RISK AND RETURN ANALYSIS OF COMMERCIAL BANKS OF NEPAL

A THESIS PROPOSAL

Submitted By:

ANUSHRUTI SILWAL

Pashupati Multiple Campus

T.U. Regd. No: 7-2-424-3-2012

Exam Roll No: 3450/17

Campus Roll No: 19

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 (MBS)

Kathmandu, Nepal

November, 2019

1
TABLE OF CONTENTS Page No.

CHAPTER-I: INTRODUCTION

1.1 Background of the Study 3

1.2 Brief Profile of the Banks 7

1.3 Focus of the Study 8

1.4 Statement of the Problem 10

1.5 Objective of the Study 11

1.6 Significance of the Study 12 12

1.7 Limitation of the Study 1212

1.8 Organization of the Study 13 13

CHAPTER-II: RESEARCH METHODOLOGY

15
2.1 Research Design
15
2.2 Population and Sample
15
2.3 Data Collection Procedures
16
2.4 Nature and Sources of Data
16
2.5 Method of Data Analysis
17
2.6 Data Analysis Tools

2
 CHAPTER – I
INTRODUCTION

1.1Background of the study Economic growth is the major force for the
development of the country and economic development is jointly determined by
various factors. Industrialization is one of the most important factors for economic
development of any country. This statement is justified by the size and quality of
the economy of the present industrialized nations.

Nepal is an agriculture dependent country whose economic status is very poor.

Depending upon only on the agriculture, Nepal could not solve the problem of
poverty. So, the non- agricultural sectors should also be given priority. The non –
agricultural sectors can also help in the economic development and problems of
employment can be solved to some extent. Hence, for this, various industries,
financial institutions, health and educational enterprises should be established.
But establishment of such institutions is not sufficient for the economic
development; their successful operation is also necessary. For successful
operation, finance is needed for each organization. Finance is the art and science
of managing money, which is concerned with the process, institutions, markets
and instructions involved in the transfer of money among and between
individuals, business and government. The proper decision made by top
management related to the management of funds, determines the future of the
organization. Investment decisions, financing decisions, and assets management
decisions related to finance.
The top management decision related to finance is based on financial analysis.
Financial analysis is the tool of decision making and covers the acquisition,
utilization, control and administration of funds. Such type of study and analysis is
performed through managerial finance. Managerial finance is the part of finance,
which is concerned with the duties of the financial manager in the business firm.

3
“Managerial is the important in all types of business whatever they are public or
private, deal with financial services or manufacturers. The type of jobs one
encounters in managerial finance range from decision regarding plant expansion
to choosing what types of securities to issue to finance expansion”( weston &
Brigham , 1996:5).

Today the field of finance is broad and dynamic. Various tool of analysis for
acquisition of funds and effective utilization have been developed. The stock
market is one of the leading sectors of company concerned with finance. After
developing the finance as a separate discipline in 1900 A.D. the scope of finance
has developed considerably. Today capital market have been established for
raising the funds from issuing the securities both primary and secondary markets
have been established for stock exchange.

Investors purchase the securities for getting returns. So, return is the main factor
of investment but it involves risk. It can be said that risk and return are the main
factors of investments. Finance deals with the risk and return on the monetary
terms of an investment. Return is the reward for waiting and compensation for
risk bearing. Though it is said that the “higher the risk, higher will be the return”.
Instead research shows that most of the investors are risk averter. They fear to
bear higher risk. So, it can be concluded that people invest their belongings in
those opportunities where there is higher return with low level of risk.

“Risk is defined in Webster’s Dictionary as a hazard; pearl; exposure to loss or

injury” (Ibid,:182) .

So, risk refers to the chance that some unfavorable event will occur. Risk is the
product of uncertainty whose magnitude depends upon the degree of variability in
uncertain cash flows. Most people view risk in the manner as just described a
chance of loss. In reality, risk occurs when the outcomes of a particular activity or
event can not be ascertained.

4
Common stock investment is a risky investment. There is the uncertainty of future
return whose main source is the price fluctuation of the stock. The stock price
may be decreased due to the economic factors such as inflation, interest rates,
strength of dolor, economic growth of the nation etc. The stock prices are also
affected by political and legal environment of the nation. The dividend received
by the investors directly contributes to the return received by the investors but at
the same time reduces the amount of earnings re – invested by the firm resulting
limited potential growth. So, mainly the risk of a stock investment can be
measured by price volatility and degree of uncertainty of dividend fluctuation.

As already mentioned that most of the investors are risk averse, the main problem
in investment is to select the security having low risk but having high return. Even
the investors cannot increase the return substantially they can reduce the risk by
diversification of the investment funds in different types of securities making a
portfolio. Making a portfolio of common stocks an investors can eliminate the
unsystematic risk considerably. But the systematic risk cannot be avoided even
investing in a portfolio. Any investors will want their investment to yield
favorable return and so they invest in those securities which provide greater
expected returns. Investment is defined as the sacrifice of current amount in
securities in anticipation of higher future benefits but want to bear low amount of
risk.

In the investment of common stock an investor agrees to pay the price for stock in
the anticipation of future dividend and growth in stock price. But various financial
and non – financial factors play a great role in price determination even the
imperfect market.
A financial market begins together people and organization that want to borrow
money with those having surplus funds. The capital market is the part of financial
market, which is related to long term debt and corporate stocks, i.e. in capital

5
market the financial assets such stocks and bonds are purchased or sold. The main
objective of such markets is to create opportunity for maximum number of people
to get benefit from the return obtained by directly the economy towards the
productive sectors by the stocks mobilizing long – term capital. The objectives is
fulfilled by the stock market providing various opportunity in investing various
stock of companies. Stock market is a financial market, which probably has the
greatest glamour is perhaps the least understood. Some observers consider it as a
legalized heaven for gambling and many investors consider stock market
investing as a game is which the role purpose is picking winners. The organized
stock exchange buys the securities of large business 50firms for the general public
where the transaction of only listed companies, are made. Where as in the over the
counter markets the stocks of the companies not listed in the stock exchange are
traded. Without the development of financial market the proper choice of
securities for investment is impossible. Mainly the financial market comprises of
money market and capital market. Money markets are the markets for short –
terms debt securities, which mature in less than one year such as 90 days treasury
bills issued by Nepal Rastra Bank. markets are the markets for long – term debts
and corporate stocks. The financial markets are classified into primary market and
secondary market on the basis of economic function. The market for new
securities is called primary market. In primary market, the shares are offered to
general public for the first time. In secondary market, the existing shares i.e. the
shares that have already been purchased by the public in primary market and
traded again and again.
In Nepal the institutional development of stock market began after the
establishment of ‘security Exchange Center’ in 1976 A.D. Now it is called Nepal
Stock Exchange Limited. But there are various problems for the development of
stock markets in Nepal even after the establishment of Nepal Stock Exchange
Limited. The main problem is that the lack of knowledge and information about
stock investment due to which the market intermediaries exploit investors. The
interested investors also gets afraid to invest in stock and the investors who are
investing in stocks are found to invest in a single security due to lack of ability to

6
analyze risk and return and low level of knowledge about the portfolio
investment. So, in Nepal proper information about the stock investment should be
provided to participate people in stock investment because the dynamic trading of
stocks may play an important role in economic development of the nation. To
exist the security market their mechanism should be created t makes easy the
exchange of securities.

“Security markets exist in order to bring together buyers and sellers of securities
meaning their mechanisms are created to facilitate the exchange of financial
assets” (Sharpe,et al.,(2003:9).

1.2 Brief profile of the banks

Himalayan Bank Ltd. (HBL)
Himalayan Bank Ltd. was established in 1993 A.D. It is the fourth joint venture bank in
Nepal, in partnership with employees' provident fund and Habib Bank Ltd. One of the
largest commercial bank of Pakistan. HBL is the first joint venture bank managed by
Nepalese Chief Executive. Beside commercial banking services, the bank also offers
industrial and merchant banking services. Himalayan bank limited has always been
committed to provide quality service to its customers with a personal touch. The bank
has also planned to adopt real banking technology and already offers unique service
such as SMS banking, internet banking and ATM service etc. Himalayan bank was listed
NEPSE in 1993 A.D.

Machhapuchchhre Bank Ltd. (MBL)

Machhapuchchhre Bank Limited (MBL) was registered in 1998 as the first
regional commercial bank from the western region of Nepal and started its
banking operations from Pokhara since year 2000. The bank facilitates its
customer needs by delivering the best of services in combination with the latest
state of the art technologies and prudent international practices. The bank is the
pioneer in introducing the latest technology in the banking industry in the country.
It is the first bank to introduce centralized banking software,

7
GLOBUS BANKING SYSTEM of Temenos, Switzerland. The bank provides
modern banking facilities such as Any Branch Banking System (ABBS), mobile
banking, safe deposit locker facilities, utility bills payment (telephone and
mobile), ATM (VISA debit cards) to its valued customers. Besides these, the bank
is providing 365 days banking and evening counter services to the customers
through many of its offices. The bank has been promoted by highly renowned
non-residential Nepalese, prominent business man and industrialists with a vision
and dedication to provide the best financial products and services in the most
efficient and professional manner. Now with a paid up capital of over 8.46 billion
rupees, 159 branch offices, 5 extension counter, 133 branchless banking units and
198 ATMs spread all across the country, it is one of the full-fledged national level
commercial banks operating in Nepal. It takes pride in having its own buildings
for its head and corporateoffice in Lazimpat, and branch offices in Naya Bazar
Pokhara, Jomsom, Baglung and
Damauli.

1.3 Focus of the study

Amongst the various securities this study has been focused on common stock of
commercial banks “Common stocks are securities that represent the ultimate
ownership (and risk) position in corporate”(Van Horne,et al.,2001:75).
This time, in Nepalese market there are 27 commercial banks are operated with huge
amount of capital among them I had been using as reference two commercial banks like

“Common stocks represent a commitment on the part of corporation to pay

periodically whatever its board of directors seems appropriate as cash dividend”(
Alexander & Bailey 2003 :5).
From these quotations it can be concluded that common stock holder of a
company assuming that ultimate risk is associated with ownership. The investors

8
invest in common stock expecting higher return but this expectation may or may
not change into reality, so it is a major risk in stock market investment. Due to
this reason the common stock is known as risky security. From overall studies it
can be concluded that in Nepal there is a problem in systematic information
between management of Nepalese companies and Nepalese investors dues to
which there is restriction in the development of stock markets in Nepal.

Banking sectors in Nepal are the most dynamic part of national economy. So, if
there are insufficies of banking and financial facilities the growth of the economic
development becomes very slow. Commercial banks collect unused funds and
mobilize it in needed sectors. It is the heart of trade and commerce. “Commercial
bank exchange money, accepts deposits, grants loans, and performs other
commercial bank functions and is not a bank meant for cooperative, agriculture,
industrial as per specific function.”(Commercial banks act 2031 B.S.) The main
objective of a commercial bank is to earn profit by proper mobilization of
resources.

The history of modern banking in Nepal was began in 1953 A.D., when Nepal
bank limited was established as a first bank of Nepal. It become public limited
company in 1953 A.D. later, in 1955 A.D., the first central bank, Nepal Rastra
bank was established which supervises, protests and directs the function of
commercial banking activities. In 1966 A.D Rastra Banijya bank was established
as a commercial bank which is fully owned by his majesty’s Government. When
government adopted the policy of the globalization and liberalization, several
financial and institutional Exchange which have highest contributions on the
market capitalization compared to others sectors. In Nepal, foreign joint ventures
banks perform better than Nepalese banks because their higher managerial
efficiency and capacity of proper management of risk. Nepalese bank have a high
degree of firm-specific risk,. Recently, two Nepalese banks Nepal bank limited
and Rastra Banijya Bank have been managed by foreign management groups but
no considerable performance have fund for the period of one year of management

9
of transfer. However, Nepalese banks have high to increase their risk attitude and
improving their internal management.

1.4 Statement of the Problems

The study “Risk and return Analysis” occupies an important place in the theory of
finance. Lack of knowledge about risk and return is the main cause of
manipulation by the financial institutions of the stock holders to the investors.
Investors attitude and perception towards stock investment is not good in
Nepalese stock market. So they feel more risk in stock investment than as its real
risk. The academicians also cannot analyze risk and return properly about the
corporate, its financial position and about the stock market because investors are
the main bases of any company and stockholders. Investors are the primary source
of revenue as a customer for the stockholders and financial intermediaries. But in
Nepal, there are no any separate institutions providing adequate information to
investors about the stock market. It seems necessary to establish separate entity,
which may accelerate the stock investment and market efficiency.
To invest in stocks one should know what the accurate price if the stock is for this
the theoretical knowledge as well as market condition should be known clearly
about the determinants of stock prices. According to the theory of stock price,
stock price in market guided by the intrinsic value, which is calculated with the
inputs- dividend, required rate of return of investors and growth in dividends, the
stock prices are assumed to remain in security market line. And if ti is not so, they
strive towards this line and come to the equilibrium. If the expected rate of return
if investors are not equal in such case the price of stock may be over priced or
under-priced. Hence, the location of expected rate of return may lie above or
below the security market line. The stocks firstly traded in the primary market by
the issuing corporation and these securities are traded in the secondary market by
the investors and stockholders. Since common stocks do not guarantee for
dividends and capital gain, it needs courage to invest on it. For the guarantee of
return a proper analysis of risk and return should be performed to the prevailing
market atmosphere. The major problems identified in this study are:

10
  What are the evaluation criteria for investing in the stock to get favorable
return?
 How the return is measured? How can higher return be achieved assuming
lower risk?
 What kind of relationship (Positive or Negative) exists between dividend
and stock prices?
 What are the determinants of stock prices?
 How the investors know the magnitude of risk?
 How much is the compensation for waiting and risk bearing?
 Does portfolio investment reduces the risk? What is the proper weight of
stocks in portfolio?
 What sort of risk exist in the stock investment of Nepalese commercial
banks?
 What kind of return exits in the stock investment of Nepalese commercial
banks?
1.5 Objectives of the study
The study is undertaken to focus on the risk and return on common stock
investment of Nepalese commercial banks. So, general level objective of this
study is to access the risk and return on common stock investment of commercial
banks. The specific level of the study are :
 To study and analysis various aspects of return and risk of common stock
investment.
 To evaluate the common stock of listed commercial banks in terms of risk
and return.
 To find out overpriced, underpriced and correctly priced (Equilibrium
priced) common stocks of commercial banks.
 To identify the covariance and correlation between the returns of common
stock of commercial banks.
 To examine the relationship between dividend and market price of stock
with the risk and return.

11
  To provide appropriate suggestions.

1.6 Significance of the study

This study has been beneficial for the entire person who is interested to know
about the capital market and commercial bank. The study suggests for a careful
judgement of risk and return relationship and also about systematic and
unsystematic risk of commercial banks. This study gives information about
Nepalese capital market analyzing risk and return. It also contributes to increase
the analytical power of the investors in capital market.

1.7 Limitation of the study

Since, the study is focusing to fulfill the partial fulfillment for the requirement
course of MBS of T.U. It has some limitations. We have limited resources and
may be difficult to explore researcher to find out new aspect. Reliability of
statistical tools used and lack of research experience are the major limitation and
some other limitations can be enlisted as follows:

 In some extent, the data published on website of related banks has been
taken.
 The study covers the relevant data and information only for 5 years.
 Time and finance constraints are also major limitation of the study.
 The secondary data is used to analyze and interpretation for result. So the
accuracy of the finding depends on the reliability of available information
 No comparison has been made with other commercial banks.

1.8 Organization of the Study

Some preliminary pages have been incorporated in the beginning of the report that
contains list of tables, list of abbreviations and list of contents. The study has been

12
organized into five chapters. Each chapter is developed to some aspects of the study risk
and return analysis of HBL and MBL. The title of each chapter is as follows:

Chapter-I: Introduction

The first chapter deals with the subject matter consisting introduction of the selected
banks, background of the study, statement of the problem, objective of the study,
significance of the study, limitation of the study and organization of the study.

Chapter-II: Review of Literature

The second chapter is mainly focused with literature review that includes a discussion
on the conceptual framework on risk and return of commercial banks and review of
major – studies relating with financial decision. It will include the review from books,
journals, thesis and independent studies.

Chapter-III: Research and Methodology

The third chapter describes the research methodology used to conduct the present
research. It deals with research design, sources of data, data processing procedures,
population and sample; period of the study, method of analysis and financial and
statistical tools.

Chapter-IV: Data Presentation and Analysis

The fourth chapter is concerned with analytical framework. It includes the analysis of
financial indicators. Analysis of mean, correlation coefficient, regression analysis, trend
analysis and financial analysis, the major findings are included are the end of the
chapter.

13
Chapter-V: Summary, Conclusion and Recommendations

The fifth chapter includes the summary, conclusion and recommendations of the study
which deals about the main theme of study and comparison of lending policy of the
banks with recommended for improvement of loan management of the selected banks.

14
 CHAPTER-II
RESEARCH METHODOLOGY
2.1 Introduction
The research methodology is the systematic way of solving research problems. Research
methodology refers to the overall research process, which a researcher conducts during his/her
study. It includes all the procedures from theoretical underpricing to the collection and analysis
of the data. As most of the data are quantitative the research is based on the scientific models. It
is compared of both parts of technical and logical aspects, on the basis of historical data.
Research is a systematic and organized effort to investigate a specific problem that needs a
solution. This process of investigation involves a series of well thought out activities of
gathering, researching, analyzing and interpreting the data with the purpose of findings answer to
the problems is called research.
Research can be conducted on the basis of primary and secondary data. Here the study of all the
data in analyzed with using appropriate financial and statistical tools outcomes are presented in
simple way.

2.2 Research Design

Research sign is a controlling media for the collection of data and it helps to collect the accurate
information, which is related to risk and return on common stock of commercial banks of Nepal
for this study. “Research design is the plan structure and strategy of investigation conceived so as
to obtain answer to research question and to control variance.
In this study, the research is based on the recent historical data, so simply it is a historical
research and covers the data from the fiscal year 2009/10 to 2013/14 . the analytical as well as
descriptive research design have been included in this study. For the analytical purpose the
annual reports and the financial statement of the related commercial banks are collected. But this
study is more analytical and empirical and less descriptive.

15
2.3 Population and Sample
In NEPSE there are altogether 28 commercial banks. But this study is concentrated on only two
commercial banks. The convenience sample method is used in this study due to the shortage of
financial resources.
The sample taken from the commercial banks are as follows:
Total Banks Sample Taken
27 Commercial Banks Hialayan Bank Limited (HBL)
Macchapuchhre Bank Liited (MBL)

2.4 Sources of Data

This study is mainly based on secondary data. But while studying individual investor’s opinion.
Bank officials, suggestion and opinion from staffs of Nepal Stock Exchange Ltd. are also taken
into consideration. Data related to the market prices of the stock market capitalization,
movement of NEPSE. Financial reports of the commercial banks are also collected. Besides, the
secondary data have been acquired from various other sources like:
 Annual reports of the concerned commercial banks.
 Trading reports published by Nepal Stock Exchange Ltd.
 Related websites.
 Material published in paper and magazines.
 Other related books and booklets

2.5 Data collection Techniques

The relevant data has collected the from the Nepal Stock Exchange Limited and concerned banks
chosen as sample for this study. Similarly, the required data have also collected from degree
Campus, Library Biratnagar, Central Library Kirtipur, Kathmandu, Shankar dev Campus
Library, Nepal Commerce Campus Minbhawan Kathmandu, Library and internet search. Apart

16
from this, informal interviewers are conducted with staffs of Nepal stock exchange limited to
generate primary data.

2.6 Data Analysis Tools

A brief explanation of the terms and tools of analysis used in this study are as follows :

2.6.1 Dividend (D)

Dividend is the reward for waiting to the investors. Dividend constitutes the main part of return
from common stock investment. Dividends are of two types, cash dividend and cash dividend. If
only cash dividend are paid there will be there no problem but stock dividend is also paid there
will be problem in calculation of total gain to the get extra numbers of shares as dividend and
simultaneously price of the stock declines due to increased no. of socks . To get the real amount
of dividend there are no any models or formula. So, the model has been developed considering
practical as well as theoretical aspect after several discussions with NEPSE staffs and investors.
The model is,
Total dividend = Cash dividend + Stock dividend %X Next year’s MPS
Where,
MPS = Market price per share.
Note: - Here, for calculating the total dividend we did not consider the stock dividend by
insufficiency of proper data.

2.6.2 Market price of stocks (MPS)

If the market price of shares of companies are followed them it can be found that there are three
of prices High, Low and Closing Price. MPS is determined by the demand and supply forces. For
the analysis, single one is needed, so average price (that of high and low) or costing price
approaches can be used. Here in the study this closing prices is taken as the market prices is
taken as the market prices of stock, which has specific time of span of one yea and study has
focused in annual basis. To get the real average, volume and price of each transaction in the
whole year are essential which is tedious and impossible too, considering the data availability
and maintenance. Hence the closing price is used the market price of stock, which has a specific
time span of one year and the study has focused in annual basis.

17
2.6.3Holding Period Return on Common Stock
Holding period return is sum of dividend income and change in market price of stock expressed
as percent of beginning of investment.
Mathematically,
R= D1 + P1 - P1-1
P1-1
Where, is also paid
R = Holding period rate of return on common stock
Dt = Cash dividend received at the end of period t.
Pt = Ending prices of Stock
Pt-1 =Beginning prices of Stock

2.6.4 Expected Rate of Return On common Stock

The study also aims to find out the expected return on the investment in the common stock. The
expected rate of return is based upon the expected cash receipt and expected capital appreciation.
The expected rate of return is arithmetic mean.
Mathematically,
E (RJ ) = ∑ RJ
n
Where,
E(Rj) = Expected rate of return on stock j.
Rj = Return on stock j.
N = Number of years that the return is taken
∑ = Sign of summation

2.6.5 Standard Deviation (S.D)

18
Standard deviation is the absolute measure of dispersion. Absolute measure of dispersion or
variation of the item around their average value. It is statistical measure of the variability if
distribution of return S.D is the standard average scatterness of returns from mean return. S.D is
the measurement of total risk in financial management.

2.6.6Coefficient of Variation (C.V)

The coefficient of variance is the relative measure of dispersion, comparable across distribution;
which is defined as the ratio of standard deviation to the mean defined as the ratio of standard
deviation to the mean expressed in percentage. It gives the risk per unit of the expected return
and gives the result regarding the unit of risk to bear for earning one unit of returns. It is
calculated as follows:

C.V = σJ
Rj
Where,
CVJ = Coefficient of variation of stick j
distribution of return S.D is the standard average scatterness of returns from mean return. S.D is
the measurement of total risk in financial management.

2.6.7 Beta Coefficient

Total risk can be classified as the diversifiable (Nonsystematic) and non- diversifiable
(systematic) risk. Making portfolio between the securities can diversify the diversifiable portion
of the total risk. But on the other hand non-diversifiable risk is created from the market related
factors. The risk cannot be diversified away and investor should expected to receive additional
return associated with the systematic risk. The systematic risk can be measured since the sources
of systematic risk are market persuasive, it is logical to measure systematic risk as the covariance
between the return of individual assets or portfolio and return of the market portfolio, which
consists of all assets. This measure of systematic risk is represented by beta (β). Securities with
beta (βj > 1) are classified is more risky(aggressive) and the securities with betas less than market
beta as less risky (defensive) in comparison with market risk.

19
 Mathematically,
ΒJ = COV(RJ Rm) = COVjm
σ2j σ2m
Where,
Bj = Beta coefficient of stock j.
COVjm = Covariance between Rj and Rm
σj = ∑(RJ-RJ)(Rm-Rm)
n

2.6.8 Correlation Coefficient

The correlation coefficient measures the direction of relationship between two sets of figures.
Correlation is the relative measurement of co-movement of the returns of the two stocks.
Correlation coefficient and co-variance are related by the following equation,
COVij = σi σj ρ ij
Therefore,
Ρij = COVij
σij
Where,
σI = standard deviation of returns for assets i.
σj = Standard deviation of returns for assets j.
ρij = correlation coefficient between assets i and j
There are following cases of correlation and risk conditions:-
 Perfectly positive correlation( ρij = +1) :-
Return on two perfectly positive correlation stocks would move up same direction so risk cannot
diversified away by investing in such assets in portfolio. Portfolio of such stocks would be
exactly as risky as the individual stocks.
 Perfectly negative correlation (ρij =-1)
Return on two perfectly negative correlated stocks would move up exactly opposite direction so
risk can be completely eliminated by holding such stocks in portfolio. But perfectly negative
correlated stock cannot be found in the real world.

20
 No relation between returns ( ρij = 0)
When the correlation between two stocks is exactly zero there is no relationship between the
returns of the two stocks. In such case some risk can be reduced.
 Intermediate risk( ρij = +0.5)
Most of the stock returns are positively correlated but are not perfectly correlated. On average
the returns on two stocks would lie on the range of to +0.4 and +0.75. Under such conditions the
portfolio of stocks reduces risk but not eliminate is completely

2.6.9Portfolio Risk and Return

Portfolio is combination of individual or group of assets. Investors have different types of
investment opportunity but they have limited resources for investment so that investors have to
choose that investment opportunity which maximizes return for a given level of risk or
minimized risk for a given level of returns. Thus, the combination of these investment is called
portfolio.

2.6.9.1Portfolio Return, E(RP)

The expected return on a portfolio is simply the weighted average of expected returns on the
individual assets in the portfolio with weights being the fraction of the total portfolio invested in
each assets.
Symbolically,
E (RP+) = WiE(Ri) + WjE(Rj)
Where,
E(RP+) = Expected return on a portfolio
Wi = Weight or proportion of fund invested in ith security
Wj = Weight or proportion of fund invested in jth security

2.6.9.2 Portfolio Risk

It is the combined standard deviation of individual stock return. It is the risk of individual
securities plus covariance between the securities. The formula for the calculation of portfolio risk
for two assets case is given by,

21
σP = √σi2Wi2+ σj2Wj2+2COV(RiRj)WiWj
OR,
σP = √σi2Wi2+ σj2Wj2 +2ρij σi σj Wi Wj
where,
σi2 =Variance of return of security (i).
Wi =Weight or proportion of security (i).
Wj =Weight or proportion of security (j).
COV(RiRj) =Covariance between return of assets i and j
ρij =correlation coefficient between the return of security i and j

2.6.10 Return on Market (Rm)

It is the percentage increase in NEPSE index. Market return is the average return of the market
as a whole. It is calculated as:
Rm = NIt – NIt-1
NI t-1
Where,
R(m) = Return on market
NIt = NEPSE index at ‘t’ time
NIt-1 = NEPSE index at ‘t-1’time

22
Bibliography

Books

Aminud B., Delong, S. & Saunders, M. N. (2002). Research methods for business students
(4thed.). Harlow: Pearson Education.
Bhattarai, P. (2004). The Nepalese financial system. Kathmandu: Asmita Books Publishers
and Distributors.
Brigham, E.F., & Ehrhardt, M.C. (2011). Financial management: Theory and practice
(13thed.). Boston: Cengage Learning Products.
Cheney, J.M., & Moses, E.A. (1992). Fundamentals of investment. New York: West
Publisher House.
Gitman, L. J. (2003). Principle of managerial finance (10thed.). New York: Harper Collins
Publication.
Gitman, L. J. (2009). Principle of managerial finance (12thed.). New York: Harper Collins
Publication.
Gitman, L. J. (2012). Principle of managerial finance (13thed.). New York: Harper Collins
Publication.
Radhaswamy, M., & Vasudevan, S.V. (1997). A text book of banking (2nd ed.). New Delhi:
Chand and Company Ltd.

Websites:

www.himalayanbank.com

www.machbank.com

www.nrb.org.np

23
24