Markets and Transactions | Reference Notes

Chapter 2
MARKETS AND TRANSACTION

1. Financial or Securities Market

A financial market or the securities market is place where the securities or financial assets
can be traded or bought and sold. The financial market is a broad term describing any
marketplace where buyers and sellers participate in the trade of financial assets such as
equities, bonds, currencies and derivatives. In other words, the place where the securities
can be liquidated is known as the securities market. Financial markets are typically defined
by having transparent pricing, basic regulations on trading, costs and fees, and market
forces determining the prices of securities that trade.

The securities market involves two parties namely; the buyer and the seller. However, the
trading mainly occurs through some financial intermediaries in between the buyers and
sellers of the securities. The stock market, bond market, derivatives market and foreign
exchange market are some examples of the securities market.

It is not necessary that the market should have physical existence as some securities
trading takes place over the networks between the securities dealers. Thus, the financial
or securities market may or may not have the precise physical location. The advancement
of information technologies has automated the various aspects of the securities trading
providing the real time transaction over the networks around the globe. Nepal Stock
Exchange (NEPSE) is the only secondary market in Nepal. Some of the other notable
financial/securities market around the world are New York Stock Exchange (NYSE),
National Association of Securities Dealers Automatic Quotation System (NASDAQ),
Bombay Stock Exchange (BSE), Hong Kong Stock Exchange (HSE), London Stock
Exchange (LSE), Shanghai Stock Exchange (SSE) etc.

The financial or securities market facilitates major three economic functions:

i. Price Discovery: The price of the financial assets or the securities is determined or
discovered in the financial market by the demand and supply of those securities.

ii. Liquidity: The financial market provides the liquidity to the securities as the
securities can be easily converted to the cash by bearing a nominal transaction
cost.

iii. Reduced Transaction Cost: As said earlier, the transaction cost of the securities
trading is relatively low in comparison to the volume of the transaction which
enables the investors to get the nearly real value of the securities. Moreover, the
investors can easily access the information that comes to the market on the basis of
which they can make the investment decision.

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2. Types of the Securities Market

There are various bases depending on which the securities market can be classified. The
securities market can be classified based on the nature of the securities traded, timing of
the transaction, and the maturity of the traded securities.

2.1. Money Market and Capital Market

Based on the maturity of the financial assets or the instruments traded, the market
can be dividend into the money market and the capital market. The money market
is the place where the short term securities with the maturity less than one year are
traded. The money market instruments are treasury bills, commercial papers,
certificate of deposits, Eurodollars, banker’s acceptance etc. In other hand, the
capital market is the place where the securities with maturity more than one year
are traded. The long term securities like common stocks, preferred stocks, bonds,
mutual funds etc are traded in the capital market.

2.2. The Primary Market

The primary market is the place where the first hand securities (Stocks, bonds and
others) are issued by the firm for the first time to raise the capital from the market.
The proceeds from the sale of the securities go to the issuing firm. So, the new
capital is added to the economy due to the transaction in the primary market. The
primary market may not have physical existence instead is the interaction between
various bodies involved like the issuing firm, investors, dealers and investment
bankers.
The trading in the primary market can occur in the following three ways:
i. Initial Public Offering (IPO): Under IPO, the issuing firm sells the new securities to
the investors. The investment banks help the firm to distribute the securities in the
market.
ii. Right Issue: In right issue the firm sells new units of securities (usually common
stocks) to the existing shareholders. Although the firm has already issued the
shares in the past, the newly sold stocks in the form of right are totally new units of
shares and floated for the first time in the market.
iii. Private Placement: Under private placement, the firms issuing the securities sell the
block shares to the institution or wealthy persons without having to hire an
investment banks to sell the securities.

2.2.1. Investment Banks

The investment banks are the financial institutions that are specialized in distribution of the
securities in the primary market. The investment banks purchase the securities or
underwrite the securities from the issuer before it is finally sold to the investors. The
investment banks are also known as the merchant banks and issue manager in Nepal.
They act as the intermediary in channeling the funds from the investors to the issuer of the
securities. Ace Capital Ltd, Global IME Capital Ltd, Nabil Investment Banking Ltd etc are
some of the major investment banks operating in Nepal. The major functions of the
investment banks are listed below:
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i. Underwriting: An underwriting is the risk bearing function in which the investment

banks agree to purchase the unsubscribed securities. At first, the investment banks
attempt to sell all the securities to the public but if the securities remains
unsubscribed, it purchase those securities in discounts or for added commission
from the issuer of the securities. Thus, the risk of under subscription is assumed by
the investment banks in an underwriting agreement.
Underwriting Spread =
(Selling or Issue Price to Public – Proceed to the issuing company)

ii. Distribution: The distribution function of the investment banks call for the marketing
of the securities in wide geographic region over broad clienteles. As the investment
banks specialize in the distribution through its networks, it is likely that the issued
shares are subscribed by the investors.

iii. Advising and Counselling: The investment banks are expert in understanding the
capital market and its changes along with the issuance of the securities. Thus, the
investment banks provide advices to the issuing companies regarding the public
issue. It facilitates the issuing companies with necessary information on securities
regulations and the capital market environment.

iv. Market Maker: The investment banks can act as the market maker to stimulate the
demand and supply of certain securities. After the issuance of the securities, it
performs the market making function assisting in providing the liquidity to the
securities issued. It establishes the healthy relationship between the issuer and the
investors which can be used by the investment banks in further issue in the future.

2.2.2. Securities Issue Process or Initial Public Offering (IPO) Process

There are series of pre-steps that the issuing company needs to complete before the
securities are floated in the market. These steps start right from the company’s decision on
need of the fund to finally acquiring the fund. The major focus is put on the company
completely raise the required fund at minimum cost from the available options. The steps
in issuing the securities are described as follows:
i. Company Decision: The companies need to make an assessment of the required
funds and the possible sources from which the funds can be raised. After the
decision of the amount required and the sources to be used, the companies can
step into the process of the selection of the investment banks to float the securities
in the market.

ii. Appointment of Issue Manager: The issuing company must take the service of the
investment banks in order to sell the securities in the market as per the Company
Act, 2006. The selection of the investment banks should be based on the reputation
and previous service history of the issue manager. In addition, the cost of issuing
the securities is also the major concern.

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iii. Prospectus Preparation: It is the legal document governing the issue of the
securities. It furnish the information regarding the securities and issuing company
on various fronts like the business area, capital structure, financial condition,
management team and the future prospects of the company. The company must file
the prospectus with SEBON in order to get approval to float the securities. The
prospectus is prepared by the issue manager and the issuing company.

iv. Filing the Prospectus with SEBON: The prospectus should be submitted to the
SEBON along with some other documents to get an approval. The due diligence
certificate of issue manager should also be filed stating that the issue manager has
reviewed all the content of the prospectus and is satisfied with the content of the
information.

v. Review by the Prospectus Vetting Committee of SEBON: The vetting committee

includes the members from SEBON, Nepal Rastra Bank, Nepal Stock Exchange,
Insurance Board and Company Registrar’s Office. The committee reviews and
ascertains that the furnished financial and other information are correct and
dependable in making the investment decision.

vi. Clarification and Update: If the review committee finds any information that is
deemed not satisfying regarding the general norms, the committee asks the issuing
company to clarify the same and update the information wherever required.

vii. Prospectus Approval by SEBOB: Upon clarification and necessary updates, the
SEBON approves the prospectus to be published. Any additional suggestions or
conditions put forth by SEBON shall be incorporated in the prospectus before it is
published.

viii. Issue Open and Close: The Company should open the issue within 2 months of the
approval of the prospectus and announcement of the issue should be made at least
7 days prior. The issue should be open for minimum five to maximum of 15 days
from the date of opening.

ix. Allotment and Refunding: The allotment of the securities shall be made based on
the numbers of applications as follows:

Number of applications Time for Refund

Upto 100,000 40 days
100,001 to 200,000 50 days
200,001 to 300,000 60 days
300,001 and above 70 days

The refunding should start within 5 days of the allotment of the securities. The
refunding shall be made in the bank account of the applicant mentioned in the
share application form. Upon failure of doing so, the company and issue
manager shall be held responsible and require to pay the applicants, the interest

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as stated by the Company Act, from the day of the closure of the issue till the
day preceding which the company started refunding.

x. Listing for the Secondary Trading: The securities have to be listed in the secondary
market before it can be traded. The stocks can be listed to the organized stock
exchange or over the counter market both of which are provided by the Nepal Stock
Exchange.

2.3. The Secondary Market

The secondary market is the market where the second hand securities or already issued
securities are traded. The secondary market provides the liquidity to the securities. Unlike
the primary market, the participants in the secondary market are mostly investors and
dealers. With primary issuances of securities or financial instruments, or the primary
market, investors purchase these securities directly from issuers such
as corporations issuing shares in an IPO or private placement. After the initial issuance,
investors can purchase from other investors in the secondary market. Nepal Stock
Exchange is the only Secondary Market in Nepal.
2.3.1. Organized Stock Exchange
The secondary market where the transaction and trading of the already listed
securities are made is known as the organized stock exchanges. It has central
physical location where the trading occurs. The securities that are not listed in the
exchange cannot be traded in this market. It is highly organized and regulated
financial market where securities (bonds, notes, shares) are bought and sold at
prices governed by the forces of demand and supply. Trades in the organized
exchanges are conducted on the floor called the 'trading floor' of the exchange
itself. Nepal Stock Exchange (NEPSE) and New York Stock Exchange (NYSE) is
an example of organized stock exchanges.

2.3.2. Over- The – Counter (OTC) Market

It is nebulous and highly networked market made up off numbers of broker and
dealers communicating the transaction details and process over the technological
means. It is not necessary to have central physical location for trading. Unlike the
organized stock exchanges, the listing of securities is not required here at OTC
market. It is popularly known as the over-the-telephone market since the bulk
securities transactions are handled through the telephone. The brokers and dealers
in the OTC market are linked to each other through networks of telephones,
telegraphs, teletypewriters, computer systems and others to directly deal with one
another and the customers. OTC market is not in place in Nepal, however; the
NEPSE provides the trading floor for OTC market for transaction of delisted and
unlisted securities whenever required. National Association of Security Dealer’s
Automated Quotation System (NASDAQ) is an example of OTC market.

2.4. Brokers and Dealers Market

Brokers and the Dealers are two major participants in the capital market. The brokers are
the intermediary that facilitates the trading of the securities for the commission. However,
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the brokers are not allowed to purchase the securities in their own accounts. Instead they
stand ready to trade on behalf of their clients. In other hand, the dealers market constitutes
the networks of the dealers which are linked with the sophisticated tools of
telecommunication. The dealers can trade the securities on their own account and remains
ready to purchase the securities at bid price and sell the securities at ask price. The ask-
bid spread is the profit for the dealers. Further, the dealers make the market for the
securities by stimulating the demand and supply of those securities.

2.5. Alternative Trading System: The Third and the Fourth Market
The market where the large blocks of the securities is traded serving the need of the
institutional investors at volume discounts which are not possible in the organized stock
exchanges. The third market helps to trade at lower transaction costs and accommodate
the quick purchase or sale of a large numbers of shares. The brokers, dealers and non-
members are the active participants of the third market. The market makers buy the
shares initially in large volume and discounts which then is sold to the individual or small
investors in favorable discounts. The fourth market is similar to the third market except that
there is direct transaction between the issuer of the securities and the institutional
investors without the use of brokers. The transaction costs are even lower due to absence
of the broker’s commission.

3. General Market Conditions

Based on the securities prices; whether they are rising or falling, the securities markets are
commonly classified as the bull or the bear market. The stock market is influenced by
several factors some of which are the investor’s attitude and confidence, the pace of
economic activities, government actions and regulatory changes. The bull market is
associated with rising prices of securities, increase economic vigor, economic optimism,
recovery while the bear market is characterized by the economic pessimism, falling prices
of securities, recession etc. The investor gain higher return in their investments during the
bull market while they can incur loss during the time of the bear market. However, there is
not fixed pattern as to how the market moves in particular.

4. Globalization of Securities Market and its Importance and Risk

With the companies going global, the securities markets have now crossed the boundary
of the single country. The cross boarder flows of capital have been routine economic
activities. With increasing globalization of the securities market, investors now look for the
high return investment opportunities beyond their home country. The global investment
allows the investors to hold the diversified portfolio across the various securities class and
industries. The investors can do away with political and regulatory related risk of one
country by investing their funds in the next. The globalization of securities market has
developed the global equity market, debt market and currency market. Even government
can raise the debt from other countries by either selling the foreign bond or the
international bonds.

The investors must be aware of an additional risk in foreign investment. The primary risk
that may affect the investment value is the foreign exchange risk caused due to the
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changes in the exchange rate. In addition, the country risk is other significant factor giving
rise to the risk in the foreign investment. The investors should be aware of changes in
market regulation, labor laws and policies, tax laws etc.

5. Regulation of Security market in Nepal

The securities market in Nepal is regulated by the Securities Board of Nepal (SEBON). It
was formed in 1993 under the provision of the securities Exchange Act, 2050. This Act
was replaced by Securities Act, 2063. The objective of the SEBON is to promote and
protect the investor’s interest by regulating issuance and trading of securities. The
securities Act, 2063 has made the enabling provisions regarding the registration, listing
and issuance of the securities by the corporate body. There are several regulations and
bye laws that are in effect to streamline the securities issuance and trading in Nepal.
Some of the majors are briefly discussed hereunder:
i. Securities Board Regulation, 2064: This regulation defines the power, duties
and responsibilities of the SEBON.
ii. Stock Exchange Operation Regulation, 2064: This regulation is related to the
licensing and operation of the stock exchange or the market. The major
provisions in this regulation include the qualification of the body corporate to
operate as a stock exchange, qualifications of the promoters and the directors of
the stock exchange, licensing process and requirements etc.
iii. Securities Business Person (Stock Broker, Dealer & Market Maker) Regulation,
2064: It is related to the licensing and operation of the stock broker, dealers and
the market makers. It has provisions regarding the qualification of the body
corporate to work as the brokers, dealers and market makers and qualification
of the promoters and the directors.
iv. Securities Business Person (Merchant Banker) Regulation, 2064: This
regulation is related to the licensing and operation of the merchant banks in
Nepal. The regulation includes the qualifications of the body corporate to
operate as the merchant banks, capital provisions, the qualifications of the
promoters and the directors.
v. Securities Registration and Issue Regulation, 2065: This act includes the
procedure of the registration of the securities, getting approval from SEBON,
issuance of the securities and disclosure of the financial information.
vi. Mutual Fund Regulation, 2067: It clarifies the provision of running the mutual
fund companies in Nepal. It further specifies the qualification of the body
corporate to work as a mutual fund company, the provisions relating to the
investment to be made by the company.
vii. Central Depository Services Regulation, 2067: The regulation has been issued
by the SEBON to facilitate the establishment of the securities depository
companies in Nepal. The establishment of the securities depository company
shall transform all the physical share certificates to the electronic or
dematerialized form.
viii. Credit Rating Regulation, 2068: It facilitates the establishment of credit rating
agency in Nepal. It prescribes the qualification and requirement to establish the

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credit rating agency in Nepal. The credit rating agency provides the rating to
various equities and debt securities.
ix. Securities Issue Guidelines, 2065: SEBON publishes the guidelines pertaining
the securities issue and reform time and again. This guideline include specific
provisions regarding the securities issue, opening and closing of the issue,
application centers, refunding etc.
x. Securities Allotment Guidelines, 2051: It specifies the provisions relating to the
division of the securities among the applicants in case of the over subscription of
the securities. It prescribes the model to be followed for the allotment of
securities for small investors to increase the numbers of small investors in the
market.
xi. Bonus Share Guideline, 2067: It specifies the legal framework for the issuance
of bonus shares by the companies and other provisions regarding the listing of
the bonus shares.
xii. Securities Listing Bye Laws: It includes the procedure and criteria of the listing
of the securities in the NEPSE and delisting of the securities. The companies
should get prior approval as per this bye laws to list the securities in the NEPSE.

Apart from above mentioned regulations, Company Act, 2063; Banks and Financial
Institution Act, 2063 and Insurance Act, 2049 are also major acts affecting the operation of
the financial institutions and markets in Nepal.

6. Types of Trading
i. Long Position/Purchase: Under this position, the securities are first bought and
hold for the certain period after which the securities are sold. The basic objective
is to buy at lower prices and sell at higher prices making a profit.

ii. Short Position/Short Sale: It is the trading in which the investors first sell the
stock and then buy it after certain period. The question arises which securities
does the investor sell before purchasing? The fact is the investor borrows the
securities from the broker or the brokers sells the securities on behalf of the
investor and deposits the proceeds from sale to the investor’s account. After
certain period, the investor needs to pay back the same securities to the broker.
Now, the investor buys securities from the market and return to the broker. The
basic objective is to sell high and buy low making the profit.

Short sales can only be made when the stock price is uptick. An Uptick rule says
that for the short sale to be executed, the stock price must have increased from
the previous trading day. The purpose of the uptick rule is to reduce the huge
speculation and manipulation of the stock price by the short seller.

7. Margin Trading
The margin trading can be made in both long position and the short position. In long
position, the investors can borrow the fixed amount in the form of loan to make the
initial purchase of the securities. The investor needs to pay the interest on borrowed

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amount usually calculated in per share basis. In other hand, under short position,
the investors are required to place initial margin in the account and the proceeds
from short sale is deposited to the investor’s account. Under margin short position,
the broker pays interest to the investors for the initial margin deposit maintained
with the broker.

8. Extra Topics (Not Included in the Course but Could be Useful)

a. Nepal Stock Exchange (NEPSE)

The history of establishment of the NEPSE dates back to 1976 AD when the
government established “Securities Marketing Center” which was later converted to
“Securities Exchange Center”. The SEC initially traded the government securities only
and finally started to list and trade the corporate securities in 1984. The need of fully
autonomous and specialized stock market, the SEC was then converted into NEPSE
in 1994.

The basic objective of NEPSE is to impart free marketability and liquidity to the
government and corporate securities by facilitating transactions in its trading floor
through member, market intermediaries, such as broker, market makers etc.

The Board of NEPSE is represented by the Government, Nepal Rastra Bank, and
Nepal Industrial and Development Corporation with respective share holdings of
58.67%, 34.60% and 6.13%. However, the NEPSE is seeking to privatize and reduce
the ownership of the government and government agencies.

i. Listed Companies and Members of the NEPSE: At the end of end of March
2015, 270 companies are listed in NEPSE including Commercial banks,
Development Banks, Finance Companies, Insurance Companies, Hydropower
Companies, Hotels, and Manufacturing Units etc. In addition, there are 61
brokers and 2 market makers as of March end 2015. The buying and selling of
securities should only go through the brokers while the brokers are not allowed
to trade the securities in their own account. Besides this, NEPSE has also
granted membership to issue and sales manager securities trader (Dealer).
Issue and sales manager works as manager to the issue and underwriter for
public issue of securities whereas securities trader (Dealer) works as individual
portfolio manager. 

ii. Listing of Securities: For trading the stocks from the NEPSE, the companies
need to list or register the securities in NEPSE. Only the listed securities are
traded in the floor. The listings are of two type namely temporary listing and
permanent listing. Temporary listings are done for redeemable preference
stocks and redeemable debentures or bonds while the permanent listings are
made for the common stocks and unlimited life preferred stocks and
debentures. Followings are the listing requirements in NEPSE:

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 The company should have record of profit for at least three

consecutive years
 The book value per share should be greater than the paid up value
 Submission of financial statements to the NEPSE
 Paid up capital should be Rs. 25 million
 The number of shares should at least be 1000 shares

Trading Procedures and Practices

Trading of securities in the secondary market involves various processes and steps. The
security exchange rules necessitates the investors to the follow such rules and processes.
In short, the securities transaction rely on the mechanics and procedures to exchange to
guide the investors in making the wise investment decisions by diverting funds in the
securities of worthwhile investments. The processes are discussed below:
i. Selecting a Broker or Brokerage Firm
Any buy and sell orders must pass through the brokers. So, investors need to
select the broker or the brokerage firm. In doing so, the investors can look for
reputation, services and other factors in selecting the brokers. Some brokers
provide full range services except the trading of securities.

ii. Order Size

The buy and sell order can be either round lots or odd lots. Normally, the buy or
sell orders of 100 shares and more is round lots while the order size of less than
100 shares is odd lots.

iii. Time Limit

The orders can be day orders, week orders and month orders which are valid till
the day, week and month respectively. Day orders expires at the end of the
trading time on same day, the week orders expires on Friday of the week when
the order was placed while month orders expires at the last trading day of the
month. Good till Cancelled (GTC) orders exists till the trading is complete or the
investors cancel the orders.

Trading System of Nepal Stock Exchange

The NEPSE has adopted an auction system of trading securities. The buying broker with
highest bid will post the price and his code number on the buying column, while the selling
broker with lowest offer will post the price and the code number on selling column. Once
the bid and offer prices match, the trading between the buying and selling brokers is
settled at trading floor. Now, with an adoption of the automated trading system; the brokers
conduct the securities transaction from their own offices.

i. Trading Hours
Trading on equities takes place on all days of week (except Saturdays and
holidays declared by exchange in advance). On Friday only odd lot trading is
done.
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The market timings of the round lot equities are:-

Market Open: - 11:00 Hours
Market Close: - 15:00 Hours.

Odd Lot Trading is done on Fridays. For Odd Lot Trading Market Timings are
Market Open: - 12:00 Hours
Market Close: - 13:00 Hours.

The exchange may however close the market on days other than schedule holidays
or may open the market on days originally declared as holidays. The exchange may
also extend, advance or reduce trading hours when it deems necessary.

ii. Board Lot

Board lot refers to the minimum numbers of the securities tradable in the
exchanges in regular trading hours. It is fixed by the exchange. The lot size is
based on the face value of securities. In case of shares, the lot size is 10 for
stocks with face value of the Rs. 100 and the size is 100 if face value is Rs. 10.
For bonds the lot size is 100 if the face value is Rs. 100 and lot size is 10 if face
value is Rs. 1000.

iii. Price Regulation

The index-based circuit breaker system applies at 3 stages of the NEPSE index
movement of 3%, 4% and 5%.These circuit breakers when triggered bring about
a trading halt in all equity. In case of 3% movement either way, there would be a
market halt for 15 minutes if the movement takes place during first hour of
trading i.e. 13:00 hours. In case this movement takes after 13:00 hours there will
be no trading halt at this level and market shall continue trading. In case of 4%
movement either way, there would be a market halt for half an hour if the
movement takes place before 14:00 hours. In case this movement takes after
14:00 hours there will be no trading halt at this level and market shall continue
trading. In case of 5% movement in either way, trading shall be halted for the
remainder of the day.

iv. Settlement
NEPSE has adopted T + 3 days system of settlement. If T is the day of
transaction the entire buying and selling activities must be settled within three
days of the transaction day. However, the same is not practiced in real scenario
as the brokers make delays in payments.

v. Brokerage Commission
The following brokerage commission is charged for the trading of the equity
securities or stocks in NEPSE:

Traded Amount Commission Rate (%)

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Up to 50,000 0.60
50,001 – 500,000 0.55
500,001 – 2,000,000 0.50
2,000,001 – 10,000,000 0.45
Above 10,000,000 0.40

In other hand, SEBON charges 0.005% on every transaction. In case of the

government securities the commission rate ranges from 0.05% to 0.20%.
vi. Board of Directors
The BOD consists of 9 directors. The BOD of NEPSE is represented by the
government (Ministry of Finance, 1), Securities Board of Nepal (2), Nepal Rastra
Bank (2), Nepal Industrial Development Corporation (1), Licensed Members (2),
and General Manager (1).

Recent Development of the Stock Market

 The new securities ordinance 2005/06 is enacted to modernize and automate the
stock exchange.
 Emphasis is given to supervision of the disclosure of listed companies requiring
them to submit annual reports within four months of the end of the fiscal years.
 Not only stocks but the debentures issued from the banking sector and such issues
have been encouraged.
 Likewise, the emphasis is given to create a bond market in Nepal through providing
the license to the selected brokers for bond transactions.
 Continued efforts have been made to achieve the qualitative transformation of the
service delivery of NEPSE by criteria such as minimum qualification of the brokers,
capital base, office space, computers and technology, manpower etc.

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