The question as printed is incomplete. It is the standard problem in which the mutual fund holds 100,000 shares of Company A and 200,000 shares of Company B, each priced at Rs 240. The fund has issued 600,000 units and has current liabilities of Rs 100,000. The answer uses these holdings.

(a) NAV of the fund

$\text{Market value of portfolio} = (100{,}000 \times 240) + (200{,}000 \times 240) = 24{,}000{,}000 + 48{,}000{,}000 = \text{Rs } 72{,}000{,}000$

$\text{Net assets} = 72{,}000{,}000 - 100{,}000 = \text{Rs } 71{,}900{,}000$

$\text{NAV per share} = \frac{71{,}900{,}000}{600{,}000} = \textbf{Rs } 119.83$

(b) Expected NAV at the end of the year

Company A rises to Rs 300 and Company B falls to Rs 220.

$\text{Net assets} = 74{,}000{,}000 - 100{,}000 = \text{Rs } 73{,}900{,}000$

$\text{Expected NAV} = \frac{73{,}900{,}000}{600{,}000} = \textbf{Rs } 123.17$

The NAV is expected to rise by about Rs 3.34 per share (about 2.8%).

a. Non-Depository Financial Institution

Meaning: A non-depository financial institution (NDFI) is a financial institution that does not accept public deposits as its main business but provides financial services such as insurance, investment, credit and contractual savings. It raises funds through premiums, contributions, shares or borrowings rather than through demand deposits.

Types:

• Insurance companies — life and non-life; collect premiums and pay claims.
• Employee Provident Fund / Citizen Investment Trust — contractual savings institutions.
• Finance companies — provide loans and hire purchase but do not take demand deposits.
• Mutual funds / Investment companies — pool savings of small investors.

Functions:

1. Mobilise savings through insurance premiums, contributions and unit sales.
2. Provide medium and long-term loans for industry, trade and housing.
3. Supply financial services such as insurance cover, pension and investment management.
4. Help in capital formation by channelling small savings into productive use.
5. Provide liquidity to investors through mutual fund units and insurance policies.
6. Support the money market and capital market as institutional investors.

Importance: They fill the gap left by banks, especially in long-term finance and risk protection. They create employment, reduce risk through insurance, and help in the economic development of the country.

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b. NEPSE

Meaning: NEPSE stands for Nepal Stock Exchange. It is the only organised secondary market for securities in Nepal. It was established in 1994 (2050 B.S.) under the Securities Exchange Act, 2063, and is headquartered in Kathmandu. It began automated screen-based trading in 2007.

Objectives:

1. Provide a fair, efficient and transparent market for buying and selling securities.
2. Facilitate liquidity to investors by allowing them to convert securities into cash.
3. Determine the fair market price of securities through demand and supply.
4. Protect the interest of investors and promote capital market development.

Functions:

1. Secondary market — provides a platform to trade listed shares, debentures and mutual fund units.
2. Listing — grants permission to companies to list their securities for trading.
3. Price determination — fixes market price through an order-driven electronic system.
4. Clearing and settlement — settles transactions through CDSC within the prescribed time.
5. Market information — publishes daily indices such as NEPSE Index, floor sheet and market capitalisation.
6. Regulation — enforces trading rules and brokers' code of conduct under SEBON supervision.

Importance: NEPSE mobilises savings into productive investment, provides liquidity, ensures fair pricing and helps in the growth of the capital market. It is regulated by the Securities Board of Nepal (SEBON).

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c. Further Public Offering (FPO)

Meaning: A Further Public Offering is the issue of new shares by a company that is already listed on the stock exchange. It is made after the company's Initial Public Offering (IPO) to raise additional capital from the public. In Nepal, FPO is issued under the Securities Exchange Act, 2063 and SEBON guidelines.

Features:

1. Made only by a company whose shares are already listed and traded.
2. Shares are issued to the general public, including new investors.
3. The issue price is generally fixed at or near the prevailing market price.
4. It increases the paid-up capital and the number of outstanding shares.
5. Existing shareholders may get a right to subscribe on a priority basis.

Objectives:

1. To raise additional capital for expansion, modernisation and working capital.
2. To meet the minimum paid-up capital requirement set by the regulator.
3. To increase public participation and widen the ownership base.
4. To improve the liquidity of the company's shares in the secondary market.

Procedure: The company obtains approval from SEBON, publishes a prospectus, opens the issue for a fixed period, collects applications, allots shares (with proportionate allotment if oversubscribed) and lists the new shares on NEPSE.

Difference from IPO: In an IPO, a company issues shares to the public for the first time; in an FPO, an already listed company issues additional shares to the public.

Why BFIs Need to Be Regulated

Banks and financial institutions (BFIs) accept public deposits and lend them out, and they operate on a small base of capital relative to the huge volume of other people's money they handle. This special nature makes regulation necessary for the following reasons:

1. Protection of depositors' funds. Deposits are held in trust. Depositors, especially small savers, cannot assess a bank's solvency or management quality. Regulation (capital standards, audits, deposit insurance) protects them from loss.

2. Fragility and risk of bank runs. Banks keep only a fraction of deposits as reserves. A loss of confidence can trigger a run, and because assets are illiquid, even a solvent bank can fail. Regulation aims to maintain confidence and stability.

3. Systemic risk and contagion. BFIs are interlinked through interbank lending, payment systems and common borrowers. The failure of one large institution can spread to others and disrupt the whole economy — the "domino effect."

4. Prevention of monopoly and concentration. BFIs can combine and dominate credit, fixing interest rates and exploiting borrowers. Regulation promotes competition and fair access to finance.

5. Consumer protection and fair practices. Without rules, banks may charge excessive interest, hide terms, mis-sell products or use unfair recovery practices. Regulation ensures transparency and grievance redressal.

6. Control of money supply and monetary policy. BFIs create credit, which affects money supply, inflation and the exchange rate. The central bank must supervise them for monetary policy to work.

7. Prevention of financial crimes. BFIs are channels for money laundering, terrorist financing, fraud and tax evasion. Regulation imposes KYC, AML and reporting duties.

8. Moral hazard and safety-net abuse. Because deposits are insured and troubled banks may be rescued, owners and managers may take excessive risks. Regulation (capital adequacy, exposure limits, prompt corrective action) disciplines such behaviour.

9. Allocation of credit to priority sectors. Regulation directs credit toward productive, deprived and priority sectors, supporting balanced development.

10. Maintaining public trust in the financial system. The whole economy depends on confidence in money and banking. Regulation preserves that confidence.

Role of NRB in Regulation of BFIs

Nepal Rastra Bank (NRB), established in 1956 under the Nepal Rastra Bank Act, is the central bank and the sole regulator and supervisor of BFIs in Nepal. Its regulatory role includes:

1. Licensing and authorization. NRB grants, refuses, suspends and revokes licences to banks and financial institutions, and approves their branches, mergers and acquisitions.

2. Framing rules and directives. It issues the NRB Act, BAFIA (Banks and Financial Institutions Act), unified directives, circulars and prudential norms on capital adequacy, loan classification, provisioning, liquidity, exposure limits and interest rates.

3. On-site supervision. NRB conducts regular and special inspections of BFIs to examine their books, loan portfolio, internal control and compliance, and issues corrective directions.

4. Off-site supervision. BFIs must submit periodic returns (balance sheet, NPL, capital, liquidity). NRB analyses these to detect early warning signals and take timely action.

5. Enforcement and corrective action. NRB can warn, fine, restrict business, remove directors or managers, appoint a management committee, or liquidate a troubled institution.

6. Deposit insurance and depositor protection. Through the Deposit and Credit Guarantee Fund, NRB safeguards small depositors.

7. Regulation of credit and monetary policy. Through bank rate, CRR, SLR, open market operations and directed lending, NRB influences credit growth and inflation.

8. Foreign exchange and capital account regulation. NRB regulates foreign exchange transactions, remittances and foreign borrowing by BFIs.

9. Promotion of financial inclusion and stability. NRB encourages branch expansion in rural areas, microfinance, digital banking and financial literacy.

10. Coordination and research. It coordinates with the government and international bodies (IMF, World Bank) and publishes reports on financial sector health.

Conclusion

Because BFIs handle public money, create credit and are prone to runs and contagion, they cannot be left to self-regulation. NRB, as the central bank, performs licensing, rule-making, supervision, enforcement and promotional functions to keep BFIs sound, protect depositors and maintain monetary and financial stability in Nepal.

Given (Rs in million): goods and services credit 310,000, debit 1,510,000 (goods 250,000 / 1,150,000; services 60,000 / 360,000); primary income 38,000 / 16,000; secondary income 600,000 / 15,000.

(a) Net of goods and services account

$310{,}000 - 1{,}510{,}000 = -\text{Rs }1{,}200{,}000 \text{ million (deficit)}$

(b) Net of primary and secondary income accounts

• Primary income: $38{,}000 - 16{,}000 = +\text{Rs }22{,}000$ million (surplus)
• Secondary income: $600{,}000 - 15{,}000 = +\text{Rs }585{,}000$ million (surplus)

(c) Accounts increasing the current account deficit

The goods and services account (deficit Rs 1,200,000 million), made up of:

• Goods: $250{,}000 - 1{,}150{,}000 = -\text{Rs }900{,}000$ million
• Services: $60{,}000 - 360{,}000 = -\text{Rs }300{,}000$ million

(d) Accounts decreasing the current account deficit

Secondary income (surplus Rs 585,000 million, mainly remittances) and primary income (surplus Rs 22,000 million).

(e) Trade balance

Trade balance = goods credit $-$ goods debit $= 250{,}000 - 1{,}150{,}000 = -\text{Rs }900{,}000$ million, i.e. a trade deficit of Rs 900,000 million.

Overall current account balance: $-1{,}200{,}000 + 22{,}000 + 585{,}000 = -\text{Rs }593{,}000$ million (deficit).

(a) Average expected inflation over the next 4 years (2024–2027)

$\frac{5+6+7+8}{4} = \frac{26}{4} = 6.5\%$

(b) Prevailing interest rate on 4-year T-bonds

With no maturity risk premium for bonds of 5 years or less, $r = r^* + IP = 2\% + 6.5\% = 8.5\%$.

(c) Implied expected inflation in 2028 (year 5)

The 5-year yield is 9%, so

$9 = 2 + \frac{5+6+7+8+X}{5} \Rightarrow 35 = 26 + X \Rightarrow X = 9\%$

(d) Factors affecting interest rates

• Real risk-free rate ($r^*$): depends on the supply of savings and the demand for investment funds.
• Expected inflation: lenders add an inflation premium to protect purchasing power.
• Default risk premium: higher for borrowers less likely to repay.
• Liquidity premium: extra yield for securities that cannot be sold quickly at fair value.
• Maturity risk premium: compensation for the greater price risk of long-term bonds.
• Government policy and economic conditions: monetary policy of Nepal Rastra Bank, government borrowing and fiscal deficits, and the level of economic activity.

a. Meaning of Open, High and Low

• Open: The price at which the first trade of the day took place. Here, NABIL opened at Rs 596.
• High: The highest price at which the stock traded during the day. Here, Rs 630.
• Low: The lowest price at which the stock traded during the day. Here, Rs 590.

b. Closing price on the trading day
The stock closed at Rs 635.

c. Maximum and minimum trading prices on the day
As per the quote:

• Maximum (High) = Rs 630
• Minimum (Low) = Rs 590

Note: The close is Rs 635, which is higher than the quoted High of Rs 630. Normally, High must be at least equal to Close. So the quote appears inconsistent; if corrected, the day’s maximum should be at least Rs 635.

d. Number of shares traded on the day
Total shares traded = 123,432 shares.

e. Total value of shares traded on the day
Turnover = Rs 37,214,250
In Nepali comma format: Rs 3,72,14,250.

f. Increase or decrease compared to previous day
The stock increased.
Close = Rs 635, Previous Close = Rs 590.
Since (635 > 590), the price increased by Rs 45.

g. Meaning of Diff%
Diff% means the percentage change in the closing price compared to the previous day’s closing price.
[ \text{Diff%} = \frac{\text{Close} - \text{Prev. Close}}{\text{Prev. Close}} \times 100 ] Here, [ \frac{635 - 590}{590} \times 100 = 7.62% ] So, +7.62% means the price increased by 7.62% over the previous day.

h. Explanation of 52 Weeks High/Low
52 Weeks High/Low shows the highest and lowest prices at which the stock traded during the past 52 weeks (one year).

• 52-week high = Rs 775
• 52-week low = Rs 495

It gives the yearly price range and helps investors judge the stock’s current price relative to its one-year performance.

Short Notes (Any TWO)

a. Ancillary Services

Ancillary services are the supporting or subsidiary services provided by commercial banks and financial institutions along with their core banking functions (deposit collection and lending). These services do not form the main business of a bank but generate additional income and add value to customers.

Major ancillary services:

1. Agency functions — acting as agent of customers for:

   • Collection of cheques, drafts, bills, and dividends
   • Payment of bills, rent, insurance premiums, and taxes
   • Purchase and sale of securities on behalf of customers
   • Remittance of funds (demand drafts, telegraphic transfers, mail transfers)

2. General utility services:

   • Issuing letters of credit and guarantees in foreign trade
   • Providing locker facilities for safe custody of valuables
   • Issuing traveler's cheques and credit cards
   • Underwriting of shares and debentures
   • Providing foreign exchange facilities
   • Supplying trade information and credit reports
   • Executing standing instructions of customers

Importance: Ancillary services diversify bank income, strengthen customer relationships, promote trade and commerce, and improve the overall profitability and stability of banks. In Nepal, commercial banks provide these services under the framework of the Nepal Rastra Bank Act and BAFIA.

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b. Securities Board of Nepal (SEBON)

The Securities Board of Nepal (SEBON) is the apex regulatory body of the securities market in Nepal. It was established on 7 June 1993 (24 Jestha 2050 BS) under the Securities Exchange Act, 1983 (2040 BS), and is headquartered in Kathmandu.

Objectives:

• To develop and regulate the securities market in Nepal
• To protect the interests of investors
• To promote good corporate governance in listed companies

Functions and Powers:

1. Regulating the issue, sale, and transfer of securities (shares, debentures, mutual funds)
2. Licensing and monitoring stock exchanges, brokers, dealers, merchant bankers, and depository institutions
3. Approving public issues, rights issues, and prospectuses of companies
4. Controlling insider trading and unfair trade practices
5. Conducting investigations and taking legal action against defaulters
6. Issuing directives and formulating rules for capital market development
7. Promoting investor education and awareness

Structure: SEBON is governed by a Board of Directors chaired by the Chairman, appointed by the Government of Nepal. It works closely with the Nepal Stock Exchange (NEPSE) and the CDS and Clearing Limited.

Significance: SEBON ensures transparency, fairness, and efficiency in the capital market, thereby building investor confidence and contributing to capital formation for national development.

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c. Credit Rating

Credit rating is an independent assessment and grading of the creditworthiness of a borrower (company, government, or financial instrument) regarding its ability to repay debt obligations on time. It is expressed in symbols or grades such as AAA, AA, A, BBB, etc.

Key features:

1. It measures the risk of default on debt instruments such as bonds, debentures, and loans.
2. It is done by specialized credit rating agencies (e.g., in Nepal, ICRA Nepal and CARE Ratings Nepal).
3. Ratings are based on analysis of financial statements, management quality, industry position, economic conditions, and repayment history.
4. Ratings are periodically reviewed and may be upgraded or downgraded.

Uses and importance:

• Helps investors assess risk before investing in securities.
• Helps lenders decide interest rates and credit limits.
• Enables companies to raise funds at lower cost with a good rating.
• Assists regulators in monitoring market discipline.
• Promotes transparency and credibility in the financial system.

In Nepal: SEBON has made credit rating mandatory for companies issuing debentures and for certain public issues, making credit rating an essential part of the capital market.

Components of the Financial System and Current Status of Financial Institutions in Nepal

1. Components of the Financial System [9 marks]

A financial system is the set of institutions, markets, instruments and mechanisms through which savings are mobilised from surplus units (savers) and channelled to deficit units (borrowers/investors). It consists of the following major components:

(a) Financial Institutions

These are the intermediaries that collect funds from savers and lend or invest them. They include:

• Depository institutions: commercial banks, development banks, finance companies and microfinance institutions, which accept deposits and provide credit.
• Contractual savings institutions: insurance companies, Employees Provident Fund, Citizen Investment Trust and Nepal Insurance Authority–regulated bodies, which collect regular premiums/contributions and invest them.
• Other institutions: Nepal Rastra Bank (the central bank), Nepal Stock Exchange, Credit Information Bureau and credit rating agencies.

(b) Financial Markets

These are the organised places or mechanisms where financial assets are bought and sold. They are of two types:

• Money market: deals in short-term instruments (up to one year) such as treasury bills, commercial papers, certificates of deposit and interbank loans. In Nepal, this market is dominated by treasury bills and interbank transactions.
• Capital market: deals in long-term securities such as shares, debentures and government bonds. It has a primary market (new issues) and a secondary market (NEPSE for trading existing securities).

(c) Financial Instruments (Assets)

These are the claims or securities through which funds are transferred. They include:

• Primary securities: shares (ordinary and preference), debentures, bonds and government securities.
• Short-term instruments: treasury bills, commercial papers, certificates of deposit and bills of exchange.
• Deposits and insurance policies: bank deposits, fixed deposits and life insurance policies.

(d) Financial Services

These are the facilities provided by financial institutions to facilitate transactions and manage risk, such as:

• Banking services (deposits, loans, remittance, letter of credit)
• Insurance and risk-pooling services
• Leasing, hire purchase and venture capital
• Merchant banking, portfolio management and credit rating
• Payment and settlement services (cheque clearing, electronic transfer, mobile banking)

(e) Financial Markets Regulators and Infrastructure

The system also includes regulatory and supervisory bodies — Nepal Rastra Bank (banking and foreign exchange), Securities Board of Nepal (securities market), Nepal Insurance Authority (insurance) and the Ministry of Finance (overall policy) — along with supporting infrastructure such as payment systems, credit information and legal frameworks.

(f) Financial Instruments' Pricing Mechanism

Interest rates, exchange rates and security prices act as the signals that guide the allocation of funds between savers and investors. In Nepal, NRB influences these through monetary policy tools such as the bank rate, CRR, SLR and open market operations.

In short, the financial system works as a bridge between savers and investors through institutions, markets, instruments, services and regulation, thereby supporting capital formation and economic growth.

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2. Current Status of Financial Institutions in Nepal [6 marks]

Nepal has a bank-dominated financial system supervised mainly by Nepal Rastra Bank. The present status can be summarised as follows:

(a) Structure and Number of Institutions

As of recent NRB data, the licensed financial institutions (BFIs) are approximately:

• Commercial banks: 20 (Class "A")
• Development banks: 17 (Class "B")
• Finance companies: 17 (Class "C")
• Microfinance institutions: 50+ (Class "D")
• Infrastructure Development Bank: 1
• Insurance companies: around 40 (life and non-life), regulated by the Nepal Insurance Authority
• Other entities: Nepal Stock Exchange (NEPSE), CDS and Clearing Ltd., Credit Information Bureau, Employees Provident Fund and Citizen Investment Trust

(b) Branch Expansion and Financial Access

• BFIs operate more than 5,000 branches across all 77 districts, with a strong push into rural and remote areas.
• Financial access has improved markedly; deposit and loan penetration has risen, and a large share of local units now have at least one bank branch.

(c) Dominance of Commercial Banks

• Commercial banks hold the largest share of total deposits, loans and assets of the banking sector.
• The three largest banks by assets are Nabil Bank, NIC Asia Bank and Global IME Bank.

(d) Financial Performance

• The banking sector remains generally profitable and well capitalised, with most BFIs maintaining capital adequacy above the regulatory minimum.
• However, in recent years, credit growth has slowed, non-performing loans (NPLs) have risen moderately, and liquidity has at times been tight.
• Net interest income has been under pressure due to high deposit costs and weak credit demand.

(d) Consolidation and Mergers

• A major merger and acquisition (M&A) drive has reduced the number of BFIs substantially over the last decade, aimed at strengthening capital base and reducing fragmentation.
• The policy of "one district, one branch" and merger incentives have reshaped the institutional landscape.

(e) Digital Financial Services

• Rapid expansion of mobile banking, internet banking, QR payments, connect IPS and mobile wallets has increased transaction convenience.
• Digital transactions have grown faster than traditional branch-based transactions, especially after the COVID-19 period.

(f) Challenges

• High NPLs in some institutions, weak credit demand, rising operational costs, cyber-security risks, and uneven access in remote districts remain key concerns.
• Coordination among regulators and financial literacy also need strengthening.

Conclusion: Nepal's financial system is now fairly broad and bank-dominated, with an expanding network and growing digitalisation. However, asset quality, credit demand and financial inclusion in remote areas remain areas requiring continued reform.

a. Balance of Payment and Balance of Trade

Balance of Payment (BoP): BoP is a systematic record of all economic transactions between the residents of a country and the rest of the world during a given period of time. It includes transactions relating to goods, services, income, transfers, and capital flows. It is prepared on a double-entry system, so it always balances in accounting sense.

Balance of Trade (BoT): Balance of trade is the difference between the value of a country's exports and imports of goods only. It is a narrow concept and is a part of the current account. If exports exceed imports, there is a trade surplus; if imports exceed exports, there is a trade deficit.

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b. Net of Goods and Services Account

Net = Credit − Debit

Goods and services: = Rs 440,000 million − Rs 2,800,000 million = − Rs 2,360,000 million (net deficit)

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c. Net of Primary Income and Secondary Income Account

Primary income: = Rs 65,500 million − Rs 31,250 million = Rs 34,250 million (net surplus)

Secondary income: = Rs 1,410,000 million − Rs 9,675 million = Rs 1,400,325 million (net surplus)

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d. Accounts Contributing to Increase the Current Account Deficit

The goods and services account (especially the goods account) has contributed to increasing the current account deficit. Goods show a huge debit of Rs 2,500,000 million against credit of only Rs 305,000 million, giving a net deficit of Rs 2,195,000 million. Similarly, services show a net deficit of Rs 165,000 million. Together, goods and services create a net deficit of Rs 2,360,000 million, which is the main factor increasing the current account deficit.

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e. Accounts Contributing to Decrease the Current Account Deficit

The primary income account and secondary income account have contributed to decreasing the current account deficit. Primary income gives a net surplus of Rs 34,250 million and secondary income gives a net surplus of Rs 1,400,325 million. These surpluses (mainly remittances under secondary income) offset a large part of the deficit arising from goods and services.

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f. Trade Deficit or Surplus

Trade balance = Exports of goods − Imports of goods = Rs 305,000 million − Rs 2,500,000 million = − Rs 2,195,000 million

So there is a trade deficit of Rs 2,195,000 million during the first nine months of fiscal year 2023/24.

Meaning: A trade deficit means the value of goods imported by the country is greater than the value of goods exported. Nepal is importing far more goods than it exports, which drains foreign exchange reserves. However, this deficit is largely financed by remittances received under secondary income.

a. Yield on 2-year Treasury securities

Given:

• Real risk-free rate, $k^* = 2\%$
• Inflation: Year 1 = 5%, Year 2 = 6%
• Maturity risk premium (MRP) up to 3 years = 0

Average inflation for 2 years: $IP_2 = \frac{5\% + 6\%}{2} = 5.5\%$

$k_{T2} = k^* + IP_2 + MRP_2 = 2\% + 5.5\% + 0 = \boxed{7.5\%}$

b. Yield on 3-year Treasury securities

Average inflation for 3 years: $IP_3 = \frac{5\% + 6\% + 7\%}{3} = \frac{18\%}{3} = 6\%$

$k_{T3} = k^* + IP_3 + MRP_3 = 2\% + 6\% + 0 = \boxed{8\%}$

c. Yield on 4-year Treasury securities

Inflation from the third year onward stays at 7%, so Year 4 inflation = 7%.

$IP_4 = \frac{5\% + 6\% + 7\% + 7\%}{4} = \frac{25\%}{4} = 6.25\%$

Given MRP₄ = 0.75%

$k_{T4} = k^* + IP_4 + MRP_4 = 2\% + 6.25\% + 0.75\% = \boxed{9\%}$

d. Reasons why long-term yields are usually larger than short-term yields

1. Maturity risk premium: The longer the maturity, the greater the exposure to interest rate risk. Prices of long-term bonds fall more sharply when market rates rise, so investors demand a premium for bearing this risk. This premium increases with maturity.
2. Inflation expectations: If investors expect inflation to rise in the future, the average expected inflation built into a long-term security is higher than that of a short-term security, pushing long-term yields up.
3. Greater uncertainty: Over a long horizon, future economic conditions, price levels and real rates are harder to predict, so lenders require extra compensation for the added uncertainty.

e. Determinants of interest rates

The nominal (quoted) interest rate on a security is determined by:

$k = k^* + IP + DRP + LP + MRP$

where:

• $k^*$ = Real risk-free rate — the rate on a default-free security with no inflation, reflecting the pure time value of money (production opportunities and time preference for consumption).
• $IP$ = Inflation premium — compensation for expected erosion of purchasing power over the life of the security.
• $DRP$ = Default risk premium — compensation for the chance the borrower fails to pay interest or principal; zero for Treasury securities.
• $LP$ = Liquidity premium — compensation for securities that cannot be sold quickly at a fair price; zero for actively traded Treasury securities.
• $MRP$ = Maturity risk premium — compensation for the interest rate (price) risk that increases with the security's term to maturity.

a. Citizen Investment Trust (CIT)

Citizen Investment Trust (CIT) is a government-owned financial institution established in 1991 (2048 B.S.) under the Citizen Investment Trust Act, 2047 B.S. It was set up to mobilize small savings from citizens and channel them into productive sectors, while also providing retirement and welfare schemes to employees.

Key features:

• Nature: A statutory, autonomous, and government-owned financial intermediary, headquartered in Kathmandu.
• Objectives: To encourage the habit of saving among citizens, collect scattered savings, invest them in productive sectors, and provide social security through pension and insurance-type schemes.
• Major functions:
  • Operates retirement and pension schemes for employees of government, semi-government, and private organizations.
  • Runs collective investment schemes (mutual funds) and sells units to the public.
  • Provides investor services such as share registration, underwriting, and portfolio management.
  • Accepts deposits under various saving schemes and invests funds in shares, debentures, and government securities.
• Importance: It channels small savings into productive investment, develops the capital market, and provides financial security to retired employees. It is one of the major institutional investors in Nepal's securities market.

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b. Insurance Board

The Insurance Board (now renamed Nepal Insurance Authority) is the regulatory and supervisory authority of the insurance sector in Nepal. It was established in 1993 (2050 B.S.) under the Insurance Act, 2049 B.S., with its head office in Kathmandu.

Key features:

• Nature: An autonomous, statutory body acting as the apex regulator of insurance business in Nepal.
• Objectives: To regulate, develop, and systematize the insurance industry; protect the interests of policyholders; and ensure the financial soundness of insurers.
• Major functions:
  • Grants, renews, suspends, or cancels the licence of insurance companies and intermediaries (agents, brokers, surveyors).
  • Issues directives, circulars, and rules for the operation of insurance business.
  • Conducts inspection, supervision, and investigation of insurance companies.
  • Approves insurance policies, premium rates, and reinsurance arrangements.
  • Settles disputes between insurers and policyholders and handles complaints.
  • Promotes insurance awareness and develops the insurance market.
• Importance: It safeguards policyholders' interests, maintains discipline and solvency in the insurance market, and helps channel long-term insurance funds into productive investment.

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c. Pension Fund

A pension fund is a fund created to provide regular income (pension) to employees after their retirement, and sometimes to their dependents after death. It is a form of retirement benefit plan under which a certain portion of salary is contributed regularly during the service period and paid back as a monthly pension after retirement.

Key features:

• Contributions: Made by the employer, the employee, or both, usually as a fixed percentage of salary.
• Accumulation: Contributions are invested in securities and other assets, and the fund grows with interest and returns.
• Payment: On retirement, the employee receives either a lump sum or a monthly pension for life.
• Types: Defined benefit plan (pension fixed in advance) and defined contribution plan (pension depends on contributions and returns).
• In Nepal: Pension funds are managed for civil servants, security personnel, and employees of organized sectors; the Employees Provident Fund (EPF) and Citizen Investment Trust (CIT) operate major retirement schemes. The Contributory Social Security Scheme under the Social Security Fund also works as a pension scheme.

Importance:

• Provides financial security and dignity to employees in old age.
• Reduces dependence on family and the state after retirement.
• Encourages long-term saving and creates a pool of investable funds for the economy.
• Helps attract and retain capable employees in organizations.

Concept of Financial System

A financial system is the organised network of institutions, markets, instruments and services through which savings are mobilised from surplus units (savers) and channelled to deficit units (borrowers/investors), facilitating the flow of funds in an economy. It acts as the bridge between those who have excess funds and those who need funds, and thereby supports production, trade, investment and economic growth.

In simple terms, the financial system is the set of arrangements that:

• Mobilises savings from households and other surplus units.
• Allocates credit/investment to productive sectors.
• Provides payment and settlement services for transactions.
• Manages and transfers risk through insurance, diversification and derivatives.
• Provides price signals (interest rates, exchange rates, security prices) that guide resource allocation.
• Maintains financial stability through regulation and supervision.

The financial system performs these functions through its institutions (banks, insurance companies, cooperatives, etc.), markets (money market and capital market), instruments (deposits, loans, shares, debentures, treasury bills, etc.) and the regulatory framework. A well-functioning financial system is essential for capital formation, efficient resource allocation and sustained economic growth.

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Major Components of the Nepalese Financial System

The Nepalese financial system consists of the following major components:

1. Financial Institutions

These are the intermediaries that collect funds and lend/invest them. In Nepal they are broadly classified as:

(a) Regulatory and Supervisory Bodies

• Nepal Rastra Bank (NRB) — the central bank, established in 1956 under the Nepal Rastra Bank Act; responsible for monetary policy, issuing currency, regulating banks and financial institutions (BFIs), and maintaining external sector stability.
• Securities Board of Nepal (SEBON) — regulator of the securities market, established in 1993.
• Insurance Board / Nepal Insurance Authority — regulator of insurance companies.
• Ministry of Finance — apex policy-making body for the financial sector.

(b) Banks and Financial Institutions (BFIs) — classified under the NRB's regulatory framework:

• Commercial Banks (Class 'A') — e.g., Nepal Investment Mega Bank, Nabil Bank, Rastriya Banijya Bank; largest in number of branches, deposits and credit.
• National Level Development Banks (Class 'B') — e.g., Nepal Development Bank type institutions.
• Regional Level Development Banks (Class 'B').
• Finance Companies (Class 'C').
• Microfinance Financial Institutions (Class 'D') — e.g., various laghubitta.
• Infrastructure Development Bank (Class 'E') — e.g., Nepal Infrastructure Bank.

(c) Other Financial Institutions

• Insurance companies (life and non-life).
• Employees Provident Fund, Citizen Investment Trust — contractual savings institutions.
• Cooperatives (savings and credit cooperatives) — large in number, though regulated partly by the Department of Cooperatives.
• Mutual funds / Collective investment schemes.

2. Financial Markets

• Money Market — short-term funds market dealing in instruments like treasury bills, interbank lending, commercial papers, certificates of deposit; largely interbank and NRB-driven in Nepal.
• Capital Market — long-term funds market dealing in shares and debentures; in Nepal dominated by NEPSE (Nepal Stock Exchange) and brokers, with SEBON as regulator.
• Foreign Exchange Market — trading of foreign currencies, regulated by NRB.

3. Financial Instruments

• Primary (direct) instruments — issued by ultimate borrowers: shares, debentures, government bonds, treasury bills.
• Secondary (indirect) instruments — issued by intermediaries: bank deposits, loans, insurance policies, mutual fund units, etc.

4. Financial Services

• Banking services (deposits, loans, remittance, LC, guarantees).
• Insurance and risk-pooling services.
• Merchant banking, underwriting, portfolio management.
• Leasing and hire purchase.
• Remittance and payment services (including digital wallets and mobile banking).

5. Regulatory and Legal Framework

• Nepal Rastra Bank Act, 2058 (2002)
• Bank and Financial Institution Act (BAFIA), 2073 (2017)
• Securities Act, 2064 (2007)
• Insurance Act, 2079 (2022)
• Foreign Exchange (Regulation) Act, 2019
• Companies Act, 2063 (2006)

These laws define the structure, licensing, capital requirements, and conduct of financial institutions and markets.

6. Financial Infrastructure and Supporting Institutions

• Credit Information Bureau (CIB) — for credit information sharing.
• Deposit and Credit Guarantee Corporation (DICGC) — deposit insurance.
• Nepal Clearing House Ltd. (NCHL) — clearing and settlement.
• Central Depository System (CDS) and Clearing Ltd. — securities settlement.
• Credit rating agencies and auditors.

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Discussion / Conclusion

The Nepalese financial system has undergone significant reform since the 1980s — from a repressed, government-directed system to a more liberalised and market-oriented one. Financial sector reform programmes (1990s onwards) focused on liberalising interest rates, opening up to private and foreign banks, strengthening NRB's supervisory capacity, and developing the capital market. As a result, the number of BFIs, branches, deposit mobilisation and financial access have increased substantially, and Nepal has made notable progress in financial inclusion.

However, challenges remain: dominance of commercial banks over other institutions, limited depth of the capital market, high non-performing loans in some periods, weak financial literacy in rural areas, and the need for stronger supervision of cooperatives and microfinance. Addressing these through effective regulation, institutional strengthening and financial literacy will make the Nepalese financial system more stable, inclusive and supportive of economic growth.

a. Value weighted index (NEPSE type)

NEPSE uses a value weighted index based on market capitalisation:

[ \text{Index} = \frac{\text{Current total market capitalisation}}{\text{Base total market capitalisation}} \times 100 ]

Taking 2020 as the base year:

So, base market capitalisation = Rs. 10,40,000.

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For 2021:

[ \text{Index}_{2021} = \frac{10,60,000}{10,40,000} \times 100 = 101.92 ]

NEPSE-type value weighted index for 2021 = 101.92

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For 2022:

Alpha had a 2-for-1 stock split at the beginning of 2022. So Alpha’s shares become 2,000 and its price is Rs. 70.

[ \text{Index}_{2022} = \frac{11,50,000}{10,40,000} \times 100 = 110.58 ]

NEPSE-type value weighted index for 2022 = 110.58

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b. Why value weighted index like NEPSE is not affected by stock split

A value weighted index uses market capitalisation:

[ \text{Market capitalisation} = \text{Market price} \times \text{Number of shares outstanding} ]

In a stock split, the number of shares increases proportionally, while the market price decreases proportionally. Therefore, the product—market capitalisation—remains unchanged.

For example, if Alpha’s price before split is Rs. 120 and shares are 1,000:

[ 120 \times 1,000 = \text{Rs. }1,20,000 ]

After a 2-for-1 split, shares become 2,000 and price becomes Rs. 60:

[ 60 \times 2,000 = \text{Rs. }1,20,000 ]

Since the numerator in the NEPSE index formula does not change due to the split alone, the index also does not change. The split only changes the number of shares and price per share, not the total market value of the company.

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c. Uses of market index

1. Measures overall market performance: It shows whether the stock market as a whole is rising, falling, or stable.
2. Benchmark for investment performance: Investors compare their portfolio or mutual fund returns with the market index.
3. Helps in investment decisions: A rising index may indicate a bullish market; a falling index may indicate a bearish market.
4. Indicates economic health: The index reflects investor confidence and general economic conditions.
5. Basis for derivatives: Index futures, options, index funds, and exchange-traded funds are based on market indices.
6. Used in calculating market return and beta: It helps measure systematic risk and required rate of return.
7. Helps regulators and policy makers: It assists in monitoring market trends and taking corrective policy measures.

Formulas used

• Non-interest income ratio = $\dfrac{\text{Non-interest income}}{\text{Total assets}} \times 100$
• Net interest margin (NIM) = $\dfrac{\text{Interest income} - \text{Interest expenses}}{\text{Total assets}} \times 100$
• Spread ratio = $\left(\dfrac{\text{Interest income}}{\text{Interest-earning assets}} - \dfrac{\text{Interest expenses}}{\text{Interest-bearing liabilities}}\right) \times 100$

Where:

• Interest-earning assets = Loans, advances and bills purchased + Investments
• Interest-bearing liabilities = Interest-bearing deposits + Debenture and bond

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a. Non-interest income ratio

City Bank: $= \frac{350}{29{,}000} \times 100 = 1.21\%$

Metro Bank: $= \frac{650}{38{,}000} \times 100 = 1.71\%$

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b. Net interest margin ratio

City Bank: $= \frac{4{,}000 - 2{,}100}{29{,}000} \times 100 = \frac{1{,}900}{29{,}000} \times 100 = 6.55\%$

Metro Bank: $= \frac{4{,}500 - 2{,}900}{38{,}000} \times 100 = \frac{1{,}600}{38{,}000} \times 100 = 4.21\%$

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c. Spread ratio

City Bank:

Interest-earning assets: $= 21{,}000 + 5{,}000 = 26{,}000$

Interest-bearing liabilities: $= 24{,}000 + 500 = 24{,}500$

Spread ratio: $= \left(\frac{4{,}000}{26{,}000} - \frac{2{,}100}{24{,}500}\right) \times 100$ $= (15.38\% - 8.57\%) = 6.81\%$

Metro Bank:

Interest-earning assets: $= 27{,}000 + 8{,}000 = 35{,}000$

Interest-bearing liabilities: $= 26{,}000 + 600 = 26{,}600$

Spread ratio: $= \left(\frac{4{,}500}{35{,}000} - \frac{2{,}900}{26{,}600}\right) \times 100$ $= (12.86\% - 10.90\%) = 1.95\%$

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Summary table

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d. Evaluation of performance

1. Non-interest income ratio: Metro Bank has a higher ratio (1.71%) than City Bank (1.21%). This means Metro Bank is relatively more successful in earning fee-based and other non-interest income compared with its total assets. It indicates better income diversification.

2. Net interest margin: City Bank has a much higher NIM (6.55%) than Metro Bank (4.21%). This shows that City Bank earns more net interest income per rupee of total assets. Its core banking business is more profitable.

3. Spread ratio: City Bank’s spread ratio (6.81%) is far higher than Metro Bank’s (1.95%). This means City Bank is managing its interest income and interest expenses more efficiently. It has either a higher yield on loans and investments or a lower cost of funds, or both.

4. Overall: City Bank appears stronger in interest-based profitability and spread management. Metro Bank is larger in total assets and has better non-interest income diversification, but its interest spread is very low. Therefore, Metro Bank needs to reduce its interest expenses or increase its interest income to improve overall performance. On the basis of the calculated ratios, City Bank shows better core banking performance.

Major Components of the Financial System of Nepal

A financial system is the set of institutions, markets, instruments and services through which savings are mobilised and channelled into productive investment. In Nepal, the financial system consists of the following major components:

1. Financial Institutions

These are the intermediaries that collect savings and supply funds to borrowers. In Nepal they include:

• Regulatory and supervisory bodies: Nepal Rastra Bank (the central bank), which regulates banks and financial institutions, and the Insurance Board / Nepal Insurance Authority, which regulates insurers.
• Banks and financial institutions (BFIs): Commercial banks (Class 'A'), development banks (Class 'B'), finance companies (Class 'C') and microfinance institutions (Class 'D').
• Other institutions: Nepal Stock Exchange (NEPSE), Employees Provident Fund, Citizen Investment Trust, insurance companies, and cooperatives.

2. Financial Markets

These are the markets where financial assets are created and traded:

• Money market: Deals in short-term instruments such as treasury bills, commercial bills and inter-bank lending. In Nepal it is largely inter-bank based and dominated by NRB operations.
• Capital market: Deals in long-term securities such as shares and debentures. NEPSE and the Securities Board of Nepal (SEBON) are its main institutions.

3. Financial Instruments

These are the claims or securities through which funds are raised and transferred, for example:

• Money market instruments: Treasury bills, commercial papers, certificates of deposit.
• Capital market instruments: Ordinary shares, preference shares, debentures, government bonds and corporate bonds.

4. Financial Services

These are the facilities provided by financial institutions to customers, such as deposit collection, lending, remittance, foreign exchange, insurance, leasing, hire purchase, merchant banking and electronic banking services.

5. Financial Markets' Participants / Users

These include households (main savers), business firms (main borrowers), the government (through treasury bills and bonds), and foreign investors and donors.

Conclusion

All these components are interdependent: the regulatory bodies supervise the institutions, the institutions operate in the money and capital markets, the markets deal in financial instruments, and financial services link savers with investors. Together they mobilise Nepal's scarce capital and support economic development.

Major Types of Insurance Services Available in Nepal for Risk Management

Insurance is a contract under which the insurer agrees to compensate the insured for a specified loss in return for a premium. In Nepal, insurance business is regulated by the Nepal Insurance Authority (formerly Beema Samiti) under the Insurance Act, 2049. The major types of insurance services available to manage risk are as follows:

1. Life Insurance This covers the risk of loss of human life. On the death of the insured, the nominee receives the sum assured. It is of the following types:

• Term Life Insurance: Protection is provided only for a fixed term; the sum assured is paid only if death occurs within the term. It is the cheapest form of life insurance.
• Whole Life Insurance: Protection continues throughout the life of the insured, and the sum assured is paid on death whenever it occurs.
• Endowment Policy: The sum assured is paid either on death within the term or on survival up to maturity, whichever is earlier. It combines protection with savings.
• Money-back Policy: Periodic payments are made to the insured during the policy term, and the balance is paid at maturity or on death.

2. Non-Life (General) Insurance This covers risks relating to property, liability and other losses other than human life. Its major forms are:

• Fire Insurance: Covers loss or damage to property, buildings, stock and goods caused by fire, lightning and related perils.
• Marine Insurance: Covers risks of loss or damage to goods and vessels during sea, air and inland transit. It includes hull insurance and cargo insurance.
• Motor Vehicle Insurance: Covers loss or damage to vehicles and liability towards third parties arising from accidents. Third-party insurance is compulsory in Nepal.
• Accident and Health Insurance: Provides compensation for death, disability or medical expenses arising from accidents and illnesses. Personal accident and mediclaim policies fall under this head.
• Crop and Livestock Insurance: Protects farmers against loss of crops due to natural calamities and death of livestock. It is important for the agricultural economy of Nepal.
• Aviation, Engineering and Miscellaneous Insurance: Covers aircraft, construction works, machinery breakdown, burglary, cash-in-transit and other special risks.

3. Reinsurance Insurance companies transfer a part of the risk they have assumed to another insurer (reinsurer) to reduce the burden of large claims. In Nepal, the Nepal Reinsurance Company Limited (Nepal Re) provides this service, and insurers are also required to cede a certain portion of risk to it. This strengthens the financial capacity of domestic insurers.

4. Micro-Insurance It provides low-premium, small-sum insurance products to low-income and rural households. It covers life, health, crops, livestock and micro-enterprises, and helps in extending risk protection to the poor and unorganised sector.

Conclusion Thus, life, non-life (fire, marine, motor, accident, health, crop and livestock), reinsurance and micro-insurance services are the major types of insurance available in Nepal. Together they help individuals and businesses transfer and share risk, reduce uncertainty, and promote economic stability.

Given:

• Reserve for loan loss (allowance) = Rs 300 million
• Minimum adequate reserve = Rs 280 million

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a. Increase in accrued expenses (provision) to replenish the reserve

Loans charged off = Rs 25 million

Reserve after charge-off: $300 - 25 = \text{Rs } 275 \text{ million}$

Required minimum reserve = Rs 280 million

Additional provision needed: $280 - 275 = \text{Rs } 5 \text{ million}$

Answer: Rs 5 million

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b. Net charge-off

Gross charge-off = Rs 35 million
Recoveries = Rs 25 million

$\text{Net charge-off} = \text{Gross charge-off} - \text{Recoveries}$ $= 35 - 25 = \text{Rs } 10 \text{ million}$

Answer: Rs 10 million

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c. Provision for loan losses for the current year

Beginning reserve = Rs 300 million
Desired ending reserve = Rs 280 million
Net charge-off = Rs 10 million

Using the allowance equation: $\text{Ending reserve} = \text{Beginning reserve} + \text{Provision} - \text{Net charge-off}$

$280 = 300 + \text{Provision} - 10$

$\text{Provision} = 280 - 300 + 10 = -\text{Rs } 10 \text{ million}$

So the bank needs a negative provision of Rs 10 million, i.e. it can reverse Rs 10 million from the loan loss reserve.

Answer: –Rs 10 million (reversal/credit)

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Final answers:

• a. Rs 5 million
• b. Rs 10 million
• c. –Rs 10 million

Value weighted index (like NEPSE):

[ \text{Index} = \frac{\text{Current total market capitalization}}{\text{Base market capitalization}} \times \text{Base index} ]

Base market capitalization = Rs. 1,400,000
Base index = 100

a. Computation of value weighted index

Asar 31, 2078

[ \text{Index}_{2078} = \frac{2,800,000}{1,400,000} \times 100 = 200 ]

Asar 31, 2079

[ \text{Index}_{2079} = \frac{2,870,000}{1,400,000} \times 100 = 205 ]

b. Percentage change in index

[ \text{Percentage change} = \frac{205 - 200}{200} \times 100 = 2.5% ]

Answer:

• Index on Asar 31, 2078 = 200
• Index on Asar 31, 2079 = 205
• Percentage change = 2.5% increase

Given:

• Existing shares: (N_0 = 150,000)
• Market price: (P_0 = \text{Rs. }150)
• New shares: (N_n = 60,000)
• Subscription price: (S = \text{Rs. }100)

a. Rights associated with one new share

[ \text{Rights per new share}=\frac{N_0}{N_n} =\frac{150,000}{60,000}=2.5 ] So, 2.5 rights are needed to buy one new share.

b. Ex-rights price

[ P_{ex}=\frac{N_0P_0+N_nS}{N_0+N_n} ] [ P_{ex}=\frac{150,000(150)+60,000(100)}{150,000+60,000} ] [ P_{ex}=\frac{22,500,000+6,000,000}{210,000} =\frac{28,500,000}{210,000} =\text{Rs. }135.7143 ] [ \boxed{P_{ex}\approx \text{Rs. }135.71} ]

c. Value of a right

[ R=\frac{P_{ex}-S}{N_0/N_n} ] [ R=\frac{135.7143-100}{2.5} =\frac{35.7143}{2.5} =\text{Rs. }14.2857 ] [ \boxed{R\approx \text{Rs. }14.29} ]

Alternatively, [ R=P_0-P_{ex}=150-135.7143=\text{Rs. }14.29 ]

d. Why a company might use a rights offering rather than a general cash offer

• Protects existing shareholders: It preserves their proportional ownership and control, avoiding dilution by outsiders.
• Lower flotation cost: Rights offerings are usually cheaper than general cash offers because they require less underwriting and marketing.
• Faster and simpler: Shares are sold directly to existing shareholders.
• Attractive subscription price: Existing shareholders can buy new shares at a discount.
• Signals confidence: A rights offering may indicate that the company expects good future prospects.
• Avoids loss of control: Ownership remains with existing shareholders rather than being transferred to new public investors.

a. Initial Public Offering (IPO)

An Initial Public Offering (IPO) is the first sale of a company's shares to the general public. It is the process by which a privately owned company becomes a publicly traded company by issuing new shares and listing them on a stock exchange.

Key features:

• First issue to the public: The company offers its shares to the public for the first time, as distinct from a further public offering (FPO) made by an already listed company.
• Raising capital: The main purpose is to raise large amounts of capital for expansion, modernisation, debt repayment or working capital needs.
• Conversion to public company: After the IPO, the company's ownership is broadened and it must follow the rules of the securities market regulator.
• Pricing: The issue price may be fixed by the company in agreement with the issue manager, or determined through book building based on investor demand.
• Regulatory approval: In Nepal, an IPO must be approved by the Securities Board of Nepal (SEBON) and is issued through an issue manager, usually a merchant banker.
• Allotment: If the issue is oversubscribed, shares are allotted by lottery; if undersubscribed, the issue may be extended or cancelled as per rules.

Advantages: access to large capital, enhanced prestige and credibility, liquidity for shareholders, and a market-determined value for the firm.

Disadvantages: dilution of ownership and control, cost and time of the issue, and the burden of disclosure and compliance.

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b. Stock Dealer

A stock dealer is a person or firm that buys and sells securities in the stock market on its own account, at its own risk, to earn profit from price differences. In Nepal, stock dealers are licensed by SEBON and are members of the Nepal Stock Exchange (NEPSE).

Functions:

• Dealing in securities: Buys securities when prices are low and sells when prices are high, thereby earning a margin.
• Market making: Provides continuous two-way quotes (buy and sell prices) and supplies liquidity to the market.
• Own account trading: Trades for its own portfolio, unlike a broker who trades on behalf of clients.
• Price stabilisation: By buying and selling actively, a dealer helps reduce sharp price fluctuations.
• Advisory role: Advises clients on the basis of its own market research and experience.

Distinction from a broker: A broker acts as an agent of the investor and earns commission; a dealer acts as a principal and earns profit from the difference between buying and selling prices. A broker does not bear price risk, while a dealer does.

Importance: Dealers increase market liquidity, narrow the bid-ask spread, assist in price discovery, and help in the smooth functioning of the secondary market.

Need for Regulation of Depository Financial Institutions by NRB

Depository financial institutions (DFIs) — commercial banks, development banks, finance companies and microfinance institutions — accept public deposits and create credit. Because they handle other people's money and are interconnected, they cannot be left to self-regulation. The Nepal Rastra Bank (NRB), as the central bank and regulatory authority under the Nepal Rastra Bank Act, 2058 and the Bank and Financial Institution Act (BAFIA), 2073, regulates them for the following reasons:

1. Protection of depositors' funds. Depositors are scattered, uninformed and cannot monitor a bank's solvency. NRB safeguards their savings through prudential rules, deposit insurance and inspection.

2. Maintenance of financial stability. Banks are highly leveraged and illiquid-prone. A single bank failure can trigger a run and contagion (systemic risk), disrupting the whole payment and credit system. Regulation contains this risk.

3. Ensuring soundness and solvency. NRB prescribes minimum capital, capital adequacy (Basel norms), liquidity, loan-loss provisioning and single-borrower limits so that institutions remain solvent and liquid.

4. Preventing concentration and monopoly. Limits on credit concentration, branch licensing and merger policy promote competition and protect small borrowers.

5. Consumer and investor protection. Regulation curbs unfair practices, hidden charges, mis-selling and discriminatory lending, and ensures fair treatment of customers.

6. Controlling money supply and credit. Through monetary policy instruments, NRB influences credit creation by DFIs to control inflation and support growth.

7. Preventing financial crimes. NRB enforces anti-money laundering (AML), know-your-customer (KYC) and anti-terrorist financing rules, curbing illegal transactions.

8. Correcting market failure. Asymmetric information, moral hazard and adverse selection are inherent in banking; regulation reduces these failures.

9. Promoting public confidence. A regulated, supervised system builds trust, which is the foundation of deposit-taking and financial intermediation.

10. Ensuring compliance with law and policy. Regulation ensures DFIs follow national economic policy, foreign exchange rules and directives issued by NRB from time to time.

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Onsite Supervision

Onsite supervision (also called inspection or examination) is carried out by NRB officials who physically visit the premises of the DFI to examine its books, records and operations. It is the most direct and reliable method of supervision.

Features:

• Conducted by a team of NRB examiners (supervisory team) at the bank's office.
• Based on a pre-announced or surprise (unannounced) examination.
• Covers both full-scope examination and targeted/limited examination of specific areas.
• Frequency depends on the risk profile of the institution — high-risk institutions are examined more often.

Areas examined:

• Capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk (CAMELS rating).
• Loan portfolio: classification, provisioning, large loans, insider lending, connected lending.
• Deposit and investment operations, cash and bank balance.
• Compliance with NRB directives, BAFIA and AML/KYC rules.
• Internal control, internal audit and corporate governance.
• Accounting records, financial statements and MIS reports.

Outcome:

• Preparation of an inspection report with findings and ratings.
• Issue of a supervisory letter/directive to rectify weaknesses within a given time.
• Follow-up examination to confirm corrective action.
• In serious cases, NRB may impose fines, restrict business, suspend directors/officials or recommend liquidation.

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Offsite Supervision

Offsite supervision is the desk-based, remote monitoring of DFIs through periodic returns, statements and reports submitted to NRB, without visiting the institution. It provides continuous surveillance between onsite examinations.

Features:

• Based on statutory returns (daily, weekly, monthly, quarterly, half-yearly, yearly).
• Carried out at NRB's Supervision Department using ratio and trend analysis.
• Helps identify early warning signals and decide where onsite examination is needed.
• Less costly and less time-consuming than onsite supervision.

Key reports used:

• Balance sheet and profit and loss account.
• Statement of assets and liabilities (daily/weekly).
• Capital adequacy and liquidity ratio statements.
• Non-performing loan (NPL) and loan classification reports.
• Large loan and sectoral credit reports.
• Foreign exchange transaction and statutory reserve reports.

Tools of analysis:

• Ratio analysis (capital, liquidity, profitability, asset quality).
• Peer group comparison and inter-temporal comparison.
• Trend and variance analysis.
• Early Warning System (EWS) indicators.

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Supervisory Tools

NRB uses a combination of tools to supervise DFIs:

Conclusion: Regulation by NRB is essential to protect depositors, ensure solvency and stability, and prevent systemic risk. Onsite supervision gives an in-depth, first-hand check of a bank's condition, while offsite supervision provides continuous remote monitoring. Together with prudential, corrective and market-discipline tools, they form an effective supervisory framework for Nepal's depository financial institutions.

Part (c) of the question is cut off. Where it is needed, I assume the standard version of the problem: the maturity risk premium (MRP) is 0.04% on a 1-year security and rises by 0.03 percentage points for each extra year.

Expected inflation

(a) Average expected inflation, 2023 to 2026

$\bar{IP}_4=\frac{5+6+6.5+7}{4}=\frac{24.5}{4}=6.125\%$

(b) Average nominal rate on a 4-year Treasury security

Ignoring the maturity risk premium, the nominal risk-free rate is the real rate plus the inflation premium.

$k_{RF}=k^*+\bar{IP}=2.5\%+6.125\%=8.625\%$

(c) Yield by maturity (assumed MRP: 0.04% for 1 year, rising by 0.03% a year)

$k_t=k^*+\bar{IP}_t+MRP_t$

The yield curve slopes upward because both the average inflation premium and the maturity risk premium rise with maturity.