Financial assets are continuously traded in liquid wholesale markets with low transaction costs, where prices reflect market perceptions almost instantaneously thus investors buying securities in an efficient market should expect to obtain an equilibrium rate of return. General EMH theory however insists that there ought to be an efficient market in which stock prices reflect all available information, and if there is no price perversion, stock prices are to reflect company’s productivity such as economic fundamentals in macroeconomics.

It is worth-noting that, policy-induced changes in current and future real interest rates influence the timing of consumption and investment decisions of households and firms. On the other hand stock prices are assumed to be determined in a forward-looking manner, reflecting the future discounted sum of return on assets. This implies that stock prices may change in response to changes in expected future dividends, the expected future interest rate that serves as a discount rate or the stock return premium. From the aforementioned, monetary policy may influence stock prices directly through the interest rate channel and indirectly through its effect on the determinants of dividends and the stock return premium by influencing the degree of uncertainty agents face (Ioannidis and Kontonikas, 2008).

From a fundamentalist point of view, making profits from stock trading depends on an investor’s ability to accurately calculate stock’s intrinsic value. This is done by examining the environment of the firm; related economic, financial and other qualitative and quantitative factors. Only then can the investor compare the stock’s intrinsic value with its current market price and decide whether the stock in overpriced or underpriced. An overpriced stock would be the one that the intrinsic value is below the market price, while the converse is true for the underpriced stock. Rational investors would buy underpriced stock, with the hope that the capital market price will rise to its intrinsic value thus making a profit from the spread. Inversely, rational investors would sell over-priced stock because they would be expected to fall in price towards their intrinsic value. Specifically, monetary policies formulation should be geared towards enhancing the efficacy with which resources are mobilized through the capital market.

This study investigates the impact of monetary policy actions on capital market returns in Nigeria. It seeks to answer the question on the nature and extent of the impact of monetary policy on the performance of the NSE in terms of capital market returns. The Central Bank of Nigeria Act stipulates that “the principal object of the Bank shall be to formulate and implement monetary policy directed to achieving and maintaining stability in the general level of prices.” In addition, “the Bank shall foster the liquidity, solvency, and proper functioning of a stable market-based financial system.”

Main Instruments that CBN uses to implement monetary policy include the following:

Open Market Operations (OMO)-This is by far the main active monetary instrument most frequently used by the CBN to manage liquidity. The OMOs were conducted through sale and purchase of government securities using repurchase agreement (REPO) with commercial banks.

Reserve Requirements-Commercial banks are required to maintain a daily proportion of their liabilities in cash-currently 6%-at the CBN. This is not an actively used monetary policy instrument.

Other Instruments include Rediscount Facilities and Lender of Last Resort Facility, which have not been recently used as the key tools for implementing monetary policy.

In Nigeria, dealing in stocks and shares started in the 1920s when the country was still under British colony. There was however no formal market, no rules and no regulations to govern stock brokerage activities. Trading took place on gentlemen’s agreement in which standard commissions were charged with clients being obligated to honor their contractual agreements of making good delivery and settling relevant costs. In 1951 an Estate Agent by the name of Francis Drummond established the first professional stock broker firm and other stock brokerage firms were later established. The NSE came into being in 1954 when trading used to take place over a cup of tea at the New Stanley Hotel (Muga ,1974). The Nigeria Stock Exchange was constituted as a voluntary association of stock brokers registered under the societies Act in 1954 and in 1991 the Nigeria Stock Exchange was incorporated under the companies Act of Nigeria as a company limited by guarantee and without a share capital. Subsequent development of the market has seen an increase in the number of stockbrokers, introduction of investment banks, establishment of custodial institutions and credit rating agencies and the number of listed companies have increased over time. Securities traded include, equities, bonds and preference shares.

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Item Type: Project Material  |  Size: 60 pages  |  Chapters: 1-5
Format: MS Word  |  Delivery: Within 30Mins.


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