Seb On Journal Issue 3

SEBON Journal
Securities Board of Nepal

Thapathali, Kathmandu
Volume III July 2007
SEBON J ournal, Vol.III, J uly 2007 2

Building a Dynamic Capital Market

- Deepak Raj Kafle

Nepalese financial system is characterized by small but a growing capital market.
During the past 14 years of its operation, securities market has witnessed three
market phases of ups and downs. The latest upswing started from the fiscal year
2002/03 and is continuing. During this phase, Nepse index, the market indicator
climbed from 205 to 621 (J uly 10, 2007). The market capitalization of the listed
stocks climbed from Rs. 35.24 billion to Rs. 169.05 billion during the same
period. During the past five years, capital mobilized through public issue and
rights offerings has been in the tune of Rs. 8.4 billion from 109 issues. In the
fiscal year 2006/2007 alone, capital worth of Rs. 2.8 billion has been mobilized
from 34 issues.

In spite of expansion in size, the securities market is yet to make quality
transformation gaining depth and maturity. The market lacks sectoral
diversification of performing listed companies, access to secondary trading
services is limited , transparency and efficiency of the issuer and market is not
sufficient, capacity of the regulator, exchange and the players is limited, the
market is featured by active individual investors and the institutional investors
are conspicuously absent. The market infrastructures supporting the trading,
clearing and settlement are not sufficient. Thus the effort to build a dynamic
market is going to be an ardent task requiring a lot of commitment and efforts of
the government, regulator, market place, maker players and the investors.

The vision for a new Nepal has to have an important place for a dynamic capital
market. It should be a market where issuers have choice to tap the funds at lower
cost while people have choice to invest in the securities with different risk and
return. In essence, securities market is a mechanism that delivers public access to
ownership and share benefit from the investment. The fund requirement to
finance the establishment and expansion of corporate sector can conveniently

Chairman, Securities Board of Nepal

come from capital market as these entities venture to tap the opportunities in the
economy.

The vision of a vibrant capital market assumes that a country has respectable
level of and visible progress in countrys governance. Some aspects of
governance like rule of law, effective tax administration, and political stability to
ensure consistency and continuity of economic policies, directly impact the
confidence of domestic and foreign investors in the market. The governance
parameter, particularly the market related ones, should be improved so as to
make a meaningful breakthrough in the capital market sector.

It is well understood that large number of intermediaries, institutions and
professionals are the players and advisors active in capital market. Regulations
and laws governing the capital market are diverse, numerous and complex too. At
this point of time, Nepalese capital market is focusing on reforming the laws,
regulations and policies, building institutional capacity, above all visualizing a
dynamic capital market in order to tap the inherent potential and managing the
cross border issue and trading of securities. This article intends to highlight
important reform initiatives and some critical aspects of capital market
development in Nepal.

Legal and regulatory aspects
Government is responsible to frame securities laws and devolve power to make
regulations. The government also has its role in formulating capital market
development plan and addressing economic, fiscal and public borrowing policies
bearing close linkages to the capital market growth. Government plan should
support appropriate structure, incentives and infrastructure for the capital market.
Nepalese capital market has basically been an outcome of government planned
efforts. It has still been a major stakeholder in the ownership and management of
the stock exchange. The Securities Board of Nepal (SEBON), the capital market
regulator has majority government nominee (four out of seven) including a full
time chairman and an expert member. The whole set of regulations are to be
approved by the government which also has the responsibility to provide
program based budgetary support to the regulator.

It is now time ripe for transforming the capital market in a way that is more
responsive to the need of the market and competition. This means that the capital
market should be more market driven shifting from the current government
driven model. As such government can focus more on creating a proactive
regulatory regime and allow the market to have sufficient flexibility. It is
expected that the reform initiatives will be more convenient when the
government is still in the driving seat in the market operation too.

Experiences of strong capital market regulator in other countries including those
in the South Asian region shows more full time members enable more
responsible regulation and enhanced professionalism. This is also how banking
regulator in Nepal is executing its regulatory functions. For effective execution of
its regulatory functions SEBON need to have three full time professional
members in place of a one full time member in the role of chairman as it
currently stands. SEBONs responsibility to formulate policies, supervise market
and enforce the cases of non-compliances can be addressed more professionally
and in a balanced way.

Another issue is that a regulatory system should have appropriate mechanism to
address the conflict of interest. It is in this context, major conflict situations
should be addressed by law whereas minor conflicts by ethics of the profession
and disclosure of the conflicting action. The securities act has allowed even the
executive of a listed company to be a member of the regulatory board. This could
be counter productive while developing policies and conducting investigation
against the cases of noncompliance.

For the given legal framework and market needs, it is hard for the regulator to
maintain its independency and autonomy. The concern here is in formulating
regulation and meeting the financial needs for its operation. The government is
still in the steering seat of regulation making. The approach and process of
regulation approval by the government has not yet been clear and time bound.
Based on the past experiences, some approach can be suggested to expedite the
process more rationally. The government should facilitate regulation making by
interfering only in those regulatory areas which are in conflict with the economic
and fiscal policies of other sectors. However, it always reserves the right to issue
directives to the regulator and thereby entrusting the regulator for formulating
regulatory standards and policies in an independent manner.

The capital market development finds place in national plans but its
implementation has suffered in absence of sufficient resource commitment and
close monitoring. The market infrastructures that may require more investment in
the beginning will pay back in terms of credible and efficient market in the
future. Furthermore, a better coordination between the regulatory agencies would
be helpful to nurture the growth of nascent capital market.

Linkage with banking regulation
The banking regulation is closely linked to the capital market regulation. Nepal
Rastra Bank (NRB), the banking regulator, has been an important player in
promoting the growth of capital market institutions at the early stage of market
development. It has representation in the SEBON to ensure coordination of the
regulatory policies. But the banks involvement extends to the management and
ownership of stock exchange and few listed companies. Recently, it has started
withdrawing from ownership and management in order to alleviate potential
conflict of interest and ensure regulatory effectiveness. As an authority of
monetary policy, financial market stability is one of the prime goals of the central
bank. It is also relevant to note that the efficiency of equity, bonds and
government securities markets also affects the successful transmission of
monitory policy.

Secondary market for the government securities has been arranged through stock
exchange under the rules and regulations under the National Debt Act and
Securities Act.

These initiations are important to give market pricing mechanism including
market based reference benchmark for setting interest rates.

Market Regulation
Business persons involved in securities businesses are regulated under market
regulation. They may be the players of secondary market taking a role of brokers,
dealers or market makers. There are two dozen brokers and other functions are
practically absent. It is in this context, SEBON has developed broker dealer
regulation prescribing fit and proper criteria for broker dealer licensing and
business operation. It is expected to define regulatory jurisdiction of the SEBON
as the government regulator and the stock exchange as the front line regulator
with defined responsibility over listing of companies, disciplining members in
the exchange and facilitating trading. However, the Securities Act oversteps by
awarding stock exchange the power to recommend the members for licensing.
This has made SEBON to wait for the stock exchanges recommendation for
granting license to the new entrants. It is normally a practice that regulator should
focus on fit and proper criteria for the entry and meeting the standards for
operating the securities business. From regulators perspective, all those meeting
the criteria and standards should be allowed to enter and remain in the business
and not usually restrict business persons to enter the market competition.

Market efficiency
The stock exchange is a place for providing efficient trading platform for the
listed companies through its members. The present legal framework has defined
the responsibility of the exchange in admitting securities for trading, providing
membership to the brokers and the dealers and providing trading, clearing and
settlement of securities. These functions are implemented through the
membership, listing and trading, clearing and settlement byelaws. The
requirement of these byelaws has been structured by SEBON under the stock
exchange regulation and stock exchange has draft byelaws suggested by the
international experts. These bylaws are meant to make the market run on more
acceptable standard practices and make the market more flexible and efficient. It
is in this context that government has a program to privatize the stock exchange
and allow it to operate under a truly corporate structure. The market looks
forward to implementing these initiatives supported by more use of IT in trading,
clearing and settlement.

The secondary trading of stocks thus far is provided mainly for those shares
going public through Initial Public Offerings (IPO). In this type of going public
of the corporate bodies i.e., the issuers have a self regulated responsibility toward
making disclosures as specified under the laws and regulation. The due diligence
responsibility for the IPO process and the disclosure lies with the issue managers
licensed by SEBON. SEBON takes the responsibility for ensuring adequacy of
disclosure through its comments while relying on the issuers for the contents and
issue managers for due diligence responsibility. The mechanism of offer for sale
as a mode of going public is not a common practice. SEBON has been
formulating appropriate policy through the upcoming regulation to enable the
existing holder of securities to offer their holdings to the public, prescribe the
disclosure requirements and responsibility for the disclosures. The window of
going public through offering requires stock exchange to be a central place for
the dissemination of corporate and market information.

Corporate Financing
The stock market is bullish and getting to new peaks. This would have been good
news if the sustainability of the market was not a serious question. For the given
performance of the listed companies, the growth trend and future prospects, the
market is higher than an analyst would justify. This may be attributable to a
number of reasons including higher liquidity and absence of other investment
opportunities, absence of institutional investor to make the market more stable
and rational, and more investment awareness of investors on the risk return and
investment profile. But the basic reason lies in the limited supply of scrip in the
market. To increase market depth, it is necessary to increase the supply of
securities.

In order to enhance the supply of securities, a new securities registration and
disclosures regulation is in the making that would bring major regulatory
changes. This regulation sets the disclosure standards for going public through
IPO or secondary offerings through stock exchange. This disclosure based
regulation is believed to encourage closely held companies to come to the capital
market and entrepreneurs to sell their holdings in favor of the general public.
Besides, this regulation enables the issue of variety of instruments. However, this
could be meaningful once of the accounting standards and auditing practices
assure full financial disclosure.

Conclusion
The government sector involvement in the market operation should gradually be
shifted to benefit from private sector efficiency and competition, and its focus
should be towards strengthening the market regulator and in building market
infrastructures. This would demand government to screen the different
regulations based on their consistency with the overall economic and fiscal
policies and not normally get involved in the details of regulation. This will help
to rationalize the market which currently is requiring balancing the interest of the
government sector stock exchange and SEBON as government regulator.

Government has recently announced opening of stock exchange for foreign
investment. In the meantime, the mechanism for collective investment vehicles
with proper enabling Trust Act would be a right step to increase the market depth
and manage outward flow of investment. Now, the urgency is in establishing
appropriate policies through regulation, and setting standards and procedural
guidelines. In this process, some regulations viz. regulation enabling SEBON to
exercise its regulatory powers, regulation requiring license for stock exchange
and setting operational standards and regulation for licensing of broker-dealers
and setting their regulatory standards have already been developed by SEBON
and awaiting governments approval. Besides, merchant banking regulation
covering issue management, underwriting and securities transfer registrar, and
SEBON's employee regulation have been drafted by the management are in the
discussion stage at the board. Other draft regulations finalized by the
management are securities registration and disclosure regulation and mutual fund
regulation. The regulations, which are currently under the approval stage of the
government are very urgent to address the emerging issues in the market before
the deadline of securities registration, and licensing of stocks exchange and
business persons as set by the Securities Act.

The stock exchange needs to adopt the listing, membership and the trading
bylaws to give appropriate standards within its jurisdictions. As the draft bylaws
have already been suggested by the international experts, it should be adopted at
the earliest. Furthermore, the stock exchange is in last phase of introducing
trading automation under the Corporate and Financial Governance project. It will
add up efficiency and transparency of the market and pave the way for further
extension to online trading.

NRB Monetary Policy and Stock Market Impacts

- Professor Dr. Manohar K. Shrestha

Monetary Policy of the Central Bank has a profound influence on the
performance of the securities market. The conduct of Monetary Policy comes
under Target and Goal Setting of Central Bank (Mishkin, 1992) that covers
various objectives such as price stability, interest rate stability, high employment,
financial market stability and stock market is an integral part of it, stability in
foreign exchange and ultimately economic stability and growth. At present,
monetary policy cannot be separated from stock market although the effects of
monetary policy are guided by the broader consideration of macro-economic
variables (Sprecher, 1994) in two ways: i) Relationship between economic
development and contribution of stock market to its sound and steady growth and
ii) Cyclical pattern generated from the changes in monetary policy and
underlying upward and downward paths creating movements in stock prices.
Apart from these basic influences, monetary policy plays a decisive controlling
function to avoid artificial rigging in stock prices to save investors from the
hands of gambling-tendency speculators.

The intervention of Central Bank (Prime, 1992) in stock market has been taken
positively to minimize the vast growing number of manipulators in the stock
market activities as well as to accomplish the goals of enhancing economic
stability, employment, income generation, capital formation, productivity of
industrial enterprises and vast economic growth to raise living standards of the
people. The monetary policy structure acts as a powerful tool (Widicus and
Stitzel, 1996) to foster and encourage the activities of the positive-driven
strategy. Monetary policy creates overall linkage to guide the stock market to
take right kind of direction and change proving vital to endure fair trading
practice and compliance of the guidelines and regulatory provisions to protect the
common interest of the investors.

Professor, Central Department of Management, Tribhuvan University, Kirtipur,

Kathmandu
As is the case in highly industrialized and advanced countries where central bank
acts as supreme legitimate authority (Hadjimichalakis, 1995) in the determination
and implementation of monetary policy aggregates, NRB in our country is fully
empowered to create money and regulate its value through the use of various
monetary tools. Tenth Five year Plan Document, 2002-2007 (NPC,2002) clearly
states that the prime objective of Monetary Policy is to maintain macro-economic
stability by ensuring adequate liquidity in the economy and sufficient credit flow
to the private sector to attain sustainable development and high growth rate in the
economy supported by price stability and favorable balance of payments. In
addition, macro-economic targets are set out to maintain average annual inflation
rate to 5%, increase the growth of broad money supply to 14.5% and narrow
money supply at annual rate of 11.5%, increase credit from banking sector to
government at 6.3% and 20% to private sector and balance of surplus targeted to
Rs. 3.7 billion.

It is in this contextual perspective that the recent announcement and the
declaration of Nepal Rastra Bank's Monetary Policy has drawn the attention of
the government, commercial banks, development banks, non-bank financial
institutions, professionals, intellectuals, investors and other interested parties. All
of them are trying to observe and analyze how such a policy is going to affect the
economy and stock market because directly or indirectly they are the
stakeholders. The necessity for NRB to have slightly cautious and tighter
Monetary Policy was designed with its justification (Economic Report, 2004/5).
This is against the background of observing slow economic growth, continued
and growing trend of inflation, slight improvement in balance of payments,
rapidly growing high level of non-performing assets and considering many other
factors influencing the economy.

Making price stability as a solo objective, NRB has basic strategy to properly
implement the Financial Sector reform Package by lowering the cash reserve
ratio. The excess liquidity of commercial banks was taken as operating target by
putting bank rate at constant level of 5% and using this as an instrument to
pursue growth of broad Money (M2) at 12.5% so that price stability could be
maintained at 5.5% level and achieve Rs.5.5 billion balance of payment surplus.
These are positive indicative signals under NRB's Monetary Policy Framework
in operation for ensuring better Liquidity Monitoring and Forecasting
Framework. Moreover, it is clearly spelled out in Economic Survey Report of
2005/6 that the Monetary Policy and Strategy of NRB as a Central Bank of the
country is to consistently maintain the macro-economic stability by using various
monetary instruments to mop up the liquidity position, control on inflationary
pressures and not to exert unnecessary pressure on the prevailing exchange rate
on the economy.

In the stock market operation too, Capital Adequacy Framework as designed by
NRB is a welcome proposition for all commercial banks, development banks,
finance companies and other non-banking financial institutions. This has been
one of leading economic variables for the purpose of investors' analysis and
judgment for making investment decisions in selected blue chips. NRB's
Monetary Policy and Directives after enactment of Banks and Financial
Institutions Act, has also been strong as it makes mandatory for all commercial
banks to meet paid-up capital requirement of Rs. 100 million by the year 2066.
Keeping this in mind, all commercial banks have planned capital adequacy in
response to NRB directives and compliance of BASEL Accord to follow
international banking standards.

NRB's stand on the implementation of it directives was very strong as even the
repetitive efforts and hard lobbying by the Nepal Bankers Association proved
futile and useless. Since the banks had to manage paid up capital of Rs. 100
million within the stipulated period, it resulted into a full fledge bullish trend in
the stock market raising the NEPSE Index to multiple points as high as 386
points as well as enhancing the volume of trading mostly in commercial bank
stocks. But, stock market development could not keep pace with real sector
development in terms of operation of trading and industrial activities. Instead,
Nepalese economy recorded poorest real sector performance (NEPSE Annual
Trading Report, 2005/6) due to frequent transport blockade, poor security
situations and other unexpected events resulting from pressure group
disturbances and total breakdown of civil society's discipline. At the same time,
Securities Board of Nepal emphasized on the continuity of Corporate and
Financial Governance Project for modernizing Stock Exchange (Annual Report,
SEBON, 2004/5), enhancing securities regulation and disclosure with added
focus on developing Central Depository System, soliciting interest from vendors
for automation of stock exchange and strengthening of institutional capacity of
NEPSE, SEBON and CRO to stabilize the capital market.

Despite all these development initiatives, NRB's Monetary Policy had an impact
on the performance of stock market as investors were lured into buying shares of
commercial banks at higher market price with the expectation that banks would
issued bones shares to increase its capital base to Rs. 100 million. As a result,
there had been tremendous demand for shares of commercial banks in every day
transaction raising stock market index to unexpected highs. Investors used their
own and borrowed capital for purchasing shares of these banks and market price
jumped in multiples showing higher top price swings. The credit facilities from
banks and financial institution accepting banks' shares as collateral became
encouraging factor to increase volume of share transactions. During such a
bullish period, it is estimated that loan from various commercial banks, financial
institutions and other non-bank financial institutions crossed more than Rs. 5
billion putting shares as collateral. The NEPSE Index reached to the almost peak
of 430 points compared to previous year figure of 287 points. During the same
period, market capitalization touched as high as Rs. 97 billion although it was
just Rs. 61.4 billion in 2004/5.

But beyond the investors imagination NRB made a change in its previous
monetary policy. The new monetary policy announced gave flexibility in the
Capital Adequacy Base Requirement of commercial banks. Under this policy
capital adequacy requirement was redefined in terms of capital adjustment
provision rather than the paid up capital. This change was as stated in BASEL II
capital. Such a policy announcement confused the investors and immediately
brought a greater setback in the stock market transaction within two-three days.
There is complete stock market closure in technical sense and thin trading
followed for some consecutive days. How the stock market is affected seriously
can be explained with drastic drop figure of NEPSE Index as follows:
Drop in NEPSE INDEX Following NRB Announcement
Before Announcement After Announcement Change (+/-)
386.59
378.59 -7.74
366.73 -12.03
358.69 -8.04
355.60 -3.09
Total Drop -30.90

The huge slip in NEPSE INDEX by 30.90 points is the highest fall that has ever
happened in the 12 years history of Stock market in Nepal. The market
capitalization that has peaked to the amount of Rs. 96.94 billion immediately
melted down and bringing it to the tune Rs. 89.02 million. The loss in market
capitalization is Rs.7.92 billion which is a huge loss resulting from NRB's
announcement of new monetary policy. How to correct the matter timely became
a felt necessity for a responsible authority in the interest of the investing public
so as not to affect the investors' fortune and also not to disturb the smoothly
running capital market operations.

To the unfavorable effects of NRB Monetary Policy statements on market price
of shares, a large gathering of the investors in NEPSE immediately reacted to
such a move on already declared policy statement of capital base requirement
imposed on commercial bank. Investors called the media to draw their attention
on the impact of new monetary policy on the stock market. The angry investors
expressed their grievances that there is no reason why such a change is felt
despite renewed emphasis and continuity of the enforcement of maintaining Rs.
100 million paid up capital to all commercial banks within stipulated time period.

Ultimately NRB wisely and positively responded to this grave concern of
investors relating to capital adjustment provision and NRB Board Meeting came
to a decision to follow with release of information that paid up capital to be
maintained would be Rs.80 million instead of Rs.100 million and banks were
allowed to distribute dividend and bonus share to the investors. Such a decision
in motivated to avoid all pitfalls and provide remedies for avoiding disturbances
and turbulence created in the capital market.

At the same time, for the first time in the stock market history, NEPSE
introduced circuit breaker by not allowing stock price to rise and fall more than
10 percent in every subsequent transaction to discourage price speculation within
a day. During the same period, SEBO discouraged mutual trading on share
transaction as this could unnecessarily rig up the market price artificially to give
false impression of price rise to investors. These measures however appreciable
cannot be permanent solution unless regulating authorities follow professional
commitment to maintain consistent policy.

Even then investors' doubt still exists as to why the earlier stand of stringent
capital base requirement of Rs.100 million paid up capital was relaxed to Rs.80
million. In fact, NRB followed a logical policy rational to make some change in
monetary policy to decrease paid up capital base to 80 percent to follow Win-
Win Situation to balance the interests of investors on hand and commercial banks
on the other hand in response to the BASEL Accord.

But, the revival of the market after the announcement of new capital base
requirement has already shown positive signs of improvements and impacts on
the stock market since NEPSE INDEX recorded as follows:

Rise in NEPSE INDEX Following NRB Announcement
Before Announcement After Announcement Change (+/-)
355.60
357.27 +2.67
383.14 +25.87
385.22 +2.08
Total Drop -30.52

This clearly shows that NEPSE INDEX revived to the previous level although
there is slight difference and market capitalization still takes time to maintain
previous record level.
The lesson learned from New Monetary Policy Announcement is that it should be
a long-term policy and should not interfere in the price sensitive capital market
phenomena determined from the free play of the market forces.

References:
Bober, Stanley, The Economics of Stock Market Cycles and Growth, Wiley and Sons, New York,
1998.
Chiristy, George A and Clendin, J ohn C., Introduction to Investment, McGraw-Hill Book
Company, Bombay, 1982.
Haberler, Gottfried, Prosperity and Depression, George Allen and Unwin Limited, London, 1955.
Hadjimichalakis Michael G. and Hadjimichalakis Karma G., Contemporay Money, Banking and
Financial Markets, Irwin, Chicago, 1995.
Loeb, Gerald M., The Battle for Investment Survival, Simon and Schuster, New York, 1998.
Ministry of Finance, Government of Nepal, Economic Survey, Fiscal Year 2004/2005, Ministry of
Finance, Singhadurbar, Kathmandu, 2005.
Mansukhani, S.K., Golden Investment Strategy: What Every Investor Should Know, Lavani
Publishing Company, Bombay, 1968.
Mishkin, Frederic S., The Economics of Money, Banking and financial Markets, Harper Collins
Publishers, New York, 1992.
National Planning Commission, Government of Nepal, Tenth Plan, 2002-2007, National Planning
Commission, Singadurbar, Kathmandu, March 2002.
Nepal Rastra Bank, Economic Report 2004/2005, Central Office, Research Department, Baluwatar,
Kathmandu, 2005.
Nepal Stock Exchange, Annual Trading Report, Fiscal Year 2005-06, Research, Listing and
Planning Division, Nepal Stock Exchange Limited, Singhadurbar Plaza, Kathmandu,
September, 2006.
Poudel, Dandapani, Monetary Policy and Transmission Mechanism in Nepal, NRB Samachar,
NRB, Baluwatar, 2061.
Securities Board of Nepal, Annual Report, Fiscal Year 2004/2005, SEBON, Thapathali,
Kathmandu, 2005.
Shrestha, Shivraj, The Efficacy of Liquidity Monitoring and Forecasting, NRB Samachar, NRB,
Baluwatar, 2062.
Sprecher, C. Ronald, Introduction in Investment Management, Houghton Miffin Company, Boston,
1975.
Thapa, Nara Bahadur, Financial Sector Stability and Monetary Policy, NRB Samachar, NRB,
Baluwatar, Kathmandu, 2062.
Widicus, William W. and Stitzel, Thomas E., Personal Investing, Homewood, Illinois, 1985.

Price Volatility and Measurement of Risk

- L. D. Mahat

People hold shares with an intention to earn money. Finance theory states that in
every return, there is some risk associated with it. While an investment in shares
has the prospect of earning good return, it also has the risk of losing large
amounts of equity. A traditional investor in stocks can only protect his or her
holdings by divesting the investments. The stock market can be a risky place for
investors if they do not know how to protect themselves from potential losses.

Change is the essence of life and risk is the integral aspect of living. This holds
equally well for the capital market. In the capital market, risk may be defined as
the chance that the expected return either may not materialize or may be less than
expected. Return earned from investment in shares of a company usually has two
components: the periodic cash flow such as receiving dividend; and the
appreciation in the price of shares, called the capital gain.

Price volatility is generally used to describe price fluctuations of a commodity.
Volatility is measured by day-to-day percentage difference in the price of
commodity. Applying the similar concept in capital market, the price volatility of
a share may be defined as the amount of variation in its price. The most volatile
shares are those with the largest variation in the value of their share price. Due to
this fact investment in such shares are considered the most risky. Volatile share
market is a market subject to price fluctuations, which increases the risk of price
changes of shares. Compared to the dividend, market price is the more crucial
factor, which contributes to the success of investment. Therefore, volatility in the
price of shares is a more critical risk associated with the capital market.

The degree of variation in the prices of shares, not the level of prices, defines a
volatile share market. Greater volatility of shares in the capital market for several
reasons matters the investors. It sheds light on what is happening in an economy-

Chartered Accountant, CSE and Company, Baluwatar, Kathmandu

and in the minds of investors. It makes investing in shares a riskier business, and
it has big knock-on effects on the prices of other securities, such as bonds.

Volatile market is not always risky for the investors. In the financial market,
return can be maximized only at the cost of incurring higher degree of risk. A fall
in the market price of shares results in decreased profit or increased loss to the
investors. However, appreciation in share price would put the investor in a
favourable position. It is, therefore, understood that many investors respond
positively to market volatility since increased volatility provides opportunity to
move into the market.

Short-term fluctuation in the price of shares also affects the investors who intend
to invest in the shares and earn returns in the short span of time in a similar
manner. The prospective investors need to find out the degree of price
fluctuations in order to know the degree of risk involved in the investment. The
degree of fluctuations in the price of shares can be found by computing price
volatility index of shares.

Volatility measures the dispersion about a central tendency. There are a number
of ways to measure the price volatility of shares. One of the widely accepted
methods is the Price Volatility Index (PVI). PVI is computed by dividing the
range of price fluctuations of a share by the average price of the same share. A
range is the difference between the highest and lowest price of shares during a
particular period and the average price of share is the average of these highest
and lowest prices. For example, if a company's shares are traded in the market at
the highest price of Rs. 1,500 and at lowest price of Rs. 700 in a particular year,
the PVI of the shares of the company becomes 0.73, i.e., {(1500-
700)/(1500+700)/2}.

PVI can be computed on an annual basis in order to find out long-term price
fluctuations. But, in order to find out long-term price fluctuations PVI can be
computed on a weekly, monthly or quarterly basis.

Nepalese capital market has always been dominated by the banking and finance
sector. The market is almost non-existent in other sectors with the exception of
few companies. Therefore, PVI of selected listed banks has been computed and
presented in the following table in order to analyze price fluctuations of their
shares.

Table 1: PVI of selected banks
Name of Bank 1998/99 1999/00 2000/01 2001/02 2002/03 Average
Nabil Bank (NABIL) 0.61 0.72 0.55 1.05 0.22 0.63
Nepal Investment Bank (NIB) 0.56 0.53 0.87 0.67 0.33 0.59
Nepal Std. Chartered Bank (NSCB) 0.53 0.54 0.50 0.71 0.24 0.51
Himalayan Bank (HBL) 0.53 0.56 0.69 0.86 0.24 0.57
Nepal SBI Bank (NSBI) 0.43 0.43 0.80 1.37 0.47 0.70
NB Bank (NBBL) 0.92 0.61 1.13 1.12 0.44 0.85
Everest Bank (EBL) 0.82 0.84 0.94 0.78 0.34 0.74
Bank of Kathmandu (BOK) 0.92 1.17 0.83 1.16 0.42 0.90

Higher the PVI riskier will be the security. Generally, a PVI value greater than 1
is considered as aggressive security. On the other hand, a PVI value less than 1 is
considered as defensive security. Over a period of 5 years, NSCB has an average
PVI far lower than 1, hence the shares of this bank has the lowest risk. The other
less risky securities are of HBL and NIB. BOK's shares are the most risky based
on PVI calculation.

Fluctuations in the price of shares of a company could arise due to price sensitive
information received by the market such as earnings announcement,
announcement of bonus and announcement of right shares. NSCB has no bonus
announcements since 1999/00. This may be one of the reasons for low PVI of
this bank. On the other hand, HBL has been maintaining lower PVI next to
NSCB, in spite of bonus announcements in all the years. NABIL had higher PVI
in 2001/02, although it had no bonus and right announcements in that year. BOK
had a PVI value 1.17 in 1999/00, although it had no bonus and right
announcements. NSBI and BOK had exceptionally higher PVI in 2001/02 as a
result of right announcements at the ratio of 2:1 and 1:1 respectively in that year.
While ancient societies used to face the risk just by believing in fate, modern
societies endeavor to manage the risk with the help of various risk management
tools and exploit the opportunity of enhancing returns. Management of risk calls
for understanding, measuring and analyzing it. PVI is one of the useful tools for
the investors to manage risk.
Nepalese Securities Market: Regulation and Development

- Kiran Thapa

1. Introduction
Looking back into the history of Nepalese securities market, we can find that the
market started in the mid 1930s with the issuance of shares by some companies.
However, the formal institutionalization began only after the establishment of
Securities Exchange Centre in 1976. The then Securities Exchange Centre was
responsible for undertaking the job of brokering, underwriting, managing public
issue, market making for government bonds and other securities markets
services. Introduction of the Companies Act in 1964, issuance of Government
Bond in 1964 and introduction of Securities Act in 1983 were the important past
initiatives for developing securities markets in Nepal. The development process
accelerated with the liberalization policy of the Government during 1990s.
During this period major initiatives were taken for the development of the
securities market, the most important one being establishment of Securities
Board of Nepal (SEBON) in 1993 as an apex regulator of securities markets.
With the establishment of SEBON the then, Securities Exchange Centre was
converted into Nepal Stock Exchange Ltd. (NEPSE), which started secondary
trading of securities with the introduction of stockbrokers. As of the March 2007
there are 23 stockbrokers, 3 securities dealers and 9 issue managers providing
securities market intermediation services and 131 listed companies.

The major regulatory framework for the securities markets is provided by
Securities Act, 2006, which has given authority to the SEBON for the regulation
of securities market. As per the Act, the major objectives of SEBON are to
regulate issue and trading of securities and market intermediaries, promote the
market and protect investor's rights. Besides, the duties and responsibilities of
Securities Board are to register securities and approve prospectus of public
companies, provide license to operate stock exchanges, provide license to operate
securities businesses, permit operation of collective investment schemes and

Mr. Thapa is Lecturer of Finance in Shanker Dev Campus.

investment funds, draft regulations, issue directives and guidelines, and approve
bylaws of stock exchanges, supervise and monitor stock exchanges and securities
business activities, take enforcement measures to ensure market integrity, frame
policies and programmes relating to securities markets and advise the
Government in this regard. Thus, the responsibility of developing and regulating
the securities markets in the country rests solely on the SEBON.

2. Status of the Market
The performance of the market during the period of 1993/94 to 2005/06, as
shown by the various indicators, reflects a progressive trend. Table 1 shows that
the annual public issue amount in the fiscal year 2005/06 is about 10 times more
than that of the fiscal year 1993/94. Similarly, the market capitalization value,
annual turnover and NEPSE Index have also increased significantly during the
period. However, average turnover to market capitalization ratio being only 4.16
indicates that the liquidity level of the market is very low. The contribution of
market capitalization to Gross Domestic Product during the period is on an
average 8.76 percent, which indicates that the securities market does not have
significant contribution to the economy.

Table 1: Trend of Securities Market
Year
Amount
of issue
(Rs in
million)
Market
capitalization
(Rs in million)
Turnover
(Rs in million)
Turnover to
Market
Capitalization
Ratio
Market
Capitalization
to GDP
Index
1993/1994 244.4 13872.0 441.6 3.18 7.24 226.03
1994/1995 174.0 12963.0 1054.3 8.13 6.17 195.48
1995/1996 293.7 12295.0 215.6 1.75 5.14 185.61
1996/1997 332.2 12698.0 416.2 3.28 4.71 176.31
1997/1998 462.4 14269.0 202.6 1.42 4.93 163.35
1998/1999 258.0 23508.0 1500.0 6.38 7.12 216.92
1999/2000 326.9 43123.0 1157.0 2.68 11.77 360.70
2000/2001 410.5 46349.4 2344.2 5.06 11.78 348.43
2001/2002 1441.3 34703.9 1540.6 4.44 8.58 227.54
2002/2003 556.3 35240.4 575.8 1.63 8.22 204.86
Year
Amount
of issue
(Rs in
million)
Market
capitalization
(Rs in million)
Turnover
(Rs in million)
Turnover to
Market
Capitalization
Ratio
Market
Capitalization
to GDP
Index
2003/2004 1027.5 41424.3 2144.3 5.18 8.77 222.04
2004/2005 1626.8 61365.9 4507.7 7.35 12.06 286.67
2005/2006 2443.3 96813.7 3451.4 3.56 17.35 386.83
Average 738.25 34509.66 1503.95 4.16 8.76 246.21
Source: Annual Reports of SEBON

Out of the total securities issue of Rs. 9597.25 million, 55.86 percent is from
commercial bank, 2.71 percent from development bank, 15.11 percent from
finance companies, 3.18 percent from insurance company, 8.30 percent from
hotel, 9.40 percent from manufacturing company, 0.03 percent from trading
companies and 5.41 percent from others. (SEBON, Annual Report, 2005/06).
This data shows that about 74 percent of the total issue is from banks and
financial institutions. The issue from real sector on one hand is very nominal
while on the other hand their issues are not often subscribed because of their
deteriorating performance. This indicates that the basis of Nepalese securities
market is very weak as the performance of the dominant sector may anytime get
deteriorated because of lack of long term investment opportunities for the
financial institutions.

The securities instruments issued in the market are dominated by risky
instruments i.e., equity, which has covered about 78 percent of the total amount
of the securities and the rest being debenture and preference shares (SEBON,
Annual Report, 2005/06). There are two mutual funds operating in the market,
however, their regulation is questionable due to the lack of proper and adequate
legal framework. All these indicate the limited diversity of securities instruments
in the market leaving no choice for the investors to invest as per their risk return
preference.

3. Issues
The above facts indicate that the securities market in Nepal is still at a nascent
stage and has failed to show impact on the overall national economy. Small
market size has made it vulnerable to manipulation and price rigging, low
turnover ratio indicates that the market is highly illiquid. Dominance of equity
instruments has restricted the participation of risk averter types of investors in the
market. There are also the various lapses in legal as well as institutional
framework of the market. The major issues of the market are briefly dealt below.

3.1 Structural deficiency in formulation of regulation
As per the provision of Securities Act, SEBON prepares regulations and issued
with the approval of the Ministry of Finance (MOF), which is also the reporting
authority of the SEBON. At present, there is only one stock exchange which is in
the ownership of government. By the authority of government, the responsibility
for the management of stock exchange goes to MOF being the reporting ministry
of SEBON, the MOF official chairing the NEPSE board would have conflict of
interest while approving the rules and regulations related to NEPSE functioning.

3.2 SEBONs structure is not broad based and the conflict of interest is not
properly balanced

As per the provision of Securities Act, the governing board of SEBON comprises
of seven members representing various government and private sector agencies,
which also includes a full-time Chairman appointed by the Government. Other
members of the Board are joint secretary from Ministry of Finance, joint
secretary from Ministry of Law, J ustice and Parliamentary Affairs, a
representative from Nepal Rastra Bank (the central bank), a representative from
Institute of Chartered Accountants of Nepal, a representative from Federation of
Nepalese Chambers of Commerce and Industries, and a member appointed by the
Government of Nepal amongst market experts (SEBON, Annual Report,
2005/06). However, if we look at the governing structure of securities regulator
of other countries, in most of the cases we can find at least two full time
members from the legal and accounting field. This is important in view of the
securities regulators responsibilities requiring frequent inputs from these fields.
The other deficiency in structure is that there is no restriction for the board
members to be involved in the listed companies as board member or chief
executives or to play other key roles. SEBON being a quasi-judiciary agency, can
penalize the listed companies in case of violation of laws, and if the member is
from that particular company being penalized, may defend against the action of
SEBON resulting to a situation of conflict of interest, which may hamper be
effective regulatory function of SEBON

3.3 Inadequacy in securities market legal framework
As visualized by the Act, many rules and regulations have to be developed for
the implementation of the Act. It is often heard in the media that the licensing of
stockbrokers has been hindered due to lack of stockbroker regulation. Besides,
there is also a lack of basic legal infrastructure for the operation of mutual funds
in the market. The trust act is also very important for the operation of central
depository system of securities and development of bond market. Recently, it
was highlighted in the newspapers that a company could not issue rights shares
on time with the provision of rights renouncement as enabled by the new
provision made in the Companies Act, 2006 and Securities Act, 2006, because
SEBON could not give proper modality for rights renouncement as per the
provision of the acts. This also shows the deficiency in the legal framework.

3.4 Slow process of enactment of laws
It is noted that the enactment of securities laws has taken near about a decade.
The securities act was prepared considering the suggestions of the capital market
study report of ADB conducted in 1995 and submitted by SEBON to the
parliament in 1999 (SEBON, Annual Report, 2000/2001). This act was passed in
2005 in the form of ordinance (SEBON, Annual Report, 2005/06). Later in 2006,
this ordinance has been approved by the parliament and issued as Securities Act,
2006. Not only the act, also the enactment of regulations is also taking unusually
long time. SEBON submitted some regulations related to stock exchange and
broker dealer to MOF after the issuance of Ordinance (SEBON, Annual Report,
2005/06), however, they were not approved by the MOF. Later, when the
Ordinance was passed in the form of Act, these regulations were again submitted
to MOF (Gorkhapatra, J une 8, 2007). All these indicate the slow rule making
process, which in view of the dynamic nature of capital market is very
embarrassing. Such type of delay may be attributed to the fact that either the
lawmakers do not understand the technical nature of market and/or the regulator
does not have sufficient capability to convince the lawmakers as well as the
government about the importance of particular law to be issued.

3.5 Lack of Institutional Infrastructures
The Central Depository System of Securities (CDS), which is very important
from the aspect of market efficiency, has not been established. Absence of CDS
is one of the reasons why the process of clearing and settlement and ownership
transfer has not been efficient and transparent. Similarly, the markets also lacks
in the services of institutions like Credit Rating Agencies, which in view of the
development of bond market is very important. Lack of alternative trading
mechanism such as OTC markets and third and fourth markets is the other
prominent issue of the market. The securities, which do not meet the listing
criteria of stock exchange or are de-listed from the stock exchange, have no
avenue for trading due to lack of such trading arrangements.

3.6 Efficiency of Stock Exchange
It is usually heard in the market and read in the newspaper that the services
provided by the stock exchange are very inefficient. Companies are often
complaining about the delay in listing. It has even been published in the
newspapers in the past that the debentures listing of Himalayan Bank Limited
had taken months because NEPSE could not develop appropriate criteria for
listing and trading of such instruments. A study of SEBON on performance of
issue manager for the period between the fiscal year 1993/94 to 2002/03,
published in SEBON J ournal Volume II reveals that out of 74 issues, only 12
were listed timely.

The trading of stocks in the floor of NEPSE is still carried out through open-out-
cry system, which has been obsolete from most exchanges in the world. Due to
lack of automated trading system of securities, the trading has not able to gain
confidence in terms of efficiency and transparency. The trading facility is limited
only in Kathmandu valley and there is no any provision for providing this facility
to the people in other parts of the country. This has also hindered in increasing
public participation in the securities markets.

3.7 Efficiency of stock broking services
Currently, there are 23 stockbrokers in the stock market, out of which about 10
are actively involved in the trading. Lack of easy entry and exit mechanism for
stockbrokers in the market has limited their number and put constraint in
providing fair and competent services. They are not concerned with expanding
their services out of the valley and mostly are found to be taken this business as a
secondary business. Questions on their professionalism are often raised and the
media time to time has also highlighted their involvement in manipulative
trading. They are often blamed for not being well equipped to provide investment
counselling services to the investors. They are also lagging behind in keeping
updated records of trading. In the fiscal year 2005/06, SEBON and NEPSE, on
their joint on-site inspection of stockbrokers, found many brokers not keeping
updated records of securities transactions and transaction orders for which they
were suspended from trading securities (SEBON, Annual Report, 2005/06).

3.8 Absence of institutional investors
The market is dominated by individual investors and most of them are not
making informed investment decisions rather driven by market rumours. Because
of lack of institutional investors in the market, there is no pressure for the issuers
to make timely and regular disclosure. The price formation process of the market
is also not fair as the market is lacking the role of such investors in stabilizing the
price of securities in case of unusual ups and downs. The role of institutional
investor in the market is known to add up new instrument through collective
investment schemes, play role in stabilization of the securities prices, make
rational analysis of information and pressurise the issuer for the regular flow of
credible information.

3.9 Information disclosure
Information is an important element of securities market. Investors can make
rational investment decision if there is sufficient information. The institutions
disseminating information are issuing companies and stock exchange. Issuing
companies have to prepare prospectus at the time of public issue. After listing
they have to disclose periodic and other material information (Securities Act,
2006). However, specific format of the prospectus has not been prescribed yet to
confirm the requirement of the Securities Act, 2006 and Companies Act, 2006. In
lack of specific standards the listed companies under the same group do not have
uniformity in corporate disclosure. The credibility of the information has always
been questionable in case of many companies as evident from the issues raised
by the newspapers from time to time on the professionalism of accountants and
auditors. Also there is no any mechanism within the securities regulator for the
review of corporate information to test the reliability.

Stock exchange has to receive and disclose the price sensitive information,
periodic information and other information of the listed companies and also
provide the trading information. Timely disclosure of market information such as
ask and bid prices, trading amount and price, traded companies, actual demand
and supply of securities, types of transaction etc. helps investors to make rational
decision and to determine the time to enter the market and exit from it. However,
only the information on price and quantity of traded securities is available in the
market.

3.10 Securities instruments
The diversity in securities market instruments attracts the investors of various
risk preferences providing the choices in the investment alternatives. But in case
of Nepalese securities market, it is mostly dominated by risky instrument (equity
share), which constitutes more than 80 percent of the total paid up value of the
securities listed in the stock exchange and the rest consisting of preference
shares, debentures/bonds and mutual funds. Recently government securities was
listed in the stock exchange, however, these securities are mostly held by
institutions and free float securities are not in the hands of individuals resulting in
limited or no trades. Lack of benchmark interest rate provided by government
securities market and the trustee mechanism, the corporate bonds issue practice
has still not been popular. So, the market has not become attractive to risk averter
and risk neutral investors.

4. Conclusion
The above analysis reveals the weak performance of the market and slow pace of
development. Several efforts were made to reform the market and improve
market performance. However, these efforts have not become fruitful because of
structural deficiencies in market mechanism. Lack of appropriate and standard
legal framework has been the major reason for not improving efficiency of
regulation. Various kinds of frauds and malpractices from the service providers
have been noted. Investors are being the victims of market hypes, as their
awareness level could not be raised adequately.

SEBON as being the regulator of securities market must be responsible for
proper functioning of market. With the enactment of new Securities Act, SEBON
should gear up for the overall development of the market. For this SEBON
should give maximum emphasis to bring into implementation of the various
regulations as provisioned by the Act. A prerequisite for this would be the
capacity building of the regulator with adequate authority and operational
autonomy, proper resources and experts, and technological enhancement.

SEBON should focus to play its role in infrastructure development, improvement
of professionalism of the market participants, enhance disclosure standards,
supervise market and take enforcement actions to ensure fairness and
transparency in the market.

The Performance of Nepalese IPOs
- Gyan Bahadur Dahal

Abstract
This paper assesses the performance of Nepalese IPOs and relates them to potential
factors. The study finds that the Nepalese IPOs are heavily oversubscribed and provide
the investors with the market adjusted excess rate of return leading to the conclusion that
Nepalese IPOs are underpriced too. The study finds that the NEPSE Index and the
subscription as times of issue have significant predicting strength on the performance of
IPOs. The study results show that phenomenon of oversubscription can be explained by
the firm size and the debt equity ratios.

I. Introduction
The performance of initial public offerings (IPOs) is one of those empirical
questions that continuously draw the attention of many researchers in finance.
Several researches have been carried out to examine the performance of IPOs in
the developed countries like United States, France, Germany, United Kingdom,
J apan, Israel etc. and in the developing countries like India, Malaysia, China, etc.
where IPO market mechanisms may not be identical. Several empirical studies
put forward that IPOs are sold at a significant discount, a phenomenon known as
underpricing, from the prices that prevail in the aftermarket that results into
significantly better performance of IPOs than that of equity market in general.
The deeper the underpricing, the higher will be the initial returns resulting into
the better performance of IPOs for the investors. On the other hand, the deeper
the underpricing, the lesser will be the net proceeds for the issuing companies
resulting into the loss of wealth of the company as it represents the part of the
cost of going public for the companies.

Various explanations have been laid down to explain why IPOs outperform the
market initially due to the underpricing of IPOs under varying IPO market
mechanisms. There are both supporting and opposing evidence for these
explanations in the finance literature. This study aims to examine the mechanism

Mr. Dahal is lecturer of finance in College of Applied Business, Kathmandu

of Nepalese IPOs market which stands out as an emerging market and their
performance.

The rest of the article is organized as follows: Section II provides the literature
review of the studies carried on different IPO market mechanisms. Section III
introduces Nepalese IPOs market mechanism. Section IV gives details of the
research data and methodology. Section V presents the empirical findings of the
study a period of 13 years from fiscal year 1993/94 to 2005/06. Finally,
conclusion is given in section VI.

II Literature Review
Empirical studies provide evidence for and against different hypotheses on the
issues of market adjusted excess return of IPOs in varying IPO market
mechanisms.

A study conducted by Security Board Nepal (2006) sheds light into the fact that
the Nepalese primary market is dominated by risky instrument i.e. equity shares
and the major portion of the total public issue approval being from bank and
finance sectors. However, Adhikari (2006) sheds light into the fact that investors
hesitate to subscribe in public issues of manufacturing and processing, trading
and hotel sectors and due to this the companies from these sectors face
difficulties in raising funds from the market. The study finds that the financial
forecasting in most of the issues is overstated. Pradhan (1993) finds that the
stocks with largest market value to book value of equity have higher price
earning ratio in Nepalese stock market. Pradhan and Balampaki (2004) find that
in Nepal the capital gain yield is positively related with the size of a firm
measured in terms of market capitalization. Timilsina (2004) concludes that the
companies making IPOs overstate their forecasted accounting figures.

Habib and Ljungqvist (2001) find that the US IPOs are underpriced by 13% on
average; Chinese IPOs are underpriced by 42% whereas the Malaysian IPOs are
underpriced by 6%. They argue that some IPOs are more underpriced than others
because their owners have less reason to care about under pricing and that the
extent to which owners care about under pricing depends on how much they sell
at the IPO. It is because the promoters who sell very few shares to the public
suffer less from under pricing than those who sell large portion of the shares
They predict that issuers can reduce the under pricing by spending more in the
IPOs promotion. They consider both the under pricing and IPO promotion costs
are the part of the costs of going public. They illustrate the US and Canadian IPO
mechanisms where issuers can choose between a best-efforts offering which is
cheap in terms of cash expenses but typically leads to high under pricing and a
firm commitment book-building which is expensive in terms of fees but leads to
lower under pricing.

Benveniste and Busaba (1997) observe that American book building mechanism
is becoming the method of choice in the context of fixed price method being
historically dominant approach in the UK and its former colonies (e.g. India and
Singapore) and in most of Europe. They also observe that fixed price mechanism
creates cascading demand thereby guaranteeing the issuer some proceeds.
However, book building mechanism generates the higher expected proceeds to
the issuers and provides option to sell additional shares at fair price but exposes
to the greater uncertainty too. Sherman (2005) too finds that the U.S. book-
building method has become increasingly popular for IPO worldwide over the
last decade.

Derrien and Womack (2003) find that the auction mechanism is associated with
less under pricing and lower variance of under pricing than other mechanisms
namely book building, and fixed price mechanism with reference to the data from
the French IPOs market where all three of the aforementioned mechanisms were
prevalent at the same period (19921998) in France. They also observe that
even though the auction procedure dominates the book building procedure in
mitigating underpricing in varied market conditions, book building procedure is
dominant in the United States and very significantly increasing in the rest of the
world. They explain that even though the mitigation of under pricing is a worthy
objective to issuers, it clearly is not their only objective. Besides, they argue that
controlling underpricing is clearly not the most important issue to underwriters
who suffer an agency conflict of interest, pitting their issuing clients against their
investor clients.

Derrien and Kecsks (2007) observe there is a two stage mechanism prevalent
in the UK in which under pricing has been found to be reduced by 10 percent to
30 percent in comparison to the traditional under pricing in which IPOs are made
at first and then the shares are listed in the secondary market. First time public
financing through equity is proceeded in two stages i.e., a firm lists and lets a
public market develop in the firms existing shares in the first stage, and sells
new shares to the public in the second stage.

Kandel, Sarig and Wohl (1999) find small but significant average abnormal
return of 4.5% from the auctioned data of IPOs in Israel where the stock price is
not fixed prior to the IPOs and where allocations are not determined by the
issuers or the underwriters unlike in the US IPOs under book building
mechanism. This implies that a small but significant underpricing is documented
even in countries where IPOs are conducted as auctions.

Kutsuna and Smith (2004) conclude that in regimes where firms can select
between book building and auctioning, issuers overwhelmingly select book
building from the IPOs data in J apan where both book building and auction
mechanisms are prevalent.

Aussenegg, Pichler, and Stomper find that when-issued trading reveals
information that is relevant for setting the IPO offer price with reference to the
IPOs data in Germany where there is a very active when issued market for IPO
shares that operates concurrently with book building. The when-issued market
also known as the grey market is a forward market for IPO shares and remains
over-the-counter trading.

Krishnamurti and Kumar (2002) show evidence regarding the widespread
underpricing of Indian IPOs, an emerging market, which has shifted to free
pricing mechanism from fixed pricing mechanism. J aitly and Sharm (2004) show
that the IPOs return is, on average, 72 percent after deregulation has been
adopted. They simulate and conclude that the initial return would have been
160% with government restriction in the Indian IPOs market.

Gouldey (2006) finds that an IPO that is oversubscribed in the pre-market sale
almost certainly will experience a short-term price increase in the secondary
market. This shows positive relationship between IPOs performance and
oversubscription.

III Nepalese IPO Market
The performance of Nepalese IPO market has made it an attractive market for the
investors. Shrestha (1992) observes that whenever the public limited companies
issue new shares, the stock market gets busy with crowds of share applicants. It is
evident by the heavy oversubscription and very good initial market returns in the
Nepal Stock Exchange Ltd.(NEPSE), the only organized stock exchange for the
listing and trading of outstanding shares
1
. The Nepalese IPO market gives issuers
and their underwriters a choice of either to issue the ordinary share at par or at
premium incase the annual general meeting (AGM) of the company decides to do
so. However, only those companies having higher net worth than the total
liabilities profit record and distribution of dividends for the last three subsequent
years can issue shares at premium.
2
Companies can issue their shares at discount
only when a special resolution is passed by the general meeting to do as per the
provision under the circumstances specified in the Company Act 2063
3
.The face
value of a share shall be Rs. 50 or any amount above it that is divisible by Rs10
for any public companies
4
. The application money should not exceed 50 percent
of the face value of share for the companies other than the banks and finance
companies as well as those companies whose audited financial statements of
three subsequent years have been published. The allotment of shares has to be
done within three months from the last day of the subscription of shares.

1
Ordinary Shares, shares, equity share and the common stocks are use interchangeably in this
paper.
2
See Section 29 of Company Act 2063.
3
See Section 64 of Company Act 2063.
4
Company is used to refer to the public company.
The issuing company appoints the issue manager as the mandatory provision by
law in order to apply to the Securities Board of Nepal (SEBON) for the approval
of public issue. The issue manager submits the due diligence certificate regarding
the proposed issue along with the prospectus and necessary documents. IPOs
may be underwritten by the issue manager or any other financial institutions.
However, underwriting of IPOs is compulsory only for manufacturing
companies. Once the application for the public issue is approved by the SEBON,
the IPOs have to be made within two months. Otherwise the company has to
obtain approval again from SEBON for public issue. IPOs are offered at a fixed
price as approved by the SEBON for public subscriptions should be open for at
least for five working days.

The share allotment, refund, and distribution of share certificate have to be
completed from 45 days to 90 days as per the share allotment guidelines of
SEBON.

The companies apply to NEPSE for the listing. Generally, listing has to be done
within 45 days from the date of the allotment. Although there is no legal barrier
for the companies to opt for the over-the-counter (OTC) market, the OTC market
is still non-existent in Nepal.

IV Research Data and Methodology
To analyze the aspects of issues and subscriptions of IPOs, all of 107 IPOs from
the fiscal year 1993/1994 to the fiscal year 2005/2006 have been taken into
account. Descriptive statistics of issues and subscription have been brought into
light. The means of issues and subscriptions have been compared by way of
paired t-test in order to determine whether the oversubscription is significantly
higher than the issues made over the study period.

In order to accomplish the aim of the studying IPOs performance, a sample of 21
IPOs time series data has randomly been selected out of total of 107 IPOs.
Audited accounting data related to the prospectuses have been collected manually
from the prospectus of sampled companies from the records. Data of NEPSE has
been collected from its website and the annual reports.

A regression analysis has been carried out in order to test the predictive power of
firm size, age of firm, portion of public issue, debt-equity ratio, price earning
ratio, Return of Nepal Stock Index, market share of issue manager, and
subscription as times of issues. To investigate the factors affecting IPOs returns,
the following Ordinary Least Squares (OLS) model is formulated:

RET =f (FS, AGE, PI, D/E, P/E, RIDX, MSI, STI) (Model 1)

Similarly, to investigate the determinants of subscriptions times of issues, the
Ordinary Least Squares (OLS) method is employed under following model:

STI =f (FS, AGE, PI, D/E, P/E, RIDX, MSI) (Model 2)

Where,
RET: Return of the IPO
FS: Firm size at the time of IPO
AGE: Age of firm in years at the time of IPO
PI: Portion of public issue
D/E: Debt-equity ratio in the year prior to the IPO
P/E: Ratio of the IPO offering price to pre-IPO earnings per share
RIDX: Return of Nepal Stock Index
MSI: Market share of issue manager
STI: Subscription times of issue

Definition of Variables
Return of IPO (RET): Return of IPO is defined as the annualized return of the
initial return which is the percentage change of the stock price from its offering
price on the day of public issue to the first trading day closing price in the
secondary market. RET has been taken as the independent variable. The initial
return has been annualized by dividing the initial return with the holding period
days and multiplying it with 365 days. The comparison of the return of IPOs with
the return of stock market can be taken as the indicator of the performance of
IPOs. The higher the RET exceeds over the return of Return of Nepal Stock
Index, the better will be the performance of IPOs and vice versa. Both of the
aforementioned returns are annualized for the comparison purpose.

Firm size (FS): Total assets of a firm can be taken as the measure of firm size.
Firm size is calculated as the natural logarithm of the total assets (LnTA) of the
firm prior to the IPO. The effect of size of total assets on the performance of
IPOs depends on degree of efficient utilization of the total assets of the company.

AGE: The age of the firm is calculated by dividing the number of days from the
date of the commencement of business to date of issue assuming 365 days in a
year. The age variable is used as the natural logarithm of age (Ln age). The study
aims to find out whether the age of a firm has significant effect on the return of
IPOs or not.

Public Issue (PI): PI is the ratio of the total shares offered to the public.
Generally, the firms that issue less of the equity to the public are perceived to be
in a better position. The firms that have better prospects prefer to issue debt
capital rather than equity capital.

P/E (P/E ratio): Ratio of the IPO offering price to pre-IPO earnings per share is
calculated to determine the P/E ratio at the time of the IPO. Only the paid up
value at the time of IPOs has been taken as the offering price to determine the
P/E ratio. P/E ratios indicate the value of Rs. 1 earnings at the time of issue. In
the context of fixed price regime in Nepal, the lower the P/E ratio, and the higher
will be the performance of IPOs as the secondary market is expected to fairly
value the shares. No P/E ratio has been calculated when the company has
negative earnings prior to the IPOs.

Return of Nepal Stock Index (RIDX): RIDX is defined as the annualized return
of the NEPSE return which is the percentage change of the Nepal Stock Index
from the day of public issue to the first trading day of stock in the secondary
market. The NEPSE return has been annualized by dividing the NEPSE return
with the holding period days and multiplying it with 365 days. Annualized return
of Nepal Stock Index has been taken as the market return in order to measure the
performance of the IPOs.

Market share of issue manager (MSI): Market share of issue manager is the
ratio of issues made by a particular issue manager out of total issues in the period
of study. Market share of issue manager is a measure of the popularity of a
particular issue manager. The study aims to find out whether the performance of
IPOs has any significant relationship with the MSI.

At first a model is developed based on the regression analysis for all the
independent variables. Then a model is proposed including the predictive
variables that have predictive power at 10 percent level of significance.

Subscription times of issue (STI): STI is determined by dividing the amount of
IPOs subscribed by the amount of IPOs issued. It indicates the demand condition
for an IPO. Therefore, it can be taken as the investors perception over the
performance of an IPO. The higher the STI, the higher is the investors
perception over the performance of the IPO. This study aims to find out whether
STI has any significant relationship with the RET.

Model 2 tries to find out the significance of predicting power of firms size, age,
portion of public issue, debt equity ratio, price earning ratio, and market share of
issue manager.

If the investors perceive that amount of total assets is indicator of better
company, they will demand more of the IPOs and vice versa. Model 2 tries to
find out whether FS has any significant relationship with STI. Similarly, this
study aims to find out whether the investors prefer the firms with a long history
or otherwise. Similarly, the portion of public issue is expected to have inverse
relationship with the STI as the larger issue does not give good signal to the
investors. Similarly, D/E is expected to have inverse relationship with the STI as
D/E indicates the level of risk. The STI is expected to have positive relationship
with RIDX as investors expect to have better performance of IPOs when the
market is bullish. MSI is expected to have positive relationship with STI as
companies are expected to choose the issue managers which have had larger
market share in terms of amount issued. On the other hand, the investors also
would choose the issue manager whose IPOs management has led to better
performance. The study aims to study whether MSI has any significant predicting
strength for STI.

V Data Analysis and Findings
Data analysis and findings have been carried out into two headings viz. general
and regression analysis.

General Analysis of Nepalese IPOs
As of fiscal year 2005/2006, a total of Rs 3760.53 million has been issued to the
public with a mean and standard deviation of Rs 35.15 million, and Rs 50.65
million per issue. The corresponding descriptive statistics of subscriptions are
given in table 1. In aggregate the issues have been oversubscribed by 593
percent. The amounts of issue and corresponding subscription have moderate
positive correlation of 0.53 and it is significant at 5 percent level of significance.
Paired sample t-test shows that the mean subscription of Rs. 243.61 million is
significantly higher than the mean issue of Rs 35.15 million. We can infer the
heavy oversubscription of IPOs from this test.

Table 1: Descriptive Statistics of IPOs
(Rs. in million)
Issue Subscription
Mean 35.15 243.61
Median 16.50 77.32
Mode 8.00 N/A
Standard Deviation 50.65 451.69
Minimum 2.00 1.03
Maximum 237.41 2798.00
Sum 3760.53 26066.36

Figures 1 and 2 shows the annual trend of Nepalese IPOs were bumpy both in
terms of number and issued amount. This shows that the development of IPO
market in Nepal has not been smooth. However, the figure 2 shows the amount of
IPOs is in increasing trend. It is because the correlation between the number of
issues and the amount issued is not significant at 5 percent level of significance
though they have moderate positive correlation of 0.52 as shown in table 3.

IPOs
0
2
4
6
8
10
12
14
16
F
Y
9
3
/
9
4
F
Y
9
4
/
9
5
F
Y
9
5
/
9
6
F
Y
9
6
/
9
7
F
Y
9
7
/
9
8
F
Y
9
8
/
9
9
F
Y
9
9
/
0
0
F
Y
0
0
/
0
1
F
Y
0
1
/
0
2
F
Y
0
2
/
0
3
F
Y
0
3
/
0
4
F
Y
0
4
/
0
5
F
Y
0
5
/
0
6
Fi scal Year
N
u
m
b
e
r

o
f

I
P
O
s

Figure 1: Trend of the Number of IPOs

IPOs Issues and Subscription
0
1000
2000
3000
4000
5000
6000
7000
F
Y
9
3
/
9
4
F
Y
9
4
/
9
5
F
Y
9
5
/
9
6
F
Y
9
6
/
9
7
F
Y
9
7
/
9
8
F
Y
9
8
/
9
9
F
Y
9
9
/
0
0
F
Y
0
0
/
0
1
F
Y
0
1
/
0
2
F
Y
0
2
/
0
3
F
Y
0
3
/
0
4
F
Y
0
4
/
0
5
F
Y
0
5
/
0
6
Fi scal Year
A
m
o
u
n
t

i
n

M
i
l
l
i
o
n

R
s

Figure 2: Trend of the Issues and Subscriptions of IPOs

Table 2 shows the descriptive statistics of annual IPOs in terms of both number
and issued amount during the study period of 13 years. It further shows that the
annual issues in terms of number as well as amounts are not smooth over the
study period.

Table 2: Descriptive statistics of annual IPOs
Number
Issued Amount
(Rs. in million)
Mean 8.23 289.27
Median 8.00 227.90
Mode 10.00 #N/A
Standard Deviation 4.09 175.29
Sum 107.00 3760.53
Minimum 2.00 57.00
Maximum 14.00 657.50

Table 3 shows that the number of IPOs and the amount of IPOs has positive
correlation and the correlation is significant at 10 percent level of significance.

Table 3: Correlation between number and issued amount of annual IPOs
Pearson Correlation .520
Sig. (2-tailed) .069
N 13

Table 4 shows that the higher the amount of issue, the higher will be the amount
of subscription. The positive correlation of 0.53 is significant at 5 percent level of
significance.

Table 4: Correlations between the issue and subscription of IPOs
Pearson Correlation .530*
Sig. (2-tailed) .000
N 107
* Correlation is significant at the 0.01 level (2-tailed).

Paired sampled t-test has been carried out in order to find out whether the
average of subscriptions is significantly higher than that of the issues.

Table 5: Paired Samples Test

Paired Differences
T df Sig. (2-tailed)
Mean Std. Deviation
Pair 1 IPOs Issues - IPOs
Subscription
-208.46 426.98 -5.05 106 0.000

Table 5 shows that the average amount subscribed is significantly higher than the
average amount of issues at 5 percent level of significance.

Return analysis of IPOs
The annualized mean return of IPOs is 63.43% which is much higher than the
annualized mean return of NEPSE which is only 10.18%. This shows that the
Nepalese IPOs are under priced in comparison to the overall market returns. This
is in confirmation with the findings of many empirical studies in other developed
and emerging capital markets. The standard deviation of annualized returns of
IPOs and NEPSE are 88.4 percent and 25.7 percent. It shows that the returns of
IPOs in Nepalese market are more risky than the overall stock market returns.
The statistics are given in table 6.

Table 6: Paired samples statistics of annualized returns of IPOs and NEPSE

Mean N Std. Deviation Std. Error Mean
Pair 1 Annualized IPOs .6343 21 .88406 .19292
Annualized NEPSE .1018 21 .25706 .05610

The correlation between annualized returns of IPOs and NEPSE is positive at
lower end. It is also not significant at 5 percent or 10 percent level of
significance. This shows that the IPOs returns move to the similar direction of
market returns but the conclusion is not definitive. Table 7 summarizes the
explanation.

Table 7: Paired samples correlations
N Correlation Sig.
Pair 1 Annualized IPOs &
Annualized NEPSE
21 .309 .173

The mean return of annualized IPOs is higher by 53.25% than that of NEPSE.
The paired sample t-test shows that the mean return of annualized IPOs is
significantly that of NEPSE at 5 percent level of significance. The results are
given in detail in table 8.

Table 8: Paired Samples Test

Paired Differences t df
Sig.
(2-tailed)
Mean Std.
Deviation
Std.
Error
Mean
95% Confidence
Interval of the
Difference

Lower Upper
Pair
1
Annualized
IPOs
Annualized
NEPSE
.53248 .84093 .18351 .14969 .91526 2.902 20 .009

The regression analysis
The results of regression analysis identify the factors affecting IPOs returns on all
variables explained in the methodology, which is given below:

RET =- 2.40 +0.091 FS +0.020 AGE +2.00 PI - 0.0053 D/E - 0.00009 P/E +
1.36 RIDX +0.50 MSI +0.0340 STI. (Equation 1)

The significance of coefficients of independent variable is found to be very low
in the above model. Besides, the problem of multicollinearity has been found
among the independent variables. Therefore, all the variables except subscription
as times of issue (STI) and Annualized NEPSE Return (RIDX) are excluded for
regression analysis as other independent variables are found to have insignificant
prediction strength to the annualized return of IPOs (RET). The finding that P/E
ratio does not have any significant relationship with IPOs in Nepalese market is
in line with the finding of Kim and Ritter (1999). Therefore, the regression
analysis has been rerun with the annualized NEPSE return and the subscription as
the times of issues as the independent variables.

The result of rerun regression is found as below:

RET =f (RIDX, STI,) has been obtained as RET =0.028 +2.00 RIDX +0.0461
ST (Equation 2)

Table 9: Model Summary
Model R R Square Adjusted R Square Std. Error of the Estimate
1 .558(a) .311 .234 .77355
A Predictors: (Constant), Annualized NEPSE Return (RET), Subscription times Issues
(STI)

The study shows that 31.1% of the variation in the IPOs returns can be explained
by the NEPSE returns and subscription as the times of issues.

Table 10: ANOVA (b)
Model Sum of Squares df
Mean
Square
F Sig.
1 Regression 4.860 2 2.430 4.061 .035(a)
Residual 10.771 18 .598
Total 15.631 20
A Predictors: (Constant), Annualized NEPSE Return (RIDX), Subscription times
Issues (STI)
B Dependent Variable: Annualized IPO Return (RET)

Table 10 shows that the regression model shows the significant relationship at 5
percent level of significance between the dependent variable viz. IPO return and
the independent variables viz. NEPSE returns and subscriptions as times of
issues. The positive coefficients of both STI and RIDX show that they have
significant positive relationship with the RET.
Table 11: Coefficients (a)
Model Unstandardized
Coefficients
Standardized
Coefficients
t Sig.
Collinearity
Statistics
B Std. Error
Beta

Tolerance VIF
1 (Constant) .028 .278 .101 .921
Subscription
times
Issues(STI)
.046 .019 .539 2.372 .029 .743 1.347
Annualized
NEPSE
(RIDX)
2.003 .781 .582 2.565 .019 .743 1.347
A Dependent Variable: Annualized IPO (RET)

Table 11 shows that both of the independent variables i.e. STI and RIX are very
good predictors as their relationship is significant at 5 percent level of
significance. It also shows that there is still nominal problem of multicollinearity
and therefore has insignificant effect on the model. NEPSE return has a little bit
more strength to affect the IPOs return than the subscription times of issues as
RIDX has slightly higher standardized beta coefficient than the STI.

Regression analysis has been performed in order to identify the significant
factors affecting the subscription times of issues. The results of regression
analysis excluding the insignificant factors are given below:

STI =- 87.9 +5.14 FS - 0.244 D/E (Equation 3)

The analysis shows that the firm size has positive relation and the debt equity
ratio has negative relation with the level of subscription. The details of the results
are given following table.

Table 12: Model Summary
Model R R Square Adjusted R Square Std. Error of the Estimate
1 .526(a) .277 .187 9.49538
A Predictors: (Constant), Debt equity ratio(D/E), Total Assets(FS)

Table 12 shows that D/E and FS explain 52 percent of the variation in the
subscription times of issues with 90 percent level of confidence. (See table 13)

Table 13: ANOVA (b)
Model Sum of Squares df Mean Square F Sig.
1 Regression 552.684 2 276.342 3.065 .075(a)
Residual 1442.595 16 90.162
Total 1995.279 18
A Predictors: (Constant), Debt equity ratio(D/E), Total Assets(FS)
B Dependent Variable: Subscription times Issues (STI)

Table 14: Coefficients (a)
Model
Unstandardized
Coefficients
Standardized
Coefficients
t Sig.
Collinearity
Statistics
B
Std.
Error
Beta

Tolerance VIF
1 (Constant) -87.881 39.920 -2.201 .043
Total
Assets(FS)
5.143 2.095 .764 2.454 .026 .467 2.14
3
Debt equity
ratio (D/E)
-.244 .121 -.627 -2.014 .061 .467 2.14
3
A Dependent Variable: Subscription times Issues (STI)

Table 14 shows that both predicting variables beta coefficients are significant at
95 percent level of confidence. There is some degree of multicollinearity as
Variance Inflation Factor (VIF) is 2.143 for both variables. However, the VIF is
much lower than the typical cutoff point of 5 which means there is less adverse
effect of multicollinearity in the model. The higher standardized beta coefficient
of FS shows that FS has greater effect than the D/E.

VI Conclusion
Nepalese IPOs have been found to be heavily oversubscribed. It shows that the
investors have a very high degree of attraction to the IPOs. The study shows that
growth of Nepalese IPOs in terms of issues and subscription has been bumpy
during the study period. The study shows that the IPOs investors make 53.25%
market adjusted returns leading to the conclusion that Nepalese IPOs are highly
underpriced. In one hand, the investors do make money from Nepalese IPOs. On
the other hands, the higher the underpricing, the higher will be the wealth loss of
promoters. This might have prevented the potential issuers from going public.
Such companies which refrain from going public might not have made
appropriate level of investment. As a result, the society and nation at large might
have lost the potential gains from the increased investment and productivity of
those companies.

IPOs returns have been affected mainly by the subscription times of issue and
general returns of stock market. The positive relationship of oversubscription
with the return of Nepalese IPOs is in line with the findings of Gouldey (2006).
The study also reveals that the firm size expressed as the size of total assets
affects the subscription times of issues positively and the debt equity ratio affects
the same negatively. The study has shed light on some of the important aspects of
the IPOs performance and opened several doors for the further researches in
Nepalese IPOs.

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403.
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Nepalese Management Review, 20-32
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Dividend Policy in Nepalese Enterprises: Case Studies

-Nabaraj Adhikari

1. Introduction
The word dividend literally means that which may or is to be divided. In
relation to an enterprise it refers to the return that a shareholder gets from the
enterprise, out of its profits, on her/his shareholding. It is that part of the profits
of the enterprise which is distributed amongst shareholders. Since business
enterprises are formed to earn profits, every such enterprise has an implied power
to declare and pay dividends, and this power is not required to express by the
memorandum or article of association. However, the mode of distribution is
regulated by the Companies Act.

Dividend is a reward to the shareholders of enterprises for their investment and
risk bearing. It is paid in cash out of profits after the depreciation and tax
requirements have been met. In addition to cash dividend, an enterprise may also
issue stock dividends (bonus shares) to its existing shareholders by means of
capitalisation of its free reserves. The amount of dividend paid to the
shareholders depends upon the type of dividend policy pursued by an enterprise.
Dividend policy refers to some kind of consistent approach to the decision
involving distribution versus retention of the profits rather than making the
decision on a purely ad-hoc basis from year to year (Hunt, Williams and
Donaldson (1971)). More recently, Brealey and Myers (2003) defined dividend
policy as the trade-off between retaining earnings on the one hand and paying out
cash and issuing new shares on the other. It is concerned with the question of
when and how much dividend should be paid. Dividend policy decision is one
of the three basic decisions of an enterprise; the other two being investment and
financing. All the three decisions are interrelated and should be taken jointly so
that an optimal combination of these decisions can be arrived at for maximisation
of owners wealth, the main objective of corporate finance.

Officer, Securities Board of Nepal


Retained profit is shareholders money, which is parked in general reserves but in
its treatment is on a par with equity capital. If retained profits are not gainfully
invested and unable to earn in excess of the cost of capital (which is higher for
equity), the enterprise ends up destroying value. Therefore, if an enterprise is
making good profits but has no use of it, in order to maintain its return on equity
it must return most of it to shareholders.

An appropriate dividend policy varies from enterprise to enterprise as it is
determined by the multiplicity of factors. In view of the variety of considerations
affecting dividend policy, it is very difficult to have one dividend policy which
can be considered completely satisfactory in all respects. Often it is a
compromise of conflicting objectives. The corporate management has to assess
the relative importance of factors and choose a line of action which is of
maximum advantage, considering the circumstances of the business and the
objective of its shareholders. Dividend decisions belong to critical area of
corporate finance which brings into open the conflicts of interest between
management and the shareholders and also between each group of shareholders
with another.

As dividend policy of every enterprise is generally different from that of the
other, it would be prudent to make case studies of some selected enterprises. This
study is an attempt to gain an insight into the whole set of circumstances and
factors that govern the dividend decision of Nepalese enterprises at the micro
level. In this study, dividend policies and practices of Nepalese enterprises in
each of the seven sectors (as categorised by Nepal Stock Exchange Ltd.) have
been analysed for the year 1995 to 2004. For the purpose of case studies,
selection of seven enterprises, one in each of seven corporate sectors has been
made. This is done on the basis of their dividend policy pattern. First of all, one
enterprise with the most stable dividend record and another with the most
irregular dividend record are chosen and then, enterprises in between these two
extremes are selected. The growth of the value has been calculated based on the
concept of exponential rate of increase. Exponential corresponds to the
assumption that value increases from a constant rate of growth. In this situation,
the size of value will increase without limit, if the growth rate is positive and
decrease if it is negative. The formula is;

rt
n
e V V
0
Or,
rt n
e
V
V
0
Or,
rtLoge
V
V
Log
n
0

Or,

t
V
V
Log
r Loge
n
0
Or,
t
V
V
antiLog
r
n
0

Where, V
0
=initial value; (r) =annual rate of change; V
n
=value at the end of
the period; and t =number of years
2. Case studies
2.1. Standard Chartered Bank Nepal Limited
2.1.1. Background information
Standard Chartered Bank Nepal Limited (previously, Nepal Grindlays Bank
Limited), one of the leading banks in the country, was established in 1985 as a
foreign joint-venture bank. Its foreign joint venture partner is the Standard
Chartered Bank Limited with 50 percent equity investment, the rest of being
Nepalese promoters. The bank is managed under Technical Services Agreement
between Standard Chartered Bank Limited and Nepalese Promoters. The bank
has wisely used newer technologies for providing services to the customers.

Table1: Deposits, investments, profits and assets
(Rs.in Mn.)
S.N. Particulars 1995 2004
Annual rate
of growth (%)
1.
2.
3.
4.
5.
6.
Deposits
Investments
Net profits after tax
Reserves
Net asset block
Total assets
5519.4
1537.5
151.1
501.7
100.2
6570.7
21161.4
11360.3
537.8
1121.1
136.2
23642.1
13.4
20.0
12.7
8.0
3.1
12.8
Source: Annual reports of Standard Chartered Bank Nepal Limited
The Bank is fairly large-sized having total paid-up capital of Rs.374.6 million as
at the end of year 2004. The Bank showed all-round improvement in its results
over the study period. Its deposits, investments, net profit after tax, reserves, net
asset block, and total assets, etc. recorded manifold increases during the 10-year
period of the study. This is evident from the Table 1.

2.1.2. Dividend policy
Review of the Banks annual reports revealed that it considered the dividend
policy to be important finance function. The Bank had target dividend payout
ratio of 100 percent on paid up value, which it maintained in four years, and in
two years it had exceeded the target level of dividend. It also viewed this policy
as a long-term finance function. Its policy is to pay more or less a stable rate of
dividend (on paid up value) to the shareholders. This is also borne out by the fact
that the Bank maintained the rate of dividend at 100 percent in years 1996, 2000,
2001, and 2002, and at 110 percent in year 2003 and 2004 with the exception of
years 1995, 1997, 1998 and 1999 when the rate was 30 percent, 90 percent, 70
percent and 80 percent respectively. The Bank also had paid 50 percent stock
dividends to its shareholders in the years 1996, 1997, and 1998 and 10 percent in
the year 2003. The Bank considered earnings and adequate capital base while
paying cash dividends and considered shareholders demand, need of capital
resource, goal of future expansion and directive of Central Bank for increasing
share capital, while paying stock dividends. The policy of maintaining the rate of
dividend was followed not only in respect of the existing equity capital but was
applicable to the increased equity capital base as well. The paid up equity capital
was increased as a result of four successive payments of stock dividends.

2.1.3. Dividend behaviour
As presented by Table 2, the total amount of dividend paid by the Bank to its
shareholders increased from Rs.30 million in the year 1995 to Rs.412.1 million in
the year 2004. This increase was caused by the increase in the equity capital as a
result of issue of stock dividends. However, in the year 1997, due to cut in the
dividend rate, the amount of dividend declined, while in the years 2000, 2001 and
2002, the amount of dividend remained constant due the maintenance of constant
dividend rate. Despite the cut in dividend rate in 1998 and 1999, the amount of
dividend increased due to the stock dividends paid in the previous years.

Table 2: Investments, profits and dividends
(Rs. in million)
Years Investments Net profits Dividends
Payout ratio*
(%)
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
1537.5
1831.0
2288.9
1031.5
2681.1
3349.9
9559.2
9275.9
10357.7
11360.3
151.1
239.2
248.1
292.4
359.4
392.6
430.8
479.2
506.9
537.8
30.0
150.0
135.0
157.9
271.6
339.5
339.5
339.5
373.5
412.1
20
63
54
54
76
86
79
71
74
77
*Ratio of equity dividends to net profits Source: Annual reports of the bank

The payout ratio recorded wide fluctuations during the study period. It ranged
from 20 to 86 percent. The decline in the payout ratio was recorded in years of
high earnings, against which only a stable rate of dividend was appropriated.

Table3: Dividend rates
Years
Dividend as % of
paid up value
Dividend as % of
net worth*
Dividend as % of
average market
price**
Stock dividend as
% of paid up
capital
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
30
100
90
70
80
100
100
100
110
110
10
37.7
16.7
18
28.3
33.4
30.5
27.5
27.3
27.5
2
11
9.7
7.6
7.3
5.7
4.2
6.4
6.9
6.5
0
50
50
50
0
0
0
0
10
0
*Paid up capital plus reserves ** Average of high, low and closing market price
Source: Securities Board of Nepal
The rate of dividend has been increased to 100 percent in the year 1996 from 30
percent in the pervious year, which has been maintained in the years 2000, 2001,
and 2002, and increased to 110 percent in the years 2003 and 2004, while in the
years 1997, 1998 and 1999 the rate has been decreased to 90 percent, 70 percent
and 80 percent respectively. The rate of dividend on net worth varied between 10
percent and 37.7 percent, while the dividend yield fluctuated between 2 percent
and 9.7 percent during the study period. The Bank paid stock dividend at the rate
of 50 percent in the years 1996, 1997 and 1998, 10 percent in the year 2003.

2.1.4. Determinants of dividend policy
Changes in profit level and financing policy are the major determinants of the
dividend policy of the Bank. The Bank increased the amount of dividend in
response to the increase in its net profits. It is evident from Table 2 that there is
an increasing trend of net profit of the Bank in 1996 and onwards. Accordingly,
the amount of dividend has been increased in those years compared to previous
years. Table 3 revealed that the Bank has declared 50 percent stock dividend in
the years 1996, 1997 and 1998 and 10 percent in 2003. The purpose of issuing
stock dividend as stated in its annual reports are to raise the capital to fulfil the
requirement of central bank, goal of future expansion and fulfilment of
shareholders' demand. In those years except in 2003, the amount of dividend has
been decreased to some extent compared to that of other years.

As a growing Bank, its requirements for funds to finance various expansion plans
were also in increasing trend, which is evident from Table 4 that the total paid up
share capital of the Bank increased from Rs.100 million to Rs.374.6 million in
during the study period. The impact of such requirements on dividend policy
would depend upon the financing policy of the Bank. The Bank obtained funds
from the sources like issue of shares, issue of stock dividends, loans from the
banks and foreign financial institutions and retained earnings. Short-term loan of
the bank has increased from Rs.16.1 million to Rs.78.3 million; retained earnings
increased from Rs.183.5 million to Rs.217.6 million and the Bank had not used
any long-term loans during the study period. In view of relying more on equity
funds and having substantial earnings, the investment requirements did not have
any adverse impact on the dividend policy.
Table 4: Share capital and loans
(Rs.in million)
Years
Total Paid-up
Capital
Long-term
loans
Short-term
loans
Retained
earnings
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
100
150
150
225.6
339.5
339.5
339.5
339.5
339.5
374.6
0
0
0
0
0
0
0
0
0
0
16.1
861.9
997.6
344.5
190.1
2430.2
1666.7
684.7
79.2
78.3
183.5
174.9
235.8
236.8
123.7
94.5
99.6
130.9
216.0
217.6
Source: Annual reports of Standard Chartered Bank Nepal Limited

2.1.5. Findings
The dividend policy of the Bank had the following characteristics.

a) Dividend policy is being taken as primary policy variable.
b) Dividend policy is being treated as a long-term finance function.
c) Attempt has been made for regular dividend payment with stable rate in
most of the years.
d) Target payout ratio is set and attempt has been made to meet the target.
e) Rate of dividend is increased or decreased with the changes in profits.
f) Requirement to increase share capital, goal of future expansion, and
shareholders demand influenced dividend policy

2.2. Peoples Finance Limited
Peoples Finance Limited was established in year1993. The company had a total
paid-up capital of Rs.31.3 million in 2004. It is evident from Table 5 that the
company had shown all-round improvement in its results over a period of time.
Its deposits, investments, net profit after tax, reserves, net block assets and total
assets etc. recorded manifold increases during the study period.

Table 5: Deposits, investments, profits and assets
(Rs.in million)
Annual rate
of growth *
(%)
1.
2.
3.
4.
5.
6.
Deposits
Investments
Reserves
Net asset block
Total assets
116.4
4.0
1.0
1.0
1.6
138.2
187.3
18.1
4.7
8.5
2.6
279.4
4.7
15.1
15.5
21.4
4.8
7.0
Source: Annual reports of Peoples Finance Limited

The company paid cash dividend only in four years over the study period. In the
years 1996, 1997, 2000 and 2004, it paid 30 percent, 30.8 percent, 18 percent and
10 percent dividends respectively. It did not pay any stock dividend over the
study period. The company considered earnings and directives of central bank for
capital adequacy requirement while paying dividends, which is evident from the
Chairmans speeches.

Table 6 reveals that the total amount of dividend paid by the company remained
more or less constant as the amount of dividend in the years 1996, 1997, 2000
and 2004 being Rs.3 million, Rs.4 million, Rs.3 million, and Rs.3.1 million
respectively. It was seen that the company paid dividend based on increase in net
profits. The net profit of the company was Rs.3.1 million in 1996 increased from
Rs.1.0 million in the previous year and again increased to Rs.5.2 million in 1997.
Same trend was in 2000 and in 2004. There was no dividend paid by the
company in 1998 as the company suffered loss in that year and in the following
year, though there was profit made by the company, there was no dividend paid,
which may be due to cumulative loss in that year. Similarly, no dividends were
paid in those years in which there were no significant profits. The range of
dividend payout ratio was 21.9 percent to 96.8 percent over the study period.

(Rs.in million)
Payout ratio *
(%)
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
4.0
6.0
6.0
11.0
13.2
12.8
15.7
20.1
16.1
11.1
1.0
3.1
5.2
-15.8
8.7
13.7
0
1.7
0.8
4.7
0
3.0
4.0
0
0
3.0
0
0
0
3.1
0
96.8
76.9
0
0
21.9
0
0
0
65.9
*Ratio of equity dividends to net profits

The rate of return in the form of dividend to the shareholders on paid up value
was zero in 1995, which increased to 30 percent in 1996 and 30.8 percent in
1997. Then, the rate of dividend on paid up value decreased to 17.6 percent in
2000 and 9.9 percent in 2004. The rate of dividend on net worth ranged from 7.8
percent to 26.9 percent and that on average market price ranged from 6.3 percent
to 22.6 percent.

Table 7: Dividend rates
Years
Dividend as %
of paid up
value
Dividend as %
of net worth*
Dividend as %
of average
market price**
Stock dividend
as % of paid
up capital
1995
1996
1997
1998
1999
2000
2001
0
30.0
30.8
0
0
17.6
0
0
26.9
20.6
0
0
11.6
0
0
14.6
22.6
0
0
6.3
0
0
0
0
0
0
0
0
Years
Dividend as %
of paid up
value
Dividend as %
of net worth*
Dividend as %
of average
market price**
Stock dividend
as % of paid
up capital
2002
2003
2004
0
0
9.9
0
0
7.8
0
0
9.5
0
0
0

Thus, it is seen that the company proposed dividend when it was in profit and did
not propose dividend when it was in loss. Besides, the dividend is also influenced
by the directives of Central Bank for loan loss provision. These facts indicate that
the company considered the dividend policy as an important decision variable in
financial policy making.

The analysis of Chairmans speeches of the company highlighted various factors
influencing its dividend policy. One of the factors is the increase in net profits. It
is evident from Table 6 that the company has increased or decreased the amount
of dividend in response to the increase or decrease in net profits.

The other factor determining the dividend policy of the company was its
financing policy. The company under the study period appeared to use external
sources of fund to finance expansion requirements. The use of external sources of
funds is borne out by the fact that the company increased share capital from
Rs.10 million to Rs.31.3 million during the period. The company had not used
any loans (short term or long term). As there was very low level of retained
earnings, it can be inferred that the company had also not used its internal
sources of funds.

Table 8: Share capital and loans
(Rs.in million)
Years
Total Paid-up
Capital
Long-term
loans
Short-term
loans
Retained
earnings
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
10.0
10.0
13.0
17.0
17.0
17.0
20.0
20.0
20.0
31.3
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0.7
0.1
0.1
-15.7
-7.0
0.1
0.1
-1.1
0.3
0.9

2.2.5. Findings
The dividend policy of the company had the following characteristics.

a) Dividend policy is being taken as primary policy variable.
b) Dividend payment is irregular and the rate is also not stable.
c) Rate of dividend is increased or decreased with the changes in profits.
d) Dividend policy is influenced by loan loss provision requirement.

2.3. Nepal Insurance Company Limited
Nepal Insurance Company Limited was established in 1947. The company, as a
subsidiary company of Nepal Bank Ltd. with 51 percent share ownership, is the
oldest insurance company with successful track record.

The investments increased to Rs.208.5 million in 2003 from Rs.99 million in
1995 with an annual growth rate of 8.3 percent. Total assets increased to
Rs.454.2 million in 2003 from Rs.135.3 million in 1995 with an annual growth
rate of 13.4 percent. Net block assets and reserves increased with annual growth
rate of 7 percent and 7.6 percent respectively from 1995 to 2003. The company's
investments, reserves, net assets block and total assets recorded manifold
increases during the year 1995 to 2003. Its net profits after tax, however,
increased with an annual growth rate of 1.0 percent and reached to Rs.28.8
million in 2003, which as compared to its business expansion is very low.

Table 9: Investments, profits and assets
(Rs. in million)
Annual rate
of growth *
(%)
1.
2.
3.
4.
5.
Investments
Reserves
Net asset block
Total assets
99
26.3
39.7
5.7
135.3
208.5
28.8
79
10.7
454.2
8.3
1
7.6
7
13.4
Source: Annual reports of Nepal Insurance Company Limited

The annual reports of the company revealed that it considered the dividend policy
to be active and primary finance function. It paid cash dividend in all the years
during the study period, which ranged from 10 to 50 percent of paid up value. It
also paid stock dividend in four years and the rate ranged from 20 percent to 25
percent of paid up value. From 1995 to 1997, the company paid dividend at
increasing rate of 20 percent to 35 percent. In 1998 and 1999 the rate of dividend
was 25 percent. In 2000, it paid 50 percent dividend, which is the highest one
compared to other years during the study period. In 2001, the dividend paid was
20 percent and in the years 2002 and 2003, the rate of dividend was 10 percent.

As revealed by Table 10, the amount of dividend paid by the company increased
from Rs.7.3 million to Rs.18.4 million from 1995 to 1997, which is decreased to
Rs.13.2 million in 1998. Again, it increased to Rs.31.6 million in 2000 and
decreased to Rs.12.6 million in 2001. In 2002 and 2003, it further decreased to
eight million. Dividend payout ratio ranged from 23.2 percent to 81.2 percent
during the study period.
(Rs. in million)
Payout ratio *
(%)
1995
1996
1997
1998
1999
2000
2001
2002
2003
99
109
143.6
146.3
168.7
132.9
143.9
164.5
208.5
26.3
34.5
35.6
25.6
25.4
38.9
37.8
34.4
28.8
7.3
13.1
18.4
13.2
15.8
31.6
12.6
8
8
27.7
38
51.7
51.6
62.2
81.2
33.3
23.2
27.8
*Ratio of equity dividends to net profits

The company also paid stock dividend in four different years. In 1995, 1996, and
1997, it paid dividend in the increasing rate of 20 percent, 30 percent and 35
percent respectively. In 1998 the rate of dividend was 25 percent which was
increased to 50 percent in 1999, while it was decreased to 25 percent in 2000, 20
percent in 2001 and 10 percent in 2002 and 2003.

Years
Dividend as %
of paid up
value
Dividend as %
of net worth*
Dividend as %
of average
market price**
Stock dividend
as % of paid up
capital
1995
1996
1997
1998
1999
2000
2001
2002
2003
20
30
35
25
25
50
20
10
10
8.7
14.7
15.1
10.6
10.6
19.7
9.8
5.1
5.1
0.8
2.6
4.2
3.3
3.6
5.1
1.8
1.5
1.7
20
20
0
20
0
0
25
0
0

The rate of dividend on net worth ranged from 5.1 percent to 19.7 percent while
the dividend yield fluctuated in between 0.8 percent and 5.1. The company paid
stock dividend at the constant rate of 20 percent in the years 1995, 1996 and 1998
and 25 percent in 2001.

From the above analysis, it is clear that one of the major determinants of
dividend policy of the company is its net profits. In 1995 to 1997 there was
increasing trend of net profits and accordingly the rate of dividend declared was
also in the same trend. In 1998, as the net profit decreased, the rate of dividend
was also decreased. In 2000, the amount of net profits increased at highest level
to Rs.38.9 million; accordingly, there was increased rate of dividend to the
highest level of 50 percent. In 2001 to 2003, the amount of net profits decreased
gradually, in response to that rate of dividend was also decreased to 10 percent.

Table 12: Share Capital, loans and retained earnings
(Rs. in million)
Years
Total paid-up
capital
Long-term
loans
Short-term
loans
Retained
earnings
1995
1996
1997
1998
1999
2000
2001
2002
2003
36.5
43.8
52.6
52.6
63.2
63.2
63.2
79
79
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0.09
0.04
1.4
0.07
2.0
1.2
1.2
1.4
11.3

Company's financing policy was the other determinant of dividend policy. Table
9 revealed that the total assets of the company increased from Rs.135.3 million to
Rs.454.2 million and net assets block increased from Rs.5.7 million to Rs.10.7
million during the study period. To finance this expansion requirement, the
company relied on the share capital, which can be inferred from the fact that the
share capital of the company was also increased from Rs.36.5 million to Rs.79
million during the period. It also financed its capital requirements from the
retained earning as evident from the fact that the amount of which had been
increased from 0.04 million to 11.3 million over the period. The company had
not used any loans, which is evident from the Table 12.

2.3.5. Findings
The preceding analysis reveals the following characteristics of dividend policy.

a) Dividend policy is taken as primary policy variable.
b) There is regularity in dividend payment.
c) There is fluctuating rates of dividend.
d) There is direct impact of net profit to the rate of dividend.

2.4. Soaltee Hotel Limited
Soaltee Hotel Limited was established in 1968 as a private limited company.
Later on, in 1975 it was converted into public limited company and International
Finance Corporation, Washington D.C. and Oberoi Hotel, India also involved as
its shareholders. The Hotel is one of the leading hotels in the country. The paid
up capital of the Hotel as at the end of 2004 was Rs.87 million.

Table13: Sales, investments, profits and assets
(Rs. in million)
S.N Particulars 1995 2004
Annual Rate of
Growth*(%)
1
2
3
4
5
6
Net sales
Investments
Reserves
Net assets block
Total assets
392.3
15.3
22.9
290.5
338.3
639.6
370.5
20.5
-44.4
186.7
508.8
414.1
-0.6
2.9
-
-4.4
4.1
-4.3
Source: Annual reports of Soaltee Hotel Limited

As can be seen from Table 13, from 1995 to 2004, investments and net assets
block of the Hotel have increased with an annual growth rate of 2.9 percent and
4.1 percent respectively. Its sales, reserves, and total assets were decreased in
2004 with an annual decrease rate of -0.6 percent, -4.4 percent and -4.3 percent
respectively from 1995. Its net profits after tax decreased drastically to Rs.44.4
million in 2004 from Rs.22.9 million in 1995.

The trend of dividend payment by the Hotel showed that it paid dividend
regularly to the shareholders from 1995 to 2001, and stock dividend in 2001. It
paid 30 percent dividend in 1995, 40 percent in 1996, 35 percent in 1997, 40
percent in 1998, 50 percent in 1999, 40 percent in 2000 and 10 percent in 2001.
Along with cash dividend, the Hotel also paid 33 percent stock dividend in 2001.
The trend of dividend payment and Chairmans speeches revealed that the Hotel
has a policy to pay more or less a stable rate of dividend.

Table 14 reveals that dividend paid by the Hotel to its shareholders during 1995
to 2004, ranged from zero to Rs.32.6 million. The amount of dividend paid was
19.9 million in 1995, Rs.26.1 million in 1996, Rs.22.8 million in 1997, Rs.26.1
million in 1998, Rs.32.6 million in 1999, Rs.26.1 million in 2001 and Rs.6.5
million in 2001. From 2001 onwards the Hotel had paid no dividends. In each
year during 1995 to 2001, the Hotel is in profit and thereafter it is in loss. It can
be seen that whenever the Hotel has highest profit, the amount of dividend paid
was also highest and when there was no profit, there was no dividend paid. This
behaviour of dividend reflected the fact that the Hotel made dividend payments
based on the level of profits. This also indicated that the Hotel considered the
dividend policy as an important variable in financial policymaking.

The ratio of the amount of dividend on net profits ranged from zero to 86.9
percent during the study period. The net sales of the Hotel was Rs.392.3 million
in year1995 which was increased as high as to Rs.527.8 million in year 1999 and
decreased as low as to Rs.296.3 million in year 2002. From the year 1995 to
1999, sales increased smoothly, and after this year the downfall of the sales
started.
Table 14: Sales, investments, profits and dividends
(Rs. in million)
Years Net sales Investments Net profits Dividends
Payout ratio*
(%)
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
392.3
476.4
497.3
523.9
527.8
499.7
454.9
296.3
300.3
370.5
15.3
14.2
15.2
31.8
29.8
31.8
29.8
29.8
27.6
20.5
22.9
47.3
42.5
51.7
57.5
46
21.6
-59.6
-37.8
-44.4
19.9
26.1
22.8
26.1
32.6
26.1
6.5
0
0
0
86.9
55.2
53.6
50.5
56.7
56.7
30.1
0
0
0
*Ratio of equity dividends to net profits Source: Annual reports of Soaltee Hotel Limited

The investments of the Hotel was Rs.15.3 million in year 1995, the sales more or
less remained constant up to year 1997, increased to Rs.31.8 million in year
1998, this sales amount more or less remained constant up to year 2002, and then
after it started to fall down.

Years
Dividend as %
of paid up
value
Dividend as %
of net worth*
Dividend as %
of average
market price**
Stock dividend
as % of paid up
capital
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
30
40
35
40
50
40
10
0
0
0
7.2
7.7
6.2
6.7
8
6.1
1.5
0
0
0
2.8
4
5.4
5.5
5.9
3
0.6
0
0
0
0
0
0
0
0
0
33.3
0
0
0

The rate of dividend on net worth ranged from zero percent to 8 percent during
the study period, on which average market price ranged from zero to 5.9 percent.

One of the major factors affecting dividend policy of the Hotel is changes in
profit level. The record of profits and dividend data of the Hotel indicated that
the rate of dividend fluctuated in conformity with the changes in its net profits.

The other important factor affecting the dividend policy is its financing policy.
The financing policy of the Hotel under the study period appeared to use external
as well as internal sources of funds to finance expansion requirements. This is
borne out by the fact that the Hotel used both long term and short-term loans in
all the years under study.

Table 16: Share capital, loans and retained earnings
(Rs. in million)
Years
Total paid-up
capital
Long-term
loans
Short-term
loans
Retained
earnings
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
65.2
65.2
65.2
65.2
65.2
65.2
25.2
87
87
87
146
104
100
74.2
38.7
15.7
5.2
40
125.2
140
57.9
81.3
83.6
54.9
42.4
8.8
8.8
8.8
6.8
0.4
7.6
21.2
19.7
25.6
24.9
19.9
15.1
0
0
0
Source: Annual reports of Soaltee Hotel Limited

The policy of using internal sources of financing is evidenced by the trend of
increasing level of retained earnings from 1995 to 2001. The Hotel, however, did
not depress the dividend payment because of retained earnings. Thus investment
requirements did not have any bearing on its dividend policy in view of the
financing policy of the Hotel to use the funds provided by external sources
(equity) and also internal sources of finance.
2.4. 5. Findings
The dividend policy of the Hotel has following feature from the above analysis.

a) Active and primary decision variable in the financial policymaking.
b) Irregularity in dividend payment due to losses in some years.
c) More or less stable rates of dividend on paid up value of share.
d) The major factors determining the dividend policy were net profits and
financing policy of using equity.

2.5. Salt Trading Company Limited
Salt Trading Company Limited was established in 1963. The company is one of
the leading trading companies in the country. The paid up capital of the company
was Rs.24.8 million as at the end of 2004. The Company showed all-round
improvement in its results except investments over study period year 1995 to
year 2004. Its sales, net profits after tax, reserves, net assets block and total assets
etc. recorded manifold increases during the study period. This is evident from the
Table 17.

Table17: Sales, investments, profits and assets
(Rs. in million)
S.N Particulars 1995 2004
Annual rate
growth*(%)
1
2
3
4
5
6
Net sales
Investments
Reserves
Net assets block
Total assets
1557.4
231.7
6
42.9
35.6
744.8
3898.9
151.8
73
584.2
466
1793
9.2
-4.2
25
26.1
25.7
8.8
Source: Annual reports of Salt Trading Company Limited

The net sales increased to Rs.3898.9 million in 2004 from that of Rs.1557.4
million in 1995 with an annual growth rate of 9.2 percent. The net profits
increased to Rs.73 million, reserves to Rs.584.2 million, and net block assets to
Rs.466 million in 2004 from Rs.6 million, Rs.42.9 million, and 35.6 million
respectively in 1995 with an annual growth of 25 percent, 26.1 percent and 25.7
percent respectively. The total assets increased to Rs.1793 million in 2004 from
Rs.744.8 million in 1995. The companys investments were decreased to
Rs.151.8 million in 2004 from Rs.231.7 million in 1995 with a decrease rate of
4.2 percent.

The trend of dividend payment by the company during the study period shows
that it paid dividend regularly except in 2000. The rate of dividend payment on
paid up value ranged from 20 percent to 30 percent. As presented in Table 19, the
company maintained the rate of dividend at 20 percent from 1995 to 2004 except
in 2000, when it paid no dividend. In 2001 and 2002 it paid 25 percent and 30
percent dividend. The trend of dividend payment and chairman speeches revealed
that the company considered the dividend policy as a primary variable in its
financial policymaking and viewed as a long-term finance policy.

The total amount of dividend paid by the company in 1995 was Rs.3.3 million
increased to Rs.4.9 million in 1996, and remained constant till 1999. The net
profit was Rs.6.1 million in 1995 increased to Rs.7.5 million in 1996 and more or
less remained constant till 1998 and decreased to Rs.5.3 million in 1999. In 2000,
it suffered loss of Rs.15.3 million and in this year it paid no dividend. Again, the
company started paying increasing rate of dividends when it started making
increasing profits 2001 onwards. This trend of dividend payment indicated that
the company paid dividend based on the level of profits.

Table 18: Sales, investments, profits and dividends
(Rs. in million)
Years Net sales Net profits Dividends
Payout ratio *
(%)
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
1557.4
1965.6
1968.9
1738.5
1842.4
1580.5
1743.1
1875.9
2461
3898.9
6.1
7.5
7.6
7.8
5.3
-15.2
10.5
26.7
50.2
73
3.3
4.9
4.9
4.9
4.9
0
6.2
7.4
5
5
54.1
65.3
64.5
62.8
92.4
0
59
27.7
10
6.8
*Ratio of equity dividends to net profits Source: Annual reports of the Company

The dividend payout ranged from zero to 92.4 percent. The return to shareholders
on their net worth ranged from zero to 8 percent and the yield rate ranged from
zero to 9.2 percent.

Years
Dividend as %
of paid up value
Dividend as %
of net worth*
Dividend as %
of average
market price**
Stock dividend
as % of paid up
capital
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
20
20
20
20
20
0
25
30
20
20
5.5
8
7.7
7.6
7.6
0
6.7
1.5
0.9
0.8
1
2.8
4.2
5.9
4.9
0
7.6
9.2
6.6
6.5
0
0
0
0
0
0
0
0
0
0

The above analysis revealed that the company paid dividend when there was
profit and did not pay dividend when there was no profit. This fact indicates that
level of profit was one of the major factors determining the dividend policy.

The other factor determining the dividend policy was the financing policy of the
company. The company contemplated greater use of external sources of funds to
finance expansion requirements. The net assets block of the company increased
from Rs.35.6 million in1995 to Rs.466 million in 2004 and the total assets moved
up from Rs.744.8 million to Rs.1793 million during this period (Table 17). To
finance this large-scale expansion, the company relied, to a greater extent, on
external sources as evident from its long-term loans being increased from
Rs.355.9 million in 1995 to Rs.1359.6 million in 2003, which was slightly
decreased to Rs.1184.1 million in 2004. The company, however, did not use any
short-term loans during the study period. The retained earnings of the company
being less than Rs.1 million, it was not significant to finance the expansion
requirements of the company. However, the amount of retained earnings in 2003
and 2004 were high as there were higher profits and the company took policy of
paying stable rate of dividend.

(Rs. in million)
Years
Total Paid-up
Capital
Long-term
loans
Short-term
loans
Retained
earnings
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
24.8
24.8
24.8
24.8
24.8
24.8
24.8
24.8
24.8
24.8
355.9
522.9
532.6
623.1
691.8
691
874.8
902.8
1359.6
1184.1
0
0
0
0
0
0
0
0
0
0
0.9
0.6
0.5
0.7
0.4
0
0.7
1.5
5.5
12
Source: Annual reports of Salt Trading Company Limited

2.5. 5. Findings
The above analysis revealed the following features of dividend policy of the
company.

a) Active and primary policy variable in the financial policymaking.
b) Regularity in dividend payment.
c) Stable rate of dividend on paid up value of share.
d) Rate of dividend based on the profit level

2.6. Unilever Limited
Unilever Limited (previously Nepal Lever Limited) was established in 1994 as a
joint-venture company with Hindustan Lever Limited, which has 80 percent
ownership stake. It is one of the leading manufacturing & processing company in
the country. The paid up capital of the company was Rs.92.1 million as at the end
of 2004.

Table 21: Sales, profits and assets
(Rs. in million)
S.N Particulars Year 1995 Year 2004
Annual rate
growth*(%)
1
2
3
4
5
Net sales
Reserves
Net assets block
Total assets
67.7
-3.8
-3.8
234.6
294.5
1524.9
140.8
303.9
135.7
859.9
31.1
-
-
-5.5
10.7
Source: Annual reports of Unilever Limited

As evident from Table 21, the total assets of the company increased to Rs.859.9
million in 2004 from Rs.294.5 million in 1995. Its net sales increased to
Rs.1524.9 million in 2004 from Rs.67.7 million in 1995 with an annual growth
rate of 31.1 percent, while its net profits increased to Rs.140.8 million in 2004
from -Rs.3.8 million in 1995 and reserves increased to Rs.303.9 million in 2004
from -Rs.3.8 million.
Review of annual reports of the company revealed that it considered the dividend
policy to be active and primary finance function. In 1995, 1996 and 1997, it did
not pay any dividend, the reason for which being lack of surplus for
appropriation due to losses in 1995 and 1996. It paid dividend in uninterrupted
pattern from 1998 to 2004, which ranged from 20 percent to 100 percent. In
1998, 1999, 2000, 2001, 2002, 2003 and 2004, it paid dividend at the rate of 20
percent, 40 percent, 50 percent, 55 percent, 40 percent, 90 percent and 100
percent respectively.

Table 22 reveals that the amount of dividend increased to Rs.18.4 million in
1998, increased to Rs.36.8 million in 1999 and Rs.46 million in 2000. The reason
behind the increase in dividend payment was increase in net profits to Rs.99.7
million in 1998, Rs.119 million in 1999 and Rs.120.6 million in 2000. However,
despite the decreased net profits to Rs.68 million in 2001, the amount of dividend
increased to Rs.50.6 million.

Table 22: Sales, profits and dividends
(Rs. in million)
Years Net sales Net profits Dividends
Payout ratio *
(%)
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
67.7
351.8
789.7
1193.6
1503.7
1728.6
1541
1236
1244.7
1524.9
-3.8
-4
24
99.7
119
120.6
68
42.6
93.2
140.8
0
0
0
18.4
36.8
46
50.6
36.8
82.9
92.1
0
0
0
18.4
30.9
38.1
74.4
86.4
88.9
65.4
*Ratio of equity dividends to net profits Source: Annual reports of Unilever Limited

In 2002, net profits decreased to Rs.42.6 million, and the amount of dividend also
decreased to Rs.36.8 million, while in 2003 and 2004, the amount of dividend to
Rs.82.9 million and Rs.92.1 million as the net profits increased to Rs.93.2 million
and Rs.140.8 million respectively. The range of dividend payout on net profits
was zero to 88.9 percent during 1995 to 2004. The financial profile of the
company thus depicted that dividend policy had been an active decision variable
as it paid dividend regularly in spite of the fair degree of variability in its
earnings. The rate of return in the form of cash dividend on paid up value was 20
percent in 1998, which was increased to 40 percent in 1999, 50 percent in 2000,
and 55 percent in 2001. This rate of return was zero in the first three years. The
company paid 20 percent dividend on paid up value in 1998, and increased to
100 percent in 2004.

Years
Dividend as %
of paid up value
Dividend as %
of net worth*
Dividend as %
of average
market price**
Stock dividend
as % of paid up
capital
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
0
0
0
20
40
50
55
40
90
100
0
0
0
10.9
14.7
14.1
14.8
10.6
23.1
23.2
0
0
0
4.5
3.4
2.4
2.4
2.4
8
7.5
0
0
0
0
0
0
0
0
0
0

During the study period, the rate of dividend on net worth ranged from zero
percent to 23.2 percent while dividend yield ranged between zero percent to 8
percent. The Unilever did not pay any stock dividend during the study period.

Based on the company's trend of financing, dividend behaviour and chairmans
speeches, the level of profit and financing policy were identified as the major
factors influencing dividend policy. It is evident from Table 22 that the company
paid dividend in conformity with the changes in its net profits.

(Rs. in million)
Years Total Paid-up
Capital
Long-term
loans
Short-term
loans
Retained
earnings
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
92.07
92.07
92.07
92.07
92.07
92.07
92.07
92.07
92.07
92.07
180
157.5
112.5
67.5
0
0
0
0
0
0
22.1
71
74.9
0
0
0
0
0
0
0
-3.8
-25.1
-5.2
76.1
158.3
232.9
250.3
256
266.3
303.9
Source: Annual reports of Unilever Limited

The financing policy of the company was to rely on internal sources of fund to
finance its expansion requirements. However, it was forced to use external
sources as well in the initial few years due to losses. Thereafter the company had
zero debt level because of receipt of dues, improved collection from domestic
businesses and strong business performance. The total assets of the company
increased to Rs.859.9 million in 2004 from Rs.294.5 million in 1995. To finance
its increasing total assets and business expansion the company extensively
retained its earnings. The retained earnings increased to Rs.303.9 million in 2004
from Rs.76.1 million in 1998; however, it did not depress the dividend payment.

2.6. 5. Findings
The above analysis revealed that the dividend policy of the company had
following characteristics;
(a) Active decision variable in the financial policymaking.
(b) Treated as a long-term finance function.
(c) Regularity in payment with increasing rate.
(d) Net profit was the major determinant
(e) Expansion requirements did not have any bearing on its dividend payment.

2.7. National Productivity & Economic Development Centre Limited
National Productivity & Economic Development Centre Limited was established
in 1988 for providing consulting services in designing industrial projects,
enhancing productivity and other industrial and economic matters. As evident
from Table 25, its total paid up capital as at the end of 2003 was Rs.7.9 million.
Its paid up capital remained constant in all the years during the study period of
1996 to 2003. The revenue increased to Rs.30.7 million in 2003 from Rs.17.2
million in 1996 with an annual growth rate of 7.2 percent. During the period, its
investments, net profits after tax, reserves, net assets block and total assets
increased to Rs.94.8 million, 7.8 million, 72.4 million, 3.7 million and Rs.80.3
million with annual growth rate of 6.2 percent, 14.7 percent, 6.5 percent, 1.8
percent and 1.2 percent respectively from Rs.57.7 million, 2.4 million, 43.1
million, 3.2 million and 73.1 million respectively.

Table 25: Revenue, investments, profits and assets
(Rs. in million)
S.N Particulars Year 1996 Year 2003
Annual rate
growth*(%)
1
2
3
4
5
6
Revenue
Investments
Reserves
Net assets block
Total assets
17.2
57.7
2.4
43.1
3.2
73.1
30.7
94.8
7.8
72.4
3.7
80.3
7.2
6.2
14.7
6.5
1.8
1.2
Source: Annual reports of National Productivity & Economic Development Centre Limited

The company considered the dividend policy to be active and primary finance
function. It regularly paid dividend during the study period. The rate of dividend
on paid up value was 15 percent in all the years except in 1997, in which it paid
25 percent dividend. It segregated certain portion of net profits in all the years to
dividend equalisation funds to maintain stability in dividend payment. The
company earned profits in all the years during the study period. It did not pay any
stock dividend during the study period.

Table 26 reveals that the amount of dividend was constant in all the years to
Rs.1.2 million except Rs.2 million in 1997, whereas there was fluctuating trend
of net profits during the period that ranged from Rs.2.4 million to Rs.11.7
million. The highest net profit was in 2000 and the lowest net profit was in 1996.
The range of dividend payout on net profits was 10.3 percent to 51.3 percent
during the study period.

Table 26: Revenue, profits and dividends: year 1996 to year 2003
(Rs. in million)
Years Revenue Net profits Dividends
Payout ratio *
(%)
1996
1997
1998
1999
2000
2001
2002
2003
17.2
20.6
20.7
25.5
31.6
33.5
22.7
30.7
2.4
3.9
3.2
6.3
11.7
2.7
4.7
7.8
1.2
2
1.2
1.2
1.2
1.2
1.2
1.2
50
51.3
37.5
19
10.3
44.4
25.5
15.4
*Ratio of equity dividends to net profits Source: Annual reports of National Productivity
& Economic Development Centre Limited

The rate of return in the form of dividend on paid up value was 15 percent in all
the years except in 1997. The rate of dividend on net worth ranged from 1.5
percent to 3.8 percent. The company thus had smooth pattern of dividend
payment during the study period.

Years
Dividend as
% of paid up
value
Dividend as % of
net worth*
Dividend as
% of average
market
price**
Stock dividend
as % of paid up
capital
1996
1997
1998
1999
2000
2001
2002
2003
15
25
15
15
15
15
15
15
2.3
3.8
2.1
1.9
1.6
1.7
1.6
1.5
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0

Table 28 revealed that the company had retained earnings only in year 1997. It
used share capital as external sources of financing. The share capital was also
constant to Rs.7.9 million in all the years during the study period. The company
being a consultant did not require short-term as well as long-term loans, neither
required to retained earnings. It had not used any loans during study period.

(Rs. in million)
Years
Total Paid-up
Capital
Long-term
loans
Short-term
loans
Retained
earnings
1996
1997
1998
1999
2000
2001
2002
2003
7.9
7.9
7.9
7.9
7.9
7.9
7.9
7.9
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
1.4
0
0
0
0
0
0
Source: Annual reports of National Productivity & Economic Development Centre Limited
The above analysis revealed that the company maintained dividend equalisation
funds from its profit to pay a constant rate of dividend. As it had not used
external loans as well as retained earnings as sources of financing, its financing
policy also did not have any influence to its dividend policy.

2.7.5. Findings
The dividend policy of the Centre had the following characteristics.

(a) Primary policy variable in the financial policymaking.
(b) A target payout ratio was maintained with stable rate.
(c) Financing pattern did not have significant influence.

2.8. Conclusions
The study reveals the dividend policy being treated as an active and primary
variable in the financial policymaking. This is characterised by the regular
payment of dividend. Standard Chartered Bank Nepal Limited, Salt Trading
Company Limited and National Productivity & Economic Development Centre
Limited pursued the policy of target dividend payout. In case of National
Productivity & Economic Development Centre Limited, dividend equalisation
fund was also created to pay target dividend.

The dividend behaviour of Standard Chartered Bank Nepal Limited and Nepal
Insurance Company Limited were uninterrupted and fluctuating, while that of
Salt Trading Company Limited and National Productivity & Economic
Development Centre Limited was at stable rate on paid up value. The dividend
behaviour of Peoples Finance Limited, Soaltee Hotel Limited and Unilever
Limited were interrupted.

The foremost factor determining dividend policy was the level of profits of the
enterprises. In all the cases the amount of dividend was in accordance with the
level of profits except in the case of National Productivity & Economic
Development Centre Limited. Financing policy was the other important factor
influencing the dividend policy. In four enterprises, the financing policy was to
rely on the external sources of funds. Consequently, investment requirements did
not have any adverse influence on the dividend policy of these enterprises. In the
cases of the enterprises, whose emphasis was on using internal sources of funds,
still it did not constraint the dividend payment. In case of stock dividend, need to
increase share capital as per the directives of the regulator, goal of future
expansion and shareholders demand were the major determinants.

References
Brealey, Richard A.and Stewart C. Myers, 2003, Principles of Corporate Finance Seventh Edition,
Tata McGraw-Hill Publishing Company Limited, New Delhi.
Hunt, Williams and Donaldson, 1971, Basic Business Finance: Text & Cases, Richard D. Irwin Inc.
Standard Chartered Bank Nepal Limited, Annual Reports fiscal years 1994/952003/04, New
Baneswor, Kathmandu.
Peoples Finance Limited, Annual Reports fiscal years 1994/95-2003/04, Tripureswor, Kathmandu.
Nepal Insurance Company Limited, Annual Reports fiscal years 1994/95 2002/03, Kamaladi,
Kathmandu.
Soaltee Hotel Limited, Annual Reports fiscal years fiscal years 1994/95 2003/04, Tahachal,
Kathmandu.
Salt Trading Limited, Annual Reports fiscal years 1994/95 2003/04, Kalimati, Kathmandu.
Unilever Limited, Annual Reports fiscal years 1994/95- 2003/04, Heritage Plaza, Kathmandu.
National Productivity & Economic Development Centre Limited, Annual Reports fiscal years
1995/962002/03, BID Balaju, Kathmandu.

Institutional Investment in Nepalese Securities Market

1. Introduction
Nepalese securities market has a history of institutionalisation of about three
decades. However, it has not fully developed to contribute meaningfully in the
economic development of the country. Total market capitalisation value reached
to Rs. 61365.89 million by the end of the fiscal year 2004/05, which is 12.17
percent of the GDP. Total paid up capital of listed securities has reached to Rs.
16771.84 million and the average annual value of securities trading in the stock
exchange is Rs. 1341.65 million. The average percentage of turnover on market
capitalisation for the last 12 years is only 4.21, which indicates low level of
liquidity in the market. The average annual public issue for the last 12 fiscal
years is Rs. 597.07 million. Till the fiscal year 2004/05, the total amount of
issued securities is Rs. 8.6 billion consisting of 76.6 percent common stock, 2.7
percent preferred stock, 8.3 percent collective investment schemes and 12.3
percent debentures. This shows not only the low supply of securities in the
market but also the lack of diversification of securities instruments. If we
particularly see the trend of debenture issue from the fiscal year 1993/94 to
2004/05 there were only four issues of debentures. There is also wide variation in
the interest rate of those debentures ranging from 6 to 14 percent. The
government securities market is yet to be integrated with the corporate bond
market that could provide benchmarking interest rate and lead to the
development of full-fledged debt market in the country. There are only two
mutual funds with total amount of capital mobilisation of Rs. 613.09 million by
the end of the fiscal year 2004/05. There is no encouraging issue of securities
from corporate sectors other than banks and financial institutions. Thus, the
insufficient supply of securities and diversification in the securities instrument
and issuing companies has been limiting the scope for institutional investment in
the market.

Study conducted by Securities Board of Nepal in the Fiscal Year 2005/06

There is significant fluctuation in the market price of the securities. In the last 12
years, there is a variation of about 448 points in the price index. The highest price
index recorded was 545.82 points in the fiscal year 2000/01 while the lowest was
97.98 points in the fiscal year 1993/94. There is up to 223 points price index
variation in a single year and up to 18.3 points price index variation within one
day transaction. Such a variation in the price of the securities indicates the
irrational behaviour of the market. This irrational behaviour of the market can be
attributed to the absence of institutional investors and nave nature of retail
investors. In addition, there is lack of professional merchant banking and stock
exchange services that could support the investors to make informed decision
through proper investment counselling, providing access to the corporate and
market information based on adequate researches.

The above scenario depicts that securities market in Nepal is yet to be matured to
be a major source of fund raising. For the proper growth and stability of the
securities market, initiatives should be taken towards promoting institutional
investment. In this perspective, SEBON has conducted this study to assess the
status of institutional investment and provide appropriate policy
recommendations for the promotion of institutional investment in the market.

2. Importance of Institutional Investors
Institutional investment has important role in sustainable development of
securities markets. Institutional investors, as compared to the retail investors, are
more equipped and resourceful to judge investment value and thus make prudent
decisions on buying and selling securities. In view to the importance of the
institutional investment, different developed and emerging markets have taken
due consideration to increase the involvement of institutional investors in the
market. In India, huge amount of funds is being mobilised through the
institutional investors. Not only domestic institutions are involved as institutional
investors in the Indian securities market, foreign institutions are also sufficiently
being encouraged to play a significant role as foreign institutional investors
(FIIs). Under the SEBI (FII) Regulations, 1995, pension funds, mutual funds,
insurance companies, investment trusts, banks, university funds, endowments,
foundations, charitable trusts and charitable societies proposing to invest on
behalf of broad based funds, are also eligible to be registered as FIIs. They are
allowed for providing services as asset management companies, institutional
portfolio managers, trustees, etc. and are allowed to invest in almost every sort of
products in the stock markets including primary and secondary markets in India.
Major roles and importance of institutional investors can be pointed out as
follows.

Institutional Investor through collective investment schemes add up new
instrument and increase investors participation in the market, which will
stimulate the issuers to raise funds through issuing securities as they will
have confidence on the subscription of proposed issues,
They can supply the securities held by them as and when the demand
arises and such activities can significantly contribute to stabilize the
market price of the securities,
Their involvement stimulate demand and supply of corporate bonds,
They can play the role of debenture trustee that will facilitate the issue of
corporate bonds,
They can provide efficient investment services to the risk averse
investors through the mobilization of various types of collective
investment schemes,
They are able to make rational analysis of the information provided by
the issuer and also pressurize them for the regular flow of credible
information, which to the greater extent can contribute in improving
confidence of the retail investors.

3. National Policy and Institutional Investment
Review of National Plans reveals that the government of Nepal has well
recognised the institutional investment as one of the major requirements for
capital market development in the country. There is continuity in bringing
different programs related to the promotion of institutional investment in the
securities market since the Eighth National Plan. The long-term approach of the
national plans is to increase the participation of the institutional investors like
mutual funds, pension funds, employees provident funds, insurance companies
etc. in the securities market thereby making at least 50.0 percent of the total
transaction through such investors.

In the Eighth Plan (1992-1997), there was a policy for encouraging the
investment of Employees Provident Fund and the Insurance Companies in the
securities market. However, neither there was any initiatives taken by the
government to implement this plan nor the institutions who were supposed to
make their investment in the securities market felt their accountability and took
initiatives according to the plan. In the plan there was a program of introducing
institutional investors to operate collective saving schemes. Accordingly, within
the plan period Citizen Unit Scheme and NCM Mutual Fund were brought into
operation with limited regulatory parameters of Securities Board of Nepal.

The Ninth Plan (1997-2002) had incorporated the program for encouraging
domestic as well as foreign institutions to operate mutual funds. It also had a
program of establishing credit rating agency and trading of the government
securities in the stock exchange. All these programs were not implemented in the
plan period. However, legislative initiatives were taken during the fiscal year
2004/05 for the trading of government securities in the stock exchange.

The Tenth Plan (2002-2007) has a program for legal reform and development of
investment regulatory system to mobilise the contractual savings in the securities
market. The plan has quantitative target regarding saving mobilisation by Citizen
Investment Trust to be at least Rs. 6.69 billion, out of which at least 50 percent
would be invested in corporate securities. The plan has equally emphasised to
raise the share of Citizen Investment Trust in the securities transaction to be at
least one billion. The plan also has program for increasing number of collective
savings schemes.

If we see the present status of contractual savings mobilisation in the securities
market, the Citizen Investment Trust has collected Rs. 6.2 billion by the end of
the first nine months of the fiscal year 2005/06, which is very near to the target.
The Trust has invested almost all the collection; however its investment in the
corporate securities is only 4.6 percent of the total investment, which is far below
the quantitative target of the plan. Also, the participation of the Trust in the
secondary securities transaction is estimated to be almost negligible. Similarly,
regarding program for increasing number of collective savings schemes, no
achievements have been made till the end of the fiscal year 2005/06.

One of the major objectives of the Tenth Plan was to issue bonds through
securities markets to meet the mid-term and long-term financing requirements of
the development projects and gradually reduce foreign loan. If this objective is to
be fulfilled, there must be the participation of institutional investors in the
market. However, neither there is increasing participation of the institutional
investors in the market, nor any initiatives have been made to issue such types of
securities instruments.

4. Present Status and Trend of Institutional Investment
Generally, the institutional investors of securities market are government
sponsored provident funds, collective investment funds, private pension funds,
bank/trust institutions, and insurance companies. In Nepal, Citizen Investment
Trust, Employees Provident Fund, NCM Mutual Fund and the insurance
companies are the existing as well as potential institutional investors. We have
seen that the national plans have also brought various programs to encourage
institutional investment in the securities market. However, the actual
achievement shows that there is no serious initiative towards the implementation
of the programs. The status and trend of the institutional investment also justify
this fact.

4.1 Citizen Investment Trust
Citizen Investment Trust (CIT) was established under the Citizen Investment
Trust Act, 1990. The objective of establishing CIT was to expand investment
opportunities by encouraging general public to save capital and to bring
dynamism in the capital market. As per the provision in the Act, the Trust can
operate subsidiary company to promote capital market as per necessity.

CIT has collected funds by operating various schemes such as Employees
Savings and Growth Scheme, Citizen Unit Scheme, Gratuity Fund Scheme and
Investor's Account Scheme. The Trust has invested the funds in corporate
securities, government bonds, term loans, and borrowings. The capital base, trend
of fund collection and investment of CIT is given in Table 1.

Table 1: Trend of Fund Collection and Investment of Citizen Investment Trust
(Rs. in million)
Particulars
Fiscal Year
1999/00 2000/01 2001/02 2002/03 2003/04
Capital 35.9 42.2 48.7 54.2 61.1
Paid up Capital 24.0 27.6 31.2 35.2 40.0
Reserve Fund 11.9 14.6 17.5 19.0 21.1
Fund Collection 583.9 1145.7 1709.7 3294.5 4923.4
Employee Savings and
Growth Scheme
353.1 673.4 803.2 1523.5 2501.3
Citizen Unit Scheme 143.3 336.8 645.2 837.4 1003.9
Gratuity Fund Scheme 33.5 53.9 118.2 656.3 1053.7
Investor's Account Scheme 54.0 81.6 143.1 277.3 364.5
Investment 647.1 933.3 1449.0 2635.4 3347.5
Corporate Securities 15.0 44.3 60.9 63.5 153.5
Government Bonds 511.3 702.0 1066.1 2021.9 2318.0
Term Loans 102.5 144.5 322.0 503.8 488.3
Borrowings 18.3 42.5 - 46.2 87.7
Source: CIT

As revealed by Table 1, the capital base of CIT by the end of the fiscal year
2003/04 reached to Rs. 61.1 million and the total fund collection reached to Rs.
4923.4 million, while the total investment was Rs. 3347.5 million. It clearly
shows that although there has been significant increase in total fund collection,
the core capital of CIT is very low. Similarly, total investment is also far lower
than total fund collection, and out of the investment, the investment in corporate
securities is insignificant. On the basis of its small capital base, there is no
possibility that the CIT can provide trust services for large issue of debentures
and mutual funds.

Regarding the investment of CIT in securities markets, it is very low compared to
the investment in other areas. Most of its investment is in government bond and
term loans. Out of total investment, only 4.58 percent investment was made in
corporate securities in the fiscal year 2003/04, which was only 2.41 percent in the
fiscal year 2002/03. Though there is increasing trend of investment in the
corporate securities, it is still very nominal as compared to the increase in
investment in other areas.

Among the fund collection schemes, the Citizen Unit Scheme was particularly
brought into operation, as an open-ended mutual fund scheme, whose major
investment, in principle, should be in the corporate securities. However, its
investment is also very nominal in corporate securities. Out of the total
investment of the scheme, the investment in corporate securities was only 6.36
percent in the fiscal year 2003/04, which was even lower in the preceding years.

Table 2: Performance Trend of Citizen Unit Scheme
(Rs. in million)
Particulars
Fiscal Year
1998/99 1999/00 2000/01 2001/02 2002/03 2003/04
Total amount of unit sold 54.46 187.37 336.78 645.26 837.47 1003.87
Total amount of unit
repurchased
11.99 44.12 110.63 280.62 432.15 536.27
Total Investment 36.22 143.88 236.40 371.50 414.43 417.04
Corporate Securities 2.72 2.03 6.75 10.50 15.43 26.54
Other Investment 33.5 141.85 229.65 361.0 399.0 390.50
Net Income 5.10 16.71 19.98 35.26 37.40 36.26
Dividend (%) 11 11 9 8.5 8 7
Number of Unit Holder 2587 4601 6270 8299 9087 9871
Source: Citizen Investment Trust

4.2 NCM Mutual Fund
NCM mutual fund was brought into operation in the fiscal year 2002/03 with the
approval of Securities Board of Nepal. The objective of NCM mutual fund was to
provide returns to the fund holders by professional management of their funds. In
the current situation of lack of sufficient securities instruments, this fund scheme
has provided opportunities to the risk averse type of investors to invest in the
capital market.

NCM mutual fund is close-ended mutual fund with ten years of maturity period,
which has also been listed in the stock exchange. The total amount of the mutual
fund is Rs. 100.0 million with par value of Rs. 10 per unit. NIDC Capital
Markets Ltd. and Nepal Industrial Development Corporation are the fund
manager and the trustee of the fund. The trend of performance of NCM Mutual
Fund is depicted in Table 3.

Table 3: Performance Trend of NCM Mutual Fund
(Rs. in million)
Particulars
Fiscal Year
2002/03 2003/04 2004/05
Outstanding Unit (in '000) 10,000 10,000 10,000
Net Assets Value 105.69 118.02 144.92
Net Assets Value per unit (Rs.) 10.57 11.80 14.49
Net Income 2.14 2.55 6.66
Dividend (%) 5 5 5
Investment 110.32 103.12 136.21
Corporate Securities 84.43 91.38 124.47
Investment in Other Sectors 25.89 11.74 11.74
No of Company Invested 29 31 35
No of Unit holders 2882 2882 2559
Institutions 19 19 20
Individuals 2863 2863 2539
Source: NIDC Capital Markets Ltd.

Total investment of NCM mutual fund was Rs. 136.21 million in the fiscal year
2004/05, out of which investment in the corporate securities was 91.38 percent.
Its portfolio of investment includes securities of 35 listed companies. The
investment trend of the fund shows that the fund has made major portion of
investment in corporate securities and has played a significant role in the
securities markets with the increased investment in corporate securities. The unit
holders of the fund include institutions and individual. Out of 2559 unit holders
in the fiscal year 2004/05, 20 are institutions. The participation of institutions as
unit holders of NCM mutual fund shows that the mutual fund can attract
institutional investors in the securities markets.

4.3 Employees Provident Fund
Employees Provident Fund (EPF) is an autonomous body incorporated under the
Employees Provident Fund Act, 1962. EPF mobilises savings collected through
compulsory provident fund contributions on the part of employers and
employees, among others, in civil, army and police services. Contributions,
earnings, and distributions are completely tax-free. Upon retirement or otherwise
ending employment, the employees (or their beneficiaries) receive tax-free lump
sum payments of the principal amount deposited and any accumulated earnings.
The EPF made investment as per the investment policy developed by it, which is
presented in Appendix 1.

The total fund of the EPF was Rs. 35,681.0 million in fiscal year 2002/03 and its
total investment was Rs. 19,042.3 million. The growth of investment of the fund
is far lower than the growth of sources over the past five years. Out of the total
investment in the fiscal year 2002/03, the investment in corporate securities is
only 1.19 percent. With this meagre investment of EPF in the corporate
securities, it is almost impossible to achieve the long-term target of the Tenth
Plan to make at least 50 percent institutional investment in the securities market.
The trend of fund collection and mobilisation of the EPF is presented in Table 4.

Table 4: Fund Collection and Mobilization of Employees Provident Fund
(Rs. in million)
Particulars
Fiscal Year
1998/99 1999/00 2000/01 2001/02 2002/03
Total Funds 1,9042.3 22,118.2 2,6215.0 30,308.0 35,681.0
Provident Funds 17,301.6 20,018.7 2,3710.0 27,349.0 32,283.0
Reserve Fund 1,517.7 1,805.8 2,071.0 2,285.0 2,278.0
Other Provisions 233.0 293.7 434.0 674.0 1,120.0
Total Investment 14,677.4 16,387.9 17,959.0 18,587.0 19,401.0
Corporate Securities 59.3 67.3 130.0 231.0 231.0
Other Investment 1,4618.1 16,320.6 17,829 18,356.0 19,170.0
Loan 3,360.0 4,566.9 6,738.0 9,801.0 14,098.0
Cash and Bank Balance 380.9 220.8 467.0 831.0 989.0
Other Assets 324.0 942.6 1,051.0 1,089.0 1,193.0
Source: Employees Provident Fund

4.4 Insurance Companies
As institutional investors, insurance companies may act as principal for their own
account, and thereby invest the assets of the insurance company in a wide array
of financial instruments, i.e., share, debenture etc. in order to produce sufficient
income to meet their obligations in the form of promised insurance benefits
(GMA (1998)). In Nepal insurance business is regulated by Insurance Board.
There were 17 insurance companies registered with Insurance Board till the end
of the fiscal year 2002/03, and most of them are listed in stock exchange. Under
the provisions of Insurance Act and Regulation, Insurance Board has adopted the
policy of facilitating the insurance companies to invest in the priority sectors.
The investment guidelines developed and implemented by Insurance Board is
presented in the Appendix 2. Accordingly, insurance companies have invested in
the National Saving Certificate and Government Bonds, fixed deposit, share and
in loan to insurance policy holders.

The aggregate total capital base of the insurance companies, which constitutes
paid up capital, reserve fund, insurance fund and other liabilities, was Rs.12,
367.2 million in the fiscal year 2002/03. The aggregate total investment was Rs.
10,419.3 million. Out of total aggregate investment of insurance companies in the
fiscal year 2002/03, the aggregate portion of investment in corporate securities
was only 1.30 percent, which is very nominal portion of their huge sources.
Table 5 presents the trend of sources and uses of funds of insurance companies.

Table 5: Capital base and Investment of Insurance Companies
(Rs. in million)
Particulars Fiscal Year
1998/99 1999/00 2000/01 2001/02 2002/03
Total Capital 6,257.3 8125.0 9830.2 10,978.1 12,367.2
Paid up Capital 467.9 452.9 768.2 1,084.8 1,184.8
Reserve Fund 611.0 554.1 720.4 1,345.0 1,112.0
Insurance Fund 3,862.2 4,288.5 5,080.2 6,629.8 8,051.6
Other Liabilities 1,316.2 2,829.5 3,261.4 1,918.5 2,018.8
Investment 5,252.0 7,206.5 8,397.6 10,054.2 10,419.3
Corporate Securities 53.64 153.26 - - 135.59
Other Investment 5,198.36 7,053.24 - - 10,283.7
1
Cash and Bank Balance 121.7 158.7 502.1 322.8 543.1
Fixed Assets 146.2 159.8 256.6 190.9 217.1
Other Assets 737.4 600.0 673.9 410.2 1,187.7
Source: Insurance Board

5 Legal and Regulatory Gaps
Review of relevant legal provision revealed that there are no major hurdles to the
institutional investors to make investment in the corporate securities. However,
the existing regulatory and enforcement issues of the institutions are inadequate
and conflicting (to some extent) to encourage their investment in the securities
market.

The Securities Ordinance, 2005 has brought the fund management services under
the purview of securities market regulation. It has incorporated the provisions
that provide basic legal framework for the management and operation of the
investment funds. However, such funds operated by the Citizen Investment Trust
and the Employees Provident Fund, which were established under special Acts
before the issuance of the Securities Ordinance, are regulated under their specific
Acts. There are no provisions incorporated in those specific Acts that recognise
the regulatory role of Securities Board of Nepal. Due to this reason, the fund
mobilisation activities of different funds have remained unmonitored, which
ultimately is creating dilemma in promoting institutional investment in the
securities market.

Citizen Investment Trust Act, 1991 and the Employees Provident Fund Act, 1962
have respectively established the Citizen Investment Trust and the Employees
Provident Fund as fund management institutions. As per these Acts, the
government appoints majority of the directors including chief executive officer,
has right to suspend the board of directors, approves bylaws and the rules and
their accounts are audited by Auditor General. Thus, the overall operational as
well as regulatory authority of the Citizen Investment Trust and Employees
Provident Fund rests on the government. However, in the present context of
following liberal economic policy, the government should only be the facilitator,
and the regulation of Citizen Investment Trust and Employees Provident Fund by
the government may not help them to professionalise in the productive
investment of their huge collection of the funds.

The Employees Provident Fund Act, 1962 has provision as per which it can
invest its savings and assets in the stocks and debentures issued by the banks and
finance companies up to the 25 percent of the issue. However, it is to be noted
that the Act has restricted its investment in the securities issued by the companies
other than bank and finance.

The Companies Ordinance, 2005 incorporates regulatory provisions regarding
the procedure of issuing mutual fund and debenture. It has also made provision
for the requirement of trustee, contract between debenture trustee and debenture
issuer, and role and responsibility of debenture trustee. However, the Ordinance
has not made clear about the criteria for the establishment and operation of
trustee services. In this situation there is urgent need for the operation and
regulation of trustee services to facilitate the issue of debentures and mutual
funds.

The Pension Fund Act, 1985 regulates the operation of pension funds. It also
allows the fund to purchase and sell share or debenture of corporate body or
public limited company and can invest in suitable area with due consideration of
security. But, in the absence of an agency to administer the Act, the
establishment and operation of pension funds have still remained under the
clouds.

The Foreign Investment and Technology Transfer Act, 1992 does not restrict for
the investment by the Foreign Institutional Investors in Nepal, however, there is
lack of provisions for the regulation of foreign portfolio investment in the
securities market. Similarly, the recently passed NRN Ordinance also lacks the
provisions and procedures for portfolio investment by NRN.

6. Summary and Conclusion
Sustainable development of securities market is not possible without active
involvement of institutional investors. With the operation of collective
investment funds, the institutional investors help in increasing participation of
general investors in the securities market. Involvement of institutional investors
in the market stimulates the issuer to issue different types of securities
instruments including bonds and debentures.

The involvement of prominent institutional investors like Citizen Investment
Trust, Employees Provident Fund, and Insurance Companies in the securities
market is very insignificant in Nepal. They have huge amount of funds under
their management; however, the unproductive mobilisation of their funds has
resulted to the sluggish fund management business in the country. There are
various programmes in the national plans to encourage the investment of these
institutions in the securities market for the productive mobilisation of their funds.
However, these programmes are not duly implemented, which could also be
attributed to the absence of special regulator for these institutions. Thus, the legal
and regulatory gaps in this respect should be duly addressed. Further, the
government should have strong commitment to implement the programs as
envisaged in the national plans.

In view of the importance of foreign portfolio investment in the market, The
Foreign Investment and Technology Transfer Act, 1992 and NRN Ordinance,
2005 should be amended to clear the procedural aspects and provision for the
regulation of such investment in the securities market.

Weak regulatory mechanism, inefficient and limited services, insufficient basic
market infrastructures, lack of professionalism in the service providers, weak
information disclosure practices etc. are the other critical issues of the securities
market, which also need to be addressed.

References
Citizen Investment Trust, 2004, Annual Report 2003/04, Putalisadak, Kathmandu.
Employees Provident Fund, 2004, Special Annual Issue, volume 62, Social Security Management
and Planning Department, Pulchowk, Lalitpur.
Employees Provident Fund, Investment Policy, 2004, Central Office, 2004, Pulchowk, Lalitpur.
Insurance Board, 2003, Annual Report 2002/03, Chabahil, Kathmandu.
Insurance Board, 2005, Investment Guidelines, 2005, Chabahil, Kathmandu.
GMA Capital Markets Limited, J uly 1998, Capital market development project 2, Final Report to
the Asian Development Bank 2, 1-332.
Government of Nepal, National Planning Commission, J uly 1998, Ninth Plan (1997- 2002),
Printing Department, Singhadurbar, Kathmandu.
Government of Nepal, National Planning Commission, March 2003, Tenth Plan (2003-2007),
Printing Department, Singhadurbar, Kathmandu.
Ministry of Law, J ustice and Parliamentary Affair, Securities Ordinance, 2005, Nepal Gazette, part
2, 23
rd
September 2005, Kathmandu.
Ministry of Law, J ustice and Parliamentary Affair, Companies Ordinance, 2005, Nepal Gazette,
part 2, 9
th
October 2005, Kathmandu.
Ministry of Law, J ustice and Parliamentary Affair, Bank and Financial Institutions Ordinance,
2005, Nepal Gazette, part 5
th
August 2005, Kathmandu.
Ministry of Law, J ustice and Parliamentary Affair, Non-resident Nepali Ordinance, 2005, Nepal
Gazette, part 2, 2
nd
September 2005, Kathmandu.
Ministry of Law and J ustice, Employees Provident Fund Act, 1962, Law Books Management
Board, 1999, Babarmahal, Kathmandu.
Ministry of Law, J ustice and Parliamentary Affair, Citizen Investment Trust Act, 1991Law Books
Management Board, 1994, Babarmahal, Kathmandu.
Ministry of Law, J ustice and Parliamentary Affair, Insurance Act, 1992, Law Books Management
Board, 1994, Babarmahal, Kathmandu.
Ministry of Law, J ustice and Parliamentary Affair, Pension Fund Act, 1985, Law Books
Ministry of Law and J ustice, Foreign Investment and Technology Transfer Act, 1992, Law Books
Nepal Rastra Bank, 2005, Unified Directives to Bank and Financial Institutions, 2005, Central
Office, Baluwatar, Kathmandu.
Nepal Rastra Bank, Mid-J anuary 2005, Banking and Financial Statistics, no. 44, Bank and
Financial Institutions Regulation Department, Central Office, Baluwatar, Kathmandu.
Securities Board of Nepal, 2004, Annual Report 2003/04, Thapathali, Kathmandu.
SEBI Manual (as amended by SEBI (amendment) Act 2002), Securities and Exchange Board of
India (Foreign Institutional Investors) Regulations, 1995, Taxmann Allied Services Pvt.
Ltd., New Delhi.
SEBI Manual (as amended by SEBI (amendment) Act 2002), Securities and Exchange Board of
India (Mutual Funds) Regulations, 1996, Taxmann Allied Services Pvt. Ltd., New
Rohtak Road, New Delhi.
Rajeshwer, Ch, J uly 2004, Perceptions and performance, Chartered Financial Analyst, 10, 7

Appendix 1

The following are the relevant provisions of Employees Provident Fund's
Investment Policy-2004.

Section 2.2 of Employees Provident Fund's Investment Policy-2004 states,
among others, the maximum limit of investment in the share/ debenture shall be
25.0 percent.

Section 6.1 states that as per the Section 19(C1) of the Employees Provident
Fund Act, 1962 the investment in the shares of bank or finance company shall be
as follows:

The Fund can invest in the promoter's share and public's share (issue) and
Preference shares of the bank or finance company.
The Fund can invest only in the share of national or regional level bank or
finance company.
The bank or finance company whose share the Fund is going to hold/ is to
hold has to be licensed for the establishment.
The Fund can invest in the promoter's share of bank or finance company
only in the condition of being the Fund's permanent representative in the
board of directors of such bank or finance company.
The Fund can also purchase the promoter's share of bank or finance
company licensed as 'A' group from the secondary securities markets. The
valuation of the share purchased as above should not exceed 10.0 percent
of net worth of the bank or finance company. But such valuation in any
case should not exceed current market price.
The Fund shall specify the other conditions as per the necessity.

Section 6.2 states that as per the Section 19 (C3) of Employees Provident Fund
Act, 1962, the Fund's investment in the debenture of company or corporate body
shall be as follows:

The company or corporate body, issuing debenture should have three years'
track records of profit.
The debenture should be redeemable.
The Fund shall purchase at least 10.0 percent of debenture issued.
The Fund shall not purchase the debenture of the corporate body if the
debt-equity ratio of such corporate body exceeds 60:40 after issuing
debenture.
The Fund shall specify the other conditions as per the necessity.

Section 11.4 of the Employees Provident Fund's Investment Policy, 2004 states
that the authority of deciding whether to investment or not in the share/ debenture
of bank or finance company or corporate body shall be in the board of directors.
Appendix 2

The following is the recent investment guidelines given by Insurance Board
(Insurance Board) to life insurance companies with respect to investment in
securities markets.

Life Insurance Companies could make investment in Citizen Unit Scheme
of Citizen Investment Trust not exceeding 5.0 percent of total investment
amount.
Life Insurance Companies could make investment in Preference Share,
Debenture and bonds of the commercial banks, development banks and
finance companies not exceeding 10.0 percent of total investment amount.
Life Insurance Company could make investment in Ordinary Share of
public limited companies not exceeding 5.0 percent of total investment
amount.

The following is the investment guidelines given by Insurance Board (Insurance
Board) to non-life insurance companies with respect to investment in securities
markets.

Non-life Insurance Companies could make investment in Citizen Unit
Scheme of Citizen Investment Trust not exceeding 20.0 percent of total
investment amount.
Non-life Insurance Companies could make investment in Preference Share,
Debenture and Bonds of commercial banks, development banks and
finance companies not exceeding 10.0 percent of total investment amount.
Non-life Insurance Companies could make investment in Ordinary Share
of Housing Development Finance Company Ltd. not exceeding 5.0 percent
of total investment amount.
Non-life Insurance Companies could make investment in Ordinary Share
of public limited company other than mentioned in 3 above not exceeding
5.0 percent of total investment amount.

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Securities Board of Nepal

Chairman, Securities Board of Nepal

Professor, Central Department of Management, Tribhuvan University, Kirtipur,

Chartered Accountant, CSE and Company, Baluwatar, Kathmandu

Mr. Thapa is Lecturer of Finance in Shanker Dev Campus.

Mr. Dahal is lecturer of finance in College of Applied Business, Kathmandu

Officer, Securities Board of Nepal

Study conducted by Securities Board of Nepal in the Fiscal Year 2005/06

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