Practical Applications & Case Studies in Investment Analysis

TAKEAWAYS:

• Learn how mutual funds (e.g., closed-end vs. open-end) are priced and traded using NAV, premiums/discounts, and real-world examples like eSewa’s savings funds.
• Understand technical vs. fundamental analysis through case studies like Daraz’s stock valuation (P/E ratios) and Pathao’s growth phase (industry life cycle).
• Apply portfolio theory to diversify investments (e.g., Ncell’s bond yields vs. NTC’s equity volatility) and calculate Sharpe ratios for real returns.
• Analyze market efficiency using NEPSE’s index movements and how derivatives (futures/options) mitigate risks in Nepal’s agriculture (e.g., rice price hedging).
• Solve margin trading problems with worked examples tied to Kathmandu’s real estate boom (leverage ratios, margin calls).
• Use economic indicators (e.g., GDP growth, inflation) to forecast sectors like tourism (Pathao’s demand) or banking (NMB’s loan portfolios).

1. Mutual Funds: NAV, Premiums, and Discounts

Mutual funds pool investors’ money to buy diversified assets (stocks, bonds). Their value is tracked via Net Asset Value (NAV)—the per-share price after deducting liabilities from total assets.

How NAV Works

NAV = (Total Assets – Liabilities) / Number of Shares Outstanding

• Open-end funds: Shares are issued/redeemed daily at NAV.
• Closed-end funds: Traded on exchanges; market price ≠ NAV (can trade at premium or discount).

Worked Example: Closed-End Funds A vs. B

An investor has Rs 10,000 to invest in two closed-end funds:

• Fund A: NAV = Rs 10, market price = Rs 10 (no premium/discount).
• Fund B: NAV = Rs 10, market price = Rs 12 (20% premium).

Question: Which fund should the investor buy if they want to maximize returns based on historical premium trends?

Solution:

1. Calculate premium/discount ratio for Fund B: Premium = (Market Price – NAV) / NAV = (12 – 10)/10 = 20%.
2. If Fund B historically trades at a premium, it may indicate strong demand. However, the investor can buy Fund A at NAV and avoid overpaying.
3. Assumption: Fund B’s premium is unsustainable (e.g., due to low liquidity). Investor buys Fund A (1,000 shares × Rs 10 = Rs 10,000).

Real-World Tie: eSewa’s Savings Fund

eSewa’s eSewa Savings Fund (a mutual fund) uses NAV to price shares. Investors buy shares at NAV (Rs 10) but may see market prices fluctuate due to demand (e.g., during festivals). If the fund trades at a 5% premium, eSewa earns extra revenue from the spread.

2. Technical vs. Fundamental Analysis: Case Studies

Technical Analysis

Focuses on price trends, charts, and volume to predict future movements.

• Tools: Moving averages, RSI, MACD.
• Example: Daraz’s stock price (hypothetical). If Daraz’s stock breaks above a 50-day moving average, traders may buy expecting upward momentum.

Mermaid Diagram: Daraz Stock Price Trend (Technical Analysis)

Fundamental Analysis

Evaluates financial health, P/E ratios, and industry trends.

• Example: Pathao’s P/E ratio (Price-to-Earnings) = Market Price / Earnings per Share.
  • If Pathao’s P/E = 20, investors pay Rs 20 for every Rs 1 of earnings.
  • Compare to competitors (e.g., Uber’s P/E = 15) to assess valuation.

Comparison Table: Technical vs. Fundamental Analysis

3. Portfolio Theory: Diversification and Risk

Portfolio theory (Markowitz) states that diversification reduces unsystematic risk without sacrificing expected return.

Worked Example: Ncell vs. NTC Portfolio

An investor has Rs 100,000 to allocate between:

• Ncell bonds (low risk, 8% yield).
• NTC equity (high risk, 15% expected return).

Step 1: Calculate correlation (ρ) between Ncell and NTC returns.

• Assume ρ = 0.3 (moderate correlation). Step 2: Use the portfolio variance formula: $${\sigma }_p^2=w_1^2{\sigma }_1^2+w_2^2{\sigma }_2^2+2w_1{w}_2\rho {\sigma }_1{\sigma }_2$$ Where:
• $w_1,w_2$ = weights (e.g., 60% Ncell, 40% NTC).
• ${\sigma }_1,{\sigma }_2$ = standard deviations (e.g., 2% for Ncell, 5% for NTC).

Solution: $${\sigma }_p^2=(0.6^2\times 0.02^2)+(0.4^2\times 0.05^2)+2\times 0.6\times 0.4\times 0.3\times 0.02\times 0.05=0.000288+0.0004+0.000036=0.000724$$ Portfolio risk (σ_p): √0.000724 ≈ 0.0269 (2.69%).

Sharpe Ratio (risk-adjusted return): $$\text{Sharpe}=\frac{R_p-R_f}{{\sigma }_p}=\frac{0.12-0.05}{0.0269}\approx 2.53$$ (Expected return = 0.6×8% + 0.4×15% = 10.2%; Risk-free rate = 5%.)

Conclusion: The portfolio outperforms a single asset with lower risk.

4. Market Efficiency and Indexes: NEPSE Case Study

Efficient Market Hypothesis (EMH): Stock prices reflect all available information. Markets can be:

1. Weak-form: Past prices/volumes are useless (technical analysis fails).
2. Semi-strong: All public info is priced in (fundamental analysis adds value).
3. Strong-form: Insider info doesn’t help (illegal).

NEPSE Index Analysis

• NEPSE All-Share Index: Tracks 100+ listed companies (e.g., NMB, IMC, Siddhartha).
• Efficiency Check: If NEPSE reacts instantly to news (e.g., NMB’s profit announcement), it’s semi-strong efficient.

Worked Example: NEPSE Crash (2020)

• Cause: COVID-19 lockdowns → tourism sector (e.g., Pathao, hotels) collapsed.
• Impact: NEPSE index dropped ~20% in 3 months.
• Implication: Markets are not fully efficient—crashes happen due to irrational panic.

Timeline Figure: NEPSE Index During COVID-19

5. Derivatives: Hedging Rice Prices

Farmers in Nepal use futures contracts to hedge against rice price volatility.

Example: Rice Futures on NEPSE

• Scenario: A farmer sells 100 kg of rice for Rs 50/kg today but fears prices will drop.
• Solution: Buys a futures contract to sell rice at Rs 50/kg in 3 months, regardless of market price.

Mermaid Diagram: Rice Futures Contract

sequenceDiagram
    participant Farmer
    participant Exchange
    participant Buyer

    Farmer->>Exchange: Buys futures contract (100 kg @ Rs 50/kg)
    Exchange->>Farmer: Locks price at Rs 50/kg
    alt Market price drops to Rs 45/kg
        Exchange->>Farmer: Farmer sells at Rs 50/kg (profit)
    else Market price rises to Rs 55/kg
        Exchange->>Farmer: Farmer sells at Rs 50/kg (loss)
    end

6. Margin Trading: Kathmandu Real Estate Boom

Margin trading allows investors to buy stocks with borrowed money (leverage).

Worked Example: Buying NMB Shares on Margin

• Investor: Rs 50,000 capital.
• Margin Requirement: 50% (standard in Nepal).
• Action: Buys NMB shares worth Rs 100,000 (borrows Rs 50,000).

Scenario 1: NMB Price Rises to Rs 1,200/share

• Initial Investment: 100 shares × Rs 1,000 = Rs 100,000.
• New Value: 100 × Rs 1,200 = Rs 120,000.
• Profit: Rs 20,000 (40% return on capital).

Scenario 2: NMB Price Drops to Rs 800/share

• New Value: 100 × Rs 800 = Rs 80,000.
• Loss: Rs 20,000 (but investor still owes Rs 50,000).
• Margin Call: Broker demands additional collateral (e.g., Rs 10,000) to cover losses.

Mermaid Diagram: Margin Trading Outcomes

7. Economic Indicators: Tourism and Pathao

Economic indicators help forecast industry trends:

• GDP Growth: If Nepal’s GDP grows by 5%, tourism (Pathao’s demand) may rise.
• Inflation: High inflation → higher borrowing costs for banks (NMB’s loan portfolios shrink).

Worked Example: Pathao’s Revenue Forecast

• Assumptions:
  • 2023 GDP growth: 4%.
  • Tourism contributes 10% to GDP.
  • Pathao’s revenue = 0.5% of tourism GDP.
• Calculation: 2023 Tourism GDP = 10% of Rs 1,000 billion = Rs 100 billion. Pathao Revenue = 0.5% × Rs 100 billion = Rs 500 million.
• 2024 Forecast: GDP growth = 5% → Tourism GDP = Rs 105 billion → Pathao Revenue = Rs 525 million.

In the Real World

1. eSewa Savings Fund

   • Idea: Uses NAV pricing and premium/discount dynamics like closed-end funds.
   • How: Investors buy shares at NAV but may pay a premium during high demand (e.g., Diwali season). eSewa earns from the spread.

2. Daraz’s Stock Valuation (Hypothetical)

   • Idea: Technical analysis (moving averages) and fundamental analysis (P/E ratio).
   • How: Traders watch Daraz’s 50-day moving average for buy signals, while investors compare its P/E (25) to Amazon’s (30) to assess growth potential.

3. Ncell’s Bond Portfolio

   • Idea: Portfolio diversification and Sharpe ratio.
   • How: Ncell issues bonds (low risk) and holds equity (high risk). By mixing both, it reduces volatility. The Sharpe ratio helps investors judge if the return justifies the risk.

Exam Tip

• Focus on worked examples: Exams often ask to calculate NAV, portfolio variance, or margin requirements. Practice step-by-step calculations (e.g., Sharpe ratio, P/E ratio).
• Compare real-world cases: Link concepts to Nepalese companies (e.g., NEPSE index efficiency, Pathao’s P/E) to stand out.
• Diagrams > Words: Always draw timelines (e.g., NEPSE crash), pie charts (portfolio allocation), or flowcharts (margin trading) to visualize answers.
• Common Pitfalls:
  • Mixing technical (charts) and fundamental (financials) analysis.
  • Forgetting to adjust for correlation (ρ) in portfolio variance.
  • Ignoring margin calls in leverage problems.
• Time Management: Spend 20% of time on definitions (e.g., EMH) and 80% on calculations (e.g., NAV, Sharpe ratio).