Analysis of Financial Products of Capital Market in Bangladesh

Dissertation on Analysis of Financial Products of Capital Market in Bangladesh: Present Status and Future Development.

Research Proposal on

Analysis of Financial Products of Capital Market in Bangladesh: Present Status and Future Development.

  

Abstract

The performance of existing financial products is an important issue in the capital market to increase the new

products for reducing the risk of dependency on common stocks. The research aims are to evaluate the growth and development of existing financial instruments and to recommend for introducing new financial instruments in the capital market of Bangladesh. The data are taken from the Dhaka stock exchange for the year 1977 to 2010 for interpretation of development and the data from 2003 to 2010 are taken for analysis and hypothesis test. There are only five products traded including three types of bonds. The average growth rate of market capitalization of common stocks, treasury bonds, mutual funds, corporate bonds & debentures are 71.02%, 124.74%, 99.85% and 105.41% respectively. The growth of market capitalization of all products is high. There is lot of scope in the market for absorbing the new products. The share of common stocks, treasury bond, corporate bond, debentures, mutual funds to total market capitalizations are 87.73%, 12.25%, 0.24%,0.17% and 0.83% respectively. The market is common stock based. The corporate bond market is very small. So, there should be increased new financial instruments in the capital market to reduce the dependency on share only. The proposed financial instruments are various types of preferred stock, bond, SWAP, option, futures, and forwards as recommendation.

Keywords: financial products, capital market, market capitalization, option, swap

1. Introduction

The capital market is one of the driving forces of an economy. Capital market is the institution that provides a

channel for the borrowing and lending of long-term funds for more than one year. It is designed to finance long term investments by business, governments, and households. Capital market consists of two segments: securities segment and non-securities segment. The securities segment is concerned with the process by which firm distributes securities to the public through the primary market and then those securities are traded in the secondary markets. The non securities segments are those where banks and other financial institution provide the long term loan. In the world capital market there are many financial instruments such as-Forward, Futures, Option: Put option, Call option, Spread, Straddle, Strip, Multi-period option: Interest Rate Caps, Floor, Collar, Compound option, Swaps- Commodity Swaps, Interest Rate swaps, Currency Swaps, Variants, Hybrid securities, Synthetic Securities, Zero coupon Bond, Repo, Reserve Repo, Junk bond, Floating rate Preferred Stock, Equity warrant, Putt able common Stock.

The existing instruments of the capital market of Bangladesh are Shares, debentures, mutual fund, and Treasury Bond: 5-year,10-year,15-year,20-year, NSD Certificate (3year&5year), REPO and REVERSE REPO,US Dollar Premium bond, US dollar investment bond, Wages Earners Development bond in the capital market of Bangladesh. Like in any other countries, a well developed tradable bond market is critical  to ensure stability and efficiency of the financial market in Bangladesh. An efficient bond market is important for managing public debt and bank liquidity and for efficient conduct of monetary policy. So far the bond market has played a limited role in the economy. The country’s financial sector is dominated by the commercial banks.

Thus the debt market in Bangladesh is characterized by excessive reliance on bank deposits, government

dominated debt instruments, non- existent corporate bond, high and risk free interest rates, absences of market based yield curve, primary auctions based activity, lack of product variation.

Now, 31 FIs (Financial Institutions) are operating in Bangladesh while the maiden one was established in 1981. Out of the total, 2 is fully government owned, 1 is the subsidiary of a SOCB, 13 were initiated by private domestic initiative and 15 were commenced by joint venture initiative.

2. Literature Review

Bangladesh Enterprise Institute (2003), conducted detail research on Improving the Investment Climate in

Bangladesh under World Bank. Bangladesh firms tend to have reasonable access to formal finance compared to other low-income countries. In 2001 credit to the private sector amounted to about 27 percent of GDP in Bangladesh. Although this ratio was lower than those in some counties in the region, it compares favorably with the average for low income countries (24 percent of GDP). It was only fractionally lower than the ratios in India (29 percent) and Pakistan (28) percent despite their higher per capita income. Other measures confirm this assessment of finance in Bangladesh. For example, nearly 66 percent of their investment capital, on average, came from retained earnings, while about 30 percent of working and investment capital came from banks. Consider national level data on nonperforming loans. Some estimates put the share of nonperforming industrial loans at around 40 percent. Since banks will have to provision for non performing loans, the large number of such loans could ultimately increase the cost of capital to entrepreneurs. The problems of financial climate are poor access to credit and high cost of borrowing. For solving these, development of secondary market for debt market and enhancement the enforcement authority and institutional capacity of the Securities and Exchange Commission are recommended. (World Bank, (2003), Washington).

B. McGuire, Paul & John D. Conroy, (2002), conducted research on Fostering Financial Innovation for the

poor. Considering financial innovation in terms of this hierarchy helps our understanding of the respective roles of policy direction (as embodied in the legal and regulatory framework) and of market forces (as seen in the behavior of actors in the financial marketplace). The policy decisions of governments, monetary authorities and regulators may effect change and stimulate innovation within all four domains. However, the top (i.e. systemic) level is where policy exerts its greatest and potentially most fruitful influence on innovation. By contrast, market forces operate with increasing influence at the successive lower levels, within ‘rules of the game’ determined primarily in the systemic domain.

Bepari, M. Khokon (2008) conducted research on Bangladesh Stock Market Growing? Key indicators based Assessment. This paper focuses on the growth of Bangladesh stock market over time. The market trends in terms of market capitalization, market liquidity, market concentration, number of listings, volatility in the market index and foreign portfolio investment were considered. The study finds that key indicators are significantly correlated. Stock market growth index is constructed considering market capitalization ratio; turn over ratio, value traded to GDP ratio and volatility in market index. The findings of the study suggest that although Bangladesh stock market is growing over time, the growth has not yet assumed any stable and obvious trend. It is concluded that Bangladesh stock market is still at an early stage of its growth path with a small market size relative to GDP and is characterized by poor liquidity and high market concentration.

Jahur, (2009) conducted study on bond market development of Bangladesh. The poor stage of bond market in Bangladesh can be attributed to some important factors such as risk & return factor, liquidity & government policy related factor, issue management factor and investment policy factor in order of magnitudes.

Rahman and Moazzem (2011) studied on ‘Capital Market of Bangladesh: Volatility in the Dhaka Stock

Exchange (DSE) and Role of Regulators’. Over the last few years, the capital market of Bangladesh has

witnessed a haughty growth which is not in line of development in the real sector of the economy. Although, the Securities and Exchange Commission (SEC) of Bangladesh has tried to correct the irregular behavior observed in the market, very often it is argued that lack of proper and firm decisions from the regulator’s side has contributed to make the market more unstable rather than to reduce it. The paper attempts to identify the casual relationship between the observed volatility in the country’s major bourses namely the Dhaka Stock Exchange (DSE) and the regulatory decisions taken by the SEC empirically. Using Vector Auto-regressive (VAR), statistically highly significant relationship was found between decisions taken by the regulatory authority and market volatility, although the direction of causality is in reverse order than theoretically and empirically expected.

Ross LEVINEAND SARAZERVOS (2012) studied on ‘Stock Markets, Banks, and Economic Growth. Do well-functioning stock markets and banks promote long-run economic growth?’ This paper shows that stock market liquidity and banking development both positively predict growth, capital accumulation, and productivity improvements when entered together in regressions, even after controlling for economic and political factors.

The results are consistent with the views that financial markets provide important services for growth, and that stock markets provide different services from banks. The paper also finds that stock market size, volatility, and international integration are not robustly linked with growth and that none of the financial indicators is closely associated with private saving rates.

Zahid Ahmad, Ather Azim Khan and Anam Tariq (2011) studied on ‘Stock market development and

economic growth: A comparative study of Pakistan and Bangladesh’ .This paper examined the relationship

between stock market development and economic growth of two Asian developing countries, that is, Pakistan and Bangladesh, after the liberalization period of 1990s. The relationship measured were in terms of size (market capitalization), liquidity (total value of stocks traded and stock turnover ratio) and volume (total number of companies listed in the stock exchange of each of the country). The study of comparative analysis was done with the help of tables and charts. The econometric results of the study by employing the regression analysis showed that Pakistan stock markets contribute to the economic growth in terms of the large size of its stock market whereas Bangladesh stock market contributes to the economic growth in terms of the liquidity of its stock market.

Bangladesh economic growth was found to be comparatively better than economic growth of Pakistan. The

study revealed that the stock markets in Pakistan and Bangladesh do not play a major role in the economic

growth but rather, these financial institutions are the driving forces for the economic growth of the country.

3. Problem Statement

The capital market of Bangladesh is small, inefficient and underdeveloped. Of the total financial system, the

‘non securities’ sector accounts for more than ninety percent of the financial activities in the countries. But this bank based system is virtually on the verge of collapse due to huge nonperforming loans and colossal volume of classified and default loans. So, we are concerned with ‘securities segment’ because the securities market can develop the national economy. The rate of institutional investment is very low in Bangladesh. The capital market has not yet attained the credibility as an reliable avenue for investment from the side of the general public. The main problems of capital market of Bangladesh are; serious dearth of risk free assets in the secondary market to individual buyers, absence of varied tradable financial Instruments.

The availability of low financial instruments in market, the capital in the market is low comparatively to the

developed country and the investors – both institutions and individual are not attracted to invest in capital market in Bangladesh. Introduction of new instruments of finances will provide the opportunities to the companies for getting required fund at lower cost. The introduction of new financing sources will increase the investor’s participation in the future offering of companies. This will raise more funds. The research aims are to evaluate the growth and development of existing financial instruments and to recommend for introducing new financial instruments in the capital market of Bangladesh. The traditional instruments are not attractive to the investors. So, it is assumed that new instruments will increase the attraction of investors and volume of capital market and will reduce the dependency on bank based credit.

4. Methodology

4.1 Objectives

1) To evaluate the growth and development of existing financial instruments in the capital market of

Bangladesh.

2) To recommend policies for introducing new financial instruments in the capital market of Bangladesh.

4.2 Collection of Data

The primary data were colleted from the interview with the executives of DSE, CSE, BB (Bangladesh

Bank), BSB(Bangladesh Shilpo Bank), ICB(Investment Corporation of Bangladesh), prospective investors,

stockbrokers, government officials, and other professionals.

Secondary data were collected from the following Sources: Publications of Securities and Exchange

Commission, Dhaka stock Exchange (DSE) Chittagong Stock Exchange (CSE), Stock market Report on

Newspaper, Bangladesh Bank, Bangladesh Bureau of Statistics, Bangladesh Economic Review, Books and

Journal, Internet Website.

Source -Islam, Mohammad Shahidul-International Journal of Marketing Studies. Oct2012, Vol. 4 Issue 5, p119-128. 10p. 5 Charts, 1 Graph. 

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