CHAPTER – 1 INTRODUCTION Boosting of nation's economic growth and solving the problem of underdeveloped economy is widely depends upon the nature of its economic infrastructure. One of the basic elements in achieving a self-reliant growth of the economy and for sustaining the desired level of economic development is an accelerated rate of investment or capital formation in the economy and the rate of investment or capital formation depends upon the efficiency of financial markets and institutions. The financial systems or markets perform this function by channeling the nation's saving into best uses. It does this by bringing together those who have surplus funds to lend and those who wish to borrow to finance their expenditures. This financial market is broadly classified as Money Market and Capital Market. Money market refers to a market where debt securities or less than one-year maturity are traded whereas capital market is the market for long-term debt and corporate stocks. The existence of an organized securities market is considered to be a pre-requisite for a modern free enterprise as well as for a mixed economy. 1.1 Capital Market: Investment decisions are taken within the framework provided by a complex of financial institutions and intermediaries, which together comprise the capital market. “Capital market means any body or individuals, whether incorporated or not, constituted for the purpose of regulating or controlling the 1
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
CHAPTER – 1INTRODUCTION
Boosting of nation's economic growth and solving the problem of
underdeveloped economy is widely depends upon the nature of its
economic infrastructure. One of the basic elements in achieving a self-
reliant growth of the economy and for sustaining the desired level of
economic development is an accelerated rate of investment or capital
formation in the economy and the rate of investment or capital
formation depends upon the efficiency of financial markets and
institutions. The financial systems or markets perform this function by
channeling the nation's saving into best uses. It does this by bringing
together those who have surplus funds to lend and those who wish to
borrow to finance their expenditures. This financial market is broadly
classified as Money Market and Capital Market. Money market refers to a
market where debt securities or less than one-year maturity are traded
whereas capital market is the market for long-term debt and corporate
stocks. The existence of an organized securities market is considered to
be a pre-requisite for a modern free enterprise as well as for a mixed
economy.
1.1 Capital Market:
Investment decisions are taken within the framework provided by a
complex of financial institutions and intermediaries, which together
comprise the capital market. “Capital market means any body or
individuals, whether incorporated or not, constituted for the purpose of
regulating or controlling the business of buying selling or dealing in
securities.” (Bhalla, 1995: 21) It is just the market for capital funds. The
word capital used in this context implies a long-term commitment on the
part of the lender and long-term need for the funds on the part of the
borrower. Both lenders and borrowers coming together in capital market
to play effective financial intermediary role in primary and secondary
market through the use of various long-term capital market instruments.
1
It has a vital role in promoting efficiency and growth. It intermediates the
flow of funds from those who want to save a part of their income from
those who want to invest in productive assets. It is the market, which
provides the mechanism for channeling current savings into investment
in productive facilities, that is, for allocating the county’s capital
resources among alternative uses. In effect, the capital market provides
an economy’s link with the future, since current decisions regarding the
allocation of capital resources are a major determining factor of
tomorrow’s output. The capital market plays a crucial role in shaping the
individual investment and portfolio decisions.
Capital market consists of securities market and non-securities market.
Securities markets implies mobilization of the funds through issuance of
the securities like shares, bonds and debentures by corporate sector and
bond, bills and debentures by government. These securities traded in
the secondary market are generally negotiable and hence can be traded
in the secondary markets. Non-securities market refers to the
mobilization of the financial resources by the financial institutions in the
form of deposits and loans.
Primary and secondary markets are the two wings of the capital market.
Primary market concerns with the issue of new companies stock whereas
the secondary market deals with the previously issued shares. The
majority of all capital market transactions occur in the secondary
market. The proceeds from the sale of securities in this market do not go
to the original issuer which means that it does not create new additional
capital. In other words, securities are traded among the individual as
well as institutional investors.
The structure of capital market can be shown as follows:
Chart:1.1: Structure of Capital Market
2
Capital Market
Security MarketNon-Security Market
Debt MarketEquity Market
Primary Market
Secondary Market
Corporate Debt Market
Government Debt
Bank Deposit
Business Venture
Fixed Assets
Other Sectors
1.2 Prices of Securities
The force of supply and demand interacts to determine a stock market
price. Prices move in trends because of an imbalance between supply
and demand. When the supply of a stock is greater than the demand,
the trend will be down as there are more sellers than buyers. When
demand exceeds supply, prices tend to rise. There are essentially two
concepts to explain the movement of stock price. They are
i) Technical Analysis
ii) Fundamental Analysis
In technical analysis, the analysis record historical financial data in
charts, study these charts in an effort to find meaningful patterns, and
use these patterns to predict future prices. Some charting techniques
are used to predict the movements of a single security; some are used
to predict the movements of a market index; and some are used to
predict both the action of individual securities and the market action.
Fundamentalists forecast stock prices on the basis of economic, industry,
and company statistics. The principal decision variables ultimately take
the form of earnings and dividends. The fundamentalist makes a
judgment of the stock's value with risk return framework based upon
earnings power and the economic environment. Fundamental analysis is
an essential, core skill for any investor as well as it helps to evaluate a
company on the basis of its sales, earnings, dividends, products,
management and other economical and industrial outlook.
1.3 Variables Affecting the Prices of Securities
Basically, price of securities is determined by the interaction of demand
and supply of corresponding securities. There are many other reasons
3
Political FactorsPolitical Factors
-Dissolve of Parliament- Ashoj-18, 2059 Event-5 Parties Movement- Maoist Insurgency (Cease fire, Peace talk and rupture of peace talk and re-starting of war) - Sep-11, 2001 event of New York - Maoist Insurgency- World-Wide Terrorism - Sep-11 event
Stock Market Price
Stock Market Price
Socio-Cultural FactorsSocio-Cultural Factors
-Traditional Investment Procedure of Nepalese- Social Attitude and Beliefs toward Investment- Investors’ Knowledge on Stock Exchange
Technological FactorsTechnological Factors
- Evolving of E-transaction- Information on Web- OTC market- Traditional Way of Transaction in NSE
Economic FactorsEconomic Factors
- Dividend Policy and profitability of the Company- Present Economic Condition- Interest Rate and Inflation- Tax System- Nepal’s Entry in WTO- Government Monetary Policy- Fiscal and Monetary Policy
that cause the stock price fluctuation. Major of them can be classified as
political factors, economic factors, socio-cultural factors and
technological factors. These variables may be closely related to the
internal factors of the corresponding companies like the dividend policy
of the company, business volume and profitability position of the
company or to the external factors like the economic condition of the
nation, government’s monetary policy, political environment of the
country etc. For this research purpose some important variables of these
classified factors are taken and analyzed on the basis of primary as well
as secondary data. As a whole, these major factors (internal and
external) that affect the price of the security can be presented on the
following chart:
Chart 1.2 : Factors Affecting Price of Securities
4
Out of these factors or variables the following major events or variables
have been taken for analyzing as research variables:
Event of “Ashwin-18, 2059 (4-Oct, 2002)”
Ceasefire on Magh 15, 2059 (29-Jan, 2003) and starting of peace-
talk
5 major political parties' movement during last seven months
Rupture of peace-talk and re-starting war at Bhadra-10, 2060
(August-27, 2003)
Nepal's entry in World Trade Organization (WTO) at Bhadra-25,
2060 (Sep-11, 2003).
1.4 Statement of the Problem
The number of public limited companies is increasing tremendously in
response to the economic liberalization and globalization policies
adopted by the Nepalese government. Such institutions are provide
banking services, insurance services and participating in developmental
works, manufacturing and processing and other various service sectors.
Although Nepal’s capital market’s history is short, the concept of capital
market is growing rapidly within a short span of time. It is mandatory to
enlist the public limited companies in Nepal Stock Exchange (NEPSE)
which creates liquidity on shares of such companies issued in the
primary market and provides floor for trading of shares. Up to now, there
are altogether 108 such companies, which are listed in NEPSE. (SEOBN-
Annual Report, 2002/03: 8)
Investors purchase the stocks of the companies through the primary
market (initial offering) or through the secondary market. Most of these
investors are not aware of the financial strength of the companies and
they do not analyze company’s financial indicators before they invest
their funds through secondary market – NEPSE. The market price of
common stock (share) does not seem to be in accordance with the
financial indicators – Net Worth per Share (NWPS), Earning per Share
(EPS), Dividend per Share (DPS) and last year's dividend. Instead, in
5
determination of the market price of share, there has been major
influence of rumors rather than strength of the companies. The Market
Price per Share (MPS) of commercial banks, especially foreign joint
venture Banks' has been much higher than MPS of other sectors.
Moreover, the overall NEPSE is depended upon MPS of such companies.
Generally, the trend is that the MPS of public quoted companies is above
their book value. The market value is determined by the supply and
demand functions. However, in an efficient market MPS fully reflects all
the historical information publicly available.
Here arises the question of efficiency of the Nepalese share market. The
high movement of share prices may be the outcome of the efficient
market behavior. An article in Spot Light states that "our stock market is
not efficient enough since all the listed companies do not make past
information available to shareholders. Many listed companies do not
produce timely financial statement or annual reports to the investors.
The dubious and hazardous movement of share prices has no sound
fundamental backing of analysis and relationship to past results revealed
in limited calculated dividend yield, net worth and price multiples. The
investors conclude that there has been a foul play using inside
information. The reaction is based on the assumption of strong form of
the market efficiency. The Security Exchange Act strictly prohibits the
misuse of inside information but the regulating authorities can make no
advance notice of how there is the use of inside information" (Subedi,
2002: 5). It denotes that every investor should be well aware of the
degree of risks in which they are investing or going to invest their saving
funds. There are very few practices of analyzing this aspect in the
Nepalese context. Most of the investors are investing their funds
haphazardly without considering risk involved in their investments.
That’s why the major issues might be whether the MPS of listed
companies, especially for selected companies, are really representing
the financial indicators, i.e. NWPS, EPS, and DPS etc.
6
More specifically, the research questions are:
1. What are the major financial indicators which have major influence
on determining the MPS?
2. Is there any specific relationship of MPS with fundamental
financial indicators (EPS, NWPS, DPS, and current year’s dividend)
or is the trend of MPS running in accordance with these financial
indicators?
3. Are the common stocks of the sampled companies are equilibrium-
priced?
4. How much the signaling and informational factors affect the share
price?
5. Whether the investors are aware of the trend of financial indicators
which have major influence on determining MPS and how much the
investor rational in terms of investment return of the common
stocks investment?
1.5 Objective of the Study
1. To identify of major financial indicators which affects on
determining the MPS.
2. To examine and evaluate the relationship of MPS with various
financial indicators like; EPS, NWPS, DPS and current year’s
dividend.
3. To identify whether stocks of the sampled companies are over-
priced, under-priced or equilibrium priced.
4. To study the signaling and informational effect on share price.
5. To examine Nepalese investors’ response on the change of price of
stock.
6. To provide suggestions on the basis of findings.
1.6 Limitation of the Study
The study will have some limitations. Basically the study is done for the
partial fulfillment of masters of business studies. Time constraints,
7
financial problem and lack of research experience will be the primary
limitation and other limitations are as follows:
1. The study will confine only to Nepal Stock Exchange and its
members.
2. The study has to be done on the secondary data of selected ten
companies of financial indicators, five from private joint venture
banks and three from selected finance companies and rest two
from insurance companies among the companies in the NEPSE.
Due to the lack of data other sectors can not be used.
3. This research study is mainly based on secondary data, which
have been collected from books, financial statement and report of
the Security Board of Nepal (SEBON) and Nepal Stock Exchange
and selected company's' annual report, company's web site and
other publications. The study covers the information of only few
fiscal years' data.
4. Foreign information and rules affecting the share market is
ignored.
5. Studies and reference were also extremely limited in the
prospective of Nepalese stock market.
1.7 Test of HypothesisOn the basis of the earlier stated variables and events which affect the price of securities, the following hypotheses have been set:
1. Null Hypothesis: There is no significant change in share price
before and after the Ashwin-18, 2059 (4-Oct, 2002) event.
Alternative Hypothesis: There is significant change in share
price before and after the Ashwin-18, 2059 (4-Oct, 2002) event.
2. Null Hypothesis: There is no significant change in share price
before and after the Ceasefire on Magh 15, 2059 (29-Jan, 2003)
and starting of peace-talk.
Alternative Hypothesis: There is significant change in share
price before and after the Ceasefire on Magh 15, 2059 (29-Jan,
2003) and starting of peace-talk.
8
3. Null Hypothesis: There is no significant change in share price
before and after the five major political parties' movement.
Alternative Hypothesis: There is significant change in share
price before and after the five major political parties' movement.
4. Null Hypothesis: There is no significant change in share price
before and after the rupture of peace-talk and re-starting war at
Bhadra-10, 2060 (August-27, 2003).
Alternative Hypothesis: There is significant change in share
price before and after the rupture of peace-talk and re-starting war
at Bhadra-10, 2060 (August-27, 2003).
5. Null Hypothesis: There is no significant change in share price
before and after Nepal's entry on WTO on Bhadra-25, 2060 (Sep-
11, 2003).
Alternative Hypothesis: There is significant change in share
price before and after the Nepal's entry on WTO on Bhadra-25,
2060 (Sep-11, 2003).
1.8 Organization of the StudyThe whole study will be divided into following five chapters:
Chapter 1: First chapter deals with introduction. This includes
background, statement of problem, objectives of the study,
limitation of the study and organization of the study.
Chapter II: Second chapter deals with the review of available
literature. It includes review of previous unpublished
Master degree thesis, books, journals, articles etc.
Chapter III: Third chapter explains the research methodology used in
the study. It includes research design, population and
sampling, sources of data, method of data analysis and
research variables etc.
Chapter IV: This chapter includes the brief outline of stock market in
Nepal.
9
Chapter V: The fifth chapter, the important chapter of the study will be
the presentation & analysis of data.
Chapter VI: The sixth & last chapter summarizes the main conclusion
that flows from the study and offers suggestion for further
improvement and conclusion of the study.
10
CHAPTER - 2REVIEW OF LITERATURE
The basic concern of the study is to focus on the pricing behaviour of the
stocks of the companies listed in Nepalese Stock Exchange. So, in this
chapter, an attempt is made to review some of the literature concerning
the stock market in Nepal and aboard as well as the market price
behaviour. The price behaviour of the stock and its trading activity has
got the tremendous concentration in security investment. So, a better
understanding of these determinants may increase investors' confidence
in the stock market and thereby enhance the effectiveness of corporate
resource allocation. Hence more and more concerns over pricing
behaviour are arising and most of the concerned books bear some
paragraph on this issue.
2.1 Conceptual Framework:
2.1.1 Capital Market:
A place where long term lending and borrowing takes place is known as
capital market. Therefore, the capital market is the market for long term
borrowing and lending. The primary instruments of the capital market
are stock and bonds (equity and debts). Therefore it includes both the
new issue market and the old market. Capital market is concerned with
long term finance; widely it consists of series of channels through which
the saving of the community are made available for industrial and
commercial enterprises and authorities. It is concerned with that private
saving, individual as well as corporate, that are turned into investment
through new capital issue and also new public loan floated by
government and semi government bodies. In capital market demands for
funds comes from agriculture, industry, trade and government while the
supply of funds comes from individual or corporate savings, institutional
investors and surplus of government.
The history of capital market is not so old for Nepalese context. The
Capital Market was developed by the establishment of Security
Exchange Center on 2033 B.S. The number of listed companies and their
11
trading was very negligible until the government of Nepal has made
economic reforms along with broad financial policy in the process of
economic liberalization. The privatization of public entities has been
started and various banking and finance companies as well as other
companies in the private sector are being established with local and
foreign investments. As they were established as public companies,
these companies have to issue some of their share of the general public.
So, the development of the security market in Nepal takes its pace only
the establishment of these banking and finance companies.
2.1.2 Security Market:
Security Market interchangeably known as the integral part of capital
market is in fact basis of the economy of a country. The most effective
use of idle and surplus resources can be brought into practice only by
means of market mechanism. Security market, a structural network of
savers and users of fund, is such a market mechanism which mobilized
the fund of savers to the users and thus this financialization boosts the
industrialization and trading activities, which will bring the positive result
to the economy as a whole. (Sharma, 2002:16)
There are two important functions of securities market, namely the
raising of funds in form of shares and debentures and trading in the
securities already issued by companies. While the first aspect is
obviously much more important from the point of view of economic
growth, the second aspects is also considerably important. In fact, if
facilities for transferring of existing securities are abundant, the raising
of new capital is considered assisted as the buyer of a new issue of
security become confident that whenever he wants to get cash he can
find a buyer of the security without much difficulty. This aspect is called
the liquidity of the stock market. Thus the liquidity of the stock market
affects the raising of new capital from the market. (Levine, 1992: 33)
Security market sets a price for the securities it trades and makes it easy
for people to trade them. Securities market facilitates the sale and resale
of transferable securities. The security market can be defined as a
12
mechanism for bringing together buyer and sellers of financial assets to
facilitate trading. Securities market is classified into two; the market in
which new securities are sold is called the primary market and the
market in which existing securities are resold is called the secondary
market. Secondary markets are created by brokers, dealers and market
makers. Brokers bring buyer and seller together with themselves
actually buying or selling; dealers set price at which they themselves are
ready to buy and sell (bid and ask price respectively). Broker and dealer
come together organized market or in stock exchange. (Gitman, 1992:
457)
2.1.3 Stock Exchange:
The stock exchange is an institution where quoted securities are
exchanged between buyers and sellers. The stock exchange provides
market in a wide range of traded securities, generally of medium to long-
term maturities, issued by companies, government and public
organizations. (Winfield, 1985: 22)
Most of the investors are attracted to the equity shares because of its
marketability and liquidity. One may like to buy more shares or selling
existing shares from time to time when he is in need of money or when
he wants to shuffle his portfolio. Since the stock exchange is a place
where a large number of buyers and sellers congregate, one can, by and
large, easily find his counterpart for sale or purchase of shares. The
investor can convert his shares into cash at the prevailing market prices
readily. The existence of a stock exchange facilitates all these functions
without which it is almost impossible to do so.
The key function of securities exchange is to create a continuous market
for securities at a price that is not very different from the price at which
they were previously sold. The continuity of securities market provides
the liquidity necessary to attract investor's funds. Without exchanges,
investors might have to hold debt securities to maturity and equity
securities indefinitely. It is doubtful that many people would be willing to
invest under such conditions. A continuous market also reduces the
13
volatility of security prices further enhancing liquidity. (Gitman, 1992:
458)
The securities exchanges help to allocate scare fund to the best uses.
That is by disclosing the price behavior of securities and requiring the
disclosure of certain corporate financial data; they allow investors to
access the securities risk and return and to move their fund into the
promising investments. An efficient market is one that allocates fund to
the most productive uses. Along with this, there is lot of functions of
security exchange such as ready market and continuous market,
evaluation of securities, safety of transactions, canalization of savings
and widening the share ownership etc. However, besides these
functions, there are three things a security exchange must do:
Determine a fair price for the securities it trades or price discovery
function.
Enable transaction to be made at as low cost as possible or
minimization of transaction cost.
Enable transaction to be made at this price quickly and easily or provision for liquidity.
Main Function of Stock Exchange: Price Discovery
Security is a legal representation of the right to receive future benefits
under conditions. Its value depends on expectation of the amount of
those benefits and evaluation of risk involved. Expectation and
evaluation reflect both the information available and the conclusions
people draw from that information. Since the market may quite big, no
single buyer or seller can influence the price of a share to any significant
extent.
Price discovery is the process of arriving at fair prices for securities. Fair
price indicates the compromise between fair offer price (lowest price at
which any well informed trader willing to sell) and fair bid price (highest
price any well informed buyer is willing to pay). Different markets do this
in different way and different ways of organizing a market affect how
closely the market approaches the ideal of fair prices. However, a very
14
important fact that should not be forgotten is the concept of ideal
market or market efficiency, which also the necessary pre-condition for
approaching to the fair price. In an ideal market value of securities equal
its price of securities and prices reflects all available information about
the market.
In the securities market there is a great importance of demand and
supply for price fixation. The price of a given stock is determined
exclusively by the interacting forces of supply and demand converting
on such stock at a given time, that the price and volumes of its past
transactions are meaningful indications of the probable relationship of
the future and demand pressure it is likely to encounter in the market
and that such relationship is the most important element in determining
the probable direction of the price movements. (Ackerman, 1980: 85)
The stock exchange produces, through its continuous process of
evaluation, prices of securities, as close as possible to investment value
based on present and future income yielding prospects of various
enterprises, capitalized at 'notional rate of interest' the rate which will
prevail if and when all the liquid savings are employed into productive
purposes. (Gupta, 1982: 148)
2.1.4 Price Determination:
The share price is determined in the floor by the interaction of market
forces i.e. demand and supply. The price is determined by the point of
equilibrium between supply and demand, the shifting of this balance
results in incessant adjusting of price in search of the ever-changing new
equilibrium. Then market price moves upward and downward. There are
many other reasons that causes the stock price fluctuation, major of
them are economic, non-economic and market factors.
Dividend is the most important factors on the determination of stock
price. Dividends are strongly influenced by the earnings power of the
15
firm. There is a very close correlation between corporate earnings &
dividends. Earning power, in turn, is strongly influenced by interest rates.
In this way, the most fundamental factor in stock price fluctuation lies in
changes in corporate earnings, which together with interest rates and
business cycle trends, contribute to making up the economic factors
influencing stock price.
The next influencing factors are non-economic factors, including changes
in political conditions, such as administrative changes, change in the
weather and other natural conditions, and changes in cultural conditions,
such as technological advance and the like. Similarly the other
influencing factors are market factors, or internal factors of the market,
considering of the tone of the market and supply-demand relations, may
be cited as the third category, that influences the stock prices. Besides
these factors the stock prices are influenced by the corporate
performance of the company, company’s policy regarding the
capitalization of earnings as well as government rules & signaling effect
of the market.
2.1.5 Theory of Price Behavior
The forces of supply and demand interact to determine a stock market
price. If demand is high and supply is low then the price of stock goes up
and vice-versa. There are essentially two schools of thought to explain
the stock price behavior. They are:-
i) Inefficient Market Theory
ii) Efficient Market Theory
Inefficient Market Theory:
Conventional approach has considered that market is inefficient, which
includes technical analysis theory. “Prior to the development of the
efficient market theory, investors were generally divided into two
groups, Fundamentalists and Technicians.” (Reilly, 1986: 347) The two
groups are analyzed as follows:
Technical Analysis
16
Technical analysis is based on the widely accepted premise that security
prices are determined by the supply of and demand for securities. The
tools of technical analysis are therefore designed to measure supply and
demand. Typically, technical analysts record historical financial data on
charts, study these charts in an effort to find meaningful patterns to
predict future prices. Some charting techniques are used to predict the
movements of a single security; some are used to predict the
movements of a market index; and some are used to predict both the
action of individual securities and the market action. The basic
assumptions underlying technical analysis are listed below:
- Market value is determined solely by the interaction of supply and
demand.
- Supply and demand is governed by numerous factors, both
rational and irrational.
- Aside from the effected of minor fluctuations in the market, stock
prices tend to move in trends that persist for appreciable lengths
of time.
- Changes in trends are caused by shifts in supply and demand.
- Shifts in supply and demand, no matter why they occur, can be
detected sooner or later in charts of market action.
- Some chart patterns tend to recur, and these recurring patterns
can be used to forecast price movements.
Technical theory involves study of the past volume and price data of the
securities to predict future price fluctuations. Technical analysis theory
of share price behavior is based on past market information. On the
assumption that history tends to repeat itself, it is believed that
knowledge of past patterns of share prices will help to predict future
prices under similar circumstances. It involves the study of past market
behavior with reference to various financial and economic variables are
to forecast the future. The changes occur in financial and economic
variables are to be adjusted in the light of the present situation.
Technical analysts or chartist, as they are commonly called, believe that
they can discern patterns in price or volume movements, and that by
17
observing and studying the past behavior patterns of given stocks, they
can use this accumulated historical information to predict the future
price movements in the security. Technical analysis comprises many
different subjective approaches, but all have one thing in common that
is, belief that these past movements are very useful in predicting future
movements. Technical analyst believes in the theory behind chart
formations and patterns. They read charts much like ancient astrologers
read the stars, looking for "head and shoulders" formations. These, they
believe, reflect the patterns of buying and selling, accumulation and
distribution, or market psychology.
Stock prices always move in trends because of an imbalance between
supply and demand. When the supply of a stock is greater than the
demand, the trend will be down as there are more sellers than buyers;
when demand exceeds supply, the trend will be up as buyers "bid up"
the price; and if the forces of supply and demand are nearly equal, the
market will move sideways in what is called a "trading range".
Eventually, new information will enter the market and the market will
begin to trend again either up or down, depending on whether the new
information is taken as positive or negative. Trend which are very brief
are called minor trends; those lasting a few weeks are known as
intermediate trends; and trends lasting for a period of months are major
trends. By analyzing trend lines we can determine what trend is in force.
It helps us to act safe in market both in bullish and bearish market.
Price moves in trends. A trend indicates there exist an inequality
between the forces of supply and demand. Such changes in the forces of
supply and demand are usually readily identifiable by the action of the
market itself as displayed in the prices. Certain patterns or formations
that appear on the charts have a meaning and can be interpreted in
terms of probable future trend development.
Dow Theory
The Dow Theory is one of the oldest and most famous technical tools
and was originated by Charles Dow, who founded the Dow-Jones
18
Company and was the editor of The Wall Street Journal around 1900. The
Dow Theory is used to predict traversal and trends in the market as a
whole or for individual securities. According to Charles Dow, the market
is always considered as having three movements, all going at the same
time. The first is the narrow movement form day to day. The second is
the short-swing, running from two weeks to a month or more; the third is
the main movement covering at least four years in duration.
Dow Theory practitioners refer to these three components as:
1. Primary Trends: They are commonly called bear or bull markets.
Delineating primary trends is the primary goal of the DOW
theorists.
2. Secondary Movements: Secondary movements are sometimes
called corrections which last only a few months.
3. Tertiary Movements: These are simply the daily fluctuations.
The Dow Theory asserts that daily fluctuations are essentially
meaningless random wiggles. Nonetheless, the chartists should
plot the asset's price or the market average each day in order to
trace out the primary and secondary trends. (Francis, 1986: 524)
Fundamental Analysis
Fundamental analysis approach involves working to analyze different
factors such as economic influences, industry factor, governmental
actions, firm’s financial statement, its competitor and pertinent company
information like product demand, earnings, dividends and management
in order to calculate an intrinsic value for firms’ securities. The analyst
who believes on fundamental facts to determine the intrinsic value of
stock is popularly known as fundamental analyst or fundamentalist.
Fundamentalists forecast stock price on the basis of economic, industry
and company statistic. The principal decision variables ultimately take
form of earrings and value with as risk- return framework based upon
earning power and the economic environment. “Fundamental analysts
believe into companies’ earnings, their management, economic outlook,
firms’ competitor's market conditions and many other factors.” (ibid)
19
The objective of fundamental security analysis is to appraise the intrinsic
value of a security. The intrinsic value is the true economic work of
financial assets. “ The fundamentalists maintain that any points of time
every stock has an intrinsic value, which should in principle be equal to
the present value of the future stream of income from that stock
discounted at an appropriate risk related rate of interest”(Bhalla, 1983:
283). Therefore the actual price of security is considered to be a function
of a set of anticipation. Price changes as anticipation changes which in
turn change, as a result of new information. In other words; a new piece
of news is released, securities market prices will adjust towards the new
values.
“The value of common stock is simply the present value of all the future
income which the owner of the share will receive”(Francis,1986: 398).
And the actual price should reflect intrinsic value of the stock i.e. good
anticipation of cash flows and capitalization rate corresponding to future
time period. But in practice, first it is not known in advance what the
appropriate discount rate should be for a particular stock. Therefore
fundamentalists estimate their intrinsic value by studying in detail of all
matters that is relevant to company. There are various models developed
by fundamentalists to reflect the price of the securities. Some of them
are as follows:
Capital Assets Pricing Model (CAPM)
The basic foundation of the theory was laid down in the microeconomics
studies of mean variance choice by Mrkowitz (1959) and Tobin (1958).
The critical extension to equilibrium in the capital market, and the
development of the CAPM, was accomplished by Sharpe(1964) and
Lintner (1965) (Stephen, 1978: 886). Like the portfolio models of
Markowitz and Tobin, the Sharpe-Lintner asset pricing model assumes a
market of risk-averse consumers who can make portfolio decisions on
the basis of the means and standard deviations of one period portfolio
returns, implicitly assuming that these standard deviations exist (Fama,
1971: 30). The CAPM substantiated the idea that, in competitive
20
equilibrium, assets earn premium over the risk less rate that increase
with their risk, by showing that the determining influence on risk
premium is the covariance between the asset and the market portfolio,
rather the own or intrinsic risk of the asset.(Stephen, 1978: 886) CAPM is
concerned with two key questions:
What is the relationship between risk and return for an efficient
portfolio?
What is the relationship between risk and return for an individual
security?
The CAPM is based on the following assumptions:
Individuals are risk averse
Individuals seek to maximize the expected utility of their portfolios
over a single period planning horizon.
Individuals have homogeneous expectations they have identical
subjective estimates if the means, variances and co-variances
among returns, expected returns & standard deviations.
Individuals can borrow and lend freely at a risk free rate of
interest.
The market is perfect; there are no taxes, there are no transaction
costs; securities are completely divisible; the market is
competitive.
The quantity of risky securities in the market is given.
Gorden’s model:
As per the Gorden’s model about relationship of dividend policy and
stock price, investors are not indifferent between current dividends and
retention of earnings. An increase in dividend payout ratio leads to
increase in the stock prices for the reason that investors consider the
dividend yield is less risky than the expected capital gain. Similarly
investors required rate of return increases as the amount of dividend
decreases. This means that there exists a positive relationship between
the amount of dividend and the stock prices.
The model is based on the following assumptions:
The firm is an all-equity firm.
21
No external financing is available.
Internal rate of return (r), appropriate discount rate (Ke) are
constant.
The firm and its stream of earnings are perpetual.
The corporate tax, do not exist.
The retention ratio (b) once decided upon is constant. Thus the
growth rate (g=br) is constant forever.
The discount rate is greater than growth rate, K>g.
As per this model, the relationship between stock price and dividend
varies on the following stages:
a) Growth firm (r>k): In case of growth firm the share price tends to
decline in correspondence with increase in payout ratio or decrease
in payout ratio or decrease in retention ratio. It means high dividend
leads to increase in share prices. Therefore dividends and stock
price are negatively correlated in such firms.
b) Normal Firm (r=k): The price of share remains constant
regardless of change in dividend. It means dividend and stock price
are free from each other in normal firm.
c) Declining Firm (r<k): The share price tends to rise in
correspondence with rise in dividend payout ratio. It means dividend
and stock prices are positively correlated with each other in a
declining firm.
J. E. Walter’s model:
As per the study of J. E. Walter on the relationship of dividend and stock
price, dividend policy of a firm affects its stock price. The relationship
between firms internal rate of return and cost of capital are the
determining factors to retain profits or distribution of dividend. The stock
price will be increased with the increase in the retention ratio of the firm
when the internal rate of return is greater than the cost of capital. Thus,
as per Walter zero dividend policy will maximize the market value of
share for growth firms.
Assumptions of Walter’s model:
22
Retained earnings constitute the exclusive sources of financing.
The firm does resort to debt or equity financing.
The firm’s internal rate of return and its cost of capital are
constant.
Value of earning per share (EPS) and dividend per share (DPS) are
remain constant.
The firm has perpetual life.
The firm distributes its entire earnings or retains it for immediate
reinvestment.
The relationship between stock price and dividend varies on the
following stages:
a) Growth Firm (r>k): If the firm’s internal rate of return exceeds
the cost of capital such firms are known as growth firms. The
relationship between dividend and stock price is negative on such
firms. It means that more dividend leads to decrease in stock price
and zero dividend will maximize the market value of shares for
such growth firms.
b) Normal Firm (r=k): If the firm’s internal rate of return and cost of
capital are equal, such firms are called normal firms and there is
no role of dividend on such firm’s stock price. Dividend payout
ratio does not affect the value of share whether the firm retains
the profit or distributes dividend.
c) Declining Firm (r<k): If the firm’s internal rate of return is less
than cost of capital, such firms are known as declining firms. The
relationship between dividend and stock price is positive that is
increase in dividend per share leads to increase in stock price of
such firms.
Thus, Walter concluded that when the firm is in growth stage then
dividend is negatively correlated with price of share. Similarly, in normal
firm there is no relationship between dividend and stock price. In the
same way, there is positive relationship between dividend and price of
stock in declining stage of firm.
23
Efficient Market Theory:
In a competitive market, the equilibrium price of any goods or services
at a particular movement in time is such that the available supply is
equated to the aggregate demand. This price represents a consensus of
the members trading in the market about the true worth of the good or
service, based on all publicly available information. As soon as a new
piece of relevant information becomes available, it is analyzed and
interpreted by the market. The result is a possible change in the existing
equilibrium price. The new equilibrium price will hold until yet another bit
of information is available for analysis and interpretation. “The role of
information is two-fold: (a) to aid in establishing a set of security prices,
such that there exist an optimal allocation of resources among firms and
an optimal allocation of securities among investors, and (b) to aid the
individual investor, who faces a given set of prices, in the selection of an
optimal portfolio of securities.” (Sharma, 2002: 27)
The word “Efficiency” as applied to securities market has unfortunately
been used to represent a variety of logically distinct concepts. In
particular it means: a) exchange efficiency (b) production efficiency and
(c) information efficiency. In this study, it is concerned only with
informational efficiency. “In an efficient market security prices ‘fully
reflect’ available information” (Fama, 1976: 133). Regardless of the form
of information, it is the key to the determination of stock prices;
therefore, it is the central issue of the efficient market concept.
An efficient market can exist if the following events occur:
1) A large number of rational, profit maximizing investors exist who
actively participate in the market by analyzing, valuing and trading
stocks. These investors are price takers; that is, one participant alone
can not affect the price of a security.
2) Information is free of cost and widely available to market participants
at approximately the same time.
3) Information is generated in a random fashion such that
announcements are basically independent of one another.
24
4) Investors react quickly and accurately to the new information,
causing stock prices to adjust accordingly. (Charles, 1943: 425)
In such a market, the current prices of a security obviously “Fully
Reflect” all available information. Similarly, “in a perfect and competitive
economy compared of rational individual with homogeneous beliefs
about future prices, by any meaningful definition present security prices
must fully reflect all available information about future prices.”
(Rubinstien, 1975: 812)
In an efficient market, market participants, acting in their own self-
interest, use available information to attempt to secure more desirable
(higher returns, ceteris paribus) portfolio position. In doing so they
collectively ensure that price movements in response to new information
are instantaneous and unbiased and will ‘fully reflect’ all relevant
information. Competition among participants to secure useful
information will drive security prices form one equilibrium level to
another so that the change in price in response to new information will
be independent of the prior change in price. Price change will be random
walk in response to the information.
“In an idle efficient market, every one knows all possible-to-know
information simultaneously, interprets it similarly, and behaves
rationally.” (Bhalla, 1974: 2). In such a world, the only price change that
would occur is due to the result from new information. “An initial and
very important premise of an efficient market is that there are large
numbers of knowledgeable and profit maximizing investors adjust the
information rapidly.” (Reilly, 1986: 166) “The degree of market efficiency
has important implications for the economy and for the investment
decision-makers. In an economic sense, it is important that security
prices provide accurate signals that can be used to allocate capital
resources correctly. Mis-priced security result in incorrect allocation of
capital.” (Cheney, 1997: 746)
In such a market, all prices are correctly stated and there are no
“bargains” in the stock market. “Efficiency in this context means the
25
ability of the capital markets to function so that prices of securities react
rapidly to new information. Such efficiency will produce prices that are
appropriate in terms of current knowledge, and investors will be less
likely to make unwise investments. A corollary is that investors will also
be less likely to discover great bargains and thereby earn extraordinary
high rates of return.” (Bhalla, 1974: 3)
The conclusion is that – “In an efficient market there are neither free
lunches nor expensive dinners. It is not possible to systematically gain or
lose abnormal profits from trading on the basis of available information.”
(Weston and Copland, 1996: 93-94). No one can consistently do better
than the average. “Efficient market theorists believe that some do better
then average because of luck. In fact they suggest that the ‘traders’ –
those who buy and sell their stocks frequently – do less well than the
stock market averages by an amount equal to the commissions they
pay.” (Rubinstien, 1975: 815)
One set of test of market efficiency examines the informational
efficiency of security prices. Existing model of efficient markets imply
that all relevant information regarding given stock is reflected in its
current market price. This notion of market efficiency can be divided into
three categories based on type of information used in making market
decisions. They are explained as follows:
a) Weak Form Market Efficiency: “Weak form market efficiency
hypothesizes that today’s security prices fully reflect all
information contained in historical security prices. This implies that
no investor can earn excess returns by developing trading rules
based on historical price or return information” (Weston and
Copland, 1996: 94)
b) Semi-strong Form Market Efficiency: It says that security
prices fully reflect all publicly available information. Thus, no
investors could earn excess return using publicly available
resources such as corporate annual reports, NEPSE price
information or published investment advisory reports. It contains
26
all publicly available data such as earnings, dividends, stock split
announcements, new products development, financing difficulties
and accounting changes. A market that quickly incorporates all
such information into prices is said to be semi-strong efficient. “If
the semi-strong hypothesis is true, then only a few than what
could be earned by using a naïve buy-and-hold strategy.” (Francis,
1986: 608)
c) Strong Form Market Efficiency: “The most stringent form of
market efficiency is the strong form, which asserts that prices fully
reflect all information, public and non public.” (Jones, 1943: 429) In
such kind of market, no group or investors should be able to earn,
over a reasonable period of time, excess rates of return by using
publicly available information in a superior manner. “An extreme
version of the strong form holds that all non public information,
including information that may be restricted to certain groups such
as corporate insiders and specialists on the exchanges, is
immediately reflected in prices. In effect, this version refers to
monopolistic access to information by certain market participants.”
(ibid)
Chart: 2.1 : Market Efficiency in Three Information Level
27
Strong FormAll Information
Semi-Strong FormPublic Information
Weak-Form Market Data
These three hypotheses are not mutually exclusive; they differ only in
the degree of market efficiency. It is notable point that a semi-strong
efficient market encompasses the weak form of the hypothesis because
price and volume data are part of the larger set of all publicly available
information. Strong-form efficiency encompasses the weak and semi-
strong forms and represents the highest level of market efficiency. It is
necessary for the weak form hypothesis to be true in order to the semi-
strong and strong form hypothesis to be true.
2.2 Review of Stock Market in International Context:
Numbers of research studies have been performed internationally on the
stock market. Some of them are as follows:
In 1900, Louis Bachelier first tested the random walk model. He tested
the model in commodity prices and found that those prices followed a
random walk. He presented the evidence that the commodity
speculation in France was a fair game. He also concluded that the
current price of a commodity was an unbiased estimate of its future
price. After the discovery of this model, large numbers of studies have
been done throughout the world.
In 1927, Slutsky proved that the randomly generated price changes look
like stock price changed and that they appear to exhibit cycles and other
patterns.
In 1933, Alfered Cowels found little evidence that stock market analysis
could predict future prices.
In 1937, Alfered Cowels and Herbert E. Jones reported that stock prices
moved with predictable trends. They gave a controversy to the random
walk model as valid share price behavior model in USA. This finding
remained a challenge against the random walk hypothesis for more than
two decades.
In 1953, Kendall made significant contribution to advance in the study of
the random walk model. He tested the model on the weekly price
28
changes of the 19 indices of British industrial shares and in the spot
price series of cotton (New York) and wheat (Chicago). He analyzed the
data by serial correlation coefficient and concluded that the subsequent
stock price movement forms random walk. He showed that the
successive price changes are statistically independent to its past price
changes.
In 1959, H.V. Roberts carried out simulation tests by comparing the
simulation of random numbers and the Dow Jones Industrial Average
Index (DJIA) for about one year starting from Dec-30, 1995 to Dec-28,
1956 and found similarity between these two series. He further observed
that the first difference of these two series produce the same pattern.
His work was significant in that he gave a number of methodological
suggestions for testing what he calls the chance model. In particular, he
suggested runs analysis for testing independence of price changes.
Moore (1962) studied weekly price changes of 30 randomly selected
stocks for the period 1951 to 1958 and found an average serial
correlation coefficient 1.06. The value was extremely low and indicated
that the weekly change data had almost no power in predicting future
prices changes.
Fama's study (1965) on the random walk model was one of the best
definitive and comprehensive ever study conducted. He observed the
daily proportionate prices of each 30 individual stocks of the Dow Jones
Industrial Average. The time periods covered started from end of 1957 to
26th, September 1962. He employed the statistical tools such as serial
correlation and runs tests to draw inference about dependence of the
price series. He calculated auto correlation coefficient for daily change in
log price series. He calculated auto correlation coefficient for daily
change in log prices for lag from 1 to 30 and found that the coefficient
for daily changes in average was +0.30, which is near to zero. But on the
daily price change in log prices for lag from 1 to 30 and found that the
coefficient for daily changes in average of +0.30, which is near to zero.
But on the daily price changes, 11 out of 30 stocks had correlation
29
coefficient more than twice their computed standard errors. The
coefficients ranged from smallest 0.06 to the largest 0.123. However,
Fama concluded, "Dependence as such as a small order of magnitude is
from a practical point of view, probably unimportant for both the
statistician and the investor". He also calculated serial correlation for lag
from 1 to10 for non-overlapping differencing intervals of four, nine and
sixteen days to examine the possibility if price change across longer
interval show dependence. All the results are again not significantly
different from zero.
Roa and Mukherjee (1971) applied spectral analysis to weekly prices of
an aluminum company's share and found no evidence contrary to
random walk model.
Fama and French (1998) pushed the common expected returns
argument for market efficiency one step further. They argued that there
are systematic patterns in the variation of expected returns through
time that suggested that it is rational. They find that the variation in
expected returns tracked by D/P or the default spread (the slopes in the
regressions of returns on D/P or the default spread) increase from high
grade bonds to low grade bonds, from bonds to stocks, and from large
stocks to small stocks. This ordering corresponds to intuition about the
risks of the securities. On the other hand, the variation in expected
returns tracked by the term spread is similar for all long term securities
(bonds and stocks), which suggests that it reflects variation in a common
premium for maturity risks. (Fama, 1991: 1584)
C.B. Gupta had commented that the capital market serves as a link
between suppliers and users of finance. It is a mechanism for the
mobilization of public savings and channeling them in productive
investments (Gupta, 1978: 325). Thus capital market works as a
powerful medium between potential investors and users of finance.
Formally the necessity of the capital market was felt not only by the
developed countries like U.S.A., U.K., Germany etc. but later as a
passage of time even the developing countries like India, Philippines,
30
Bangladesh, Nepal etc begins to feel its necessity. Now they adopted it
too.
In connection with the necessity of capital market, S.L.N. Simha in his
book "The Capital Market in India" has observed that capital is an
extremely fascinating subject. An efficient capital market is an
indispensable pre-requisite to economic development. In fact even as
regards the resources for the public sector, the capital market has a
rather important role to play (Simha, 1960: 1).
The study conducted by Bary Borsworth on ' Industrial Production and
Price of Common Stock', 1953-1975 has revealed that the stock market
and economic activity move in similar cyclical patterns. This
fundamental relationship shows that the stock price is meaningful in the
sense of reflecting real economic variables.
The investment decision in the stock market is a function of the
prevailing market price and return to capital. By return to capital is
meant the algebraic sum of increment in the value of yield (Dookha,
1962: 82).
A senior economist, Ross Levine in the finance and private sector
department division of World Bank's Policy Research Department, has
mentioned in his article that stock market may affect the economic
activity through the creation of liquidity. Many profitable investments
require a long-term commitment of capital, but investors are often
reluctant to relinquish control of their savings from long periods. Liquid
equity markets make investment less risky and more attractive because
they allow savers to acquire an asset-equity and to sell it quickly and
cheaply if they need access to their savings or want to alter their
portfolios. At the same time, companies enjoy the permanent access to
capital raised through issues. By facilitating long-term, more profitable
investments, liquid markets improve the allocation of capital and
enhance the prospect for the long -term economic growth. Further by
making investment less risky on more profitable stock market liquidity
can also lead to more investment (Levin, 1996: 133).
31
“Common stock has one important investment characteristic and one
important speculative characteristic. Their investment value and
average market price tend to increase irregularly but persistently over
the decades as their net worth builds up through the reinvestment of
undistributed earnings. However, most of the common stocks are subject
to irrational and excessive price fluctuations in both decisions as the
consequence of the ingrained tendency of most people to speculative or
gamble, i.e. to give way to hope, fear and greed.”(Chandra, 1995: 35)
Hara, on the article on Financial Journal writes that information plays
important role in the discovery of assets (securities). Further the writer
says that, “The premise developed in this talk is that liquidity and price
discovery are important dimensions of asset markets and, by extension,
of asset prices. That information should affect asset prices is hardly new;
finance researchers have long focused on the information efficiency of
asset prices. The innovation here is the argument that when information
is asymmetric, uniformed investors demand compensation for portfolio-
induced risks which they cannot diversify.”
“Note that my arguments do not imply that markets are necessarily
inefficient; there are no arbitrage opportunities here, nor is there the
provisional free lunch. Traders with superior information will move prices
toward full information levels, but continuously attaining full information
levels is not credible– new information arrives, old information is
obsolete. Market prices can be martingales with respect to information,
but if traders have diverse information sets, then these expectations
need not be the same across traders. Thus, as in microstructure models,
the adjustment of prices of full information values can differ widely
across markets that are deemed efficient. And it is this difference in
adjustment that gives rise to the effects discussed here.” (Hara, 2003:
1351)
2.3 Review of Journals, Books and Articles of Stock
Market in Nepalese Context:
32
As stock market is in infancy stage in Nepalese context, there are limited
books, journals and research studies concerning stock market and its
pricing behaviour. So, the available articles, books, previous research
works, which are related to stock market are consulted and reviewed.
A book about capital market by Dr. R.S.Mahat entitled "Capital Markets
Financial Flows and Industrial Finance in Nepal" was written in the early
period of the development of capital market and before the
establishment of stock exchange. So Dr. Mahat made the first priority to
establish stock exchange for the development of stock market. He also
writes that Nepalese stock market is still in infancy stage and some
drawbacks to the development of stock markets are strong historical and
social reasons as well as mass poverty and illiteracy in Nepalese society.
He further points out that some conscious and educated people of urban
areas are also not investing in the industrial sector instead they are
investing on the real estate especially building construction. Although
the book is written in the early stage of the development of stock
market, the limitations of Nepalese society regarding the investment in
stock market is still reality of Nepalese Capital market.
Similarly the next book by Dr. R.S. Pradhan's is very valuable for the
purpose of analyzing the capital market in Nepal. In his book he writes
about the Stock Market behaviour in Nepal that “A number of studies
have been conducted on the stock market behaviour in developed and
big capital markets but their relevance is yet to be seen in the context of
smaller and underdeveloped capital markets.”(Pradhan, 1994: 42-43). As
per the book, the stock market behaviour in smaller and underdeveloped
capital markets is thus one of the important areas of the study in
finance. Information on stock market behaviour in such smaller and
underdeveloped capital markets would help development of realistic
theoretical models and formulation of relevant hypotheses for empirical
testing in finance. Thus it is felt necessary to study stock market
behaviour in the context of smaller and under-developed capital
33
markets, and this chapter prepared with reference to Nepal is a small
attempt towards that end.
"In Nepal, the listing of shares in Stock Exchange Center (SEC) and their
trading in the stock market is a recent phenomenon. The Nepalese stock
market is characterized by low trading volume, absence of professional
brokers, early stage of growth, limited movement of share prices, and
limited information available to investors. A number of researchers are
available on government owned public enterprises but researches on
enterprises whose stocks are listed in SEC and traded in stock market
are yet to come up in Nepal. Viewed in this way, this chapter is expected
to provide at least some insights into stock market behaviour in Nepal.
This chapter can be considered important, as Nepal has already started
the process of privatization of public or government owned enterprises."
(ibid)
Among the various empirical contradictions to the Asset Pricing Model of
Sharpe(1964), Linter (1965), and Black(1972), the most prominent is the
size effect of Banz(1981). He finds that average returns on large stocks
are lower while average returns on small stocks are higher. The positive
relation between leverage and average returns on US stocks and a
firm’s book value of common equity to its market value is documented
by Stattman (1980) and Rosenberg, Reid, and Lanstein (1985). Similarly,
Chan Hamao, and Lakonishok (1991) find the strong role of book-to
market equity in explaining the cross-section of average returns on
Japanese stocks. Basu (1983) also finds earnings-price ratio is explaining
the cross-section of average returns on US stocks. Again, Ball (1978)
finds that earnings price relation is likely to be higher for stocks with
higher risks and expected returns. Though there are these findings in the
context of developed and big capital markets, their applicability is yet to
be seen in the context of smaller under-developed capital markets. This
chapter therefore attempts to assess some of the cross-section
behaviour of stock market similar to ones as described above in the
context of Nepal. In an attempt to assess the stock market behaviour in
34
Nepal, it specifically examines the relationship of market equity, market
value to book value, price earning and dividends with liquidity,
profitability, leverage, assets turnover and interest coverage.
In the book, "Shareholder's Democracy and AGM feedback" Prof.
Manohar Kumar Shrestha has focused various issues related to
protection of shareholder's expectation. Success of companies directly
depends on the protection of their owners. But how can this be
accomplished is main question. Thus it is necessary to develop a
possible guidance for enhancing the efficiency for public limited
companies to contribute directly in the growth of national economy on
one hand and ensuring handsome return to the shareholders on the
other hand to maid their investment meaningful and worthwhile. At
present, the overall shareholders' democracy in terms of protection their
interest is basically focused on the payment of satisfactory dividend and
the maximization of shareholders' wealth by appreciating the value of
shares they sold. (Shrestha, 1999: 25)
“Investors were enlightened and they stated inquiring about company’s
financial health and future prospect before buying or selling shares.
People turned to price-earning multiples: NEPSE indexes informed trading
became sort of a norm when stock market entered 1995. Many who could
not cope e\with the system of intelligent speculation left the ground. As a
result, the numbers of buyers gradually came down and so did the
prices.”(The Kathmandu Post, May 18,1996: 6)
Panta, Rekha analyzed in her study, "Current status of share market in
Nepal", the trend of Nepalese stock market and present state of primary
and secondary market was found satisfactory. According to her study,
the development of stock market primarily depends on program and
their implementation. In Nepal, the overall policy environment has not
been conducted to the development of stock market. Therefore, it is
difficult to develop more efficient secondary market, trading system for
both equity and debt securities.
35
Capital Market is a crucial element in the national economy. Its role in
reinvigorating and boosting the economic activity in the country holds
significant. The strategic plan released by securities board can, to a
great extent, energize the investors, dealers by increasing investor
interest in it. Security market experiences both boom and boast soon
after the beginning of securities trading through brokers' member in the
stock exchange floor. Through the market started to function quickly
boosting the price of share to an unexpected level, it could not sustained
(Business age, 1999: 10).
“Return from investment in stock is not short run phenomenon.” Investors
have to learn few things before they make investment on stock. First of all
they should know the financial health of that company. For example; if
somebody want to invest in the share of Standard Charted Bank, he/she
must see its balance sheet or at least paid-up capital, last year net profit,
current year anticipated profit and calculate earning per share and price
earning per share and price earnings ratio. These two numbers would give a
fair idea about company health and then market price would judged through
the discount factors based upon one of the sound company’s data. Market
price is equal to earning per share divided by discount factor. EPS can
derived by dividing total net profit after tax by total number of shares and
price earning ratio by dividing market price per share by EPS. Lower the P/E
ratio higher the chance of profit with capital gain and others.” (Business
age, 2001: 20)
“Investment in share has traditionally been done by rating the institutions
on the price of price earning ratio or dividend. Hardly do investors
compare current assets with current liabilities or take a look at the debt
equity ratio. Unless investors begin analyzing the intricate financial
details of corporate institutions before making investment decision, the
market cannot develop smoothly.
Share investment has traditionally been guided by the investors return.
Most earning of investor here have been in the form of dividends rather
than capital gains, though high dividends are often seen, incorporate
36
finance theory as a wasteful use of scares capital. With the commercial
bank becoming the only potential destination, other stocks market
participants hardly making profit, and even they did failing to meet
investors expectations, demand for shares of commercial banks outpaced
supply and their price boomed.
Now the latest slums in the secondary market, despite a pretty good
performance by commercial banks, make it more apparent that
investment in the past was done on whim. Even officials at the stock
exchange and the securities board, refuting investors’ allegations of the
market manipulation and insiders’ trading of last February, discreetly
claimed that the Nepalese stock market is in a nascent stage. And that,
investment are made more on an impulse, rather than through market
study and credit rating.”(Business age 2001:25)
“ADB experts have seen many obstacles to the growth of the capital
market. This includes low level of investors' confidence, disclosure of poor
and manipulated financial information weak enforcement of regulation
absence of instructional investors, lack of diversity in the range of
financial instruments and the scope of active participation for the various
intermediaries limited by vertical barriers.”(The Rising Nepal, 2001: 7).
2.4 Review of Unpublished Masters' Degree Thesis:
There are many masters' thesis prepared by various researcher in the
subsequent previous years. Among them some thesis are reviewed here
for analysis of literature.
On the study of Mr. Bharat Prasad Bhatta, he focused that, resource
mobilization has a vital role in the developing economy like Nepal. The
development of the Stock market is a must for the resource mobilization.
There are various problems of Nepalese Stock market, which have
checked the resource mobilization in the economy. In his research work,
"Dynamic of Stock Market in Nepal" Mr.Bhatta set the following
objectives and followed by the some recommendation too which is given
below:
37
To analyze the trend of the Nepalese stock market.
To diagnose and compare the sectoral financial status of the stock
in Nepalese stock market
To analyze the market share prices of the Nepalese stock market.
To find out the impact of the secondary or primary market and vice
versa.
According to the above objectives "Mr. Bhatta recommended the
following points by his recommendation and conclusion section:
The government should make not only policies for the capital
market development but also implement these policies
appropriately.
Investment in corporate sector should be encouraged and their
share should be listed in the stock exchange.
The regulatory authorities of the stock market should cerate an
environment to rise the trading of share in the stock exchange.
The government should make appropriate policies and
programs for the enhancement of the entrepreneurship
development in the Nepalese economy.
In his conclusion he try to show that although it has become late to take
steps to overcome such problems of the Nepalese stock market in order
to make it active and supportive, the stock market has a good prospect
for the resource mobilization to finance the productive enterprises in the
Nepalese economy.
Likewise the main objectives of the dissertation prepared by Mr.
Khagendra Prasad Ojha, entitled "Financial Performance and Common
stock pricing" at 2000 were:
To study and examine the difference of financial performance and
stock price.
To examine the relationship of dividend and stock price.
To explore the signaling effect on stock price.
The findings presented on behalf of the given objectives were:
38
Nepalese stock market is in infancy stage. In general it is very new
and just started to develop.
Dominance of banking sector is prevalent in the market due to
other industries including finance -companies, insurance and
manufacturing is not encouraging.
Due to the lack of the proper investment opportunity most of the
investors have directed their savings towards the secondary stock
market.
Corporate firm with long history have a relatively stable
profitability parameters than the firm established after the
economize liberalization of 1990.
Older firms have been issuing bonus share more times than the
new one
Dividend per share is relatively more stable than dividend pay out
ratio. That’s why pay out ratio and dividend yield has been highly
fluctuating.
There is significant positive correlation between the dividend paid
and stock prices of banking and manufacturing industries. All other
industries have not the perfect correlation between the dividend
paid and stock prizes.
The study done by Mr. Ojha denotes that Nepalese stock market is still in
developing stage. Some corporate firms with long history have relatively
stable profitable parameters then that of the newly established firms.
Similarly dividend pay out ratio and dividend yield is more fluctuating
and there is positive relationship between dividend and stock price of
the firms. However it may be affected due to the change in time period
and other constraints at present.
“Mr. Mukti Pd. Aryal (1995) has conducted research on ‘The General
Behavior of stock Market Prices’.
The objectives of the study were;
To discuss theoretically the movements of stock market prices as
predicted by the random walk model;
39
To develop the empirical probability distribution of successive price
changes of an individual common stock and a stock market as a
whole;
To examine whether the successive price changes of stock market are
independent to each other or not?
He used the 21 stock (common) out of listed companies in Nepal Stock
Exchange through the study consists of daily closing prices for almost 8
months period.
He used the serial correlation test and run test as Test Methodology:
Serial Correlation Test: He applied serial correlation to test whether
the price changes of shares are independent to each other. For this
purpose he computed the serial correlation of 1-5 lag days applying the
natural logarithm model for daily price changes.
Runs Test: In order to test the random walk model he also applied run
tests. He analyzed runs by total numbers of expected runs, runs by signs
and runs by length.
The major findings and conclusion of the study are as follows:
He found average correlation of 0.102, 0.109, 0.088, 0.045 and 0.04 of
1,2,3,4 & 5 lag days respectively. The results of estimated co-efficient of
serial correlation were quite large and average estimates of co-efficient
were substantially positive in most of cases except of few individual
cases. And the results of runs test were also consistence with the results
of serial correlation tests. Results of the findings, he concluded,” the
stock price changes can be explained as serially positive dependent to
each other as an adequate description of reality i.e., today’s price
changes of an individual common stock is not as unbiased and
independent outcomes of yesterday price changes of Bernoulli
process.”(Aryal, 1995: 103)
On the research paper on," Stock Market Behaviour of Listed Joint
Venture Company in Nepal” conducted by Mr. Bachhu Ram Dahal
describes the stock market as the back bone of the country. Further he
40
set the main objective of his study was to study, examine and analyze
the stock market behavior. Specifically the objectives were:
To study and analyze stock price trend and volume of stock traded
on the secondary market.
To study and analyze the rate of listing of new companies and
maintenance of listed company in Nepal Stock Exchange Ltd.
To study and analyze the investors views regarding the decision on
stock investment.
To study and examine the signaling factors' impact on stock price
with the help of NEPSE index.
To suggest the abstract to the interested parties related to stock
market.
In his conclusion Mr. Dahal says that Stock Market is the backbone of
investment sector of the country. So by promoting the stock market in
sizeable economic sector raise the economic development by mobilizing
swing into productive sectors by making suitable investment for making
suitable investment environment different elements like price trend
NEPSE index, volume of stock traded, rate of listing. Signaling factors
should be analyzed.
Stock market was not properly analyzed for smooth operation of
secondary market. It shows gap between theory and practice of
investment. In Nepalese stock market the study of market behavior is a
very useful subject matter if properly analyzes for the development of
stock market.
Nepal stock exchange limited is analyzing stock market behavior in very
little area regarding the stock market. So experts should be recruited
and analyzed market behavior in efficient way so that all parties
interested with stock market can get benefit from this. The data analysis
showed that Nepal stock exchange is not providing facilities for investors
such as general awareness about investment, investment procedure for
general public and movement of stock trend in different periods and
their cause are not explained. Most of the investors are complaining that
41
the market makers, brokers, and NEPSES staffs are making coalition for
fraudulent activities towards investors. So NEPSE should clear this type
of charge for the development of stock market.
The role of market players in the market should made effective in
promoting capital market on the country by giving proper training and
adopting changes environment with modern tools and technique.
Investment is the lifeblood of economic development. It is evident that
stock exchange will continue to fulfill their vital functions in the national
economy. So long as private enterprises exist, we know that the stock
exchange is the place where stock and shares are bought and sold. The
substantial competition in innumerable buyer and seller determines the
prices with a measure of precision that cannot be obtained in other
unorganized market. So, stock market is the properly market for the
development of the national economy.
The development of stock market in Nepal is both challenging and
difficult. Though the viewpoint of share transition, public interest towards
stock market, the trend of the price movement, information system etc
indicates the low performance of stock market. The problem like lack of
strong professional analysis, independent buyer and seller, well trained
manpower and management delay in transfer of shares, rational investor
exist from the Nepalese stock market. Moreover there are many other
attraction that stock market able to attract the new generation toward it.
Stock market will be the strong market for the unemployed young
generation to build their career in capital market; i.e. it has lots of
prospects of development.
From Dahal’s study it seems that no comprehensive research has been
conducted in relation to the development of stock market in Nepal,
major problems facing by Nepalese stock market and expectation of
future growth. Thus, the stock market further requires timely research to
explore details of the problem and prospects of stock market in Nepal.
42
Mr. Sadakar Timilsina (1997) has conducted research on “Dividend and
Stock Price”
The study was carried out by the data for 16 enterprises from 1900 to
1994.
The main objectives of that study were as follows:
To test the difference between dividend per share and stock prices
To determine the impact of dividend policy on stock price.
To identify whether it is possible to increase the market value of
the stock changing dividend policy or payout ratio.
To explain the price behavior, the study used simultaneous equation
model as developed by Friend and Puckett (1964). The main findings of
that study were as follows:
The difference between dividend per share and stock prices is
positive in the sample companies.
Dividend per share affects the share prices variedly in different
sectors.
Changing the dividend policy or dividend per share might help
to increase the market price of share.
The difference between stock prices and retained earnings per
share is not prominent.
The difference between stock prices and lagged earnings ratio is
negative.
Though there were above-mentioned studies in the context of
Nepal, it has overcome necessary to find out whether their
findings are still valid.
Tililsina’s study was based on 45 observations. The number of companies
included in the same was only 16, which is quite low. Studies on
dividends conducted in the context of Nepal are based on Secondary data
only. No study has been conducted on dividends by using primary data as
yet. There is a need to conduct is survey of financial executives in order
to find out more qualitative facts on dividends which can not be
determined through the use of secondary data. This is the first attempt
that studies dividends based on questionnaire survey. Moreover, the
43
earlier studies on dividends have become old and need to be update and
validated because of the rapid changes taking place in financial market of
Nepal.
Mr. Surya Chandra Shrestha (1999) has conducted research on ‘Stock
Price Behavior in Nepal’, this study aims to examine the efficiency of the
stock market in Nepal.
The objectives of the study were:
To examine the serial correlation of successive daily price changes
of the individuals stocks.
To determine whether the sequence of price changes is consistent
with changes of the series of random numbers expected under the
independent Bernoulli process.
To determine the efficiency of the stock market through the
theoretical model of efficient market hypothesis in the Nepalese
stock market.
To provide feedback policy towards institutional development of
efficient market.
He used the data considering the daily closing price of 30 listed
companies’ shares (ordinary) in the NEPSE. His study period was consists
of almost hour and half years. He used the as serial correlation test and
run test as Test Methodology.
Serial Correlation Test: He applied serial correlation to test the stock
price behavior of Nepal Stock Exchange by giving sight in whether the
price changes of shares are independent to each other. For this purpose
he computed the serial correlation of 1-15 lag days applying the natural
logarithm model for daily price changes.
Run Test: He also, In order to test independence of stock prices, applied
runs test. He analyzed runs by total numbers of expected runs and runs
signs.
The major findings and conclusions drawn on this study were:
44
After applying the required models and methodologies he found average
correlation coefficient of 0.2055, 0.0825, 0.0704 for 1,2 and 3 lag days
respectively. And for lags 5 to 15 days were less than 0.07. In overall,
large number of serial correlation coefficients of the log price changes of
the 30 stocks for the sample periods are significantly departed from zero.
In addition runs analysis also followed the serial correlation results that
mean there has significant difference between actual numbers of runs for
series of daily closing prices changes of the market. By the results of his
applied models and methodologies he concluded,” the successive price
changes are not independent random variable for the 30 sample stocks
listed in the NEPSE. Therefore, the random walk theory is not suitable
description for the stock market price behavior in Nepal.
By the study of Mr. Shrestha, large number of serial correlation
coefficients of the log price changes of the 30 stocks for the sample
periods is significantly departed from zero. In addition runs analysis also
followed the serial correlation result that means there has significant
difference between actual numbers of runs for series of daily closing
prices changes of the market. In the study Mr. Shrestha has applied for
technical analysis only to get the result of share price behavior and he
has not used any fundamental tools for analysis.
From the above all studies conducted by various researchers, it seems
that Nepalese stock market is still in developing stage and it is facing
various challenges. Further more it also shows that there are very few
research works conducted about the market price behaviour on the stock
market. Most of the above stated studies use technical methods and
statistical methods like run test, correlation coefficient, NEPSE trend etc
for the analysis purpose. Only few of the studies use fundamental
analysis tools for the research work. More than that none of the studies
are concerned about the financial indicators like EPS, DPS and NWPS
which are the most influencing factors for the MPS. So, this study tries to
analyze the relationship of these factors with the pricing behaviour of the
stock of selected companies as well as it also tries to show the influence
45
of the important events happened in the country on market price of the
stock.
46
CHAPTER - 3RESEARCH METHODOLOGY
Research means to search again and again. We study the social
problem again and again to find out the something more about the
phenomenon. The first look may not be adequate. It prone to error, we
enter in to the subject matter again and again and study the problems
differently and thoroughly each time. This process is called research.
Research is a systematic and organized effort to investigate a specific
problem that needs solution.
Methodology refers the various steps that are generally adopted by a
researcher in studying his research problem along with the logic behind
it. Thus, Research methodology is a way to systematically solve the
research problem, what we are doing at present.
In this chapter, Research Methodology, we deal mainly with the method,
which are used in the period of research. In this regard, this chapter
explains not only talk of the research methods but also consider the logic
behind the methods, which are used in the context of our research
study. So, research design, sources of data and uses of statistical and
financial tools are basically explained in this chapter.
To draw inferences on the market performance of stock market and price
formation, different measure have been used, while collecting and
interpreting relevant data, facts and figures with a view to systematic
data collection and data's interpretation. Simple statistical tools have
been used to finish this research works, which represent the explanatory
and descriptive analysis of the relevant information and data.
Both descriptive and analytical types of research are employed to fulfill
the objective of research work. Primary sources of data as questionnaire,
interview with officials are used to find out the public awareness
regarding the investment in the shares, their risks and return and pricing
of shares of the selected companies listed in the stock exchange.
47
3.1 Research Design:
Research design is the organized way of research methods or
techniques used through the entire study. It is an integrated system that
guides the researcher in formulating, implementing, and controlling the
study. "Research Design is a plan, structure and strategy of investigation
conceived so as to obtain answer to research question and to control
variances", (Kothari, 1991: 24).The present study is basically related
with the Nepalese stock market and the share price behavior of the
selected listed companies. The study will explore the collection of data,
tabulation and compilation of data, computation of compiled data and
financial parameters, findings, conclusion and recommendations. To
analyze the past phenomena historical research design has been used.
Similarly to access the opinion, behavior or characteristics of a given
population and to describe the situation and events occurring at present,
descriptive research design has been used. In the same way, to analyze
the significant relation between MPS on EPS, DPS, NWPS various
statistical tools has been used under the phenomena of quantitative
research design. The research design is thus an integrated frame that
guides the researcher in planning and executing the research works.
3.2 Universe and Sample:
The analysis of stock market of the selected banking, financial and
insurance companies and their pricing behaviour largely depends on the
number of such companies listed in the Nepal Stock Exchange (NEPSE)
and share issuance by these companies. More over that share price will
be infected by the supply and demand and the supply and demand of
such shares depends upon the information available in the market.
Therefore, all the banking, financial and insurance companies listed in
the Nepal Stock Exchange and information regarding these companies
are taken as the total population. Due to the low volume and amount of
48
share transaction and insufficient data, other sectors like Mfg. sector,
service sector and others sectors have been neglected while taking the
sampling companies from the listed companies in Nepal Stock Exchange.
The samples will be taken using stratified as follows:
Table: 3.1 : Sampling ProcedureS
NoSector No of
Company
Listed
No of Sample compani
es
Percentage
Sample Companies
1 Commercial Bank
11 5 45% Nepal Arab Bank LtdStandard Chartered BankHimalayan BankNepal Bangladesh BankEverest Bank
Regarding the influencing factors for price fluctuation of share in capital
market different investors gave different views and their own ideas. 26
of the total 83 respondents, that is 31% gave their views as dividend as
the influencing factors, 19 that is 23% said earning per share, 11 which
is 13% said political stability of the country,14 which is 17% said
economic growth of the country, 5 that is 6% said world wide trend, 2
which is 2% of the respondents said volume of transactions and 6 which
is 7% said rumors. Theoretically, DPS and EPS are the major factors to
influence the share price of a company which is also reflected in the
respondent’s view.
Table: 5.24; Factors Affecting Price of SharesResearch variables
No. Of investors %
1 Dividend 26 31%2 Earning Per Share 19 23%3 Political Stability 11 13%4 Economic Growth 14 17%5 World Wide Trend 5 6%
6Volume of Transactions 2 2%
7 Rumors 6 7%Total 83 100%
Investors Views Regarding the Returns from their Investment
To find out how much the investors are satisfied from the returns from
their investments, question was presented to the respondents as the
level of return from the investment presently getting in comparison their
95
expectation. None of the respondents replied that they are getting very
high return however 5 out of 64 which is 6% replied that they are
getting high level of return, similarly 22 that is 27% said moderate, 25
that is 30% low and 12 that is 14% very low. The results is presented in
the following
Table: 5.25; Satisfaction form the Return of Shares
S.No.
Research variables
No. Of investors %
1 Very High 0 0%2 High 5 6%3 Moderate 22 27%4 Low 25 30%5 Very Low 12 14%
Total 64 100%
5.5 The Major Findings:
The major findings based on the analysis are presented as follows:
1. According to the coefficient of co-relation the relationship of MPS on
EPS, DPS, NWPS and current year’s DPS of HBL, NB bank, Everest
bank, Universal finance, Himalayan General Insurance and Everest
Insurance are all positive. Similarly, in case of NABIL bank and
Peoples Finance, the relationship of MPS on EPS, NWPS is positive and
with last year’s dividend is negative. But the calculation shows that
there is no relationship between MPS and DPS of NABIL bank where as
People Finance has not declared any dividend during the study
period. In case of SCB, the three financial indicators, DPS, NWPS and
last year’s dividend is negative and there exists no relation with EPS.
Similarly, for the Annapurna Finance the relationship of MPS with EPS
is negative where as the relation is positive with DPS, NWPS and last
year’s dividend. Disregarding the exceptional case, it is found from
the calculation of correlation coefficient that in average for all
companies, EPS, DPS and NWPS has good positive relationship with
MPS and EPS is the most influencing factor among them.
2. According to the multiple regression, during the five years study
period, the DPS and NWPS of NABIL bank is negatively influenced
96
MPS. Similarly, the analysis shows that the combined effect on MPS of
EPS, DPS and NWPS of NABIL bank is 47.10% which indicates that the
change in MPS of the NABIL is due to the combined effect of EPS, DPS
and NWPS and 52.90% change in MPS is caused by other external
factors. The calculated value of significant f (0.836), shows the
calculated model of multiple regression is statistically insignificant at
5% level of significance.
3. The combined effect on MPS of EPS, DPS and NWPS of SCB is 93.20%
which indicates that the change in MPS of the SCB is due to the
combined effect of EPS, DPS and NWPS and only 7.80% change in
MPS is caused by other external factors. The regression model is
statistically insignificant at 5% level of significance as the value of
significant f is 0.328 which is greater than 0.05.
4. The regression model for HBL shows that EPS, DPS and NWPS
significantly affected the MPS of HBL. Only 15.8% variation on MPS is
caused due to the other factors than EPS, DPS and NWPS. But this
relationship established by regression model is statistically
insignificant at 5% level of significance as the value of significant f is
0.49 which is greater than 0.05.
5. The combined effect on MPS of EPS, DPS and NWPS of NB bank is
98.10% which indicates that the MPS of NB bank is most significantly
affected by these factors during the study period. The regression
model is statistically insignificant at 5% level of significance as the
value of significant f is 0.19 which is greater than 0.05.
6. The pricing behaviour of MPS of Everest Bank is significantly
influenced by the combined effect of EPS, DPS and NWPS of the
company during the study period. And only 6.00% change in MPS is
caused by other external factors different then EPS, DPS and NWPS.
The regression model is statistically insignificant at 5% level of
significance as the value of significant f is 0.309 which is greater than
0.05.
97
7. Different form the sample banking companies, the fluctuation in the
MPS of AFCL is less affected by the combined effect of EPS, DPS and
NWPS and 88.00% variation in MPS is caused by other irrelevant
factors. And the regression model is statically insignificant at 5 %
level of significance.
8. The combined effect on MPS of EPS and NWPS of Peoples Finance Co.
Ltd. is 46.20% which indicates that the change in MPS of the Peoples
Finance Co. is due to the combined effect of EPS and NWPS and only
53.80% change in MPS is caused by other external factors. Since,
Peoples Finance did not distribute any dividend during the study
period; the affect of DPS on MPS could not be calculated. The
regression model is statistically insignificant at 5% level of
significance as the value of significant f is 0.538 which is greater than
0.05.
9. The change in MPS of UFL due to the combined effect of EPS, DPS and
NWPS by 98.90% and 1.10% variation is caused by other irrelevant
factors. And the regression model is statistically insignificant at 5%
level of significance as the value of f is 0.134.
10. The change in MPS of Himalayan General Insurance Co. due to the
combined effect of EPS, DPS and NWPS by 93.10% and 6.90%
variation is caused by other irrelevant factors. The regression model
is statistically insignificant at 5% level of significance that the value of
f is 0.33.
11. As per the result of whole banking sector, in average 61.9%
change in the MPS of the banking sector companies is due to the
effect of the change in EPS, DPS and NWPS of the banking companies
only 39.10% variation in MPS is caused by the other irrelevant factors.
So, the calculation shows that EPS, DPS and NWPS of banking sectors
companies are more important in the formation of MPS than other
factors. Similarly, the regression model is also statistically significant
at 5% level of significance that the value of f is 0.
98
12. Difference from the banking sector, the change in MPS of the
whole Finance Co. sector is less which is 40.1% affected by financial
indicators like EPS, DPS and NWPS and more which is 59.9% due to
the other factors. The regression model is statistically insignificant at
5% level of significance.
13. As per the result computed from the combined effect on MPS of
EPS, DPS and NWPS as a whole Insurance sector is 80.60%, which
indicates that in average, the change in MPS of Insurance companies
is due to the combined effect of EPS, DPS and NWPS and only 19.40%
variation is caused by the other factors. The regression model is
statistically significant at 5% level of significance that the value of f is
0.031 which is greater than 0.05.
14. The result computed from the whole sampled companies shows
that the change in MPS of the sampled companies during the study
period is affected due to the change in EPS, DPS and NWPS by 60.3%
and 39.7% change in MPS is due to the other factors than these
financial indicators. It shows that in average, the pricing behaviour of
the sampled companies is significantly affected by EPS, DPS and
NWPS. This relationship model is also statistically significant at 5%
level of significance.
15. With respect to the calculation of actual rate of return and required
rate of return, 9 companies out of 10 have actual rate of return are
more than required rate of return. So, these companies stock price
are under priced where as the actual rate of return of Himalayan
General Insurance is less than required rate of return; thus its stock
price is found over priced. From the calculation it is found that in
average the required rate of return is low and investors would not
invest in shares for such low return instead they will invest in fixed
deposit of banking and financial institutions which is less risky
compared to shares. But this result occurs due to the calculation of
only five years data and drastically decreasing interest rate and risk
free rate.
99
16. It is find out from the T-test that the political event of Ashwin-18,
2059 has not significantly affected the stock price at NEPSE.
17. As the peaceful environment in a country play a catalyst role in the
investing activity, the share price on NEPSE has been positively
affected by the event of Ceasefire on Magh 15, 2059 as the
alternative hypothesis accepted that null hypothesis rejected at 5%
level of significance at 9 degree of freedom. It shows that Nepalese
investors are aware of the political and other environment of the
country.
18. The signaling and informational factors on the event of rupture of
peace talk and re-start of war on Bhadra 10, 2060 has not affected
the price of the stock in NEPSE based on the analysis as the null
hypothesis accepted at 5% level of significance at 9 degree freedom.
19. The share price in NEPSE has not been affected due to the
signaling factors on the event of Nepal’s entry in WTO on 11-Sept.
2003 as the null hypothesis accepted at 5% level of significance at 9
degree freedom.
20. The NEPSE index has affected by the event of five major parties
political movement as the alternative hypothesis accepted at 5%
level of significance and 6 degree freedom.
21. On analyzing the primary data collected from the respondent most
of the investors were asked for their preference of investment sector
major portion of them choose the banking sector and minor for hotel
sector and business venture.
22. It was found that the investors’ major motives for owning the
shares of company are for better price appreciation and to receive
the dividend.
23. An evident find out from the study is that Nepalese stock market
has the shortage of professional investors. It seems that investors buy
the stock only for dividend and they are not interested on speculative
100
motive. Some investors are interested on the pricing behavior but
they are not interested on trading of the shares in secondary
markets. Similarly, people are only investing in shares with the excess
money they have over their expenditure. So, Nepalese security
market has the shortage of professional investors.
24. Major of the investors are not trading in secondary market and
those who trade in secondary market, sold their shares due to the
expected price appreciation and few of the investors sell their shares
due to the non declaration of the dividend by the company.
25. As per the respondent major of the investor who purchases the
shares from the secondary market, purchase it due to the high rate of
dividend.
26. The respondents are aware about the price of their share which
they own that major of the respondents used to seek the price of their
shares on weekly basis on secondary market.
27. It has been proved that the major influencing factor to the price of
the share is current dividend that respondents given the high weight
for dividend and lowest weight was given to the volume of transaction
out of seven options.
28. As per the respondents investors are not satisfied for the level of
return which they are getting as major of the respondents replied for
level of return to low out of the five options.
101
CHAPTER – 6SUMMARY, CONCLUSION AND
RECOMMENDATIONS
This chapter presents the summary and conclusions drawn form the
analysis of the study. The study was conducted to find out the behavior
of stock price with respect to the movement of various financial
indicators, certain external events and other factors. Similarly, the study
also tried to find out the investors’ response toward the change in the
MPS of their stock. For these purpose, 10 sampled companies were
selected and the study was based on the five years data of the
corresponding selected companies from 1997-98 to 2001-02. Various
statistical as well as financial tools were adopted as test methodology.
6.1 Summary
Price of security is the outcomes of investor’s psychology. The
psychology of investors is affected by various factors. Here in Nepalese
market, dividend and price appreciation of stock is major factors for the
investors to decide about purchasing of shares. Along with the DPS and
price appreciation, EPS, NWPS, market rumors, political and economic
environment etcetera are the other factors to influence the buying and
purchasing behavior of the investors. But one must look into financial
status of organization before making investments. If the organization is
not financially strong then it is likely to loose one’s investment one day
or other.
The first objective of the study is to find out the relationship of market
price of share (MPS) with various financial indicators like EPS, DPS, NWPS
and last year's dividend. To find out the above stated objective financial
as well as statistical tools have been used. Among the 10 selected
companies, the most positive relationship of MPS with EPS is 0.79 of NB
bank and the least relationship of MPS with EPS is -0.22 of UFL. Similarly,
in case of DPS, the highest relationship is 0.97 of NB bank and lowest
relationship is -0.29 of Everest Insurance Company. With regard to the
102
NWPS, NB bank's MPS has most positive relationship and the lowest
relationship is -0.55 of SCB. In average EPS is highly co-related with MPS
and DPS is least correlated with MPS of selected companies.
Similarly, to find out the impact of the combined effect of EPS, DPS and
NWPS on MPS, multiple regressions analysis has been conducted with
help of SPSS software. For this purpose r2 has been calculated which
denotes the combined effect of EPS, DPS and NWPS on MPS. As per the
calculation, the highest co-efficient of determination (r2) of UFL is 98.9%
which means the MPS of UFL is mostly influenced by the combined
effect of EPS, DPS and NWPS among the all selected listed companies
during the study period. Only 1.10% variation in MPS is due to the other
extraneous factors. Similarly the lowest co-efficient of determination (r2)
is 46.20 % of PFL which indicates that the MPS of the PFL is least
influenced by combined effect of EPS, DPS and NWPS among the all
selected listed companies. 53.80% variation in MPS of the Company is
influenced by the other external factors. The co-efficient of
determination(r2) of whole selected companies which is 60.3%, shows
that in average, the MPS of the companies are influenced by the
combined effect of EPS, DPS and NWPS and this relationship is also
statistically significant at 5% level of significance.
The next objective of the study is about the identification of the price of
stock whether it is over priced, under priced or equilibrium priced. To
find out the pricing status of stocks, actual rate of return and required
rate of return was compared. Generally, the trend is that the MPS of
public quoted companies is above their book value. The market value is
determined by the supply and demand functions. However, in an
efficient market MPS fully reflects all the historical information publicly
available. As per the presentation, the highest required rate of return is
31.56% of Everest Insurance and the lowest required rate of return is
10.89% of Himalayan Bank Ltd. Similarly, in case of actual rate of return,
NB bank has highest return that is 61.86% and the lowest is 19.36% of
Himalayan Bank Ltd. From the comparison it has been found that actual
103
rate of return is higher than the required rate of return of 9 selected
companies out of 10. Only one HGI company’s actual rate of return
(29.45%) is less than the required rate of return (30.97%). It reveals that
the stock price of 9 companies out of 10, are under priced and the only
Himalayan General Insurance Company’s stock price is found over priced
during the study period. Similarly, none of the sample companies’ stocks
are found to be equilibrium priced. The main reason for under-valuation
of the stock of the sampled companies is that the price of the stock had
reached the highest point during the study period of the banking and
financial companies. But the NEPSE index did not follow the same speed
and the rate of Treasury bill issued by NRB also heavily decreased during
the study period. It makes the actual rate of return of the sampled
companies high and the required rate of return low. So, most of the
sampled companies’ share price become undervalued during the study
period.
Signaling and informational factors also play the major role in the pricing
of the security in secondary market. But it depends on the events
occurred in the country. To find out the signaling and informational
effect on share price, paired T-test was conducted to get the result of
third objective of the study. For this purpose five major events occurred
during the last year of the study period in the country has been taken
and hypothesis was set whether the events have influenced the NEPSE
index or not. As per the calculation three null hypothesis were accepted
which means the NEPSE index was not affected by the three
corresponding events of Ashwin-18, 2059, Rupture of peace talk and
starting of re-war at Bhadra -10, 2060 and the event of Nepal’s entry in
WTO at Sep-11, 2003 respectively. Similarly, the remaining two null
hypotheses were rejected. It shows that the two events, ceasefire on
Magh-15, 2059 and the event of five major political parties’ movement
have influenced the NEPSE index.
The decision for investment largely depends on the information about
the performance of the company. In general, most investors prefer to
104
buy shares of those companies whose earning are very attractive and
dividend pay out ratio is high. However, rational investor analyzes not
only earnings but also various information regarding the companies’
management and their dividend policy, economic situation, market
condition and many other factors before actually making an investment.
But as per the questionnaire analysis, it is found that most of the
investors invest in shares for dividend and price appreciation and most
of them are not interested about the other indicators which could affect
the price of share. It also seems from the questionnaire analysis that the
investors are conscious about the market price of the share they have
bought as many investors seek for their share’s price daily or weekly.
Although they seek for their share price, most of the investors are not
trading their shares in secondary market, which shows that most of the
investors are holding their shares for only dividend and they are not
using the change in share price for speculative purpose.
6.2 Conclusion:
The study shows that in average market price of share of the sampled
companies are seems to be influenced by the combined effect among
the analyzed financial indicators like EPS, DPS and NWPS. However
current year's dividend has minimum role in the fluctuation of the
market price. But these indicators are not alone to influence the price of
share and there are other external factors such as economic situation,
economic growth, political situation and other major events occurred in
the country are also responsible for the pricing behaviour of the stock of
the sample companies. Among the analyzed financial indicators EPS
seems to be most closely related with the market price of share. Most of
the sample companies’ stock price found to be under valued because
their required rate of return is lower than the actual rate of return. This
happens because of the decreasing trend of the risk free rate of return
which causes the required rate of return lower and the increasing trend
105
of the price of the sampled companies which makes the actual rate of
return high.
Similarly, the study also shows that the some major events occurred in
the country also effect on the market price of share. So, the political,
economical and social environment has also close relationship with the
pricing behaviour of share and they influence the stock market with
respect to the importance of the event. The study also shows that
Nepalese investors are more conscious towards the dividend and price
appreciation of the shares they are investing but most of the investors
are only using buy and hold strategy as only few of them are trading
their shares in secondary market. This shows that there lacks
professionalism in Nepalese investors.
6.3 Recommendations:
The findings of the study may be an important information for those who
concern, directly of indirectly, with the stock market activities. Thus, the
following recommendations can be outlined for the concerned:
1. From the study it seems that Nepalese investors have limited
knowledge about security market. It lacks of professional
investors. So, the concerned authority is recommended to make
aware about the security market to the general public so that they
are interested to invest in security market and the previous
investors could change as professional investors.
2. Most of the stocks of banking and finance companies are
undervalued in the stock market. So, investors are recommended
to buy these undervalued stocks by selling other overvalued
stocks.
3. As per the study, investors are trading the stocks with-out proper
analyzing of the financial indicators of these companies. So,
investors are recommended for the detail study of the financial
106
indicators of those companies before trading the stocks of such
companies.
4. The price fluctuating trend is not predictable by general investors.
So, investors are recommended to get the consultancy service
from the investment experts while making the investment.
5. Signaling factors should be analyzed on regular basis by the
concerned authority so that the future movements of price can be
predicted from the side of analyst and investors.
107
BIBLIOGRAPHY
Ackerman, Irving L. 1980. How to Invest in Philippine Stock Market, New Delhi: McGraw Hill Publication Co.
Agarwal, Dr. Govind Ram. 2002. Dynamics of Business Environment of Nepal, Kathmandu: M.K. Publishers and Distributors.
Agrawal, Jagadish. 2000. “Nepal's Capital Market: What it Takes to Improve”, Business Age vol.2, July: Page 47.
Amihud, Y. and Mendelson, H. 1979. “Liquidity and Assets Price: Financial Management Implications”, Journal of Financial Management. Vol. IX, No.9.
Bhalla, V.K. 1986. Investment Management. Delhi: S. Chand & Company.
Bhalla, V.K. 1983. Investment Management, Security Analysis and Portfolio Management. Bombay: S. Chanda Publishing Co.
Bhatta, Bharat P. 1995. “Dynamics of Stock Market in Nepal”, Unpublished Masters Degree Thesis (M.A. Economics), Tribhuvan University.
Bhattarai, Pramod. 2002. Capital Market in Nepal. Kathmandu: Asmita Books and Stationary.
Blake, David. 1999. Financial Market Analysis. New York: McGraw Hill Series in Finance.
Chandra, Prasanna. 1995. Financial Management Theory and Prctice. New Delhi: Tata McGraw Hill Publishing Co.
Cheney, M. John & Edward A. Moses. 1994. Fundamentals of Investments. 1st Ed., West Publishing Company.
Dahal, B. Ram. 2002. “Stock Market Behaviour of Listed Joint Stock Companies in Nepal”, Unpublished Masters Degree Thesis, Shanker Dev Campus.
Dean, William H. 1973. Finance. Illinois: The Dryden Press
Doodha, Kersi D. 1962. Stock Exchange in Developing Economy. Bombay: University Press.
108
Edmister, Robert O. 1990. Financial Institutions, Markets and Management. 2nd Ed. Mc Graw-Hill International Edition.
Fama, Eugeue F. 1991. “Efficient Capital Markets:II”, The Journal of Finance, Vol. XLVI. No. 5. December.
Francis, J.C. 1998. Management of Investment. 2nd Ed. Singapore: McGraw Hill Book Company
Francis, J.C. 1986. Investment Analysis and Management. New York: McGraw Hill Publication.
Ghimire, Atma Ram. 2003. “Stalling New Brokers”, New Business Age : Page 42. March.
Gitman, J. Lawrence. 1985. Principle of Managerial Finance. 4th Ed. New York: Harper & Row Publishers.
Gupta, O.P. 1979. “The Random Walk Theory of Stock Market Price Behaviour: A Survey”, Review of Commerce Studies, Vol. 8. March: Page 15-75, New Delhi: Anmol Publications.
Gupta, O.P. 1985. Behaviour of Share Price in India, a Test of Market Efficiency. New Delhi: National Publishing House.
Gupta, O.P. 1989. Stock Market Efficiency and Price Behaviour. New Delhi: National Publishing House.
Gupta, U.L. 1982. Working of Stock Exchange in India, Bombay.
Hara, O. Maurein. 2003. “Price Discovery and Market Efficiency” The journal of Finance Vol 58, August
Horne, James C. Van. 1990. Financial Management and Policy, 8th Edition, New Delhi: Prentice Hall of India
Howard, Wolf k. and Pant. 1999. A Hand Book for Social Science Research and Thesis Writing. Kathmandu: Buddha Academy.
Jacob, Nancy L. and Others. 1984. Investments. Richard D. Irwin. Inc.
Jones, Charles Parkers. 1943. Investment Analysis and Management. 2nd Edition, USA
Joshi,P.R.2001. Research Methodology, Kathmandu: Buddha Academic Publishers and distributors Pvt. Ltd.
109
Khan, M.Y., Jain P.K. 1983. Financial Management, New Delhi: Tata McGraw Hill Publishing Company.
Kharel, S.L. 2002. A Study on Stock Market Efficiency and Share Price Behaviour in Nepal, Unpublished Masters Degree Thesis, Shanker Dev Campus.
Khatiwada, Mohan. 2055. B.S. “A Study on the Security Investment in Nepal”, Unpublished Masters Degree Thesis, Tribhuvan University.
Kohn, Meir. 1999. Financial Institutions and Markets, 2nd Ed. New Delhi: Tata Mc Grawhill.
Kothari, C.R. 1994. Quantative Techniques. New Delhi: Vikash Publishing House Pvt. Ltd.
Levin, Richard and Rubin David S. 1999. Statistics for Management. New Delhi: Prentice Hall of India.
Mahat, R.S. 1981. Capital Markets Financial Flows and Industrial Finance in Nepal. Kathmandu: Sajha Prakashan.
Nepal Stock Exchange , Annual Report. 1996/97 to 2002/03.
Nepal Stock Exchange , Trading Report. 1996/97 to 2002/03.
Ojha, Khagendra. 2000. “Financial Performance and Common Stock Pricing”, Unpublished Masters Degree Thesis, Tribhuvan University.
Palat, Rajhu. 1991. Shares for Investment and Wealth. Bombay: India Book Distributors.
Pandey, I.M. 1995. Financial Management, New Delhi: Vikash Publishing House.
Panta, Rekha. 2000. “Current Status and Problems of Stock Market”, Unpublished Masters Degree Thesis, Center Department of Economics, Tribhuvan University.
Pradhan, Radhe S. 1994. Financial Management Practices in Nepal. New Delhi: Vikas Publishing House Pvt. Ltd.
Pant, Prem Raj.1998, Research Methodology. Kathmandu: Buddha Academy
110
Raghunathan V. 1994. Stock Exchange and Investments: Straight Answers to 125 Nagging Questions, New Delhi: Tata McGraw Hill.
Reilly, Frank k. 1986. Investment, Japan: The Dryden press / CBS publishing Ltd.
Breaver
Ross, Stephen A. 1978. “The Current Status of the Capital Assets Pricing Model”, The Journal of Finance, Vol.XXXIII. No. 3. June
Rubinstein, M.E. 1975. “Securities Markets Efficiency in an Arrow- Debreu Economy”. American Economic Review, Vol-65.
SEBO, Annual Report. Fiscal Year. 2001/02.
SEBO, Annual Report. Fiscal Year. 2002/03.
Sharma, P.K. 2002. A Study on Liquidity, Corporate Performance and Share Price Behaviour in Nepal, Unpublished Masters Degree Thesis, Shanker Dev Campus.
Sharp, William and others 1999. Investments. 5th Edition, India: Prentice Hall of India.
Shrestha, Manohar K. 2001. “How Efficient is the Stock Market?”, Spot Light.
Shrestha, M.K. and Manandhar, K.D. 1999. “Bonus Share Issue Practice in Nepalese Corporate Firms”, Management Dynamics. Vol-9, Shanker Dev Campus.
Shrestha, Surya Chandra. 1999. A Study on Stock Price Behaviour in Nepal. MBA Dissertation, Public Youth Campus.
Solomon, Ezra. 1963. The Theory of Financial Management. Colombia: University Press.
Subedi, Badri. 2002. A Study on Investors’ Awareness in the Security Market in Nepal, Unpublished Masters Degree Thesis, Shanker Dev Campus.
The Kathmandu Post, May 18,1996.
Timilsina, Sadakar. 1997. “Dividend and Stock Prices: An Empirical Study”, Unpublished Masters Degree Thesis, Tribhuvan University.
111
Turabian Kate L. 1987. A Manual for Writers of Term Papers, Thesis and Dissertations. Chicago: The University of Chicago Press.
Winfield, R.G. 1985. Success in Investment. England: John Murray Publication.
Weston, J. Fred and Copeland. 1992. Managerial Finance 9th Edition, New York: The Dryden Press.