Investment Securities & Markets: Types, Markets & Nepal’s Landscape

TAKEAWAYS:

• Investment securities are classified into debt (bonds, loans), equity (stocks, mutual funds), and derivatives (options, futures) based on risk, return, and ownership rights.
• Primary markets issue new securities (e.g., IPOs), while secondary markets (e.g., NEPSE) trade existing ones—affecting liquidity and prices.
• Nepal’s investment environment includes NEPSE (stocks), NMBL (bonds), and SEBON (regulator), with unique challenges like political risk and limited derivatives.
• Real-world tie-ins: Khalti’s IPO (equity), Ncell’s bond issuances (debt), and eSewa’s mutual fund partnerships (collective investments).
• Key metrics: Market capitalization, NAV (for funds), and conversion values (for convertible securities) determine investor decisions.
• Exam focus: Compare securities, calculate NAV/discounts, and analyze Nepal’s market structure (e.g., NEPSE vs. NMBL).

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1. Classification of Investment Securities

Investment securities are financial instruments that represent ownership or debt claims. They are broadly categorized into three types, each with distinct characteristics, risks, and returns.

A. Debt Securities (Fixed Income)

Debt securities are loans made by investors to issuers (governments or corporations) in exchange for periodic interest payments and repayment of principal at maturity.

Key Types of Debt Securities

```mermaid
timeline
    title Bond Payment Timeline (5-Year Bond)
    2024 : Coupon Payment (Rs. 50)
    2025 : Coupon Payment (Rs. 50)
    2026 : Coupon Payment (Rs. 50)
    2027 : Coupon Payment (Rs. 50)
    2028 : Coupon + Principal (Rs. 1,050)

Worked Example: Current Yield of a Bond

A bond with a face value of Rs. 1,000 pays an 11% annual coupon and is currently trading at Rs. 950. Calculate its current yield. Solution: Current yield = (Annual coupon payment / Market price) × 100 = (11% of Rs. 1,000) / Rs. 950 × 100 = Rs. 110 / Rs. 950 × 100 = 11.58%

Real-World Link: NMBL’s 10-year bonds (issued at Rs. 1,000) with a 9% coupon trading at Rs. 920 would have a current yield of 9.78%, making them attractive to income-seeking investors like pension funds.

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B. Equity Securities (Ownership Instruments)

Equity securities represent ownership in a company and entitle holders to dividends and capital appreciation.

Key Types of Equity Securities

Worked Example: Conversion Value of a Convertible Bond

A convertible bond of Company Y can be converted into 5 common stocks. If the stock price is Rs. 175, what is the conversion value? Solution: Conversion value = Number of shares × Market price per share = 5 × Rs. 175 = Rs. 875

Real-World Link: If NMBL’s convertible bond (trading at Rs. 900) has a conversion value of Rs. 875, investors might convert it to equity if they expect the stock price to rise above Rs. 175.

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C. Derivative Securities

Derivatives derive their value from underlying assets (stocks, bonds, commodities) and are used for hedging or speculation.

Key Types of Derivatives

Shows profit/loss at expiration based on stock price vs. strike price. (Image: Gxti, CC BY 3.0, via Wikimedia Commons)

Real-World Link:

• Pathao’s IPO (Equity): When Pathao listed on NEPSE, investors bought shares (equity) expecting capital gains.
• Ncell’s Bond Issuances (Debt): Ncell issues bonds to raise capital for expansion, with investors earning fixed interest.
• NEPSE Index Futures (Derivatives): While not widely traded in Nepal, global examples like Nifty futures (India) let traders hedge against market downturns.

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2. Investment Markets: Primary vs. Secondary

Markets facilitate the buying and selling of securities. Their structure impacts liquidity, pricing, and investor access.

A. Primary Market

• Definition: Where new securities are issued and sold to investors for the first time (e.g., IPOs).
• Key Features:
  • Proceeds go to the issuer (company/government).
  • Underwritten by investment banks (e.g., NMB Capital, Standard Chartered Nepal).
  • Example: eSewa’s IPO (2021) raised Rs. 1.2 billion.

```mermaid
flowchart LR
    A[Issuer<br>(eSewa)] -->|Drafts Prospectus| B[Regulator<br>(SEBON)]
    B -->|Approves| C[Underwriter<br>(NMB Capital)]
    C -->|Markets IPO| D[Investors<br>(Public)]
    D -->|Subscribe| C
    C -->|Allots Shares| A

Worked Example: NAV of a Closed-End Fund

A closed-end fund has assets worth Rs. 2,250 million, liabilities of Rs. 50 million, and 100 million shares outstanding. It trades at an 8% discount to NAV. What is its market price? Solution:

1. NAV per share = (Assets – Liabilities) / Shares outstanding = (Rs. 2,250M – Rs. 50M) / 100M = Rs. 2,200M / 100M = Rs. 22 per share
2. Market price = NAV × (1 – Discount) = Rs. 22 × (1 – 0.08) = Rs. 20.24 per share

Real-World Link: Nepal’s NMB Mutual Fund (closed-end) might trade at a discount if investor demand is low, as seen in 2023 when its NAV was Rs. 120 but traded at Rs. 110.

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B. Secondary Market

• Definition: Where existing securities are traded among investors (no new capital for issuers).
• Key Features:
  • Provides liquidity and price discovery.
  • Examples: NEPSE (stocks), NMBL (bonds), SEBON-regulated platforms.
• Types:
  • Exchange-Traded: NEPSE (auction market).
  • Over-the-Counter (OTC): Less regulated, e.g., private bond trades.

Real-World Link:

• Khalti’s Stock Performance: After its IPO, Khalti’s shares trade on NEPSE’s secondary market, with prices fluctuating based on earnings and market sentiment.
• Ncell’s Bond Trading: Investors buy/sell Ncell’s bonds on the secondary market, affecting their yield.

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3. Nepal’s Investment Environment

Nepal’s investment landscape is shaped by regulatory bodies, market participants, and unique challenges.

A. Regulatory Bodies

B. Key Investment Markets in Nepal

C. Challenges in Nepal’s Investment Environment

1. Political and Regulatory Risks:
   • Frequent policy changes (e.g., tax reforms) disrupt market stability.
   • Example: NEPSE’s 2021 crash due to political uncertainty.
2. Limited Derivatives Market:
   • No standardized futures/options (unlike India’s NSE).
3. Low Retail Participation:
   • Only ~200,000 active investors on NEPSE (vs. millions in India).
4. Liquidity Constraints:
   • Thin trading volumes for many stocks (e.g., Micro Finance Bank shares).

Real-World Example: When NTC’s stock surged after its privatization announcement, retail investors rushed to buy, but low liquidity led to wide bid-ask spreads (difference between buying/selling prices).

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4. Types of Security Markets

Security markets can also be classified based on maturity, geography, and organization.

A. Money Market vs. Capital Market

B. Organized vs. Unorganized Markets

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5. Investment Process for Financial Assets in Nepal

The process of investing in financial assets in Nepal involves five key steps:

```mermaid
flowchart TD
    A[1. Research<br>(Company Fundamentals)] --> B[2. Choose<br>Security Type]
    B --> C[3. Open<br>Dematerialized Account<br>(CDS account for NEPSE)]
    C --> D[4. Place Order<br>(via broker or online)]
    D --> E[5. Settlement & Custody<br>(NEPSE/SEBON)]

Step-by-Step Process

1. Research:
   • Analyze financial statements (e.g., NMB’s balance sheet).
   • Check PE ratio (Price/Earnings) of stocks like NTC.
2. Choose Security:
   • Debt (bonds) for stable income; equity (stocks) for growth.
3. Open Account:
   • For NEPSE: Open a Central Depository System (CDS) account via a broker (e.g., NMB Capital, Standard Chartered).
4. Place Order:
   • Buy/sell via NEPSE’s online platform or mobile apps (e.g., eSewa Trade).
5. Settlement:
   • T+2 settlement (trade settles in 2 days).
   • Custody of shares held by CDS.

Real-World Example: An investor wanting to buy Ncell’s stock would:

1. Research Ncell’s earnings growth.
2. Open a CDS account with a broker.
3. Place a market order for 100 shares at Rs. 150.
4. Settle in 2 days; shares credited to their CDS account.

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6. Comparison of Investment Securities

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In the Real World

1. eSewa’s IPO (Equity):

   • When eSewa listed on NEPSE in 2021, it issued 10 million shares at Rs. 120 each, raising Rs. 1.2 billion.
   • Concept Applied: Primary market issuance (IPO) and secondary market trading (NEPSE).
   • Investor Impact: Retail investors could buy shares, but liquidity was low initially due to limited trading volume.

2. Ncell’s Bond Issuances (Debt):

   • Ncell issues 5-year bonds to fund expansion, offering 9-10% interest.
   • Concept Applied: Debt securities provide fixed income; investors earn periodic coupons.
   • Real Calculation: A Rs. 1,000 bond with 9% coupon pays Rs. 90 annually. If traded at Rs. 950, current yield = 9.47%.

3. Khalti’s Mutual Fund Partnerships (Collective Investment):

   • Khalti partners with NMB Mutual Fund to offer liquid funds for retail investors.
   • Concept Applied: Mutual funds pool money to invest in diversified portfolios (bonds, stocks).
   • NAV Example: If the fund’s NAV is Rs. 110 but trades at Rs. 105 (5% discount), investors get a bargain.

4. NEPSE’s Market Indices (Benchmarking):

   • The NEPSE Index tracks 50-100 stocks (e.g., NMB, NTC, Global IME).
   • Concept Applied: Market indices reflect overall performance; used by funds to benchmark returns.
   • Example: If the NEPSE Index rises 5%, most stocks (like NMB) likely appreciate.

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Exam Tip

Based on past exam patterns, focus on:

1. Calculations:

   • NAV of funds, current yield of bonds, conversion value of bonds, and expected returns using CAPM (though CAPM is Unit 5, it often appears here).
   • Example Question: "A bond with a 10% coupon trades at Rs. 950. Calculate its current yield." (Answer: 10.53%).

2. Definitions and Comparisons:

   • Differentiate between primary vs. secondary markets, debt vs. equity, and organized vs. unorganized markets.
   • Example Question: "Describe the investment process for financial assets in Nepal." (Answer: Research → Open account → Place order → Settlement).

3. Nepal-Specific Context:

   • Know the roles of SEBON, NEPSE, and NMBL.
   • Example Question: "Discuss the status of the investment environment in Nepal." (Answer: Highlight political risk, low liquidity, and regulatory challenges).

4. Real-World Applications:

   • Relate theories to Ncell bonds, NMB stocks, or eSewa’s IPO.
   • Example Question: "How does the conversion value of a bond relate to its market price?" (Answer: If conversion value > market price, investors may convert to equity).

5. Common Pitfalls:

   • Discount vs. Premium: A bond trading at a discount (below par) has a higher yield; a premium (above par) has a lower yield.
   • NAV vs. Market Price: Closed-end funds often trade at discounts/premiums to NAV due to supply-demand imbalances.

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Final Visual Summary

```mermaid
mindmap
  root((Investment Securities & Markets))
    Primary Market
      IPOs
      New Issues
    Secondary Market
      NEPSE
      NMBL
    Debt Securities
      Bonds
      T-bills
    Equity Securities
      Common Stock
      Preferred Stock
    Derivatives
      Futures
      Options
    Nepal's Environment
      SEBON
      NEPSE
      NMBL
      Challenges
        Political Risk
        Low Liquidity