Chapter I: Introduction

1.1. Background of the Study

Nepalese economy is in developing phase. Due to political instability, unplanned
economic activities and geographical situation the economic growth has been sluggish.
However after the suitable financial policies and adaptation of economic liberalization
financial institutions and economic activities have grown in urban and city areas of the
country (MOF, 2006). The economy of the country mainly depends upon the utilization
of resources and mobilization of capital. It is regarded as general barometer that
measures the proper collection and mobilization of saving of productive and income
generating sector. The growth of the stock market in developing and emerging markets
has become one of the most important topics in the area of the financial development.
Stock market allows companies to acquire capital easily and efficiently because they
create a market for efficient business transactions to take place. They are also important
stimulants to economic development because they provide alternatives to debt financing.
Adjasi and Biekpe (2009) state that the fund generated in the stock market can be
channeled to projects that help stimulate investment activities and lead to the promotion
of sustainable investment and economic growth.

The history of security market began with the flotation of shares by Biratnagar Jute Mills
Ltd. and Nepal Bank Ltd. in 1990 B.S. in Nepal. However, after the establishment of
Securities Kharid Bikri Kendra Limited (SKBKL) in 2033 B.S. had started secondary
transaction .The establishment of Security Exchange Board of Nepal (SEBON) in 2050
B.S. and conversion of SKBKL into Nepal Dhitopattra Binimaya Bazar ltd. In the same
year with the objectives of operating and managing secondary transactions of securities
came into existence. Similarly securities Transaction Regulation, securities Listing
Bylaw provisioned to bring Transaction Bylaw Membership of securities Market and
Transaction Bylaw in operation. In 2005 Securities related Ordinance, 2004 was framed
and enacted, and finally, in 2007 Securities Act, 2063 B.S. was promulgated as another
milestone in the history of Securities market of Nepal.
Stock market can encourage economic growth by providing an avenue for growing
companies to raise capital in low cost. Companies usually borrow money from bank in
order to meet their short term cash requirement. However, when they need long term
finance they may sell their ownership interest in the company by using common and
preferred stock. The stock exchange serves two critical functions it provides a critical
link between companies that need fund to set up new business or to expand their
operational and investor that have excess fund to invest in such companies and it’s also
provides a regulated market of share at market price determined by demand and
supply .The price of the stock, the economist’s makes us to believe is determined by the
forces of demand and supply in a free economy. In the securities market, both the
primary and secondary market are influences from the Macro and Micro economic
prospective. Macroeconomic factor includes politics general economic conditions and
micro economic factor includes earning per share, return on assets, dividend per share,
dividend payout ratio, dividend yield, rumor investor reaction government policies,
dividend and right share declaration, etc. Stock price in the market is not static rather it
changes every day. The stock (market) price is different from its par value and book
value. Stock price movement is not independent in nature and both extrinsic as well as
intrinsic factor have been established to exercise influences over stock price.

Sharpe (1964) started from Markowitz’s theory (1952) and developed the first single
factor model of evaluation of financial assets. This model is called Capital Asset Pricing
Model (CAPM). CAPM is used in finance for the theoretical determination of stocks’
returns and it shows that the expected return of a stock can be explained by a single
factor: the market’s expected return, the relationship between them being linear and
positive. To measure the sensitivity of a stock’s return to the return of the market, there’s
an indicator of systematic risk, called beta.

Voluminous empirical contradictions of the asset pricing model of Sharpe (1964),

Lintner (1965), and Black (1972) have emerged during the past two three decades that
market betas fail to describe the cross-section of expected returns Trying to improve the
CAPM model by eliminating some of its disadvantages, Stephen Ross (1976) formulated
Arbitrage Pricing Theory. Starting from the concept of arbitrage, he develops a multi
factors model in which the stock’s return is explained by several factors of macro
economical nature. Banz (1981) documents a strong negative relation between average
return and firm size. Chan, Hamao, and Lakonishok (1991) find that book-to-market
(B/M) ratio is also a powerful variable for explaining average returns on Japanese stocks.
Fama and French (1992) confirm that two easily measured variables, size and book-to-
market equity, combine to capture the cross-sectional variation in average returns
associated with market beta. In 1996, Eugene Fama and Kenneth French have elaborated
a model in which they showed that a stock’s return can be explained by three factors:
market’s return, the company’s size and market to book value. The standard model of
stock valuation postulates that expected cash flows from stocks and the required rate of
return (commensurate with the riskiness of cash flows) are the prime determinants of
stock prices.

The basic aim of investors from investing in company’s stock is to raise profits which are
attained by stock returns of companies. The stock return is the essential element in
selecting the sound investments decisions. Furthermore, any investor in selecting their
best investment decision is to achieve stock returns with more efficiently, competently
and a lesser amount of risk. Yet, the investors must need information about those stock
returns of companies that can increase profits. The information which exists about
company’s stock is based on internal or external information of that company. Internal
information of the company is reflected in its financial reports such as balance sheet,
profit and loss statement and cash flow statement. The outside information of companies
are available in the stock exchange market. Consequently, these internal and factors can
affect the stock returns. Furthermore, external information determines the stock prices in
the stock exchange market and has influence on investment decisions made by investors
(Moridi and & Mousavi, 2009). Dividend is the most important factors on the
determination of stock price. Dividends are strongly influenced by the earnings power of
the firm. There is a close relationship between corporate earnings and dividends.
Velenkar, Ankita and Ahuja (2017) disclosed that there is a positive impact of earning
and dividend on share price. The most fundamental factor, stock price fluctuation lies in
changes in corporate earnings, which together interest rates and business cycle trends,
contribute to making up the economic factors influencing stock price. Similarly, the
other influencing factors are market factors or internal factors of the market considering
of the tone of the market and supply demand relationship may be cited as the third
category, that influence the stock prices. Besides these factors the stock prices influenced
by the corporate performance of the company, company’s policy regarding the
capitalization of earnings as well as governments rules and signaling effect of the
market. Today most of the developing countries are boosting their economic
development though the contribution of this investment sector.

It is expected that the finding of this study would provide some meaningful insights to
understand the determinants of Nepalese stock market returns, useful to both policy
maker and investor.

1.2 Statement of Problems

Over the last several decades the influencing factors of share price has been extensively
studied in developed as well as developing capital market. The pioneering work on share
price determinants by Collins (1957) for the US identified dividend, net profit, operating
earnings and book value as the factors influencing share prices. Following Collins (1957)
there have been various attempts to identify the determinants of share prices for different
markets. As per the study conducted in India, an investor suggested to take care of
accounting variable of company before investing (Sharma, 2011). Sharma (2011)
mentioned that earning per share and dividend per share were the strongest determinants
of market price. These studies documented that firm specific variables play a major role
in determination of stock return.

In Nepalese context, prominent sector in stock market is banking sector. These securities
are traded in a large volume whose price is higher. Stock return which is measured by the
market price of share is a function of various factors. Both qualitative and quantitative
factors determine the stock returns, to specify what factors have influences over the stock
return is unpredictable issue. More studies reveled that there exist a significance
relationship between the stock return and different fundamentals. According to Pradhan
and Balampki (2004) book to market ratio is found to be more informative in explaining
the stock return.( Silwal and Napit, 2019) have studied on the fundamental of stock price
in Nepalese commercial banks and study revealed that book value per share, price to
earnings ratio, return on equity have positive relationship with stock price where as
dividend yield has positive but mimimumminimum influence on the price of stock and
furthermore, size has negative relationship and is statistically insignificant with stock
price. As per this study, most influential factor that determine stock price in Nepal is
book value per share.

Likewise Bhattarai (2014) believes that dividend yield has inverse relationship with
market price and size has insignificant impact on market price of share. Hence size have
no explanatory power towards stock price. Similarly as per study done in Pakistan on
Karachi stock exchange, earning per share has more influence on share price and it has
positive and significant relationship with share price.

Most of the researches that have been done in previous years is related with the share
price and its determinants. (Kheradyar and & Ibrahim, 2011) have studied whether
financial ratios can predict stock returns in Malaysia stock exchange. The researchers
have selected three financial ratios that include dividend yield (DY), earning yield (EY)
and book-to-market ratio (B/M) that have been documented to predict stock returns. The
obtained results indicate that the financial ratios can predict stock return, as the B/M has
the higher predictive power than DY and EY respectively. Extensive research like this is
still lack in Nepal. Moreover, the empirical evidences tested over the time provide no
consistent result in explaining stock returns. So this study is interested in understanding
the certain accounting information which could influences the stock return in Nepalese
stock market. Therefore this study directed to resolve the following research issues in the
context of Nepal:

a) Is there any relationship between earning yield and banking stock returns in
Nepal?

b) Do dividend yield predict banking stock returns in Nepal?

c) Do the cash flow yield explain banking stock returns in Nepal?

d) Is there any role of book to market ratio in predicting banking stocks returns in
Nepal?

e) What is the firm size effect on banking stock returns in Nepal ?

1.3 objective Objective of the studyStudy

The prime objective of this study is to analyze the relationship between firm specific
fundamentals and banking stock returns in Nepal. In order to achieve the main objective,
the following are the specific objectives:
 a) To analyze the relationship of between earnings yield with and banking stock
return in Nepal.

b) To examine the relationship between dividend yield and banking stock return in
Nepal .

c) To access assess the association of between cash flow yield with and the banking
stock return in Nepal.

d) To examine the relationship between book to market ratio and banking stock
return in Nepal .

e) To analyze the relationship of firm size with and the banking stock return in
Nepal.

1.4 Hypothesis of the studyStudy

This study is based on the following hypothesis:

a) There is significant positive relationship between earning yield and stock return.

b) There is significant negative relationship between dividend yield and stock

return.

c) There is significant negative relationship between cash flow yield and stock
return.

d) There is significant negative relationship between book to market ratio and stock
return.

e) There is significant positive relationship between size and stock return.

Note: You have to discuss the hypothesized relationship in problem

statement parts based on the previous empirical documentation.

1.5 Rationale of the studyStudy

The stock price is one indicator of the successful management of the company, if the
stock price of a company always increases, the investor or prospective investor considers
that the company succeeded in managing their business. The investor invests money in
capital market with the expectation of acquiring good returns from their investment. But
on the other hand, investors should be willing to bear the risk is also high. Based on that,
then in investing in the stock market, factors other than profit, investors should consider
the risk factors. The risk factors of investing can be measured by beta. So, this study
focus on the factor other than the market risk that would influences the stock return.
Shiller (1981) found that stock prices are not stable and fluctuate excessively in relation
to the news about fundamentals (as dividends) primarily due to market irrationality.
Thus, it is asserted that understanding the impact of various fundamental variables on
stock price is very much helpful to investors as it will help them in taking profitable
investment decisions.

The major drawback for our stock market is the regulatory system as it is still in a
developing phase and information transparency are not certainly proficient to get the
confidence of the investors and provide the sufficient basis for analyzing the data without
anomalies. Beside this, Government and Nepalese Bank do not playing the desired role
to create the stable market with expected outcome of investors. In addition, investors
have also lack of knowledge (fundamental and technical) about capital market. As a
result, they cannot cut a good figure from share market. There are some determinants
which have great impact on share price. How these determinants influence stock return’s
have been shown through this research. An investor can make their investment decision
by taking information from this report. Moreover, the stock market authority might find
the results helpful in avoiding any unexpected catastrophe, controlling market strategies,
improving the stock market industry, and assessing the degree to which the stock market
may need to be reformed.

Society also get benefited from this study by getting the information about the
determinants which can brings out the changes in stock price through which they can
change their investment portfolio by investing in a productive sector as in many societies
individual investor invest in many financial institution like cooperative banks in rural
areas.

In addition, the study would also be useful to academician and student who are willing to
investigate on the similar topics in future as it works as a base of literature. This study
validates some of the findings of previous authors by testing the relationships between
book to market ratio, dividend yield, earning yield, cash flow yield, size and stock
return’s of the sample firms. Thus, this study adds substance to the existing theory
developed by previous authors.

1.6 Limitation of the Study

There are some limitations in this study which are pointed out below:

a) This study is based on secondary data published by the sampled banks over the
period of ten year s(2009/10 to 2018/19) and are available on the official web
page of the concerned banks. Result may vary if primary data will be
considered(Why did you select study period from 2009/10 to

2018/19?).

b) This research is concentrated at 10 sampled commercial banks only so, the

conclusion derived their of cannot be generalized on the total capital market.

(Why only 10 sample banks?????)

c) The study only examines the effect of firm specific fundamentals (Dividend
yield, Earning yield, Book to market equity, SIZE & Cash Flow Yield) based on
the financial factors i.e. accounting information. The study does n’t not examine
internal qualitative factors like company profile, goodwill, AGM, company
announcements and other external factor affecting the share price such as
inflation, interest rate, macro-economic factors, etc. (Why??????)
1.7 Organization of the studyStudy
The whole study was organized in the five different chapters. Chapter I concentrated on
general background of study, statement of the problem, objective of the study, hypothesis
of the study, rationale of the study and limitation of the study. Whereas, chapter II deal
with review of various Journals, books published or unpublished reports, articles and
previous thesis related with the stock price and its determinants. Similarly, chapter III
deals with methodology followed to achieve the objective of the study, which includes
research design, nature and source of data, population and sample, various descriptions
of tools and techniques for data collection and analytical tools. Along with this, chapter
IV deals with presentation, analysis and interpretation of data. It also includes the finding
of the study. And finally, chapter V deals with discussion, summary and conclusion of
the entire study. Bibliography and appendices are also included at the end of the chapter.

Note: Please make a bibliography list