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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). References: 1. Akhtar, M. F., Ali, K., & Sadaqat, S. (2011). Liquidity risk management: a comparative study between conventional and Islamic banks of Pakistan. Interdisciplinary Journal of Research in Business, 1(1), 35-44. 2. Barry, C. B. (1974). Portfolio analysis under uncertain means, variances, and covariances. The Journal of Finance, 29(2), 515-522. 3. Berk, J. B., Green, R. C., & Naik, V. (1999). Optimal investment, growth options, and security returns. The Journal of Finance, 54(5), 1553-1607. 4. Bogle, J. C. (2007). Guarantee Your The Little Book of Common Sense Investing: The Only Way to Fair Share of Stock Market Returns. Retrieved from https://www.goodreads.com/book/show/171127.The_Little_Book_of_Common_Sense_Inves ting. 5. Cukierman, A. (1980). The effects of uncertainty on investment under risk neutrality with endogenous information. The Journal of Political Economy, 462-475. 6. Duxbury, D., & Summers, B. (2004). Financial risk perception: Are individuals variance averse or loss averse? Economics Letters, 84(1), 21-28. 7. Gladwell, M. (2008). Outliers: The Story of Success. Retrieved from https://www.goodreads.com/book/show/3228917-outliers 8. Lee, S., & Kim, M. (2012). Adolescents’ financial literacy: The role of financial socialization agents, financial experiences, and money attitudes in shaping financial literacy among South Korean youth. Journal of adolescence, 35(4), 969-980. 9. Lusardi, A., & Tufano, P. (2009). Debt literacy, financial experiences, and overindebtedness: National Bureau of Economic Research. 10. Mitra, K., Reiss, M. C., & Capella, L. M. (1999). An examination of perceived risk, information search and behavioral intentions in search, experience and credence services. Journal of Services Marketing, 13(3), 208-228. 11. Orman, S. (2004). The money book for the young. Retrieved from https://www.goodreads.com/book/show/127277.The_Money_Book_for_the_Young_Fabulou s_Broke. 12. Sethi, R. (2009). I Will Teach You to Be Rich. Retrieved from https://www.goodreads.com/book/show/4924862-i-will-teach-you-to-be-rich 13. SourceOECD. (2006). OECD Factbook: Economic, Environmental and Social Statistics: Organisation for Economic Co-operation and Development. 14. Stein, J. C. (2003). Agency, information and corporate investment. Handbook of the Economics of Finance, 1, 111-165. 15. Rasheed and Arshad. (2009). 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