Determining Stock Price - NEPSE

The role of the financial market is crucial in the mobilization of financial resources through financial intermediation. The financial market is a specialized market that is responsible for channeling financial resources from the surplus units (savers) to the deficit units (those who need additional funds) to carry out economic activities such as investment. Such investment is the real investment of an economy which adds value to the existing resources of the economy. In this regard, while the primary market has a greater role for providing funds for real investment, the secondary market provides the liquidity for primary market investors.

Though financial investment opportunity in Nepal is limited due to the infant stage of the economy, the consciousness and interest of Nepalese investors in the stock market has been increasing over the decade. The number of applications filed by the general public for both the initial public offerings and further public offerings of joint stock companies during the past few years also shows an increasing interest of the Nepalese in the bourse.

Nepal Stock Exchange (NEPSE) is only a formal stock exchange of Nepal established under the Company Act and operating under the Securities Exchange Act, 1983. It is a reliable barometer to measure the economic condition of the country. Every major change in our country and its economy is reflected in the prices of shares. The rise or fall in the NEPSE’s indices indicates the boom or recession cycle of the economy. Therefore, the stock exchange is also known as the pulse of an economy or even an economic mirror reflecting the economic conditions of a country.

The NEPSE was established with the objective of conveying free marketability and liquidity to the government and corporate securities by facilitating transactions in its trading floor through members, investors, market intermediaries, such as brokers or market makers. Initially, it was established as the Securities Exchange Center Ltd, in 1976, which had consolidated functions of facilitating and promoting the growth of capital markets. Before its conversion into the regular stock exchange we know, it was the only institution for capital markets undertaking investment bankers’ jobs such as brokering, underwriting, managing public issues, market making for government bonds and other financial services. Nepal Government, under a program initiated to reform the capital markets converted the Securities Exchange Center into NEPSE in 1993. However, NEPSE opened its trading floor later on 13th January 1994.

Furthermore, the Government of Nepal, Nepal Rastra Bank, Nepal Industrial Development Corporation and Members are the shareholders of NEPSE. The Members of NEPSE are permitted to act as intermediaries in the buying and selling of government bonds and listed corporate securities. At present, there are 50 member brokers and 2 market makers who operate on the trading floor as per the rules and byelaws of the Securities Exchange Act, 1983. Besides this, NEPSE has also granted membership to issue and sales managers and securities’ traders (dealers). An issue and sales manager work as a manager for issues and as an underwriter for the public issue of securities whereas securities’ traders work as individual portfolio managers (See NEPSE Online).

NEPSE lists various securities such as stock, bond and mutual fund unit of 221 Nepalese companies. It encourages people to invest in such companies’ securities by regulating new issues, better trading practices and by educating public about their investment. The presence of NEPSE is an assurance to the Nepalese investors that their investment can be easily converted into cash. The variety of short- and long-term investment opportunities provided by NEPSE through quality financial intermediary services has enabled individuals to make reasonable and adequate decisions about the risks and rewards of investing their funds. The stocks of renowned companies are actively traded so such companies can easily raise fresh capital through further public offerings. The valuation of securities is useful for investors, government and creditors. The investors can know the value of their investment, the creditors can value the creditworthiness and the Government can impose taxes on the value of securities. The stock market helps to value the securities on the basis of demand and supply factors. Regarding this, the stock price in NEPSE, its indices and movements has always been a matter of discussion among stakeholders such as general public, media, policy makers, regulators, bankers and investors. Therefore, it is an interesting topic to discuss the stock price determination in the NEPSE.

Theoretically, the price of any financial asset is drawn as the present value of the expected cash flow that shall be generated by the asset in the future course of action. But in reality, it is nearly hard and requires much expertise and consideration in order to draw the exact future cash flow of any asset such as a common stock. Practically, the price of a stock is drawn by the stock market on the basis of the demand and supply function of particular assets. Moreover, the pricing function of any investment opportunity is strictly based on available information regarding the risk and return. Briefly, from the Figure above, the stock price of a particular stock is determined by the available firm-related information of the stock compared to the market opportunity. The listed companies’ periodic financial and other vital information such as profitability, risk-taking of firm, growth and expansion, and board or executive decisions and activities are discriminated through a formal medium regularly in NEPSE. The positive information of a particular firm regarding future earnings and growth contributes to an increase in the stock price whereas negative information impacts negatively on the stock price. Therefore, there is a direct relationship between the firm-related information and the stock price in the market.

Unlike this, market opportunity is indirectly related to the direction of the stock price. The market opportunity refers to the market interest rate which is determined by the availability of the liquidity or investable funds with the various actors such as bankers, investors and individual savers of an economy. If the supply of investable funds is low in the market, it will increase the market interest rate on the one hand and decrease the overall demand pressure in the stock market on the other hand: Hence, this will reduce the stock price along with market indices. Similarly, if the supply of the investable funds is sufficient, the overall demand pressure in the stock market will be increased resulting in the increase of stock prices along with market indices though there may not be any further firm-related information available to the market. NEPSE operates on the ‘NEPSE Automated Trading System (NATS)’, a fully screen-based automated trading system which adopts the principle of an order driven market. Purchase and sale of physical as well as dematerialized securities is done through NATS. The trading system is an open auction trading system where the ordered prices from both stock buyers and sellers are entered in the NATS through respective broker accounts. Any matching is executed and further deals are settled by the brokers on the behalf of their clients. The last matching is displayed on screens as current prices of the stock. The top 5 buying and selling orders can be seen in the market depth section of the online system of NEPSE. Besides that, the initial order price can be set between 5% deviation of the previous price in either direction, and further orders can be deviated below 10% deviation. The new information available for a respective firm only influences the firm’s stock price whereas the news related to any possible changes in macroeconomic factors influences the whole stock market and NEPSE indices. Though statutory requirements have ensured the dissemination of vital information that affects the stock price for each listed company, it is not always an equitable exchange of information for all investors. The discrepancy towards the access of such information is called information asymmetry which always creates problems for general investors who relay strictly on formal sources whereas it also creates an opportunity for inside traders and speculators. Therefore, the pricing game is not entirely fair in some cases, and one should be always aware about price hikes and the speculation done by various influencer groups in NEPSE.

The Author:  Suvash Khanal is a faculty member of MBS and BBS at KIST.

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