Download Study of Pakistani market where investors have high financial risk

Role of financial literacy in investment: Study of Pakistani market
where investors have high financial risk and financial constraint.
NoumanAhmed
(MS Student, Management Sciences)
Riphah International University – Rawalpindi
CMS-10877-Cell # 0336-5395259- E-mail:[email protected]
Introduction: This paper will cover the moderating impact of financial literacy while making
an investment decision. Financial risk and financial constraint are independent variables. Data
will be collected using primary source that is by distributing questionnaire. Distribution of
questionnaire is further divided into two different segments. First segment consists of university
students and second segment consists of stock exchange participants. Reason for dividing this
research into two segments is to observe whether there is any difference between two returns or
not (due to change in financial literacy).
INDEPENDENT VARIABLES
DEPENDENT VARIABLE
Financial Risk
(-)
‘
’
’
Investment
Financial Constraint
(-)
Financial Literacy
(-)
MODERATING VARIABLE
H1: There is negative relationship between financial risk and investment.
H2: There is negative relationship between financial constraints and investment.
H3: There is positive relation between investment and financial literacy.
H4: There is positive relation between investment and financial literacy (Stock market
participants).
H5: There is negative relation between investment and financial illiteracy (University students)
H6: Financial literacy decreases negative relationship between investment and financial risk.
H7: Financial literacy decreases negative relationship between investment and financial
constraint.
Background: Past literature suggested that financial literacy is an important issue not for big
investors or businessmen but also for a common person who is taking his daily routine decisions
(children’s education plans, saving and consumption plans , investing for retirement, family
consumption decision etc ). Amazingly past researchers conformed that people of developed
countries are as much ignorant about their financial decisions (because of lack of financial
literacy) as the people of developing countries. People are unclear about the basic financial
concepts and instruments, with which they are dealing with (e.g. debt and equity financing which
leads them to future mortgagees and losses, nominal and real interest rates, stock and mutual
funds investments, concept of compounding etc). In short investor’s investment decision hinders
a lot from financial constraints (agency cost, information asymmetry, resistances in money
market make securities underpriced, shortage of internal resources and huge cost of external
capital etc) and financial risk (default risk, liquidity risk, business risk, buying potential risk or
risk due to increasing commodities prices, risk due to interest charges, market risk and finally
political risk). Especially talking about Pakistani market where an investor is facing many
different kinds of risks at same time. So investor should know about his/her risk profile, because
past studies confirm positive relationship between risk and return, which means by taking
calculated risk investors can maximize their returns. Concept of financial literacy do not prevails
in Pakistan as it is new concept even for developed countries. It is worthwhile investment which
will which reduces constraints and make investors to take measureable risks to improve their
investment decisions. Financial literacy make person capable of managing his money and risks
associated with it. Financially literate individual can recognize benefits of savings in long-run
and has encouraging attitude towards financial planning. This paper benefits entire population of
Pakistan (including a common person having a small business or family budgeting issues to a
professional business man) because many of us lacks in basic financial concepts. But for a while
my main focus is youth of Pakistan for which I selected one sample of university students, to get
know where they lacks and where they should pay attention because ultimately tomorrow
financial responsibilities are upon them so they should be prepared for them.
History: Financial literacy generally means to understand how to make money and how to
make efficient decisions regarding usage of money. Many different institutes are taking different
valuable steps in promotion of financial literacy among common people mainly named as OECD
(Organization of Economic Co-ordination and Development) and PACFL (President Advisory
Council on Financial Literacy). Orman (2004) defined financial literacy as “the ability to use
knowledge and skills to manage financial resources effectively for a lifetime of financial wellbeing”. Talking about Pakistan two famous names are NFLP (National-wide Financial Literacy
Program) and SAFE (South Asian Federation of Exchanges). Past researchers did considerable
work in relation among investment, risk and its constraints but not much work has been done on
concept and importance of financial literacy. Zwiebel (1996) defined investment as “decision of
how, when, and where to spent money or capital in sake of earning profit”. Barry (1974) defined
financial risk as “the variability of returns from those that are expected”. Stein (2003) defined
financial constraints as “problem whereby a firm foregoes investments because it lacks access to
external financial resources and does not have internal funds to pursue a profitable opportunity”.
As financial literacy still has less considerable attention for developed countries, so its
prevalence in developing countries should be an important question to be raised. As per NFLP
survey conducted in 2012 by Asian development bank and initiated by state bank of Pakistan,
arose question that (is financial literacy an important issue for Pakistan?) results suggested that
86.6% of respondents answered ‘yes’, 8.4% answered ‘possibly’ and 5% said ‘no’. Pakistan state
bank’s governor Yaseen Anwar also admired the work of NFLP and highlighted importance of
financial literacy for stakeholders. Sethi (2009) said that financial literacy not only contributes in
business decision making but also in daily family decisions (scheduling household budgets,
scheduling for saving account after retirement, taking decisions about children’s education etc).
Therefore not only professional investors but also a common person should have a knowhow of
basic financial literacy and financial concepts to avoid situations like frauds and
misrepresentations. Bogle (2007) stated that grown-ups are unaware of basic financial concepts.
Survey was conducted in which respondents were asked about practice of compounded interest
rate, 67% respondents said that they knew about it but after testing their actual concepts only
28% people actually know right about it. Additionaly OECD did study in U.S and found that vast
percantage of workers are not planning for their retirements. Financial literacy also varies on
gender, race and age differences. Generally it is seen that pople under 50 years of age, women
without collage degree and black people are very ignorant about their financial literacy due to
which their investments are exposed to different kins of risks and constraints resultant in losses.
People in developed countries even like U.S are unaware about debt literacy, one-third are aware
on compounding on interest (Lusardi & Tufano, 2009). Gladwell (2008) said most of the people
cannot understand the basic financial instruments. If we look at relationship between investment
and risk most people are risk averse in nature especially talking of Pakistani market where there
is high level of uncertainties everywhere (Akhtar, Ali & Sadaqat, 2011). Adding to this Duxbury
and Summers (2003) said that women are further risk disinclined then men. Mitra, Reiss and
Capella (1999) stated that investors that avoid risk usually take more time in gathering relevant
and important information which result in wastage of important time and recourses. This thought
is further supported by (Cukierman, 1980). There is negative relationship between risk and return
which result in preferences of low risk investments on high risk investments (Berk, Green &
Naik, 1999). Barry (1974) said opposite to this by stating view of traditionalists who state
positive relation between risk and return. While behaviorists said that higher the variation in
returns higher the risk will, past studies also said that investors are more associated to loss than
variation.
Context: Financial literacy is important for individual in formation of healthy community and
society. Improved financial knowledge result in high standards of living by limiting risks and
constraints. Most of us are not risk takers but risk avoiders as due to unstable economic, financial
and political reasons (Akhtar et al., 2011). Inconsistency of political conditions however prevails
in Pakistan from 1947. Traditionalists state that higher risk result in higher returns because of
involved risk premium. Pakistan carries 12% and 7.5% risk premium due to its political risk.
Financial literacy in an important issue of today not only for developing countries but also for
developed countries. As west in still not proficient in it, therefore it’s understanding in country
like Pakistan is questionable. SAFE confirms its importance in Pakistan. As per NFLP survey
conducted in 2012 by Asian development bank and initiated by state bank of Pakistan, arose
question that (is financial literacy an important issue for Pakistan?) results suggested that 86.6%
of respondents answered ‘yes’, 8.4% answered ‘possibly’ and 5% said ‘no’. Pakistan state bank’s
governor Yaseen Anwar also admired the work of NFLP and highlighted importance of financial
literacy for stakeholders. Managing director of Lahore stock exchange Mr Aftab Ahmad
Chaudhry highlighted importance of initiation of financial literacy programs for Pakistani youth.
Pakistan due to its instable economic conditions got low rates of investments and savings
therefore youth of Pakistan is unaware of modern financial products and services. In order to
mange such problems youth should be financially literate to take smart decisions. Some main
causes of low level of financial literacy in Pakistan is due to high proportion of youth, women,
rural population, low literacy rate, low income people. Rasheed and Arshad (2009) also confirm
this point that Pakistani youth lacks in financial literacy. Lack of financial literacy resulted in
cause of many major and minor issues. Some are listed below.
1. Youth unaware of right way to save and invest money.
2. Families who are to take necessary financial decisions for their well-being are open to high
risks.
3. Many Individuals are unaware of insurance policies, credit, pension and retirement planning.
4. Suspicious and uncertain financial environment of Pakistan.
5. Individuals overconfident of their financial knowledge actually unaware of basic concepts.
6. Low level of trust of individuals in financial institutions.
It is not possible to address all issues related to financial literacy in single paper because of time
limitations. This paper will focus youth who actually are not aware of financial concepts because
they are not practicing them but only study them in universities. Comparison of stock market
participants financial knowledge and university students will lead to know the gapes and
ultimately result in formulation of strategies which will help them in making smart money
related decisions.
Novelty: Different researchers work on many different relationships of investment with
different variables but limited research is done in field of financial literacy in Pakistan. At least I
found not a single paper in Pakistani context when we talk of moderating impact of financial
literacy on investment while investment is in direct relation with risk and constraints. Past
reports and literature strongly emphasis on this issue.
In past researchers did lot of work to examine impact of different variables on investment
decision making, yet not much research related to moderating impact of financial literacy on
investment (while financial risk and financial constraint are independent variables) is taken into
consideration. If we look at relationship between investment and risk most people are risk averse
in nature especially talking of Pakistani market where there is high level of uncertainties
everywhere (Akhtar, Ali & Sadaqat, 2011). Pakistan carries 12% and 7.5% risk premium due to
its political risk. As per NFLP survey conducted in 2012 by Asian development bank and
initiated by state bank of Pakistan, arose question that (is financial literacy an important issue for
Pakistan?) results suggested that 86.6% of respondents answered ‘yes’, 8.4% answered
‘possibly’ and 5% said ‘no’. Pakistan state bank’s governor Yaseen Anwar also admired the
work of NFLP and highlighted importance of financial literacy for stakeholders. Managing
director of Lahore stock exchange Mr Aftab Ahmad Chaudhry highlighted importance of
initiation of financial literacy programs for Pakistani youth. Pakistan due to its instable economic
conditions got low rates of investments and savings therefore youth of Pakistan is unaware of
modern financial products and services. In order to mange such problems youth should be
financially literate to take smart decisions. Some main causes of low level of financial literacy in
Pakistan is due to high proportion of youth, women, rural population, low literacy rate, low
income people. Rasheed and Arshad (2009) also confirm this point that Pakistani youth lacks in
financial literacy.
Problem statement: Financial literacy is wide spread common issue of whole world now a
days. This paper only addresses lack of financial literacy in university youth of Pakistan, as
university youth is the brightest upcoming future of any country. However not only youth but
most of elders of various disciplines also lack in financial literacy but this research cannot cover
that portion because of time and resource limitations. This sample cannot be a representative of
whole population but will tell the gapes in financial literacy of youth and will help in making
strategies to overcome those gapes.
Due to time and access limitations firm’s managers, executives and CEO’s will not be taken as
part of sample. They are important contenders of firm’s investment decisions. Future research
should manly focus those positions of different sectors, as financial literacy is not only the
problem of general public but also of managers as said by (Lee and Kim, 2012) .Further, many
other variables still need to be observed. In future other variables could be taken into observation
such as (friend’s and coworkers’ recommendations, opinions of family members, opinions of the
firm’s majority stock holders, diversification needs, dividend policy etc).
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