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Before making investment, an investor should be aware about the economy, industry, & company in which he wants to invest.

What is economy?

The economy encompasses everything related to the production and consumption of goods and services in an geographic region.

One more way to look at the economy is to look at the gross domestic product. Gross domestic product (GDP) refers to the market value of all final goods and services produced within a country in a given period. GDP is the sum of consumer spending Business investment government spending net export.

Some Facts About Indian economy:

The Economy of India is the ninth largest in the world by nominal GDP and the third largest by purchasing power parity (PPP). Market Price GDP of India for the year 2011-12 is estimated to be at Rs.82.79 trillions, which is 15.7% higher than previous fiscal year. Economic growth rates are projected at around 7.0% for the 2011-12 fiscal year. The country is one of the G-20 major economies.

What is Investors Required rate of return & Business cycle?

As we are know that the investors required rate of return is equals to risk free rate of return+{beta*(market rate of return-risk free rate of return}. We see that the risk free rate of return and market risk premium are the two key ingredients in determining the required rate of return. Both are very sensitive to change in economic activities, because interest rates are changes according to changes in economies activities.

An economy goes through two phases expansion & contraction known as the business or economic cycle.

Expansion phase of the business cycle is when the economy moves from a downturn to a peak. It is a period when business activity surges and gross domestic product expands until it reaches a peak period of time during which sales of a product or business activity increases very rapidly.

Contraction phase of the business cycle in which the economy as a whole is in decline. More specifically, contraction occurs after the business cycle peaks, but before it becomes a trough. According to most economists, a contraction is said to occur when a country's real GDP has declined for two or more consecutive quarters.

How investors required rate of return is sensitive or depends on business cycle?

As we already learn that business cycle is of two types. If business cycle is running in the phase of expansion period means there is rise in economic activities then there will be heavy production and supply of goods and services and enough demand from consumer side also, hence there will be enhance in the demand of credit for buying or consuming goods and services, it will lead to inflation consequentially increase in prevailing interest rates in market,& ultimately this situation will increase the required rate of return of investor.

If business cycle is running in the phase of contraction period means there is slowdown in economic activities, then there will be low volume production and supply of goods and services, and less demand from consumer side, hence there will be less demand of credit, there will be decrease in interest rates consequentially investors required rate of return will be on lower side.

Due care of various economic factors during investment:

1. Liquidity in  system - less liquidity situations means shortage of funds in market, it leads to increase in interest rates consequentially companies cost of funding increase, it hammers profits of company and share prices of that company goes down and there lose loss to investor.

2. Climate OR monsoon situation- in an agriculture base economy monsoon plays a vital role, situation of bad monsoon curtails the demand & consumption levels, it adversely affects profits of companies and therefore loss to investor & vice versa.

3. Inflation rate in the economy-inflationary conditions puts pressure on margins of companies, (e.g. of petrol & diesel cost)

4. Technological development and innovation increases productivity. This drives investment and increases profits, pushing growth.

5. Various industry growth rates. (like construction, mining, mfg, power, auto, banking, metal etc.)

6. National income growth rates.

7. GDP estimates.

8. Increase decrease in foreign investment.

9. Increase decrease in exports.

10. Trade liberalization, capital mobility & exchange rate policy.


Finally I want to conclude that investors return depend on condition of economy. And a good economy would help in improving the living standards of individuals, who would have higher money for spending. This increases consumption, and business as a whole sees a increased sales and profit which ultimately drives the share prices up and plus returns to investors.

Published by

CA Lokesh Pokharna
(CA (Ahmedabad,Bhilwara,Chittorgarh))
Category Others   Report

1 Likes   31 Shares   8862 Views


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