FMI Term Paper Final

8/2/2019 FMI Term Paper Final

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F-618; Financial Markets &

Institutions.1

Introduction to Capital Market of Bangladesh

Capital market plays a significant role for the proper functioning ofcapitalistic economy, as they channelize funds from the savers to theborrowers. The securities market allows sound listed companies to raiseadditional capital quickly and cheaply, as they enjoy reputation. A vibrantand liquid securities market encourages people to increase in savings byoffering attractive and rewarding securities in terms of higher return,lower risk and easy option for conversion to cash. Capital markets IncludePrimary Market, where new securities are sold & Secondary Market,where existing securities that are issued through the primary market aretraded. Primary Markets involve investment bankers, who havespecialization in selling new securities. Secondary Markets consist ofequity markets, bond markets and derivative markets.

It is encouraging to see that the capital market of Bangladesh is growingat a slower pace and has reached at a emerging stage. After the bubbleand burst of 1996, capital market has attracted a lot more attention,importance and awareness that have led to whatever infrastructure wehave in the market today. This flow of experience for market furtherimproved the awareness and knowledge level of investors as well asissuers.

Investors in Bangladesh became increasingly interested in equitymarkets because many entrepreneurs look for requirements of fund from

the equity markets for many reasons. In this connection Dhaka StockExchange Limited play an integral part of the industrialization of thecountry. The major regulators in Bangladesh capital market areSecurities and Exchange Commission, stock exchanges, Registrar of JointStock Companies and Investment Corporation of Bangladesh. The majorfunctions of stock market are listed below:

1. The companies can arrange their long term capital for businessexpansion from market with a minimum cost. The banks aresuitable only for short term and mid-term financing.

2. The companies listed in the stock exchange come under regulation

of Securities and Exchange Commission, which ensures thecorporate governance of the companies. The financial statement oflisted companies is quite informative and valuable than unlistedcompanies.

3. The most important factor is that stock market can attractinvestment. People reduce their consumption and invest here toearn better in future.

4. Stock market can finance huge fund for large projects easily.5. Finally, stock market is considered as the barometer of economy.

An efficient stock market is the leading indicator of the economy.


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A Brief History of Capital Market

Capital market of Bangladesh was in a dormant stage during the decades

of sixties, seventies and early part of eighties. During that period, fewcompanies assessed in capital market & investors were not interested orfamiliar in corporate securities. The origin of the Stock Market in Dhakagoes back to 1954 when a Stock Exchange was formed in Narayangonj.Then in 1958 the Stock Exchange was transferred to Dhaka. TheCompanies Act 1913 and the Capital issues (Continuance of Control) Act1954 were two pieces of legislation was governing the Stock Market inthe country. Later the Securities & Exchange Ordinance was promulgatedin 1969. It was only in 1992, the capital market of Bangladesh started tobe recognized as a source of finance for industry & business. The first

international investor arrived in March 1993 soon followed by a folk ofinternational stockbrokers. With the success of big public issues in 1994and 1995, investors took the capital market as an alternative to moneymarket as a source of financing. Chittagong Stock Exchange Limited,second stock exchange of Bangladesh, has started trading from 10th

October 1995. It is estimated that an aggregate amount of Tk. 20 billionhas been raised against public issues, right issues and private placementof shares, debentures and other securities during 1992 through 1996.After that the unprecedented market crash in 1996 has shaken theconfidence of the investors and its impact is still lingering. Some majordevelopment, particularly the introduction of on-line computer trading in

countrys two bourses, and also some organizational (internal) changesor reforms have taken place since then. As a result of the reforms of thecapital market, the market has overcome the crisis period and in 2008Bangladeshi Index was in sixth position around the world.

Salient Features of the Capital Market of Bangladesh

The salient features of capital market of Bangladesh are discussed below:

NUMBEROFLISTEDSECURITIES:The number of listed securities in DSE is500. Among them 231 are companies, 37 are mutual funds, 8 aredebentures, 221 are Treasury Bonds and only 3 are corporate bond.

A SMALL NUMBER OF INVESTORS: The Bangladesh stock markets arecharacterized by a small number of investors.

LOWFOREIGN INVESTMENT: The role of Foreign Direct Investment (FDI)and Foreign Portfolio Investment (FPI) in the development of capitalmarket of Bangladesh is undeniable. However, Foreign Direct Investment(FDI) was US$ 900 million (July to Apr) and Foreign Portfolio Investment

(FPI) was US$ -123 million (July to Apr).


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LOWLIQUIDITYLEVEL: The stock market in Bangladesh is characterizedby a thin market having small market capitalization ratio & low level ofliquidity. If a big investor takes any attempt at selling a relatively largequantity, this will cause a large decrease in prices, i.e. an erosion of

capital value.

INSUFFICIENT TRADABLE CAPITAL INSTRUMENTS: Illiquidity is ratherintensified by the absence of varied tradable capital instruments. TheBangladeshi and foreign investors are experiencing the scarcity ofdiversified products in Bangladesh. The platform of this market is supplyand demand mismatch. Due to the absence of diversified products, theliquidity of market is declining.

LACKOFINVESTORS AWARENESS: A major portion of our population doesnot have proper awareness about the stock market. So, an investmentculture needs to be developed in our country through training up thegeneral investors as well as the authorized representatives.

INFORMATION ASYMMETRY: The access to the information remains amajor problem in the market. While a handful of institutional investorsmay enjoy certain benefits since they have an investment unit mannedwith qualified officers, nothing exists for retail investors. And, in the

absence of independent research houses, retail investors primarily focuson advices given by their brokers, and rumors. This is frightening and itoften leads to enormous losses for small investors who are vital for a low-income and pre-emerging market like Bangladesh. Filtering ofinformation among different types of investors may leave scopes formanipulation, this assumptions has been proven in 1996 at the cost ofmany individuals and households.

LACK OF PROFESSIONAL PORTFOLIO MANAGEMENT: We face the lack ofprofessional portfolio management in our Capital Market.

INSIGNIFICANT INVESTMENT FROM INSTITUTIONAL INVESTORS: An estimatesuggests that the ratio of institutional-to-retail investors is between 20-25%. This is considered low for a developing market like ours.Institutional investors bring long-term commitment hence stability in themarket. The presence of institutional investors also ensures better levelof valuation due to their specialized skills. While we do have public sectoras well as private sector institutional investors in the economy,proprietary investment from these institutions is not significant- otherthan Investment Corporation of Bangladesh that was created in 1976 and

currently manages several mutual funds.


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WEAK CORPORATE GOVERNANCE: The level of corporate governance ofinternational standard is lacking. Inadequate disclosure requirement andculture of family-owned conglomerates deter the expansion of corporategovernance into the local industry. Unless the local market adheres to

and effectively enforces a standard corporate governance system, therewill not be a level-playing ground for international business houses vis--vis local operators.

VALUATION DISPARITY: An important aspect for capital market isreflection of fair value of scripts. We find analysis touching the ruse ordrop in stock prices on a post-facto basis, but investors would be glad toreceive projections and recommendations from research analysts. This isnot adequately present in the current scenario, and due to this reasonInvestors are perhaps depending much on speculative analysis resultinginto volatility in the market as opposed to fundamental analysis. For thisreason, the market is not receiving attention of an important segment ofinvestors, both foreign and local.

OTHERCHARACTERISTICS: the other remarkable features of Bangladeshstock markets are laid down as follows:

Existence of only dealer-broker member (no specialist/ marketmaker)

Inefficient capital market operational & informational

Lack of proper or adequate disclosures of information & Lack of enforcement with the compliance of rules and regulations

Problems & Prospects of BD Capital Market

Crash in 2010

Bangladesh's stock market performance, measured in terms of the stockprice index, has been one of the best globally for a number of years. Itsupward surge defied global and regional market developments. When

almost all markets across the globe collapsed during the global economiccrisis, DGEN was perhaps one of the very few which defied the globaltrend and maintained its upward progression fueled by localdevelopments/conditions.

The recent debacle in the stock market is an issue of debate. All thestakeholders and particularly the small investors want to know the truestory behind the incident. Government also wants to know the reasonand wants to address the issue to avoid further debacle in future.There is a major difference between two debacles of share market in2006 and 2010. The former happened in secondary market but this time

the manipulation happened during valuation and fixation of offered priceof share and in side trading by different stake holders. It happened


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behind the screen. Even Investment Corporation of Bangladesh (ICB) alsoplayed in the game. They have purchased share of Tk 8.0 billion through15 Omnibus accounts in October and November, 2010. They of courseplayed the game for some influential officials in the government.

When it started its upward trend in 2007, the market was certainlyundervalued, and there were fundamental economic reasons for it to goup. At that time the average Price/Earning (P/E) ratio was in single digitand the market capitalization was less than 10 per cent of gross domesticproduct (GDP). The sustained upward surge, however, went beyond whatcould be justified by economic fundamentals by early 2010.

Since mid-2010, as the index crossed the 5000 mark, the market hasclearly been driven by speculative forces. During the last two-monthperiod leading up to the peak, the index increased by more than 2000

points before crossing the 8900 level on December 5. To put it in properperspective, the index level was at about 1500 until this recent surgestarted in 2007. Daily market turnover increased 30 fold about Tk. 1.0billion to Tk. 33 billion over the three-year period. Clearly, economicfundamentals cannot support this level of valuation gain and turnover,and the market is bound to correct itself once it runs out of steam.

The recent drop in the stock market index needs to be evaluated in thiscontext. Even after a more than 2500 point decline, the index is still wellabove its mid-2010 levels. The corrections and volatility in the priceindex that we have experienced in recent days is nothing uncommon,

and fully in line with what has been observed in many other important,and much larger stock markets across the globe. For the market to startconsolidating, it needs to shed itself of speculative elements, and thatcan only happen once market valuations come back to their fundamentallevels.

The problem was created for a simple reason that there is a gap betweendemand and supply of stocks in the market. The primary reason is thatthe regulator could not stop manipulation rather the officials of SEC wereinvolved in trading and other unfair practices. The other agencies andinstitutions having stakes in the share market possibly failed to perform

the need of oversight functions.

The share market experienced bullish trend in most part of the last yearbecause of the overexposure of some commercial banks and otherfinancial institutions. Bangladesh Bank was not much aware about banks'exposure to the stock market. They had invested beyond the limit of 10per cent of their deposit. This is also unethical to invest depositor'smoney risking the investment and even without their benefit. One of thecommercial banks made profit of Tk 10.40 billion last year. Of thisamount of profit, Tk 4.40 billion came during the last month by investing

in share market. Allegations have been found that bank officials providedfalse loan to fake clients for investment in the share markets. The


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Bangladesh Bank also investigated allocation of Tk 24 billion industrialloans by a bank to its clients last year.

The situation worsened when it was made mandatory for all banks to

maintain their investment in the stock market equivalent to 10 percent oftheir total deposit and to comply by December, 2010, when in reality, theratio was much higher than this level. The central banks measure to risecash reserve requirement of schedule banks from 5 per cent to 6 percentalso has a small impact on cash flow in the capital market.

The management of listed companies was busy to make easy money.The listed companies have withdrawn about Tk 170 billion from themarket through private placement, issue of preference share and directlisting at the initial stage of listing with stock market. The private

placement could reason unfair transaction. Companies sold their share tocivil, military bureaucrats and also to other influential persons. Directorsof Companies also benefited from direct listing.

Another manner of manipulation was revaluation of assets and issue ofbonus share which has a link to manipulation of market. It happened inmany cases in Z category companies who either do not pay dividend toshareholder, or, do not meet at Annual General Meeting, or are unable tocomply with other rules of SEC. Those Z category companies issued rightshare to the members and again sold those shares in the peak market.SEC did not give attention to Z category companies for preventing

increase of price of share and find out the reason, stopping them to issueright share to the members. No proper vigilance and enforcementfunction was visible.

It is found that the directors of some listed companies sold their shareamounting Tk 60 billion. Most of those companies are banks, insurancecompanies and some manufacturers. These Directors are awarded bonusshares through revaluation, and also there was no ground to selling outthe controlling share of own companies and banks. The auditors andissue managers, and valuation companies also manipulate theinformation and SEC approved the reports in opaque manner.

The country's common people and hundreds of thousands of unemployedyouths have entered into the overheated market as a record 1.57 millionBeneficiary Owners (BO) accounts, more than half of the total investors,entered into the market in 2010.

When Bangladesh economy looks like a good shape based oncapital/share market, that time Trading on the Dhaka Stock Exchangeindex was halted after it fell by 660 points, or 9.25%, in less than anhour. Chittagong Stock Market also met a similar fate. An abrupt crash ofthe market sparked violent protests from the Bangladeshi investors. Itwas the biggest one-day fall in its 55-year history. It is estimated thatover three million people - many of them small-scale individual investors


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- have lost money because of the plunging share prices. The benchmarkindex had climbed by 80% in 2010 but has lost more than 27% sinceearly December. The experts give their comment that the immediatereason for this crash was the policy of the regulators of the market who

laid down a limit for investment by the banks and other financialinstitutions in the stocks. This was done in order to avoid the marketbeing overvalued. As the banks and other big investor institutionswithdrew the capital from the market, the panic ensued. In this way, theindex got down to 5,203.08 in February 2011 from 8,602.44 of November2010. However, in table-1 we will see the DSI, DGEN & DSE 20 index fromJanuary 2010 to November 2011:

MonthIndex Mont

hIndex Month Index

DSI DSI DSI DGEN DSE 20Jan-10 4,422.8

15,367.1

13,030.1

9 Jan-116,198.8

2 7,484.234,701.7

4Feb-10 4,549.6

05,560.5

62,992.9

3Feb-11

4,317.89

5,203.083,514.5

1Mar-10 4,573.8

15,582.3

32,952.0

1Mar-11

5,275.13

6,352.103,968.3

8Apr-10 4,641.5

45,654.8

83,039.1

7Apr-11

5,032.95

6,050.853,826.2

2May-10 5,030.0

56,107.8

13,432.2

3May-11

4,798.37

5,758.263,795.8

6Jun-10 5,111.6

36,153.6

83,650.0

4Jun-11

5,093.19

6,117.234,069.1

0

Jul-10 5,278.89

6,342.76

3,721.78

Jul-11 5,380.10

6,459.62 4,264.63

Aug-10 5,555.49

6,657.97

3,874.50

Aug-11

5,195.68

6,212.004,190.4

7Sep-10 5,930.9

07,097.3

84,137.9

3Sep-11

4,944.96

5,910.204,080.0

5Oct-10 6,612.1

47,957.1

24,533.1

8Oct-11

4,205.07

5,036.503,749.9

6Nov-10 7,135.1

68,602.4

45,119.1

3Nov-11

4,403.37

5,268.553,894.6

8Dec-10 6,877.6

6

8,290.4

1

5,204.9

8

Table 1: Index from January 2010 to November 2011

Graphical presentation of the DGEN index from January 2010 toNovember 2011 is as follows:


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Fig 1: Index from January 2010 to November 2011

From the graph we can see that the index started falling after November2010 and continued upto February 2011. Later on though a bit uptrend isnoticed but the ultimate result is 5,268.55 DGEN index at the end ofNovember 2011.

Possible Reasons for Stock Market Crash

Bangladesh suffered a big bang crash in stock market last few monthswhich results in many investors loss and especially trust of the smallinvestors have drastically reduced from the market. One of the biggestreasons may be is that market got artificial rise just to encourage thesmall and medium investors and as soon as they stuck their money in themarket big fishes withdrew their money to a large extent hence causessudden decline.

Crash of Bangladesh market is a big blow to small investors, most of

which heavily rely on stock market. Although artificial rise of stock pricesis never a good omen for the economy but a sudden fall of market isequally damaging. The authorities in Bangladesh should have thought ofthe consequences of their decision to set the limits for the banks andother financial institutions to invest in the stocks. I do no doubt the goodintention of the authorities but the way it was done and implemented hadserious repercussions. They should have done it slowly and gradually. Atthis point of time it is not clear how much time and effort is required forBangladesh stock market to recover from this shock.

Having been a passive investor in a small way and watching things from

a far, we outlined the following reasons for the market gyration while itwas in motion, so it was good to see some of the recent policy responses


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address some of the points raised below. We believe the following playeda major role in contributing to the crash: Disproportion of Supply and Demand of Share: In the market in

comparison with the total investor i.e. the demand supply of New

Share was not adequate. So, there was always a higher demand forthe existing securities.

Aggressive Investment made by the Investors: Reportedly,aggressive investment made by the investors in the capital market isthe main reason behind the share market bubble and said asubsequent plunge in share prices has put pressure on the financialsector with a portion of bank credit being diverted to stock investmentfrom productive sectors.

Overenthusiastic Investors: Unrealistic expectation of investorswho for some reason or another seem to think the market would onlygo up (taking a longer term view -- in decades -- this is probably notcompletely off the mark when anyone takes into account Bangladesh'sgrowing economy, competitive positioning and progressive integrationwith the world market economy). Most of the investors thought it wasbecause it was going up and they heard from other people it was agood script. A good portion of the investments in Bangladesh stockexchange are trend-driven and unfortunately even rumour-driven.

Use of Omnibus Account: An omnibus account is a stock holdingaccount that involves more than 10,000 investors although actualshareholders, individual investors don't have the accounts in theirnames. Bulk amount of shares have been traded from hidden oromnibus accounts used as a major tool of stock market manipulation,according to the government probe body on the recent marketdebacle. Most big players chose omnibus accounts to gamble in themarket, as it's not possible to find out issue-wise or client-wisetransactions of actual number of shares from omnibus accounts.

Share Splitting used as a Tool to Inflate Prices: Split of sharesused as a tool to sweep up small investors' money had been a majorreason behind the massive price inflation on the stock market for therecent market debacle.Split of shares affected the circuit breaker onshare price movement, the probe body said. In order to control pricemovement, the circuit breaker threshold remains low, if the shareprice slab is high.Market capitalization of the companies, which splittheir shares between July 2009 and December 2010, soared by 655percent, and that of those which did not split shares went up by 46percent at the same time. This fragmentation of shares had an"unexpected impact" on share prices and liquidity in the market.Market capitalization of companies that did not split shares was three

times higher than the companies that split shares until July 2, 2009.But market capitalization of companies, which split shares, doubled


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compared to the ones that did not between July 2009 and December2010, the committee found.

Issuance of Right Shares in the wrong way: On issuance of rightshares, a company's earnings per share are diluted as the number of

shares gets increased. Although share prices are supposed to comedown after that, the opposite happens on Bangladesh's capitalmarket. Here the prices go up after issuance of right shares.

Stock Protectors turned Predators: Market regulator officials andtheir relatives made windfall profits from share market by usingpower, which played a major role behind the recent stock marketmanipulation, as per government probe.

Policy Failure from Securities and Exchange Commission(SEC): Policy failure from Securities and Exchange Commission (SEC)to make any meaningful policy change that could have stopped thebubble when the market was moving up 3% + every week for months.It's not sustainable or even natural for markets to rise consistently ona daily basis as it has for the last nine months or so and we have seenwhat happens when it does. While we agree that there was somewarning from the policy makers, they failed to take any concertedactions to impact the rise in any sustainable way. And when the SECdid take action, the regulators were flimsy in adhering to the policies,caving under pressure whenever there was protest as often happenedwhen there was a 2% correction. This whimsical behavior does not

exactly lend to its credibility as a market regulator. When an overduemarket correction was finally underway, the constant policy change ofSEC didn't help the fact; it added additional uncertainty to a marketthat was already volatile. If there is one thing markets hate more thannegative news, its downbeat uncertainties. Had the regulatorsstayed away and not made drastic policy changes every other hour,things would have been more manageable. Another policy mistakemade by the regulators was stopping trading practically every day fora week. This is the last resort a regulator takes, yet they were doing itpractically every day. Before taking such a hasty decision, one shouldask what kind of confidence this instills in the market. Adding fuel to

the fire, regulators supposedly put an index breaker in place yet it didnot kick in when it was required. Had regulators want to resort toclosing the market, they should have done things properly by closingthe market for a week or so and let the "Bengali emotions" settledown a bit while also using the time properly as a stop gap measure.This time could also have been used to shore up any other supportthey wanted to implement in concerted efforts with the financialinstitutions as was finally done.

Frequent Change in Equity to Loan Ratio: The Security andExchange Commission (SEC), the regulatory authority for supervising

the stock market, has taken some steps to control the marketinstability. To limit investor funds flowing into these already


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overheated/more than saturated shares and help the market to cooldown, the SEC has tightened the conditions of margin loans. Initially,the SEC set the limit of equity to loan ratio at 1:1.5, later which wasmodified to 1:1 when the market was already in a bullish mood.

Revision in Maximum Market Exposure of Banks: Anotherregulation was introduced on the maximum market exposure of banksat a time when the banks have already invested more than the limit.New embargo on share market exposure triggered the collapse assome banks, which had invested heavily in the market, tried to off-load their shares quickly. Most of the investors, very emotional innature, are small investors who invest without looking at thefundamentals of the market. Panic seized those investors when theindex started to fall which apparently led them to panic selling. That

eventually led to a nasty fall as predicted by many.

Revision in Statutory Reserve Requirement of Banks: Upwardfixation of Statutory Reserve Requirement resulted in liquidity crisis aswell as constrain in flow of money in the capital market resulted in fallof share price.

Manipulators Played on the "Psychological Weakness:Manipulators played on the "psychological weakness" of retailinvestors and encouraged them to buy lower denominated shares that

had a huge impact on the stock market.

Violating the Rules of SEC by High Officials: Many high officialshave involvement with stock business in spite of prohibition. Thisviolation has an impact on the overall market.

BO Accounts Maintain by High Officials of ICB: High officials ofICB also maintained BO account in own and joint names.

Involvement of Some Political Persons in the Share Scam:Some veteran political personnel were also involved in this sharedebacle.

Biases related to behavior of investors: One of the major biasesis the tendency of the investors to hold on to a "losing share" too longand sell "winning share" too soon. Apparently investors fear lossesmuch more compared with the possibilities of value gains. When theinvestors find that the value of a share is decreasing, prudent portfoliomanagement strategy demands the sale of the share if the marketprice covers the cost of purchase, the cost of financing and the cost of

transaction and to reinvest the proceeds in undervalued shares. It iseven necessary sometime to sale the share at loss and try to recover


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the loss by investing in another share. But sometime investors hold onto "losing share" with the hope that its price will rise soon.

Another type of bias is termed as confirmation bias, whereby investors

look for information to validate their prior opinions and decisions.Sometime, after making an investment decision, investors look forinformation to justify their prior decisions and rumour plays animportant role at that point. If there is a shift of sentiment regardingthe particular share, some investors move together which increasesthe prices and the volatility of that particular share during tradinghours.

Escalation bias is commonly known as "averaging down" and is arelatively popular investor practice. If investment in a particular share

has declined in value since the initial purchase, investors rather thanadmitting it as a mistake and selling if, put more money to purchasethe same shares with an expectation that the price of that shares willrise soon. But careful analysis is very essential to undertake thisdecision.

Investment behaviour depends not only on the fundamental valuesregarding the investment but also on the sentiment. People investwith an expectation of future income from the investments.Expectation can be explained partially by the standard theory offinance and by fundamental and technical analyses. But behaviour of

the investors is very important to understand expectation becauseeven though risk aversion is the common phenomenon of theinvestors but some investors like to speculate with high risk and earna very high return and these have a spill-over effect among thegeneral investors. General investors jump on the bandwagon withoutunderstanding the nature of risk and return.

Violation of Insider Trading Prohibition: Generally, a personviolates the insider trading prohibition when that person violates aduty owed either to the person on the other side of the transaction orto a third party (such as a customer or employer) by trading on ordisclosing the information. The insider trading prohibition applies to anissuer's directors, officers and employees, investment bankers,underwriters, accountants, lawyers and consultants, as well as otherpersons who have entered into special relationships of confidencewith an issuer of securities.

Examples of insider trading cases:

Corporate officers, directors, and employees who traded thecorporation's securities after learning of significant, confidentialcorporate developments;

Friends, business associates, family members of such officers,directors, and employees, who traded the securities after receivingsuch information;


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Employees of law, banking, brokerage firms who were given suchinformation to provide services to the corporation whose securitiesthey traded;

Government employees who learned of such information becauseof their employment by the government; and

Other persons who misappropriated, and took advantage of,confidential information from their employers.

Because insider trading undermines investor confidence in thefairness and integrity of the securities markets, the stock marketregulators all over the world has treated the detection andprosecution of insider trading violations as one of its enforcementpriorities.

Greed, Fear & Noise: Stock market trading is an activity that iscontrolled by human emotions. It is inescapable that there is always afear of losing and the greed to win. The behaviour of "Noise trading" isalso coupled with these emotions. Even if one studies thefundamentals of a listed company, he still consciously orsubconsciously depends on "noise trading".

Greed and fear are the two basic human emotions at work in the stockmarket. These two emotions are the motivating force behind almostall market participants. In the case of trading, when a declining trendcomes, the regret and frustration can carry over into the next trade.

This particular problem is fuelled by the expectation that every tradeone enters into should be money-spinning. But the fact is, not everytrade will be profitable!

Greed creates the reverse problem. With a couple of consecutiveprofitable trades, the ego can be enlarged and one can feel himself tobe unbeatable. This would eventually lead one to such kind of tradesthat he normally would not have entered into.

When stocks make strong moves to the upside, greed from all the

cumulative market participants joins the move that leads to upwardmovement of the index. But the tragic thing is that the stocks pricesusually fall faster then they go up, and when this happens, fear gripsall the participants.

Despite reaching the "sell" price, many hold on because greed is bytheir side, hoping for a further increase. Next day a heavy sellingmight start but still greed suggests one to hang in there and the pricewould come back. The price keeps going down rapidly andsubsequently, fear starts to grow. But by that time, it is too late andone's nice profit has turned into a loss.


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One might be saying that greed and fear will never get in the way ofhis trading, but greed and fear always will be in trading. It is notsomething to be ashamed of. It is something one has to admit to, ifone is to become a successful stock trader or investor.

"Noise trading" is one of the market forces that cause equity prices todeviate from their true values. The term 'noise' describes the constantchanges in market prices and volumes that cause investors to getconfused about the market's direction. Most "noise traders" believethey are making sound investment decisions when they follow marketnoise.

Nobody knows exactly what would be the maximum and minimumprice of a particular share. People think that the capital market is just

a money spinner and once one has invested, he would get ahandsome profit within a short time. They should keep in mind thattraditional banking gives 9-12 per cent interest per annum and thusdream of realizing a profit more than 20-30 per cent or even morewithin a few days or a month is never wise because there is always achance of a reverse swing.

It is extremely vital to focus on not losing instead of focusing on thepotential profit because if one loses, especially the small investor, hemight not be able to trade further. Thus, discipline is what will makeone take a profit at the right time, get out with a small loss at the

right time, wait for the right entry point or perhaps not trade at all.The other factor is self-control over greed, fear and noise. Absence ofthis control has led to sharp rise and drastic fall in our capital market,besides factors like manipulation (which is focused by many).

Remedies to Avoid Stock Market Crash in Future

Partnership Building with Other Developed Exchanges: Our firstlong-term recommendation for the SEC/our exchanges is to build apartnership with other developed exchanges in the region to become

competent; much like the Bombay exchange has with SingaporeExchange. This will facilitate knowledge-sharing that can potentiallybe adapted to our exchange over time, whether it's surveillanceprogramme or technology adaptation. Singapore Exchange is apremier bourse in the region that not only enjoys confidence of globalinvestors and institutions all over but is also one of the mostprofitable.

Review SECs Policy on Dividend and Right Share: Our secondrecommendation for the SEC to review its policy on share dividendsand rights share is to ensure that it does not add to instability of the

market. We are pleading ignorance here as I could not find anydocuments to understand on what basis dividends bonus share andrights share are approved by SEC but my feeling is that it is a very


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arbitrary and non-transparent process. The arbitrary nature of thisprocess not only opens it up for abuse and outside influence but alsoindirectly fuels some of the high P/E ratio we are witnessing in some ofthe sectors and companies right now.

The other important recommendations are as below:

Demutualization of DSE & CSE: The demutualization of theexchanges begins after the crash. Demutualization will meanconverting these organizations into for-profit share-holding joint stockcompanies. Demutualization offers potential opportunities forstrengthening governance, offering alternative business models,raising capital and improving operational efficiency. Most of the majorexchanges in our neighboring countries have already gone through

the process of demutualization.

However, our exchanges do not seem to be ready for it yet partlybecause of unfounded concern of the existing members. It may bementioned that a membership can be transferred in exchange of afabulous amount of money and, therefore, cause of concern however,unfounded, is understandable.

While demutualization is likely to take some time, currently themember-based exchanges are managed by boards of elected andnon-elected mix of directors. Being member-based, the exchanges

lack proper corporate management and the chief executive officers(CEOs) may often be influenced by leading members. This can be amajor cause of concern of the investors and other stake holders.

Corporate Governance Practice in the Exchanges: Corporategovernance practice in the exchanges is extremely important becausethey are the front-line regulators and need to function independentlywithout being influenced by the members to ensure transparency andbuild confidence among stake holders. The exchanges have enormousresponsibilities that include listing of companies as per listingregulation, providing screen-based automated trading of listedsecurities, settlement of trading under settlement and transactionregulation, administration and control of market, monitoring activitiesof listed companies and the very important function of marketsurveillance.

High Degree of Expertise & Professionalism with AdequateInfra-structure: For efficient execution of responsibilities, exchangesneed high degree of expertise and professionalism and adequateinfra-structure. These are not there in any of the exchanges. Onebasic problem is lack of professional manpower for management ofcapital market. The market expanded quickly in the last few years.New asset management companies, mutual funds, merchant banks,broker houses and other market intermediaries sprang up to seize the


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opportunities of a rapidly emerging market. All of them need capitalmarket professionals and there are not many. As a result, theexchanges like many other capital market-related organizations areshort of trained manpower.

The SEC is addressing the problem by establishing a securitiestraining institute. Meanwhile the problem is likely to continue orperhaps aggravate and the exchanges will have to struggle with theproblem. Other infrastructural facilities also need to be improved tostrengthen market monitoring, surveillance and control. Settlementprocedure in the exchanges is outdated. Establishment of theproposed company for automated settlement calls for urgentattention.

Overall Supervision: The Vital Roles of SEC: The exchanges workunder overall supervision and guidance of Securities and ExchangeCommission (SEC). The commission, established by an act of theparliament in 1993, consists of a chairman and four members. Thecommission chairman and members are appointed by the governmentfor a three-year term. Once appointed they cannot be removed by thegovernment except under certain special circumstances likeconviction in a criminal case or losing mental balance. The basicpurpose of the commission is to provide regulation of the capitalmarket in order to protect interest of the investors, develop securitiesmarket and frame necessary regulations and rules for the purpose.

The function of the commission includes taking necessary steps to:

(a) Ensure proper issue of securities,(b) Regulate stock exchanges or any securities market business,(c) Regulate activities of market intermediaries like stock brokers,bankers to the issue, merchant banks, issue managers, under writers,portfolio managers, investment advisors, asset managementcompanies, custodians, credit rating companies or any otherintermediary likely to be involved in securities market,(d) Regulate mutual funds,

(e) Prevent manipulation and frauds,(f) Stop related parties transaction,(g)Ensure submission of properly audited annual reports and periodicdisclosures in a transparent manner by the listed companies,(h) Ensure compliance of securities laws,(i) Undertake market surveillance,(j) Conduct proper inquiry into allegations of fraud and irregularities,(k) Promote investor education and securities training to all involved,(l) Undertake research and publication, and(m) Frame rules and regulations for proper regulation of the market.

SEC conducts its business independently and does not needgovernment approval even while framing new rules and regulations.


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However, government is competent to issue directives to thecommission, subject to prior consultation with the commission. Animportant function of the commission is to frame rules underSecurities and Exchange Commission Act, 1993 and Securities and

Exchange Ordinance, 1969 for carrying out the purposes of the actand ordinance. Regulations made by the stock exchanges need toconform to the provisions of these laws and rules. Such regulationscan be made by the exchanges only with prior approval of thecommission.

Perhaps, the most important function of the commission is to improvequality of financial disclosure and transparency of the listedcompanies. This is also the most challenging area. Ultimately, aninvestor takes investment decision on the basis of financial

statements of the companies and, therefore, ensuring credibility ofthese statements is extremely important. Submission of annualfinancial statement by the issuer companies to the commission andexchanges is binding. These audited statements are required toinclude a balance sheet, profit and loss account, cash flows statementand notes to the account. It is mandatory to prepare this statement inaccordance with the requirements of the international accountingstandards as adopted by the Institute of Chartered Accountants ofBangladesh (ICAB).

Examination of these audited financial statements is a vital

responsibility of the SEC. This needs adequate manpower andexpertise and the commission lacks both. However, the commissionhas been trying to carry out this responsibility as far as possible withits limited resources. If in the opinion of the commission, the auditedfinancial statements do not reflect the true state of affairs of the listedcompany, it can refer the matter to the ICAB with a request to takeappropriate disciplinary action against the concerned charteredaccountants within a period of sixty days. If ICAB does not take anyaction or, in the opinion of the commission, the action taken by theInstitute is not satisfactory, it can give an opportunity to theconcerned firm or chartered accountants an opportunity to explain theposition. If such explanation is not satisfactory to the commission, itcan declare the concerned firm of chartered accountants or theauditor ineligible for acting as an auditor of any listed company for amaximum period of five years.

For ensuring quality and credibility of financial disclosure, thecommission should have played an important role in this area.Unfortunately, that has not been the case. Examination of auditedstatements needs high degree of professional standard. Thecommission can not afford to employ that level of professionals with

its poor pay structure. As a result, this job is done without noticeableconsequence. Improving quality of audit, ensuring proper audit fees,promoting ethical standard in this area are important responsibilities


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that call for urgent attention of the ICAB and government. ICAB is aself-regulatory body but its regulation has not been adequate due tovarious reasons. Perhaps, the Institute should come forward with ideasto improve its regulatory function. This is important for the capital

market and for the financial sector as a whole.

SEC also has to do various other works requiring high degree ofexpertise. Examination of Initial Public Offerings (IPOs) and premiumproposals control over prospectus and documents, understandingcomplex securities laws, market surveillance, detecting fraud andmany similar works need a team of efficient and confident work forcethat simply is not there.

The DSE market capitalization in September, 2007 was only $ 9.0

billion. Current market capitalization is about $ 50 billion. Number ofBO account holders is up from less than one million to more thanthree million. Number of market intermediaries has increased insimilar proportion. But SEC is working with almost similar manpower.Thorough restructuring of manpower, up-gradation of their requiredprofessional standard and improving compensation package arenecessary for efficient market regulation by the commission.

In the general public perception, the main responsibility of the SEC isto regulate price index of the market. Whenever the market is over- orunder-priced, SEC is held responsible for that. Regulating market price

of the stock is not a responsibility of any regulator anywhere. Ideally,market price of shares should be left to market forces. This has notbeen the case in Bangladesh.

Market Intervention by SEC: Most of the small investors inBangladesh are inexperienced with very little idea about the stockexchange. Many of them are not capable of understanding financialstrength of companies. They are guided by advice of others who arepossibly equally ignorant. So, investments are, often, rumour-driven. Arumour-based small market is more vulnerable to manipulation.Bangladesh stock market is no exception. So market intervention bySEC becomes necessary at times to protect the interest of theinexperienced investors. In doing so, a situation has been created inwhich SEC is expected to regulate stock price. Of late, in the contextof a highly over-priced market, the commission is possibly moreconcerned with the bubble in the market than its normalresponsibilities. This is indeed a paradoxical situation for thecommission. Regulating a small and inexperienced market is aformidable task.

Assistance from International Association of SecuritiesCommissions: A brief reference to the international regulator ispossibly necessary to complete this piece of writing. Bangladesh is amember of the International Association of Securities Commissions


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(IOSCO). This organization was established in 1983 with a permanentsecretariat in Madrid to regulate world's securities and future markets.IOSCO has membership of more than one hundred countries andregulate more than 90% of world' securities markets. Role of this

organization is to assist its members to promote high standard ofregulation in order to maintain just, efficient and sound market and toact as a forum of national regulators.

IOSCO has a set of objectives and principles and recommends all itsmembers to adopt these regulatory principles. It also has a committeefor emerging markets and Bangladesh is a member of this committee.However, it only recommends the principles and does not have themandate to enforce them on member countries. Bangladeshmaintains a low profile in the activities of this organization and needs

to be more actively involved in IOSCO like our neighboring countries.Closer association with IOSCO can equip SEC with the knowledge ofthe latest securities laws and practices in developed and emergingmarkets and help improve professional expertise of the commission.

Changes in Book Building Method: The Securities and ExchangeCommission (SEC) has sent to the finance ministry for approval aguideline that, among others, contains the maximum allowable price-earning (P/E) ratio at 15 for a company willing to go public under thebook building method, sources said.

The securities regulator has also proposed the formation of a five-member committee to review the balance sheets of the companiesthat are interested to go public under book building method. A topofficial of the SEC said the review committee will work until thegovernment forms the Financial Reporting Council of Bangladesh. Inthe revised guideline, the regulator has also proposed a two-monthlock-in on the shares of institutional investors who will quote to fix thecompanies' indicative prices during road shows.

The Role of Bangladesh Bank: The role of Bangladesh Bank shouldhave been more strong and timely in dealing with the commercialbanks involvement in the market. The experts observed that untilnow all blames fell on only SEC as a regulator. Khondaker IbrahimKhaled, probe committee chief, said he highlighted the regulatorylapses by the central bank officials in some decision making process in2009 and 2010, which resulted in market bubbles.

Ibrahim Khaled, however, said that he tried his best to find out theresponsibilities of regulators and share traders, explicitly in a veryshort period of time. No doubt, SEC has played the most devastatingrole. However, he said other agencies and institutions having stakes

in the share market possibly failed to perform the need of oversightfunctions. For example, BB should have come down more strongly


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and much earlier to arrest the over exposure of the commercial banksto the market, he added.

Because of the overexposure of some commercial banks, the share

market experienced bullish trend in most part of the last year. The BBshould also have more effectively track down the money commercialbanks had invested in the share market.

Regulators then took measures to limit the proportion of deposits thatbanks can invest in the stock market, amid concerns over sharesbeing over-valued and financial institutions getting over-exposed tothe volatility in the capital market.

Reform of SEC : The government should reform the securitiesregulator, identifying its "complete failure" to remove irregularities asone of the prime factors leading to the largest ever fall of the prices ofthe listed issues in the capital market. It also suggested that thegovernment should disallow forthwith any "distribution of placementshares" as many key persons have "become corrupt" through bothallotment and transfer of such shares.

We think the government should appoint the persons of integrity atthe office of the Securities and Exchange Commission (SEC), thecapital market watchdog, so that they cannot be influenced by thevested quarters. The system of distribution of private placement

shares has polluted the society.

We have seen that the private placement has become a very alarmingissue in the country as a large number of people were used in theprocess of allotment of placement shares for the interest of the vestedquarters.

It is alleged that many important persons, including the key officials ofgovernment, securities' regulator, Investment Corporation ofBangladesh (ICB) and both the bourses were favored with placementshares to serve the interests of such vested quarters. In one example,we have found that the placement shares of Tk 190 million weretransferred to two individual addresses. Even some journalists whocover stock market were involved in the business of placementshares.

According to the probe body's chief, the committee in itsrecommendation largely blamed the securities regulator for recentstock market scam as it completely failed to ensure 'due-diligence'about issues in the primary market.

The irresponsibility and dilly-dally on the part of the SEC paved theway for corruption and irregularities that occurred in the stock market.


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SEC Official should not involve in the Secondary Market: Afterinvestigation we like to suggest the government to stop involvementof any SEC official in share transaction in the secondary market.

Casino or Investment: Awareness of Investors :The stock markethad become a casino and that is apparently true. So, people camehere, gamble and tried to make hard cash. And many have been ableto make it. At least we know few of them have made it. Alright, butwhat is a casino? A casino is a public place for gambling and otherentertainments.

Firstly we have to make the investor realize that stock market is notCasino. Its a place where people should invest for long term to getcapital gain and dividend gain. Financial illiteracy is one of the major

problems in our stock market.

They have mostly invested in an overpriced market with theexpectation of gaining abnormal returns, but have in fact ruined theirluck. Interestingly, a majority of the small investors who burnt theirfingers already did not even know that they were gambling with.

A substantially large number of small investors are innocent in thesense that they are not properly educated and trained on principles ofinvestment and the mechanism of stock market. It is quite usual thatmarket will have investors from a variety of professions including,

businessmen, students, service holders, and therefore many of themwill have no knowledge at all on finance, financial market or marketmechanism. Because, everyone does not study finance or economicsor may not have enough time to study first and then go to the market.Despite this fact, authorities kept the stock market wide open to alland sundry, failed to create adequate awareness among investors onthe darker side of the market, and did not take enough care for thesafety of the investors.

Therefore, small investors have always been overlooked. The mostlydisregarded is their psychology which is the key determinant of theirconfidence. Mob psychology constitutes mob confidence. Wheneverstocks keep falling for any reason, investors start losing theirconfidence, rush to panic sale, and finally cause further plunge in theprices. This is true not only for Bangladesh, but also for the US and therest of the world. It's quite normal. Investors' psychology andconfidence are the basic foundations of a market mechanism.

Investors' confidence has two major characteristics: Once it is ragged,it causes massive damage to the market structure for a long term,and it takes a substantial amount of time and other resources to get

confidence back to the earlier level. Hence the cost of downwardconfidence is very high in two ways: one is the cost of the consequent


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impact on the market due to loss of confidence and the other is thecost of recovery to a desired level from such condition.

Improve Investors' Confidence: Harsh and adverse comments ofmany well-known political figures have hit the psychology of theinvestors negatively, generated anger, and reduced even further theconfidence level on the government. Therefore, adverse and harshcomments by different parties, differing and conflicting views,comments, and decisions by Bangladesh Bank, the ministry of financeand the SEC have created massive degree of no confidence amongthe investors. The market plunged further down. Nothing could stop itand at one stage it seemed non-stoppable. But at the same timeprotests along with violence have been going on. The situation is notnormal; thousands of investors have become indecisive, as they find

no more confidence on the regulators and the government.

The primary objective of all government initiatives must be to improveinvestors' confidence by honoring and respecting their psychology. Aneffective measure may be to communicate with the investors throughmass media more widely with a common message by the top officesof the market. They should sit in a serious multilateral dialogue. Thedialogue may include the Bangladesh Bank, SEC, ministry of finance,Merchant Bank Association (BMBA), top financial experts, analysts andacademics along with investors' representatives to find out a commonstrategy for the future development of the stock market. The dialogue

may be arranged by the SEC or the ministry of finance that would sortout both short- and long-term approaches for restoring investors'confidence and market structure.

Common people and investors want to hear things about the marketthat will make them feel better and confident. They are now frustratedand are lacking proper direction. The strategy paper should set clearcut suggestions and strategies for the investors that will get themback on track. Later, we believe, a joint press conference by the headsof the top offices can pronounce the outcome of the dialogue. We aresure such a well planned and well organized dialogue at a fixed datecan come up with a common strategy paper and effectively restorethe confidence of the investors. This would create a strong positiveimpression on the investors' psychology regarding the willingness,intention, and degree of coordination of all the offices mentionedabove which, in turn, would lift up the confidence level on the futureprogress of the market.

Activate the Institutional Participants : As one of the manymeasures, the regulators must take immediate steps to fully activatethe institutional participants who are the vital players in the market.

We are not yet clear why the intuitional investors are almost inactive.One answer was the liquidity crisis but recently that has also beenremoved as can be perceived speaking to the banking professionals.


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We have no idea about the real reasons although we feel that thereshould be an urgent full-fledged reactivation of the institutionalparticipants.

However, the gambling issue is there still now. The government istrying hard to find out the culprits. Every day there are such promisesand every night they go into oblivion. The government is trying, reallyworking hard to find them. True, but they are still unable to find outthose big gamblers who have destroyed the market and ruined thefate of millions of small investors.

Dividends Collection is much safer Investment in volatilemarket: After a runaway rally in the last calendar year, stock marketin Bangladesh has finally witnessed a pause over the past few months

with some volatility. After sustaining an upward momentum, the stockmarkets have refused to move upwards in a straight line, and areshowing signs of choppiness over the past several weeks. While one ofthe reason why the benchmark indices have taken some profit takingover the past few weeks includes the spiraling crude oil prices and ashift in focus of investors towards precious commodities, there aresome investors, still betting on stocks, which could offer healthyreturns even in times, when market takes time to consolidate nearcurrent levels before a decisive breakout.

So what could be the ideal preposition for such investors, to make the

best out of market, even when volatility has dampened the spirits ofinvestors looking for a healthy return in last few weeks? One of theideal foils, under such volatile circumstances, could be to look for safedividend yield options, which keep offering steady returns over aperiod of time. While choosing the dividend yield options, an investorneeds to outline a few factors, which could be:

For one, to select such dividend yield options, by checking out theconsistency of the past few years, of the dividend paid bycompanies chosen. For that matter, only the companies offeringuninterrupted dividend every year, usually qualify as the idealdividend yield plays.

Apart from same, even amongst the stocks which qualify amongstthe dividend yield stories, there are outright winners, in which suchcompanies may have even been aggressive enough to raise thedividend paid several times over the past few years, toauthoritatively qualify as outright winners.

In case of such dividend yield stories, the ideal bet should beplaced on stocks, which have a strong statement in the making,with the product they offer, so as subsequently qualify as growthstories, apart from being dividend yield options.

Investors should remember that in order to get a right mix of

portfolio between growth in the portfolio and the dividend yieldoptions, only a part of the portfolio should be allocated to the


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dividend options, rather than entirely betting on them. Any suchmove could hamper the chances of getting a healthy return out ofaggressive portfolio.

Also, investors opting for dividend yield should not frequently get

into the habit of shuffling their selection of dividend yield optionsand remain put with the same as a strategic part of portfolio asdefensive stocks.

Such types of companies should do well during inflationaryeconomic conditions, as they would be able to pass cost increasesover the consumers, who demand that specific product type. Therising dividend would also provide investors with an inflationadjusted stream of income, which would maintain and grow itspurchasing power over time.

Investors should be selective enough to not to overpay for them.

The lost decade for stocks was caused exactly because investorsbid up stock prices to high levels.

Following Some Advice Regarding Investment in the StockMarket

All Investor should to be more careful and consider couple of thinkwhen he/she invest money in market

Never sell valuable property only to invest in share market

If anyone is not well educated about share market than only investin primary share of reputed companies and don't take risk anyway.

Try to attend in seminars which are conducted by stock exchangesto teach investors about the current condition and investmentpolicy of share market.

Discuss with educated and experienced people to learn aboutshare market and Read newspapers, books, etc to learn aboutshare market

Invest in Secondary market very meticulously when he or she hasconfident that know well about the secondary market.

Never and Never invest only hear the fake information about thecondition of various companies. Many evil people make rumor to

plunder the hard earned money of small investors. And alwayskeep it mind that invest in share market is like invest in other riskybusiness. Nobody can earn money here only by luck

Conclusion

The bullish mood of the market attracted an increasing number of smallinvestors to the market, with the number of new Beneficiary Owners'(BO) accounts surging to high levels. All these opened up the potentialfor the stock market to become a real alternative to mobilize funds for

investment, moving away from the traditional dependence on thebanking system. However, while welcoming these developments, the


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recent dilemma may discourage the small investors. The past experiencesuggests that the 1996 shock lasted almost 8 years.

It is expected that the implementations of the above suggestions would

help strengthen our share market and beware of manipulators. In thecountrys financial sector through ameliorating concerns regardingmarket failure and redressing problems arising from missing markets andinstitutions. Last but not least, serious act with prudence to strengthenour share market and beware of manipulators. And the government ofBangladesh may be under pressure to intervene in order to protect thehard earned money of the small investors from being lost due to thisunusual crash of the stock market. So, this is the right time to worktogether (Government as well as other financial institutes) to decide whatactions to take to save the market from further falls.

Stock Market is by and large well established all over the world. Itsexpansion plays important roles in output growth, capital formation formega projects like Bridges/Expressways/ Subways. The Banking sector,which leads the financial sector in Bangladesh, has served the economyvery well, and its exposure is broadly comparable with other developingcountries. However, the share-market has considerably lagged behind inBangladesh. The current increase in investors' attention in theBangladesh capital market is a welcome development which has to benurtured cautiously otherwise every now and then this sort ofcatastrophe will be observed. Regulatory agency should not fix the rules

depending on the index point rather they should compel those initially.Once law is formulated and applied, the authority should let the systemrun on its own way because any intervention on a smoothly runningsystem just creates panic among the small investors. This is the righttime to learn from the past and make a complete overhaul of the market.

Documents

FMI Term Paper Final