Money & Capital Markets in Nepal: Structure, Instruments & Operations

Core Concepts: Money vs. Capital Markets

1. Definitions and Key Differences

classDiagram
    class MoneyMarket {
        + Short-term (≤1 year)
        + High liquidity
        + Low risk
        + Instruments: T-bills, CDs, commercial paper
    }
    class CapitalMarket {
        + Long-term (>1 year)
        + Higher risk/return
        + Instruments: Bonds, stocks, derivatives
    }
    MoneyMarket --> "Funds" CapitalMarket : "Flows into"
    CapitalMarket --> "Issued by" Government : "Sovereign bonds"
    CapitalMarket --> "Issued by" Corporates : "Shares/bonds"

Why it matters:

• Money markets fund daily operations (e.g., banks borrowing overnight via repo).
• Capital markets fuel growth (e.g., Himal Cement raising Rs. 2B for expansion).

2. Instruments in Nepal’s Markets

A. Money Market Instruments

1. Treasury Bills (T-bills)

• What: Short-term debt instruments issued by Nepal Rastra Bank (NRB) to manage liquidity.
• Tenor: 91-day, 182-day, or 364-day.
• How it works:
  • Sold via auction (e.g., Rs. 100 cr auctioned in 2079).
  • Yield = (Face Value – Purchase Price)/Purchase Price × (365/Days to Maturity).
  • No default risk (backed by NRB).

2. Commercial Paper (CP)

• What: Unsecured, short-term debt issued by banks/corporates (e.g., NMB Bank, Himal Cement).
• Tenor: 7–180 days.
• Example:
  • Himal Cement issues Rs. 50 cr CP at 8% for 90 days.
  • Investor: A bank buys it for Rs. 49 cr; matures at Rs. 50 cr.

3. Certificate of Deposit (CD)

• What: Time-bound deposit issued by banks (e.g., Nabil Bank, Global IME).
• Tenor: 7 days to 1 year.
• Example:
  • You deposit Rs. 100,000 in Global IME for 182 days at 7.5%.
  • Maturity value = Rs. 100,000 × (1 + 0.075 × 182/365) = Rs. 103,700.

B. Capital Market Instruments

1. Shares (Equity)

• Primary Market: New shares issued (e.g., NMB Bank’s IPO in 2078).
• Secondary Market: Trading on NEPSE (e.g., NMB share price: Rs. 220 → Rs. 320 in 1 year).
• Rights Issue Example:
  • Green Food Ltd. offers 1 new share at Rs. 100 for every 2 held (current price: Rs. 200).
  • Calculation:
    • Theoretical Ex-Rights Price (TERP) = (Market Price × Old Shares + Subscription Price × New Shares) / Total Shares
    • TERP = (Rs. 200 × 2 + Rs. 100 × 1) / 3 = Rs. 166.67.

2. Bonds (Debentures)

• Types:
  • Government Bonds: Issued by NRB (e.g., 10-year bond at 8.5%).
  • Corporate Bonds: Issued by companies (e.g., Himalaya Power’s Rs. 50 cr bond at 9%).
• Key Terms:
  • Face Value: Rs. 100 (unless stated).
  • Coupon Rate: Annual interest (e.g., 8% of face value).
  • Yield: Actual return (e.g., if bought at Rs. 95, yield = (8/95) × 100 = 8.42%).

3. Regulatory Bodies in Nepal

4. Real-World Applications in Nepal

A. How Nepal Rastra Bank (NRB) Uses Money Markets

• Scenario: NRB needs to inject Rs. 500 cr into the economy to boost growth.
• Action:
  1. Auctions 91-day T-bills at Rs. 100 cr each.
  2. Banks/companies bid (e.g., NMB offers 7.8%, Global IME offers 7.9%).
  3. NRB accepts NMB’s bid → NMB pays Rs. 98 cr, gets Rs. 100 cr at maturity.
• Impact:
  • Liquidity increases → banks lend more → businesses grow.
  • Repo rate adjusts (currently 5.5% in 2023) to control inflation.

B. Rights Issue: Himal Cement’s Expansion

• Company: Himal Cement Ltd. (listed on NEPSE).
• Goal: Raise Rs. 200 cr for a new plant.
• Rights Offer:
  • Current share price: Rs. 320.
  • Offer: 1 new share at Rs. 100 for every 2 held.
  • TERP Calculation:

    TERP = (Rs. 320 × 2 + Rs. 100 × 1) / 3 = Rs. 246.67
    

• Investor Decision:
  • If you hold 100 shares:
    • Option 1: Sell all → Rs. 32,000.
    • Option 2: Keep + subscribe → 150 shares worth Rs. 246.67 × 150 = Rs. 37,000.
  • Upside: Potential for higher share price post-expansion.

C. NEPSE Trading: NMB Bank’s Share Price

• Data:
  • 2078 Asar: Rs. 200 (1M shares outstanding).
  • 2079 Asar: Rs. 320 (1M shares).
• Market Capitalization:
  • 2078: Rs. 200 cr (Rs. 200 × 1M).
  • 2079: Rs. 320 cr (Rs. 320 × 1M).
• Why the Rise?:
  • Dividend growth: NMB paid Rs. 10/share in 2078 → Rs. 15/share in 2079.
  • Loan growth: NMB’s loan book expanded by 20%.

5. Worked Example: Treasury Bill Yield Calculation

Problem: NRB auctions a 182-day T-bill with a face value of Rs. 100. The winning bid is Rs. 97. Calculate the yield.

Solution:

1. Discount = Face Value – Purchase Price = Rs. 100 – Rs. 97 = Rs. 3.
2. Yield Formula: $$\text{Yield}=\left(\frac{\text{Discount}}{\text{Purchase Price}}\right)\times \left(\frac{365}{\text{Days}}\right)$$
3. Calculation: $$\text{Yield}=\left(\frac{3}{97}\right)\times \left(\frac{365}{182}\right)=0.0624\times 2=\ast \ast 6.24\%\ast \ast$$

Real-World Tie-In:

• If Nabil Bank buys this T-bill, it earns 6.24% risk-free.
• Alternative: Park funds in a CD at 7% → T-bill is safer but lower yield.

6. Primary vs. Secondary Markets: Comparison

Mermaid Diagram: Market Flow

7. Challenges in Nepal’s Markets

A. Money Market Issues

• Low Participation: Only banks/financial institutions trade T-bills.
• Liquidity Crunch: Frequent repo rate hikes (e.g., 5.5% in 2023).
• Solution: NRB encourages corporate CP issuance (e.g., Himal Cement’s Rs. 50 cr CP).

B. Capital Market Issues

• Low Retail Investor Base: Only 5% of Nepalis own stocks (vs. 20% in India).
• Volatility: NEPSE index drops 15% in 2079 due to global recession.
• Solution: SEBON’s investor education campaigns (e.g., "SIP in Mutual Funds").

In the Real World

1. eSewa & Khalti (Digital Payments)

   • Idea Used: Money Market Liquidity Management
   • How: When you transfer Rs. 10,000 via eSewa, the funds sit in Nabil Bank’s overnight repo market (earning ~5.5% until used). Banks borrow/lend these short-term funds to meet reserve requirements.

2. NMB Bank’s IPO (2078)

   • Idea Used: Primary Market Issuance
   • How: NMB raised Rs. 500 cr by selling 2.5M shares at Rs. 200 each. The underwriter (Global IME) ensured demand. Now, shares trade at Rs. 320 on NEPSE.

3. Himal Cement’s Rights Issue

   • Idea Used: Capital Raising via Secondary Market
   • How: Existing shareholders got priority to buy new shares at Rs. 100 (vs. market price Rs. 320). This diluted shares but funded expansion. Post-issue, the share price rose to Rs. 350 as the new plant boosted profits.

4. NRB’s T-Bill Auctions

   • Idea Used: Monetary Policy Tool
   • How: When inflation hits 8% (2079), NRB auctions more T-bills to absorb excess liquidity. Banks bid aggressively, pushing yields up (e.g., from 6% to 7.5%).

Exam Tip

What Examiners Look For

1. Definitions with Examples:

   • Don’t just say "Primary market is where new shares are issued." Show with:
     • "NMB Bank’s IPO in 2078 was a primary market transaction where 2.5M shares were sold at Rs. 200 each to raise Rs. 500 cr."

2. Calculations:

   • T-bill yield, TERP for rights issues, and market cap changes are high-scoring. Always show step-by-step working.
   • Example:

     "Calculate the yield if NRB sells a 182-day T-bill at Rs. 95 for Rs. 100 face value." Answer: Discount = Rs. 5 Yield = (5/95) × (365/182) = 10.5%.

3. Regulatory Roles:

   • NRB = Money market + monetary policy (repo rate, T-bills).
   • SEBON = Capital market + IPO rules.
   • NEPSE = Trading platform.
   • Mix them up: "How does NRB’s repo rate hike affect NEPSE?" → Higher rates → lower stock prices (cost of capital rises).

4. Real-World Applications:

   • Link theory to Nepal:
     • "Explain how Himal Cement’s rights issue helps its expansion." → Funds new plant → higher future earnings → share price rises.
     • "Why does NRB auction T-bills?" → To control inflation by absorbing excess liquidity.

5. Common Pitfalls:

   • Confusing primary/secondary markets: Primary = new issue; secondary = trading.
   • Ignoring face value: Always assume Rs. 100 unless stated otherwise.
   • Skipping units: Yields are annualized; TERP uses weighted average.

Model Answer Structure

For a 5-mark question like "Explain the functions of secondary markets with an example":

1. Definition (1 mark): "Secondary markets are platforms where existing securities (shares, bonds) are traded after their initial issuance."
2. Functions (3 marks):
   • Liquidity: Investors can sell NMB shares anytime on NEPSE.
   • Price Discovery: NMB’s share price moves from Rs. 200 (IPO) to Rs. 320 based on demand.
   • Capital Formation: New investors enter via secondary trading (e.g., buying NMB at Rs. 300).
   • Market Efficiency: Transparent pricing reduces information asymmetry.
3. Example (1 mark): "In Nepal, NEPSE’s secondary market allows retail investors to buy/sell shares of Himal Cement, which was initially issued in the primary market at Rs. 200."

Summary Table: Key Instruments

Practice Questions

1. NRB auctions a 364-day T-bill at Rs. 92 for Rs. 100 face value. Calculate the yield.
2. Himal Cement offers 1 new share at Rs. 120 for every 3 held. Current price: Rs. 360. Calculate TERP.
3. Compare the roles of NRB and SEBON in regulating Nepal’s financial markets.
4. Why might a company prefer a rights issue over an IPO for raising capital?

Final Note:

• Money markets = Short-term, liquid, low-risk (T-bills, CDs).
• Capital markets = Long-term, growth funding (shares, bonds).
• NRB = Controls money supply; SEBON = Regulates capital markets.
• Always relate to Nepal: NMB Bank, NEPSE, NRB’s repo rate, Himal Cement’s rights issue.