b. Percentage of Premium or Discount

Formula:

$\text{Premium/(Discount)} = \frac{\text{Market Price} - \text{NAV}}{\text{NAV}} \times 100$

Given:

• Market price = Rs. 20 per share
• NAV = Rs. 19.20 per share

Substituting:

$= \frac{20 - 19.20}{19.20} \times 100 = \frac{0.80}{19.20} \times 100 = 4.17\%$

Result: Since the market price (Rs. 20) is greater than the NAV (Rs. 19.20), the fund is selling at a premium of 4.17%.

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c. Holding Period Return (HPR)

Given:

• Purchase price (P₀) = Rs. 19.20 per share
• Dividend received (D) = Rs. 2
• Capital gain distribution (CG) = Rs. 1.50
• Selling price = 10% discount on Rs. 25 per share

Step 1: Selling price (P₁)

$P_1 = 25 - (10\% \times 25) = 25 - 2.50 = \text{Rs. } 22.50$

Step 2: Formula

$\text{HPR} = \frac{D + CG + (P_1 - P_0)}{P_0} \times 100$

Step 3: Substituting

$= \frac{2 + 1.50 + (22.50 - 19.20)}{19.20} \times 100$

$= \frac{2 + 1.50 + 3.30}{19.20} \times 100$

$= \frac{6.80}{19.20} \times 100$

$= 35.42\%$

Result: The holding period return is 35.42%.

Adjusting for the split. Alpha's 2-for-1 split at the end of 2022 halves its 2022 price to Rs 7.50 (and doubles its shares from 1,000 to 2,000), so 2022 is restated on the post-split basis. Market values are unchanged by the split.

(a) Price-weighted index (2022 = 100)

$\text{Index}_{2023} = \frac{84}{82.5}\times 100 = 101.82,\qquad \text{Index}_{2024} = \frac{100}{82.5}\times 100 = 121.21$

(Using the divisor method gives the same result: the divisor falls from 3 to $82.5/30 = 2.75$.)

(b) Value-weighted index (base value = 100 in 2022)

$\text{Index}_{2023} = \frac{252{,}000}{205{,}000}\times 100 = 122.93,\qquad \text{Index}_{2024} = \frac{300{,}000}{205{,}000}\times 100 = 146.34$

(c) Returns on the index

$R_t = \frac{\text{Index}_t - \text{Index}_{t-1}}{\text{Index}_{t-1}}\times 100$

The two indices disagree in 2023 because the price-weighted index gives most weight to high-priced stocks (Beta, Delta), while the value-weighted index also reflects the larger number of shares outstanding in 2023.

(a) Value of the Put Option and Ambika's Gain

Given:

Step 1: Value of the put option at expiry

A put option gives the holder the right to sell at the strike price. Since the market price (Rs. 450) is below the strike price (Rs. 500), the option is in-the-money and will be exercised.

$V_p = (E - S) \times \text{Number of shares}$ $V_p = (500 - 450) \times 100 = \text{Rs. } 5{,}000$

Value of the option = Rs. 5,000

Step 2: Total premium paid

$\text{Premium} = 10 \times 100 = \text{Rs. } 1{,}000$

Step 3: Net gain (loss) to Ambika

$\text{Net gain} = \text{Value of option} - \text{Premium paid}$ $= 5{,}000 - 1{,}000 = \text{Rs. } 4{,}000$

Conclusion: Ambika gains Rs. 4,000 by exercising the put option. Had the stock price stayed at or above Rs. 500, she would have let the option expire and her loss would have been limited to the premium of Rs. 1,000 — this limited downside is the essential attraction of a put option.

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(b) Sharpe's Measure and Treynor's Measure of Portfolio Performance

Both are risk-adjusted performance measures developed to judge whether a portfolio's return adequately compensates for the risk borne. They differ in the definition of risk used as the denominator.

1. Sharpe's Measure (Reward-to-Variability Ratio)

Developed by William F. Sharpe, it measures excess return per unit of total risk (systematic + unsystematic), where total risk is the standard deviation of portfolio returns.

$S_p = \frac{\bar{R}_p - R_f}{\sigma_p}$

Where:

• $\bar{R}_p$ = average return of the portfolio
• $R_f$ = risk-free rate of return
• $\sigma_p$ = standard deviation of the portfolio's returns (total risk)

Interpretation: A higher Sharpe ratio means better performance per unit of total risk. It is the appropriate measure when the portfolio is not fully diversified, because unsystematic risk is still present and is captured by $\sigma_p$. It is also useful for evaluating the entire portfolio of an individual investor who holds only that portfolio.

2. Treynor's Measure (Reward-to-Volatility Ratio)

Developed by Jack L. Treynor, it measures excess return per unit of systematic risk, where systematic risk is measured by beta ($\beta_p$).

$T_p = \frac{\bar{R}_p - R_f}{\beta_p}$

Where:

• $\beta_p$ = beta coefficient of the portfolio, measuring its sensitivity to market movements (non-diversifiable risk)

Interpretation: A higher Treynor ratio indicates superior performance per unit of market risk. It is the appropriate measure when the portfolio is well diversified, so that unsystematic risk has been eliminated and only market risk remains relevant. It is widely used to rank the performance of mutual fund managers, since a fund manager should be rewarded only for market risk, not for risk that could have been diversified away.

Comparison of the Two Measures

Conclusion: Both measures convert return into return-per-unit-of-risk, so that portfolios with different risk levels can be compared fairly. The choice between them depends on whether the investor's portfolio is diversified: use Sharpe when total risk matters, and Treynor when only market risk is relevant.

Current Investment Environment in Nepal

1. Introduction

The investment environment refers to the sum total of economic, political, legal, social and institutional factors that influence the decision to invest in a country. In Nepal, the investment environment has improved considerably after the restoration of democracy in 1990 and especially after the enactment of the Foreign Investment and Technology Transfer Act (FITTA), 2019 and the Public-Private Partnership and Investment Act, 2019. Yet the country still ranks low in global ease-of-doing-business and competitiveness indices. The present environment is therefore a mixed picture of reform and constraint.

2. Positive Features of the Current Investment Environment

a) Liberal policy and legal framework. Nepal follows a liberal, market-oriented economic policy. Almost all sectors except a small negative list (defence, arms, explosives, radioactive materials, real estate trading, etc.) are open to both domestic and foreign investment. FITTA, 2019 allows 100% foreign ownership in most industries and permits repatriation of profits, dividends and capital.

b) Institutional arrangements. The Department of Industries, Investment Board Nepal (IBN), Nepal Rastra Bank, and Industrial Enterprise Development Institute facilitate investment. IBN fast-tracks large projects above Rs 6 billion. One-stop service centres have been set up in all seven provinces.

c) Incentives and facilities. Investors enjoy tax holidays (5–10 years depending on sector and location), concessional loans in priority sectors, duty exemptions on capital goods and raw materials for export industries, and special facilities in Special Economic Zones (SEZs) such as Bhairahawa and Simara.

d) Remittance-financed liquidity. Remittances of around Rs 1,300 billion per year keep banks flush with deposits. Interest rates on loans have generally been moderate in recent years, and credit to the private sector has expanded.

e) Market access. Nepal's membership in WTO (2004), SAFTA, BIMSTEC and the GSP facility with developed countries gives preferential access to large markets. The growing middle class and urbanisation have expanded domestic demand.

f) Emerging sectors. Hydropower (potential of 83,000 MW), tourism, agro-processing, information technology, cement, and herbal medicine are attracting both domestic and foreign investment. Nepal has signed Bilateral Investment Promotion and Protection Agreements (BIPPAs) with several countries and Double Taxation Avoidance Agreements (DTAAs) with 11 countries.

3. Negative Features and Constraints

a) Political instability. Frequent changes in government, weak implementation of commitments, and policy inconsistency discourage long-term investors. Laws are amended often, creating uncertainty.

b) Poor infrastructure. Inadequate roads, unreliable electricity (though improved), limited internet connectivity, and insufficient water supply raise the cost of doing business. Landlocked geography adds high transit costs.

c) Bureaucratic hurdles. Despite one-stop service, investors still face lengthy registration procedures, multiple approvals, corruption, and lack of coordination among agencies. Enforcement of contracts is weak.

d) Labour problems. Labour laws are rigid in some respects; trade unionism, strikes, and shortage of skilled labour reduce productivity. Labour unrest in the industrial corridor has sometimes forced factory closures.

e) Small market and low purchasing power. With a population of about 30 million and per capita income around Rs 1,50,000, the domestic market is small. Low savings and capital formation limit domestic investment.

f) Financial sector weaknesses. High non-performing loans in some cooperatives, limited access to long-term finance, and underdeveloped capital market restrict large-scale investment. The share market is thin and volatile.

g) Security and legal hurdles. Occasional strikes, extortion, and delays in dispute settlement raise risk. Foreign investors also complain about difficulties in repatriating capital and about unclear land acquisition rules.

4. Recent Developments

• Make in Nepal / Swadeshi campaign and budget provisions for import substitution.
• Digital Nepal Framework and expansion of IT parks.
• Amendment of FITTA and PPP rules to simplify approval.
• Nepal Investment Summit 2024 attracted commitments of over Rs 900 billion.
• Sovereign credit rating (BB– from Fitch) has begun, which helps foreign borrowing.
• Green hydrogen, data centres, and special economic zones are new priority areas.

5. Suggestions to Improve the Investment Environment

1. Ensure political stability and continuity of policies.
2. Improve infrastructure — roads, power, water, and digital connectivity.
3. Strengthen one-stop service and reduce bureaucratic red tape.
4. Reform labour laws and develop skilled human resources.
5. Develop the capital market and long-term financing institutions.
6. Ensure transparent, corruption-free administration and quick dispute settlement.
7. Promote public-private partnership in infrastructure.
8. Market Nepal abroad through investment summits and economic diplomacy.

6. Conclusion

The current investment environment in Nepal is liberal in policy but weak in practice. Legal and institutional reforms have created a favourable framework, and sectors such as hydropower, tourism, and IT offer genuine opportunities. However, political instability, infrastructural deficiency, bureaucratic hurdles, and labour problems continue to hold back both domestic and foreign investors. If these constraints are addressed through stable policies, better infrastructure, and good governance, Nepal can significantly improve its investment climate and accelerate economic growth.

Given

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a. Expected returns and standard deviations

Expected return

$E(R)=\sum p_iR_i$

For Stock Alpha:

$E(R_A)=0.30(10)+0.40(20)+0.30(30)$ $=3+8+9=20\%$

For Stock Beta:

$E(R_B)=0.30(25)+0.40(20)+0.30(15)$ $=7.5+8+4.5=20\%$

Standard deviation

$\sigma=\sqrt{\sum p_i(R_i-E(R))^2}$

For Alpha:

$\sigma_A^2=30+0+30=60$ $\sigma_A=\sqrt{60}=7.75\%$

For Beta:

$\sigma_B^2=7.5+0+7.5=15$ $\sigma_B=\sqrt{15}=3.87\%$

Answer:

• Stock Alpha: Expected return = 20%, Standard deviation = 7.75%
• Stock Beta: Expected return = 20%, Standard deviation = 3.87%

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b. Which stock would you prefer?

Both stocks have the same expected return of 20%, but Stock Beta has a lower standard deviation, i.e. lower risk.

Therefore, a risk-averse investor would prefer Stock Beta, because it provides the same expected return with less risk.

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c. Correlation coefficient between Alpha and Beta

Covariance:

$\text{Cov}(A,B)=\sum p_i(R_A-E(R_A))(R_B-E(R_B))$

$\text{Cov}(A,B)=-15+0-15=-30$

Correlation coefficient:

$r_{AB}=\frac{\text{Cov}(A,B)}{\sigma_A\sigma_B}$

$r_{AB}=\frac{-30}{\sqrt{60}\times\sqrt{15}}$ $=\frac{-30}{\sqrt{900}}=\frac{-30}{30}=-1$

Answer: Correlation coefficient = −1

This means the returns of Stock Alpha and Stock Beta are perfectly negatively correlated.

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d. Portfolio with 70% in Alpha and 30% in Beta

Let:

$w_A=0.70,\quad w_B=0.30$

Expected portfolio return

$E(R_p)=w_AE(R_A)+w_BE(R_B)$

$E(R_p)=0.70(20)+0.30(20)$ $=14+6=20\%$

Portfolio risk

$\sigma_p^2=w_A^2\sigma_A^2+w_B^2\sigma_B^2+2w_Aw_B\text{Cov}(A,B)$

$\sigma_p^2=(0.70)^2(60)+(0.30)^2(15)+2(0.70)(0.30)(-30)$

$=29.4+1.35-12.6=18.15$

$\sigma_p=\sqrt{18.15}=4.26\%$

Answer:

• Expected portfolio return = 20%
• Portfolio risk = 4.26%

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e. New portfolio: 20% in risk-free asset and 80% in portfolio from part (d)

Risk-free rate:

$R_f=6\%$

Weight in risk-free asset:

$w_f=0.20$

Weight in risky portfolio:

$w_p=0.80$

Expected return

$E(R_{\text{new}})=w_fR_f+w_pE(R_p)$

$=0.20(6)+0.80(20)$ $=1.2+16=17.2\%$

Risk

Since the risk-free asset has zero standard deviation:

$\sigma_{\text{new}}=w_p\sigma_p$

$=0.80(4.26)=3.41\%$

Answer:

• Expected return of new portfolio = 17.2%
• Risk of new portfolio = 3.41%

Given: Par = Rs 1,000, coupon = 9% so annual coupon = Rs 90, $n = 10$, price $P_0 =$ Rs 1,020.

(a) Yield to maturity

$1{,}020 = \sum_{t=1}^{10}\frac{90}{(1+y)^t} + \frac{1{,}000}{(1+y)^{10}}$

Approximation: $YTM \approx \dfrac{90 + (1000-1020)/10}{(1000+1020)/2} = \dfrac{88}{1010} = 8.71\%$

Trial and error: at 8.5%, price = Rs 1,032.8; at 9%, price = Rs 1,000; interpolating (or refining) gives

$YTM \approx \mathbf{8.69\%}$

Check at 8.69%: $90 \times 6.4455 + 1000 \times 0.4344 \approx$ Rs 1,020.

(b) Current yield

$CY = \frac{\text{Annual coupon}}{\text{Market price}} = \frac{90}{1{,}020}\times 100 = \mathbf{8.82\%}$

(c) Capital gain/loss

Capital gain/loss = Redemption value − Purchase price = 1,000 − 1,020 = Rs −20, i.e. a capital loss of Rs 20 per bond if held to maturity (the bond sells at a premium).

(d) Yield to call (call price Rs 1,050 at the end of year 5)

$1{,}020 = \sum_{t=1}^{5}\frac{90}{(1+y)^t} + \frac{1{,}050}{(1+y)^5}$

Approximation: $YTC \approx \dfrac{90 + (1050-1020)/5}{(1050+1020)/2} = \dfrac{96}{1035} = 9.28\%$

Trial and error: at 9%, value = 90 × 3.8897 + 1,050 × 0.6499 = Rs 1,032.5; at 9.5%, value = Rs 1,012.6; interpolating gives

$YTC \approx \mathbf{9.31\%}$

Since YTC (9.31%) exceeds YTM (8.69%), the call at a premium raises the investor's return if the bond is called.

(a) Price-weighted index (PWI)

$PWI = \frac{\sum P}{\text{divisor}}$

• Day 0: (80 + 100 + 120)/3 = 300/3 = 100
• Day 1: (90 + 110 + 130)/3 = 330/3 = 110
• Day 2: Beta splits two-for-one, so its Day 1 price becomes 110/2 = 55 and the divisor must be adjusted so the index is unchanged by the split:

$\text{New divisor} = \frac{90 + 55 + 130}{110} = \frac{275}{110} = 2.5$

$PWI_{2} = \frac{110 + 65 + 120}{2.5} = \frac{295}{2.5} = \textbf{118}$

(b) Return on Day 1 based on PWI

$\frac{110 - 100}{100} = \textbf{10\%}$

(c) Value-weighted index (VWI), base = 100 on Day 0

Total market value (Q × P):

• Day 0: 200×80 + 300×100 + 400×120 = 16,000 + 30,000 + 48,000 = Rs 94,000
• Day 1: 200×90 + 300×110 + 400×130 = 18,000 + 33,000 + 52,000 = Rs 1,03,000
• Day 2: 200×110 + 600×65 + 400×120 = 22,000 + 39,000 + 48,000 = Rs 1,09,000

$VWI_1 = \frac{1{,}03{,}000}{94{,}000}\times 100 = \textbf{109.57}$

$VWI_2 = \frac{1{,}09{,}000}{94{,}000}\times 100 = \textbf{115.96}$

The split doubles Beta's shares and halves its price, so market value is unaffected and no adjustment is needed.

(d) Return on Day 2 based on VWI

$\frac{115.96 - 109.57}{109.57} = \frac{1{,}09{,}000 - 1{,}03{,}000}{1{,}03{,}000} = \textbf{5.83\%}$

Given data

Risk-free rate $R_f = 5\%$

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a. Sharpe's index

$S_p = \frac{\bar{R}_p - R_f}{\sigma_p}$

Portfolio A: $S_A = \frac{16 - 5}{12} = \frac{11}{12} = 0.9167$

Portfolio B: $S_B = \frac{14 - 5}{5} = \frac{9}{5} = 1.8000$

Portfolio C: $S_C = \frac{11 - 5}{7} = \frac{6}{7} = 0.8571$

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b. Treynor's index

$T_p = \frac{\bar{R}_p - R_f}{\beta_p}$

Portfolio A: $T_A = \frac{16 - 5}{1.15} = \frac{11}{1.15} = 9.5652\%$

Portfolio B: $T_B = \frac{14 - 5}{1.05} = \frac{9}{1.05} = 8.5714\%$

Portfolio C: $T_C = \frac{11 - 5}{0.80} = \frac{6}{0.80} = 7.5000\%$

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c. Interpretation

Sharpe's index (excess return per unit of total risk): Portfolio B has the highest Sharpe index (1.80), followed by A (0.9167) and C (0.8571). This means B gives the highest excess return per unit of total risk and is the best performer on a total-risk basis. A and C are close, with A slightly better than C.

Treynor's index (excess return per unit of systematic risk): Portfolio A has the highest Treynor index (9.5652%), followed by B (8.5714%) and C (7.50%). This means A gives the highest excess return per unit of market (systematic) risk and is the best performer on a systematic-risk basis.

Reason for the difference: The two measures rank B and A differently because B has a very low standard deviation (5%) but a relatively high beta (1.05), i.e. B's risk is mostly systematic. Since Sharpe punishes total risk and B's total risk is small, B ranks first. A carries more total risk (12%) but its beta is only 1.15, so its unsystematic risk is large; Treynor ignores unsystematic risk and therefore ranks A first. Portfolio C is the weakest performer under both measures.

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d. Preference between Treynor's and Sharpe's measures

Treynor's measure is preferable when the portfolio being evaluated is only one part of a well-diversified portfolio (or when the investor already holds a diversified fund). In that case unsystematic risk is diversified away, so only systematic risk (beta) is relevant and Treynor's index is the correct yardstick.

Sharpe's measure is preferable when the portfolio is the investor's entire investment (not diversified), because then total risk — both systematic and unsystematic — is borne by the investor and must be rewarded. It is also more widely used because it needs only the portfolio's own return and standard deviation, and standard deviation is easier to interpret and compute than beta.

So neither measure is universally superior: use Treynor for evaluating a sub-portfolio within a diversified holding, and Sharpe for evaluating a total, undiversified portfolio.

Investment Processes for Financial Assets in Nepal

1. Identification of investment objectives The investor first defines the purpose of investment — regular income, capital appreciation, liquidity, or safety of principal — along with the investment horizon (short, medium or long term) and the level of risk he or she is willing to bear. This step sets the benchmark against which every later decision is judged.

2. Assessment of the investor's profile The investor's age, income, savings capacity, tax situation, liabilities and risk tolerance are examined. A young salaried person may accept equity risk, while a retired person prefers fixed-income instruments. This determines the appropriate asset allocation.

3. Study of the investment environment and available avenues In Nepal the main financial assets available are:

• Bank and financial institution deposits (savings, fixed deposits)
• Government securities — Treasury bills, development bonds, citizen savings bonds issued through Nepal Rastra Bank
• Corporate debentures and bonds
• Ordinary and preference shares of listed companies
• Mutual fund units (closed-end and open-end schemes of mutual fund companies)
• Insurance policies and provident/retirement funds
• Foreign currency deposits and, to a limited extent, foreign securities through authorised channels

4. Analysis and evaluation of alternatives The investor compares the expected return, risk, liquidity, marketability, tax treatment and maturity of each avenue. Tools used include:

• Fundamental analysis (financial statements, EPS, P/E ratio, net worth, dividend history)
• Technical analysis (price trends, charts, trading volume)
• Risk–return analysis and portfolio theory (diversification, beta, standard deviation)

5. Portfolio construction (asset allocation and selection) Based on the analysis, funds are allocated among asset classes and specific securities. Diversification is applied across sectors, companies and maturities to reduce unsystematic risk. The investor decides the proportion of equity, debt and other assets according to his or her profile.

6. Opening an account and placing the order To buy and sell listed securities the investor must:

• Open a Demat account and a Merchant (trading) account through a licensed broker of the Nepal Stock Exchange (NEPSE)
• Obtain a CRN (Client Registration Number) from the Central Depository System (CDS) and Clearing Ltd.
• Deposit the required margin/collateral with the broker
• Place buy or sell orders through the broker (TMS — Trading Management System), either at market price or at a limit price

7. Execution and settlement NEPSE matches orders and executes trades. Settlement in Nepal follows the T+3 rolling settlement system, i.e. payment and delivery of securities take place within three working days after the trade date. Shares are transferred electronically through CDS and Clearing Ltd., and money is settled through the broker's bank account.

8. Monitoring and review The investor continuously tracks market prices, company performance, interest rates, inflation, NRB monetary policy and political conditions. The portfolio is reviewed periodically and rebalanced by selling overvalued and buying undervalued securities.

9. Evaluation of performance Actual return (capital gain plus dividend/interest) is compared with the expected return and with a benchmark such as the NEPSE index or bank deposit rate. Risk-adjusted measures such as Sharpe's ratio may be used.

10. Revision of the portfolio If performance falls short of objectives or the investor's circumstances change, the portfolio is revised — securities are switched, holdings increased or reduced, and the cycle of analysis, selection and monitoring is repeated.

Regulatory framework: These processes operate under the Securities Board of Nepal (SEBON) as regulator, NEPSE as the secondary market, CDS and Clearing Ltd. as depository, and Nepal Rastra Bank for money market and government securities. Investments by foreigners and in foreign assets are regulated by the Foreign Exchange (Regulation) Act, 2019 and NRB directives.

Conclusion The investment process in Nepal is a continuous, circular sequence — setting objectives, analysing alternatives, constructing and executing the portfolio, then monitoring, evaluating and revising it — all carried out within the legal and institutional framework of SEBON, NEPSE, CDS and NRB.

Present Investment Environment in Nepal

1. Present Investment Environment in Nepal

The investment environment of a country refers to the sum total of economic, political, legal, social and institutional factors that influence the decision to invest. Nepal's present investment environment can be described under the following headings:

a) Political and legal environment Nepal has been a federal democratic republic since 2008, with a constitution promulgated in 2015. The country has seen frequent changes of government, which creates policy uncertainty. However, several laws have been enacted to protect investors: the Foreign Investment and Technology Transfer Act (FITTA), 2019, the Industrial Enterprises Act, 2020, the Public–Private Partnership and Investment Act, 2019, the Companies Act, 2006, and the Securities Act, 2006. Under FITTA 2019, foreign investors may own up to 100% equity in most sectors (except a few restricted/prohibited ones), and repatriation of profits, dividends and capital is legally guaranteed. Nepal is also a member of WTO and SAFTA, and has signed Bilateral Investment Promotion and Protection Agreements (BIPPAs) with several countries.

b) Economic environment Nepal is a small, open, import-dependent economy with a GDP of about Rs 5,700 billion. Remittances from abroad contribute roughly one-fourth of GDP and are the main source of foreign exchange. Inflation has generally remained moderate (around 5–7%). The economy is dominated by agriculture (about 24% of GDP) and services (about 60%), while the industrial base is weak. Growth has averaged only about 4–5% in recent years, and the economy is vulnerable to shocks such as the COVID-19 pandemic, earthquakes, and trade disruptions with India.

c) Monetary and financial environment Nepal Rastra Bank (NRB) is the central bank. It follows a pegged exchange rate with the Indian rupee (Rs 1.60 = IRs 1), which provides stability but limits independent monetary policy. Interest rates on deposits and loans are relatively high compared to developed countries. The banking sector is fairly sound, with adequate capital and low non-performing loans. Financial access has expanded rapidly through branch expansion and mobile/digital banking. However, the cost of capital remains high and long-term financing is scarce.

d) Infrastructure and factor environment Infrastructure is a major constraint. Road connectivity has improved but remains poor in hill and mountain districts. Electricity supply has become more reliable after the end of load-shedding (2017), yet transmission and distribution are weak. Skilled labour is in short supply because of large-scale out-migration of youth. Land acquisition, industrial land, and reliable water supply are difficult to obtain. These raise the cost of doing business.

e) Legal–administrative and social environment Bureaucratic procedures, multiple approvals, and weak coordination among federal, provincial and local governments increase transaction costs. Corruption and contract enforcement problems persist. On the positive side, Nepal has a young labour force, growing urban middle class, expanding tourism potential, abundant hydropower potential (about 42,000 MW), and a large market for remittance-financed consumption.

f) Recent trends Nepal has improved its position in the World Bank's Ease of Doing Business rankings in the past, and has introduced online company registration, one-stop service centres, and investment summits. FDI commitments have increased in hydropower, tourism, ICT and manufacturing. The Nepal Stock Exchange (NEPSE) has seen high volatility but growing participation. Overall, the investment environment is improving but still not fully investment-friendly due to political instability, weak infrastructure, high cost of capital, and administrative hurdles.

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2. Types of Security Markets in Nepal

A security market is a market where securities such as shares, debentures and government bonds are bought and sold. In Nepal, the security market is regulated by the Securities Board of Nepal (SEBON) under the Securities Act, 2006. The main types are:

A. On the basis of issue (Primary and Secondary Market)

1) Primary Market (New Issue Market) This is the market where new securities are issued for the first time by companies or the government. Funds flow directly from investors to issuers. In Nepal, primary issues take place through:

• Initial Public Offering (IPO) — first sale of shares to the public.
• Further Public Offering (FPO) — additional shares issued by an already listed company.
• Rights Issue — shares offered to existing shareholders in proportion to their holding.
• Bonus Issue — free shares issued from accumulated profits.
• Debenture/Bond Issue — long-term debt securities issued by companies or government.
• Auction — government securities sold through NRB auction.

2) Secondary Market This is the market where existing securities are traded among investors. The company does not receive funds here; ownership simply changes hands. In Nepal, the secondary market operates through:

• NEPSE (Nepal Stock Exchange) — the only organised stock exchange, established in 1994, located in Kathmandu.
• Broker members — licensed brokers who execute buy/sell orders.
• Online trading system (TMS) — investors trade through brokers using the Trading Management System.
• CDSC (CDS and Clearing Limited) — handles dematerialisation and settlement of securities.

B. On the basis of organisation (Organised and Unorganised Market)

3) Organised Market A formal, regulated market with fixed rules, trading hours, licensed intermediaries and a clearing house. NEPSE is the organised market in Nepal.

4) Unorganised Market (Over-the-Counter / Informal) An informal market where securities are bought and sold outside the exchange, without standard rules. Such transactions are limited in Nepal and are not legally recognised.

C. On the basis of maturity of securities

5) Money Market A market for short-term securities with maturity up to one year. In Nepal, it includes:

• Treasury bills (NRB)
• Commercial papers
• Inter-bank lending
• Repo and reverse repo transactions

6) Capital Market A market for long-term securities with maturity above one year. It includes:

• Stock market — trading of equity shares through NEPSE.
• Bond market — trading of debentures, government bonds and corporate bonds.

D. On the basis of trading instruments

7) Stock Market Deals in equity shares of companies. NEPSE is the stock market of Nepal.

8) Bond Market Deals in debt securities such as government bonds, corporate debentures and foreign bonds. In Nepal, the bond market is still small and mostly limited to government securities.

9) Derivative Market Deals in financial derivatives like futures, options and swaps. This market is not yet developed in Nepal; SEBON has been preparing the legal framework for it.

E. On the basis of issue to investors

10) Domestic Market Securities issued and traded within the country among domestic investors.

11) International Market Securities issued in foreign markets, such as Global Depository Receipts (GDRs) and American Depository Receipts (ADRs). Nepali companies have made very limited use of this market.

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Conclusion Nepal's investment environment is gradually improving with legal reforms, growing financial access and rising FDI, but it still suffers from political instability, weak infrastructure and high capital costs. The security market is dominated by the primary and secondary markets operating through SEBON, NEPSE and CDSC, while the bond, derivative and international markets remain underdeveloped. Strengthening these markets and ensuring a stable investment climate are essential for mobilising domestic and foreign capital for Nepal's development.

Given:
Returns in percent; return of stock N in third state is ((5)) = (-5%).

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a. Expected returns of stock M and stock N

[ E(R_M)=\sum p_iR_{Mi} ]

[ E(R_M)=0.30(10)+0.40(15)+0.30(20) ]

[ E(R_M)=3+6+6=15% ]

[ E(R_N)=0.30(35)+0.40(15)+0.30(-5) ]

[ E(R_N)=10.5+6-1.5=15% ]

Expected return of stock M = 15%
Expected return of stock N = 15%

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b. Standard deviations of stock M and stock N

[ \sigma^2=\sum p_i(R_i-E(R))^2 ]

For stock M:

[ \sigma_M^2=0.30(10-15)^2+0.40(15-15)^2+0.30(20-15)^2 ]

[ \sigma_M^2=0.30(25)+0+0.30(25)=7.5+7.5=15 ]

[ \sigma_M=\sqrt{15}=3.87298\approx 3.87% ]

For stock N:

[ \sigma_N^2=0.30(35-15)^2+0.40(15-15)^2+0.30(-5-15)^2 ]

[ \sigma_N^2=0.30(400)+0+0.30(400)=120+120=240 ]

[ \sigma_N=\sqrt{240}=15.49193\approx 15.49% ]

Standard deviation of stock M = 3.87%
Standard deviation of stock N = 15.49%

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c. Coefficient of variation and investment preference

[ CV=\frac{\sigma}{E(R)}\times 100 ]

Stock M:

[ CV_M=\frac{3.87298}{15}\times 100=25.82% ]

Stock N:

[ CV_N=\frac{15.49193}{15}\times 100=103.28% ]

Stock M has the same expected return as stock N but much lower risk. Therefore, a risk-averse investor should prefer stock M.

Preferred stock: Stock M

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d. Correlation coefficient between stock M and stock N

[ Cov(M,N)=\sum p_i(R_{Mi}-E(R_M))(R_{Ni}-E(R_N)) ]

[ Cov(M,N)=0.30(10-15)(35-15)+0.40(15-15)(15-15)+0.30(20-15)(-5-15) ]

[ Cov(M,N)=0.30(-5)(20)+0+0.30(5)(-20) ]

[ Cov(M,N)=-30+0-30=-60 ]

[ r_{MN}=\frac{Cov(M,N)}{\sigma_M\sigma_N} ]

[ r_{MN}=\frac{-60}{\sqrt{15}\sqrt{240}} ]

[ r_{MN}=\frac{-60}{\sqrt{3600}}=\frac{-60}{60}=-1 ]

Correlation coefficient = (-1)
This means stock M and stock N are perfectly negatively correlated.

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e. Portfolio return and risk

Weights:

[ w_M=0.45,\qquad w_N=0.55 ]

Expected portfolio return:

[ E(R_p)=w_ME(R_M)+w_NE(R_N) ]

[ E(R_p)=0.45(15)+0.55(15)=15% ]

Portfolio risk:

[ \sigma_p^2=w_M^2\sigma_M^2+w_N^2\sigma_N^2+2w_Mw_NCov(M,N) ]

[ \sigma_p^2=(0.45)^2(15)+(0.55)^2(240)+2(0.45)(0.55)(-60) ]

[ \sigma_p^2=3.0375+72.6-29.7=45.9375 ]

[ \sigma_p=\sqrt{45.9375}=6.7777\approx 6.78% ]

Expected portfolio return = 15%
Portfolio risk = 6.78%

Given: par value = Rs 1,000; coupon = 11% so annual interest = Rs 110; n = 5 years; market price = Rs 950.

(a) Current yield

$\frac{110}{950}\times 100 = \textbf{11.58\%}$

(b) Yield to maturity

Approximate formula:

$YTM = \frac{110 + \frac{1000-950}{5}}{\frac{1000+950}{2}} = \frac{120}{975} = 12.31\%$

Exact (trial and error, interpolating between 12% and 13%):

• At 12%: PV = 110 × 3.6048 + 1,000 × 0.5674 = Rs 963.93
• At 13%: PV = 110 × 3.5172 + 1,000 × 0.5428 = Rs 929.69

$YTM = 12\% + \frac{963.93-950}{963.93-929.69}\times 1\% \approx \textbf{12.4\%}$

(At 12.4% the present value is Rs 950.03, confirming the result.)

(c) Capital gain

If the bond is held to maturity and redeemed at par: Rs 1,000 − Rs 950 = Rs 50 (about 5.26% of the price).

(d) Buy or not at Rs 950 (required return 12%)

$V = 110 \times PVIFA_{12\%,5} + 1000 \times PVIF_{12\%,5} = 110(3.6048) + 1000(0.5674) = \text{Rs } 963.93$

Intrinsic value (Rs 963.93) is greater than the market price (Rs 950), and the YTM (12.4%) exceeds the required return of 12%, so the bond is undervalued and should be bought.

(e) Yield to maturity versus yield to call

(a) Market price of the closed-end fund’s shares

Given:

• Portfolio assets = Rs 2,250 million
• Liabilities = Rs 50 million
• Shares outstanding = 100 million
• Discount from NAV = 8%

First, calculate net assets:

[ \text{Net assets} = \text{Portfolio assets} - \text{Liabilities} ]

[ = 2250 - 50 = \text{Rs 2200 million} ]

Now, calculate NAV per share:

[ \text{NAV per share} = \frac{\text{Net assets}}{\text{Number of shares outstanding}} ]

[ = \frac{2200}{100} = \text{Rs 22 per share} ]

Since the fund trades at an 8% discount from NAV:

[ \text{Market price} = \text{NAV} \times (1 - \text{Discount rate}) ]

[ = 22 \times (1 - 0.08) ]

[ = 22 \times 0.92 = \text{Rs 20.24 per share} ]

Therefore, the market price of the fund’s shares is Rs 20.24 per share.

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(b) Advantages and disadvantages of mutual funds

Advantages:

1. Diversification: A mutual fund invests in many securities, reducing unsystematic risk.
2. Professional management: Experienced fund managers research and manage the portfolio.
3. Small investment: Investors can start with a small amount and still get a diversified portfolio.
4. Liquidity: Open-end funds can be redeemed easily; closed-end funds are traded on stock exchanges.
5. Convenience: Systematic investment plans, automatic reinvestment, and record-keeping are available.
6. Economies of scale: Large pooled funds enjoy lower brokerage and transaction costs.
7. Transparency and regulation: NAV is disclosed regularly, and in Nepal mutual funds are regulated by SEBON.
8. Variety: Investors can choose equity, debt, balanced, money market, or index funds as per their risk preference.

Disadvantages:

1. Management fees and expenses: Fees reduce the actual return earned by investors.
2. Loss of control: Investors cannot directly choose the securities in the portfolio.
3. No guaranteed return: Returns depend on market performance; capital may also be lost.
4. Market risk remains: Diversification cannot eliminate systematic or market risk.
5. Poor performance possible: A fund manager may underperform the market or peer funds.
6. Closed-end discount: Closed-end funds may trade below NAV, causing loss on sale.
7. Tax and regulatory restrictions: Distributions may be taxable, and investment choices are regulated.
8. Impersonal service: Mutual funds offer standard products, not tailor-made portfolios for individual needs.

Given:

• Net income = Rs. 7.5 million = Rs. 7,500,000
• Sales = Rs. 60 million = Rs. 60,000,000
• Shares outstanding = 1,000,000
• Total assets = Rs. 150 million
• Stockholders' equity = Rs. 110 million
• Dividend per share (DPS) = Rs. 4.5
• Market price per share (MPS) = Rs. 300
• Earnings growth rate = 5%

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a. Earnings Per Share (EPS)

$\text{EPS} = \frac{\text{Net Income}}{\text{Shares Outstanding}} = \frac{7{,}500{,}000}{1{,}000{,}000} = \text{Rs. } 7.5$

EPS = Rs. 7.5 per share

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b. Book Value Per Share and Price-to-Book-Value Ratio

$\text{Book Value Per Share} = \frac{\text{Stockholders' Equity}}{\text{Shares Outstanding}} = \frac{110{,}000{,}000}{1{,}000{,}000} = \text{Rs. } 110$

$\text{P/B Ratio} = \frac{\text{MPS}}{\text{BVPS}} = \frac{300}{110} = 2.73 \text{ times}$

BVPS = Rs. 110; P/B Ratio = 2.73 times

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c. P/E Ratio and Net Profit Margin

$\text{P/E Ratio} = \frac{\text{MPS}}{\text{EPS}} = \frac{300}{7.5} = 40 \text{ times}$

$\text{Net Profit Margin} = \frac{\text{Net Income}}{\text{Sales}} \times 100 = \frac{7{,}500{,}000}{60{,}000{,}000} \times 100 = 12.5\%$

P/E Ratio = 40 times; Net Profit Margin = 12.5%

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d. Dividend Payout Ratio and Dividend Yield

$\text{Dividend Payout Ratio} = \frac{\text{DPS}}{\text{EPS}} \times 100 = \frac{4.5}{7.5} \times 100 = 60\%$

$\text{Dividend Yield} = \frac{\text{DPS}}{\text{MPS}} \times 100 = \frac{4.5}{300} \times 100 = 1.5\%$

Payout Ratio = 60%; Dividend Yield = 1.5%

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e. PEG Ratio

$\text{PEG Ratio} = \frac{\text{P/E Ratio}}{\text{Earnings Growth Rate}} = \frac{40}{5} = 8$

PEG Ratio = 8

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Summary of Results:

Systematic Steps Involved in Investing

Investment is the commitment of funds to one or more assets with the expectation of earning a return over time. A rational investor does not invest randomly; the process follows a logical sequence of steps. The systematic steps involved in investing are as follows:

1. Determination of investment objectives The first step is to define clearly what the investor wants to achieve. Objectives may be stated in terms of return required, risk tolerance, liquidity needs, and time horizon. Common objectives are regular income, capital appreciation, safety of principal, and tax saving. Objectives must be specific and measurable, because they guide every later decision.

2. Assessment of the investor's profile The investor's age, income, family responsibilities, net worth, liabilities, and attitude towards risk are analysed. This gives the investor's risk capacity (ability to bear loss) and risk tolerance (willingness to bear loss). The lower of the two becomes the effective risk limit.

3. Formulation of investment policy An investment policy is a written statement that converts objectives and the investor's profile into guidelines. It specifies the asset classes permitted (equity, debt, real estate, gold, deposits), the target proportion of each, the minimum acceptable return, the maximum permissible risk, and the liquidity requirement. The policy acts as a discipline against impulsive decisions.

4. Analysis and valuation of securities Potential investments are studied through fundamental analysis (economy, industry, and company analysis) and technical analysis (price trends and patterns). Each security is then valued using models such as the dividend discount model, discounted cash flow, or relative valuation, and its intrinsic value is compared with the market price to identify undervalued or overvalued securities.

5. Portfolio construction Selected securities are combined into a portfolio. Here the principles of diversification and correlation are applied so that the total risk of the portfolio is lower than the average risk of individual securities. The portfolio is built to lie on the efficient frontier, giving the highest expected return for a given level of risk.

6. Execution of investment The portfolio is actually purchased. This involves choosing the mode of investment (primary market, secondary market, mutual funds, or direct purchase), selecting brokers or intermediaries, deciding the timing and mode of payment, and completing the legal formalities. Transaction costs and taxes at the time of purchase are also considered.

7. Monitoring and performance evaluation After investment, the portfolio is reviewed periodically. Actual return is compared with the expected return and with a suitable benchmark such as the NEPSE index or a Treasury bill rate. Risk-adjusted measures like Sharpe, Treynor, and Jensen ratios are used to judge whether the portfolio is performing as intended.

8. Portfolio revision If evaluation shows that objectives are not being met, or if market conditions and the investor's circumstances have changed, the portfolio is revised. This involves selling some securities and buying others, or changing the proportion of asset classes. Revision is done in a balanced way so that transaction costs do not eat up the gains.

Thus, investing is a continuous and dynamic process beginning with objective setting and ending with revision, after which the cycle repeats.

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Effect of Taxes, Life Cycle of Investors and Economic Environment on Investment

(a) Considerations about taxes

Taxes directly reduce the net return from an investment, so they influence both the choice of asset and the timing of investment.

1. Effect on net return. Return should always be measured after tax. If two securities give the same pre-tax return but are taxed differently, the one with lower tax is superior. For example, in Nepal, interest on bank deposits is subject to tax at source, whereas capital gains on listed shares are taxed at a comparatively lower rate. An investor in a high tax bracket will therefore prefer capital gains to interest income.

2. Choice of asset. Tax-exempt or tax-favoured instruments such as provident funds, citizen investment trusts, insurance policies, and government bonds attract investors who want to reduce tax liability. Conversely, highly taxed assets must offer a higher pre-tax return to be acceptable.

3. Tax planning and timing. Investors delay the sale of appreciated securities to shift income to a year when their tax slab is lower, and they realise losses to set off against gains. Holding period rules also matter, because long-term gains are often taxed more lightly than short-term gains.

4. Effect on portfolio composition. A tax-conscious investor tilts the portfolio towards assets whose returns are taxed at a lower rate or deferred, and holds tax-inefficient assets in tax-sheltered accounts. Thus taxes change the after-tax efficient frontier and hence the optimal portfolio.

(b) Life cycle of investors

An investor's needs, income, and risk capacity change with age, so the investment strategy also changes over the life cycle.

1. Accumulation phase (young, early career). Income is rising, liabilities are few, and the time horizon is long. Such investors can bear high risk and therefore hold a large proportion of equity and growth assets. They can also afford to invest regularly and to ride out short-term market fluctuations.

2. Consolidation phase (middle age). Income is at its peak but responsibilities such as children's education, housing loans, and family maintenance are also high. The portfolio becomes balanced, mixing equity for growth with debt for stability and regular income. Liquidity needs increase.

3. Spending phase (pre-retirement and retirement). Income falls and the need for capital preservation and regular cash flow rises. The portfolio shifts towards fixed deposits, bonds, annuities, and dividend-paying shares. Risk tolerance is low because there is little time to recover from losses.

4. Gifting and estate phase (old age). The focus moves to protecting capital, meeting medical expenses, and transferring wealth to heirs. Safety and liquidity dominate, and tax-efficient transfer of assets becomes important.

Thus the same investor follows different policies at different stages, and a portfolio suitable for a young person is unsuitable for a retiree.

(c) Different economic environment

The state of the economy determines the return and risk available from each asset class, so investment decisions must be adjusted to the economic environment.

1. Expansion or boom. National income, employment, and corporate profits rise. Interest rates tend to rise and inflation may appear. Equity and real estate perform well, so investors increase their exposure to growth assets. Bond prices fall as interest rates rise, so long-term bonds become less attractive.

2. Recession or depression. Output, employment, and profits fall. Interest rates and inflation decline. Equity prices fall and risk rises, so investors move towards government securities, fixed deposits, and gold for safety. Defensive shares of essential-goods companies are preferred over cyclical shares.

3. Inflationary environment. Rising prices erode the real value of fixed-income returns. Investors shift to real assets such as land, gold, and inflation-indexed or equity instruments that provide a hedge against inflation, and avoid long-term fixed deposits.

4. Deflationary environment. Falling prices raise the real burden of debt and reduce corporate earnings. Cash and high-quality bonds become attractive because their real value rises.

5. Monetary and fiscal policy. A tight monetary policy raises interest rates and discourages equity investment, while an expansionary policy lowers rates and encourages it. Fiscal policy affects disposable income and hence savings and investment through taxation and government expenditure.

6. Balance of payments and exchange rate. A depreciating domestic currency raises the return on foreign-currency assets and on export-oriented companies, while a stable or appreciating currency favours importers and domestic assets. Political stability, government policy, and global conditions also affect investor confidence and hence market prices.

Conclusion. Taxes reduce the net return and therefore influence asset choice and timing; the life cycle determines risk capacity and hence the equity–debt mix; and the economic environment determines which asset classes are likely to perform well. A successful investor therefore reviews all three factors continuously and adjusts the portfolio through the systematic steps of the investment process.

Given Data

Investment Rs 5,00,000, split equally: $w_A = w_B = 0.50$.

a. Expected returns and standard deviations

$E(R_A) = 0.30(-5) + 0.40(10) + 0.30(15) = 7\%$

$E(R_B) = 0.30(20) + 0.40(15) + 0.30(-10) = 9\%$

Stock A:

$\sigma_A = \sqrt{66.00} = 8.12\%$

Stock B:

$\sigma_B = \sqrt{159.00} = 12.61\%$

b. Covariance and correlation

$\text{Cov}(A,B) = -78.00$

$\rho_{AB} = \frac{-78.00}{8.124 \times 12.610} = -0.76$

c. Portfolio return and standard deviation

$E(R_p) = 0.5(7) + 0.5(9) = 8\%$

$\sigma_p^2 = (0.5)^2(66) + (0.5)^2(159) + 2(0.5)(0.5)(-78) = 16.50 + 39.75 - 39.00 = 17.25$

$\sigma_p = \sqrt{17.25} = 4.15\%$

d. Preference

The portfolio is preferred. Its return (8%) is higher than Stock A and only 1 point below Stock B, but its risk (4.15%) is far lower than either stock, because the returns are strongly negatively correlated ($\rho = -0.76$). It also has the lowest coefficient of variation (0.52), the best return per unit of risk.

e. CAPM check

Required return $= R_f + \beta(R_m - R_f)$, with $R_f = 4\%$ and market premium $= 6\%$.

• Stock A: $4 + 0.5(6) = 7\%$. Expected return is 7%, equal to the required return, so A is fairly priced.
• Stock B: $4 + 1.1(6) = 10.6\%$. Expected return is 9%, below the required 10.6% (alpha $= -1.6\%$), so B is overvalued.

Face value is taken as Rs 1,000 for each bond.

Bond A (semi-annual coupon)

Coupon = 8% × 1,000 / 2 = Rs 40; $n = 20$ half-years; $r = 10\%/2 = 5\%$.

$P = 40 \times \frac{1-(1.05)^{-20}}{0.05} + \frac{1{,}000}{(1.05)^{20}} = 498.49 + 376.89 \approx \textbf{Rs } 875.38$

The bond sells at a discount because the coupon rate (8%) is below the market rate (10%).

Bond B (called after 2 years, no penalty)

The bond is expected to be redeemed at par after 2 years, so only two coupons of Rs 100 and the Rs 1,000 face value are received. $r = 7\%$.

$P = \frac{100}{1.07} + \frac{1{,}100}{(1.07)^2} = 93.46 + 960.78 \approx \textbf{Rs } 1{,}054.24$

Bond C

Annual coupon = Rs 90; price = Rs 939.

$\text{Current yield} = \frac{90}{939} = 9.58\%$

For YTM, solve $939 = 90 \times PVIFA(r,10) + 1{,}000 \times PVIF(r,10)$. Approximation:

$YTM \approx \frac{90 + (1000-939)/10}{(1000+939)/2} = \frac{96.1}{969.5} = 9.91\%$

Trial and error gives the exact value, YTM ≈ 9.99%, about 10% (at 10%, the price is Rs 938.55).

Bond D (duration)

Coupon Rs 100, face Rs 1,000, 4 years, YTM 12%.

$D = \frac{3{,}258.54}{939.25} \approx \textbf{3.47 years}$

Bonds E and F (coupon 8.25%, market rate 10%)

(i) Yes, the prices differ.

• Bond E (5 years): $82.5 \times 3.7908 + 1{,}000 \times 0.6209 \approx$ Rs 933.66
• Bond F (10 years): $82.5 \times 6.1446 + 1{,}000 \times 0.3855 \approx$ Rs 892.47

(ii) Both have the same coupon and market rate, and both sell at a discount because the coupon is below the market rate. The longer-maturity bond F has a larger discount, since the below-market coupons last for more years and the face value is received later and discounted more heavily. Hence longer-maturity bonds are more sensitive to interest-rate changes (greater interest-rate risk).