RISK AND RETURN ANALYSIS OF LEADING

COMMERCIAL BANKS IN NEPAL

(A CASE STUDY OF NIBL, NABIL, HBL)

By:
NAGENDRA PRASAD CHHIMAL
Shankar Dev Campus
TU Reg. No. 7-1-003-1129-96
Campus Roll No. 1757/060

A thesis Submitted to:

Office of the Dean
Faculty of Management
Tribhuvan University

In Partial Fulfillment of the Requirement for the Degree of Master of Business

Studies (M.B.S.)

Kathmandu, Nepal
September, 2009
 VIVA – VOCE SHEET

We have conducted the viva-voce examination of the thesis presented by

NAGENDRA PRASAD CHHIMAL

Entitled
RISK AND RETURN ANALYSIS OF LEADING COMMERCIAL BANKS IN NEPAL
(A CASE STUDY OF NIBL, NABIL, HBL)

and found the thesis to be original work of the student written according to the
prescribed format. We recommend the thesis to be accepted as partial fulfillment
of the requirement for

Master in Business Studies (M.B.S.)

VIVA – VOCE COMMITTEE

Head of Research Department: _________________________________

Thesis Supervisor: _________________________________

Thesis Supervisor: _________________________________

Member (External Expert): _________________________________

Date: …………............
 RECOMMENDATION

This is to certify that the thesis

Submitted by

NAGENDRA PRASAD CHHIMAL

Entitled

A Study on
Risk and Return Analysis of Leading Commercial Banks in Nepal
(A case study of Nepal Investment Bank, Nabil Bank and Himalayan Bank)

has been prepared as approved by this department in the prescribed format of

the Faculty of Management. This thesis is forwarded for examination

______________________ _________________________
(Mr. Dhruba Subedi) (Dr. Kamal DeepDhakal)
(Thesis Supervisor) (Campus Chief)

_______________________ _________________________
(Mr. Shashikanta mainali) Professor
Thesis Supervisor (Mr. Bisheswor Man shrestha)
Head of Research Department
 ABBREVIATION

M.B.S. Master of Business Studies

B.S. Bikram Sambat
J.V.B. Joint Venture Bank
SML Security Market line
NABIL Nabil Bank Limited
CAPM Capital Assets Pricing Model
ATM Automatic Tailoring Machine
S.D. Standard Deviation
SEBO/N Security Exchange Board of Nepal
C.S. Common Stock
NRB Nepal Rastra Bank
ANOVA Analysis of Variance
NEPSE Nepal Stock Exchange
FY Fiscal Year
NIBL Nepal Investment Bank Limited
CP Closing Price
BVPS Book Value per Share
HBL Himalayan Bank Limited
Ltd Limited
T.U. Tribhuvan University
 ACKNOWLEDGEMENT

The title of thesis “Risk and return analysis of leading commercial Banks in Nepal” is
prepared for the Master‟s degree practical requirement of MBS course under Tribhuvan
University of Nepal. The aim of the study is to analyze the comparative risk and return
position of the sample Banks of Nepal.

I would like to express my great pleasure to my heartiest and sincere thanks to my honorable
thesis supervisor to Associate professor Shashi Kant Mainali and lecturer Dhurba Subedi,
who have guided me throughout this research. I also give the heartiest thanks to Lecturer
Shreebhadra Neupane for his kindly help to prepare the thesis. I am also indebted them for
the best direction, useful suggestions and incentive challengeable comments of the thesis
preparation. I couldn‟t complete this thesis without their valuable guidance.

I am also indebted for sincere and timely co-operation provided respected staff of Shanker
Dev Campus. I would also like to thank my Friend Mr. Kiran Awal for his kindly co-
operation towards this thesis.

I would like to express my heartfelt gratitude to my respective parents, family members for
spending their valuable effort for giving the time to complete my higher education up to
Master level. Despite of them I also give thanks to them who gave me the regular inspiration
and continuous contribution.

However, I am alone responsible for errors, deficiencies and apologize for any of them
committed that is remained in this work.

Lastly, I would like to express my thanks to Mr. Raju Sharma and Mr. Suresh Nepali for their
collaboration of computer typing and setting.

September, 2009 Nagendra Prasad Chhimal

 Declarations

I hereby declare that the work reported in this thesis entitled „ A case studu of risk and return
analysis of common stocks on commercial banks of Nepal‟ submitted to shanker Dev
Campus, faculty of management , Tribhuvan University is my original work done in the form
of partial fulfillment of the requirement for the Master of Business studies (M.B.S.) under
the guidance and supervision of Mr. Dhruba Subedi and Mr. Shashikanta Mainali, Shanker
dev Campus, Putalisadak, Kathmandu.

September, 2009
Nagendra Prasad Chhimal
(Researcher)
Roll No: 1757/060
T.U. Registration Number: 7-1-003-1129-96
Shanker Dev Campus
 TABLE OF CONTENTS
Recommendation
Viva-Voce Sheet
Declaration
Acknowledgement
Table of Contents
List of Tables
List of Figures
Abbreviations

CHAPTER I INTRODUTION Page No:

1 Introduction ................................................................................................................1
1.1 Purpose of the study ................................................................................................2
1.2 Focus of the study .................................................................................................. 4
1.3 Statement of the Problem ....................................................................................... 5
1.4 Objectives of the study .......................................................................................... 7
1.5 Significance of the study ....................................................................................... 7
1.6 Limitations of the study ..........................................................................................8
1.7 Organization of the Study .......................................................................................8
1.8 Research Methodology ...........................................................................................9
1.8.1 Research Design .......................................................................................9
1.8.2 Population and Sample ...........................................................................10
1.8.3 Sources of Data .......................................................................................10
1.8.4 Data Collection Techniques ....................................................................10
1.8.5 Data Analysis Tools ................................................................................11

CAHPTER II REVIEW OF LITERATURE

2.1 Conceptual Framework ..........................................................................................12
2.1.1 Primary Market ......................................................................................14
2.1.2 Secondary Market .................................................................................. 14
2.1.3 Money Market .........................................................................................14
2.1.4 Capital Market ........................................................................................14
2.1.5 Development of Nepalese Capital Market .............................................15
2.1.6 Meaning of Risk .....................................................................................16
2.1.7 Sources of Risk ...................................................................................... 17
2.1.8 Types of Risks........................................................................................ 22
2.1.9 Expected Rate of Return .........................................................................25
2.1.10 Single- Period Rate of Return .............................................................. 27
2.1.11 Relationship Between Risk and Return .............................................. 28
2.2 Review of Related Studies ................................................................................... 29
2.2.1 Review of Journals and Articles .............................................................29
2.2.2 Review of Thesis.....................................................................................31

CHAPTER III RESEARCH METHODOLOGY

3.1 Introduction ............................................................................................................36
3.2 Sources of Data ......................................................................................................36
3.3 Research Design ....................................................................................................37
3.4 Data Collection Techniques ...................................................................................37
3.5 Data Analysis Tools ...............................................................................................37
3.6 Population and Sample ..........................................................................................38
3.7 Methods of Analysis .............................................................................................38
3.7.1 Financial Tools...............................................................................................38
3.7.1.1 Market Price of Stock ........................................................................38
3.7.1.2 Earning per Share ..............................................................................39
3.7.1.3 Dividend ............................................................................................39
3.7.1.4 P/E Ratio .......................................................................................39
3.7.1.5 Return on C.S. investment .................................................................39
3.7.1.6 Expected Return on Common Stock ..................................................40
3.7.1.7 Standard Deviation.............................................................................40
3.7.1.8 Co-efficient of Variation .................................................................41
3.7.1.9 Beta Coefficient .................................................................................42
3.7.1.10 Required Rate of Return ....................................................................43
3.7.1.11 Portfolio Return .................................................................................43
3.7.1.12 Portfolio Risk ....................................................................................44
3.7.1.13 Risk Minimizing Portfolio .................................................................44
3.7.2 Statistical Tools..............................................................................................44
3.7.2.1 Correlation Co-efficient .....................................................................44
3.7.3 Test of Hypothesis .........................................................................................46

CHAPTER IV PRESENTATION AND ANALYSIS OF DATA

4.1 Data Presentation and analysis based on secondary data.......................................48
4.2 Analysis of historical return of sampled banks ......................................................48
4.3 Descriptive Analysis of Banks ..............................................................................49
4.3.1 Nepal Investment Bank Limited .............................................................49
4.3.2 Himalayan Bank Limited ........................................................................51
4.3.3 Nabil Bank Limited.................................................................................53
4.4 NEPSE (Market) ....................................................................................................56
4.5 Statistical and Financial Analysis of Banks ...........................................................58
4.5.1 Nepal Investment Bank ...........................................................................59
4.5.2 Himalayan Bank......................................................................................60
4.5.3 Nabil Bank ..............................................................................................62
4.6 Testing of Hypothesis ...........................................................................................63
4.6.1 Testing of Hypothesis of Expected return of NIBL
with Overall markets return .................................................................63
4.6.2 Testing of Hypothesis of Expected return of Nabil
with Overall markets return ...............................................................64
4.6.3 Testing of Hypothesis of Expected return of HBL
with Overall markets return .................................................................66
4.7 Major Findings of the Study ..................................................................................67

CHAPTER V SUMMARY, CONCLUSION & RECOMMENDATIONS

5.1 Summary ...............................................................................................................70
5.2 Conclusions ...........................................................................................................72
5.3 Recommendations .................................................................................................72

Bibliography
Appendix
 LIST OF TABLES
Table No. Title Page No.
3.1 ANOVA ................................................................................................................47
4.3.1 MPS, Dividend, BVPS, EPS P/E Ratio and Market to Book ratio of NIBL ......50
4.3.2 MPS, Dividend, BVPS, EPS P/E Ratio and Market to Book ratio of HBL........52
4.3.3 MPS, Dividend, BVPS, EPS P/E Ratio and Market to Book ratio of Nabil ......55
4.4.1 NEPSE Index and Annual rate of return .............................................................57
4.4.2 Average rate of return, variance, standard deviation and C.V. of market
Portfolio .............................................................................................................58
4.5.1 Statistical and financial indicator of NIBL .........................................................59
4.5.2 Statistical and financial indicator of HBL ..........................................................60
4.5.3 Statistical and financial indicator of Nabil..........................................................62
4.6.1 Major statistical and financial indicators of sample Banks ................................68
4.6.2 Maximum and Minimum Rate of Return of individual stocks and market
(NEPSE) during the review period. ....................................................................68
 LIST OF FIGURES
Figure No. Title Page No.
2.1 Systematic & Unsystematic Risk ..........................................................................24
2.2 Security Market Line .............................................................................................27
2.3 Relationship Between Risk and return ...................................................................29
4.3.1 The relationship between closing price, EPS and DPS of NIBL ........................51
4.3.2 The relationship between closing price, EPS and DPS of HBL .........................53
4.3.3 The relationship between closing price, EPS and DPS of Nabil ........................56
4.4.1 NEPSE Index ......................................................................................................57
4.4.2..............................................................................................................................58
 CHAPTER I
INTRODUCTION
1. Introduction
The Nepal is the kingdom of Himalayas which is located between India in East, West, South
and China in North. Nepal is a land locked country & home place of natural beauty with
traces of artifacts. Industrial & Commercial activities play a vital role in the economic
Development of the country. As development continues, the share of industry and service
sector dominates. Predominantly Nepal is an agriculture country. Agriculture is still the main
economy of the country. Nepal is giving emphasis on the upliftment of its economy like any
other country. The economic development will depend upon various factors. Financial
institutions are viewed as catalyst in the process of economic growth. Due to the mobilization
of domestic resources, capital formation and its proper utilization plays an important role in
the economic development of a country. Every financial institution, big or small plays an
important role in the development of a country. In other hand, the financial sector, banking is
regarded as a profitable sector.

The Modern Banking in Nepal has institutionally developed just 71 years before. The first
commercial bank was established in 30Kartik 1994 B.S. with the name of Nepal Bank Ltd as
a semi govt. Organization. The initial authorized capital of the bank was 10 million rupees
and issued capital was 25 lakh with paid-up of 8 lakh 42 thousand. Now its capital has been
increased substantially. This first commercial bank was established 128 years after the
establishment of the first commercial bank in India. In this way Nepal lags 128 years behind
even for establishing a simple banking institution.

At first, the authority and responsibility of central bank was given to Nepal Bank Limited, but
with the change of time, it was necessary to establish a central bank. So, Nepal Rastra Bank
was established as a central bank in 14th Baisakh 2013 B.S. under Nepal Rastra Bank act
2012 B.S. The growth and development of the country is possible only when competitive and
efficient Banking service reaches every corner of the country. However, as the central bank,
Nepal Rastra Bank had its own limitations and as a commercial bank it was not logical for
Nepal Bank Limited to go to unprofitable sectors. So, to catch up with this problem, the
Government Established Rastriya Banijya Bank in 2022 B.S. (1965 A.D.) under Banijya
Bank Act 2021, as a fully state owned commercial bank.

1.1 Purpose of the study:

This study is focused in “Risk & Return Analysis" of leading Commercial Banks in Nepal:
Nabil Bank Limited, Nepal Invesment Bank Ltd. & Himalayan Bank Ltd.

NABIL Bank Limited is the first JVB of Nepal, commenced its operations in 12thJuly 1984
A.D. Dubai bank Ltd, Dubai (later acquired by Emirates Bank International Limited, Dubai-
EBIL) was the first joint venture partner of NABIL. Later EBIL sold its entire stock to
National Bank Ltd, Bangladesh (NBL). NABIL Bank Ltd. Had the official name Nepal Arab
Bank Limited till 31stDec 2001. Hence 50% equity shares of NABIL are held by NBL and
out of another 50% shares, 20% shares has been hold by financial institutions and remaining
30% shares were issued to general public of Nepal. NABIL was incorporated with the
objective of extending international standard modern banking services to various sectors of
the society. Pursuing its objective, NABIL provides a full range of commercial banking
services through its 24 points of representation across the kingdom and over 170 reputed
correspondent banks across the globe. NABIL, as a pioneer in introducing many innovative
products and marketing concepts in the domestic banking sector, represents a milestone in the
banking history of Nepal as it started an era of modern banking with customer satisfaction
measured as a focal objective while doing business. Operations of the bank including day-to-day
operations and risk Management is managed by highly qualified and experienced management
team. Bank is fully equipped with modern technology which includes ATMs, credit cards, state-
of art, world-renowned software from Infosys Technologies System, Bangalore, India, internet
banking system and Telebanking system.

Nepal Investment Bank Ltd. (NIBL), previously Nepal Indosuez Bank ltd., was established
in 1986 as a joint venture between Nepalese & French Partners (holding 50% of the capital)
was credit Agricore Indosuez, a subsidiary of one of the largest banking groups in the world.
With the decision of Credit Agricore Indosuez to divest, a group of companies comprising of
bankers, professionals, industrialist and businessmen, in April 2002, acquired 50% of the
holdings of Credit Agricore Indosuez in Nepal Indosuez Bank. The name of the Bank was
changed to Nepal Investment Bank Ltd. upon approval of the Bank's Annual general
Meeting, Nepal Rastra Bank and company Registrar's Office. The shareholding structure
comprises of a group of companies holding 50% of the capital, Rastriya Banijya Bank
holding 15% of the Capital, Rastriya Beema Sansthan holding 15% of the Capital, The
general Public holding 20% of the Capital. It has highest paid up capital of Rs.2.4 billion and
market capitalization has increased by over 2000% during last 7 years. It has the highest total
assets growth of Rs.11.28 billion.

Himalayan Bank Limited (HBL) established and promoted in 1993 by a group of prominent
businessman, bankers and financial institutions with Habib Bank Limited of Pakistan, as the
joint-venture partner today stands as one of the largest private-sector commercial banks in the
country. The Bank's loan portfolio, comprising of a healthy mix of diversified sectors stands
at Rs. 20.18 billion, whereas the deposit portfolio of the Bank stands at Rs. 31.84 billion,
which is one of the biggest portfolios vis -a-vis other private-sector commercial banks in the
country. The Bank also possesses a healthy foreign currency deposit portfolio that provides
good returns. Inward remittances have consistently been on the upswing for years, enabling
the Bank to earn much required forex earnings and providing a cushion for trade financing.

The fast growth of the Bank has been made possible through the strategic approach which is
undertaken and the years of hard work and perseverance on the part of the Board, top
management and qualified human resources. Any business opportunities that have come
along has been thoroughly evaluated and tapped whenever found feasible. The Bank has put
into use all available forms of resources to grab the opportunities available in the banking
sector.

Today HBL boast of having one of the largest ATM networks in the country. The number of
branches has grown at a steady pace. To increase our service base and tap new businesses in
these emerging markets, The Bank has invested heavily in cutting-edge technology to
complement our business capability, with the understanding that technology in today's world
has become a necessity as a driving force if we are to excel. In line with this, The Bank has
upgraded our software to the T24r8 version of TEMENOS. The cared business has expanded
rapidly and the Bank today offers al forms of cared services for its customers-credit cards,
debit card and pre-paid cards. The card business has turn turned out to be a lucrative and
impressive business for the Bank as more and more customers are being attracted towards
card banking.
To support both the trade financing and remittance businesses, The Bank has been
continuously expanding their correspondent network. To ensure that customers optimally
enjoy modern baking, The Bank is providing technology-driven services such as Internet
banking and SMS banking.

The progress of the Bank over the last 16 years is testimony to the quality of our leadership
and human resources. HBL believe in hiring the best and giving the best. The Bank has
followed a customer-oriented approach and therefore has been able to win the trust of the
customers over the years.

1.2 Focus of the study

Generally, risk and return analysis is concerned to identify the sustainable position of
financial sector. Risk and return is the basic concept in the corporate finance and it guides the
other modern theories and principal as well as it assists in taking various financial and
qualitative financial decisions. The relationship between risk and return can be defined by the
investors‟ perception about risk and the demand for compensation. No investor will take any
investment position in risky assets unless they are convinced of adequate compensation for
the percept risks. In fact, there is positive relation between risk and return. Risk has been
defined as the chance that the actual return deviation from the expected returns and risk is the
percept fact of life that is the product of uncertainty and it magnitude depend upon the degree
of variability in future‟s uncertain cash flows. Risk and return is an indication of opportunity
of losing investment value. It is insensible to talk about returns without talking about risks
because investment decision involves the trade off between risk and return and the trade off
between these two variables is positive. There is positive relation between risk and return.
Thus an investor, in general, can attain more return through the selection of dominating assets
that involves high risks. Risk in a stock reflects the uncertainty about the future return i.e.,
actual return may be less than the expected return. The main source of uncertainty about
future return is that, the price at which the stock can be affected by economics factors such as
interest rates, economic growths, inflation liquidity, marketability, financial performance and
strength of the dollar. The risk of stock can be measured by the price volatility. One of the
main sectors of financial market is capital market where Stocks and Bonds are traded. Among
all, stock market is seemed to very active market and basically concerned to maximize the
wealth of stockholders. It plays vital role in economy. Financial market is the mechanism
designed to facilitate the exchange of security by bringing buyer and seller in the trading
floor. It allows supplier and demanders of funds to make transaction. Capital market is
important intermediary through the networks of funds within the economy can be made
active. In general, capital market refers to the market where various long-term securities are
issued and traded for the tradeoff between liquidity position risk of their prospective portfolio
in the response to availability of information and marketability of securities and its prices. If
the capital market is efficient, the current stock price fully reflects available information but
full efficient market is very difficult to meet in the real corporate world. So, investor should
learn fully and carefully as possible as about actual investment world. Political, legal,
economical, social, and technological factors affect the capital market. All financial
institutions are also affected by capital market. Many financial institutions are listed with
Nepal Stock Exchange (NEPSE).

1.3 Statement of the problem

Capital market investment in this present context plays the major role in the socio-economic
development of the country. Having the sensitive nature, economic, social and political
interference would directly affect on it. The stage of development of capital market in any
country and its effective growth is depended upon the aggregate economic condition, saving
and investment opportunity etc. There are various institution involved in capital market, they
have not been able to show good performances according to the expectation of investors. At
the same time there is no denying in the fact that investors are responsible for not having self-
control, self-judgment in the choice of securities for investment. Thus having lack of
adequate knowledge about the securities of certain in companies, investors are haphazardly
investing in shares.

Generally, investors purchase financial assets such as stocks or bonds for their desire to
increase their investment wealth i.e. earn positive rate of return on their investment. Risk and
return analysis is worked out to identify the sustainable position of any organization and
financial institution. Capital market in Nepal has grown rapidly after the establishment of the
security market named NEPSE with in the very short period of time. However, the attitudes
and knowledge of the most investors have not changed yet. They are influenced by liquidity
position rather than information in the financial market. Investors usually lack any idea of
risk and return because most of the investors appear to be least familiar with the financial
market. They can make wrong investment decisions based on the hunches rather than on real
term analysis. Though some investors follow the rational investment procedure and portfolio
analysis but they still lack perfect awareness about the risk and return factors. Without getting
theoretical knowledge about risk associated with investment, most of the investors are
making investment on the stocks. This may be termed as improper practice. This situation
motivates the present researcher to undertake a research project entitled "Risk and return
analysis of selected commercial banks in Nepal". If the bank issues shares, there becomes
huge demand rather than the supply but if other sectors such as hotels insurance companies
and manufacturing companies issue new shares, the least investors desire to invest their
money. In Nepalese context, most of people deposit their saving in banks instead of making
investment in the financial assets available in the capital markets like investment in shares,
debentures and other derivative securities. Many investors are not rational towards their
investment decision. They don‟t know how to make rationale investment by assessing the risk
percept in the investment and the level of return to compensate the percept risk. In Nepal,
most of the financial institution issues only the common stocks and capital market is also
dominated by the trading of the stocks.
Some research problems are as follows:
1. In what extent, the investors should be compensated for taking a certain degree of risk?
2. How do they know the scale and intensity of risk?
3. One expects favorable returns by holding stock. But what are the criteria for evaluation?
4. How can one make higher return assuming lower risk?

1.4 Objectives of the study

The main objective of this study is to evaluate the risk and return an common stock
investment of listed commercial banks in Nepal. The specifics objectives of the present study
are listed down as follows:

1. To analyze the systematic risk of the selected commercial banks

2. To analyze the unsystematic risk of the selected commercial banks.
3. To analyze the risks and return of selected commercial banks.
4. To analyze whether the common stocks of selected banks are over or under priced.
5. To find out whether the investors analyze the risk and return while making investment in
the common stocks of commercial banks.

1.5 Significance of the study

This research is not only fulfilling MBS course of T.U, but also to provide some knowledge
about Nepalese stock market development along with providing ideas to minimize the risk on
stock investment. The trend of flow of investment in stock is essential for achieving growth
of an economy. This study will be helpful for other researcher in the area of investment as it
provides suggestion to some extent.

The study is to point out the risk and return position of investing shares of commercial banks
in Nepal. The study will be helpful for investors as well as commercial banks. It also provides
proper guidelines for making choices of stocks and bonds on the basic of risk and return. It is
also important to those people who are interested to know about risk and return and capital
market in Nepal. It provides the consolidated basic data and information about the NEPSE
and commercial banks under study. This study will cover the investors' perception upon the
risk and return factors while investing in common stocks of commercial banks. It will provide
the brief information on risk and return from the investors' perspectives.

1.6 Limitations of the study:

There are some limitations of this study. The main limitations of the study are:
• As the study is the partial fulfillment of MBS program, the time assigned for it is limited
i.e. to be completed within the specified time frame. Consequently the study faced time
and resource constraints.
• The study covers the data for only a period of five year i.e. from 2059/60 to 2064/65 and
conclusion drawn confines only to above period.
• The study is based on the secondary data due to which the accuracy of the data is based
on the reliability of the source.
• Although there are many joint venture banks, the study confines to only two banks.

1.7 Organization of the Study

This research has been organized in five chapters. The titles of this chapter are discussed
below:
Chapter One: Introduction
This chapter is introductory and deals with the subject matter of the study including general
background of the study, purpose of the study, statement of the problems, objectives of the
study, significance of the study, limitation of the study, organizing the study.
Chapter Two: Review of literature
This chapter contains the profound review of available literature related to the area of this
study. It is directed towards the review of conceptual Framework and Review of Major
related study. Risk and return, its relationship, determinants, measuring techniques and
methods etc are reviewed from the available literatures
Chapter Three: Research Methodology
This method presents Research Methodology used in the study which includes various tools
and techniques of the data. It consists of research method as library research and field
research, source of the data and population & sample, research design, methods of data
analysis etc.
Chapter Four: Presentation and data Analysis
This chapter presents the analysis and presentation of data by using various methods of
statistical and financial tools pie charts and tables will be used accordingly.
Chapter Five: Conclusion and Recommendation
This Chapter is for Summary of main findings conclusion, recommendation and suggestions
for the further improvement.

1.8 Research Methodology:

Research Methodology describes the methods and process applied in the entire aspect of the
study focus of Data, data gathering instrument and procedure, data tabulating, processing and
methods of analysis. To achieve the basic objective of the study, it will follow the following
Research Methodology:

1.8.1 Research design

The present study is based on descriptive and analytical research design. Descriptive research
design is used to describe the relationship between risk and return from tables, graphs, trend
lines, and figures with basic calculation of present collected data. Similarly analytical
research design is used to analyze the standard deviation, correlation coefficient, coefficient
of variation, beta coefficient, risk premium, expected return, and average rate of return, of
sampled banks. Analytical research design evaluates the present data clearly. The study has
been carried out the ten years periods from 1st July 1998 to 30th June 2008.

1.8.2 Population and sample

Total population of the study is many commercial banks listed in NEPSE which are taken on
the basis of listed years of commercial banks. The study is carried out those commercial
banks which are listed before 15th July 1998 A.D. in NEPSE. For research purpose NABIL
Bank Ltd, Nepal Investment Bank Ltd and Himalayan Bank Ltd is selected for comparative
study. These banks have the large volume of transactions and they also have many branches
in different sectors of the country. So, the large numbers of employees are also involved in
commercial banks. Therefore, the present study could not cover all the employees of selected
banks. However, the researcher tried to cover as many employees as possible.

1.8.3 Sources of data:-

The data for the study depends upon the secondary sources as well as primary data. The main
source of data is the reports of NEPSE, website of the SEBO/N, websites, and annual reports
of commercial banks and periodicals published data of NRB. Annual report of NEPSE has
been used to take financial statement and trading report of listed commercial banks. The data
has been taken from NEPSE to with draw the opening and closing prices. Similarly, SEBO/N
has been visited to collect annual report of sampled banks. Websites have been clicked to
take the operational data of commercial banks. For the primary data, a survey on the risk and
return on common stock from the investors‟ perspective has been conducted. The numbers of
respondents are 60 who respond the questionnaire properly.

1.8.4 Data collection techniques

The data for the present study have been collected from secondary sources for the
fundamental analysis and primary data has been collected for technical analysis. The annual
reports of commercial banks have been taken from SEBO/N. Similarly; NEPSE price and
sector price have been taken from NEPSE. NRB was visited to collect the Treasury-Bills rate
and banking and financial statistics. After that collected data were recorded in mater sheet
manually then data were entered to spread sheet to work out statistical and financial analysis
ratios. These data are also used to prepare figures and tables. To process the data of the
present study manual and computer based program were used like Microsoft word and excel.

1.8.5 Data analysis tools

All the data are presented and analyzed to fulfill the objectives developed in the introduction
chapter to illustrate the research. Worksheets and figures have been used for the data
presentation to evaluate risk and returns. Categorically, the present study has used financial
and statistical tools.

The data for the study depends upon the secondary sources as well as primary data. The main
source of data is the reports of NEPSE, website reports of the SEBO/N, websites, and annual
reports of commercial banks and periodicals published data of NRB. Annual report of
NEPSE has been used to take financial statement and trading report of listed commercial
banks. The data has been taken from NEPSE to with draw the opening and closing prices.
Similarly, SEBO/N has been visited to collect annual report of sampled banks. Websites have
been clicked to take the operational data of commercial banks. For the primary data, a survey
on the risk and return on common stock from the investors‟ perspective has been conducted.
The numbers of respondents are 60 who respond the questionnaire properly.
 CHAPTER II
REVIEW OF LITERATURE

Risk and Return have importance in Financial Management. Theoretical aspect of risk and
return is also explored in this chapter. Some of the Master's Degree Thesis has also been
reviewed. So this chapter explores various theories and research studies that are closely
related and provide valuable inputs to conduct the present study successfully. The whole
chapter has been divided mainly into two parts- theoretical review and of thesis review.

2.1 Conceptual Framework

The objective of this section is to know how various writers have described about risk and
return. This study is focused on the common stock investment. It is may be defined as a share
in the ownership of the firm. Common stockholder are real owners of business firm. Common
stocks are more risky than both preferred stock and bond but it has also benefit like voting
right, right in participation in profit and may be purchase and sold immediately.

Capital market is also called security market as well as financial market. Capital market is the
mechanism designed to facilitate the exchange the financial assets or securities by bringing
buyer and seller of securities together. Precisely speaking, security market allows suppliers
and demanders of funds to make transactions. It can be various types and forms classified as
different bases capital market and money market, share and debenture market. For our
research concern, capital markets--the market defined as any body of the individuals, whether
incorporated or not, constituted for the purpose of regulating controlling the business of
selling or dealing securities. According to Brigham & Eharadt, 10th edition, “capital markets
are the market for intermediate or long-term debt and corporate stocks. Intermediate term
refers those financial assets having the maturity periods equal to five years and more than
five years. Capital market consists of the security market and non security market implies
mobilization of the funds through issuance of securities like share, debenture, and other
derivative securities. These securities traded in the markets are generally negotiable and
hence can be traded in secondary market. Non security market refers to the mobilization of
the nonfinancial resources. However the Various definitions of the capital stock market can
be described as follows,
"Common stock represents ownership status in a firm. It has a residual claim, in the sense
that shareholders can receive earnings only after the payment of all others claims of
securities. But it has also an unlimited potential for dividend payment through increasing
earnings and for capital gains through raising prices. The risk is highest with common stock
investment. Common stock holders usually have voting rights in the management of the
corporation bond holders and usually holders of preferred stock have no voting rights. Since
the value of common stock depends largely on its earning, it is often issued with on par value.
In the case of bankruptcy common stock holders are in the principal entitled only to assets
remaining after all period claimants have been satisfied when investors buy common stock,
they receive certificate of ownership as a proof of there being part of the company. The
certificate states the number of shares purchased and their par value." (Bhalla; 2000: 196)

"Common stock holders are the owner of the corporation. As owners, common stock holder
have certain rights, the most important are the right to participate in profit distribution, the
right to vote etc. From the corporation viewpoint, common stock represents a fund raising
device. From the investors' viewpoint, stock ownership gives the stockholders an opportunity
to share in the profit when declared as dividend, opportunities to make money on
appreciation in the value of the securities and the opportunity to vote for directors of the
corporation." (Bradley; 1993:104)

Common stock holders of a corporation are its residual owners, their claim to income
and asset comes after creditors and preference share holders have been paid in full. As
a result, a stockholders return on investment is less certain than the return to lender or
to preference stock holder. On the other hand, the share of the common stock can be
authorized either with or without per value. The par value of the stock is merely a
stated figure in the corporate character and is of little economic significance. "A
company should not issue stock at a price less than par value because stock holders
who bought stock for less than par value would be liable to creditors for the difference
between the below pre price they paid and the par value", (Van Horne; 1997:98).

Basically capital market can be divided into four parts:

2.1.1 Primary market
Primary market is the market through which the funds are transferred from saver to
demander. Hence, securities available for the first time are offered through the primary
securities markets. The issuer may be a brand new company or one that has been in business
for many years. The key is that securities absorb new funds for the coffers of the issuer. It is
also known as New Issue Market (NIM)

2.1.2 Secondary market

Once they have been issued in the primary market, investor may seller trade them in the
secondary market called secondary capital market. It deals with previously issued share
mainly traded through the stock exchange, over the counter (OTC) market and the direct
dealing, generally the majority of all security transaction.

2.1.3 Money Market

Money market is also called short term financial market which is the set of supplying short
term debt or working capital needed for industries, business or incorporated etc.

2.1.4 Capital Market

Capital Market is the market where the transaction of long-term finance is made. The funds
collected in this market are raised and traded by long-term financial instruments such as
equities and bonds.

2.1.5 Development of Nepalese capital market

Stock investment practice in Nepal has been developed after the establishment of the
Biratnagar Jute Industry and Nepal bank Ltd. in 1937 AD. The majority of shares issued by
companies would belong to the government ownership till 1980‟s. Initial public Offerings
(IPO‟s) were hardly found in practices and funds were collected through the direct placement
of bonds. The major objectives of raising the fund would be the development of the
infrastructure and pubic welfare programs. It has helped flourishing the primary government
bond market. Government had issued treasury bills in 1962 AD for the first time to finance
the infrastructure development. Furthermore, it was prescribed by the issuance of the
development bonds in 1964 AD. Security Market Center (SMC) is established by Industrial
policy in 1977 AD. Security Exchange Act (SEA) was approved by legislation and came into
existence with effect from 13th April, 1984 AD. The former Securities Exchange Center was
converted into Nepal stock Exchange (NEPSE) with the major objective of arranging
marketability and liquidity of to the government and corporate securities. Floor trading
through market intermediaries such as brokers‟ market makers has also evolved; restoration
of democracy following the political movement of 1990 has brought lots of reforms in the
finance sector. Liberalization in the real sense was initiated. Nepal launched „Extended
Adjustment Program‟ in 1992 AD by taking Extended Structural Adjustment Facility (ESAF)
through the amendment in the SEA. This has led to established of the Securities Exchange
Board Nepal (SEBO/N) and was given the responsibility of regulating and developing the
transactions of the stocks and bonds in the floor through its member intermediaries where
NEPSE is to facilitate the transactions of the stocks and bonds in the floors through its
member intermediaries. NEPSE presently has 72 organized, 11 issue managers and 2
portfolio managers that is dealer in the secondary market. NEPSE is planning to increase the
share broker number by 27 to make 50 in the near future. Some processes are already made
for this. Similarly, Non Residence Nepalese (NRN) has declared to establish a multipurpose
mutual fund investment company with amount of Rs. 10 billion in nearer future which help to
grow the capital market in Nepal. In addition to this, various state-owned enterprises like
Nepal Electricity Authority (NEA) has already issued bond and Nepal Telecom Corporation
(NTC) planning to issue bonds. Thus market share to the general public which is encouraging
for the capital market encouraging and becoming alternative investment sectors for the
investors.

2.1.6 Meaning of risk

"Risk can be defined as the variability of possible returns around the expected return of an
investment. For some investment this variability can be quite small", (Thapa; 2005:4.3). Each
investor has his or her own attitude about risk and how much he or she can tolerate. Since
investment alternative have different types of risk associated with them. The investor must
determine which combination of alternative matches his or her particular risk tolerances.
Most investors know that there is no free lunch, that is, the return you can expect is a function
of the risk you take. Those investors who can tolerate higher level of risks should be
rewarded with high value of returns. Most empirical studies of historical risk-return
relationships support this statement. Intelligent investment involves combining investment
alternatives in a portfolio that offers a fair return for the risks you are willing to assume. Risk
is complicated subject and needs to be properly analyzed. The relationship between risks is
described by the investor‟s perception about risk and their demand for compensation. No
investor will like to invest in risky assets unless he is assumed of adequate compensation for
the assumption of the risk. Therefore, it is the investor required risk premium that establishes
a line between risk and return in a market dominated by rational investors, higher risks will
command by rational premium and the trade off between risk and risk premium. Risk is
measured in many ways but commonly three methods are viewed as useful standard. These
are:

Beta coefficient
This is a mathematical value that measures the risk of one asset in term of its effect on the
risk of group of assets called portfolio. It is concerned solely with market related risk as
would be the concern for the investor holding stocks and bonds. It is derived mathematically
so that a high beta indicates a high level of risk and low beta represents a low level of risk.

Standard deviation
This is the measurement of the dispersion of forecast returns when such returns approximate
a normal probability distribution. It is a statistical concept and widely used to measure risk
from holding a single asset. The standard deviation is derived so that a high standard
deviation represents a large dispersion of return and it involved high degree of risk. On the
other hand, a low standard deviation is a small dispersion and represents low degree of risk.

Subjective estimates
A subjective risk measure occurs when qualitative rather than quantitative measures are used
to measure dispersion. We will use the definition of risk that deals with dispersion of return.
We will also note that mathematical approaches can be used to estimate such dispersion.

2.1.7 Sources of risk (Thapa; 2005:4.4 & Annual Report of NIBL)

An investment is commitment of money that is expected to generate addition money. Every
investment entails some degree of risks. A major objective of financial institution is to
increase the returns for its owner by taking minimum risk. The effective management of the
risk is central to its performance. Indeed, it can be argued that the main business function of
financial institution is managing these risks through the consumption of maximum time and
efforts in understanding and managing the various source and kinds of risks factors with its
different natures and complexities. The primary risks factors that create investment
uncertainties are as follows:

Interest rate risk

Interest rate risk is the potential variability of return caused by changes in the market interest
rates. IF market interest raise, then investments values and market prices will fall and vice
versa. The primary security purchased by financial institutions often has maturity and
liquidity characteristics which are different from those of secondary security that financial
institutions sell. In mismatching the maturities of asserts and liabilities as part of their asset
transformation function. Financial institutions potentially expose themselves the interest rate
risks. Suppose when interest rate increases and maturity period of assets is greater than the
maturity period of liabilities. At that time, if interest rate increases it decreases the market
value of assets in comparison of its liabilities.

Market risks
Risk arising out of adverse movements in exchange rates, interest rates, liquidity and prices
of equity are covered under market risk management. In line with capital framework
prescribed by NRB, bank focuses on exchange risk management for managing/computing the
capital charge on market risk. In addition the interest rate risk, liquidity risk and equity risk
are assessed at a regular interval to strengthen market risk management.

Market risk is also the uncertainty in the future value of the bank's on-balance sheet and off-
balance sheet financial items resulting from interest rates, foreign currency, equity, and
commodity risks. The Asset Liability Management committee (ALCO) serves as the primary
oversight and decision making body that provides strategic directions for the bank's
management of market risk. The key elements in the market risk management framework are
principles and policies, risk limits and risk measures. The prescribed approach for the
computation of capital charge for market risk is very simple and thus may not be directly
aligned with the magnitude of risk. Likewise, the approach only incorporates risks arising out
of adverse movements in exchange rates while ignoring other forms of risks like interest rate
risk and equity risks.

Credit risk
The credit risk of individual borrowers or counterparties as well as at the portfolio level is
assessed. The credit review assessment cover risk rating systems, portfolio analysis, large
exposures and risk concentrations. All Corporate and Institutional borrowers including SME
borrowers, at individual and group level, are assigned internal credit rating that supports
identification and measurement of risk and integrated into overall credit risk analysis.

Credit risk is the probability that a Bank's borrower or counter party will fail to meet its
payment obligations in accordance with the terms of approval of the credit. This includes
non-repayment of capital and / or interest within the agreed time frame, at the agreed rate
interest and in the agreed currency. The goal of credit risk management is to maximize a
bank's risk-adjusted rate of return by maintaining credit risk exposure within acceptable
parameters. The effective management of credit risk is a critical component of a
comprehensive approach to risk management and essential to the long-term success of any
banking organization.

For most banks, loans are the largest and most obvious source of credit risk; however, other
sources of credit risk exist throughout the activities of a bank, including in the banking book
and the trading book, and both on and off the balance sheet Banks increasingly face credit
risk in various financial instruments other than loans, trade financing, foreign exchange
transactions, and in the extension of commitments and guarantees and the settlement of
transactions.

Operational Risk
Operational risk is the risk of loss resulting from inadequate internal processes, people, and
systems, or from external events. Operational risk itself is not a new concept, and well run
banks have been addressing it in their internal controls and corporate governance structures.
However, applying an explicit regulatory capital charge against operational risk is a relatively
new and evolving idea. Basel II requires banks to hold capital against the risk of unexpected
loss that could arise from the failure of operational systems.
The most important types of operational risk involve breakdowns in internal controls and
corporate governance. Such breakdowns can lead to financial loss through error, fraud, or
failure to perform in a timely manner or cause the interests of the bank to be compromised in
some other way, for example, by its dealers, lending officers or other staff exceeding their
authority or conducting business in an unethical or risky manner.

Liquidity risk
Liquidity is crucial to the ongoing viability of any financial institution. The capital positions
can have a telling effect on institution's ability to obtain liquidity, especially in a crisis. NIBL
has adequate systems for measuring, monitoring and controlling liquidity risk. We evaluate
the adequacy of capital given their own liquidity profile and the liquidity of the markets in
which they operate. We also make use of stress testing to determine ne their liquidity needs
and the adequacy of capital.

Liquidity risk is the probability of loss arising form a situation where (1) there will not be
enough cash and/or cash equivalents to meet the needs of depositors and borrowers, (2) sale
of illiquid assets will yield less than their fair value, or (3) illiquid assets will not be sold at
the desired time due to lack of buyers. Liquidity risk relates to the ability of the Bank
maintain sufficient liquid assets at reasonable cost to meet its financial obligations as and
when they fall due. Liquidity risk' arises from situations in which a party interested in trading
an asset cannot do it because nobody in the market wants to trade that asset. Liquidity risk
becomes particularly important to parties who are about to hold or currently hold an asset,
since it affects their ability to trade.

The bank's liquidity policy is to ensure that all contractual commitments can be met by
readily available source of funding. In addition, liquid assets are maintained in relation to
cash flows to provide further sources of funding in the event of a crisis. The bank also has
excellent access to financial markets to ensure the availability of funds.

Foreign Exchange Risk

Foreign Exchange rate risk arises from exchange rate movements which affect the profit of
the bank from its foreign exchange open position. Because of bank's exposure to foreign
currency, foreign exchange risk management is a fundamental component in market risk
management of the bank. It involves prudent management of foreign currency positions in
order to control, within set parameters, the impact of changes in exchange rates on the
financial position of the Bank. The frequency and direction of rate changes, the extent of the
foreign currency exposure and the ability of counterparties to honor their obligations to the
Bank are significant factors in foreign exchange risk management. This risk is managed by
setting pre-determined limits on open foreign positions, the monitoring of the open positions
against these limits and the setting and monitoring of stop-loss mechanism. In order to
mangage the foreign exchange risk and protect the bank's financial position.

Callability risk
Some bonds and preferred stocks are issued with a provision that allows the issuer to call
them in for repurchase. The portion of a security's total variability of return that derives from
the possibility that the issue may be called is the callability risk.

Convertibility risk
Call ability risk and convertibility risks are in two aspects. First both are contractual
stipulations that included in the term of original security issue. Second, both of these
provisions alter the variability of return from the affected security. Convertibility risk is that
portion of the variability of return from a convertible bond of convertible preferred stocks.
That reflects the possibility that the investment may be converted into the issuer‟s common
stocks at a time or under terms harmful to the investor‟s best interest.

Industrial risk
An industry is as a group of companies that compete with each other to market homogenous
products. Industry risk is that portion of risk that can be an investment variability of return
caused by events that affects the product and firms that make up of an industry. The stage of
industry cycle, international tariffs and/of quotas on the product produced by an industry
related taxes, industry wide labor union problems, environmental restriction, raw materials
acts and affect all the firms in the industry simultaneously. As a result of these
commonalities, the prices of the securities issued by competing firms tend to rise and fall
together.

Political risk
Political risk arises from the exploitation of a politically weak group for the benefits of
politically strong group, with the efforts of various groups to improve their relative positions
increasing the variability return from the affected assets. Regardless of whether the changes
that cause political or by economic interests, the resulting variability of return is called
political risk if it is accomplished through legislative, judicial or administrative branches of
government. Political risk can be classified as international political risk and domestic
political risk.

Other risks
Besides these above mentioned risks, there are other risks like off balance sheet risk,
technological and operational risk, country and sovereign risk, insolvency risk etc.

2.1.8 Types of risks

Total risk of the rate or return for an individual security or portfolio is measured by the
standard deviation or variance of the rate of return. According to Capital Asset Pricing Model
(CAPM), total risk can be divided into two parts i.e. systematic risk and unsystematic risk.

Systematic risk
It is the portion of the total risk of an individual security caused by market factors that
simultaneously affect the prices of all securities. It is the also called non-diversifiable risk. In
other words, it arises from the changes in the economy and market condition. For example,
high inflation, recession, impact of political factors, wars, depression, long-term changes, etc,
which are beyond the control of company management. It affects all the firms in the market.
The portion of risk is non-diversifiable and cannot be reduced. The systematic risk is
rewarded in the form of risk premium. Sometimes, systematic risk is called market risk.
Systematic risk affects almost all assets in the economy, at least to some degree, whereas
systematic risk affects at most a small number of assets. The principle of diversification has
an important implication to a diversified investor, only systematic risk matters. It follows that
in deciding whether or not buy a particular individual asset, a diversified investor will only
concerned with that asset‟s systematic risk. This is a key observation and it allows us to say
great deal about the risks and returns on individual asset, in particular, it is the basis for a
famous relationship between risk and return called the security market line. To develop the
SML, we introduce the equally famous Beta coefficient one of the measurement unit of
modern finance. Beta coefficient and SML are the key concepts because to get supply us with
at least part of the answer to the question of how to go about determining the required return
on an investment.

Unsystematic Risk
Unsystematic risk is unique to a particular company or industry. It is independent of
economic, political and other factor that affect all securities in systematic manner. A wild cat
risk may affect only one company a new competitor may begin to produce essentially the
same product or a technological break through can make an existing product absolute. "For
most stocks, unsystematic risk accounts for between 60 to 70 percent of stocks total risk or
standard deviation." (Van Horne and Wachowitz; 1995:91). The relationship among
systematic, unsystematic and total risk are shown below.
Total risk (σj) = Systematic Risk + Unsystematic Risk
Systematic Risk and unsystematic Risk can be written as

Systematic Risk (SR) =COVjm

σm
Where,
SR = Systematic Risk
Covjm = Covariace of Stock j and Market Return
σm = Standard Deviation of Market

Unsystematic Risk (USR)

USR = σj - COVjm
σm
Where, σj = Standard Deviation of Stock j
Proportion on of SR = SR/TR
Where,
TR = Total Risk
Proportion of USR = 1-Proportion of SR

Figure 2.1
Systematic & Unsystematic Risk

(Source: Van Horne and Wachowitz;1995:96)

Where,
Systematic risk = σj Pjm
Unsystematic risk = σj (1-Pjm).
Pjm = Correlation coefficient between the return of given stock (j) and the return on market
portfolio.

"For most stocks, unsystematic risk accounts for between 60 to 70 percent of stocks total risk
or standard deviation". (Van Horne and Wachowitz; 1995:96)

However by diversification, unsystematic risk can be reduced and ever eliminated if

diversification is efficient. Therefore, not all the risk involved in holding a stock is relevant
since part of their risk can be diversified away. The important risk of stocks is its unavoidable
systematic risk. Investor will be compensated for bearing this systematic risk. They should
not however expect the market to provide may extra compensation for bearing avoidable risk.
It is the large that lies behind Capital Assets Pricing Model (CAPM).

In the case of single stock, the risk of portfolio is the standard deviation of that stock. As the
randomly selected stocks held in the portfolio are increased, the total risk of the portfolios
reduced. Such a reduction is at decreasing rate. Thus a substantial proportion of the portfolio
risk can be eliminated with a relatively moderate amount of diversification.

Total risk = systematic risk + unsystematic risk

2.1.9 Expected rate of return

The expected rate of return or holding period return is based upon the expected cash receipts
over the holding period and expected ending or selling price. Depending upon the assumption
made about cash receipts and ending price, a number of expected returns rate are possible.
These possible rates estimated by the investors are summarized in the expected rate of return.
“The expected rate of return must be greater or equal to the required rate of return in order for
the investor to find the investment acceptable.” (Cheney and Moses; 1995)

Capital Assets Pricing Model

The relevant risk for an individual asset is systematic risk (or market related risk) because
non market risk can be eliminated by diversification. The relationship between an asset's
return and its systematic risk can be expressed by CAPM, which is also called the security
market line (SML) (Thapa; 2005:5.19). The equation of the CAPM is E (Rj) = Rf+ [E (Rm) -
Rf] βj

Where,
E (Rj) = Expected rate of return for the asset j.
Rf = Risk free rate of return (Usually assumed as to be a short term T- bill rate)
E (Rm) = Expected market return.
βj = Assets beta
Or
 βJ = COV (jm )
VARm
Where,
COV (j,m ) = covariance between Assets j and market return
VAR (m) = variance of market returns
There are some assumptions under the CAPM model. According to (Sharpe, Alex, and
Bailey; 1998) has outlines eight assumptions as follows:
1. Investors evaluate portfolio by looking at the expected return and standard deviation of
the portfolio over one period horizon.
2. Individual assets are infinitely divisible. It implies that an investor can buy a fraction of a
share of s/he so desires.
3. There is a risk free rate at which an investor may lend i.e. invest money or borrow money.
4. Taxes and transaction costs are irrelevant.
5. All the investors have the same one person horizon.
6. The risk free rate is the same for all investors.
7. Information is freely and instantly available to all the investors.
8. Investors are homogenous expectations. It implies that everyone has same perception in
regard to the expected returns, standard deviation and covariance of the securities.

The CAPM is an equilibrium model for measuring the risk and return trade off for all assets
including both inefficient and efficient portfolios. A graph of CAPM is given in the figure.
Figure 2.2
Security Market Line
(Source: Van Horne and wachowitz; 1996:49)

2.1.10 Single- Period Rate of Return (Thapa; 2005:4.2)

Single period rate of return may be defined as the change in value plus any cash distributions
expressed as a percentage of the beginning of period investment value. An investor can
obtain two kinds of income from investment in a share of stock or a bond. They are as
follows:
1. Income from price appreciation (or losses from price depreciation)
sometimes called capital gains (or losses). This quantity is denoted as Pt+1-
Pt.
2. Cash flow income from cash dividend or coupon interest payments,
represented by the convention Ct.
Sum of these two sources of income (or loss) equals the total return and can be expressed in
percentage as follows:

Single Period Rate of Return = Pt+1-Pt+Dt or It

Pt
Where,
Pt = Starting price of security
Pt+1 = Ending price of security
Dt = Cash dividend for time t
It = Interest at time t

2.1.11 Relationship between Risk and Return

"The expected return from any investment proposal will be linked in fundamental relationship
to the degree of risk in the proposal. In order to be acceptable a higher risk proposal must
offer a higher forecast return than lower risk proposal". (Hampton; 1996:341). "The observe
difference in both the levels and variability of the rate of return across securities are
indicative of the underlying risk and relation in the market" (Loric, Dodd and Kempton;
1985:1029). Generally, there is a positive relationship between rate or return and risk. It
means an investor can usually attain more return by selecting dominant assets that involve
more risk. While it is not always true that a riskier asset will pay a higher average rate of
return, it is usually. The reason is that investors are risk averse. As a result, high-risk assets
must offer investors' high return to induce them to make the riskier investment normally;
investors are likely to prefer more return and less risk. It means investors will not choose an
investment that guarantee less return when investments promising higher returns in the same
level of risk class are readily available.
 Figure 2.3
Relationship between Risk and Return

(Source : Van Horne: 1998:245)

2.2 Review of Related Studies

2.2.1 Review of Journals and Articles
Shrestha, (1998), in her article," Lending Operation of Commercial Banks of Nepal and its
impact on GDP" has presented with the objective to make an analysis of contribution of
commercial bank's lending to the gross domestic product (GDP) of Nepal. Thus, in
conclusion, she has accepted the hypothesis i.e. 43 there has been positive impact by the
lending of commercial banks in various sectors of economy, except service sector investment.

Ojha, (2000), in his article, "Financial Performance and Common Stock Pricing" has
concluded that an investment in common stock of a corporate firm neither ensures annual
return nor ensures the return of principle. Therefore, investment in common stock is very
sensitive on the ground of the risk. Dividend to common stockholders is paid only if the firm
makes an operating profit after tax and preference dividend.

Elton, (1999) in “Expected Return, Realized Return and Asset Pricing Tests” has discussed
about the factors affecting expected returns on asset and the sensitivity of expected return to
those factors, and the reward for bearing this sensitivity. The data set covers the period from
July 1st, 1991 through December31st 1997. The history shows almost all the testing is done
taking realized return as a proxy for expected return. Using realized return as a proxy for
expected return is that the unexpected returns are independent, so that as the observation
interval increases they tend to a mean of zero. The purpose of this article is to convince the
reader there is a distinction and worth to find out alternative ways to estimate expected
returns. Following preliminary tests are done in the study:
A constant risk premium
Forward rates and risk premium
Factor analysis
Changing risk premiums

His research shows that, “Realized Returns are a very poor measure of Expected Return”.
That information surprisingly highly influences a number of expected returns, and that
information surprises highly influence a number of factors in asset pricing model. The
empirical use of judgment and factor dependability can be used to draw implication which
will govern to the great extend the pricing decision fix and accurate.

Joshi, (2004), has published and article on risk and return analysis of common stock of five
listed commercial banks. The main objective of the scholar‟s study was to assess the risk
associated with return on common stock investment of the basis of selected tools. For the
study, the researcher is used five years data 1998 -2002. He has used arithmetic mean to
calculate the return, standard deviation and coefficient of variations, which are used to
measure unsystematic risk and beta coefficient. The measurement explains sensitivity or
volatility of the stock with market and individual banks. Correlation is a statistical tool i.e. is
used to measure relationship between risk and return. The researcher also used t-test to
calculate hypothesis. The major findings of his study are that banking sector has the expected
return is 21.77 percent, risk is 36.1 percent and CV is 1.66, similarly finance and insurance
sector has 21.77 percent and 1.66, hotel sectors has 10.16 percent, 72.4 percent, 7.123,
trading sectors has 6.68 percent, 80.68 percent, 11.76, other sectors has -16.61 percent, 50.45
percent and 3.037. Market expected return of 10.2 percent and risk of 39.57 percent, CV of
3.88. SCB has maximum market capitalization and NBBL has the minimum market
capitalization. Market capitalization as well as NEPSE index has heavily influenced by
banking sector. If investors wish to generate higher return then they should bear higher risk
and invest in the share of SCBL and if they are risk averters and they want to invest in single
assets. They can invest in the share of NBL or HBL because these two stocks have lower risk
that of portfolio risk.
Poudel, (April 2002), in his study “An Assessment of Risk and Return Elements” has come
up with the conclusion that the risk-return characteristics do not seem to be the same for all
the shares review. He further added the shares with larger standard deviations seem to be able
to produce higher rates of return. The portion of unsystematic risk is very high with the
shares having negative beta coefficient. The risk per unit of return, as measured by the
coefficient of variation, is less than that of the market as a whole for all the individual shares.
Most of the shares fall under the category of defensive stocks (having beta coefficients less
than 1).

2.2.2 Review of Thesis:

During the review, the researcher has found numerous studies conducted for the partial
fulfillment of Masters Degree. Some of them, which are relevant to this study, are reviewed
in the following paragraphs.

Pandey, (2000), in her study “Risk and Return Analysis of Common Stock Investment” has
taken 7 listed insurance companies data from 2049 to 2056. She focused on following
objectives: -
To understanding and identify problems faced by an individual investor and insurance
company.
To calculate the risk and return of the common stocks and their portfolio.
To analyze the volatility of different stock of insurance companies and other variables
that should be considered while deciding investment in stocks.
She has used Study design, Population & Sample and Secondary data collection techniques as
the methodology. Her research findings are based on market capitalization, size of NIC is the
biggest one. Expected return on the common stock of NLGI is maximum (i.e. 65.39%). This
high rate of return is due to unrealistic annual return in 2050\51. Expected return on common
stock of HGI and EIC is lowest with negative value. In overall industrial sector, 46 expected
return of finance and industrial sector is highest. . Overall, market expected return is 50%.
Annualized return is unexpectedly high in FY 2050\51 and then declines in the preceding
Years. This is all about return. When risk and return compared to different industries, finance
and insurance is best as per highest expected return with higher degree of risk whereas
trading industry has minimum return and risk. In Nepal, however, in terms of the volume of
transaction the situation of the capital market, according to NEPSE sources has remained
quite optimistic, in aggregate, commercial banks occupy large percentage of traded amount
whereas insurance sector is being low responsive to wards its trading Though it is difficult to
estimate the exact volume of business potential in insurance, one can have a rough idea by
looking at the insurance depth compared to the potentials in the business, the figure is too
low, which is also agreed by both the insurance board and insurance companies they accuse
government for not doing enough to realize the potentials. Premium collection per capital of
population is quite less not even a dollar.

Upadhyaya, (2001), In his study "Risk and Return on Common Stock Investment of
Commercial Bank in Nepal" has the objectives to evaluate the common stock of the listed
commercial banks in terms of risk and return and to perform sector wise comparison on the
basis of market capitalization from study. Mr. Upadhaya found the common stock of Nepal
Grindlays Bank (Now Standard Chartered Bank) bears the maximum rate of return
(127.84%) and Nepal SBI Bank has minimum (7.77%) rate of return. In the context of
industries or sector, expected return of other sector is highest and manufacturing and
production sector is found least performer. This study had analyzed that "High Risk High
Return" because in this study it has found common stock of NGBL is most risky and Nepal
SBI is least risky. Common stock of Everest Bank is most volatile, common stock of Nepal
Indosuez Bank is the least volatile and common stock of all the commercial banks is
overpriced. Mr. Upadhyaya has recommended for the portfolio construction, to select the
stock that have higher return with not correlated or negatively correlated stocks otherwise
stock can not be diversity risk properly."

Adhikari, (2002), in his thesis “ Risk and Return on Common Stock Investment” is based on
8 listed commercial bank covering nine years from fiscal Year 1992/93 to 2000/01 had tried
to assess the risk and return on common stock o listed commercial banks by financial and
statistical tools. His main objectives of the study are to evaluate common stock of listed
commercial banks in terms of risk and return i.e. expected rate of return, standard deviation
and determine whether the shares of commercial banks in Nepal are over priced or under
priced by using the CAPM. In his study, he found the expected rate of return in the common
stock of BOKL is maximum and common stock of Himalayan Bank Ltd is minimum.
Similarly SCBL has the best common stock for investment because its C.V is the lowest risk
per unit of return. However, HBL has highest risk per unit of return HBL‟s expected rate of
return is lower than market return. According to Beta Coefficient BOKL‟s common stock is
most volatile and SCBL‟s common stock is least volatile. All banks common stock move
positive with market as their betas are positive but SCBL, HBL, SBI & EBL are having
defensive and Nabil, NIB, BOK and NBB have aggressive type of Common Stock. Besides
that all the analyzed commercial bank‟s common stocks are under priced, that means their
stocks value will be increased in near future. Therefore, investors can purchase the common
stock of any Banks.

Bhatta, (2003), in his thesis “Investment in Shares of Commercial Banks in Nepal” had tried
to assess the risk and return on common stocks investment of eight commercial banks (on the
basis of financial and statistical tools). An assessment of Risk and Return Elements using the
data over the period of FY 1996/97 to 2000/01 has been made.

The main objective of his study was to examine the movement of market price of shares, to
find out the relationship between the return on individual shares and return on market and to
determine the shares of commercial banks in Nepal are correctly priced or not. In his thesis,
he finds out that risk return characteristics do not seem to be the same for all the shares
reviewed and the portion of unsystematic risk is very high with shares having negative beta
coefficient. Similarly he found out that most of the shares fall under the category of
aggressive stock( having beta coefficient more than one) while some under the defensive
stock (having beta coefficient 0.99 approximately one) according to the price evaluation, the
study shows that all the banks shares are under priced and hence positively correlated with
market return.

Manandhar, (2005), in his study “A Study of Risk and Return Analysis on Common Stock
Investment” with special reference to six listed commercial banks. The main objective of the
study is to evaluate common stock of listed commercial bank in terms of risk and return and
to perform sector wise comparison on the basis of market capitalization, to identify whether
the share of commercial banks are overpriced, under priced or at equilibrium price, to identify
the correlation between returns of commercial banks, & to construct optimum portfolio from
listed common stock. Major findings of the study are as follows:
 The return is the income received on a stock investment, which is usually expressed in
percentage. Expected return on the common stock of EBL is maximum (44.44%) which is
very high rate of return. in reality this rate exists only due to effect of unrealistic annual
return because of the issues of banks share and increase in share price. Similarly expected
return of the CS of NIBL is found minimum (24.21%).
Risk is the variability of return which is measured in terms of standard deviation on the
basis of S.D. common stock of NSBI is most risky since it had high S.D. and C.S. of NIBL
is least risky because of its lowest S.D. on the other hand, we know that coefficient of
variation is more rational basis of investment decision. Which measures the risk per unit of
return on the basis of CV; CS of NIBL is the best among all banks. NIBL has 1.4977 unit
of risk per 1 unit of return. But CS of SBI has the highest risk per unit return i.e. 3.5495.
Diversification of fund by making a portfolio can reduce unsystematic risk of individual
security significantly. If investors select the securities for investment, which have highly
negative correlation of returns, the risk can be returns of two stocks in highly positive, risk
reduction is not so significant. So, portfolio between the C.S. of same industry cannot
reduce risk properly. In this study, SBI and EBL have negative correlation between their
returns, which is favorable with the viewpoint of the diversification. And all other banks
have positive correlation among their returns. So, the portfolio construction among their
returns. So, the portfolio construction of the common stock of these banks will not
completely reduce any risk, which is not favorable as portfolio construction is concerned.

Research Gap
The previous researchers have conducted their thesis in the similar topic the present
researcher has selected, there is fundamental difference between those and focused only on
the risk and return aspect of selected commercial banks from investors perspectives. This
research has further tried to identify the correlation among returns of the commercial banks
under study which plays a significant role in risk reduction by portfolio construction and
systematic and unsystematic risk has been identified for each bank which is not done by
previous researchers. Most of the previous researches reviewed have been carried out with
less than seven year data. Here, in this research seven year‟s data has been taken for analysis.
Similarly, the number of sample firms takes by the previous researchers is five or more. But
this research has been conducted with reference to three sample firms which give more clear
vision for all the investors who invest in common stock investment of commercial banks
listed in NEPSE. However, almost effort has been put upon to save it from allegation of being
copy of previous research works done in the similar topic.
 CHAPTER – III
RESEARCH METHODOLOGY

3.1 Introduction
Research methodology is the systematic way of solving research problems and which
ultimately refer to the overall research process. It includes research design, sources of data,
analytical tools, and procedures of collection and analysis of data. As most of the data are
quantitative the research is based on the specific models. It is composed of both parts of
technical aspect and logical aspect, on the basis of historical data. Research is systematic and
organized effort to investigate a specific problem that needs a solution. This process of
investigation involves a series of well throughout activities of gathering recording,
classifying, analyzing and interpreting the data with the purpose of finding answer to the
problem. Thus the entire process by which we attempt to solve problems is called research.

The basic objectives of this study are to analyze the risk and return of the selected three
commercial banks namely, Nepal Investment Bank, Nabil Bank and Himalayan Bank
Limited. The content refers to the approach of the research process from theoretical
foundation to the collection and analysis of data. As most of the data are quantitative study is
based on scientific models. It is the compilation of technical aspect and logical aspect on the
basis of the primary and secondary data. Detail research methods are described in following
headings.

3.2 Sources of Data

The data required for the research is collected from the secondary as well as primary sources.
The research is based on recent historical data of last five years. During the study, informal
opinion survey has also been taken with the individual‟s investors, bank officials, staff of
Nepal stock exchange (NEPSE) and Securities Exchange Board of Nepal (SEBO/N). Data
related to the market prices of stocks, market capitalization, movement is taken from the
trading report published by NEPSE, SEBO/N (Website), Annual report of commercial banks
and their financial statement are also collected from the respective sample banks. NEPSE
periodicals, articles and previous research report etc. has also been considered.
3.3 Research Design
Research design is necessary to fulfill the objectives of well-set research. Research design
may be defined as framework, plan and structure far collecting, analyzing and evaluating
data. It deals with the common stocks of commercial banks on the basis of available
information. As the title of the study suggests, it is more analytical and empirical but less
descriptive. The present study is based on descriptive and analytical research design.
Descriptive research design is used to describe the relationship between risk and return from
tables, graphs, trend lines, and figures with basic calculation of present collected data.
Similarly analytical research design is used to analyze the standard deviation, correlation
coefficient, coefficient of variation, beta coefficient, risk premium, expected return, and
average rate of return, of sampled banks. Analytical research design evaluates the present
data clearly. The study has been carried out the five years periods from 15 July 2003 to 15
July 2008.

3.4 Data Collection Techniques

The present study data have been collected from secondary sources for the fundamental
analysis and primary sources has been collected for technical analysis. The annual reports of
commercial banks have been taken. Similarly; NEPSE price and sector price have been taken
from NEPSE. SEBO/N is taken from websites. NRB was visited to collect the Treasury-Bills
rate and banking and financial statistics. After that collected data were recorded in mater
sheet manually then data were entered to spread sheet to work out statistical and financial
analysis ratios. These data are also used to prepare figures and tables. To process the data of
the present study manual and computer based program were used like Microsoft word and
excel.

3.5 Data Analysis Tools

All the data are presented and analyzed to fulfill the objectives developed in the introduction
chapter to illustrate the research. Worksheets and figures have been used for the data
presentation to evaluate risk and returns. Categorically, the present study has used financial
and statistical tools.

3.6 Population and sample

Presently NEPSE has listed 145 companies up to 15 july2007/2008 Total population of the
study is many commercial banks listed in NEPSE which are taken on the basis of listed years
of commercial banks in NEPSE. For research purpose, only three listed commercial Banks
are taken for the study as sample. Himalayan Bank Ltd, Nabil Bank Ltd and Nepal
Investment Bank Ltd are selected for comparative study. These banks have the large volume
of transactions and they also have many branches in different sectors of the country. So, the
large numbers of employees are also involved in commercial banks. Therefore, the present
study could not cover all the employees of selected banks. However, the researcher tried to
cover as many employees as possible.

3.7 Methods of analysis

The collected data are analyzed by using various financial tools, as well as statistical tools,
which are given and defined below.

3.7.1 Financial Tools

3.7.2 Statistical Tools
3.7.3 Test of Hypothesis

3.7.1 Financial Tools

3.7.1.1 Market Price of Stock (P0)
There is single price record available i.e. closing price. Closing price is used as market price
of stock, which has a specific time span of one year and the study has focused in annual basis
while average price represents the price of whole year. Hence, it is very difficult to get
reliable and representative information.

3.7.1.2 Earnings per share (EPS)

Earning refers to the net income after tax of the company. Earning per share (EPS) is the
results of net income after tax dividend by the outstanding number of common shares. It can
be expressed as:
3.7.1.3 Dividend (D)
Dividend is reward to the shareholders for their investment. It can be given in the form of
cash or shares. If a company declares only the cash dividend, there is no problem to take
dividend amount. But if company declare stock dividend (bonus share), it is difficult to obtain
the amount that really shareholder has gained. In case of stock dividend the formula for total
dividend amount is considered as follows:

Total dividend=Cash dividend+ stock dividend%× next years MPS

Where, MPS= Market price per share

3.7.1.4 Price Earning Ratio (P/E Ratio)

This ratio is closely related to the earning of the Yield/earning price ratio. This is computed
by dividing the market price of share by the EPS.

Where,
EPS =Earning per share
MPS= Market price per share

3.7.1.5 Return on Common Stock Investment (Rj)

Income received on investment and any change in market price, the stock return is usually
expressed as a percent of the beginning price of the investment. It is the income received on
investment plus any change in market price. Symbolically,

Where,
Pt = Price of a stock at time t
Pt+1 =Price of a stock at time t+1
Dt =Cash dividend received at time t
Rj= Actual Rate of Return on common stock at time t
3.7.1.6 Expected Return on Common Stock E (Rj) or

Expected return is simply arithmetic mean of the past years return. This is an average return
on common stock. Symbolically,

Where,
E (Rj) = Expected rate of return on stock j
Σ = sign of summation
n = number of years that the return is taken

3.7.1.7 Standard Deviation (σj)

The standard deviation is the one of the measurement tool of the investment risk. It is a
statistical concept which is widely used to measure risk from holding a single asset. It shows
the total risk of a single asset. If higher the standard deviation, there will be large dispersion
of return and is higher the risk of the asset. Similarly if the lower the standard deviation, there
will be small dispersion of return and lower the risk of the asset. It is a statistical measure of
the variability of a distribution of return around its mean. It is the square root of the variance
and measures the unsystematic risk in stock investment. The formula for calculating the
standard deviation is presented symbolically as,

where
n= no. of observation
Rj=possible rate of return
=Average or mean return

=Standard deviation of returns on stock j during the time period n

The variance can also be used to measure risk, which is the square of the standard deviation.
Total risk (σj) can also be defined as the sum of systematic risk plus unsystematic risk.
Systematic risk has its source factors that affect all marketable assets and thus cannot be
diversified away. The sources of systematic risk are market- pervasive. The measure of
systematic risk permits an investor to evaluate an asset‟s required rate of return relative to the
systematic risk of the stock. Unsystematic risk can be reduced through diversification. The
relationships among total risk, systematic risk and unsystematic risk are shown below.

In the equation (ρjm) is correlation coefficient between the returns of a given stock (j) and
return on market portfolio (m).

3.7.1.8 Coefficient of Variation (C.V)

The coefficient of variation is the other useful measure of risk. It is the standard deviation
divided by the expected return, which measures risk per unit of return. The larger the C.V. the
larger the relative risk of the investment. It provides a more meaningful basis for comparison
when the expected returns on two alternatives are not the same. The C.V. is more useful
when we consider investments, which have different expected rates of return and different
levels of risk. (J. Fred Weston and Eugene F. Brigham “Managerial Finance” 1993:10th
edition). The coefficient of variation (CV) is a „relative measure of dispersion‟ that is useful
in comparing the risk of assets with differing expected returns. Higher the coefficient of
variation, greater the risk .It is the ratio of the standard deviation of a distribution to the mean
of that distribution. It is a measure of relative risk. Symbolically,

Where,
E(Rj) = Expected return on stock j
σj = Standard deviation of returns on stock j
C.V =Coefficient of variation

3.7.1.9 Beta Coefficient (β)

Beta (β) measures the individual banks' relative risk portfolio of NEPSE. It helps to measure
the inherent risk in the sampled banks. 'It can be measured by the degree to which the
sampled shares tend to move up and down with the NEPSE'. As beta (β) measures the relative
volatility of a security's return in relation to the market return, it should be measured in terms
of the securities and market covariance and the market's variance. "The beta (β) of security is
the appropriate measure of its risk because beta (β) is proportional to the risk that the security
contributes to the optimal portfolio." Beta (β) can be measured as follows:

Where,
= Beta coefficient of stock j

Covariancej,m = Covariance of return between asset j and the market portfolio m

= Variance of the return on the market portfolio, m

3.7.1.10. Required Rate of Return (Rj)

Required rate or return is minimum expected rate of return needed to induce an investor to
invest his/her money. It is always more than risk- less rate of return. Normally, when an
individual investment is giving higher return, this type of investment is known as under-
priced investment. Such under price investment should be purchased. Similarly if the realized
rate of return is less than required rate of return, it is said to be over-priced asset. Such asset
should not be purchased. If those types of asset are holding, it should be sold immediately.

Rj = Rf + [ E(Rm) - Rf]βj

Where,
Rj = Expected rate of return on a security or asset j
Rf = Risk free rate of return on investment
E(Rm) = Expected Market rate of return
βj = Overall risk in investing in a large market
3.7.1.11. Portfolio Return E(Rp)
Portfolio is combination of two or more securities of assets. The portfolio is the holding of
securities and investment in financial assets i.e. bond, stock. Portfolio management is related
to the efficient portfolio investment in the financial assets. (Analysis is only for two assets
portfolio.) Symbolically,

E(Rp) = WA × E(RA) + WB×E(RB)

Where,
WA = Weight of stock A
WB = Weight of stock B
E(RA) = Expected return on stock A
E(RB) = Expected return on stock B
E(Rp) = Expected return on portfolio

3.7.1.12. Portfolio Risk (σ P )

It is a function of the proportions invested in the components, the riskiness of the components
and correlation of returns on the component securities. It is measured by the combination of
the standard deviation of individual stock return. Symbolically,

For Two Assets Case:

Where,

= Standard deviation of portfolio returns of stock A and B

Cov(RA,RB)= Equivalent representations for covariance of returns between asset A and B

3.7.1.13. Risk Minimizing Portfolio

It is the portfolio with the lowest level of risk in the efficient frontier. It is also called risk
minimizing weight or optimal weight. In two- stock portfolio, the optimal weight to invest in
stock I and j are calculated as follows:
Symbolically,

WA= weight of stock A that minimize the portfolio risk of stock A and stock B
σA = Standard deviation of stock A
σB = Standard deviation of stock B
3.7.2 Statistical Tools
3.7.2.1 Correlation coefficient (ρij)
The correlation is also a measure of the relationship between two assets. It values are limited
between the range of +1 and -1. Correlation and covariance are related by the following
equation.

Therefore,

where,
σi and σj = The standard deviation of returns for assets i and j.
ρij = The correlation coefficient for assets i and j.

There are various causes of correlation and risk condition, which are presented as below:

Perfectly positive correlation (ρij = +1)

Returns on two perfectly correlated stocks would move up and down together and a portfolio
consisting of two such stocks would be exactly as risky as the individual stocks. Thus
diversification does nothing to reduce risk if the portfolio consists of perfectly positively
correlated stock.

Perfectly Negative Correlation (ρij = −1)

Returns on two perfectly negatively correlated stocks would move perfectly together but in
exactly opposite directions. In this condition, risk can be completely eliminated. Perfect
negative correlation almost never found in the real world.

No relationship between returns (ρij = 0)

When the correlation between two stocks is exactly zero, there is no relationship between the
returns; they are independent of each other. In this condition, some risk can be reduced.
Intermediate risk (ρij = +0.5)
Most stocks are positively correlated, but not perfectly. On average the returns on two stocks
would lie on the range of +0.4 and +0.75. Under this condition combining stocks into
portfolios reduces risk but does not eliminate it completely.

3.7.3 Test of Hypothesis

i) Test of significance for a single mean
It is applied for hypothesis testing 1st to test whether there is any significant difference
between average risk of commercial bank with market portfolio or not. If the test is “test of
significance for a single mean”, the test statistic (t) is given by:

where,
n = sample size
s = estimated standard deviation of population parameter which is given as
μ = population mean
X = sample mean
n = total no. of observation

ii) ANOVA in one –way classification:

In one way classification, the effect of any factor is taken into consideration. There are so
many methods to compute F-test, short cut method of computing F- ratio is desirable to use
and steps are as follows:
a) To sum of the values of all the items of all the samples and denote it by T.
b) To calculate the correction factor

Where
N = total no. of items in all the samples
c) To find square of all the items of all the samples and add them together.

d) To find out the total sum of square (SST) by subtracting T2/N from the sum of square of
all the items of the samples.
e) To find out to total sum of square between the samples (SSC) by subtracting T2/N from
the sum of the total divided by no. of item in each samples.
f) To find out to total sum of square within samples (SSR) by
Using SSR = SST - SSC
g) To prepare ANOVA table to compute F
Table3.1
ANOVA Table

h) To make decision if the computed value of “F” is less than its critical value “H0”
is accepted otherwise “H0” is rejected.
 CHAPTER IV
PRESENTATION AND ANALYSIS OF DATA

This Chapter is the main part of the study. With reference to the various readings and
literature review in the preceding chapter effort is made to analyze the recent Nepalese stock
market movement to the listed commercial banks. The chapter focuses on the analysis of data
and presentation of data of the sampled banks. Categorically this chapter has been divided
into two sections. First section deals with the analysis of risk and return on common stocks of
selected bank based on fundamental approach. For this, the required data has been obtained
from the secondary source. Similarly, second section deals with the analysis of risk and return
on common stocks of selected bank from the investors‟ perspective. For this the required data
has been obtained from the primary source. Different table and diagrams are used to make the
result easily understandable.

4.1 Data presentation and analysis based on secondary data

First section deals with the analysis of risk and return on common stocks of selected bank
based on fundamental approach. The study covers ten years period from 15th July 1999 to
15th July 2008. This chapter consists of historical return, average return, coefficient of
variation, standard deviation, correlation coefficient and beta coefficient of sampled banks.
Beta coefficient of banks is used to measure market sensitivity. The standard deviation is
used to measure diversify risk. Similarly, year end return and average return are used to
evaluate the return position of sampled banks. It has demonstrated the figures and table to
analyze the present data.

4.2 Analysis of historical return of sampled banks

The present study includes three commercial banks listed with NEPSE. They are NABIL,
HBL and NIBL and. The study periods covers for five years. To analyze the risk and return
of commercial banks, various return figures and tables has been used. Historical return of
sampled banks is calculated by using dividend per share and closing and opening price of
sampled banks. This chapter also makes the comparative analysis of return of all three
sampled banks.
4.3 Descriptive Analysis of Banks
4.3.1 Nepal Investment bank Limited.
Though the introduction of the Nepal Investment Bank is already given in the previous
chapter, for revision the researcher will introduce further with more information.

Nepal Investment Bank Ltd., the second joint venture bank in Nepal was established in 1986.
It was established in the collaboration with Banque Indosouez, Paris with 50% share holding
and Nepalese financial institution. The overall management used to be handled by foreign
counter part. As at July 15th 2008, the bank had a network of 19 branches. In order to expand
and serve customers through a wider network, the bank is going to expand additional
branches during the FY 2008/09. The bank witnessed encouraging recognition from the
market of the new name and management. We have been able to enhance our services to our
customers by providing them extended banking hours and keeping the bank open for 365
days. The products of the bank, namely Vehicle Financing, Ezee Saving Scheme and Locker
Services, received favorable responses from the market. Bank has been awarded "Bank of the
year 2003 and 2007" by the London-based Financial Times Group's The Banker, making it
the first all Nepal-managed ban ever to receive the award. The bank was judged as the best
bank in Nepal by the Banker's editorial team, which consists of high profile senior business
and banking figures. The bank has implemented its own Financial Switch system, which
provides online transactions from different delivery channels such as ATM, POS terminals.
The bank set another milestone in introducing updated technology by launching an
international "VISA ELECTON DEBIT CARD", the first of its kind in Nepal, which will
provide convenient banking to customers. The card will also give easy access to cash at the
bank's ATMs as well as at other bank's ATMs and payments at merchants'' establishments
having POS terminals. Besides these, the bank effort to introduce updated technology and to
deliver to customers the best service, will in near future, introduce an international Credit
Card (VISA) for which all-preliminary arrangements, namely securing of membership,
approval etc., have alr3ady achieved. Bank expects to launch the credit cards within this
fiscal year and an application has also been forwarded to Master Card for acquiring and
issuing business.
As at July 15th 2008, the number of staff increased to 616 as compared to 514 last years of
which, the number of staff completed more than 10 years of service is 74. To improved the
skills and knowledge of staff, the bank contuses to provide job-related training, both house
and externally.

Table 4.3.1
MPS, Dividend, BVPS, EPS, P/E Ratio and market to Book ratio of NIBL

FY CP BVPS Cash Stock Total EPS P/E Market

(Rs.) (Rs.) DPS DPS DPS (Rs.) Ratio to Data
(Rs.) (Rs.) (Rs.) Book Source:
ratio AGM
2003/04 940 247 15 0 15 51.70 18.18 3.81 Report of
2004/05 800 201 12.5 0 12.5 39.50 20.25 3.98 NIBL
2005/06 1260 240 20 35.46 55.46 59.35 21.23 5.25
2006/07 1729 234 5 25 30 62.57 27.63 7.39 The

2007/08 2450 223 7.5 33.33 40.83 57.87 42.33 10.99 closing
market
price of share is decreased in year 2004/05 and increased in year 2007/08. No stock Dividend
is distributed in 2003/04 and 2004/05. The bank is distributed the cash dividend ranging from
Rs.5 to Rs.20 per share. The total DPS is highest in 2005/06.

Figure 4.3.1
The relationship between closing price, EPS and DPS
The EPS is lowest in 2004/05 and highest in year 2006/07. The price earning ratio which is
used to take the judgment of the firm's performance is highest in 2007/08. The ration is
recorded to change from 18.18 to 42.33. It reflects the investor's expectation about the growth
in the firms earning. But if this ratio declines the management is also interested in the market
appraisal of the firm performance and focus on it to find the causes. The Price Earning ratio
of the Bank has considerable growth. The market to book ratio of the bank ranges from 3.81
to 10.98 in the five year period.

4.3.2 Himalayan Bank Limited

The researcher is providing the further description of the Himalayan Bank. Himalayan Bank
Ltd. is the fourth joint venture bank in Nepal was established in 1991 in collaboration with
Habib Bank Ltd., Pakistan. The shareholding pattern of the foreign counter part is only 20%
whereas the remaining part is financed by promoters group is 51%, Nepalese financial
institute 14% and general public 15%.

Himalayan bank Ltd. was incorporated in 1992 by the distinguished business penalties of
Nepal in partnership with employees Provident Fund and Habib Bank limited of Pakistan.
Bank operation was commenced from January 1993.

As the first commercial bank of Nepal with maximum number of share holding by the
Nepalese private sector. Besides commercial activities, the bank also offers industrial and
merchant banking.
The bank at present has 17 branches working around the country. The bank has a very
expressive plan of establishing more branches in different parts of the kingdom in near
Himalayan Bank's policy is to extend quality and personalized services to its customers as
promptly as possible. All customers are treated with utmost courtesy as valued clients. The
Bank, as far as possible, offers tailor made facilities to its clients, based on the unique needs
and requirements. To extend more efficient services to its customers, Himalayan bank has
been adopting innovative and latest banking technology. This has not only helped the bank to
constantly improve its services level but has also kept prepared for future adaptation of new
technology.

Table 4.3.2
MPS, BVPS, EPS, P/E Ratio & Market to Book value Ratio of HBL
Data
FY CP BVPS Cash Stock Total EPS P/E Market to Sourc
(Rs.) (Rs.) DPS DPS DPS (Rs.) Ratio Book ratio e:
(Rs.) (Rs.) (Rs.) AGM
2003/04 840 246.93 0 20 20 49.05 17.12 3.4 Repor

2004/05 920 239.59 11.5 25 36.58 47.91 19.20 3.84 t of

8 HBL

2005/06 1100 228.72 30 5 35 59.24 18.57 4.81

Closin
2006/07 1740 264.74 15 25 40 60.66 28.69 6.57
g
2007/08 1980 247.95 25 20 45 62.74 31.56 7.99
marke
t price of share is decreased in year 2003/04 and increased in year 2007/08. The Bank is
distributed lowest stock dividend in 2005/06. The firm is distributing the Cash DPS ranging
from 0 to Rs.30 & Total DPS is ranging from Rs. 20 to Rs.45. The market to Book Ratio of
the Bank is ranging from 3.4 to 7.99 in the five year period. The market to Book ratio of 7.99
in the 2007/08 shows that the bank was worth 699% more than the funds the shareholders put
into it whereas at the 2003/04 of review period it was 3.4 which was 240% more than the
funds the shareholders put into it.
Figure 4.3.2
The relationship between closing price, EPS and DPS
Earning per share is lowest in year 2004/05. The P/E ratio is used to take the judgment of
investor or make the base of the Firm's performance. It reflects the expectation of the
investor about the growth in the firm's earning. The P/E ratio is highest in 2007/08 and lowest
in 2003/04. But if this ratio declines the management is also interested in the market appraisal
of the firm performance and focus on it to find the causes. P/E ratio is ranging from 17.12 to
31.56. The bank has medium growth in earnings.

4.3.3 Nabil Bank Limited

The arrival of Nabil Bank in Nepal on the 12th of July 1984 through a joint venture with
Dubai Bank Ltd. under a Technical Service Agreement (TSA) marks a new dawn in the
Nepalese banking industry. What is more admirable is with the opening of then Nepal Arab
Bank Ltd, Customer Service or marketing took a U-turn. That in substance accelerated the
evolution in banking products and services thereafter in Nepal. The bank commenced with a
team of about 50 staff members and Rs. 28 million as capital.
Today Nabil entering the 25th year of operation has proved that it has through its past
progressions and through different phases in the banking industry achieved two things we can
take pride in: first it has large clientele base and supportive stakeholders, secondly, it has
succeeded in positioning itself robustly in the market for which the credit goes to Team
Nabil. Today the Bank has established itself as the Bank of 1st Choice. We are the largest
bank in terms of the network and number of branches amongst the commercial banks with a
wide network of ATMs and offerings including a range of diversified service products. We
have a number of domains in our precedence of excellence that mirrors where we stand in the
market. In this span of 24 years of banking operation Nabil has already distributed rich cash
dividends, spectacular returns on asset and equity even during the most trying times. All of
which endorses the strength and drive with which Nabil proceeds. We, in order to make our
presence felt in every walk of life and serve people across all social strata and segments, have
expanded our network by adding 9 more branches that totals to 28 points of representation in
the nation. We have diversified our realms of business in the interests of our customers and
are also being inspired by the noble cause of adding value to economic development. We
have multiple sectors in focus to serve host of entrepreneurs as our new strategies are to
expand dynamically, exploring new avenues and opportunities. We thus have packaged our
service products into well a diversified range consisting of corporate banking, trade finance,
along with consumer and retail banking services specifically, card products, microfinance and
the like to reach out to the masses. We have been able to reach where we are today having
lived our values of being C.R.I.S.P at all times. We have teamed together, built on our
strengths, taking larger strides as we Surge Ahead Faster – Further together in the years ahead
to be the 1st Choice Provider of Complete Financial Solutions of all our stakeholders.

In the latest annual reports, the Bank has focused to improve its operational efficiency by
upgrading the information capability. Among the many 'firsts' to credit of Nabil, the business
of Credit Cards Issuance and Acquiring is one. It introduced Master Card to the Nepalese
Rupees and US Dollar and also issued Visa Card by introducing Visa Electron. Growing
network ATM facilities are available to account holders. Debit visa cards with PIN numbers
are issued to encourage customers to avail of 24 hours ATM facility. Nabil is the sole
principal agent Bank in Nepal of Western Union Financial Services & facilities transfer of
funds, through an on-line computer system, instantly to or form more than 170,000 locations
in 196 countries and territories. In keeping with the Bank's tradition of providing superior
services to its customers as well as to increase its shareholders' return on investments in the
long term, Nabil has already commenced the implementation of a world class banking
software developed by a world renowned software company. With the activation of this
system in all branches by April 2004, the bank will be able to further enhance its operating
efficiency and offer customer data access and offsite services equal to the offered anywhere.
Besides, the bank has planned to increase ATM service in various branches as well as
upgrade the ATM service with new stitching system so that the customers would be able to
take their money out from any of the ATM service outlets of the bank. This indicates that the
bank has been providing very good working environment for customer services and human
resource development.
 Table 4.3.3
MPS, BVPS, EPS, P/E Ratio & Market to Book value Ratio of Nabil
Data
FY CP BVP Cash Stock Total EPS P/E Market Source:
(Rs.) S DPS DPS DPS (Rs.) Ratio to Book AGM
(Rs.) (Rs.) (Rs.) (Rs.) ratio Report of

2003/04 1000 301 65 0 65 92.61 10.80 3.32 Nabil

2004/05 1505 337 70 0 70 105.49 14.27 4.46

The
2005/06 2240 381 85 0 85 129.21 17.34 5.88
closing
2006/07 5050 418 100 40 140 137.08 36.84 12.08
market
2007/08 5275 354 60 40 100 108.31 48.70 14.90
price of
share is decreased in year 2003/04 & increased in year 2007/08. No stock dividend is
distributed by the bank in Year 2003/04, 2004/05 & 2005/06. The bank has distributed cash
dividend ranging from Rs.60 to Rs.100. The EPS is highest in year 2006/07.
Figure 4.3.3
The relationship between Closing Price, EPS & DPS.

Price Earning ratio is used to measure by the investors to take judgment or make base of the
firm's performance. It shows the expectation of the investor about the growth in the firm's
earnings. The management will also take interest in the market appraisal of the firm's
performance and get attention if this ratio declines. The price earning ratio of the bank is
recorded to be changes from 10.80 to 48.70. Which shows 451% increase over the five year
period? The P/E ratio shows considerable growth in the bank's earnings.
The Market to book ratio of the bank is ranging from 3.32 to 14.90 in the five year review
period. In FY 2003/04 this ratio was 3.32. Which shows the bank worth was 232% more than
the funds the shareholders put into it whereas in 2007/08 it was 14.90 which shows the bank
is worth 1390% more than the funds the shareholders put into it.

4.4 NEPSE (Market)

The expected rate of return on the market is the return on the market portfolio of all the
traded securities. The year ended NEPSE index is used as the market return into account.

Table 4.4.1
NEPSE Index and Annual rate of return

year NEPSE Index Annual Return(R)

2002/03 222.04 __
2003/04 286.67 0.2911
2004/05 386.86 0.3495
2005/06 683.95 0.7680
2006/07 963.4 0.4086
2007/08 746.69 0.2249
Total 1.5923

Figure 4.4.1
NEPSE Index
By the end of fiscal year, the price index of the listed securities is (NEPSE Index) remained at
746.69 points, which is lower than the previous fiscal year by 22.49%. The highest NEPSE
Index is recorded in 2006/07 over the five year review period.

Figure 4.4.2
Expected Rate of Return on market (NEPSE)

The expected rate of return on the market is negative in FY 2007/08 and highest in 2005/06
over the five year review period.

Table 4.4.2
Average rate of return, Variance, standard deviation and C.V. of Market Portfolio

Average rate of return 0.3185

Variance 0.1015
Standard Deviation 0.3186
Co- efficient of variation 1.0003

4.5 Statistical and Financial Analysis of Banks

In this part the historical risk and return is observed. The expected return may be differing
from historical rate of return. According to Alexander, Sharpe & Bailey, "However, despite
the objection, it is worth while to examine historical returns to see how they can be used to
come up will meaningful prediction about the future." To bridge the gap, many researchers
have worked on it, but it is not without objection.

4.5.1 Nepal Investment Bank Ltd.

Table 4.5.1
Statistical and Financial Indicator of NIBL
Required rate of Return 9.24%
Average rate of Return 45.93%
Excess rate of Return 36.69%
Covariance 0.0827
Standard Deviation 50.97%
Co-efficient of Variation 1.1097
Beta 0.8147
Alpha 0.1998
Co-efficient of Correlation 0.5094
Co- efficient of determination 0.2595
Systematic Risk 25.97%
Unsystematic Risk 25.01%
Total Risk 50.98%
The average rate of return of NIBL is 45.93%, which is 36.69% greater than the required rate
of return. The positive excess rate of return implies that the security is under priced. It reveals
that this bank is expected to earn a higher rate of return that is necessary to compensate an
investor for the level of systematic Risk it bears. If an investor holds the shares of NIBL,
obviously he/she will earn 36.69% more return than the proper compensation for the level of
risk, which cannot diversify market risk.

The Beta of NIBL is 0.8147. It reveals that the stock has high degree of positive correlation
with the market (NEPSE). The return of NIBL is less volatile than the market. Due to positive
changes in Beta of the stock of NIBL, the increment of 1% in NEPSE will increase the stock
of NIBL by 0.8147 %. From the viewpoint of volatility, the stock is less volatile than the
market. The stock is therefore can be categorized as defensive stock.
The Alpha (intercept) is 0.1998 or 19.98%. It shows that the return of NIBL is 19.98% even
market return is Zero. From the portfolio management point of view, one can increase the
weight of the stock with positive alpha. The coefficient of correlation of the bank is 0.5094.
This positive correlation indicates that when the market return goes up by 1%, return of bank
also goes up by 0.5094.

Looking at the coefficient of variation, the share of NIBL has risk 1.1097 per unit of return.
Standard deviation measure the total risk of an investment which is 50.97%. Only a portion
of the total risk is rewarded by the bank share's returns and the unrewarded portion of the risk
is the unsystematic risk. Out of the total risk associated with the common stock investment of
Nepal Investment Bank 25.01% of risk is unsystematic risk or diversifiable risk. Systematic
risk or un-diversifiable risk is 25.97% this indicates that total variability in return caused by
market factors that simultaneously affect the price of all securities.

4.5.2 Himalayan Bank Ltd.

Table 4.5.2
Statistical and Financial Indicator of HBL
Required rate of Return 5.63%
Average rate of Return 23.54%
Excess rate of Return 17.91%
 Covariance 0.0150
Standard Deviation 4.10%
Co-efficient of Variation 0.1742
Beta 0.1478
Alpha 0.1883
Co-efficient of Correlation 0.8670
Co- efficient of determination 0.7517
Systematic Risk 4.71%
Unsystematic Risk 0.55%
Total Risk 5.26%
Average rate of return of Himalayan Bank Limited is 23.54%, which is 17.91% greater than
required rate of return. This positive excess return implies that the security is under priced. It
reveals that this bank is expected to earn a higher rate of return that is necessary to
compensate an investor for the level of systematic risk it bears. If an investor holds the shares
of Himalayan Bank, obviously it will earn 17.91% more return than the proper compensation
for the level of risk, which can not be diversified way (market risk).

Beta of Himalayan Bank is 0.1478. It reveals that the stock has positive correlation with the
market (NEPSE). The return of Himalayan Bank is more volatile than the market. As beta of
this stock is measured 0.1478, the positive change in NEPSE. If 1% changes in NEPSE, the
stock will have positive response by 0.1478%. From the viewpoint of volatility, the stock is
more volatile than market. This stock therefore can be categorized as aggressive stock.

The intercept (Alpha) is 0.1883 or 18.83%. It shows that the return of HBL is 18.83% even
market return is zero. From the portfolio management point of view, one can increase the
weight of the stock with positive alpha. The coefficient of correlation of the bank is 0.8670.
This positive correlation indicates that when the market return goes up by 1%, return of bank
also goes up by 0.8670%.

Looking at the coefficient of variation, the share of Himalayan bank has risk 0.1472 per unit
of return. It shows the bank has low risk per unit. Standard deviation measure the total risk of
an investment which is 4.10%. Only a portion of the total risk is rewarded by the bank share's
returns and the unrewarded portion of the risk is the unsystematic risk. Out of the total risk
associated with the common stock investment of Himalayan Bank 0.55% of risk is
unsystematic risk or diversifiable risk. The bank has very low unsystematic risk, which shows
the internal management of Bank is very good. Systematic risk or un-diversifiable risk is
4.71% this indicates that total variability in return caused by market factors that
simultaneously affect the price of all securities.

4.5.3 Nabil Bank Ltd.

Table 4.5.3
Statistical and Financial Indicator of Nabil
Required rate of Return 8.63%
Average rate of Return 35.10%
Excess rate of Return 26.47%
Covariance 0.0455
Standard Deviation 21.34%
Co-efficient of Variation 0.6080
Beta 0.4483
Alpha 0.2082
Co-efficient of Correlation 0.6621
Co- efficient of determination 0.4383
Systematic Risk 14.28%
Unsystematic Risk 12%
Total Risk 26.28%

The average rate of return of Nabil is 35.10%, which is 26.47% greater than the required rate
of return. The positive excess rate of return implies that the security is under priced. It reveals
that this bank is expected to earn a higher rate of return that is necessary to compensate an
investor for the level of systematic Risk it bears. If an investor holds the shares of Nabil,
obviously it will earn 26.47% more return than the proper compensation for the level of risk,
which cannot diversify market risk.

The Beta of Nabil is 0.4483. It reveals that the stock has high degree of positive correlation
with the market (NEPSE). The return of Nabil is less volatile than the market. Due to positive
changes in Beta of the stock of Nabil, the increment of 1% in NEPSE will increase the stock
of Nabil by 0.4483 %. From the viewpoint of volatility, the stock is less volatile than the
market. The stock is therefore can be categorized as defensive stock.
The Alpha (intercept) is 0.2082 or 20.82%. It shows that the return of Nabil is 20.28% even
market return is Zero. From the portfolio management point of view, one can increase the
weight of the stock with positive alpha. The coefficient of correlation of the bank is 0.6621.
This positive correlation indicates that when the market return goes up by 1%, return of bank
also goes up by 0.6621%.
Looking at the coefficient of variation, the share of Nabil has risk 0.6080 per unit of return.
Standard deviation measure the total risk of an investment which is 21.34%. Only a portion of the
total risk is rewarded by the bank share's returns and the unrewarded portion of the risk is the
unsystematic risk. Out of the total risk associated with the common stock investment of Nabil
Bank 12% of risk is unsystematic risk or diversifiable risk. Systematic risk or un-diversifiable risk
is 14.28% this indicates that total variability in return caused by market factors that
simultaneously affect the price of all securities.

4.6 Testing Of Hypothesis

The hypothesis is based on the text of significance for difference of mean (t-test). For this
expected return of selected banks are calculated in following table.

4.6.1 Testing of Hypothesis of Expected Return of NIBL with overall Market Return

For NIBL For Market

Sample size ( ) =5 = 5 Years

Expected Return = 0.4593 = 0.3185

Standard Deviation (S1) = 0.5097 S2 = 0.3186

Null Hypothesis (H0)

= i.e. there is no significance difference between the expected return of NIBL and
overall market.

Alternative Hypothesis (H1)

i.e. there is significance difference between the expected return of NIBL and
overall market.

The test statistics (t) is:

 Where,
= Expected returns of common stocks of NIBL.

= Expected returns of common stocks of market.

= = No. of years in Sample.

s2 = Estimated variance of Population.

:. s2 =

= 0.1806

= Variance of common stock of NIBL.

= Variance of market return.

:.

= 0.5239

Degree of freedom = = 5+5-2 = 8

Level of Significance = 5%
The tabulated value of t at 5% level of significance and 8 degree of freedom is 2.306.

Decision:
Since the calculated value of't' is less than the tabulated value. The null hypothesis is
accepted at 5% level of significance i.e. there is no significance difference between the
expected return of NIBL and overall market rate of return.

4.6.2 Testing of Hypothesis of Expected Return of Nabil with overall Market Return
For Nabil For Market
Sample size ( ) =5 = 5 Years

Expected Return = 0.3510 = 0.3185

Standard Deviation (S1) = 0.2134 S2 = 0.3186

Null Hypothesis (H0)
= i.e. there is no significance difference between the expected
return of Nabil and overall market.

Alternative Hypothesis (H1)

i.e. there is significance difference between the expected return of Nabil and
overall market.

The test statistics (t) is:

Where,
= Expected returns of common stocks of Nabil.

= Expected returns of common stocks of market.

= = No. of years in Sample.

s2 = Estimated variance of Population.

:. s2 =

= 0.0735

= Variance of common stock of Nabil.

= Variance of market return.

:.

=0.1895
Degree of freedom = = 5+5-2 = 8
Level of Significance = 5%
The tabulated value of t at 5% level of significance and 8 degree of freedom is 2.306.
Decision:
Since the calculated value of 't' is less than the tabulated value. The null hypothesis is
accepted at 5% level of significance i.e. there is no significance difference between the
expected return of Nabil and overall market rate of return.

4.6.3 Testing of Hypothesis of Expected Return of HBLwith overall Market Return

For HBL For Market
Sample size ( ) =5 = 5 Years

Expected Return = 0.2354 = 0.3185

Standard Deviation (S1) = 0.0410 S2 = 0.3186

Null Hypothesis (H0)

= i.e. there is no significance difference between the expected return of HBL and
overall market.

Alternative Hypothesis (H1)

i.e. there is significance difference between the expected return of HBL and
overall market.

The test statistics (t) is:

Where,
= Expected returns of common stocks of HBL.

= Expected returns of common stocks of market.

 = = No. of years in Sample.

s2 = Estimated variance of Population.

:. s2 =

= 0.0516

= Variance of common stock of HBL.

= Variance of market return.

:.

= -0.5784

Degree of freedom = = 5+5-2 = 8

Level of Significance = 5%
The tabulated value of t at 5% level of significance and 8 degree of
freedom is 2.306.

Decision:
Since the calculated value of 't' is less than the tabulated value. The null hypothesis is
accepted at 5% level of significance i.e. there is no significance difference between the
expected return of HBL and overall market rate of return.

4.7 Major Findings of the Study

From the risk perspective, standard deviation, variance, co-efficient of variation is calculated
though beta is taken as an indicator to measure the relative risk of the individual stock to the
market.
 Table 4.6.1
Major statistical and financial indicators of sample Banks
Indicators Nepal Investment Bank Nabil Bank Himalayan Banks
Covariance 0.0827 0.0455 0.0150
Standard Deviation 0.5097 0.2134 0.0410
Co-efficient of Variation 1.1017 0.6080 0.1742
Beta 0.8147 0.4483 0.1478
Alpha 0.1998 0.2082 0.1883
Co-efficient of correlation 0.5094 0.6621 0.8670
Co-efficient of Determination 0.2595 0.4383 0.7517
Total Risk 50.98% 26.28% 5.26%
Systematic Risk 25.97% 14.28% 4.71%
Unsystematic Risk 25.01% 12% 0.55%
Required rate of return 9.24% 8.63 5.63
Average rate of return 45.93% 35.10 23.54
Excess rate of return 36.69 26.47 17.91

From the above table the realized rate of return are not equal to the calculated required rate of
return. This analysis shows that the entire Bank's stock required rate of return is less than
average rate of return of individual stock. The stocks with higher realized ate of return than
the required rate of return are under priced and the prices of stocks will increase in the market
that is striving toward the equilibrium. The above table shows that all of the three Banks are
under priced.

Table 4.6.2
Maximum and Minimum Rate of Return of individual stocks and market (NEPSE)
during the review period.

Fiscal Year NIBL Nabil HBL NEPSE

2003/04 2.87%
2004/05 -13.56% 57.50%
2005/06 139.43% 76.80%
2006/07 61.82%
2007/08 6.44% -22.49%

All the socks' return has positive correlation with the market rate of return. The correlation
with the stock of HBL is highest and the stock of NIBL has lowest in the period of review.
All three Banks have beta co-efficient less than one. So these are called defensive stock. It
indicates that share is less risky than the market. All the stocks have positive value of 'Alpha',
so these stocks can generate income even market does earn nothing.

Maximum return of NIBL is 139.43% under the review period of 2005/06 whereas in the
same period NEPSE has lowest return i.e. 76.80%. In 2007/08 of review period the NEPSE
has negative return of -22.49% whereas Nabil Bank has positive return of 6.44%. In 2004/05
of review period NIBL has negative return of -13.56%, whereas Nabil has positive rate of
return of 57.50%.

Based on the standard deviation of the returns of stocks, the stocks of NIBL can be
considered as high- risk securities. The HBL has lowest risk with comparison of other two
banks. However the realized rate of return are not the same and in such case the used of
standard deviation may not provide meaningful basis for measuring risk. Looking at the co-
efficient of variation, the stocks of HBL has lowest risk per unit of return, the highest being
with the stock of NIBL. The systematic part of the total risk is due to the individual stocks
correlation co-efficient with the market portfolio. All the stocks have systematic risk less than
total risk. Only a portion of the total risk is rewarded by the bank share's returns and the
unrewarded portion of the risk is the unsystematic risk. The systematic risk is highest in
NIBL and lowest in HBL.

CHAPTER V
 SUMMARY, CONCLUSION AND RECOMMENDATION

For this chapter the researcher has focused to effort first to present summary of major
findings and conclusion drawn from the analysis. Last step proceeds with the
recommendation.

5.1 Summary
Nowadays the business age is a globalization and competitive age. Therefore, the business
world of today is very different from the past. The changing life style of people has also
changed their desires and needs. Due to this, WTO has also given more fluctuation and
opportunities in the business. Due to development of technology and different opportunity,
today‟s business is more developing than the past. Investors are also aware of how and where
to invest their capital. So, no investors want to invest their capital on risky assets unless they
are fully assured that investment is safe for the future. There are different types of investors
with their nature. According to the risk bearing capacity some are risk seeking, some are risk
averse and some may be neutral. Risk is the fact of life and return is reward for bearing risk.
Risk plays a central role in the analysis of investment. Higher risk give higher return and the
trade off between the two assumes a linear relationship between risk and return.

The risk and return relationship is described by investor's perception about risk and their
demand for compensation. The investor won't like to invest in risky assets unless one is
assured of adequate compensation for the acceptance of risk. In investment analysis, risk
plays a major role. The trade off between risk and return can be aided by financial ratios too.

It can be said that the rate of return on investment of many factors including the real cost of
money, inflation risk, maturity risk, default risk etc. The investors willingly offer more
capital at higher rate of return whereas users of capital always show their readiness to use
more capital at lower rate.

The stock market is one of the parts of capital market. It is getting high attention not only for
the professional or institutional investors but also for the private investors. Capital market
plays an important role in the economic development by the process of collecting, saving and
stimulating capital formation. The efficient Capital market can be developed by gearing up
saving and create suitable investment atmosphere as well as sound corporate culture. The
possible well developed capital market takes better advantage of opportunities. The Nepalese
capital market is not well developed however its performance Is showing a gradual
improvement to providing investors the opportunity to participate in primary and secondary
market activities. Through the stock market investment is assumed as the least understood,
investor's attitude towards financial investment has been increasing and the demand is high
especially for common stock.

Common stock is known to be the most risky security and life blood of stock market. An
investment in common stock of corporate firm neither ensures an annual return nor ensures
the return of principal. To invest in common stock, it is very sensitive on the aground of risk.
Dividend to common stockholders is paid only if the firm makes an operating profit after tax
and preference dividend. The company can return the principal in case of its liquidation only
to the extent of the residual assets after satisfying to all its creditors and preferential
shareholders.

The test of hypothesis shows the relationship between individual stock's return and market
return but won't show exactly what it means. There are no sources to get perfect information
about the future regarding risk and return of investment in Nepal. But it is difficult to have
perfect analysis. The main objectives of the study is to analyze the risk, return and other
relevant variables that help in marking decision about investment on securities of the listed
commercial Banks in Nepal. Thus listed three commercial banks are taken as sample to
analyze the risk and return in common stock investment. The brief review of related studies
has been performed, while analyzing the risk and return. Scientific methods are used in data
analysis and tables, figures are used to represent the results. Secondary data are collected
from NEPSE, SEBO/N, and Annual Reports of related Banks, NRB and websites.
Conclusions of analysis and recommendations are drawn as follows.

5.2 Conclusions
The study made on risk analysis of common stocks of listed three commercial banks is based
on secondary data from fiscal year 2003/04 to 2007/08. In this study, expected rate of return
of NIBL‟s stock is highest i.e. 139.43% in commercial banks. Like wise in terms of standard
deviation, NIBL has the highest risk i.e. 50.97%. But, generally standard deviation is not used
to determining risk, as there may be different expected return. Therefore, the coefficient of
variation is considered as the best mechanism to measure the risk. On the basis of C.V.
NIBL‟s stock seems to be the most risky with 1.1017. The Beta of NIBL is highest i.e.
0.8147. The Beta is also the symptom of systematic risk. The Alpha (intercept) is highest i.e.
0.2082 in the Nabil. It shows it earns 20.82% more than market even market doesn't hold. On
the other hand; it is found that the required rates of return of all the above-mentioned banks
are lower than its expected rate or return. It means that all the sample institutions stocks are
under priced. Similarly, the study made to analyze the diversifiable and undiversifiable risk
reflects that all the samples stock except have high systematic risk. And such risk cannot be
diversified on minimized. This type of stock is known as aggressive stock. Thus, it is
reflected format he above study that has the highest unsystematic risk, which can be
minimized or eliminated. Such type of stock can be mentioned as defensive stock.
Correlation between the stock in HBL and Market (NEPSE) is highest positive of 0.8670 and
lowest positive in NIBL with market of 0.5094.

5.3 Recommendations
Above conclusions have prescribed following recommendations.
1. There is unimaginary relationship between required rates of return and expected rate of
return of securities of sampled banks'. Excess return of banks is more than 15 percent,
which one may not be realistic. So, all the investors are recommended to conduct
technical analysis as well as fundamental analysis to know the correct price of common
stock. Technical analysis reveals stock‟s future performance based on the market price
trend and investors‟ future expectation.
2. The rate of return of common stocks of commercial banks is highly sensitive to market.
Some are highly positively correlated and some has moderately correlated to the market.
So, market should be further analyzed by the investors to balance the risk and return
properly.
3. Generally, it is believed that higher the return, higher will be the risk. Investment risks
are better covered through a large and diversified portfolio. Diversifying an investment is
a way of reducing the risk. Here, all the risky sampled banks are recommended to
diversify their investment policy in less risky securities.
4. The result of correlation between risk and return is insignificant. The result is
unsatisfactory because the sample size of the study is too small and the data for the study
is used from annual report and website which may not be sufficient so it is suggested that
for the further researcher will recommend including sufficient sample size.
5. If investor is risk averter, it is recommended him or her to invest in HBL and if investor
is risk seeker, then suggested to invest in NIBL.
6. Nepalese investors are requested to develop an appropriate basis for their investment on
common stock as per the requirement. They are recommended to invest their fund by
performing multiple analyses.
7. As risk and return are positively correlated they are requested to assess these factors as
an important and recommended to analyze these factors with different financial tools and
techniques.
8. All investors are recommended to put adequate consideration on risk and return factors
while making investment on common stocks of commercial banks. They are requested to
follow not only a few factors like market price per share, goodwill and image of
commercial banks, dividend policy and market rumor etc.
 BIBILOGRPHY
Adhikari, D. (2002), “Risk and Return on Common Stock Investment”. An Unpublished
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Websites Date
www.hbl.com.np. FY 2002/03 to 2007/08
www.nabil.bank.com. FY 2002/03 to 2007/08
www.nepalstock.com. FY 2002/03 to 2007/08
www.nibl.com.np FY 2002/03 to 2007/08
www.nrb.com.org FY 2002/03 to 2007/08
 APPENDIX - 1
NEPSE(MARKET)
FY NEPSE INDEX Rm Rm-E(Rm) [Rm-E(Rm)]2
2002/03 222.04 ___
2003/04 286.67 0.2911 -0.0274 0.0080
2004/05 386.86 0.3495 0.0310 0.0010
2005/06 683.95 0.7680 0.4495 0.2021
2006/07 963.4 0.4080 0.0901 0.0081
2007/08 746.69 -0.2249 -0.5434 0.2953
1.5923 0.5073
Expected rate of Return on Market[E(Rm)] = 1.5923/5=0.3185
Variance of Market return = 0.1015
Standard Deviation of market return( = 0.3186
Co-efficient of variation(C.V.) = 0.3186/0.3185= 1.0003
 APPENDIX - 2

NABIL BANK LIMITED

FY C.P. DPS

2002/03 740 __ __ __ __ __

2003/04 1000 65 0.4392 0.0882 0.0078 -0.0024

2004/05 1505 70 0.5750 0.2240 0.0502 0.0069

2005/06 2240 85 0.5449 0.1939 0.0376 0.0872

2006/07 5050 140 0.1317 -0.2193 0.0481 -0.0198

2007/08 5275 100 0.0644 -0.2866 0.0821 0.1557

1.7552 0.2258 0.2276

Expected Rate of return E(Rj) = 1.7552/5 = 0.3510

Variance of Return = 0.2258/5 = 0.0452

Standard Deviation ( = = 0.2134

Co-efficient of Variation (C.V.) = =0.6080

Covariance(j,m) = = 0.0455

Beta(β) = =0.4483

Alpha(α) = 0.3510 – 0.4483 ×0.3185= 0.1883

Systematic Risk(SR) = = 0.1428

Unsystematic Risk(USR) = 0.2134(1-0.6621) = 0.12

Correlation Co-efficient(r) = = 0.6621

Co-efficient of Determination( = 0.4384

 APPENDIX - 3

HIMALAYAN BANK LIMITED

FY C.P. DPS

2002/03 836 __ __ __ __ __

2003/04 840 20 0.0287 -0.2067 0.0427 0.0057

2004/05 920 31.5 0.1328 -0.1026 0.0105 -0.0032

8

2005/06 1100 35 0.2337 -0.0017 0.000003 -0.0008

2006/07 1740 40 0.6182 0.3828 0.1465 0.0345

2007/08 1980 45 0.1638 -0.0716 0.0051 0.0389

1.1772 0.2048 0.0751

Expected Rate of return E(Rj) = 1.1772/5 = 0.2354

Variance of Return = 0.2048/5 = 0.4096

Standard Deviation ( = = 0.0410

Co-efficient of Variation (C.V.) = = 0.1748

Covariance(j,m) = = 0.0150

Beta(β) = = 0.1478

Alpha(α) = 0.2354 – 0.1478 ×0.3185 = 0.1883

Systematic Risk(SR) = = 0.0471

Unsystematic Risk(USR) = 0.0410 (1 - 0.8670) = 0.0055

Correlation Co-efficient(r) = = 0.8670

Co-efficient of Determination( = 0.7517

 APPENDIX - 4

NEPAL INVESTMENT BANK LIMITED

FY C.P. DPS

2002/03 795 __ __ __ __ __

2003/04 940 15 0.2013 -0.2580 0.0666 0.0071

2004/05 800 12.5 -0.1356 -0.5949 0.3539 -0.0184

2005/06 1260 655. 1.3943 0.9350 0.8742 0.4203

46

2006/07 1729 30 0.3960 0.0633 0.0040 -0.0057

2007/08 2450 40.8 0.4406 0.0187 0.0003 0.0102

3

2.2966 1.2990 0.4135

Expected Rate of return E(Rj) = 2.2966/5 = 0.4593

Variance of Return = 1.2990/5 = 0.2598

Standard Deviation ( = = 0.5097

Co-efficient of Variation (C.V.) = =1.1097

Covariance(j,m) = = 0.0827

Beta(β) = = 0.8147

Alpha(α) = 0.4513 – 0.8147 ×0.3185 = 0.1998

Systematic Risk(SR) = = 0.2597

Unsystematic Risk(USR) = 0.5097 (1-0.5094) = 0.2501

Correlation Co-efficient(r) = = 0.5094

Co-efficient of Determination( = 0.2595