Capital Market: Instruments, Functions & Nepal’s Market

TAKEAWAYS:

• The capital market is a long-term funding marketplace where companies raise equity/debt via instruments like shares, bonds, and debentures, while investors earn returns through dividends, capital gains, or interest.
• Primary vs. secondary markets: Primary markets issue new securities (e.g., IPOs on NEPSE), while secondary markets (like NEPSE’s trading floor) enable resale of existing shares.
• Key instruments: Shares (equity), debentures (long-term debt), and global depository receipts (GDRs) allow companies to tap international capital.
• Regulators in Nepal: SEBON oversees issuers, while NEPSE operates the exchange; both enforce disclosure and investor protection rules.
• Valuation: Share prices reflect dividend discount models (DDM) or earnings per share (EPS), while bonds use yield-to-maturity (YTM) calculations.
• Risk-return tradeoff: Higher-risk instruments (e.g., venture capital shares) demand higher expected returns, while government bonds offer stability but lower yields.

1. Definition and Structure of the Capital Market

The capital market is a financial marketplace where long-term funds (typically >1 year) are raised and traded. It connects issuers (companies/governments needing capital) with investors (individuals, institutions, or foreign entities seeking returns). Unlike the money market (short-term), capital markets focus on permanent capital for expansion, R&D, or infrastructure.

Key Components

Primary vs. Secondary Markets

2. Capital Market Instruments

These are financial tools used to raise capital. Nepal’s capital market features:

A. Equity Instruments (Shares)

• Definition: Ownership stakes in a company, traded on exchanges (e.g., NEPSE).
• Types:
  • Ordinary Shares: Voting rights + dividends (e.g., Ncell’s Class A shares).
  • Preference Shares: Fixed dividends, no voting rights (e.g., NMB Bank’s 8% preference shares).
  • Rights Shares: Offered to existing shareholders to maintain ownership (e.g., NTC’s 2022 rights issue).

Worked Example: Valuing a Share Using DDM Assume: Himalayan Brewery pays a constant dividend of NPR 5/share. The required return is 12%. Calculate its theoretical price. Solution: $$P_0=\frac{D}{k}=\frac{5}{0.12}=\text{NPR }41.67$$ In the real world: If the market price exceeds NPR 41.67, the share is overvalued; below, it’s undervalued.

B. Debt Instruments (Debentures)

• Definition: Long-term loans (5–15 years) issued by companies, secured by assets.
• Types:
  • Secured Debentures: Backed by collateral (e.g., NMB Bank’s mortgage-backed debentures).
  • Unsecured Debentures: No collateral (riskier, e.g., Daraz Nepal’s corporate bonds).
  • Convertible Debentures: Can be converted to equity (e.g., Ncell’s 2023 convertible bonds).

Comparison Table: Shares vs. Debentures

3. Global Depository Receipts (GDRs) and ADRs

• Definition: Foreign securities traded in international markets (e.g., New York, London).
  • GDR: Traded in Europe (e.g., Ncell’s GDRs listed in London).
  • ADR: Traded in the U.S. (e.g., Nepal’s NMB Bank ADRs).
• Advantages for Nepalese Companies:
  • Access to global investors (e.g., Ncell raised USD 300M via GDRs in 2019).
  • Currency diversification (reduces NPR volatility risk).
• Disadvantages:
  • Regulatory complexity (SEBON + foreign exchange controls).
  • Higher costs (underwriting fees, legal compliance).

4. Regulatory Framework in Nepal

Nepal’s capital market is governed by:

1. Security Exchange Board of Nepal (SEBON):
   • Role: Regulates issuers, audits financial statements, and enforces disclosure rules.
   • Example: SEBON banned insider trading in 2022 after NMB Bank’s suspicious share price spikes.
2. Nepal Stock Exchange (NEPSE):
   • Role: Operates the exchange, matches buyers/sellers, and publishes indices (e.g., NEPSE All Share Index).
   • Trading Systems:
     • Screen-Based Trading (SBT): Replaced open-outcry in 2020.
     • Central Depository (CDS): Holds shares electronically (reduces physical certificate risks).

Mermaid Diagram: Accounting Cycle in NEPSE Trading

flowchart TD
    A["Investor Places Order"] --> B["Broker Submits to NEPSE"]
    B --> C{"NEPSE Matches Buy/Sell"}
    C -->|"Match Found"| D["Trade Executed"]
    C -->|"No Match"| E["Order Cancelled"]
    D --> F["CDS Updates Shareholding"]
    F --> G["Dividends/Interest Paid to Investor"]
    G --> H["Tax Deducted by CDS"]

5. Risk and Return in Capital Markets

Investors demand higher returns for higher risk. Key metrics:

A. Risk Measures

1. Beta (β):
   • Measures volatility relative to the market.
   • Example: If Ncell has β = 1.2, its shares are 20% more volatile than the NEPSE index.
2. Standard Deviation:
   • Example: Himalayan Brewery’s share price SD = 15% (high risk vs. NMB Bank’s 8%).

B. Return Measures

1. Dividend Yield: $$\text{Dividend Yield}=\frac{\text{Annual Dividend}}{\text{Share Price}}\times 100$$ Example: NMB Bank’s NPR 2 dividend on a NPR 500 share = 0.4% yield.
2. Capital Gains Yield: $$\text{CGY}=\frac{\text{New Price}-\text{Old Price}}{\text{Old Price}}\times 100$$ Example: If you bought Ncell at NPR 100 and sold at NPR 120, CGY = 20%.

Real-World Example: NEPSE’s 2022 Crash

• Event: COVID-19 recovery hopes led to a 30% drop in the NEPSE index in March 2022.
• Risk-Return Tradeoff:
  • High-risk: Venture capital (e.g., Daraz Nepal’s early shares) offered 50%+ returns but high failure risk.
  • Low-risk: Government bonds (e.g., Nepal’s 10-year bond) yielded 8%, but capital was safer.

6. Capital Market in Nepal: Case Study

Business: Kathmandu’s Retail Shop (e.g., "Everest Mart") Scenario: The shop wants to expand but lacks NPR 50 million. It issues 100,000 shares at NPR 500/share via NEPSE.

Journal Entry for Issuance

| Date       | Particulars                     | Dr (NPR) | Cr (NPR) |
|------------|----------------------------------|----------|----------|
| 2024-01-15 | Bank A/c                          | 50,000,000 |          |
|            | To Share Capital A/c             |          | 50,000,000 |
|            | (Issued 100,000 shares @ NPR 500) |          |          |

Post-Issue Valuation

• Earnings Before Issue (EBIT): NPR 10 million
• Shares Outstanding: 50,000 (pre-issue)
• EPS (Pre-Issue): NPR 200/share
• EPS (Post-Issue): NPR 100/share (dilution effect)
• Market Reaction: Share price drops from NPR 600 to NPR 450 due to dilution.

In the Real World

1. Ncell’s GDRs (London Stock Exchange)

   • Idea Used: Global Depository Receipts (GDRs) to raise USD 300 million.
   • How: Ncell issued GDRs convertible to shares, allowing foreign investors to buy without NPR risks. The proceeds funded 5G expansion in Nepal.

2. NMB Bank’s Debentures

   • Idea Used: Secured Debentures for long-term funding.
   • How: NMB Bank issued 10-year, 9% debentures backed by its loan portfolio. Retail investors earned fixed 9% annual interest, while the bank used funds to expand SME lending.

3. Daraz Nepal’s IPO (2023)

   • Idea Used: Primary Market Issuance for growth capital.
   • How: Daraz raised NPR 10 billion via an IPO on NEPSE to compete with Amazon India. The IPO was oversubscribed by 15x, showing high investor demand for e-commerce equity.

Exam Tip

1. Definitions: Memorize key terms like:
   • Capital Market: "Market for long-term funds (>1 year) via shares/debentures."
   • SEBON: "Regulatory body for Nepal’s securities market."
2. Numerical Questions:
   • Always show step-by-step calculations (e.g., DDM, EPS, YTM).
   • Example: If asked to value a share, state assumptions (e.g., "constant dividend growth of 5%").
3. Comparisons:
   • Primary vs. Secondary Markets: Focus on participants and price setting.
   • Shares vs. Debentures: Highlight risk, returns, and tax benefits.
4. Nepal-Specific Examples:
   • NEPSE, SEBON, Ncell’s GDRs, NMB Bank’s debentures are high-scoring in exams.
5. Diagrams:
   • Draw T-accounts for share issuance or flowcharts of NEPSE trading to explain processes visually.
6. Common Pitfalls:
   • Confusing money market (short-term) with capital market (long-term).
   • Ignoring dilution effects in share issuance questions.

Final Note: Capital markets are the engine of economic growth. In Nepal, they fund everything from Ncell’s 5G towers to Everest Mart’s expansion. Master this unit, and you’ll understand how investments create jobs, businesses, and wealth—not just abstract numbers.