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CHAPTER – I

INTRODUCTION

1.1 Background of the Study

Common stock is a form of corporate equity ownership, a type of security. It is a


security that represents ownership in a corporation. They are on the bottom of the
priority ladder for ownership structure; in the event of liquidation. They have rights to
a company's assets only after bondholders, preferred shareholders and other debt
holders are paid in full.

If a company goes bankrupt, the common stockholders do not receive their money
until the creditors and preferred shareholders have received their respective share of
the leftover assets. This makes common stock riskier than debt or preferred shares.
The upside to common shares is they usually outperform bonds and preferred shares
in the long run.

The term "risk and return" refers to the potential financial loss or gain experienced
through investments in securities. An investor who has registered a profit is said to
have seen a "return" on his or her investment. The "risk" of the investment,
meanwhile, denotes the possibility or likelihood that the investor could lose money. If
an investor decides to invest in a security that has a relatively low risk, the potential
return on that investment is typically fairly small. Conversely, an investment in a
security that has a high risk factor also has the potential to gain higher returns. Return
on investment can be measured by nominal rate or real rate (money earned after the
impact of inflation has been figured into the value of the investment).

Return is the reward received from investment for waiting and compensation for risk
bearing. Return is the major factor behind any investment but it involves risk. It can
be said that risk and return play the dominant role in investment. Researchers have
shown that most of investors are risk averter. So, it can be concluded that people
invest their belongings in those opportunities where they can get higher return with
bearing low level of risk.

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The concept of risk and return are the determinant for the valuation of securities.
However, risk means that we do not know what is going to happen even though we
occasionally have a good idea of the range of possibilities that we face. In general
sense, risk can be defined as the change of loss. Assets having greater changes of loss
are viewed as more risky than those with lesser changes of loss. More formally, the
term risk is used interchangeably with uncertainty to refer to the variability of returns
associated with a given asset.

Out of the various types of the securities, this study deals with common stock
investment. It is a risky investment than both bonds and preferred stock but it has also
benefit like voting right in participation in profit. And also, common stock may be
purchased and sold immediately. There is the uncertainty of future return whose main
source is the price fluctuation of the common stock. The stock price may be decreased
due to the economic factor such as inflation, interest rates, strength of dollar,
economic growth of the nation etc. The stock price is also affected by political and
legal environment of the nation. The dividend received by the investor directly
contributes to the return received by the investors but at the same time reduces the
amount of earning re-invested by the firm resulting limited potential growth. So,
primarily the risk of a stock investment can be measured by its price volatility and
degree of uncertainty of dividend fluctuation.

Most of the investors are risk averse. Investors must seek to identify the stocks having
low risk which results high returns. A rational investor wants to maximize his/her
return at minimum risk. Even the Investors can’t increase the return; substantially
they can reduce the risk by diversification of investment in different securities making
a portfolio. Making a portfolio of common stock, an investor can’t eliminate all the
risk. Risk is of two types, i.e. systematic risk and unsystematic risk. Unsystematic risk
can be eliminated by diversification. Business risk & financial risk is the componentof
unsystematic risk. But, the systematic risk can’t be avoided through portfolio of stock.

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1.1.1 Profile of the Selected Banks

Everest Bank Limited (EBL)

EBL was founded in 1994 with an objective of extending professionalized & efficient
banking services to various segments of the society. Panjab National Bank (PNB)
joined hands with EBL as a Joint Venture and holds 20% equity.

EBL Provides customer friendly services through its wide network connected through
ABBS system which enables customers for operational transactions from any
branches. The bank has 53 branches, 80 ATM counters, 374 Business Correspondents
& 22 Government Revenue Collection counter across the countrytill the end of Fiscal
Year 2071/72, making it a very efficient & accessible bank for its customers, anytime
& anywhere.

1.2 Statement of Problem

Recent trend shows that the general public is interested to invest their small money on
the common stock on financial institution like commercial banks. But, lack of proper
information about market status and situation, and poor knowledge, market
intermediaries take advantage of investors. Due to these limitations, many investors
fear to invest into such stocks.

In the context of Nepal, there are no any separate institutions, which may provide
information required to make rational decisions that can accelerate the stock
investment and market efficiency. Government policy is less encouraging in
promoting common stock investment. Most of the Nepalese investors invest their fund
in single security rather than investing in portfolio of security through diversification
of risk. Not only general public but even most of educate people related on such
subject can’t prominently analyze the risk and return in stock market investment.

Due to lack of information and poor knowledge, individual investor is manipulated or


exploited by the financial institutions or other market intermediaries to such an extent
that investing in common stock is intolerably hazardous. There is another problem for
financial sector to earn goodwill among the public because some financial companies
have collapsed due to improper use of public funds. Investors are responsible to make
rational investment decision rather than switching blame to others. Most of the
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rational investors hold portfolio of stock and are more associated with the risk of
portfolio than with the risk of the individual securities.

Investors feel more risk in stock investment than its real risk. To set up their
confidence, unbiased analysis and information about it, is a must. Risk and return of
individual stock and portfolio is therefore being a major requirement to increase stock
investment and stock market efficiency as well. Brokers, issue manager, stock broker
and all the related persons in those domains must be responsible to set the policies, &
evaluate relative riskiness of their decision. Securities market and other institutional
set up are yet to work towards providing knowledge and skill to investors. Hence,
this present study seeks to explore the answers of the following questions:

 What is the risk & return of investment in common stock of commercial


banks?
 What is the proportion of systematic & unsystematic risk from the total risks?
 Is the common stock of commercial banks are overpriced, underpriced or at
equilibrium price?

These are the burning issues that have influenced to carry out this study. Investment
on common stock is the main sources of fund for the companies. The investors are the
sources of revenue and ultimately they are the backbone of economic development of
the nation. So, every policy and plan of financial institutions and government have to
stipulate them to invest on common stock. For this, there is great need of such
institutions, which can provide valuable information that accelerate the stock
investment & market efficiency.

1.3 Objectives of the Study

In Nepal, many investors are facing various problems in setting their investment
policies, evaluating financial assets, constructing portfolio and revising and analyzing
their portfolio performances. The key objective of this study is to evaluate the risk &
return on common stock investment of the selected Nepalese commercial banks. In
connection with the main objectives, the specific objectives of the study are as
follows:

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 To evaluate the risk & return associated with the common stock investment of
commercial banks.

 To segregate total risks into systematic & unsystematic risks.

 To evaluate common stock’s price under CAPM method.

1.4 Significance of the Study

The investment analysis of any organization flashes its investment policy. The sound
investment policy makes a good impact on the economy of the country. The success
and the prosperity of any organization or institution rely heavily upon the successful
investment policy. Successful formulation and effective implementation of investment
policy is the prime requisition for the successful performance of any organization.

But, due to lack of proper & adequate knowledge, investors are investing their
valuable funds through trial and error approach. So, it is necessary to establish vivid
picture about the return from investing in securities after analysis the portfolio. Most
of public investors i.e. existing and potential are not well known about the real
financial strength and weakness of the public companies in which they are investing
or going to invest their funds.

Every research work or study should be fruitful. This study will give correct
information about Nepalese stock market by analyzing risk and return and will
definitely contribute to increase the analytical power of the investor in stock market.
In the context of Nepal, the capital market is growing very steadily. The market is not
efficient, there are very few magazines or articles related to capital market and very
few studies are made on the topics "Risk & Return". Because of these, some investors
are investing on the capital market without any proper knowledge and information.
So, the study will be more significant for exploring and increasing stock investment.

The main significance of this study is:

 This study will be beneficial for the entire person who is directly related to the
Nepalese stock market.
 The study is matter of crying needs to identify the possible return with
responsible risk.
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 The study will prove beneficial to the present investors to analyze and revise
their actions.
 This study helps to identify risk and return trade-off of their investment.
 This study will be helpful in taking right decisions.
 The study will be significant to academicians, students, researchers, teachers
or persons practicing in the field of finance.
 The study helps to find out whether the shares of commercial banks in Nepal
are overpriced or underpriced by analyzing the risk and return of the
individual shares.
 The study will act as guidelines, suggestions and recommendations to
Nepalese investors & financial institutions.

1.6 Organization of the Study

This study has been organized in five chapters starting from Introduction, Review of
Literature, Research Methodology, and Presentation & Analysis of data to Summary,
Conclusion & Recommendations, each devoted to analysis of risk & return on
investment in commercial banks. The titles of each of these chapters are summarized
and the contents of each of these chapters are briefly mentioned below:

Chapter – I: Introduction

This chapter is introductory which includes background of the study, profile of selected
banks, focus of the study, statement of the problem, objectives of the study, significance
of the study & limitations of the study.

Chapter – II: Review of Literature

The second chapter deals with the review of available literature which includes
conceptual/theoretical review, review of journals/articles, review of other independence
studies in Nepal, review of thesis & research gap.

Chapter- III: Research Methodology

The third chapter explains the research methodology used in the study. Research
methodology is the systematic method of finding facts/results of the given problem

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more specifically & adopted to meet the objectives of this study. It includes research
design, population & sample, nature & sources of data, data collection procedures &
data analysis tools.

Chapter IV: Data Analysis and Presentation

The fourth chapter is the main body of the research. In this chapter, the data required
for the study are presented, analyzed and interpreted by using different statistical tools
and techniques. Tables, charts, bar-graphs, etc. will be used accordingly.

Chapter V: Summary, Conclusion and Recommendations

The last chapter of the study covers the summary of the study, the main conclusion
that results from the study & offer recommendations on the basis of findings &
provides guideline for the further study.

Besides these, the bibliography and appendices are incorporated at the end of the
thesis. Similarly, acknowledgement, table of contents, list of tables, list of figures,
abbreviations are included in the front part of the thesis report.

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CHAPTER - II

REVIEW OF LITERATURE

Review of literature is the study of past research studies and relevant materials. It is
an advancement of existing knowledge and in-depth study of subject matter. It starts
with a search of suitable topic and continues throughout the volumes of similar or
limited subjects. It is very rare to find out completely new problem. In literature
review, researcher takes hints from past dissertation but he/she should take need of
replication. Literature review means reviewing research place. It is a vital and
mandatory process in research works. During the review of this research, in depth
study and theoretical investigation regarding risk and return on Nepalese commercial
banks is made. For the study, different related study with this topic has been
reviewed.

2.1 Conceptual Review

It is the conceptual framework on which the entire thesis will be based. This study
explores the theoretical aspects of the risk and return on investment from various
books. Analyzing the risk and return imparts knowledge about the relationship
between risk and associated return on any type of investment. It also incorporates the
review as well as background of commercial banks in Nepal.

2.1.1 Common Stock

Common stock represents equity or an ownership position in a corporation. It is


residual claim in the sense that creditors and preference shareholders must be paid as
scheduled before common stock holders can receive any payments. In bankruptcy,
common stock holders are in the principal entitled only to any value remaining after
all other claims having been satisfied (Sharpe et al., 1999:457).

The common stockholders of a corporation are its residual owners; their claim to
income and assets comes after creditors and preferred stockholders have been paid in
full. As a result, a stockholder’s return on investment is less certain than the return to
a lender or to a preferred stockholder. On the other hand, the return to a common
stockholder is not bounded on the upside as are returns to the others. A share of

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acommon stock can be authorized with or without par value. The par value of stock is
merely a stated figure in the corporate charter and is of little economic significance. A
company should not issue stock at a price less than par value because stockholders
who bought stock for less than par value would be liable to creditors for the
differences between the below par price they paid and the par value (VanHorne,
2002:27).

2.1.2 Security Market

Security markets exist in order to bring together buyers and sellers of securities,
meaning that they are mechanisms created to facilitate the exchange of financial as-
sets. There are many ways in which security markets can be distinguished. One way
has already been mentioned: primary and secondary markets. Here the key distinction
is whether the securities are being offered for sale by the issuer. Interestingly, the
primary market itself can be subdivided into seasoned and unseasoned new issues. A
seasoned new issue refers to the offering of an additional amount of an already
existing security, whereas an unseasoned new issue involves the initial offering of a
security to the public. Unseasoned new equity issues are often referred to as initial
public offerings, or ipos.

Another way of distinguishing between security markets considers the life span of
financial assets. Money markets typically involve financial assets that expire in one
year or less, whereas capital markets typically involve financial assets with life spans
of greater than one year. Thus Treasury bills are traded in a money market, and
Treasury bonds are traded in a capital market (Sharpe et al., 1999:9-10).

2.1.3 Market Price of the Share

The market price of a firm's stock represents the value that market participants place
on the company (VanHorne, 2002:4). The market prices reflect the true or intrinsic
value of the share based on the underlying future cash flows. The implications of such
a level of market efficiency are clear and no one can consistently beat the market i.e.
earns abnormal returns (Paudel, 2002:4).

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2.1.4Stock Valuation

Many corporati ons don’t issue preferred stock, so the bulk of equity issues are called
common stock. Common stock also has a nominal par value, but it is mostly an
accounting/legal relic and has no bearing on the dividends or price of the stock. Since
dividends on common stock are determined by the board, their cash flows are the
most uncertain of the financial instruments discussed so far. Shareholders have a
residual claim on the firm’s assets, which is the value leftover after all other claims
have been paid. Thus, any earnings remaining after all other obligations are met, are
either paid out in dividends or retained by the firm, ostensibly to be used as capital for
the firm’s growth. These retained earnings increase the residual claim, potentially
increasing the value of stock shares (Schmitz, 2012: 148).

2.1.5 Concept of Investment on Common Stock

Some investment alternatives are preferred over others since the risk and return
characteristics on such underlying investment alternatives satisfy the individual
investor's expectations. Return expected on share investment can be partitioned into
dividend and capital gain components. Both these two components of the total return
on share investment are not certain with investors having to make decisions in an
uncertain environment. Fixed deposits, National Saving Bonds and the other saving
products/ schemes offered by non-bank financial institutions are the other investment
alternatives available in the market producing a fixed rate of return over the investor's
investment horizon. Investments in shares are risky in relation to investments in other
fixed income securities. Despite the risk element inherent to investment in shares,
most investors desire to invest in shares in anticipation that the future price of the
stock will increase. The intrinsic, or theoretical, price of the stock today can be
ascertained by analyzing publicly disclosed financial investment. Investors, in most
cases, do not analyze published financial statement before they make the investment
in shares of a given company. The actual market price of the stock striving towards
equilibrium must reflect the theoretical value of the stock determined by using some
valuation models. Determining the intrinsic value of the stock today and comparing it
with the actual market price however, are rare in practice (Paudel, 2002:2-3).

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2.1.6 The Expected Rate of Return on Common Stock

How much return should be earned from an investment is a puzzle for investors in an
increasingly competitive market. Therefore, investing in a stock market is getting an
additional risk to the funds of individuals or firms, since stock market volatility arises
from different aspects. In other words, when determining an investment, individuals
or firms must choose the investment in such a way that the return of the investment
exceeds its cost. However, in determining the capitalized value of an investment, the
investor must be able to estimate the cash inflows and cash outflows over the
investment period. Not only that, other factors also have to be considered in
determining the investment since various risks and uncertainties are associated with
an investment within a rapidly changing market. The market risk premium,systematic
risk, firm size, and PE ratio are key factors in determining the expected rate of return
on common stock (Gunarathna, 2014:1)

2.1.7 Risk on Commons Stock

In a word of uncertainty, the return may not be realized. Risk can be thought of as the
possibility that the actual return from holding a security will deviate from the
expected return. The greater the magnitude of deviation and greater the probability of
its occurrence, the greater is said to be the risk of the security (VanHorne, 2002:37).

The risk of an investment often depends on how long you plan to hold the investment.
Common stocks, for example, can be extremely risky for short term investors.
However, over the long haul the bumps tend to even out, and thus, stocks are less
risky when held as part of a long-term portfolio. (Brigham & Houston, 2007:279)

2.1.8 Relationship between Risk & Return

The return on an investment and the risk of an investment are basic concepts in
finance. Return on an investment is the financial outcome for the investor. Risk is
present whenever investors are not certain about the outcomes an investment will
produce. Suppose, however, that investors can attach a probability to each possible
dollar return that may occur. Investors can then draw up a probability distribution for
the dollar returns from the investment. A probability distributionis a list of the
possible dollar returns from the investment together with the probability of each

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return. It is often assumed that an investment’s distribution of returns follows a
normal distribution. This is a convenient assumption because a normal distribution
can be fully described by its expected value and standard deviation. Therefore, an
investment’s distribution of returns can be fully described by its expected return and
risk. (Pierson et al. 2012:169-171).

For the business, the position is the opposite of that of the investors: sources offinance
that are relatively risky (from the business’s point of view) tend to be cheap in terms
of servicing cost; safe sources tend to be expensive. The level of returns required by
secured lenders is relatively low but the existence of such loans represents, as we shall
see a potential threat to the welfare of the shareholders. Equity investors expect high
returns, but issuing additional ordinary shares does not tend greatly to increase the
risk borne by the original shareholders (Mclaney, 2009:219).

2.1.9 Systematic and Unsystematic Risks

Systematic risk is due to risk factors that affect the overall market – such as changes
in the nation’s economy, tax reform by Congress, or a change in the world energy
situation. These are risks that affect securities overall and, consequently, cannot be
diversified away. In other words, even an investor who holds a well-diversified
portfolio will be exposed to this type of risk. Unsystematic risk is risk unique to a
particular company or industry; it is independent of economic, political, and other
factors that affect all securities in a systematic manner. A wildcat strike may affect
only one company; a new competitor may begin to produce essentially the same
product; or a technological breakthrough may make an existing product obsolete. For
most stocks, unsystematic risk accounts for around 50 percent of the stock’s total risk
or standard deviation. However, by diversification this kind of risk can be reduced
and even eliminated if diversification is efficient. Therefore not all of the risk
involved in holding a stock is relevant, because part of this risk can be diversified
away. The important risk of a stock is its unavoidable or systematic risk. Investors can
expect to be compensated for bearing this systematic risk. They should not, however,
expect the market to provide any extra compensation for bearing avoidable risk. It is
this logic that lies behind the capital-asset pricing model.

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Total risk ( j ) = Systematic Risk (nondiversifiable or unavoidable) + Unsystematic

Risk (diversifiable or avoidable). (Van Horne & Wachowicz, 2008:105-106)

Diversifiable risk (sometimes called unsystematic risk) represents the portion ofan
asset’s risk that is associated with random causes that can be eliminatedthrough
diversification. It is attributable to firm-specific events, such as strikes,lawsuits,
regulatory actions, or the loss of a key account. Nondiversifiable risk (also called
systematic risk) is attributable to market factors that affect all firms; it cannot be
eliminated through diversification. Factors such as war, inflation, the overall state of
the economy, internationalincidents, and political events account for nondiversifiable
risk. Because any investor can easily create a portfolio of assets that will
eliminatevirtually all diversifiable risk, the only relevant risk is nondiversifiable risk.
Anyinvestor or firm therefore must be concerned solely with nondiversifiable risk.
The measurement of nondiversifiable risk is thus of primary importance inselecting
assets with the most desired risk–return characteristics (Gitman & Zutter, 2012:329-
330).

Figure: 2.1
Systematic and Systematic Risk

Diversifiable Risk

Portfolio
Risk

Total Risk
Nondiversifiable Risk

Number of Securities in Portfolio


2.1.10 Capital Assets Pricing Model (CAPM)

Capital market theory represented a major step forward in how investors should think
aboutthe investment process. The formula for the CML offers a precise way of

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calculating the return that investors can expect for (1) providing their financial capital
(RFR), and (2) bearing σport units of risk ([E(RM) − RFR]/σM). This last term is
especially significant because it expresses the expected risk premium prevailing in the
marketplace. Unfortunately, capital market theory is an incomplete explanation for the
relationship that exists between risk and return. To understand why, recall that the
CML defined the risk an investor bears by the total volatility (σ) of the investment.
However, since investors cannot expect to be compensated for any portion of risk that
they could have diversified away (i.e., unsystematic risk), the CML must be based on
the assumption that investors only hold fully diversified portfolios, for which total
risk and systematic risk are the same thing. The limitation is thus that the CML cannot
provide an explanation for the risk-return trade-off for individual risky assets because
the standard deviation for these securities will contain a substantial amount of unique
risk.The capital asset pricing model (CAPM) extends capital market theory in a way
that allows investors to evaluate the risk-return trade-off for both diversified
portfolios and individual securities.To do this, the CAPM redefines the relevant
measure of risk from total volatility to just the nondiversifiable portion of that total
volatility (i.e., systematic risk). This new risk measure is called the beta coefficient,
and it calculates the level of a security’s systematic risk compared to that of the
market portfolio. Using beta as the relevant measure of risk, the CAPM then redefines
the expected risk premium per unit of risk in a commensurate fashion. This in turn
leads once again to an expression of the expected return that can be decomposed into
(1) the risk-free rate and (2) the expected risk premium. (Reily and Brown, 2012: 216-
217)

2.1.11The Systematic Risk as Measured by Beta

The second measure with which we are concerned, and most important for our
purposes, is the beta. The beta is simply the slope of the characteristic line. The
relationship between excess returns for the stock and excess returns for the market
portfolio is known as the characteristic line, and it is used as a proxy for the expected
relationship between the two sets of excess returns.

Beta depicts the sensitivity of the security's excess return to that of the market
portfolio. If the slope is 1, it means that excess returns for the stock vary
proportionally with between returns for the excess returns for the market portfolio. In

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other words, the stock has the same unstock avoidable or systematic risk as the market
as a whole. A slope steeper than 1 market means that the stock's excess return varies
more than proportionally with the excess return of the market portfolio. Put another
way, it has more systematic risk than the market as a whole. This type of stock is
often called an "aggressive" investment. A slope less than 1, means that the stock has
less unavoidable or systematic risk than does the market as a whole. This type of
stock is often called a "defensive" investment (Van Horne, 2002:64).

2.2 Review of Thesis

However, risk & return is not a new concept for financial analysis, in context of Nepal
and its very slow growing capital market, few studies are made regarding this topic.
Some studies related to the topic of risk and return has been conducted in the partial
fulfillment of the requirements of Master degree in Business Studies. In this study,
only relevant subject matters are reviewed which are as follows:

Mishra (2002) analyzed “Risk and Return on Common Stock Investment of


Commercial Banks in Nepal; with special reference to five listed commercial banks”.
Themajor objective of this study was to promote and protect the interest of the
investor byregulation the issuance sales and distribution of securities and purchases,
sale orexchange of securities. The study also intends to supervise and monitor the
activities of the stockexchange and of other related firms carrying on securities
business. In addition, he tried torender contribution to the development of capital
market by making securitiestransactions fair, healthy, efficient and responsible.

Followings are the finding of the study; it was noticed that there was a positive
correlation between risk and return character of the company. Nepalese capital market
being inefficient, the price index itself was not sufficient to give the information about
the prevailing market. Situation and the company proper regulation should be
introduced so that there is more transparency in issuance, sales and distribution of the
securities. Investors do not have any idea about the procedures of the securities
issuance. Neither company nor the stock brokers transmit any information to the
investors about the current market situation and hence, it becomes difficult for
common investors to invest in the securities.

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Both government authorities and the stock exchange regulator body should try to
promote healthy practices so that the stock brokers do not give false information to
the investors for their personal benefit which is a common practice in Nepal. Investors
should get regular information about the systematic risk (Beta), Return on Equity and
P/E Ratio of various listed companies in some way; it is given in economic times for
the companies listed in Nepal Stock Exchange. Security exchange Board of Nepal
should make this mandates easier for the investors to calculate risk and return of
portfolio.

Bhatta (1995) in his thesis paper “Assessment of the performance of listedcompanies


in Nepal”had concluded that there is high significant positive correlation between risk
and returnin the common stock of the company. Investors expect higher return from
the stock which associates higher risk. Nepalese capital market is not efficient one so
the stock price does not contain all the information relating to market and company
itself. Neither the stock exchange tries to disseminate the information nor do investors
analyze the overall relevant information of the stocks so the market return and risk
both may not show high priced stocks. Bhatta furthermore addressed that Investors in
Nepal have not yet forwarded to invest in portfolio of securities. An analysis of the
two securities portfolio shows thatif the correlation is perfectly negative, the risk can
be totally minimizes. In this situation, the risk can totally be diversified. If there is
perfectly positive correlation ship between the returns of the two securities then the
risk cannot diversified.

Bhatta in his thesis also focused in the analysis of risk and return in common stock
investment but due to many other aspects to analysis, the investors cannot easily
assess the results. Indeed, study concentrates the companies and stock market rather
than focusing the viewpoint of investors.

2.3 Research Gap

There are number of research works performed by various researchers on the topic of
“Risk & Return Analysis of Nepalese Commercial Banks”. Some researchers used
very few sample size which may not cover the whole population & other researchers
used nominal fiscal period which may not provide the whole scenario of market.
Some researchers used only statistical tools & techniques to analyze the risk & return

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of assets or securities of corporations. This research work on the topic of “Risk &
Return Analysis of Common Stock Investment of Nepalese Commercial Banks with
References to EBL” has taken the five years data from F/Y 2067/68 to F/Y 2071/72&
four commercial banks as sample. Thus, this study is different from other research
works.

In the study of few thesis on the similar topic by past researchers, there has been
found a poor analysis of risk & return. The previous researchers used the NEPSE
Index, but this study finds out the conclusions using industry index i.e. banking index
which is a sub-index. Banking index is computed on the basis of listed commercial
banks. The main gap of this thesis is that it provides an idea about how to analyze the
risk and return and conclude the under or overvaluation of common stock. The
previous researchers only analyzed about the risk and return. They didn’t give any
suggestions about undervalued or overvalued stock. Thus, the present study provides
more reliable & accurate conclusion than previous research works.

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CHAPTER - III

RESEARCH METHODOLOGY

The research methodology is the systematic way of solving research problems.


Research methodology refers to the overall research processes, which a researcher
conducts during his/her study. It includes all the procedures from theoretical
foundation to the collection and analysis of data. As most of the data are quantitative,
the research is based on the scientific models. It is composed of both parts of technical
aspect and logical aspect on the basis of historical data.

In it, the various steps are studied that are generally adopted by studying research
problem along with the logic behind them. This section focuses on the method of
research used in this study. Research methodology includes research design,
population and sample of data, data collection procedures, nature of sources of data,
data analysis tools & technique used.In this study, all the data are secondary and these
data are analyzed using appropriate financial as well as statistical tools. Outcomes are
presented in a simple way.

3.1 Research Design

Research design is a plan that specifies the sources and types of information relevant
to the research problem. It is a strategy specifying which approach will be used for
gathering and analyzing the data. It also includes the time and cost budgets since most
studies are done under these two constraints. In fact, the research design is the
conceptual structure within which research is conducted; it constitutes the blue print
for the collection, measurement and analysis of data.

The research design of this study is analytical. Analytical in the sense that all the
available data are analyzed by using various statistical tools & techniques such as
return, standard deviation, coefficient of variation, correlation coefficient etc. This
study is based on historical data. So, it is a historical research which covers the five
years period data from the FY 2067/68 to FY 2071/72.

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3.2 Population and Sample

3.2.1 Population

Population or universe refers to the entire group of people, events or things of interest
that the researcher wishes to investigate. The population of this study is 29 companies
listed in Nepse under commercial banks group during the FY 2071/72.

3.2.2 Sample Size

A sample is a collection of items or elements from a population or universe. Hence, a


sample is only a portion or subset of the universe or population. It comprises some
observations selected from the population. Here, researcher has used random
sampling to select the sample.The sample consists of 4 selected banks. Thus, these
banks are chosen as sample for the study. The selected sample banks for the analysis
are:

 Bank Limited ()
 Bank of Kathmandu Lumbini ()
 Everest Bank Limited (EBL)
 Nepal Bank ()

3.3 Data Collection Procedures

It shows the sources of data & how they are collected. Most of the data necessary for
the research is collected from the secondary sources. Data related to the market prices
of stocks, NEPSE index etc. is taken from the trading report published by NEPSE.
Financial statements of commercial banks and their annual reports are also collected.
The collection procedure is summarized below:

 Financial documents provided by the related banks on their website.


 Trading Report published by Nepal Stock Exchange.
 Related websites of finance.
 Materials published in papers and magazines.
 Other related books and booklets.

19
3.4 Data Analysis Tools

For the accomplishment of the envisaged objectives of this research study, various
financial and statistical tools have been employed in the course of the analysis of data.
These tools are;

3.4.1 Standard Deviation and Variance

Investment in shares or stocks is always associated with risks. The extent of such risk
has, therefore, been measured in terms of Harry Markowitz's "mean-variance" concept
which states that returns were measured by mean return and the risk by the standard
deviation or its square, variance. Standard deviation is a measure of the variability of
the distribution of returns around its mean value, and hence shows the total risk
involved in a single stock. In the symbolic form, standard deviation is;

∑(𝑅𝑗 −𝑅̅𝑗 )
σj = √ 𝑛−1

Where,

σj = Standard deviation of the returns on the stock 'j'

Rj = Annual rate of return of stock ‘j’

̅j = Average (Expected) rate of return of stock ‘j’


R

n = number of observations.

Apart from the standard deviation, variance has also been used to measure the extent
of risk in a stock. Variance is the square of the standard deviation, and as "mean-
variance" concept states, higher the value, higher is the risk associated with the
individual stock. In the symbolic form, variance is;

Variance (σj2)= Variance of stock 'j'

3.4.2 Coefficient of Variation (C.V)

The standard deviation can sometimes be misleading in comparing the risk, or


uncertainty,surrounding alternatives if they differ in size. In this case, the coefficient
of variation is used to measure risk.It is the measure of relative dispersion (risk). It

20
measures the risk per unit of return.Higher the coefficient of variation, greater is the
risk.

Mathematically,
𝜎𝑗
C.V = ̅̅̅𝑗
𝑅

Where,
C.V= Coefficient of Variation
σj= Standard deviations of returns of stock ‘j’
R j = Expected return on stock ‘j’.

3.4.3 Covariance (COVjm)

Covariance is a statistical measure of the degree to which two variables, such as 'Rj'
and 'Rm' move together. The covariance between two variables, in this case is;

 
COV(Rj, Rm) = 
(R j  R j )( Rm  Rm )
n 1

Where,

COV(Rj, Rm) = covariance between the individual stock 'j' and the market 'm'

Rj= Annual rate of return of individual asset 'j'

Rm = Annual rate of market return

𝑅̅ j = Expected rate of return of asset 'j' &

̅m = Expected rate of return of the market


R

n = number of observations

3.4.4 Correlation Coefficient (r jm )

The other measure for the extent of relationship and its direction between the single
stock return and the market rate of return is the correlation coefficient. It can be
directly derived from the covariance as;

21
COV jm
r jm 
 j m
Where,
r jm  Correlation coefficient between stock ‘j’ & market ‘m’
COVjm = Covariance between stock ‘j’ & market ‘m’
 j  Risk of the stock ‘j’
 m  Risk of the market ‘m’

The covariance may have any positive or negative value whereas the value of the
correlation coefficient ranges from +1 to -1.

In the case of the covariance, if it is positive, 'j' and 'm' move together. Conversely, if
it is negative, the two variables, 'j' and 'm', tends to move the opposite direction. The
covariance, however, does not affect the portfolio’s expected return.Unlike the
covariance, correlation coefficient reveals the degree or strength of relationship
between the returns two variables i.e. 'j' and 'm'. A positive correlation coefficient
indicates that the returns from two variables generally move in the same direction,
whereas a negative correlation coefficient implies that they generally move in
opposite directions. The stronger the relationship, the higher the correlation
coefficient is to one of the two extreme values. A zero correlation coefficient implies
that the returns from two variables are uncorrelated; they show no tendency to vary
together in either a positive or negative linear fashion.

3.4.5 Beta Coefficient

Beta coefficient (β), therefore, measures the co-movement of a security in relation to


the market. Hence, it shows the market sensitivity of stock. Higher the beta (β),
greater is the sensitivity and reaction to the market movement. Beta coefficient of a
particular stock may be <1, =1 & >1 (1≤β≤1), whereas beta coefficient of the market
is always equal to 1. A stock with β>1 is considered to be aggressive and as such
more risky than market. A stock with β<1 is considered to be defensive and as such
less risk than market.Mathematically,

𝐶𝑂𝑉(𝑅𝑗 ,𝑅𝑚 )
Βj = 2
𝜎𝑚

22
Where,

βj= beta coefficient of the stock 'j'

COV(Rj, Rm) = Covariance of return of stock 'j' and return of the market 'm'

σ2m= Variance of the market return

3.4.6 Systematic and Unsystematic Risk

Standard deviation of an individual stock, however, does not indicate its contribution
to the risk and return of a diversified portfolio so it can be segregate to systematic and
unsystematic risk.

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.
Unsystematic risk can be reduced through diversification. The relationships among
total risk, systematic risk and unsystematic risk are shown below as described in
Sharpe index model.

Total risk (σj ) = Systematic risk + Unsystematic risk

Systematic risk (SR) = 𝛽𝑗 × 𝜎𝑚

Unsystematic risk (TR) = TR  SR

Where,

𝛽𝑗 = Beta of stock ‘j’

𝜎𝑚 = Standard deviation of market

TR = Total Risk

SR = Systematic Risk

23
3.4.7 CAPM

Apart from analysis of risk and return on stock, the investor also needs to know about
pricing of stock. Investor generally buys the stock with undervalued. For this, CAPM
model can be used. It is a model that describes the relationship between risk and
expected (required) return. If the expected return using the CAPM is higher than the
investor's required return, the security is undervalued and the investor should buy it.If
the expected return using the CAPM is lower than the investor's required return, the
security is overvalued and should be sold. If we assume that unsystematic risk is
diversified away, the required rate of return for stock 'j'is

Rj = R f  ( Rm  RF )
j

Where,

Rj= Required rate of return for stock 'j'

R f = Risk Free rate

Rm = Market Expected return

 j = Beta of Stock 'j'

3.5 Data Description and Sources

Data are collected for analysis. The data can be analyzed by using financial and
statistical tools. A brief description of the terms used in this study is as follows:

3.5.1 Market Price of Stock (P)

The major data of this study is market price of stock.The market price of a firm's
stock represents the value that market participants place on the company. It is taken
from the annual reports of all four sample banks used in analysis of this study.

3.5.2 Dividend (D)

Dividend is return to the shareholders for their investment. It can be given in the form
of cash or shares or both. Apart from cash dividend, if company offers dividend in the

24
form of shares, its monetary valuation is hardly possible and creates difficulties.
However the formula for the valuation of the total dividend has been specified as:

TDt= CDt+ SDt%×MPS (t+1)

Where,

TD = Total Dividend

CD = Cash Dividend

SD = Stock Dividend

MPS= Market Price per Share

t = Time period

3.5.3 Annual return on Common Stock Investment (R)

Annual return on common stock is also known as single period rate of return. It has
been calculated as the ratio of receivedon investment plus any the market price of the
proceeding period. Mathematically,

𝐷𝑡 +(𝑃𝑡 −𝑃𝑡−1 )
Rt = 𝑃𝑡−1

Where,

Rt=Actual Rate of Return of common stock at time‘t’

D= Cash dividend at time‘t’

Pt= MPS at time 't'

Pt-1 = MPS at time't-1'

3.5.4 Expected Rate of Return on Common Stock ( R j )

Expected rate of return is simply the arithmetic mean of the actual rate of return.
This is an average return on common stock. Mathematically,

25
∑𝑅𝑗
𝑅̅𝑗 = 𝑛

Where,
( R j ) = Expected rate of return on stock ‘j’

n = Number of years that the return is taken


Σ = Sign of summation

26
CHAPTER - IV

DATA ANALYSIS AND PRESENTATION

This chapter is the main body of the study. The chapter includes analysis of collected
data and their presentation. In this chapter, secondary data are analyzed in table,
figure, chart and diagram form. Detail data of market price of stock, earning per share,
dividend of each bank and relevant data of NEPSE index are presented and their
interpretation and analysis is done. With reference to various readings and literature
review in the proceeding chapter, effort is made to analyze and establish the
relationship between risk and return of stock investment with a special reference to
listed commercial banks. This chapter also analyzes the systematic and unsystematic
risk of each commercial Bank. The main objective of the study is to present data &
analyze them with the help of various financial & statistical tools.

4.1 Analysis of Market Movement

Index is one of the most important indicators of secondary market which is regarded
as mirror of the economy of the country. NEPSE index group consists of different
indices & they are computed as per market capitalization. Among them, overall
NEPSE index is the oldest one which is being calculated from the initial days of
NEPSE. There is only stock market in Nepal, known as Nepal Stock Exchange,
shortly NEPSE. In the context of Nepalese financial market, average market
movement is represented by the NEPSE index and average return or market return can
be found by using NEPSE index. NEPSE index is calculated by considering all listed
shares including that of promoter share of all listed companies at NEPSE.The NEPSE
index is adjusted and changed continuously.

27
Figure: 4.1

NEPSE Index Movement

1200
1036.11
1000
961.23

800
Index in points

749.1

600
518.33
400
362.85 389.74

200

0
2066/067 2067/068 2068/069 2069/070 2070/071 2071/072
Fiscal Year

Figure 4.1 shows that the NEPSE index is 749.10 in the initial year which sharply
decreases to 362.85 in the F/Y 2067/068. Thereafter, it shows the increasing trend
until the F/Y 2070/071 and again decreased in F/Y 2071/072. The maximum index is
1036.11 points in the fiscal year 2070/071& that of minimum is 362.85 in the F/Y
2067/068.

4.2 Analysis of Banking Industry Index Movement

Commercial Banking index is a sub-index of NEPSE, which is computed only on the


basis of commercial banking sector. The number of listed companies under
commercial banks group by Nepse is 29 at the end of FY 2071/72. The study takes
sample of four commercial banks for the analysis. Banking index is the mirror of the
growth & development of the banking field.

28
Table: 4.1

Commercial Banking Industry Index Movement

Commercial Bank Index


Annual return
Fiscal Year Index (Rm) (𝑅𝑚 − 𝑅̅𝑚 ) (𝑅𝑚 − 𝑅̅𝑚 )2
2067/68 328.7 -0.2806 -0.3194 0.1020
2068/69 358.57 0.0909 0.0521 0.0027
2069/70 505.48 0.4097 0.3709 0.1376
2070/71 945 0.8695 0.8307 0.6901
2071/72 831.35 -0.1203 -0.1590 0.0253
∑𝑅𝑚 = 0.1938 ∑(𝑅𝑚 − 𝑅̅𝑚 )2 = 0.9578
̅ 𝒎)
Expected Return ( 𝑹 0.0388
Risk (𝝈𝒎 ) 48.93%
Variance(𝝈𝟐𝒎 ) 0.2395

Source: Annual report of NEPSE from 2067 to 2072& Appendix I

Table 4.1 shows the commercial banking industry movement in different years. The
highest point of Banking index is 945 in the year 2070/071& that of the lowest was
328.7 in the year 2067/068. Thereafter, it shows the increasing trend until the F/Y
2070/071& later shows the decreasing trend till 2071/072.

Similarly, table 4.1 also shows that the expected rate of return, standard deviation &
variance are 3.88%, 48.93% % & 23.95 % respectively.

Table 4.1 also shows the annual rate of return of banking sector. In the initial F/Y
2067/068, it had negative return of 28.06%.The annual return is in increasing trend
up to F/Y 2070/071. This means, the investor has earned the profit from the common
stock investment in commercial banks in the particular year. But, In the F/Y
2071/072, the annual rate of return of the banking sector is negative. The highest
negative return is 12.03%. Here, the investor suffers loss from banking investment.

29
4.3 Risk & Return Analysis of Sample Banks

As the study has taken a special reference to listed commercial banks, common stock
of listed commercial bank are analyzed here separately. Among the listed banks, the
study has focused on the four commercial banks:

1. Everest Bank Limited (EBL)

4.3.1 Year wise MPS, EPS & P/E Ratio of EBL

The year wise MPS, EPS, P/E Ratio, total dividend & annual return are given below:

Table: 4.2

MPS, EPS, Total Dividend& P/E Ratio of EBL

Fiscal MPS Cash Dividend Stock Total EPS PE Ratio


Year (Rs) Dividend (%) Dividend (Rs)
2067/68 1094 50 10 153.3 83.18 13.15
2068/69 1033 1.58 30 478.88 88.55 11.67
2069/70 1591 50 10 313.1 91.88 17.32
2070/71 2631 50 12 304.4 86.04 30.58
2071/72 2120 5 30 1020.5 78.04 27.17

Source: Annual Report of EBL from 2067-72& Appendix II

Table 4.2 shows that EBL pays both the cash and stock dividend in each fiscal year.
However, stock dividend fluctuates more than cash dividend. The highest cash
dividend is paid in the F/Y 2067/068, 2069/070 & 2070/071 respectively (i.e. Rs. 50
per share). The maximum & the minimum P/E ratio of EBL are 30.58 times & 11.67
times in the F/Y 2070/071& 2068/069 respectively. Similarly, EPS fluctuates every
year. It is the highest in the F/Y 2069/070 (i.e. Rs. 91.88) & the lowest in the F/Y
2071/072 i.e. Rs. 78.04.

Similarly, Table 4.2 also reflects the closing MPS of EBL. It is maximum in the F/Y
2070/071(i.e. Rs. 2631& the minimum in the F/Y 2068/069 i.e. Rs. 1033. The market

30
price of EBL drops from the F/Y 2067/068 to 2068/069. However, it rises in the F/Y
2069/070 and F/Y 2070/071 and then again declines in the F/Y 2071/072.

Figure: 4.2

Annual Return on Stock of EBL

0.9
0.8433 0.845
0.8
0.7
Annual Return in %

0.6
0.5
0.4 0.3819

0.3
0.2
0.1 -0.02348 0.1937

0
-0.1 2067/068
2068/069
2069/070
2070/071
2071/072
Fiscal Year

Source: Annual Report of EBL from 2067-72 & Appendix II

Figure 4.2 shows the annual return on stock of EBL. It is negative in the F/Y
2067/068 (i.e.-0.2348) & that of lowest positive return is 0.1937 in the F/Y 2071/072.
However, in the F/Y 2068/69, 2069/70& 2070/071 the returns on stock are 0.3819,
0.8433&0.8450 respectively. From the analysis, it is concluded that the negative
return on stock may be the heavy fall in the market price of common stock.

31
4.3.2 Overall Risk & Return Results of EBL

The overall risk & return of EBL is tabulated below:

Table: 4.3

Overall Risk & Return Results of EBL

Variables Value

Expected Return ( REBL ) 40.58%

Risk (  EBL ) 45.83%

Variance (  EBL )2 21.01%

Coefficient of Variation (CV) 1.1293


Covariance between return on Banking industry & return of EBL ( COV EBL, BI ) 0.1911

Correlation between return of EBL & return of Banking industry ( rEBL, BI ) 0.8519

Beta Coefficient (  EBL ) 0.7979

Systematic Risk (SR) 39.04%


Unsystematic Risk (USR) 6.79%
Proportion of systematic risk in total risk 85.18%
Proportion of unsystematic risk in total risk 14.82%

Source: Appendix VI, VII&XIV

Table 4.3 reveals that the expected rate of return of EBL is positive (i.e. 40.58%) with
the S.D of 45.83% & CV of 1.1293. This represents that to receive per unit return
1.1293 unit of risk must be beared.

The beta coefficient of EBL is 0.7979 which is lower than 1 & therefore, this is a
defensive stock & found to be less risky. Correlation coefficient between commercial
banking index & EBL is 0.8519 which is positive & it shows the positive relation.
The EBL has 39.04% systematic risks & 6.79% unsystematic risks out of total risk of
45.83%.

32
Figure: 4.3
Proportion of Systematic Risk & Unsystematic Risk of EBL

6.79%

Systematic Risk
Unsystematic risk

85.18%

Source: Appendix XIV

Figure 4.3 shows that the EBL has 6.79% unsystematic risk which can be
diversifiedwhich the management of the company should focus to minimize &
85.81% systematic risk which can’t be diversified.Since the systematic risk is very
high in the company, it cannot be reduced throughdiversification. All equity investors
have to bear this risk.

4.4 Comparative Analysis of Sample Commercial Banks based on


Risk & Return

From the above calculation & presentation, the expected return, standard deviation
& coefficient of variation is presented in tabulation form.

The following table shows the expected return, standard deviation & coefficient of
variation of the sample banks in the study period of five years i.e. from F/Y
2067/068 to 2071/072.

33
Table: 4.10

Expected Return, Standard Deviation & Coefficient of Variation of the Sample Banks

S.N Commercial Expected Return Standard Coefficient of


Banks Deviation ( ) Variation (C.V )
(R )
1. EBL 40.58% 45.83% 1.1293

Source: Appendix III, V, VII & IX

Table 4.10 shows the comparison of expected returns, standard deviation & the
coefficient of variation between the sampled banks. EBL has 40.58% % of expected
return..

4.5 Market Sensitivity (Beta Coefficient Analysis)

Market sensitivity of the stock is explained by its beta coefficient. Beta coefficient
(β) measures how much is the systematic risk on the assets. It measures the
responsiveness of a security to movement in the market. Beta coefficient shows the
volatility of stock which cannot be diversifiable. Beta coefficient of market is
always equal to 1.

34
Table: 4.11
Beta Coefficient of Sample Commercial Banks
S.N Sample Banks Beta (βj) Types of Stock
1. EBL 0.7979 Defensive
2. 1.1442 Aggressive
3. -0.0027 Defensive
4. 0.6563 Defensive

Source: Appendix VII, IX, XI&XIII

Table 4.11 shows that the beta coefficients of all the banks are less than 1 except
bank. So, the stocks of Everest, & are defensive type of stocks whereas the stock of
is aggressive. has the highest beta coefficient than other banks. This implies that the
stock of is strong contributor and highly influenced by day-to-day market trading.
Hence, it is more volatile to the market. On the other hand, the stock of has the
negative beta coefficient which means that it is inversely correlated with the market.

4.6 Analysis of Systematic Risk & Unsystematic Risk of Sample


Commercial Banks

Total risk or total variability of returns of an asset is measured by variance &


standard deviation. The total risk can be divided into two parts: diversifiable & non
diversifiable risks. The SR & USR of total risk of sample banks are shown in below
table:

Table: 4.12
Proportion of SR & USR in Total Risk of Sample Banks
S.N Sample Banks Portion of SR (%) Portion of USR (%)
1. EBL 85.18% 14.82%

Table 4.12 shows the proportion of SR & USR in total risk of four sample banks.
bank has the highest proportion of SR (i.e. 86.02%) which can’t be avoided or
diversifiable. On the other hand, has the highest proportion of USR (i.e. 100.74%)
which can be eliminated from the internal management. The unsystematic risk can
be minimized from portfolio creation in investment.

35
4.7 Analysis of Common Stock’s Price of Sample Banks by CAPM Model

CAPM is a model that describes the relationship between risk and expected (required)
return. If the expected return using the CAPM is higher than the investor's required
return, the security is undervalued and the investor should buy it.If the expected return
using the CAPM is lower than the investor's required return, the security is
overvalued and should be sold.

For this analysis, the risk free rate of return is needed, which is taken from the interest
rate of Treasury bill issued by NRB. NRB issued Treasury bill, 91 days duration. 91
days duration Treasury bill rate is taken as a risk free rate from website of NRB which
is 0.1739%.

Generally, for the price evaluation, the calculation of required rate of return is
necessary & it can be calculated by using following formula,

Rj = R f  ( Rm  RF )
j

Table: 4.13

Required Rate of Return, Expected Return using CAPM& Price Evaluation

Investor’s Required Expected Return Using Price


Bank Return CAPM Evaluation
Everest 40.58% 3.13% Overvalued

According to the table 4.13, the common stock of all the sample banks is overpriced.
The overvalued stock’s value may decrease in the near future providing the investors
low return. So, investors should sell these stocks.

4.9 Major Findings of the Study

The major findings from the study of risk & return of selected commercial banks can
be summarized below:

 The covariance and correlation coefficient of Everest, are positive which


shows that they move the same direction of commercial banking index.

36
 The common stocks of all the sample commercial banks are overpriced. In this
circumstance, investors can gain from the sale of overpriced stocks.

37
CHAPTER– V

SUMMARY, CONCLUSION AND


RECOMMENDATIONS

5.1 Summary

The study has been primarily focused on the risk and return analysis of common stock
investment of Nepalese commercial banks among other securities. Investors of
common stock are ultimate owners of the company, who are ultimately associated
with risk and return. Risk and return is an updated concept for modern investment
decision & acts as basic foundation of safer investment. Risk and return analysis
should always be addressed before investment. So as to maximize the share price, the
financial manager must learn to assess two key determinants i.e. risk and return. It
becomes easier when there is existence of developed and healthy stock market.

Common stock is the most risky security and life blood of stock market and
investment in common stock of company can’t ensure the annual return and the return
on principal. Therefore, investment in the common stock is very sensitive on the
ground of risk. Dividend to common stockholder is paid only if the firm makes on
operative profit after tax preference dividend. Common stock has attracted more
investors in Nepal. Rush in the primary market during the primary issue is one of the
examples. But private investor plays a vital role in economic development of the
nation by mobilizing the disposed capital in different from the society.

The relationship between risk and return is described by investor’s perceptions about
risk and their demand for compensation. No investors will like to invest in risky assets
unless she/he is assured of adequate compensation for the acceptance of risk. Hence,
risk plays a central role in the analysis of investment process, identification of
overpriced & underpriced securities, making appropriate investment strategies as well
as construction of efficient portfolio. Risk, return & time are the elements of
investment. It is the investor required risk premium that establishes a link between
risk and return in a market dominated by rational investors. The higher risk will

38
command by rational premium and the tradeoff between the two assumes a liner
relationship between risk and risk premium.

The fundamental objective of the study is to evaluate the risk & return of selected
commercial banks. Among the 29 companies listed in Nepse under commercial banks
group during the FY 2071/72, only four commercial banks namely EBL, , & are taken
as reference to analyze the risk & return. Data of last five years are taken for the
study. Market price per share & dividend per share of the concerned banks are used to
analyze the risk & return of the common stock of the banks. Secondary data are
collected from the NEPSE, NRB, SEBON, related banks and their websites. Other
subjective types of information are collected through the officials of NRB, SEBON
and NEPSE. While analyzing the risk & return, various financial & statistical tools
such as expected return, standard deviation, coefficient of variance, coefficient of
correlation & required rate of return have been used for the analysis & interpretation
of the data.

5.2 Conclusion

 The study shows that all the sample banks have positive rate of return.

 Comparing the expected rate of return & required rate of return depicts that
the common stock of EBL, are overpriced. It indicates that EBL, banks have
stock with good income opportunity. The price may decrease in near future
which leads to lower the return of investors. So it is better to sell these stocks
instead of holding them for longer period of time. Here investors can gain by
selling the stocks which are being overvalued.

5.3 Recommendations

The findings of the study might be important for those who are interested in the
investment in common stock of commercial banks directly or indirectly. Basically, the
study has been focused on the individual investors who are going to invest their funds
on the banking sector. Based on the major findings of the study, the following
recommendations have been developed:

39
 Among the selected four commercial banks, the stocks of all the commercial
banks are overpriced. So, an investor is recommended to sell these overpriced
stocks to maximize the benefit from the investment.
 Unsystematic risk arises from such factors which are concerned with the firm.
This risk is unique to a particular security. Examples are: strike, change in
management. This type of risk can be diversified by various measures like
establishing a proper and stable management within the company, avoiding
conflict between management and workers, strong policies and rules within
the organization, etc. And Systematic risk refers to variability in return on
investment due to market factors that affect all investments in a similar
fashion. Examples of such factors are: Level of economic activities (recession
or boom), variation in interest rates, inflation, political developments, etc. This
type of risk is non-diversifiable; it cannot be reduced through diversification.
All equity investors have to bear this risk.
 Investment on common stock is a risky job. Investors have to focus not only
on return but also on risk. Higher the return, higher will be the risk definitely.
However, it does not guarantee return and principal both. Hence, it is risk in
the short term investment and therefore, the investors need to be prepared for
it. The financial institutions and companies should provide the real financial
statements. The data provided by NEPSE and the company itself is different in
certain cases. It creates confusion to the possible investor about the actual
financial condition of the company. The value of assets and liabilities should
not be manipulated by the company to show the under profitability or over
profitability.
 The development of stock market is also dependent on political stability of the
country. So, the government should be stable for the growth & development of
stock market.

40