Research on the Interaction Among Interest Rate, Exchange Rate Fluctuations and Capital Market

Transcription

1 Research on the Interaction Among Interest Rate, Exchange Rate Fluctuations and Capital Market MINGLIANG LI, XINHUI ZHOU Donghua University 1882 West Yan'An Road, Shanghai Cha Shanghai LiX University of Commerce 2800 Wenxiang Road, Shanghai Cha Abstract: - The terest and exchange fluctuations have very significant impacts on the domestic economy and capital market development. Adopted from the traditional theory such as the terest parity, capital flow theory and the classical theory of IS-LM model, the paper does an -depth theoretical and empirical research and analysis on the teraction and complex relationship among the three aspects of RMB terest s, RMB appreciation and securities prices when they change. Research shows that there are strong correlations between Chese foreign exchange market, money market and stock market; with the RMB appreciation and terest crease, the capital accumulation effect and stock assets revaluation effect will promote the overall price level of Chese Capital market risg. At the same time, view of the less flexibility current RMB terest and exchange, and the reverse impacts between currency appreciation and terest s, we expect that the effect from RMB appreciation on the capital market will be weakened compared to the past situation of yen appreciation. However, due to the effect that the RMB appreciation is expected to form some ternational hot money flows, which maybe form a Chese economic bubble, this trends can not be neglected, it should be did to mata a high vigilance and to cautiously deal with the relationship between the RMB appreciation and terest s rise particularly. Key-Words: - Currency revaluation, terest s, capital flows 1 Introduction Interest and exchange are the two most important variables of prices market economy, and they are very important for national economic and capital market development. Interest and exchange fluctuations will have an effect on the respective domestic capital markets through their own path and various mechanisms. In open economy, a country's money market and foreign exchange market have gradually been tegd. As two powerful tools of the money market and foreign exchange market regulation, terest s and exchange s have a strong relationship between the constrats lked. Because of teraction and mutual fluence of the two powerful tools the process of transmission, terest s and exchange s will have an effect of complex and diverse on the capital market. Therefore, for the capital markets which there is the existence of the exchange revaluation pressure and hike at the same time, not only we will study on the potential impact of hike and exchange fluctuations to the capital markets, but also must give full attention to research the teraction between terest s and exchange fluctuations and its complex impact on the market. Based on this basic idea, this article will focus on the theoretical study and practical analysis on this tripartite relationship. 1.1 Interest Rate Fluctuation and the Capital Market ISSN: Issue 1, Volume 6, January 2009

2 Many progresses have been made study on the relationship such as Capital markets and terest s, exchange s and capital markets, terest s and exchange s, but there are not many studies on the impact Cha's capital market that the terest, exchange fluctuations at the same time will have. The theory on the relationship between terest s and securities prices is more mature, that is of the view that there is a negative correlation between terest s and securities prices. At the same time, accordg to the come capitalization method of pricg, stock price equals to the sum of the dividend (dividend) discount future, that is: V t i 1 D (1 t 1 R Here, V t represents the theory prices of stock the first period t, and D t 1 represents corpo dividends paid the first t + i, R t represents the return on vestment the first period t that vestors expect, usually market terest s. Above formula shows that stock prices and corpo earngs will change the same direction, there is a negative correlation between securities prices and terest s of currency market. That is, when terest rises, stock prices will fall. On the contrary, when terest falls, stock prices will raise. Because we have not yet achieved the reform to deregulate terest s to leave them to market forces, for Cha's capital market terest for the Yuan is an economic endogenous variable as well as a variable policy. As an economic variable, market terest s will brgs about of macro-economic environment and the operatg results of listed companies, and will have multiple effects on the stock price. As a policy variable, terest adjustments will undoubtedly have an effect on the policy expectancy of vestors. Benefits of policy terest s or adverse impact tend to be significantly enlarged and have an impact on stock prices. 1.2 Fluctuations of RMB Exchange Rate and Capital Market Foreign exchange market and capital market are two important components of the fancial markets, which have a special tie and a strong correlation. The theory on relationships between exchange and capital market can be divided to two categories. One is goods market approaches. Dornbusch and t ) Fischer (1980) poted out that when the exchange rises and local currency will lower its value devaluation, exports will be creased, imports will be reduced, which means that domestic enterprises will have more ternational markets and better profit space. The share prices of listed companies also follow up. These traditional methods of analysis economics will brg to a conclusion that exchange fluctuations will affect the prices of securities the same direction. Another of the theory on relationships between exchange and capital market is Portfolio Balance Approaches that the exchange depends largely on the relationship between foreign currency supply and demand. Stock price fluctuations could affect the demand for the currency and the level of exchange. A thrivg stock market will attract the flow of overseas capital, which will crease the demand for local currency, the exchange will drop, local currency will appreciate. On the other hand, a fallg stock market can lead to domestic and foreign capital outflow, which the exchange will rise and local currency will depreciate. This analysis will brg to a conclusion that exchange fluctuations will affect the prices of securities the reverse direction. At the same time, sce the 1990s, a number of studies have been carried out on the history of the stock market and exchange movements by statistical methods of measurement an attempt to understand the relationship between exchange fluctuations and the stock market a particular country. Ma and Kao (1990) found that appreciation of the currency had an adverse effect on the domestic stock market which a country was of superiority export, and a positive effect on the domestic stock market which a country was of superiority import. Studies by Jorion (1990, 1991), Bodnar and Gentry (1993), and Bartov and Bodnar (1994) and Ajayi and Mougoue (1996), had shown that there was a significant correlation between the exchange and stock market. Studies by Pan, Fok & Lui (1999) showed that there was a causal Granger relationship about the exchange on the stock market, and relationship of the stock market on the exchange is relatively weak. At the same time, they found that relationship between stock market and exchange became stronger after the Asian fancial crisis. The above study results and analysis of the practical experience of foreign countries had shown that there are some relationships between the stock market and foreign exchange markets. In the period when economy of a country or a region experiences rapid growth, the ternational purchasg power of currency the country or ISSN: Issue 1, Volume 6, January 2009

3 region will evitably be enhanced, and flows of arbitrage capital will be duced, and currency appreciation will be led. Currency appreciation will attract a large number of speculative hot money to the Domestic fancial markets. At the same time, exchange s will affect the share price and slow revaluation of a country's currency will have a positive role promotg the country's securities markets. The fluctuations the stock market will cause adjustments of exchange policy and exchange. Especially when a country's securities market is becomg more open, foreign exchange and stock markets are terrelated a greater degree. 1.3 Interest Rate of RMB and Fluctuations of Exchange Rate Interest and exchange are the two most important variables of price market economy. Interest is the price of domestic capital and the exchange is prices of domestic capital relative to foreign capital. On condition that a country s economy is Open, money market and foreign exchange market are gradually united. As two powerful tools of adjustment to money market and foreign exchange market, as well as the central bank's ma monetary policy tool, terest and exchange react upon one another the process of conduction, and have strong constra relations each other. Before capital market is analyzed under the pressure of revaluation of RMB and terest hike, we must fd out the relationship between terest s and exchange fluctuations. With regard to the relationship between terest s and exchange s, there are relevant research results cludg the parity theory of terest, the monetary theory of flexible price, the Donne Bush model, and so on. There is a lack of unity and understandg these theories about the relationship between terest s and exchange. The parity theory of terest is the classical theory of how to expla, predict the relationship between terest s and exchange s. The essence of the view the parity theory of terest is that on condition that capital is of sufficient ternational liquidity, vestors arbitrage will make different currency-denomated similar assets ternational fancial markets have the same return. In general, as cost of capital money market terest has a strong correlation with exchange and stock market prices. At the same time, exchange fluctuations will also have an impact on the price of the stock market by market terest s. Especially on condition that the fancial market is open, the exchange becomes more and more sensitive to the terest. In this respect, we can make use of the number model to expla. Accordg to the Gordon model, the expected stock price equals to the base year dividend per share divided by the difference between the discount and the growth of annual dividend with that formula: P = D/(i-g) Here, P stands for the stock price, D the base year dividend per share, i the discount, g the dividend growth. If g assumed to be a constant, because i = r + k, of which r stands for market, k for stock returns of risk, Gordon model can be expressed as: P = D / (r + k-g) (1) The model shows that market terest s are variable the opposite direction of stock prices. At the same time, accordg to parity theory of terest, balanced relationship between exchange s and terest s can be reflected by parity formula of terest which can be expressed as a formula: f = r - r * (2) Where f stands for discount (premium) of the long-term local currency, r for the domestic market terest, r * for the foreign market terest. The model shows that when there is difference between terest s of two countries, the funds will flow from the country with low terest s to another country with high terest to make a profit. The long-term difference between the currencies of two countries is decided by the terest difference of the two countries. The currency of a country with high terest must be at discount the long-term market of exchange. The currency of a country with low terest must be at premium the long-term market of exchange. The long-term premium (or discount) of local currency equals to difference between national and foreign terest. If the terest parity formula (2) is corpod to the Gordon model (1), it is: P = D/(r*+f+ k -g) (3) The formula (3) showed that there is a reverse relationship between the stock price P and discount (premium) of the long-term local currency f, and there is a positive relationship between the stock price P and the local currency's value. This means that the fall a country's exchange (local currency appreciation) will lead to a rise of the country's stock market prices. On the contrary, a rise a country's exchange (devaluation of the local ISSN: Issue 1, Volume 6, January 2009

4 currency) will lead to a decle the price of the stock market. The impact on the exchange which Changes terest s have will be as the follows: terest s will cause the balance of payments through various means and different ways, and the balance of payments will eventually lead to exchange s. In practice, a smooth operation of transmission about terest s on the role of the exchange needs a series of conditions. To study the effectiveness of the theory of exchange s and terest s, it requires that capital flow to and out of border. As long as capital can complete freedom of ternational flows, terest effectively affect the import and export through the mechanism of exchange. As for the present situation, Cha is still transition from a planned economy to a market economy durg the transition period, the market-oriented degree of terest and exchange is still low. This is maly manifested : first, to a certa degree terest is of control, is not entirely determed by market supply and demand, terest flexibility for consumer demand and vestment demand cha is lower than developed market economy countries. Next, exchange s is not flexible, major of foreign exchange supply and demand are reflected by foreign exchange reserves. In the specific period of transition, the stitutional factors did not make transmission mechanism of terest s on the exchange play a full role the market economy. As for Cha, capital is still controlled. If the relationship between terest s and import and export is analyzed from the exchange pot of view, its practical significance will be greatly reduced. 1.4 Mechanism for Common Action of Interest Rate and Exchange Rate to the Capital Market In the capital markets, an effect that terest has on exchange and that exchange has on securities prices will be maly achieved by flows of arbitrage capital. The flows of arbitrage capital depend primarily on the price comparison of the risk return of arbitrage and the time cost of arbitrage. When a country's currency devaluation is expected, a weak local currency means that the currency risk of vestment is risg, there is pressure on the outflow of capital. In order to crease costs of ternational speculative capital and crack down on speculation, the authority often adopt the policy of high terest s. Rise terest s of a country will promptly cause their stock market fell. Especially on condition that the fancial market has been opened, the exchange becomes more and more sensitive to the of terest. In our country, the risk reward of arbitrage is made up of two parts: first, the differences between the level of domestic terest s and ternational the level of terest s; next, of expected the Yuan. When the risk reward is higher than the cost arbitrage, arbitrage capital will flow through various channels, so that the supply of foreign exchange will crease the foreign exchange market, and expectations of appreciation the RMB market will be produced. Although Cha still carries out policies of strgent capital controls, but a variety of short-term arbitrage capital will flow Cha's capital markets through various channels and a variety of styles. The short-term arbitrage capital cludg the gray capital that used to flow out will enter Cha's capital markets through various legitimate channels, such as trade Credit, vestment come, remittances and current transfers, shareholder loans, donations and so on. The flow of hot money Cha will impact prices, and brg about flationary pressures and the pressure on rise terest s. At the same time, rise RMB terest s will further lead to the flow of more arbitrage capital, which can produce a greater pressure on appreciation of the RMB and accele the pace of RMB appreciation, thus push up the prices of securities assets. From the above theoretical analysis, we can brg to a conclusion that there is the more complicated relationship among terest s, exchange s and capital markets. Changes terest s and exchange fluctuations will have an impact on prices of securities. At the same time, fluctuations of stock market price, turn, will have an impact on terest s and exchange s. As a result, this impact is more subtle, which results the stability of the money market and foreign exchange markets, creases the frequent fluctuations of terest s (real terest s) and exchange. 2 Problem Formulation Many progresses have been made study on the relationship such as Capital markets and terest s, exchange s and capital markets, terest s and exchange s, but there are not many studies on the impact Cha's capital market that the terest, exchange ISSN: Issue 1, Volume 6, January 2009

5 fluctuations at the same time will have. In the capital markets, how terest affects exchange and how exchange affects securities prices will eventually be achieved by the cross-border capital flows. Arbitrage capital depends primarily on the price comparison of the risk arbitrage and the cost of time to pay. In our country, the risk reward of someone who engages arbitrage is made up of two parts, first, differences between the level of domestic terest s and ternational terest s, that is, the r d -r f, secondly, expected the of RMB, that is e. The arbitrage cost is made of the credibility of policy and the transaction costs caused by foreign exchange and capital controls. At present, we have a very favourable ternational trade balance, the supply of foreign exchange is creasg. it is market expectations that RMB will contue to mata a slight appreciation trend ( e<0). So the reward for the risk of arbitrage capital flows is (r d -r f ) - e the domestic fancial market. With regard to RMB appreciation, terest s and capital flows, its impact to capital market on the potential effect, we would like to discuss and analyze. First of all, when the contued appreciation of RMB is expected, the ternational arbitrage capital will try to enter the domestic market through various channels. Accordg to the classic IS-LM model (Figure 1), the flow of hot money will make money supply crease Cha's currency market, so that the LM curve is shifted to right from LM0 to LM1. When the IS curve mata unchanged, tersection pots of the LM1 curve and the IS curve is the E1. So that the domestic real terest s is dropped from r0 to r1, and lead to the proportion of domestic commodity prices rise a short period of time. With economic overheatg and flation pressures, the People's Bank of Cha is to raise its terest[1]. At the same time, accordance with the theory of capital flows related to ternational economics: F = f (r +, r * -) The ternational flow of capital is maly determed by the difference terest s. The net flow of capital F correlates closely to domestic terest s r and negatively to foreign terest s. When domestic terest s R rise, it is bound to attract more ternational volvement speculative capital. Accordg to the IRP's well-known law and decision theory of equilibrium exchange s, when domestic terest s r rise a short period of time, it is bound to expand the demand for local currency on ternational fancial market. So that the local currency exchange s e will crease, and lead to local currency appreciation. That is, domestic terest s r correlates closely to exchange e. Because of the teraction between terest and appreciation of the RMB, it makes impact of terest and appreciation of the RMB on the capital markets more subtle complicated. On the relationship between them, we can plan for the followg analysis. In the coordate system, the horizontal axis represents the price of securities P, the left vertical axis represents the market terest r, the right vertical axis represents the RMB exchange. The r p cure show that the price of securities P correlates negatively to the market terest r. The e p curve show that the price of the Securities P correlates closely to Exchange Rate e (direct price under the law). When e rises, the e p curve will move to e p1 from left to right. When the terest r rises, the r p curve will move to r p1 from right to left. So the r p curve and the ep1 curve will tersect at E1, the price of securities rise from P 0 to P 1. However, because there is a positive relationship between terest and exchange, when the terest r rises, the ternational arbitrage capital will make the RMB exchange appreciation or more appreciation. So at this time, terest s r would rise fact, the e p curve will move to the ep2 curve from left to right. The ep2 curve and the rp1 curve will tersect at E2,which offset squeezg effect that terest r rise will make on securities prices, and make stock price rise from P1 to P2[3]. 3 An Empirical Study on the Correlations Among RMB Interest Rate, Exchange Rate Fluctuation and Cha Capital Market 3.1 RMB Interest Rate Fluctuation and the Capital Market Some ternal research has been carried out on the issue of the effects of terest fluctuations Cha. Guo Jlong and Li Wenjun (2004) had made use of arbitrage pricg model to study effects of Cha's terest change on the stock market, and brought to a conclusion that there is a negative relationship between equilibrium share prices and terest s. Tu Xiao M (2005) had analyzed the long- term and short-term effect of Cha's terest adjustments on the stock market sce 1993, brought to a conclusion that: In the short term effect, stock prices have a negative relevance to terest ISSN: Issue 1, Volume 6, January 2009

6 s, the long run, the ma trend of stock prices change is decided by terest s and results change of listed companies direction and magnitude together. Accordg to statistics, we generalized the terest durg and the trend of Shanghai Composite Index, and found that they moved opposite directions, i.e. if terest decled, both Shanghai Comp and the theoretical price of stock market rose, and vise versa. Durg , however, although average terest fell down, Shanghai Comp didn t go up, went down as well. This is because at that time, the average EPS of listed companies ( YoY) dropped faster than the terest (-5.11% YoY), therefore resultg the decle theoretical price of stocks and hence the descendg Shanghai Comp. The fact that the terest durg kept fallg down and Shanghai Comp didn t crease but decrease, as a result, simply illusts that the long-term impact of terest on the stock market Cha cocides with the theoretical analysis, i.e. the long-term trend of stock price is determed by the combation of terest and company performance. To learn more, please refer to Table 1. Table 1: Volatility of Shanghai Comp before and after the terest (units:%) 3.2 RMB Exchange Rate Fluctuation and Capital Market Agast the backdrop of the pressure of RMB appreciation, because the exchange is an exogenous variable the stock market, this pressure is likely to directly or directly fluence Cha's securities market through the development of macro-economic environment, earngs of listed companies, ternational capital flows and market expectations psychology and other factors, and will have a profound impact on Cha's capital markets. An effect that appreciation of exchange has on the capital market is maly reflected two aspects of the current account and capital account. (1) The impact of current account: re-evaluation effect of listed company value In theory, local currency appreciation for foreign currency would make the depreciation of assets and liabilities foreign currency. The delivery of the Yuan revaluation will be by the cha of import and export, which will produce different effects on the value of list companies of different sectors. In particular, because enterprises which degree of dependence on imports and exports is high, there are more sensitive to Yuan exchange, the more pronounced value effect of the Yuan appreciation will be had on the enterprises. The Yuan appreciation will have a positive effect to enhance the value on the import-domant enterprises and the import service enterprises. The Yuan appreciation will have a negative effect on the domant export-oriented enterprises, export service enterprises and import substitution enterprises. The two different effects will transfer to stock price performance. (2) The impact of capital account: promotg effect of stock market funds In the system of floatg exchange, appreciation or depreciation of currency the foreign exchange market is bound to trigger a correspondg adjustment of asset portfolio and the flow of capital and direction of capital. These directly affect transaction price of money market and capital market, and produce the delivery effects of asset prices the different stock markets. Although Cha is still adoptg a more strgent capital controls, but the face of the expected appreciation of the RMB, speculative arbitrage capital of foreign vestors will try to enter the domestic market through various channels, which will have the contug impact on Cha's stock market. This impact and fluence will be reflected two aspects. First, the performance of arbitrage capital will accele the flow of funds and will knock on prices of stock. Appreciation or revaluation of the RMB exchange that is expected will produce the potential arbitrage value, which will attract foreign speculative capital flows order to obta an exchange ga. What attracts these speculative capitals is capital markets which the liquidity degree is high. Second, Appreciation of the exchange will have an effect on the structure of stock price. its of appreciation of the RMB exchange will have a direct impact on the re-evaluation of the domestic stock market value, which results the vestment promotion effect that the trsic value is enhanced. These two factors can produce a effect that Chese stock market will rise to unprecedented prosperity. ISSN: Issue 1, Volume 6, January 2009

7 date 50 days tradg before the terest 30 days tradg before the terest 10 days tradg before the terest 3 days tradg before the terest the day tradg the terest 3 days tradg after the terest 10 days tradg after the terest 30 days tradg after the terest 50 days tradg after the terest 21 Apr May July May, Aug, Oct Mar Jul Dec Jun Nov Feb Dec Mar Oct Mar Apr Aug Source: RMB Interest Rate and Exchange Rate Fluctuation The empirical study on the impact of RMB terest on exchange durg shows that: the long run, RMB nomal effective terest is coordation with terest, and the long-term coefficient of elasticity of RMB relative terest to nomal effective terest is a mus value. In other words, the terest change Cha has left a strong fluence on RMB nomal effective terest and the terest will change of RMB nomal effective terest a wider range. Interest will exert a relatively strong fluence on nomal effective terest the long run, but a weaker one for the short term. Generally speakg, western countries where the economies are more open, terest can directly fluence the exchange through capital flows. In Cha, under the current exchange and terest mechanism and policy orientation, the capital account is not open enough so that terest fails to affect exchange full play. Therefore, terest can hardly directly fluence ISSN: Issue 1, Volume 6, January 2009

8 the exchange through capital flows but directly affect it by commodity market. The transmission mechanism of terest to exchange is weakened, and as a result the theory of Interest Rate Parity is of limited application Cha, which can be illustd by the relationship between the RMB exchange and terest durg We had studied the RMB exchange and compared 1-year deposit terest of Cha with that of the United States. In theory, when terest s of RMB rd is higher than that of the U.S. dollar r f, the devaluation of the RMB exchange moves towards; when terest s of RMB rd is lower than that of the U.S. dollar r f, the RMB exchange tends to rise. However, the reality is not the same, the RMB exchange had contued appreciatg from 1994 to 1996, which range was about 4.5 percent. r twisted and uncoordated. As a result, we can not fully understand and discuss the relationship between the RMB exchange and terest s accordance with the general terest parity theory, as well as the problem that the pressure of RMB revaluation and terest hike have the possible impact on capital market. 0 P0 P1 E1 E 0 rp1 r rp IS LM 0 LM 1 P2 E2 ep r 0 E 0 ep1 r 1 0 Figure 1: RMB appreciation will lead to the reduction In the level of real terest s The empirical analysis above the relationship between RMB exchange and terest showed that at the present stage the RMB exchange can not be explaed by terest parity. This is maly related to such factors. First, Cha's fancial market is still not perfect. Second, the terest mechanism is not fully market-oriented. Thirdly the capital account has been strictly controlled. Because foreign exchange transaction costs and friction coefficient are both high, and market formation is complete, market efficiency is not high, so that the terest parity become special cha, the relationship among the RMB exchange, terest s, capital flows were E 1 y p Figure 2: the relationship among RMB appreciation, terest s and securities prices It is worth notg that at present as Cha's accession to the WTO, the domestic market was opened further, the marketg process was pushed forward, degree of tegration of the world economy and Cha's economy was creased, the dependence on foreign trade was risg. he role of the parity has been creased. In particular, from July 21, 2005, Cha itiated the managed floatg exchange system reform of the Yuan that is based on market supply and demand with reference to a basket of currencies. As the Yuan is gradually convertible and the flow of capital is free, the ability of terest parity to expla and predict will become more and more relevant. 4 Conclusion ep2 e ISSN: Issue 1, Volume 6, January 2009

9 4.1 The Basic Conclusion First, foreign exchange market, money market and securities market are of relevance to each other. The capital effect and revaluation caused by the dual pressure of the terest crease and RMB appreciation will become a combed force to drive the general price of Cha capital market to a new level and thus promote the development of the market. Second, considerg the relatively low elasticity of RMB terest and exchange, together with the reverse effect caused by terest crease and appreciation of the currency, the fluence of RMB appreciation on the capital market is expected to be weaker than the previous Yen appreciation Japan. Fally, given the considerable trend of ternational hot money pourg to Cha driven by the expectation of RMB appreciation, it is necessary to keep high alert to the potential economic bubble the capital market. 4.2 Policy Recommendations First, careful handlg the relationship between terest s hike and the appreciation, and be ware of the cycle such as terest hike - the flow of hot money, to accele the appreciation - to accele the flow of hot money - stock prices contued to rise. As terest of the Yuan is far from market-oriented, the sensitivity of terest is very low and of latency, for the majority of domestic enterprises the sensitivity of vestment behavior to terest s is low, the role that terest s hike curbs overheated vestment is limited. As a result, the domestic economy coolg can not simply rely on terest rise. On the other hand, terest s rise may lead to speedg up the flow of short-term capital and acceleratg the pace of RMB appreciation, which creasg pressure on RMB appreciation will be creased. Consequently external economic imbalances may be led to, and the coolg effect of terest rise may be offset, which leads to liquidity surplus and the economy contue to overheat. The excess hot money will flow to the securities market that is of a high degree of the liquidity. the contug flow of hot money will likely lead to the creation of the bubble economy. Second, contue to expand floatg space of the RMB exchange, and gradually establish the balanced formation mechanism of an effective and flexible exchange market and. Because RMB exchange implements a managed floatg system, the face of large capital flows, Cha's monetary policy dependence is restricted, which makes Cha's monetary policy a dilemma. As a result, the long run, the establishment of an effective flexible exchange mechanism of RMB is a more realistic option. Of course, because Cha's fancial market is imperfect, capital market openness is not high, if the RMB exchange is market-oriented, this will be detrimental to the stability of foreign exchange market and stock market, and the excessive market volatility will cause a fancial crisis. The fully market-oriented exchange of RMB must be a slow process to move forward. Thirdly, sce the relationship between the RMB exchange and stock price is becomg creasgly significant, we should adopt the countermeasure on the relationship with an aim to safeguard the development of fancial market and dustries national economy. on one side, focusg on characteristic of abnormality regard to the relationship, we should release the control on the exchange market and foreign exchange market and solve the issue of shares-respectively placed order to improve the mechanism of stock price shapg, brg back the relation to the normal state under market society. On the other hand, the mutual effect between the two are appearg, with the elasticity of exchange strengthened, the countermeasure should be adopted to prevent the expansion and deterioration of fancial vibration, also ensure the development of fancial market and dustries national economy. References: [1] JiangBoKe and so on, the free convertibility of the RMB and capital controls, FuDan University Press, [2] YanKun, Japan's Fancial Research, Economics and Management Press, [3] iangboke, and so on, the control of the money market open economy, FuDan University Press, [4] Li-Qun Zhou, Wu ZhiWen, study on the effectiveness of terest policy ---- On the dispute over terest s, Management World, [5] Xiong Peng, the Empirical Study on the effectiveness of RMB the terest to exchange : , Fancial Essays, [6] Liu JiPeng, the appreciation of the RMB exchange will speed up the process of QFII ISSN: Issue 1, Volume 6, January 2009

10 to the market, the East Asian Economic Review, [7] Sun MgChun, Zhang Pg, the RMB exchange, the terest and arbitrage capital flows, fancial research, [8] Liu GanZhou, The analysis of mechanism for teraction between exchange fluctuations and fluctuations the stock market price, Guangxi College for Fancial, ISSN: Issue 1, Volume 6, January 2009