Nepalese Financial System. and. Investment Environment. Narayan Prasad Paudel. Ratna Pustak Bhandar. Kathmandu, Nepal

Transcription

1 Nepalese Financial System and Investment Environment Narayan Prasad Paudel Ratna Pustak Bhandar Kathmandu, Nepal

2 CONTENT. Chapter 1 Nepalese Financial System 1-62 Financial System and Economic Development 1 Nepal's Financial Sector 3 An Overview of Financial System in Nepal 4 The Supply of Financial Services in Nepal 5 Problems of the Financial Sector Development 6 The Financial Sector Reform 8 A Framework of Freedom for the Private Sector 8 Investment Problems and Prospective in the Private Sector 9 Problems relating to private sector development 9 Measures for effective development of the private sector in Nepal 9 Important Acts to be formulated in Nepal 10 Investment Environment in Nepal 11 Policy issues for the private sector development 12 Major constraint on the private sector ' 13 Role of Privatization in Capital Market Development: A Global Observation 14 Tax Policy for Listed Companies, Financial Instruments and Transactions 16 Privatization Process in Nepal 17 Private Sector Development and Strategic Opportunities 19 Development of institutional mechanism in Nepal 21 Economic reforms 21 Need of Financial Service Centre in Nepal 22 Operation of a money and bond market and need of a credit rating agency 22 Asian experience in establishing credit rating agencies 23 A move towards establishing a credit rating agency in Nepal 26 Prospective Investment Environment 28 Impediments to private sector involvement in infrastructure development 28 Measures for improvement on private sector development in Nepal 28 Common problems in the existing legal framework 29 Measures to Remedy Problems and Overall Private Sector Development 30 Legislative reform 30 Institutional development for private sector development 31 Strengthening the existing institutional mechanism 31 Strengthening the corporate governance 33 Banking and Financial System in Nepal 34 vu

3 Current trends in banking 35 Upcoming trends in banking 35 Size of global banking industry 36 Banking industry and economic environment 36 Competitiveness of the banking industry 37 Nature and scope of the banking industry 37 Growth in the banking sector 39 Role of banking in the economic development 39 Regulatory influences 40 Banking and Financial Institutions Act, Legal requirement for the establishment and operation of commercial banks in Nepal 41 Theoretical Prescription of CAMELS framework 41 Capital adequacy 42 Classification of bank 45 Money making mechanism of banks 48 Functions of banks 48 An overview of the Rastriya Banijya Bank 50 Product/Services and facilities provided 52 Banking process 53 Assets quality in banking industry 54 Interest rate and its determinants 55 Remittance Economy in Nepal 56 Conceptual background of remittance 56 Current trend in the remittance economy in Nepal 56 Trend of remittance 56 Key issues in remittance 57 Remittance business and stakeholders 57 Modes of using remittance 58 Microfinance bank and remittance business in Nepal 59 Effects of remittance on the exchange rate 59 Flow of funds in remittance operations 59 Application of different electronic cards 60 Money transfer agencies 60 Chapter 2 Corporate Governance, Public Finance and Government Budget Corporate governance in Nepal 63 Significance of corporate governance 64 Principles of corporate governance in the banking sector 64 Existing laws and regulation and corporate governance 65 Challenges to ensure good corporate governance 67 Vlll

4 An Overview of Performance of Global Economy 69 Consumer price 69 Net aggregate domestic demand 69 Economic growth rates of neighbors 70 Economic Growth Rates of Nepal and Neighboring (SAARC) Countries 70 An Overview of Sector-wise Domestic Financial Performance 71 Agriculture sector 71 Non-agriculture Sector 71 Manufacturing industry 72 Construction industry 72 Wholesale and retail trade 72 Hotel and restaurant 72 Transport, communication and warehousing 72 Financial intermediation 72 Capital Formation 73 Public Finance and Government Budget 73 An overview on the government budget of fiscal year 2009/10 73 Review of economic status and budget implementation of the fiscal year 2008/09 73 An overview of the Government budget for the V\ 2008/09 77 An overview of the focus of the budget 77 Important Issues and challenges addressed in the budget 78 Recognition of private sector through public private participation 79 The salient features of the budget 79 More focus on sustainable economic development of the country 81 Some other innovative features of the budget 82 Chapter 3 Development Finance Development Finance and Investment 84 The Demand for Financial Services in Nepal 85 Access to Financial Services 86 Constraints on the Increase Access to Financial Services 87 Declining Access to Financial Services in Nepal 87 Improving Access to Financial Services in Nepal 89 Rural Development Banks (RDBs) and Microfinance Activities in Nepal 89 Outcome and consequences of microfinance 90 Problems and challenges 90 The Reform Program for Regional Rural Development Banks 90 Microfinance and Services to Low Income Households 91 Increase Access for Small Business and Low Income Households 92 Conceptual Framework of Microfinance 93 IX

5 Microfinance Institutions and Financial Services in Nepal 94 Microfinance Institutions (MFI^) 96 Clients of microfinance 96 Exposure of microfinance in Nepal 96 The microfinance sector in Nepal 97 The Regulatory Status of Microcredit Institutions 97 Regulation of Microfinance Institutions 98 Challenges in Microcredit Delivery in Nepal 99 Main Issues in Microfinance 100 Formal 100 Semiformal 100 Informal 101 Nature of Microfinance Industry 101 Nature of Microfinance Institutions 102 The Institutional Sector 103 The Nepal Rastra Bank (NRB) 103 Microfinance Wholesale Apex Institutions 103 Status of Major Microfinance Service Outreach 105 Credit Delivery Perspective 106 Inability of the lender to access borrowers 107 Inability to observe the borrowers Effort 108 Inability of Lender to Observe the Magnitude of Return 108 Credit Delivery Methodologies of Microfinance Industry 109 Strategy for Serving Low-income households 110 Strategies for Safer Lending to Small Business 111 A Case of Rwanda's Microfinance Crisis 111 Capitalization on a Large Branch Network: A Case of Khan Bank 112 Performance of Microfinance in Nepal 112 Performance of financial cooperatives 113 Performance of financial NGOs 113 Performance of microfinance development banks 113 Chapter 4 Mutual Fund and Institutional Investors Policy Framework for Financial Market Development in Nepal 115 Mutual funds 116 Managed investment companies 117 Collective investment funds 119 Mutual fund investors' fund selection ability 120 Mutual fund and other investment companies 121 Types ofinvestment companies 122

6 Cost of investing in mutual funds 123 Fees and mutual fund returns 123 Financial intermediaries and their role 123 Investment bankers 124 Contractual savings and institutional investors 124 Employees'Provident Fund 126 Insurance companies 126 An Overview on Mutual Fund Study and Investment Performance 127 Measuring Mutual Fund Performance with Characteristic-based Benchmarks 144 Mutual Fund Investors' Fund Selection Ability 144 The Performance of Hedge Funds: Risk, Return and Incentives 145 Computation of net Asset value (NAV) 148 The recipe for success to mutual fund investors 148 Chapter 5 Capital Market and Regulation General Background of Financial Market and Environment 150 Regulation of Capital Market and Intermediaries 150 Efficient Capital Market 151 Capital Market in Nepal 152 Capital Market and Nepalese Economy 153 Capital Market and Investment Prospective in Nepal 153 Framework for Capital Market Development 154 Obstructions in Capital Market Development in Nepal 154 Consideration About Capital Market Development in Nepal 156 Role of Non-bank financial Institutions in the Capital Market 160 Information Disclosure Practices in the Nepalese Capital Market 161 Legal framework on DivUend and Share Prices in Nepal 163 Government's Long-term Plan Regarding Capital Market Development 165 Financial Markets and Institutions 167 The Nepal Rastra Bank (NRB) as a capital market regulator 168 The Securities Board Nepal as a regulator of the capital market 168 Financial Institutions in Nepalese Securities Market 169 The Primary Securities Market and Legal Arrangement 170 The Impact of the Changing Capital Market Structure 170 Market Risk and Model Risk for a Financial Institution 171 Recent Economic Development in Nepal 173 Chapter 6 Fundamentals of Stock Market XI

7 Financial markets and the economy 173 Primary and secondary markets 174 Stock Market in Nepal 174 The structure of secondary securities market in Nepal 176 Organized exchanges 177 The Nepalese Securities Market: Regulations, Trends and Challenges 178 Financial Market Efficiency 180 The Primary Securities Market in Nepal 180 Investment banking and broker-dealer services 181 Roles of investment bankers in the securities market 182 Stock Market Liquidity 182 Process to Obtain Membership of the Stock Exchange 185 Fundamentals of Listing of Securities 186 Trading Mechanism in NEPSE 187 Trading Strategies and Fundamental Mispricing 190 Stock Market Efficiency and Share Price Behavior in Nepal 191 An Efficient Market Theory 194 Efficiency of stock market 195 Information quality and effects on stock returns 196 Dominant assets and efficient portfolios 196 Stock market efficiency and economic efficiency: Is there a connection? 197 Stock returns and real activity: Is there still a connection? 197 An idle market 198 Past Studies of Return Predictions 199 Chapter 7 Fundamentals of Investment The Effects of Public Investment on Private Investment 201 How to Improve Investment Decisions 202 Effects of volatility 203 Effect of size, P/E and leverage 203 Effect of book on market value: The Fama-French study 203 Investors and the investment process 204 Investors and objectives 204 Investor constraints 204 Taxes and investment strategy 204 Security selection 205 Security Analysis 205 Holding period return 205 Measuring holding period returns 205 Historical risk /returns on alternative investments 206 xu

8 Fundamental Security Analysis 206 Fundamental security analysis: a theoretical framework 207 Economic analysis and its significance 207 Industry analysis 208 Company Analysis 208 Valuation of securities 209 Prices of Securities 210 Technical Analysis 210 Technical analysis theory 210 Random walk theory 211 Inflation, real stock returns, and monetary policy 212 Impact ofmacroeconomic Change on Beta 212 Returns from Investing in Equity Mutual Funds 213 Fixed Income Securities 214 Derivative securities 214 Equity 215 Investment Analysis: Coping with Change 216 Investment Policy 217 Investment Opportunities and the Market Reaction to Equity Offerings 217 The Investment Performance of Equity Pension Fund Manger 218 Optimal investment, growth options and security returns 218 The impact of interest rates on expected returns 219 Nepalese Study on Investment Performance 219 Chapter 8 Security Analysis and Portfolio Management Investment Policy 222 Security Analysis 222 Definition of risk in CAPM 222 Using security expected returns 225 Relationship between risk and return 225 Measurement of risk 226 Alternative measure of risk 227 Rates of return 227 Risk and risk premiums 228 The risk-return trade-off 228 Empirical Implications of Theories of Corporate Risk Management 228 Development of Portfolio Theory 229 Strategic asset allocation 229 The input to portfolio analysis 230 Portfolio design theory 230 xiu

9 Effective asset allocation 230 Portfolio Optimization 231 Portfolio Management 231 Portfolio Types and Their Needs 232 Portfolio strategy 233 Characteristics of portfolios in general 233 Process and Principles of Portfolio Investment 235 Objectives of portfolio management 235 Timing and selection of individual investment 236 Timing of Portfolio Investment and Performance Evaluation 236 General Background of Portfolio Management 237 Some background assumptions 237 v., Portfolio objectives 238 Portfolio Analysis: Risk and Return 239 Portfolio Analysis 239 The Formation of Optimal Portfolio 241 Setting the cut-off rate (c) 242 Constructing the optimal portfolio 242 Return Expectations and Portfolio Performance 242 Determining expected returns and standard deviation for portfolios 243, Strategy for portfolio selection 244 Portfolio Implementation 244 Portfolio monitoring 244 Portfolio constraint 245 Portfolio risk and return 245 Portfolio expected return 246 Portfolio risk 246 Determining the rate of return on a portfolio 246 Risk and return analysis 247 Beta coefficient 247 Portfolio risk 247 Beta 249 Estimating beta 249 Accuracy of historical betas 250 Accuracy of adjusted beta 251 Fundamental betas 251 Random error terms 253 Does the "Beta" Measure Risks? 254 The portfolio approach 254 Equilibrium approach 254 Stability of beta 254 Relation between betas and returns 255 xiv

10 Empirical evidence on betas and returns 256 Sources of Risk 259 Systematic and unsystematic risk 260 Relationship between systematic risk and returns 260 A Measure of dispersion 261 Variance of combination of assets 261 Variance of returns for an individual investment 261 Covariance of returns 262 Standard deviation of a portfolio 262 Risk and return past and prologue 263 Risk and Return: Portfolio Theory, CAPM and APM 263 Risk and return of a single asset 263 Portfolio theory and risk diversification 264 Portfolio Return: two-asset case 264 Portfolio Risk in Two-Asset Case 265 Portfolio Construction Strategies 265 Prediction of portfolio weight 266 Weighting scheme 266 Price Series and Portfolio Construction 269 Optimal portfolios with risk-free lending and borrowing 271 Optimal portfolios with risk-free lending and risk-free-plus premium borrowing 271 Optimal portfolios with risk-free lending and no borrowing 271 An Empirical Examination of Risk Management Practices 271 Delineating Efficient Portfolios 272 Diversification 273 Portfolio market risk 274 Portfolio unique risk 274 Cases Where Diversification Does not Help 274 Perfectly positively correlated returns 274 Perfectly negatively correlated returns 274 The correlation structure of security returns 275 Markowitz Diversification 275 Simple diversification 275 Diversification across industries 276 Superfluous diversification 276 Strategic Asset Allocation 276 Tactical Asset Allocation 277 Strategic International Diversification 277 Diversification Returns and Asset Contributions 277 Benefit of Diversification in Emerging Market 278 Dynamic Strategies for Asset Allocation 279 Buy-and-hold strategies 280 xv

11 Constant-mix strategies 280 The active manager portfolio selection problem 280 Portfolio Management: Theoretical Framework 281 Monitoring and Revising Investment Portfolios 282 Portfolio Optimization Within a Surplus Framework 283 Portfolio enhancement using emerging markets and conditioning information 284 Asset pricing and portfolio diversification: evidence from emerging financial markets 284 Risk Adjusted Portfolio Performance Measurement 285 Hedging and Coordinated Risk Management 286 Credit Risk in Private Debt Portfolio 286 A Test of the Positive Risk-return Trade-off 287 Managerial Utility Maximization Hypotheses 287 Signaling managerial skill 288 Alternatives to risk management as controls 288 Selection of risk management strategy 289 Evaluating the Performance of a Portfolio Managers 289 Risk-Adjusted Measures of Performance 290 Sharpe's reward-to-variability ratio 291 Treynor's reward-to-variability ratio 292 Treynor vs. Sharpe measure 292 Jensen's differential return measure 292 Overview on Portfolio Models 293 Markowitz model: the mean-variance criterion 294 Sharpe's single index model 295 The capital asset pricing model (CAPM) 295 Single-index models: an overview 300 Multi-index models 301 General multi-index models 302 Industry index models 302 The arbitrage pricing model (APM) 303 Concept of return under APM 305 The arbitrage pricing model (APT)- a new approach to explaining asset prices 305 Estimating and testing APT 308 A Test of the Positive Risk-return Trade-off 309 Arbitrage opportunities and profits 310 The Arbitrage Pricing Theory Approach to Strategic Portfolio Planning 311 The constant correlation Model 312 The market model 313 Sharpe Linter and Black (SLB) model 313 Zero -Beta model 314 The P model and its performance for the economy 315 Specification tests of a market model of Asia-Pacific stock returns 315 Other portfolio selection models 316 xvi

12 An empirical study of portfolio insurance 317 Experimental Design 319 Chapter 9 Global Portfolio Management Recent Trends in Investment Environment 321 Globalization 321 Securitization 322 Financial engineering 322 Portfolio Diversification into the Emerging Market 322 Foreign Portfolio Investment 322 Stock Market Liberalization and Economic Reform 323 Economic reforms 323 Issue posed by foreign portfolio investment 324 Global Portfolio Management 324 Do emerging stock markets affect economic growth through c reation of liquidity? 324 Corporate investment, cash flow, and financial structure at the turn of the twentieth century 325 Analyzing Overseas Investments 325 Benefit of Foreign Direct Investment (FDI) for Developing Countries 326 Investors in Emerging Markets and Their Motivations 326 Foreign Investment: A Door Half-Open 328 Fiscal Policy and Private Investment in Developing Countries 331 Investors Protection and Compensation Plan 331 Regulation of the investors compensation plan 332 Investor awareness program 333 Risk Management Practices in the Gold Mining Industry 333 Foreign Direct Investment in Developing Countries 333 Benefit of International Portfolio Diversification 334 Portfolio Investment in Developing Countries 334 Portfolio Investment Follows to Emerging Markets 335 Asset Pricing and Portfolio Diversification 336 Evidence from emerging financial markets 336 Market integration and investment barriers in emerging equity markets 336 Leading Stock Market in the World 337 Emerging vs. Developed Markets 337 World Stock Market Histories 339 Global Investment Choices 340 Investment Companies 344 Informational Efficiency of European Equity Markets 345 Foreign Portfolio Investment 346 Re-emerging Markets 348 xv 11

13 How markets emerge 349 A new paradigm: the evolution of investment management 350 Portfolio Investments in Emerging Stock Markets: Direct and Indirect Barriers 351 Effects on portfolio flows and volatility of stock prices 351 Institutional constraints 352 Foreign portfolio investment in India: emerging trends and pplicy developments 352 Using chaos measures to examine international capital market integration 352 Home bias at home: local equity preference in domestic portfolios 353._ Portfolio behavior of commercial banks in the commonwealth Caribbean 353 How Beneficial is Foreign Direct Investment for Developing Countries 354 Universal hedging: optimizing currency risk and reward in international equity portfolios 354 Risk management in a universal banking environment 355 World Re-emerging markets (International Portfolio) 356 Some International Stock Exchanges 357 Major Stock Market Indices in the World 358 Modeling Stock Market Volatility in Australia 359 Indian Capital Market 361 Chapter 10 Financial Management and Reporting Financial Reporting and Information Disclosure 362 Users of Financial Statements and their Information Needs 363 The Objective of Financial Statements 364 Assumptions of Financial Statements 366 Constraints on Disclosure of Information 369 Cash Flow and Investment: Evidence from Internal Capital Markets 376 Objective of cash flow statement 377 Scope of cash flow statement 377 Benefit of cash flow statement 377 Presentation of Cash Flow Statement 378 An Overview of Financial Management System 382 Financial Management: Discipline and Profession 383 Financial Management in the New Millennium 384 Forms of Business Organization 384 Goals of corporations 385 Factor affecting stock prices 386 Discipline and Profession of Financial Management 386 Agency Relationship 387 Agency conflict between stockholders versus managers 387 Agency conflict between stockholders versus creditors 389 XVlll