Why the economics analysis and in depth understanding of economic factors are important for efficient decision making in capital market?
Investors always try to formulate best possible portfolio by investing in the capital market for the purpose of getting capital gain and dividend (cash or stock). It is not an easy task to choose best investment alternatives because proper analysis is required. Only a specialized person would be able to analyze the market and identify the potentials. Many people think that only financial analysis is enough to make investment but in real sense not only financial analysis but also economic analysis is required.
In case of financial analysis we only consider company and industrial outcome by fundamental and technical analysis. But whenever we go for analysis by considering economics we have to analyze the macroeconomic factors that may have impact on the capital market. An economist or any other professionals those have knowledge of economics can do this analysis on behalf of investors. But investors also have to have basic ideas of how economics factors can influence the price of the investment securities.
- Market Interest Rate
- Economic Recession
- Employment Rate
Effect of Inflation in the Capital Market
In an inflationary economy investors have less money to invest because investors have to spend more money for their consumption. As because there is a less demand of the stock in the capital market, the price should be lower; we know that lower the demand lower the price. In the other sense in case of company, for inflation the production cost of the company is higher than the previous. So company’s income will be lower that stimulate the price of the stock. We know that the stock which provides more dividends to the stock holders, that stock should price higher than the other company which provide lower dividends.
Effect of Market Interest Rate in the Capital Market
If the market interest rate increases then investor will prefer fixed income securities rather lower earning risky securities. Suppose government bond providing 10% of interest then this bond will get more preference compared with risky investment. On the other hand if the interest rate is lower in the market then investor will borrow the money at lower interest and invest in the capital market.
Because of economic recession there may have positive impact on the capital market. Normally at the beginning of recession investor loose but there is always an expectation that in near future there will be positive movement in the stock price in the market, so investor prefer invest when there is recession. This will happened only if there is strong form of efficiency exists in the market.
On the other hand if there is an economic boom situation exists then there may have a possibility of declining market price movement.
With the increase of number of employment of a country per capital income will also increase. For this people will have extra money after consumption. If people capital market is performing well then investor will interested to invest their surplus amount of money. So higher the employment higher the earning and it does increase the investment in the capital market.
Political Condition of a Country
Political condition is one of the main factors which have a huge impact on the overall economy and the capital market. People believe that a positive economic condition is required to maintain a stable capital market. Several financial decisions taken by the government over time to time, so it is also important know how much preference a capital market gets from the government.
In a capital market investors basically invest in a long term securities so investor must consider all probable aspects and economic factors before making investment. A choice of investment in capital market can lead to a huge capital loss, so proper analysis has to done by the professional and select best opportunities.
Finally one thing is that an investor should consider economic factors which have impact on the capital market and proper financial and economic analysis must be done before investing in the capital market.
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