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FINANCIAL CHRONICLE™ » FINANCIAL CHRONICLE™ »  Who decides the reference price?

Who decides the reference price?

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1 Who decides the reference price? Empty Who decides the reference price? Wed Jul 13, 2011 9:06 am

milanka

milanka
Vice President - Equity Analytics
Vice President - Equity Analytics
Investors in the stock market generally look at the All Share Price Index to decide the strength of the market. If the Index is positive and its value has increased the investor will conclude that the market is strong. This will lead investors and traders to enter the market either as buyers or sellers. The All Share Price Index was severely distorted on the 7th by LOLC Finance understating the reference price. The stock was listed on the Diri Savi Board which is the second Board of the Colombo Stock Exchange.

The All Share Price Index is a market capitalization weighted Price Index. The Market Capitalization is multiplied by the Price Relative which is the price for the day divided by the price during the base year. Generally the base year is 1985.But when there is a new listing such a base year price is not available to determine the base price? The Stock Exchange takes into account the Reference price. But what if the opening price is not the reference price? Using a low Reference price will exaggerate the price changes for the day. This I suspect is what happens when the new companies are listed through an ‘Introduction’. If so the Index will not reflect the true state of the market.

Although the reference price was given by the Company as Rs 5.00, the trading did not show any bid or asking price at Rs 5.00.Why? According to the Asian Tribune the company had sold its shares after a 2 for one split at Rs 5.00 after first making a Rights Issue at Rs 10. It says the share now costs the LOLC only 0.70 cents. Were all this disclosed to the investors in the introductory document? The Document said “There are no shares being sold privately or in conjunction with this Introduction” after the issue of 100 million in October 2010, to Lanka ORIX Leasing Company PLC, by way of a Rights Issue. There is no reference to a share split after that.

Why did the company give such a low reference price? On what basis were the reference price determined and what its relationship to the valuation is either on earnings basis (0.63) or net asset value? The share has traded even at Rs 22 which is several times the reference price. But the price has dropped now to Rs 12 or so, causing enormous capital losses to retail investors. Who decides the reference price? Is it based on an independent valuation as is required for listings via an Initial Public Issue? Should there not be an inquiry by the authorities regarding the adequacy of the disclosure and the reference price?

I think it is better to exclude the shares of the Diri Savi Board from the computation of the All Share Price Index. Perhaps a separate Diri Savi Board Index should be prepared and published.

The market must be made more attractive to long term investors by making the market more transparent. As for speculators they must know that they run big risks in a bear market when they speculate. Speculation itself is not necessarily a vice, but its participants must be absolutely willing to accept the fact that they are risking their principal.

The writer is an economist and is the General Manager of a Colombo based stock brokering firm. You can reach him via raja.senanayake712@gmail.com

http://www.news360.lk/markets/stock-market/colombo-stock-exchange-needs-to-be-more-transparent-to-help-long-term-investors

http://forum.srilankaequity.com/u188

2 Who decides the reference price? Empty Re: Who decides the reference price? Wed Jul 13, 2011 6:47 pm

Liber Abaci


Senior Equity Analytic
Senior Equity Analytic
.Thank you for a thought provoking post .

I thought for some time, did some calculations, but still I can't understand the following statement .

The All Share Price Index was severely distorted on the 7th by LOLC Finance understating the reference price. .


Let's do the computation.
On this particular day ,ie 7 th July

ASI - 6918.14
Market Capitalisation - RS 2404.72 bn
LOFC Closing - Rs 12.60
LOFC shares in issue - 2,800,000,000

ASI is computed based on following formula,

ASI = Market capitalisation of all listed companies * 100
market capitalisation at the base year.

As you have indicated base year is taken as average market capitalisation of 1985.

Now, coming back to 7th July ASI computation, on account of LOFC , Numerator of the above formula has been increased by ( 12.60 * 2,800,000,000) - 35.28 bn

Since LOFC did not exist in 1985, I am not very sure

1 ) how denominator of the formula is computed .
2 ) how the reference price ( Rs 5/- ) get accounted in the computation
3) how much is the distortion due to reference price set @ Rs 5.00

If you ( or some one else ) can explain the above 3 questions , I would be much grateful.

I think this will be interesting to every body., since we get exact idea how the new IPO's / Introductions will affect ASI.







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