Fundamentals of Investment

Four Money Market Vehicles

1. Treasury Bills: Short-term government papers (91/182/364 days in Nepal) sold at a discount through NRB auctions.
2. Commercial Paper: Unsecured short-term promissory notes issued by creditworthy companies to meet working-capital needs.
3. Certificates of Deposit: Bank-issued time deposits with fixed maturity and interest, negotiable in secondary dealing.
4. Banker’s Acceptances: Time drafts guaranteed (accepted) by a bank, widely used to finance trade.

Call Option Payoff and Profit

• Payoff (value at expiry): $\max(400 - 350, 0) = \mathbf{\text{Rs. } 50}$ per share.
• Net profit: Payoff $-$ premium $= 50 - 25 = \mathbf{\text{Rs. } 25}$ per share.

The option is exercised because the market price (Rs. 400) exceeds the strike (Rs. 350).

CAPM Required Return

Decision: SELL. The stock’s expected return (10%) is below its required return (12.5%), so it is overpriced — it does not compensate for its systematic risk.

Major Sources of Risk

1. Business Risk: Uncertainty of operating earnings from competition, costs, and demand shifts.
2. Financial Risk: Added volatility from debt financing and fixed interest obligations.
3. Liquidity Risk: Inability to sell quickly at a fair price (thin trading on NEPSE).
4. Exchange Rate Risk: Losses from currency movement on foreign exposure.
5. Default (Credit) Risk: Issuer failure to pay interest or principal on time.

Open-End vs Closed-End Funds

Most Nepali mutual funds are closed-end schemes listed on NEPSE.

Technical Analysis of Financial Securities

Technical analysis forecasts future price movements by studying historical price charts, trading volume, trends, moving averages, and support/resistance levels rather than company fundamentals. It assumes prices reflect all known information and move in persistent trends, so chart patterns repeat. It contrasts with fundamental analysis, which values securities from earnings, dividends, and economic factors.

Major Sources of Investment Information

1. Audited annual reports and quarterly disclosures of listed companies.
2. SEBON notices and prospectus filings for public issues.
3. NEPSE trading disclosures, price-volume data, and corporate announcements.
4. Financial press (Karobar, Arthik Abhiyan) and broker research notes.
5. NRB reports on monetary policy, interest rates, and banking health.

Meaning of Fixed Income Securities

Fixed income securities are debt contracts that promise specified, scheduled payments — periodic interest plus principal repayment at maturity. Examples: T-bills, government bonds, corporate debentures, and bank fixed deposits. They offer certain income with priority over shares, but limited upside compared to equity.

Term Structure of Interest Rates

The term structure is the relationship between bond yields and terms to maturity at a point in time, displayed graphically as the yield curve. An upward curve means long rates exceed short rates. It is explained by the expectations theory (future short rates), the liquidity premium theory (extra compensation for long holding), and the segmented markets theory (maturity-habitat preferences).

Conversion Value

(The 10% growth rate is not needed here — conversion value depends only on the conversion ratio and the current share price.)

Gautam Short Sells 2,000 Shares at Rs. 100

Short-sale proceeds $= 2,000 \times 100 = \text{Rs. } 200,000$; initial equity $= 60\% \times 200,000 = \mathbf{\text{Rs. } 120,000}$; account total $= 320,000$.

Part (a): At Rs. 115

• Margin loan (shares owed): $2,000 \times 115 = \mathbf{\text{Rs. } 230,000}$
• Margin equity: $320,000 - 230,000 = \mathbf{\text{Rs. } 90,000}$

Part (b): Margin Call Price

At Rs. 115 the actual margin is $90,000 / 230,000 = 39.13\% > 30\%$, so no margin call is received.

Part (c): Return if Price Falls to Rs. 80

• Profit $= (100 - 80) \times 2,000 = \text{Rs. } 40,000$
• Rate of return $= 40,000 / 120,000 = \mathbf{33.33\%}$

Part (a): Constant 9% Growth Forever

• D1 $= 12 \times 1.09 = \text{Rs. } 13.08$
• V0 $= 13.08 / (0.16 - 0.09) = 13.08 / 0.07 = \mathbf{\text{Rs. } 186.86}$

Part (b): 10% for 3 Years, then 6%

• D1 $= 12(1.10) = \text{Rs. } 13.20$; D2 $= 13.20(1.10) = \text{Rs. } 14.52$; D3 $= 14.52(1.10) = \text{Rs. } 15.97$
• P3 $= D4 / (k - g_2) = 15.97(1.06) / (0.16 - 0.06) = 16.93 / 0.10 = \text{Rs. } 169.31$
• V0 $= 13.20/1.16 + 14.52/1.16^2 + 15.97/1.16^3 + 169.31/1.16^3$
• V0 $= 11.38 + 10.79 + 10.23 + 108.47 = \mathbf{\text{Rs. } 140.88}$

Part (a): Net Asset Value

• Portfolio value $= 2,000(120) + 3,000(140) + 4,000(150) + 5,000(110)$
• Portfolio value $= 240,000 + 420,000 + 600,000 + 550,000 = \text{Rs. } 1,810,000$
• NAV $= (1,810,000 - 100,000) / 50,000 = 1,710,000 / 50,000 = \mathbf{\text{Rs. } 34.20}$ per share

Part (b): Premium or Discount at Rs. 32

The fund sells at a 6.43% discount to NAV (typical of closed-end funds).

Part (a): Price-Weighted Indexes

• PWI(Day 0) $= (80 + 100 + 120) / 3 = \mathbf{100.00}$
• PWI(Day 1) $= (90 + 110 + 130) / 3 = \mathbf{110.00}$
• Day 2 divisor adjustment (Beta splits 2-for-1): new divisor $= (110 + 65 + 120) / 110 = 295 / 110 = 2.6818$
• PWI(Day 2) $= 295 / 2.6818 = \mathbf{110.00}$ — the split itself changes nothing.

Part (b): Day 1 Return (PWI)

Part (c): Value-Weighted Indexes (Base 100)

• MV0 $= 200(80) + 300(100) + 400(120) = \text{Rs. } 94,000$
• MV1 $= 200(90) + 300(110) + 400(130) = \text{Rs. } 103,000 \Rightarrow$ VWI1 $= 100 \times 103,000/94,000 = \mathbf{109.57}$
• MV2 $= 200(110) + 600(65) + 400(120) = \text{Rs. } 109,000 \Rightarrow$ VWI2 $= 100 \times 109,000/94,000 = \mathbf{115.96}$

(Splits need no VWI adjustment since market value is unaffected; Beta’s rise to Rs. 65 post-split, i.e. Rs. 130 pre-split equivalent, is genuine appreciation.)

Part (d): Day 2 Return (VWI)

Part (a): Sharpe Indexes $(R_p - R_f)/\sigma_p$

• A: $(16 - 5) / 12 = 11 / 12 = \mathbf{0.92}$
• B: $(14 - 5) / 5 = 9 / 5 = \mathbf{1.80}$
• C: $(11 - 5) / 7 = 6 / 7 = \mathbf{0.86}$

Part (b): Treynor Indexes $(R_p - R_f)/\beta_p$

• A: $(16 - 5) / 1.15 = 11 / 1.15 = \mathbf{9.57}$
• B: $(14 - 5) / 1.05 = 9 / 1.05 = \mathbf{8.57}$
• C: $(11 - 5) / 0.80 = 6 / 0.80 = \mathbf{7.50}$

Part (c): Interpretation

Sharpe ranks B > A > C — Portfolio B earns the most per unit of total risk thanks to its tiny 5% volatility. Treynor ranks A > B > C — Portfolio A earns the most per unit of systematic (beta) risk. The rankings differ because Sharpe rewards low total volatility while Treynor only prices beta exposure: B’s risk is mostly diversifiable, so Treynor gives it no credit for avoiding it.

Part (d): Which Measure to Prefer?

Prefer Treynor when the portfolio is one slice of a larger diversified fund (only systematic risk matters, diversifiable risk washes out). Prefer Sharpe for a stand-alone portfolio an investor holds alone, since total volatility is then the true risk borne.

Investment Process for Financial Assets in Nepal

1. KYC and Demat Account: Open a dematerialized account with a CDSC-licensed depository participant — citizenship, PAN, photograph, and bank details required.
2. Broker Selection: Choose a SEBON-licensed broker (NEPSE member) and sign the client agreement.
3. Trading (TMS) Account: Activate the broker’s online Trade Management System login for order placement.
4. Fund Transfer: Load the trading wallet via connectIPS, bank transfer, or cheque through the linked bank account.
5. Order Placement: Enter buy/sell orders (market or limit) on TMS during NEPSE trading hours; orders match on price-time priority.
6. Clearing and Settlement: Trades clear through CDSC on a T+2 cycle — shares credit to demat, funds settle to bank.
7. Monitoring and Review: Track holdings, corporate actions (dividends, bonus/rights), and rebalance toward goals.

Present Investment Environment in Nepal

Nepal’s investment environment has deepened rapidly: demat accounts run into millions, daily NEPSE turnover is a household topic, and banks, insurers, hydropower companies, and mutual funds compete for savings. Growth drivers include a young investor base, mobile trading (TMS), expanding merchant banking, and steady hydropower and banking listings. Constraints remain — limited free float, high retail speculation, thin corporate bond supply, and policy swings around margin lending and capital gains tax.

Types of Security Markets in Nepal

1. Primary Market: New securities are issued via IPO, FPO, and rights offerings approved by SEBON and managed by issue managers; applicants apply through C-ASBA.
2. Secondary Market (NEPSE): Listed shares, debentures, and mutual fund units trade continuously through licensed brokers with T+2 CDSC settlement.
3. Money Market: NRB, commercial banks, and finance companies deal in T-bills, interbank lending, and short-term deposits.
4. Bond Market (developing): Government development bonds plus NEPSE-listed corporate debentures; institutional base led by CIT, EPF, insurers, and the Social Security Fund.
5. Mutual Fund Market: Mostly closed-end schemes trading on NEPSE at premiums or discounts to NAV, alongside a growing open-end segment.

Reading Note

The Third-state return of Stock N is printed as “(5” — read as (5), i.e. −5%, per the standard accounting convention that parentheses denote negative values.

Part (a): Expected Returns

• E(M) $= 0.30(10) + 0.40(15) + 0.30(20) = 3 + 6 + 6 = \mathbf{15\%}$
• E(N) $= 0.30(35) + 0.40(15) + 0.30(-5) = 10.5 + 6 - 1.5 = \mathbf{15\%}$

Part (b): Standard Deviations

• Var(M) $= 0.30(-5)^2 + 0.40(0)^2 + 0.30(5)^2 = 7.5 + 0 + 7.5 = 15$; SD(M) $= \mathbf{3.87\%}$
• Var(N) $= 0.30(20)^2 + 0.40(0)^2 + 0.30(-20)^2 = 120 + 0 + 120 = 240$; SD(N) $= \mathbf{15.49\%}$

Part (c): Coefficients of Variation

• CV(M) $= 3.87 / 15 = \mathbf{0.26}$; CV(N) $= 15.49 / 15 = \mathbf{1.03}$
• Prefer Stock M — identical 15% expected return at roughly one-quarter the relative risk.

Part (d): Correlation Coefficient

• Cov(M,N) $= 0.30(-5)(20) + 0.40(0)(0) + 0.30(5)(-20) = -30 + 0 - 30 = -60$
• $\rho = -60 / (3.87 \times 15.49) = -60 / 60 = \mathbf{-1.0}$ — perfect negative correlation.

Part (e): 45/55 Portfolio

• E(Rp) $= 0.45(15) + 0.55(15) = \mathbf{15\%}$
• Var(Rp) $= 0.45^2(15) + 0.55^2(240) + 2(0.45)(0.55)(-60) = 3.04 + 72.60 - 29.70 = 45.94$
• SD(Rp) $= \sqrt{45.94} = \mathbf{6.78\%}$

Part (a): Current Yield

Part (b): Yield to Maturity

Solve $110 \times PVIFA(r, 5) + 1,000/(1+r)^5 = 950$:

• At 12.5%: $110(3.5606) + 554.93 = 391.66 + 554.93 = 946.59$ (too low a price → rate too high)
• At 12.4%: $110(3.5694) + 557.40 = 392.63 + 557.40 = 950.03 \approx 950$

Part (c): Capital Gain

Part (d): Buy Decision

Yes, buy. The bond’s YTM (12.40%) exceeds the required 12% return, so at Rs. 950 it is underpriced relative to the required yield.

Part (e): YTM vs Yield to Call

YTC replaces maturity with the call date and par with the call price; investors use the lower of the two (yield-to-worst) for callable issues.