Capital Market: Concept, Functions, Instruments & Nepal’s Role

Core Concepts

What is the Capital Market?

The capital market is a financial marketplace where long-term funds (typically >1 year) are raised by issuing securities (shares, bonds, debentures) and traded between savers (investors) and users (businesses/government).

graph LR
    A["Capital Market"] --> B["Primary Market"]
    A --> C["Secondary Market"]
    B --> D["New Issues"]
    B --> E["IPOs"]
    B --> F["Rights Issues"]
    C --> G["Stock Exchanges"]
    C --> H["OTC Trading"]
    G --> I["NEPSE (Nepal)"]
    G --> J["NYSE/NASDAQ (USA)"]

Key Features:

• Long-term financing (vs. money market’s short-term).
• Riskier but higher returns than money market instruments.
• Regulated (e.g., SEBON in Nepal, SEC in the US).

Functions of the Capital Market

The capital market performs five critical functions:

Key Instruments of the Capital Market

1. Equity Shares

• Definition: Ownership stake in a company. Investors become shareholders.
• Types in Nepal:
  • Ordinary Shares: Voting rights + dividends (e.g., Nepal Investment Bank shares).
  • Preference Shares: Fixed dividends, no voting rights (e.g., Everest Bank preference shares).
• Example:
  • Kathmandu Retail Shop (KRS) issues 10,000 ordinary shares at Rs. 100 each to raise Rs. 1M for expansion.

pie
    title Equity Shareholders in KRS
    "Retail Investors" : 60
    "Institutional Investors" : 30
    "Founders" : 10

2. Debentures

• Definition: Long-term debt instrument issued by companies (not government).
• Features:
  • Fixed interest rate (e.g., 10% p.a.).
  • No voting rights.
  • Secured by company assets.
• Example:
  • Ncell issues Rs. 500M in 5-year debentures at 9% interest to fund 4G network upgrades.

3. Bonds

• Definition: Long-term debt issued by government or corporations (e.g., treasury bonds, corporate bonds).
• Types:
  • Government Bonds: Issued by Nepal Rastra Bank (NRB) or Ministry of Finance.
  • Corporate Bonds: Issued by companies like NMB Bank.
• Example:
  • NRB issues 10-year bonds at 8% to manage fiscal deficit.

4. Mutual Funds

• Definition: Pooled funds from multiple investors managed by professionals.
• Types in Nepal:
  • Open-ended: Can be bought/sold anytime (e.g., NMB Mutual Fund).
  • Closed-ended: Fixed number of shares (e.g., Citizen Investment Trust).
• Example:
  • An investor buys Rs. 100 in a mutual fund. After 1 year:
    • Dividend: Rs. 2
    • Capital gain: Rs. 3
    • Exit fee: Rs. 1.5
    • Selling price: Rs. 106
    • Total return: $(106-100)+2-1.5=\text{Rs. 6.5}$ (6.5% return).

Participants in Nepal’s Capital Market

Nepal’s Capital Market: NEPSE and SEBON

Nepal Stock Exchange (NEPSE)

• Founded: 1994.
• Listed Companies: ~250 (as of 2023), including Ncell, NMB Bank, Nepal Investment Bank.
• Indices:
  • Nepse Index: Tracks top 20 companies.
  • Nepse Hydropower Index: Focuses on energy sector.
• Trading Mechanism:
  • Screen-based trading (since 2008).
  • Lot size: Typically 100 shares per trade.

classDiagram
    class NEPSE {
        +List Companies
        +Facilitate Trading
        +Publish Indices
    }
    class SEBON {
        +Regulate Market
        +Approved Issuers
        +Enforce Rules
    }
    class Investor {
        +Buy/Sell Shares
        +Diversify Portfolio
    }
    NEPSE --> Investor : "Trades with"
    SEBON --> NEPSE : "Regulates"

Securities Board of Nepal (SEBON)

• Role:
  • Approves new listings.
  • Enforces disclosure rules.
  • Investigates market manipulation.
• Key Regulations:
  • Minimum public float: 25% for IPOs.
  • Disclosure: Companies must publish annual reports.
  • Insider trading: Prohibited (punishable by fine/imprisonment).

In the Real World

1. NEPSE and Ncell’s IPO (2019)

   • Idea Used: Primary Market Function (Fund Mobilization)
   • How: Ncell raised Rs. 10.3 billion via IPO to expand its 4G network. Retail investors could buy shares at Rs. 100 per share, with the company using proceeds for infrastructure upgrades.

2. Daraz’s Funding via Merchant Bankers

   • Idea Used: Merchant Bankers’ Role
   • How: Merchant Bank Limited advised Daraz on its private equity funding (raised $100M from SoftBank) to scale operations in Nepal. Merchant bankers structured the deal, conducted due diligence, and marketed the investment to global investors.

3. NMB Bank’s Debenture Issue (2022)

   • Idea Used: Debentures (Long-term Debt)
   • How: NMB Bank issued Rs. 2 billion in 7-year debentures at 9% interest to fund SME loans. Retail investors (via banks) could buy these as an alternative to fixed deposits, earning higher returns than savings accounts.

4. Citizen Investment Trust (CIT) for Retail Investors

   • Idea Used: Closed-ended Mutual Funds
   • How: CIT pools money from small investors to buy a diversified portfolio of stocks (e.g., Nepal Bank, Himalayan Bank). Unlike open-ended funds, CIT shares trade on NEPSE, providing liquidity.

Worked Example: Equity Financing for a Kathmandu Retail Shop

Scenario: Kathmandu Retail Shop (KRS) wants to expand by opening 3 new branches. It decides to raise Rs. 5 million via equity financing.

Step 1: Determine Share Capital

• Authorized Capital: Rs. 10M (100,000 shares of Rs. 100 each).
• Issued Capital: Rs. 5M (50,000 shares sold to public).
• Reserve Capital: Rs. 5M (kept for future issues).

pie
    title KRS’s Capital Structure
    "Issued Shares (50%)" : 50
    "Reserve Capital (50%)" : 50

Step 2: Allotment of Shares

• Public Subscription: 60,000 shares applied (Rs. 100 each).
• Allotment:
  • Fully Subscribed: 50,000 shares allotted.
  • Excess Applications: 10,000 shares rejected (refunded).
  • Unissued Shares: 50,000 shares remain in reserve.

Step 3: Post-IPO Scenario

• Market Price: Shares trade at Rs. 120 on NEPSE (premium of Rs. 20).
• Dividend: KRS declares 10% dividend (Rs. 10 per share).
• Investor’s Gain:
  • Purchase Price: Rs. 100 (IPO) + Rs. 20 (premium) = Rs. 120.
  • Dividend: Rs. 10.
  • Capital Gain: If sold at Rs. 150 → Rs. 30 gain.

Comparison: Money Market vs. Capital Market

Advantages and Disadvantages of Capital Market

Advantages

1. Economic Growth: Funds infrastructure (e.g., NTC’s hydropower projects).
2. Diversification: Investors spread risk across sectors.
3. Liquidity: Secondary market allows easy buying/selling.
4. Transparency: Regulators (SEBON) ensure fair disclosure.

Disadvantages

1. Market Volatility: Prices fluctuate (e.g., NEPSE index dropped 20% in 2020).
2. Regulatory Risks: Policy changes (e.g., SEBON’s new rules) can impact investments.
3. Information Asymmetry: Small investors may lack access to company data.
4. Speculation: Short-term trading can distort long-term value.

Exam Tip

1. Define Clearly: Start answers with precise definitions (e.g., "The capital market is a platform...").
2. Use Examples: Always tie theory to Nepal’s context (NEPSE, Ncell, NMB Bank).
   • Example: "Like Ncell’s IPO, companies raise long-term funds via the primary market."
3. Diagrams > Text: Draw mermaid flowcharts for processes (e.g., IPO steps) or pie charts for capital structure.
4. Numerical Questions: Practice share allotment calculations (like KRS example) and return on investment (ROI) for mutual funds.
5. Regulation Focus: Mention SEBON’s role when discussing market efficiency or risks.
6. Compare Tables: For questions like "Money vs. Capital Market", use a 2-column table with clear labels.

Key Formula to Remember: $$\text{Return on Investment (ROI)}=\frac{\text{Dividend}+\text{Capital Gain}-\text{Fee}}{\text{Initial Investment}}\times 100$$ Example: $$\text{ROI}=\frac{2+(106-100)-1.5}{100}\times 100=6.5\%$$