Chapter – 1

Introduction

1.1 Background of the study:

The main driver for the country's stability and sustainable progress is economic growth.
Different variables jointly decide growth. One of the most significant reasons for any
country's economic growth is industrialization. Finance is for corporate organizations and
businesses, just as blood is vital for human beings. Every corporate enterprise should base
financial management on its decision-making. The collection and utilization of funds is
primarily concerned with financial accounting. In using capital tools to develop the country's
productive industries, the financial market plays a crucial role. For the smooth running of the
financial system, there should be the appropriate market for such system which is called
financial market. That is the sector that exchanges financial claims and financial services.
The economy is made up of two main sectors: the capital market and the money market. The
capital market refers to a market where long-term investments are involved. The borrowing
and lending of long-term funds facilitates this process. The money market refers to a market
that deals with buying and selling money. The item that is traded in the money market is
liquidity. It deals with all financial documents, such as treasury bills, commercial bills,
deposit certificates, etc.

A bank is a financial institution that is allowed to accept deposit and make loans. Financial
services such as money management, currency trading, and safe deposit boxes can also be
offered by banks. Many various types of banks are available, including retail banks,
commercial or industrial banks, agricultural bank, development banks and investment banks.
Banks are governed by the government or the central bank in most nations. In simple terms,
A bank is an entity that invests with money and collects it from customers on deposit,
honoring clients who draw on demand against those deposits, receiving cheques for
customers and the loan or investment of excess deposits before payment is necessary.

Commercial banks work with funds from other individuals. They have to find ways to keep
their investments liquid in order to satisfy their clients' demands. The term commercial bank
applies to a financial institution that takes deposits, provides checking account services,
makes various loans, and provides individuals and small businesses with basic financial
items such as certificates of deposit (CDs) and savings accounts. Commercial banks provide
the general public with basic financial services for both individual customers and small and
mid-sized enterprises. These services include, as mentioned above, checking and savings
accounts, loans and mortgages, basic investment services such as CDs, and other services
such as safe deposit boxes.
 Risk applies to the possibility that there may be any unfavorable case. Risk is the result of
volatility whose magnitude in unpredictable cash flows depends on the degree of variability.
Risk is described in financial terminology as the probability that the real gains of an event or
investment will vary from an anticipated outcome or return. Risk entails the likelihood of
losing any or more of an initial investment. “Risk is defined in Webster’s Dictionary as a
hazard; pearl; exposure to loss or injury” (Ibid,:182) . Many individuals see risk in the way
that a possibility of failure has just been defined. In truth, risk occurs where it is difficult to
determine the effects of a given activity or occurrence. They have given range, variance,
standard deviation, coefficient of variance (CV) and beta as a parameter for the measurement
of risk.

The return is the average benefit or loss experienced for a given period of time on an
investment. A positive return indicates a win, while a negative return represents a loss. It is
also defined as the anticipated positive cash flow from an investment. Investors are primarily
concerned with development. They will pursue projects that deliver the long-term promise of
higher-than-average revenue, profits and capital appreciation growth. The discrepancy
between the outflow and the inflow of funds is often known as the return. A higher return is
always good for the companies because it shows that the organization is generating profit
from the business.

1.2 Brief profile of the banks:

Prabhu Bank Ltd.

Prabhu Bank Limited is a Nepalese commercial bank. The bank is a 'A' level commercial
bank authorized by Nepal Rastra Bank and has branches throughout the nation with its
headquarters in Kathmandu, offering full commercial banking services. Prabhu Bank's
growth was phenomenal, especially following the merger of Grand Bank Nepal Limited, Kist
Bank Ltd, Prabhu Bikash Bank Ltd, Gaurishankar Development Bank Ltd and Zenith
Finance Ltd in 2016, which achieved the status of "A" level financial institution licensed and
supervised by Nepal's central bank, Nepal Rastra Bank. The key goal of Prabhu Bank is to
become Nepal's leading commercial bank by supplying our customers with the best quality
financial products and services.

Sanima Bank Ltd.

Sanima Bank started operations in 2004 as a development bank at the national level. In 2012,
Sanima secured an operating license from Nepal Rastra Bank to act as a 'A' level commercial
bank. Within and outside the Kathmandu Valley, Sanima has 85 full-fledged branches and 14
extension counters and has further plans to extend its presence in different parts of the
country. In recent years the bank has remained successful in opening new branches in
 different cities of Nepal and the bank is also increasing its customer base by offering quality
services to the clients. The bank was founded with a mission to provide consumer focus in a
streamlined way with banking and financial solutions while bringing value to the interests of
its stakeholders.

1.3 Focus of the study

This research is focused on an evaluation of the risk and return associated with commercial
banks' share prices. The risk and return of commercial banks are entirely dependent on the
analysis of the portfolio. Consequently, this research also reflects on the risk and return
analysis of how an investor can make an investment judgment on the securities of
commercial banks in Nepal.

1.4 Statement of the problem:

Investors buy financial assets such as shares or bonds because they want to maximize their
income, – i.e., generate a significant return on their money. The future remains unpredictable,
the rate of return their investment would realize is not known to investors. Since commercial
banks can produce such benefits in the future, they spend various kinds of their subject
matter. Investors should not calculate the return because their investments entail different
uncertainties and investors are able to consider the pricing condition of the companies listed.
Current trends show that all economic activities in Nepal are not working properly due to
numerous reasons, such as unnecessary political regulation, political violence and different
topography, lack of proper appraisal by state or central banks, government policy dispute,
etc. The biggest concern is that the risk and return of business conditions will not be perfectly
measured by public companies. There is no idea of risk and return for investors. In the
context of Nepal, most of the people are still unknown about share, bond debenture and they
deposit their money in the bank. The mindset and perception of investors towards stock
investments in the Nepalese stock market is not healthy. So, they feel a greater risk than the
actual risk when investing in stocks. The risk and return situation for commercial banks has
been examined in this sense. Systematic and unsystematic risk role analysis have helped to
make investment decisions in order to minimize the risk. Some of the major problems
identified in this research are as follows:

i. What is the total risk and return position of the commercial bank?

ii. What sort of risk and return exist in the stock investment of Nepalese commercial
banks?
iii. What are the determinants of stock prices?
iv. What type of relationship exists between dividend and stock prices?
 v. What are the commercial banks' average rate of return?

vi. What are the evaluation criteria for investing in the stock to get favorable return?
vii. What is the systematic risk and unsystematic risk of the commercial bank?

1.5 Objectives of the study:

1
As we all know that the primary objectives of this research or study is to analyze the risk
and return of the commercial bank. The specific objectives of the research are outlined
below:

 To figure out the annual average rate of return of commercial banks in Nepal?
 To find out overpriced, underpriced and correctly priced common stocks of
commercial banks.
 To analyze the systematic risk and unsystematic risk of commercial bank.
 To analyze the market rate of return and beta.
 To analyze the relationship between the risk and return of the dividend and the market
price of the stock.
 To compute the total risk and return position of the commercial bank.
 To provide appropriate suggestions for effective performance.

1.6 Significance of the study:

This study was useful for the entire individual interested in learning about the capital market
and the commercial bank. The study suggests a careful assessment of the relationship
between risk and return and also of the systematic and unsystematic risk of commercial
banks. This research provides details on the risk and return valuation of the Nepalese stock
market. It also aims to improve the intellectual capacity of stock market investors. This
research or study will be very helpful in evaluating the risk and return of the commercial
bank in country.

1.7 Limitation of the study:

Similar to other research this research also has some limitations. The main limitation is the
reliability of the statistical instruments used and the lack of analysis expertise, and some
other limitations can be identified as follows:
 The study will only cover the relevant data and information for a period of 5 years.
1

https://www.academia.edu/42459416/RISK_AND_RETURN_ANALYSIS_OF_COMMERCIAL_BANKS_IN_NEPAL#:~:te
xt=The%20main%20aim%20is%20to,price%20of%20the%20commercial%20banks.
  The study mainly focuses on risk and return of Prabhu Bank ltd. And Sanima Bank
ltd.
 Time and finance constraints are also main limitation of the study.
 Comparison is not made with another commercial bank.
 Analysis is based on the tools developed in the context of efficient market condition.
 The data released on the website of the associated banks has been taken up to some
degree.

1.8 Review of literature:

The writer takes clues from previous dissertation in the literature review, however he or she
can take care of replication. Literature analysis involves evaluating scientific results and
other pertinent prepositions in the associated field of the thesis so that all the past studies
their findings and deficiencies and more tests take place. In research papers, it is a critical
and mandatory process. Literature analysis is the study of previous studies of literature and
related content. It is a promotion of current awareness and in-depth analysis of subject
matter. This begins with a quest for an appropriate subject and continues throughout the
volumes of similar or related topics. It is very unusual to uncover an entirely new problem.

The analysis of the relevant theoretical literature and the previous relevant research is
presented in this chapter. It is divided into three sections: conceptual analysis, analysis of
relevant research and study gap. Different experiments are carried out in numerous books and
journals. Various databases, websites and other various forms of references have also been
used in the analysis. In this, those experiments and problems are reviewed. Many other
studies have been included in the research report, some of the studies found that bank
expansion into banking activities which impact the event that made banks only restricted
entry into non-banking activities. The research uses statistical methods to measure the
systemic, unsystematic, unsystematic and overall probability of certain risk, i.e. variation,
standard deviation, t-statistical and signed rank used by Aminud, Delong and Saunders
(2002). 2In their research paper on a report on risk and return analysis of selected stocks in
India, Krishnaprabha and Vijayakumar (2015) concluded that risk and return appraisal plays
a crucial role in most human decision-making systems. Each investor needs to avoid risk and
optimize profitability.

3
A analysis on the risk and return of listed commercial banks in Nepal was undertaken by
Lamichhane (2006). The research's primary objective was to evaluate the risk and return
analysis of commercial banks listed in Nepal. The analyst used 5 years of data for the

2
http://ijsrm.in/index.php/ijsrm/article/view/579
3
https://www.nepjol.info/index.php/pravaha/article/view/20231/16623
 analysis. To measure the return, standard deviation, variance coefficient and beta coefficient,
she used financial and statistical methods.

A research on the risk and return valuation of listed firms was undertaken by Karki (2006).
The study's main objective was to evaluate the risk and return situation of the numerous
commercial banks listed and to analyze whether portfolio or individual stock investments are
better. The research covered five years of data from the years 1998/99 to 2002/003 for five
NEPSE-listed commercial banks. The key result of this report is that the share price of almost
all banks is declining, taking into account the pattern of price movement of selected banks'
shares, but there is an indication of improvement seen in the listing company's share price.

4
A research on the risk and return valuation of common stocks of listed commercial banks
was performed by Bijukchhe (2009). In the CAPM model, she analyzed the systemic risk and
return in the frame work. The researchers used 5 years of data from 2002 to 2007 for the
analysis. In order to measure the annual return, estimated rate of return, standard deviation,
coefficient of variance, beta coefficient and predicted rate of return, the researchers used
financial and statistical methods. The key outcomes of her analysis are NIBL, EBL, NABIL,
SCBNL and HBL's overall return rate of 26 percent, 57 percent, 71 percent, 45 percent and
25 percent, respectively. NABIL has the highest return among the banks sampled, and HBL
has the lowest return. EBL is the lowest risk and NIBL is the higher risk of all the banks
sampled from the analysis in terms of risk or on the basis of the coefficient of variance.

A research on risk and return valuation for commercial banks in Nepal was performed by
Sharma (2012). An overview of the annual average rate of commercial banks in Nepal was
the key objective of the report. The researchers used 10 years of data from 2000 to 2010 for
the analysis. To measure the return, standard deviation, variance coefficient and beta
coefficient, she used financial and statistical methods. The key conclusions of her studies are
that NABIL, HBL, NIB and EBL have an overall return rate of 33 percent, 29.3 percent,
15.65 percent and 48.7 percent.

Research gap
A research gap is an issue or concern that has not been addressed within your area by any of
the current studies or research. Previous research related to this subject are very old and not
revised. In order to be more conclusive about the risk and return analysis of commercial
banks in Nepal, previous studies give restricted results, more thorough testing and
modification of required variables are necessary. Therefore, the analysis on the subject in
changing scenarios has been carried out to remove the above limitations, similarly the
previous research will be revised and checked by addressing several developments in the

4
https://www.academia.edu/42459416/RISK_AND_RETURN_ANALYSIS_OF_COMMERCIAL_BANKS_IN_NEPAL
 Nepalese banking field. All the research gaps will be covered and accurate result will be
produced at the end.

Chapter – 2
Research Methodology
2.1 Introduction:

This research aims to gain insight into the examination of the risk and return of selected
commercial banks. An effort is made to apply a sound and systematic methodology necessary to
make this analysis relevant. The methodology of research is the specific procedures or
techniques used to identify, select, process, and analyze a topic's information. In a research
paper, the section on methodology allows the reader to critically assess the overall validity and
reliability of a study. On the basis of primary and secondary results, analysis may be performed.
The analysis of all the data examined with the use of relevant financial and statistical methods is
described in a simplified way here. This chapter is intended to shed some light on the methods
used to undertake this report, which attempts to examine and draw some patient conclusions
regarding the risk and return of selected commercial banks. Research design, data collection
techniques, data collection, data processing, research procedures and metrics have been used for
this purpose.

2.1 Research design:

Research design is the research plan framework and technique formulated to respond to research
concerns and to manage variance. The framework of research methodology and procedures
selected by a researcher is research design. The type of research issue facing a company will
decide the nature of the research and not vice-versa. A study's design process decides which
instruments to use and how they are used. This analysis is focused on research methodology that
is descriptive and analytical. Descriptive research design is used with the help of displayed data
to explain the relationship between risk and return from the table, trend lines and figures. An
analytical research design study uses standard deviation, coefficient of variation, beta coefficient,
CAPM and average rate of return of sampled banks.

2.2 Population and sample

A population is the whole community from which you want to draw conclusions. The particular
group that you would gather data from is a sample. Population and sample are very essential to
conduct the research. In context of Nepal there are 27 commercial banks, but the research is
focused on the sample of two commercial banks. A random sampling technique was used to pick
the sampled banks. The sample commercial bank that I have taken to conduct the research are
Prabhu Bank Ltd. and Sanima Bank Ltd.

2.3 Nature and sources of data

Different types of information and data are required to conduct the research, so secondary data
sources are having been used. 5Secondary data is the data that has already been gathered and
made freely accessible for scholars to use for their own analysis by primary sources. But when
researching the viewpoint of each particular investor. Officials of the bank, recommendations
and feedback from the employees of Nepal Stock Exchange Ltd. will also be taken into account.
Financial data of the commercial banks are also collected for accurate results. The secondary
data are collected from the following sources:

 Website
 Annual reports of the concerned commercial banks
 Reports of Nepal Stock Exchange Ltd.
 Material published in paper and magazines
 Other related books and booklets

2.4 Data Collection Techniques:

All the information needed for the thesis was gathered from secondary sources. The annual
report of commercial banks has been taken from the website. Different journals and articles were
used to collect the information and data. Informal interviews were also conducted with the staff
of banks to gather the primary data. Report published by the Nepal Stock Exchange Ltd. is also
used to gather the data.

2.5 Data analysis tools

To meet the aims of the report, all the knowledge was provided and analyzed. Different financial
and mathematical methods have been used to explain the analysis work and are discussed in
detail as follows:

 Dividend (D): 6A dividend is the payment, as determined by the board of directors of the
corporation, of any of a company's profits to a class of its owners. There are no models or
5
https://www.formpl.us/blog/secondary-data
6
https://www.investopedia.com/terms/d/dividend.asp
 formula to get the actual dividend number. The model was then established after many
meetings with NEPSE employees and investors, taking into account both realistic and
theoretical aspects.

Total dividend=Cash dividend+ Stock dividend % X Next year MPS

Where,

MPS = Market price per share

 Holding Period Return (HPR): 7In finance, the return on an asset or portfolio for the
entire period during which it was held is the holding period return (HPR). The formula
for HPR is;

Mathematically,

Dt + P 1−P 0
R=
P0

Where, is also paid

R = Holding period rate of return on common stock
Dt = Cash dividend received at the end of period t.
P1 = Ending prices of Stock
P0 =Beginning prices of Stock

 Expected rate of return: 8The return on investment that an investor hopes to obtain is
the expected rate of return. The way to calculate expected rate of return is;

Mathematically,
∑ Rj
E (R j ) =
n
Where,
E ( R j ) = Average rate of return on stock j
n=number of stock

7
https://en.wikipedia.org/wiki/Holding_period_return
8
https://www.accountingtools.com/articles/the-expected-rate-of-return.html#:~:text=What%20is%20the
%20Expected%20Rate,the%20probabilities%20summing%20to%20100%25.
  Standard Deviation (S.D): 9The standard deviation is a statistic that calculates a dataset's
dispersion relative to its mean and is measured as the variance's square root. 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. The formula to calculate standard deviation is;

∑ ( R−R ՟ ) 2
Standard deviation( σ j) =

Where,
√ n−1

σ j=Standard deviation of return on stock j

R=Expected rate of return on stock
R ՟=Average rate of return on stock
n=Number of observation

 Coefficient of variation (C.V): 10The ratio of the standard deviation to the mean is the
coefficient of variance (CV). The larger the variance coefficient, the greater the
dispersion degree around the mean. The way to calculate coefficient of variation is;

σj
CV =
R ՟j

Where,

CV = Coefficient of variation
σ j=Standard deviation of stock j
R ՟ j= Average mean return of stock j

9
https://www.investopedia.com/terms/s/standarddeviation.asp#:~:text=The%20standard%20deviation%20is
%20a,square%20root%20of%20the%20variance.&text=If%20the%20data%20points%20are,the%20higher%20the
%20standard%20deviation.
10
https://www.insee.fr/en/metadonnees/definition/c1366#:~:text=The%20coefficient%20of%20variation
%20(CV,generally%20expressed%20as%20a%20percentage.&text=The%20lower%20the%20value%20of,the
%20more%20precise%20the%20estimate.
  Beta coefficient: 11A measure of systemic risk is a beta coefficient. For rating the
systemic risk of various properties, the beta coefficient can be used. The formula to
calculate beta coefficient is;

COV ( jm)
βj =
σ m2

Where,

β j =Beta of stock j

COV ( jm)=Covariance between stock j∧m

σ m 2=Variance of market

11
https://www.investopedia.com/terms/b/beta.asp