CHAPTER – I

INTRODUCTION

1.1 Background of the Study

Banking has become a part of daily life of today's people. The development in
the banking facilities have added a numerable values to the customers,
producers, entrepreneurs, travelers and investors around the word. Despite the
importance from the view point of service facilities to the users, it plays a
significant role in the economic development and the welfare of the people.
Bank assists both the flow of goods and services for the product to the
consumers and the financial activities of the government. Banking provides the
country with a monetary system of making payment and is in important part of
the financial, which makes loan to maintain and increases the level of
consumption and production in the country.

Modern banking begins in Nepal with the establishment of Nepal Bank Ltd. in
1937 A.D. The authorized capital was contributed by the government 51% and
remaining 49% by public. In 1955, Nepal Rastra Bank was established as the
central bank of the country with the objectives of supervising, protecting and
directing the functions of commercial banks and maintaining a sound monetary
and financial stability in the country. Prior to the establishment of Nepal Rastra
Bank, Nepal Bank Ltd. acted as the central bank of the country. In 1966 A.D
another commercial bank fully owned by government named Rastriya Banijya
Bank was established under the Banijya Bank act 1964 A.D. Agriculture
Development was as established in 1967 A.D with the objective of enhancing
the agriculture development in the country. Agricultural Development provides
banking services in some urban areas of Nepal as that other commercial banks.

1.1.1 Meaning of Commercial Bank

According to G. Crowther, "A bank is an institution which collects money
from those who have it spare or who are saving it out of their income and

1
lends this out to those who requires it" (Crowther, 2003: 2). It is established
by law. So, it's a legal entity. Crowther has described that the merchants,
money lenders and goldsmiths are the ancestors of modern banks.

Commercial bank means a bank which operates currency exchanges

transactions, accepts deposits, provides loan, performs dealing relating of
commerce except the banks which have been specified for the cooperative,
agriculture, industry or other similar specific objectives (His Majesty's
Government, Commercial Bank Act, 2031 B.S.).

Commercial banks are those banks, which pool together the savings of the
community and arrange them for the productive use. Commercial banks
transfer monetary sources from savers to users. They accept deposits from the
public on the condition that they are repayable. They provide loans and
advances from the money, which they receive through deposits. Apart from
financing, they also render services like collection of bills of checks, safe
keeping of the valuables, financial advising etc. to their customers.

1.1.2 Functions of Commercial Banks

There are many functions of commercial banks. The followings are the main
functions performed by the commercial banks:

i. Accepting Deposits
Commercial banks accept deposits in three forms namely current, saving
and fixed deposits.
a. Current deposits: - Current deposit is also known as demand deposit. Under
this, any amount may be deposited in this account. The bank does not pay
any interest on such
b. saving deposits: - Saving deposit is one of the deposits collected
from small depositors and low-income depositors. The bank usually pays
small interest to the depositors against their deposits. This is also called
saving account.

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c. Fixed deposit: - Fixed deposit is the one in which a customer is required to
keep a fixed amount with bank for a specific period, generally by those who
do not need money for a stipulated period. The bank pays a higher interest
on such deposits.

ii. Advancing Loans

Commercial bank provides loans and advances from the money, which it
receives by way of deposits. Direct loans and advances are given to all
types of persons against the personal security of the borrowers of against
the security of movable of immovable properties. Banks in four forms
grant loans, namely:
a. Overdrafts
b. Direct Loans
c. Cash Credit
d. Discounting Bills of Exchange

iii. Agency Services

Commercial bank undertakes the payment of subscriptions, insurance premium,
rent, income tax etc. It collects cheques, bills, dividends, interest, pensions etc.
on behalf of the customers. The bank charges a small amount of
commission for those services. It undertakes to buy and sell securities on
behalf of its customers. Commercial bank also acts as a trustee, executor and
administrator.

iv. Credit Creation

Credit creation is very important function of the commercial banks. They
accept deposits and advance loans. When the bank advances loans, it opens
an account to draw the money by cheque according to his needs. By granting
loans, the bank creates credit or deposit.

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v. Other Functions
Other functions of commercial banks include:
1. Assist in foreign trade:
2. Carrying out the foreign currency exchange.
3. To provide travelers cheque.
4. To facilitate in financial policy formulation by gathering and
providing trading and monetary transaction related information.
5. To underwrite the debentures.
6. To accept the bills of exchanges.
7. To provide advice to customers, entrepreneurs, and businessmen on
economic matter.
8. To create credit on the specific basis and expand credit.
9. To issue credit card, debit card, master card, visa card etc.

1.1.3 History of Banking Development in Nepal

Formally, Nepal's banking history had begun with the establishment of
Nepal Bank Limited in 1994 B.S. At that time, this bank had authorized capital
of Rs. 10 million of paid up capital of Rs. 842 thousand. Nepal Bank Limited
was the first commercial bank with 51 percent government equity. As a central
bank, Nepal Rastra Bank was established in 2013 B.S. under the provision of
Nepal Rastra Bank Act, 2012 B.S. with the objective of helping in the
development of monetary and financial sector by undertaking various
functions.

Another progress was added when Rastriya Banijya Bank came into existence
in 1966 (2022 B.S.) fully government ownership with the authorized capital of
Rs. 10 million and paid up capital of Rs. 2.5 million under the Banijya
Bank Act 1965 (2021 B.S.). Likewise, Agriculture Development Bank was
established in 1968 (2024 B.S.) under the Agriculture Development Bank Act,
1968 (2024 B.S.) with the objective of increasing the life standard of those
people who are involved in agriculture.

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 In 1980, the government introduced, 'financial sector reforms'. The government
adopted liberalized economic policies to develop the financial sector. As a pre-
condition to economic liberalization, the foreign investment and technology
transfer Act, 1981 came into existence. The government allowed private sectors
to open banks. The government allowed the entry of foreign banks as joint
ventures with up to a maximum of 50 percent equity participation. Many joint
venture commercial banks and financial institutions were established.
List of Licensed Commercial Banks
S.N. Name of Bank Established Date Head Office
1. Nepal Bank Ltd. 1994/07/30 Kathmandu
2. Rastriya Banijaya Bank Ltd 2022/10/10 Kathmandu
3. NABIL Bank Ltd 2041/03/29 Kathmandu
4. Nepal Investment Bank Ltd. 2042/11/16 Kathmandu
5. Standard Chartered Bank Nepal Ltd 2043/10/16 Kathmandu
6. Himilayan Bank Limited 2049/10/05 Kathmandu
7. Nepal Bangladesh Bank Ltd. 2050/02/23 Kathmandu
8. Nepal SBI Bank Ltd. 2050/03/23 Kathmandu
9. Everest Bank Ltd. 2051/07/01 Kathmandu
10. Bank of Kathmandu Ltd. 2051/11/28 Kathmandu
11. Nepal Credit and Commerce Bank Ltd. 2053/06/28 Kathmandu
12. Lumbini Bank Ltd 2055/04/01 Narayangadh
13. Nepal Industrial and Commercial Bank Ltd. 2055/04/05 Biratnagar
14. Kumari Bank Ltd. 2056/08/24 Kathmandu
15. Machhapuchhre Bank Ltd 2057/06/17 Pokhara
16. Laxmi Bank Ltd 2058/06/11 Birjunj
17. Siddhartha Bank Ltd 2058/06/12 Kathmandu
18. Agriculture Development Bank 2062/03/30 Kathmandu
19. Global Bank Ltd. 2063/09/18 Birjunj
20. Citizens Bank International Ltd. 2064/01/07 Kathmandu
21. Prime Commercial Bank Ltd. 2064/06/07 Kathmandu
22. Bank of Asia Nepal Ltd. 2064/06/25 Kathmandu
23. Sunrise Bank Ltd. 2064/06/25 Kathmandu
24. Development Credit Bank Ltd. 2065/02/12 Kathmandu
25. NMB Bank Ltd. 2065/02/20 Kathmandu
26. Kist Bank Limited 2066/01/24 Kathmandu
27 Janata Bank 2067 Kathmandu
28 Mega Bank 2067 Kathmandu
(Source: Mid July 2010, Nepal Rastra Bank)

5
1.1.4 Investment
Investment is a word of many meaning. If new investment concepts involve
and take a root, the whole investment scene could be changed dramatically
over the next few years. In modern world, most of the people like to have more
wealth and income and time to enjoy them at least they want to make the best
use of what they already have. How to get more and how to make the best uses
of what is available in economic problem. People invest their saving in
different types of assets. Assets are classified in two different categories i.e.
financial assets and real assets. Investment in real assets refers to the
investment of fund in real goods such as land and building, vehicles and
computer etc. Investment in financial securities means putting the money in the
piece of paper such as shares, debentures, bonds and treasury bills etc.

Investment, in other hand, is the sacrifice of certain present value of uncertain

future rewards. According to A.N. Ahuja investment means' an act or the
activity of giving up a benefit presently enjoyed in order to gain a benefit in the
future.

For the investors generally these comprises the structure of subjective

preferences for the size and regularity of the income to be received from, and
for the safety and negotiability of specific investments or combinations of
investments, as these are appraised from time to time. When the analysis passes
from the stage of description to the higher stage of security selection his frame
of reference widens. He how considers not only securities but security holders
as well. In the formulation of a program for the acquisition and management of
a security portfolio, the first and most basic step is to distinguish clearly
between investment and speculation.

Portfolio investment refers to an investment that combines several assets. It is a

collection of securities. The portfolio theory is concerned with the selection of
optimal portfolio that provides risk for any specified rate of return. Portfolio

6
theory has been developed for financial assets. Thus, making investment form
selected optimal portfolio i.e. the portfolio that provides the highest rate of
return with least possible amount of risk is the real investment portfolio.

Most securities available for investment have uncertain outcomes and are thus
risky. The basic problem facing each investor is to determine which
particularly risky securities to owe. Because a portfolio is collection of
securities, this problem is equivalent to investor selection optimal portfolio
from a set of possible portfolios. Hence, this situation is often referred to as the
portfolio selection problem. One solution to this problem as put for in 1952 by
Harry Markowitz in a landmark paper that is generally viewed as the origin of
modern investment theory (Sharpe etal : Investment; 119).

1.1.5 Portfolio Management

Portfolio management can be also defined as aggregation and management of a
diverse portfolio of supply resources which will act as a hedge against various
risks that may affect specific resources. Under a more market driven power
sector with a power pool or pool Co wholesale market structure, a portfolio
manager would aggregate and manage a diverse portfolio of spot market
purchase, contracts for difference, future contracts and other market hedging
type contracts and mechanisms(www:[Link]/resources/[Link])

In finance, a portfolio is a collection of investment held by an institution or a

private individual. In building up and investment portfolio a financial
institution will conduct its own investment analysis whilst a private individual
my make use of the service of a merchant bank which offers portfolio
management. Holding a portfolio is a part of an investment and risk limiting
strategy called diversification ([Link]/search).

The term 'portfolio' simply means collection of investment. For an investor

through the stock exchange the portfolio will be collection of shareholding in
different companies. For a property investor portfolio will be collection of
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buildings. To a financial manager within an industrial company portfolio will
be a collection of real capital projects. It will be apparent that the actual nature
of components of a portfolio depends on the population of opportunities from
which the selection has been made (Brockinton, 1990:148).

In short, portfolio management is the process of selection a bundle of securities

or the selection of the investment sectors (real sector also) that provide the
investing organization a maximum yield for a given level of risk. Portfolio
management can be also taken as risk and return management. It aims to
determine and appropriate asset mix which attains optimal level of risk and
return. Portfolio, technically known as efficient portfolio, is a superior
portfolio. The efficient portfolio is a function of not risk and return on
individual asset included but also the effect of relationship among the asset on
the sum total of portfolio risk and return.

Objectives of the Portfolio Management

The portfolio management is a complex task. Investment matrix is one of the
many approaches, which may be used in this connection. The various
considerations involved in investment decisions Portfolio Management of
Listed Commercial Banks In Nepal 28 liquidity, safety and yield of the
investment. Image of the organization is also to be taken in account. These
considerations may be taken into account and an overall view obtained through
a matrix approach by allotting marks for each consideration totaling them. The
investors would like to have the following objectives of portfolio management.
a. Capital
b. Safety or security of an investment’
c. Income by way of dividends and interests,
d. Marketability
e. Liquidity
f. Tax planning- capital gains tax, income tax and wealth tax,
g. Risk avoidance or minimization of risk.

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1.2 Focus of the Study
Major focus of the study is about commercial banks and their investment
portfolio. This study concentrates about meaning of commercial banks and
their functions, mainly the analysis of investment portfolio. The study focus
how the selected commercial banks perform the regular jobs and how and what
portion they invest the funds in different asserts and securities, what policies
they obey to mobilize the deposits.

The commercial banks are those institutions which deal in accepting deposit of
individual and giving loans. These banks provide working capital needs of
trade, industry and even to agricultural sector. Moreover commercial banks
also provide technical and administrative assistance to industries, trade and
business enterprises. They transfer monetary sources form savers to users.
Commercial bank is a corporation, which accepts demand deposits subject to
check and makes short terms loans to business enterprises, regardless of the
scope of its other services.

The commercial banks play an important role in the modern economy.

Commercial banks are the heart of financial system. They make fund available
through their leading and investing activities to borrowers, individuals,
business firms and services. a commercial bank must mobilize its deposits and
other funds in profitable, secured, stable and marketable sector.

Investment policy provides the bank several inputs through which they handle
their investment operation efficiently ensuring that maximum return, with
minimum risks, which ultimately leads the bank to the way of success. Thus,
investment is the most important function of commercial banks. It is a very
challenging task for commercial bank. So, a bank has to very caution while
investing their funds in various sectors. The success of a commercial bank
heavily depends upon the proper management of it's invest able funds, i.e.

9
Portfolio management. So this study also concentrates about how to manage
the funds properly analyzing portfolio of investment.

1.3 Statement of the Problem

Many financial institutions have been established in our country to assist in the
process of economic development. The major problem in all underdeveloped
countries like Nepal is capital creation and their proper utilization. In such
countries commercial banks have more responsibilities to avoid above problem
and contribute to the economy. The problems of investment and lending
activities have become serious process for developing countries like Nepal.
Nowadays Nepalese CBs is not capable to invest their funds in more profitable
sector. They are found more interest in investment in less risky and liquid
sector. This is due to lack of sound investment policy and portfolio
management of banks. They have no special view towards policy of investment
portfolio. They do not have attention towards proper matching of deposit and
investment.

The banks invest their funds in limited are as to achieve highest economy of
profit. There is hesitation to invest in long term projects cause of more safety
minded. Commercial banks are following conservative loan and investment
policy. Now, the banking sector has reached to the remote areas of the country
and has inspired a good deal in the growth of the economy. Various problems
appear in resources mobilization by financial institution of Nepal. The fact
problem is poor investment environment prevailing in Nepal. If the funds are
wrongly invested neglecting analysis of any financial risk, business risk and
other various types of risk and factor, the bank cannot obtain profitable return
as well. Therefore, portfolio analysis between various types of investment
made by commercial banks is important issues, which helps to minimize risk
by diversifying total risk to different sectors. But portfolio management
activities of Nepalese commercial bank as well as financial institutions to
invest their funds in a good sector, which affects the investment portfolios.

10
Nowadays commercial banks have to face competition with other financial
institutions to grab the investment opportunity.

Based on the above discussion on the research problems, some of the

commonly identified research questions for present research are identified as
follows:
a. What is the relationship between investment and loan & advances?
b. How is effectiveness of fund mobilization and investment policy of
commercial banks?
c. Does the effect exist of the investment decision in total earnings of the
commercial banks?
d. How does commercial bank manage the risk and return using investment
portfolio diversification?
e. What is the trend of investment in different assets and loan portfolio?
f. How much ability in performance of commercial banks in investment
portfolio?

1.4 Objectives of the Study

The main objective of the study is to identify the situation of portfolio
management of commercial banks on Nepal. The specific objectives of the
study are as follows.
 To examine the existing situation of portfolio management (investment
and loans and advances) of sample banks.
 To analyze the financial performance of sample banks of Nepal.
 To analyze the risk and return of sample banks
 To examine the trend of loan and advances and investment in total deposit
and forecast it.

1.5 Significance of the Study

The present analysis of any organization flashes its investment policy; sound
investment policy makes a good impact on the economy of country. The
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success and prosperity of any organization or institution relies heavily on the
successful investment of its available resource into the profitable sector.
Successful formulation and effective implementation of investment policy is
the prime requisition for the successful performance of any organization.

The research work is the study of portfolio analysis of commercial banks of

Nepal. The present study focuses on the portfolio management of the selected
banks in different sectors. In addition to the portfolio investment, the study
examines the financial performance of the selected banks and provides some
inferences regarding the proper mix of investment structure for the
maximization of the return of the banks. Hence, it is hoped that this study will
significant for the individual investors, interested persons and policy makers
and bank management too.

1.6 Limitations of the Study

This study has following limitation:
 The study will basically concern with portfolio investment management of
commercial banks based on investment in different sectors. It doesn’t
consider other financial aspect of the banks.
 The study is mainly based on secondary data. Consequently, the results
depend on the reliability of secondary data.
 The study covers only for the period of five years.
 Out of various commercial banks, only five commercial banks have been
taken as sample for the study.
 The truth of research result is based on the reliability of the secondary
data.

1.7 Organization of the Study

This study has been organized in to five chapters and each chapters are devoted
to some aspects of the study of portfolio management. The organization of
study is arranged as follows.
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Chapter –I : Introduction
In the first chapter introduction of the study topics and other relevant topics and
are given. This chapter provides the introduction of portfolio management and
background to the study.

Chapter –II : Review of Literature

In this chapter the study report is for review of literature. Review of literature
has mainly two parts. One is conceptual frame work and other is review of
related studies. In this chapter, the importance researches by academicians and
researcher studies are reviewed that give ample knowledge to the new
researcher.

Chapter –III : Research Methodology

This chapter is for research methodology. It gives the idea of research design,
information of the population and samples used for the study purpose.
Similarly, data collection and tools and techniques of analysis are also given to
this chapter.

Chapter –IV: Data Analysis and Presentation

This chapter is the main part of this study. It represents the data and
information collection from secondary. The data are collected from the
secondary sources and interpreted by using various financial and statistical
tools and techniques.

Chapter - V: Summary, Conclusion and Recommendation

The last chapter includes summary and conclusions of the study and some
recommendations and suggestions that were found relevant to suggest and
recommend from the study.

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 CHAPTER – II
REVIEW OF LITERATURE

This chapter is considered to the review of major related literature about

the portfolio management and related studies. For this study, various
books, journals, articles and some past thesis were also reviewed. Since
there are not so much adequate study materials related with this topic
published in Nepal, this study has to refer almost all books related with
this topic published in other countries than Nepal. The concept of this portfolio
management and its analysis is clear from the following studies.

2.1 Conceptual/Theoretical Review

Portfolio management is the process of selecting a bundle of securities that
provides the investing organization a maximum yield for a given level of risk
or alternatively ensuring minimum level of risk for a given level of return. It
can be also taken as risk and return management. Its aims to determine an
appropriate asset mix which attains optimum level of risk and return.

Portfolio management of the bank assets basically means allocation of fund to

different components of banking assets having degrees of risk and varying
rates of returns in such a way that balance conflicting goal of maximum
yield and minimum risk. When the process of portfolio management of bank
assets are done various factor such as, availability of fund, liquidity
requirement, central banks policy etc. should be considered. As the task of
portfolio management of the bank assets is to be carried out within the given
macro economic environment the manager should carefully watch related
macro economic indicators such as; interest rate, inflation rate, national
income, savings ratio etc. assets of the bank can be broadly classified into:
1. Investment
2. Loans and advances

14
Portfolio theory was originally proposed by Harry Markoviz in 1952 A.D. the
theory is concerned with selection of an optimal portfolio by risk averse
investors. Risk averse investors is an investors who selects a portfolio that
maximizes expected return for any given level of risk or minimizes risk for any
given level of expected returns. Risk adverse investors will select only
efficient portfolios. Portfolio theory can be used to determine the combination
of these securities that will create the set of efficient portfolios. The selection of
the optimal portfolio depends upon the investor’s performance for risk and
return.

Portfolio investment refers to the investment that combines several assets. The
modern portfolio theory explains the relationship between assets risk and
return. The theory is founded on the mechanics of measuring the effect
of an asset on risk and return of portfolio. Portfolio investment assumes
that the mean and variance of returns are the only two factors that the
investor cares. Based on this assumption, we can say that rational investor
always prefers the highest possible mean return for a given level of risk or
the lowest possible level of risk for a given amount of return.

Portfolio, technically known as efficient portfolios, is a superior portfolio. The

efficient portfolios is a function of not only risk and return of individual asset
included, but also the effect of the relationship among the assets on the sum
total of portfolio risk and return. The portfolio return is straight weight average
of the individual asset. But the portfolio risk is not weighted average of
the variances of return of individual assets. The portfolio risk is affected
by the variance of return as well as the covariance between the return of
individual assets included in the portfolio and their respective weights.

Portfolio analysis considers the determination of future risk and return in

holding various blends of individual securities. Portfolio expected return is a
weighted average of the expected return of individual securities but

15
portfolio variance is sharp contrast, can be something less than a weighted
average of security variance. As a result investor can reduce portfolio risk by
adding another security with greater individual risk then other security in the
portfolio. The seemingly curious result occurs because risk greatly on the
covariance among return of individuals securities.

The aim of portfolio management is to achieve the maximum return from a

portfolio which has been delegated to be managed by an individual or financial
institution. The manager has to balance the parameters which define a good
investment i.e. security, liquidity and return. The goal is to obtain the highest
return for the client of managed portfolio

2.1.1 Investment
Investment, in its broadest sense, means the sacrifice of current dollars for
future dollars. Two different attributes are generally involved: time and risk.
The sacrifice takes place in the present and is certain. The reward comes later,
if at all, and the magnitude is generally uncertain (Francis, Op. Cit., p. 1).

Investments are made in assets. Assets in all are of two types: real assets and
financial assets (stocks, bond, t-bill etc.). These two investments are
not competitive but complementary, highly developed institutions for
financial investment greatly facilitating real investment.

The Investment Process (Sharpe, et. al., Op. Cit., pp 11-14).

The investment process describes how an investor should go about making
decisions with regard to what marketable securities to invest in, how extensive
the investment should be, and when the investment should be made. A
five step procedure for making these decisions forms the basis of the
investment process.

16
 1. Set Investment Policy: It involves determining the investor's objectives
and the amount of his or her inevitable wealth. Investment objective
should be stated in terms of both risk and return.
2. Perform Security Analysis: It involves examining several individual
securities or groups of securities within the broad categories of
financial assets previously identified.
3. Construct a Portfolio: The third step in the investment process,
portfolio construction, involves identifying those specific assets in
which to invest, as well as determining the proportions of the
investor's wealth to put into each one. Here the issues of selectivity,
timing and diversification need to be addressed by the investor.
4. Revise the Portfolio: Portfolio revision concerns the periodic
repetition of the previous three steps. That is, overtime the investor
may change his or her investment objectives, which in turn may
cause the currently held portfolio to be less than optimal.
5. Evaluate the Performance of the Portfolio: It involves determining
periodically how the portfolio performed, in terms not only the
return earned but also the risk experienced by the investor.

[Link] Investment Return

Single-Period Measure of Return
The investment return is defined as the after tax increase in the value of
the initial investment. The increase in value can come from two sources: a
direct cash payment to the investor or an increase in the market value of the
investment relative to the original purchase price. The rate of return over
the holding period, or holding period return (HPR), is computed as:

(Ending Price Beginning Price)  Cash Receipts

HPR 
Begining Price

17
Annualized Holding Period Returns
One possibility is to take the simple arithmetic average of the annual HPRs
computed by:
n
HPR   ( HPRt ) / n
t 1

The simple arithmetic average, however, ignores the compounding effect that
results if the first period’s return is reinvested. In addition, the result of an
arithmetic average return can be distorted if there are large differences in
the rates of return across time periods. Large differences in the periodic
rates of return over longer investment horizons will cause the arithmetic rate of
return to be misleading.

The geometric mean rate of return does not suffer from this flaw. The
geometric mean rate of return, HPR g, is defined as the rate of return
that would make the initial investment equal to the ending investment
value. The formula for the geometric mean rate of return is,
n
HPR   (1  HPRt ) / n  1
t 1

Required Rate of Return

"When setting the required rate of return on an investment, an investor must
consider the real rate of return, expected inflation and risk. Because
consumption is forgone today, the investor is entitled to a rate of return
that compensates for this deferred consumption. Since the investor expects
to receive an increase in the real goods purchased later and assuming for
the moment, zero expected inflation and risk, the required rate could equal the
real rate of return, in which case it would represent the pure time value of
money. The capital markets determine this rate based upon the supply of
money to be invested relative to the demand for borrowed money"
(Cheney & Moses, 1995: 33).

18
The required rate of return is the minimum rate of return that an investor
expects from his/her investment in risky assets. It is the function of real rate of
return and risk. The required rate of return is the return on risk free assets i.e.
government securities plus risk premium. It is determined by CAPM/SML.

The required rate of return using CAPM/SML is:

Required Rate of Return (K)  R F  ( Rm  R F ) 

Expected Rate of Return

If an investment is to be made, the expected rate of return, or the expected
holding period return, should be equal to or greater than the required rate of
return for that investment. The expected rate of return is based upon the
expected cash receipts (e.g., dividends or interest) over the holding period and
the expected ending or selling price. The expected rate of return is an ex-ante
or unknown future return.

If the investor can describe the possible variables that will influence each of the
possible rates of return and assign probabilities to these outcomes, the
expected rate of return should equal the weighted average of the various
possibilities. Listing the possible investment results and assigning probabilities
to each of these outcomes is the same as creating a probability distribution in
statistics. Probability distributions are used to describe possible outcomes and
to assign individual probabilities, from zero (no chance of occurring) to one
(full certainty that the outcome will happen), to each possible outcome.

The investor has forecast possible outcomes, each based upon a possible
state of the economy. Each economic state will result in a different
expected rate of return. Subjective probabilities are assigned to each
outcome. The overall expected rate of return, E (HPR), can be calculated as a
weighted average of the forecasts.
n
E ( HPR)   Pj HPR j
j 1

19
[Link] Risk
Risk can be defined as the variability of possible returns around the expected
return of an investment.

Each investor has his or her own attitude about risk and how much he or she
can tolerate. Since investment alternatives have different types of risks
associated with them, the investor must determine which combination of
alternatives matches his or her particular risk tolerances.

Financial analysts and statisticians prefer to use a quantitative risk surrogate

called the variance of returns, denoted Var (r). The variance of an asset's rates
of return equals the sum of the products of the squared deviations of each
possible rate of return from the expected rate of return multiplied by the
probability that the rate of return occurs (Francis, Op. Cit.:12-13).
T
Var (r )   P t [r1  E (r1 )]2
t 1

= P1 [r1 – E(r1)] 2 + P2 [r2 – E(r2)] 2+ .. .. + Pt [rt – E(rt)]2

The square root of the variance of the rates of return is called the standard
deviation (σ) of the rates of return.

Standarddeviation( )  Var(r)

The standard deviation and the variance are equally acceptable and
conceptually equivalent quantitative measures of an asset's total risk.

2.1.2 Trade-Off between Risk and Return

Risk is complicated subject and needs to be properly analyzed. The relationship
between risk and return is described by investor's perception about risk
and their demand for compensation. No investor will like to invest in
risky assets unless he is assured of adequate compensation for the

20
assumption of risk. Therefore, it is the investors required risk premiums that
establish a link between risk and return. In a market dominated by rational
investor, higher risk will command by rational premiums and the trade-off
between the two assumes a linear relationship between risk and risk premium.

Utility Functions and Investors Choice (Van Horne, Op. Cit., pp. 58-59)
The best mix of expected return and standard deviation for a security portfolio
depends on the investors' utility function. If you are a risk averse investor who
associate risk with divergence from expected value of return, your utility
function might be depicted in the following figure. The expected return is
plotted on the vertical axis, while the standard deviation is along the
horizontal. The curves are known as indifferences curves; the investor is
indifferent between any combination of expected return and standard deviation
on a particular curve. In other words, a curve is defined by those
combinations of expected return and standard deviation that results in a fixed
level of expected utility.

Figure 2.1
Hypothetical Indifference Curves

E(R)

Increasing Utility

O Standard Deviation

(Source: Van Home, 2000: 59).

21
The greater the slope of indifference curves, the more averse the investor is to
risk. As we move to the left in Fig.2.1, each successive curve represents a
higher level of expected utility. It is important to note that the exact shape of
the indifference curves will not be the same for different investors. While the
curves for all risk-averse investors will be upward sloping, a variety of
shapes are possible, depending on the risk preferences of the individual. As
an investor, you want to hold that portfolio of securities that places you on the
highest indifference curve.

Investors are risk averse. As a result, high-risk assets must offer investors high
returns to induce them to make the riskier investments.
Figure 2.2
Positive Trade off between Risk & Return

Return Market Risk Premium Line

r3 %

r2 %

r1 %

Risk,
1 2 3

The Figure 2.2 represents a higher risk premium. For taking risk 1, the
expected return in r1 when an investor assumes risk 2, the return must be r2
increasing the return (risk premium) by r2-r1 for assuming more risk: 2 - 1.
The assumption of linear relationship states that the risk premium must
increase or decrease in proportion to a change in level of risk. It also indicates-
higher the risk, higher the return and lower the risk lower the return.

22
2.1.3 Portfolio Analysis
[Link] Portfolio and Diversification
According to Jack Clark Francis. "Investment positions are undertaken with the
goal of earning some expected rate of return. Diversification is essential to
the creation of an efficient because it can reduce the variability of
returns around the expected return (Francis, Op. Cit., pp. 58-59).

Raymond, Brockington defined, "The term 'Portfolio' simply means

collection of investments. For an investor through the stock exchange
will be a collection of shareholdings in different companies. For a
property investor, portfolio will be a collection of buildings. To a financial
manager with in an industrial company, portfolio will be a collection of real
capital projects. It will be apparent that the actual nature of the components of
a portfolio demands on the population of opportunities from which the
selection has been made (Raymond Brockington).

Feorge B. Cohen et al. defined the portfolio management as – " Portfolio

management is the art of handling a pool of funds so that it not only preserves
its original worth but also overtime appreciates in value and yields an adequate
return consistent with the level of risk assumed" (Feorge, Op. Cit., p. 75).

"Portfolio is simply a combination of two or more securities or assets" (Francis,

Op. Cit., p. 229).
The portfolio manager seeking efficient investments works with two kinds of
statistics – expected return statistics and risk statistics. The expected return
and risk statistics for individual assets are the exogenously determined
input data analyzed by the portfolio analyst. The objective of portfolio
analysis is to develop a portfolio that has the maximum return at whatever
level of risk the investor deems appropriate" (Van Horne and Wachowicz, Op.
Cit., p. 90).

23
Diversification is a risk management technique that mixes a wide variety of
investments within a portfolio. It is designed to minimize the impact of any one
security on overall portfolio performance. "Diversification is possibly the
greatest way to reduce the risk. This is why mutual funds are so popular
([Link]

Diversification means reducing the investment risk by dividing the investment

among a variety of assets. Diversification helps to reduce risk because different
investments will rise and fall independent of each other. The combinations of
these assets more often than not will cancel out each other' fluctuation, thereof
reducing risk.

"Diversification in investments can be achieved in many different ways.

Individuals can diversify across one type of asset classification – such as
stocks. To do this, one might purchase shares in the leading companies
across many different (and unrelated) industries. Many other diversification
strategies are also possible. You can diversify your portfolio across different
types of assets (stocks, bonds, and real estate for example) or diversify by
regional decisions (such as state, region, or country). Thousands of opinions
exist" ([Link]

The common saying "Don't put all your eggs in one basket" is the essence of
the principle of diversification. Because all investments carry with them
some level of risk, it is important to diversify and spread your money into
many different investments.

"Diversification is important for very investor. In fact, it is so important

that in 1990, Harry M. Markowitz won the Nobel Prize largely for his
work on diversification"
([Link]

24
"Investors can reduce their potential for loss through diversification.
The key to diversification is the age-old adage, "don't put all of your eggs in
one basket." The main point of diversification is to reduce risk rather than
improve expected return. This is the power of diversification: the whole
is greater than the sum of its parts ([Link]

Diversification can help to reduce portfolio risk by eliminating

unsystematic risk for which investors are not rewarded. Investors are
rewarded for taking market risk. By choosing securities of different
companies in different industries, we can minimize the risks associated
with a particular company's "bad luck". Diversification among
companies, industries and asset classes affords the investor the greatest
protection against business risk, financial risk and volatility. Investments
whose price movements are opposite each other are negatively correlated.
When negatively correlated assets are combined within a portfolio, the
portfolio volatility is reduced.

There are some different diversification techniques for reducing a portfolio risk
(Francis, Op. Cit., pp. 228-235).

1. Simple Diversification
Simple diversification can be defines as "not putting all the eggs in one
basket" or "spreading the risks". But it does not eliminate risk by
creating a simple diversified portfolio.

2. Diversification across Industries

Some investment counselors advocate selecting securities from different
industries to achieve better diversification. But, empirical research has shown
that diversifying across industries is not much better than simply selecting
securities randomly since all industries are highly correlated with one another.

25
3. Superfluous Diversification
If 10 or 15 different assets are selected for a portfolio, the maximum
risk reduction benefits from simple diversification have most likely been
attained. Further spreading of the portfolio's assets is superfluous
diversification and should be avoided.

4. Simple Diversification across Quality Rating Categories

Quality ratings measure default risk – essentially the risk of bankruptcy.
The highest quality portfolio of randomly diversified stocks was able to
achieve lower levels of risk than the simply diversified portfolios of lower-
quality stocks. This result reflects the fact that default risk (as measured by
the quality ratings) is part of total risk. The higher quality portfolios
contain assets with less default risk. This finding suggests that portfolio
managers can reduce portfolio risk to levels lower than those attainable
with simple diversification by not diversifying across lower-quality assets.

5. Markowitz Diversification
Markowitz diversification may be defined as "combining assets which are
less than perfectly positively correlated in order to reduce portfolio risk
without sacrificing portfolio returns" (H. Markowitz, "Portfolio Selection".
Journal of Finance, 1952, p. 89). It can sometimes reduce risk below the
undiversificable level. Markowitz diversification is more analytical than
simple diversification and considers assets' correlations (or covariance).
The lower the correlation between assets, the more that Markowitz
diversification will be able to reduce the portfolio's risk.

Applying Markowitz diversification to a collection of potential investment

assets with a computer is called Markowitz Portfolio Analysis. It is a
scientific way to manage a portfolio, and its results are quite interesting.
Since Markowitz portfolio analysis considers both the risk and return of
dozens, or hundreds, or thousands of different securities simultaneously, it

26
is a more powerful method of analyzing a portfolio than using intuition or
selecting investments by committee.

* Expected Portfolio Return

The expected portfolio return is the simple weighted average of the expected
returns from the investment represented by a portfolio. This expected
return is calculated by determining the expected return of each
component of the portfolio and using these returns to compute a weighted
average. The weights used are the portfolio weights, which describe how the
portfolio's investment is weighted among the various assets/securities. Portfolio
weights are percentages of the total dollar amount available to be invested in
the portfolio and sum to 1. The expected return of a portfolio E (RP), is
calculated as:
n
Expected Portfolio Return  E ( RP  X j E ( R J )
j 1

Where
E (RP) = The expected return on the portfolio
E (Rj) = The expected return of asset j
Xj = The portfolio weight for asset j, where ΣWj = 1.0
n = Number of assets/securities in a portfolio

In a two asset portfolio comprising risk free asset and risky asset, the portfolio
return will be as:
Expected Portfolio Return = E (RP) = XF E (RF) + Xm. E (Rm)

* Portfolio Risk
Total portfolio risk is measured by the variance of the portfolio's rate of
return distribution. The portfolio risk depends on the risk of the
individual securities and the covariance between the returns of the individual
securities. The risk (variance of returns) from a portfolio made up of n assets is
defined as:

27
 n n
Portfolio Risk  Var ( RP )   X i X j  ij  i j
i 1 j 1

Where,
Xi = Proportion of investment in security i.
Xj = Proportion of investment in security j.
ρij = Correlation coefficient between i and j securities.
σi = Standard deviation of security i.
σj = Standard deviation of security j.

Risk: Systematic Vs. Unsystematic Risk

Systematic Risk: Systematic risk is that portion of total variability in returns

caused by market factors that simultaneously affect the prices of all
securities (Francis, p. 265). Systematic risk is the variability of a
security's return with that of the overall stock market. It is also called
unavoidable risk. It is measured by the beta. The beta of a stock is the slope of
the characteristic line between returns for the stock and those for the market.
Beta depicts the sensitivity of the security's excess returns to that of the market
portfolio. If the slope is 1, it means that excess returns for the stock
vary proportionately with excess returns for the market portfolio. In
other words, the stock has the same unavoidable or systematic risk as
the market as a whole. A slope steeper than 1 means that the stock's excess
return varies more than proportionately 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" stock. NA 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"
stock (Weston and Copeland, 1992).

"Changes in the economic, political and sociological environment that

affect securities markets are sources of systematic risk. Systematic variability

28
of return is found in nearly all securities to varying degrees because most
securities tend to move together in a systematic manner" (Francis, Op. Cit.,
p. 265).

Unsystematic Risk: Unsystematic risk is that portion of total risk which is

unique to the firm that issued the securities. It is the amount of a stock’s
variance unexplained by overall market movements. It can be diversified away.
It derives from the variability of the stock's excess return not associated
with movements in the excess return of the market as a whole.
Figure 2.3
Risk & Diversification

p

Unique Risk /
Unsystematic Risk
pi

Total Risk
Market Risk /
Systematic Risk

(Source: Van Horne, 2000)

"Events such as labor strikes, management errors, inventions, advertising

campaigns, shifts in consumer taste, and lawsuits cause unsystematic
variability in the value of a market asset. Since unsystematic changes affect
one firm, or at most a few firms, they must be forecast separately for each firm
and for each individual incident. Unsystematic security price movements are

29
statistically independent from each other, and so they may be averaged to zero
when different assets are combined to form a diversified portfolio. Therefore,
unsystematic risk is also called diversifiable risk (Ibid).

[Link] Markowitz Portfolio Selection Model

A portfolio is a collection of securities. There exists a problem of portfolio
selection. Investors face a problem of selection optimum portfolio from a set of
possible portfolio. Hence, it is often referred to a portfolio selection problem.
One solution to this problem was put forth in 1952 by Harry M. Markowitz,
when he published a landmark paper that is generally viewed as the origin of
the modern portfolio theory approach to investing.

Markowitz's approach begins by assuming that an investor has a given sum of

money to invest at the present time. Markowitz's approach considers the single
period rate of return. Single period rate of return is simply the total return an
investor would receive during the investment period or holding period.

Makowitz's model is a theoretical framework for the analysis of risk-

return choices. Decisions are based on the concept of efficient portfolios. A
portfolio is said to be efficient when it provides maximum expected return for
the same level of risk or provides minimum risk for the same level of return.

Portfolio Theory Assumptions

The portfolio selection model developed by Harry M Markowitz is based on
several assumptions regarding investor's behavior (Bhalla, 2001: 500).
i. Investors consider each investment alternative as being represented by a
probability distribution of expected returns over same holding period.
ii. Investors maximize one period-expected utility and possess utility curve,
which demonstrates diminishing marginal utility of wealth.
iii. Individuals estimate the risk on the basis of the variability of expected
returns.

30
iv. Investors base decisions solely on expected return and variance of returns
only.
v. For a given risk level, investors prefer high returns to lower returns.
Similarly, for a given level of expected return, investors prefer less risk to
more risk.

[Link] The Efficient Set Theorem (Sharpe et. al., op. cit., p. 171)
An infinite number of portfolios can be formed from a set of N securities. The
investor can buy any one security or buy more securities in order to create a
portfolio. An investor can distribute his or her investing money in different
securities.
Figure 2.4
Feasible and Efficient Set

rp

r3 %
H
E

Feasible
r2 % Set

r1 %
G p

(Source: Sharpe et. al., 2002: 172)

The investor should not have to evaluate all these portfolios. The investor can
select an optimal portfolio from a feasible set of portfolios. Efficient set
theorem states that:

31
An investor will choose his or her optimal portfolio from the set of portfolios
that:
i. Offer maximum expected return for varying levels of risk, and
ii. Offer minimum risk for varying levels of expected return.

The set of portfolios meeting these two conditions is known as the efficient set.
Efficient set is also known as the efficient frontier.

[Link] The Feasible Set (Ibid, p. 172)

Figure 2.4 is an illustration of the location of the feasible set/the opportunity
set. Efficient set can be identified from the feasible set. The feasible set simply
represents all portfolios that could be formed from a group of N securities. All
the possible portfolios, which could be formed from the N securities, lie either
on or within the boundary of feasible set. In general, this set will have an
umbrella type shape similar to the one shown in the Figurer 2.4.

[Link] The Efficient Set Theorem Applied to the Feasible Set (Ibid, pp.
172-173)
The efficient set can now be located by applying the efficient set theorem to
this feasible set. To begin with, the set of portfolios that meet the first condition
of the efficient set theorem must be identified. Looking at Figure 2.4, there is
no portfolio offering less risk than that of portfolio E because if a vertical line
were drawn through E, there would be no point in the feasible set that was to
the left of the line. Also, there is no portfolio offering more risk than that of
portfolio H because if a vertical line were drawn through H, there would no
point in the feasible set to the right of the line. Thus the set of
portfolios offering maximum expected return for varying levels of risk is the
set of portfolios lying on the northern boundary of the feasible set between
points E and H.

32
Considering the second condition next, there is no portfolio offering an
expected return greater than portfolio S (because no point in the feasible set lies
above a horizontal line going through S). Similarly, there is no portfolio G,
because no point in the feasible set lies below a horizontal line going though G.
Thus, the set of portfolios offering minimum risk for varying levels of
expected return is the set of portfolios lying on the western boundary of
the feasible set between G and S.

Remember that both conditions have to be met in order to identify the efficient
set. It can be seen that only those portfolios lying on the northwest boundary
between points E and S do so. Accordingly, these portfolios form the efficient
set, and it is from this set of efficient portfolios that the risk-averse investor
will find his or her optimal one. All the other feasible portfolios are inefficient
portfolios and can be ignored.

[Link] Selection of the Optimal Portfolio (Ibid, p. 173)

To select an optimal portfolio, an investor should plot his or her indifference
curves on the efficient set and this proceed to choose the portfolio that is on the
indifference curve that is farthest northwest. This portfolio will correspond
to the point at which an indifference curve is just tangent to the efficient set. As
can be seen in the Figure 2.5, this is portfolio O* on indifference curve I2.
Although the investor would prefer a portfolio on I3, no such portfolio
exists; wanting to be on this indifference curve is just wishful thinking.
In regard to I1, there are several portfolios that the investor could choose (for
example O). However, the figure shows that portfolio O* dominates such
portfolios because it is on an indifference curve that is farther northwest. The
portfolio selection for a highly risk-averse investor has been shown in Figure
2.6.

33
 Figure 2.5: Figure 2.6:
Selecting an Optimal Portfolio Portfolio Selection for a Highly Risk-
Averse Investor

(Source: Sharpe, 2002: 173). (Source: Sharpe, 2002: 174)

Upon reflection, the efficient set theorem is quite rational. The efficient set
theorem, stating that the investor needs to be concerned only with
portfolios that lie on the northwest boundary of the feasible set, is a logical
consequence.

Mean-Variance Indifference Curves

Indifference curves represent the investor’s risk preferences. Through
indifferences curves, it is possible for an investor to determine the
various combinations of expected returns and risks that provide a constant
utility. Joshi (2002) writes that the curves can be drawn on a two
dimensional figure, where the horizontal axis indicates risk as measured by
standard deviation (denoted by σρ) and the vertical axis indicates reward as
measured by expected return ( denoted by rp).
The sets of mean variance indifference curves are literally a theory of choice.
The only assumptions necessary to draw the indifference curves for risk-averse
investors are
 People prefer more wealth to less
 They have diminishing marginal utility of wealth
34
These assumptions, if valid, imply that all decision makers are risk
averse and will require higher return to accept greater risk.

Indifference curves cannot intersect. “A risk adverse investor will find any
portfolio that is lying on an indifference curve that is “father north-west” to be
more desirable (that is, to provide greater utility) than any portfolio lying on
an indifference curve that is “not as far northwest”. Last, he further
describes that an investor has an infinite number of indifference curves.”

2.1.4 Capital Asset Pricing Model (CAPM)

Capital Asset Pricing Model (CAPM) is a descriptive model of how
assets are priced. The major implication of the model is that the expected
return of an asset will be related to a measure of risk for that asset known as
beta. The exact manner in which expected return and beta are related is
specified by the CAPM.

"The capital assets pricing model states that the expected risk premium
on each investment is proportional to its beta. This means that each investment
should lie on the sloping security market line connecting treasury bills and
Market Portfolio (Myers and Brealey, 2003: 200).

In market equilibrium, a security will be expected to provide a return

commensurate with its unavoidable risk. This is simply the risk that cannot be
avoided by diversification. The greater the unavoidable risk of a security, the
greater the return that investors will expect from the security. The relationship
between expected return and unavoidable risk, and the valuation of securities
that follows, is the essence of the capital asset pricing model (CAPM).
This model was developed by William F. Sharpe (1990 Nobel Prize winner in
economics) and John Lintner in the 1960s, and it has had important
implications for finance ever since (Van Horne, op. cit., p. 62).

35
The CAPM used to calculate the required rate of return for stock j is:
E (Rj) = Rf + [E(Rm) – Rf] j

Where,
E (Rj) = The expected or ex-ante return on the jth risky asset.
Rf = The rate of return on a risk less asset.
E(Rm) = The expected or ex ante return on the market portfolio.
βj = Cov (Rj, Rm)/Var (Rm) = a measure of the undiversifiable risk of the
jth security.

The greater the beta of a security, the greater the risk and the greater the
expected return required. Likewise, the lower the beta, the lower the risk, the
more valuable it becomes and the lower the expected return required.

"In market equilibrium, the relationship between an individual security's

expected rate of return and its systematic risk, as measured by beta, will
be linear. The relationship is known as the security market line" (Ibid, p. 70).
When the CAPM is graphed in a figure, it is called the Security Market Line
(SML). In equilibrium, all securities must be priced so that they fall on the
SML. The fact is that they have different variances, which are irrelevant for
determining their expected return, because total risk contains a diversifiable
component, which is not priced in market equilibrium. SML may be used to
explain the required rate of return on all securities whether or not they
are efficient. The SML provides a unique relationship between
undiversifiable risk (measured by beta) and expected rate of return. Hence,
if we can accurately measure the beta of a security, we can estimate its
equilibrium risk-adjusted rate of return.

36
 Figure 2.7
The Security Market Line / CAPM
E(Rj)
SML

E ( Rm )  R f
Slope   m O

E(Rm) Risk Premium

Rf Risk-free Return

j
m=1

(Source: Van Horne, 2000: 71)

The CAPM or SML is an equilibrium theory of how to price and

measure risk. It has many applications for capital budgeting, asset valuation,
determination of cost of equity capital and the explaining risk in the structure
of interest rates.

The logic of the SML equation is that the required return on any investment is
the risk free return plus a risk adjustment factor. The risk adjustment factor
is obtained by multiplying the risk premium required for the market
return by the risky ness of the individual investment. If the returns on the
individual investment fluctuate by exactly the same degree as the returns on the
market as a whole, the beta for the security is one. In this situation, the required
return on the individual investment is the same as the required return on the
total market. The risk premium is measured by the slope of SML.

37
Assumptions of the CAPM (Chenery & Moses, op. cit., p. 75).
Capital market theory (CMT) uses portfolio theory; thus the assumptions
underlying portfolio theory also pertain to the CAPM. The additional
assumptions underlying CMT and the CAPM appear less realistic than
the portfolio theory assumptions. The assumptions of CMT are as follows:
1. All investors are risk-averse. Thus, all investors seek to be on the
efficient frontier.
2. There are no constraints on the amount of money that can be borrowed or
lent. Borrowing and lending occur at the identical risk-free rate, Rf.
3. All investors have identical beliefs about the expected returns and risks of
assets and portfolios; that is all investors have homogeneous expectations.
4. All investors have a common investment horizon, whether it is one month,
three months, one year, or whatever.
5. All the investments are infinitively divisible and marketable; that is, it is
possible to buy or sell any portion of an asset or portfolio.
6. Taxes and transaction costs do not exist. That is, there are no tax effects,
costs of acquiring information or transaction costs associated with buying
or selling securities. These are often referred to as perfect market
assumptions. Markets are assumed to be competitive; therefore, the
same investment opportunities are available to all investors.
7. There are no unanticipated changes in inflation or interest rates.
8. The capital markets are in a state of equilibrium or striving toward
equilibrium. There are no under priced or overpriced securities; if under
pricing or overpricing exists, the prices will move to correct this
disequilibrium situation.

Under and Over Valuations (Van Horne, op. cit., p. 71).

In market equilibrium, the CAPM implies an expected return-risk
relationship for all individual securities (the security market line). If an
individual security has an expected return-risk combination that places it above
the security line, it will be undervalued in the market. That is, it provides an

38
expected return in excess of that required by the market for the systematic risk
involved. R j  R f  [ E ( Rm )  R f )  j .As a result, the security will be attractive to

investors. According to the theory, the increased demand will cause the price o
rise until the expected return declines sufficiently for the security to lie on the
security market line and, thereby, for R j  R f  [ E ( Rm )  R f )  j An overvalued

security is characterized by an expected return-risk combination that places

it below the security market line. This security is unattractive, and investors
holding it will sell it and those not holding it will avoid it. The price will fall
and expected return will rise until there is consistency with the security
market line and with equilibrium pricing.

Efficient Frontier
Collections of possible portfolios are the attainable sets. Cheney and Moses
(1992) define at any given level of risk or return, however there is no one
portfolio that provides the highest (lowest) level of expected return or risk. This
set of portfolio that dominates all other portfolio in the attainable set is referred
to as the efficient frontier. They further add once the investor has determined
the expected returns and standard deviations for each of the assets and
correlation coefficients between the assets, then the portfolios on the efficient
frontier can be identified. Estimation of the efficient frontier requires quadratic
programming that will simultaneously estimate the minimum portfolio risk at
each level of expected return.

Olsen (1983) writes when only common stocks are considered as

components of portfolio on the efficient frontier, a sample size of several
hundred randomly selected securities will provide an estimate of the
efficient frontier not significantly different from the frontier obtained by using
the entire universe of common stocks.

39
Capital Market Line (CML)
“The efficient frontier that can be constructed without borrowing or lending is
convex towards the E(r) axis in risk-return space. However, if borrowing and
lending opportunities are concluded in the analysis, linear set of investment
opportunities called the capital market line emerges”.

Sharpe’s (1964) writes the CML is the locus of the portfolio that wealth-
seeking risks-averse investor will fond more desirable than any other
portfolios. Fisher and Jordan (2000) describe that all investor will end up
with portfolios somewhere along CML and all efficient portfolios would
lie along CML. However, not all securities or portfolios lie along the CML.
From the derivation of the efficient frontier we know that all portfolios, except
those that are efficient, lay below the CML. Observing the CML tells us
something about the market price of risk

2.1.5 Portfolio Performance Evaluation (Francis, op. cit., pp. 644-662)

[Link] Sharpe's Portfolio Performance Measure
Ranking portfolio's average returns ignores the skill with which they minimize
risk and therefore presents an oversimplified picture. Hence, in assessing the
performance of a portfolio, it is necessary to consider both risk and return.
William F. Sharpe devised an index of portfolio performance for portfolio i as:

Risk Pemium r j  R
Si  
Total Risk 

Where,
Si = Sharpe index of portfolio performance for portfolio i.
rj = Average return from portfolio i.
σi = Standard deviation of returns for portfolio i.
R = Risk-less rate of interest.

40
rj – R is the risk premium for portfolio i. The risk premium is the additional
return over and above the risk-less rate that is paid to induce investors to
assume risk.

Sharpe's index of performance generates one number that is determined by both

the risk and the return of the portfolio or other investment being evaluated.

[Link] Treynor's Portfolio Performance Measure

Jack Treynor conceived and index of portfolio performance that is based on
systematic risk, as measured by portfolios' beta coefficients. He suggests
measuring a portfolio's return relative to its systematic risk rather than relative
to its total risk, as does the Sharpe measure. Treynor's index is ascertained as:

Risk Pemium rj  R
Tp  
Systematic Risk Index p

Where,
TP = Treynor's index of portfolio performance for portfolio i.
rj = Average return from portfolio i.
βP = Systematic risk index of returns for portfolio i.
R = Risk-less rate of interest.

[Link] Jensen's Portfolio Performance Measure

Dr. Michael C. Jensen has modified the characteristic regression line to make it
useful as a one parameter investment performance measure. The basic random
variables in Jensen's model are risk premiums, such as:
rpi,t = ri,t – Rt

Where,
rpi,t = Risk premium for asset I in period t.
ri,t = One period rate of return from asset I in period t.
Rt = Risk-less rate observed in period t.

41
2.3 Reviews from Articles
The article in the web page [Link] "Are you over diversified"
mentioned that many individual investor could not tolerate the short
term fluctuation in the stock market. Diversifying the portfolio is the best way
to smooth out the ride. Diversification is the risk management techniques that
mix a wide variety of investments within a portfolio in order to minimize the
impact that only one security will have on the overall performance of the
portfolio. Diversification low the risk of your portfolio. Academics have
complex formulas to demonstrate how this works.

The Article "Selection of Portfolio" in web page [Link] by

Prof. Dr. Vijay Pal Chatarjee mentioned some guideline to select optimal
portfolio. He mentioned that investor like high-expected return for given level
of risk is efficient portfolios. If an investor wants to know the marginal impact
of the stock on the risk of the portfolio, then he/she must not looks at the risk of
that stock in isolation but rather at its contribution to portfolio risk. That is
dependent on the stocks sensitivity to changes in the value of the portfolios. If
the investor can borrow and lend at the risk free rate of interest, then they
should always hold a mixture of the risk free investment and one particular
common stock portfolio. The composition of this portfolio depends on when
the investment liquidated. Risk is lower in the short term. Diversification of
the portfolio can reduce the unique risk. If such diversification results an
expected portfolio return or risk level that is below/above the desired level
then, then borrowing and lending can be used to achieve the desired
level. Portfolio strategy should be mouled according to the need of each
individual investor. Since each portfolio provides an expected return based on
a particular level of risk, while constructing portfolios, care should be
taken to ensure that the portfolio does not exceed the risk bearing capacity of
the investor.

42
It is constructed in such a way that it provides the highest return for a
given acceptable level of risk. In an efficient portfolio, there is a
straight-line relationship between the expected return and the marginal
contribution to portfolio risk. This is true because an investor would include a
security, which contributes to increasing the risk of the portfolio as a whole
only when it offers higher return and increases the expected return of the
portfolios.

An article published on the Kathmandu Post Daily on 28th April 2004 on

entitled "Effective Banking" by L.D. Mahat, explained that the efficient of
banks could be measured using different parameters. The concept of
productivity and profitability can be applies while evaluating efficiency of
banks. The term productivity refers to the relationship between the quality of
inputs employed and the quality of outputs produced. An increase in
productivity means that more output can be produced from the same inputs or
the same outputs can be produced from the less inputs. Interest expenses to
interest income ratio shows the efficiency of banks in mobilizing resources
at lower cost and investing in high yielding assets. In other words, if
reflects the efficiency in the use of funds. The operating profit to total income
ratio helps in assessing whether bank are doing the right things internally.
According to Mr. Mahat the analysis of operational efficiency of banks will
help one in understanding the extent of exposure of banks under the
changed scenario and in deciding when to back upon. This may also help
the inefficient bank to upgrade their efficiency and be wire in the situation
developing due to slowdown in the economy. The regulation should also be
concerned on the fact that the banks with unfavorable ratio may bring
catastrophe in the banking industry.

An article entitled "International Portfolio Investment Flows" by Michael. J.

Brennam and Hennery Cao developed a model of international equity portfolio
investment flows based in difference in informational endowment between

43
foreign and domestic investors. It is shown that when domestic investor's
posses a cumulative information advantages over foreign investor about
their domestic market investor tends to purchase foreign assets in period,
when the return on foreign assets is high and to sell when the return is low.
The article has concluded that if foreign and domestic investors are differently
informed then portfolio flows between two continue will be linear function of
the contemporaneous return in all national market indices, and if domestic
investors about domestic securities, the coefficient of the most market return
will be positive. It had developed a model of international equity portfolio
flows that relies on informational difference between foreign and domestic
investors. The examination of US portfolio investment in emerging market
has shown the strong evidence that US purchase are positively associate with
the local market return in many countries.

Diversification is the important component in helping you reaches your long-

range financial goal while minimizing your risk. At the same time,
diversification is not an ironclad guarantee against loss. No matter how much
diversification you employ, investing involves taking on same sort of risk.

Another question frequently baffles investors. How many stocks should be

brought in order to reach optimal diversification? According to portfolio
theorists, after around 20 securities, you have reduced almost all
the individual security risk in a portfolio. This assumes you by stocks of
different sizes from various industries.

It is well known that risk and return are the major things of analysis
but there is so many factors to be consider while making investment. Imperfect
knowledge and imperfect data creates more risk. Investors are not always risk
averters. Some of the investors are risk lovers but they expect same
considerations for bearing more risk. Acceptance of risk level is different
investors, so they are interested in various stocks, which have

44
incompatible risk. Mr. Terrance Odeon mentioned risk loving nature of
investor in the finance of journal Vol. 53 1998. He further mentioned that
investor has unique risk bearing capacity and choice in investment varies
accordingly to level of risk.

2.4 Reviews from Thesis

There are some studies had been conducted as a thesis for the partial fulfillment
of Master degree. Here some thesis is reviewed:-

Joshi (2002), conducted a research entitled "Investor Problem in Choice

of Optimum Portfolio of Stock Exchange" with reference to various
commercial banks financial companies and others. There are some of the
objectives of this study. The main objective of this research is to analyze the
trend of NEPSE and try to find out the portfolio of NEPSE to invest. This
research also suggests the majors for the improvement of the stock
market as well for better meet of investors. Mr. Joshi has taken selected
and short-listed a companies which are categorized in "grade A" in NEPSE
as his sample size. From this he has find that SCBNL has the greater expected
return i.e. Rs. 2358.85 and Necon Airlines the lowest expected return i.e. Rs.-
3.34. Likewise, NBBL has the greater risk i.e. =Rs 753.04 and the CIT has the
lowest risk i.e. =Rs.4.08. Higher C.V. explains that the stocks are highly
volatile and thus much risks. So as per lesser coefficient of variation
PFC, NABIL & CIT are the best stock to invest whose coefficient of
variation are 205%, 308% and 344.71% respectively. The correlation
coefficient between PFC & NSBIBL is 0.07479 where as correlation
coefficient between PFC & CIT is 0.17645. Both are positive but lower degree
of positive correlation. It means when one increases another also increases and
vice versa.

Khaniya (2003), entitled "Investment Portfolio Analysis of Joint Venture

Banks". The main objective of the research was to analyze the portfolio

45
investment of the listed joint venture banks:-NABIL, SCBNL, HBL,
NBBL and EBL. In this research the researcher tries to analyze the risk and
return of joint venture banks and the financial performance analysis. This
research helps to provide the suggestive package based on the analysis of
data. The major of the study is that the SCBNL and HBL have better position.
NBBL and NABIL have a low position in the industry. But EBL has a very low
position in the industry because of having mean return on shareholder's fund
resulting from the negative return.

Shrestha (2004), research entitled to "Optimum Portfolio Investment

in NEPSE". The objective of the research was to analyze the optimum portfolio
investment in NEPSE. The main objective of the research was to analyze the
performance of listed companies in the term of expected rate of return and
company specific risk, required rate of return, systematic risk and
diversification of risk and to find out the optimum portfolio through portfolio
concept. He takes the seven years data of seven commercial banks,
finance companies, insurance companies, manufacturing companies and other
company. From this the researcher concludes that NABIL is the best security
for risk lover investor and NIBL is the best alternative for risk averter
investor in banking securities. BOK is the most risky asset. NCM is the most
risky assets and YFC is the best security to risk averter investors in securities of
finance companies. The best security in the insurance companies is EICL on
the base of risk and return characteristics. Regarding the risk and risk of the
manufacturing securities BNL is the best security. The risk and return of other
securities are not satisfactory. Only BBCL is providing positive return, which
is also lower than market. Market return of NEPSE index is 7% and standard
deviation of market is 36.11%. The market rate of return is not satisfactory
in comparison to its risk level. Among the selected securities, YFC is the
best security having minimum coefficient of variation i.e. 0.9910 with the
return of 31% and risk of 30.72%. According to the researcher investor

46
selected securities on the basis of fundamental analysis rather than technical
analysis. Investors are risk lovers

Neupane (2005), made a research entitled “Determinants of Stock Price

in NEPSE” and tried to explore the factors that have significant influence
on the stock price in NEPSE. He concluded his study by quoting;

Nepalese investors have not adequate education about the capital market. They
do not have good knowledge and information to analyze the scenario and to
forecast share price. Perhaps due to this reason stock price in NEPSE
rather shows irrational behavior.

In NEPSE, DPS, BPS & EPS individually do not have constituent

relationship with the market price of the share among the listed
companies. The pricing behavior varies from one company to another. But
EPS, BPS & DPS, jointly have significant effect in market price of the share.
So, there may be other major factors affecting the share price significantly.
NEPSE is in its primary stage, adopting open out cry system for stock
trading and stockbrokers lack professionalism to create investing
opportunities in NEPSE.

 Commercial banking sector has dominated the overall performance of

NEPSE. Manufacturing & processing, trading and hotel sectors have
weak performance. So, financial intermediaries are strong but their
ultimate investment is suffering.
 Companies’ performances (earning, dividend, book value, risk
etc) information disclosed , timely AGM , political stability, national
economy, demand & supply situation, strikes, demonstrations,
ceasefire and peace talks (and their outbreak) are the major factors
affecting the share price in NEPSE, according to the respondent of
survey. Interest rate, retention ratio, cost of equity, tax rate, gold price ,

47
 value of US $ , global economy, market liquidity, season, day of
the weak, size of the firm, change in the management do not
significantly affect the price of the share in NEPSE.
 There is deficiency of proper laws and policies regarding the
capital market. Shareholders are feeling unsecured to invest in
security markets due to poor regulatory mechanism to protect
shareholders interests. The implementation of existing laws is weak.
 Listed companies do not provide sufficient information (financial as
well as non financial) to their shareholders and they are not able to act
according to the shareholders’ interests. The performance of
most of the listed companies is not transparent.
 Since NEPSE is in increasing trend, in spite of unfavorable environment
for investment, Nepalese citizens have a huge amount of scattered
fund remained unproductive, which can be used in the industrial
development through capital market to accelerate the economic growth
of the nation.
 With the existing Maoist problem, industrial development and capital
market development is impossible. So, the peaceful solution of the
Maoist problem is preliminary condition for capital market and
economic development in Nepal.

Phuyal (2006), has conducted research on “Stock Price Behavior of

Selected Banking and Insurance Companies” is related with stock price
behavior. He has tried to show the functional relationship of MPS with other
financial indicators: DPS, EPS, NWPS and price appreciation along with the
fundamental concept of stock market. He has attempted to show the behavior
of chartists (Technicians) and fundamentalists in relation to projection of equity
prices. To achieve the basic aim of this study, he set following objectives at the
time of research.
 To identify the major financial indicators which affect on
determining MPS.

48
  To examine and evaluate the relationship of MPS with various
financial indicators like; EPS, NWPS, DPS and current years dividend.
 To identify whether stocks of the sampled companies are over
priced, under- priced or equilibrium priced.
 To study the singling and informational effect on share price.
 To examine Nepalese investors’ response on the change of stock.

Regmi (2008), has conducted research on “Portfolio Analysis on Investment

of Nepalese Commercial Banks” is to describe to minimized risk and
maximized return by portfolio management and existing situation of
portfolio management of commercial bank in Nepal and to measure the
financial performance of selected five listed banks in NEPSE, their risk, return,
trend, and portfolio patterns.

The general objective of the present study is to identify the current

situation of investment portfolio of commercial banks in Nepal. The
specific objectives are as follows.
 To highlight the concept of investment and loans and advances portfolio.
 To evaluate the financial performance of commercial banks in term of
investment strategies.
 To analyze the risk and return ratio of commercial banks.
 To analyze how commercial banks manage their risk and return on
investment using portfolio concept.

Shrestha (2008), research entitled to “A Study on Portfolio Management of

Nepalese Commercial Banks (With reference to BOKL, HBL, NABIL and
Nepal Investment Bank Ltd.)

To achieve the above objective, he has taken 5-year financial data of

five leading commercial banks, three finance companies and two
Insurance companies. He applied econometric model to show the relationship
49
between the independent variables and their linear impact on MPS. Correlation
coefficient and regression equations were calculated and derived to estimate
future MPS. However, this study covered very few variables due to which the
inferences drawn might lead to wrong conclusion. In research design, he
explained, “To draw inferences on the market performance of stock market and
price formation, different measures have been used, while collecting and
interpreting relevant data, facts and figures with a view to systematic
data collection and data’s interpretation. Simple statistical tools have been used
to finish this research works, which represent the explanatory and descriptive
analysis of the relevant information and data.” Nevertheless, this study tries to
explore the determinants of equity price by way of showing the functional
relationship between the equity price and financial indicators along with the
fundamental knowledge of stock market in Nepalese context. The major
findings of this study are given below:
 Nepalese investors have limited knowledge about security market. It lacks
of professional investors.
 Most of the stocks of banking and finance companies are under valued in
the stock market.
 Investors are trading the stocks without proper analysis of the
financial indicators.
 The price fluctuating trend is not predictable by general investors.
 Signaling factors should be analyzed on regular basis by the
concerned authority so that the future movements of price can be
predicted from the side of analyst and investors.

Poudel (2006), Prepared the thesis entitled "An investment Portfolio

Analysis of Joint Venture Banks in Nepal. The study is based only to the
portfolio analysis between banking sector and other sector.

The main objective of this study is to identify the situation of

portfolio management of commercial bank of Nepal and portfolio analysis

50
between banking sector and other sector. The specific objectives of the study
are as follows:
 To examine risk and return of commercial banks.
 To analyze market sensitivity.
 To know about systematic, unsystematic risk and analyze them in
portfolio construction process.
 To analyze portfolio return and risk.
 To evaluate financial performance of commercial banks of Nepal Under
study.

Major Findings:
 SCBL Stock has the highest expected return i.e. 20.486% and HBL has
the lowest expected return i.e 3.48% NIBL and SBIBL stock have the
expected return is 11.63%. The risk (S.D)of SBIBL is the highest i.e.
62.22% and SCBL has the lowest risk i.e. 33.10% . HBL and NIBL hasa
risk of 37.24% and 37%, respectively. The market risk (Market S.D) is
36.40%. So it shows that SCBL has higher the return lower level risk.
 All the returns of commercial bank's are positively correlated with returns
of market because all values are nearly equal to +1. SBIBL stocks return
are the highest positively correlated and SCBL stocks returns are
lease positively correlated with return of market. All banks has a beta less
than 1 except SBIBL. SBIBL has highest beta i.e. 1.63 and SCBL has the
lowest beta i.e. 0.77. So stock returns of SBIBL are more volatile and
stock returns of SCBL is less volatile among four commercial banks.
 Total risk of SBIBL stock is highest and total risk of SCBL stock is
lowest among four banks. SBIBL stock has 91% of undiversifiable risk
only 9% of its risk on total risk is diversifiable risk. HBL has 84.5% of
undiversifiable risk and remaining 16.5% diversifable risk on total risk.
NIBL and SCBL have an 85.5% and 72% of undiversifiable risk and
14.5% and 28% risk and diversifiable risk respectively.

51
  The required rate of return of SBIBL is the highest i.e 16.34% and SCBL
stock is the lowest i.e. 9.9%. Other bank HBL and NIBL have a required
rate of return of 11.18% and 11.18% respectively. SCBL stocks required
rate of return is less than expected return, so the stocks price is
under priced. But other banks stock required rate of return is greater than
expected return so the stock price is one Priced.
 NIBL has the highest portfolio return i.e. 8.2643 and it has the highest
portfolio risk i.e. 20.03%. HBL has the lowest portfolio return i.e.
4.2447% and it has the lowest portfolio risk i.e. 0.4831%. SCBL and
SBIBL has a portfolio return of 6.1683% and portfolio risk of
9.8134% and 0.6145% respectively.

 The performance measure shows that the stock of NIBL is the highest i.e.
4.118, stock of HBL is lowest i.e. 0.0984. Sock of SCBL is second higher
i.e. 0.2055 and stock of SBIBL is in third position among banks.

Gaytan (2006), prepared the thesis entitled "Investment portfolio of

commercial banks in Nepal." The study is based only on those factors, which
are related with investment portfolio analysis, on secondary data published by
and collected from selected banks and from the journals and unpublished
articles and thesis, only five commercial banks are taken under study. The
study covers a period of eight fiscal years which are tabulated and processed
for drawing conclusion.

The main objective of the study is to identify the current situation of

investment portfolio of commercial bank in Nepal. The specific objectives are
as follows:-
 To emphasize the concept of investment and loans and advance portfolio.
 To assess the financial performance of commercial banks in term of
investment approach.
 To analyze the risk and return ratio of commercial banks.

52
  To provide useful information based on the analysis of the data.

Major Findings:
Based on the analysis of the various data remarkable findings are drawn up.
The major findings are as follows:

Investment Portfolio: In investment portfolio, the industry average investment

on government securities is 84.33%, among the CBS, EBL has invested the
highest amount of funds on govt. Securities i.e. 98.58% and NIBL has
invested lowest 55.84% other banks SCBL, NABIL and EBL have been
investing highest amount of funds on share and debenture among CBS and
EBL have invested lowest amount of funds on S and D. i.e. 1.42%
NABIL and HBL have invested lower than industry average and the
industry average in this case is 15.67% on which NIBL is invested higher
than industry average i.e. 44.16%. In case of NRB bonds no one banks are
investing. There is zero amount of investment.

Loan and Advances Portfolio: In loan and advances portfolio, the industry
average investment on Govt. Enterprise is 2.28%, Among the CB's HBL
has invested the highest amount of funds on Govt. enterprises i.e. 3.89% and
EBL has invested lowest 1.08%, NIBL and NABIL are below the industry
average i.e.

1.41%, and 1.36% respectively and HBL is higher the industry average of
3.89% EBL is investing highest amount of funds on Private sector among
CBs i.e. 97.01% and NIBL has invested above the industry average on private
sector i.e. 96.32%. And SCBL and HBL have invested lowest amount of funds
on Private Sector i.e 93.70% and 94.17% respectively. NABIL is investing the
highest amount of funds on for bill P and D as compared to other CBs i.e.
3.38%.

53
The industry average in this case is 2.44%. NIBL, EBL and HBL has
invested lower than the industry average i.e. 2.27%, 1.91% and 1.99%
respectively but SCBL have invested above industry average i.e. 2.65%.

Portfolio Risk and Return on Investment: There is positive Correlation

coefficient between return on investment made by CBs in Govt. Securities
loan and advance i.e. 0.613. And there is low positive correlation coefficient
between return on investment made CBs in Govt. Securities and S & D and
loan & advance and S & D i.e. 0.032 and 0.207 respectively. This shows the
low degree of normal relationship between assets. Such assets are very useful
to make portfolio combination, so that the risk of the portfolio will be
significantly reduced.
According to the Calculation Portfolio Return is lesser than the individual
return of S & D. and L & A but higher than individual return of Govt.
Securities. And portfolio risk is less than the individual risk of L & A and
Govt. securities but very lower risk than individual risk of S & D this is
due to low correlation between assets which shows the portfolio reduce risk.

Risk and Return: The average return on Govt. Securities 4.57%

and its coefficient of variation is 28% which is very low return among other
investment but higher risk than L & A investment.

"Investors' Problems in Choice of Optimum Portfolio of Stocks in Nepal

Stock Exchange" (Joshi, 2002)

A thesis entitled "Investor's problems in choice of optimum portfolio of stocks

in Nepal stock exchange" was undertaken by Roopak Joshi in July 2002.

The main objective of this study was to identify the investors' problems
in choice of optimum portfolio of stocks in NEPSE which concluded that
portfolio management is a new concept for Nepalese investor. Due to lack
of sufficient information proper investment is not possible. Proper investment
54
needs huge information internal as well as external. The stock market of Nepal
is also in growing stage only. The only one stock exchange located in
Kathmandu. Traditional cry system for trading stocks, limited number of
security broker, lack of opportunity of invest and many other reasons are there,
which are acting as barrier of development of NEPSE."

Joshi further also concluded that most of the investors do not know in which
stock to make investment and how to formulate the portfolio. Even many
brokers do not furnish the information to the investors. Investors are trading
the securities mostly under the pressure of brokers.

"Portfolio Management of Listed Commercial Banks and Insurance

Companies in Nepal" (Sharma, Durga Mani, 2004)

A thesis entitled "Portfolio Management of listed commercial banks and

insurance companies in Nepal" was undertaken by Durga Mani Sharma in
March 2004. The main objectives of the study were to analyze the current
status of portfolio management of listed commercial banks and insurance
companies in Nepal, to analyze the return and risk of the common stocks of
listed commercial banks and insurance companies to analyze the
diversifiable and undiversifiable risk of the return on common stocks, to
analyze the portfolio return and risk and to determine whether the shares of
commercial banks and insurance companies are correctly priced or not.

In order to achieve the set objectives, Sharma used five years (FY 1998 to
2002) historical data of four commercials banks and four insurance companies
as sample. The study had the following findings:
1. The share of NABIL offered the highest average rate of return i.e. 83.06
percent with highest risk i.e. 96.60 percent where as the share of NIBL
offered the lowest average rate of return i.e. 33.09 percent with the least
risk i.e. 40.06 percent. On the basis of average rate of return, the shares of

55
 NABIL seemed to be the best of investment. Considering the overall
market, however, the shares of the commercial banks were attractive for
investment.
2. Coefficient of variation can depict the exact position of risk per
unit of return. Lower CV is preferable. It seemed that the CV of SCBNL
was the highest and of HBL was the lowest among all. So, investors
retaining the stocks of SCBNL should assume more risk than any others.

3. The stock of EVIC had the highest average rate of return i.e. 49.16 percent
and PRIC had the lowest average rate of return i.e. 21.74 percent among
all. However, the least risky stocks were UNIC.
4. Coefficient of variation is the best measure to make investment decisions,
which gives the exact situation of risk per unit of return. The
CVs of HGIC, UNIC, EVIC, and PRIC were 1.69, 1.70, 1.51 and 2.30
respectively. Here, risk per unit of return of EVIC was the lowest among
all whereas of PRIC was the highest. On the basis of CV, the common
stock of EVIC was attractive among all.
5. The average market return is only 10.73 percent with the standard
deviation of 39.25 percent (Variance of returns being 15.41 percent). The
return might not be regarded as attractive with respect to its risk.
Coefficient of variation, which measures the risk per unit of return, is
3.66. It seemed that the market was more risky than the individual stocks
of listed companies.
6. All the selected commercial banks have invested their large amount of
money in government securities.
7. Average portfolio returns of SCBNL, HBL, NIBL and NABIL are 11.15
percent, 10.08 percent, 8.89 percent and 8.09 percent respectively. The
portfolio return of SCBNL appeared highest and that of NABIL appeared
least among all.
8. Portfolio risk (Portfolio standard deviation) of SCBNL, HBL, NIBL and
NABIL are 25.96 percent, 30.67 percent, 35.13 percent, 22.56 percent

56
 respectively. With respect to portfolio standard deviation, the portfolio of
NIBL appeared most risky among all and the portfolio of NABIL
appeared least risky. The two asset portfolio of all the commercial banks
seems to be very dissatisfactory. However, the risk of the portfolios
managed by the companies is less than the market risk i.e. 39.25 percent.
9. HGIC and UNIC didn't make any investment in shares of other
companies. All the insurance companies except PRIC have invested
their large amount in government securities.
10. The return on the portfolio of HGIC is 6.83 percent, UNIC is 7.35 percent,
EVIC is 6.08 percent and PRIC is 7.42 percent with a standard
deviation of 22.47 percent, 32.97 percent, 23.11 percent and 29.38
percent respectively. It seems that the portfolio returns of all the insurance
companies are greater than the risk free rate. And for all insurance
companies, the average portfolio returns are same.

2.5 Research Gap

Based on the review of the previous researches, researcher found that most of
the previous researches on portfolio management have been conducted
showing the risk and return of the stocks. Portfolio management of commercial
bank’s assets basically means the collection of fund to different components
but none of the researches are done on making analysis of portfolio
management. Previous researches are not able to show the real picture of
investment pattern of the commercial banks. Thus, this research aims to
conduct the research from the bank’s side regarding the portfolio investment
management available resources of the bank for the maximization of return to
the bank.

57
 CHAPTER – III
RESEARCH METHODOLOGY

The research methodology is the process of arriving to the solution of

the problem through planned and systematic dealing with the collection,
analysis, and interpretation of fact and figure. Research is a systematic
method of finding out solution to a problem whereas research methodology
refers to the various sequential steps to adopt by a researcher in studying a
problem with certain objectives in view. To find out such solution of
problems various statistical and financial tools and techniques are applied
according to the nature of phenomena. This chapter mainly deals with the
research methodology used to ascertain the study objectives. Under this,
research design, population and sample, sample selection method, data
collection and analysis techniques have been described.

3.1 Research Design

Proper planning is essential to get success either in battlefield or in research.
Research design is a strategic approach to be proactively maintained probable
cause and effects. A researcher also develops a framework or design of strategy
to get solution of research problem. Research design is a brief structure design
of strategic investment conceived to get research objectives. This research is
acquainted to examine and find out the problem and possibility of generating
the portfolio investment for the public with special reference to financial
securities listed in NEPSE. Nature of this research is historical, descriptive
and analytical research because this research based on historic data,
generalized theorem of financial management and investment analysis
evaluation the data of reference companies.

58
3.2 Population and Samples of Data
The term population of data denotes for the data of securities listed in NEPSE
and Sample data are the data from organizations selected from population
in few numbers. First, research has considered only common stock as sample
and second, those securities which were listed NEPSE in FY 1996/97, are
selected. Third, random selection model on the personal judgment of
researcher is used to select sample organizations for the study. The population
data of this study are data from all companies listed in NEPSE and sample data
among them.

Many companies are already listed in NEPSE and this is on-going process.
From the population of 29 commercial banks, the samples taken from the
study are NABIL, EBL and NIBL.

3.3 Nature and Sources of Data

Data are the mathematical expression of variables. Data help to develop some
understanding in quantitative phenomenon. The data collected from field
survey from the questioner is primary data so that researcher made some
question and given to the different people to fill up and from that result
researcher made an analysis. The data collected from others and made
available as published or unpublished statistics are secondary data. Those
data helped during this research period. Sources of secondary data are
published and unpublished data from organization like shareholder report,
annual report, reviews and reports, report and reviews from SEBO, trading
reports of NEPSE, statistics report and annual report of NRB, articles from
various magazines, previous thesis and dissertation, homepages, books
and journals.

3.4 Data Collection Techniques

Data were not available in readymade format. Data manipulated as per
research requirements. First, needed data assessed. Second, data are collected

59
and only essential are selected, classified and such a way that they represent
qualitative and quantitative glimpse. Only manipulated data used in this
research. To manipulate data Computer Application program MS- Office,
Professional Edition, 2003 were used. Techniques of data collection are as
follows:

 Library Research
 Internet, Homepages and Related Links study
 Review and reports of concerns

3.5 Data Analysis Tools

Various financial and statistical tools were used to analyze the data ratio
analysis, correlation coefficient, trend analysis, risk and return, standard
deviation, hypothesis test, etc were used in the study. A brief explanations of
statistical and financial tools employed in this study is given below.

a) Financial Tools
There are several tools which can be applied in order to analyze the
performance of CBs. But the following main financial tools are used to
analyze.

I. Ratio Analysis
The relationship between the two accounting figures expressed mathematically
is known as ratio. Ratio analysis is used to compare a firm’s financial
performance and status to that of other firms or to itself on time (Gitman,
1990:275). Likewise, ratio refers to the numerical or quantitative relationship
between two items or variables. In simple language it is one number expressed
in term of another and can be worked out by dividing the number to the other
i.e. it is calculated by dividing one items of the relationship with the other
(Munakarmi, 2002:204). In financial analysis, ratio is used as an index of
yardstick for evaluating the financial position and performance of the firms.

60
Since, this study mainly moves around investment portfolio of CBs. Only such
ratios which are related to investment of CBs are taken here. Hence, in this
study the following ratios are calculated and analyzed.

1. Total Investment to Total Deposit Ratios

Investment is one of the major credits created to earn income. This
implies the utilization of firms deposit on investment in government securities.
This ratio can be obtained by dividing total investment by total deposit. This
can be mentioned as;
Total Investment
Total Deposit

2. Loan and Advances to Total Deposit Ratio

This ratio assesses to what extent the banks are able to utilize the
depositor’s funds to earn profit by providing loan and advances. It is computed
by dividing the total amounts of loans and advances by total deposited funds.
The formula used to computed this ratio is as
Loan and Advances
Total Deposit

High ratio is the symptom of higher/ proper utilization of funds and low ratio is
the single of balance remained unutilized/ idle.

2. Investment on Government Securities to Total Deposit Ratio

This ratio assesses to what extent the banks are able to utilize the
depositor’s funds to earn profit by investing on Government Securities. It is
computed by dividing the total amounts of Investment on Government
Securities by total deposited funds. The formula used to computed this ratio is
as
Investment in Government Securities
Total Deposit

61
4. Net Profit to Total Assets Ratio
This ratio is very much crucial for measuring the profitability of funds invested
in the banks assets. It measures the return on assets. It is computed by
dividing the net profit after tax by total assets. The formula used for
computing this ratio is as
Net profit After Tax
Total Assets

5. Investment on Government Securities to Total Outside

Investment Ratio
This ratio is crucial for measuring the investment on government
securities out of total outside investment. This ratio is calculated by
dividing investment on government securities by total outside investment.

Investment on Government Securities

Total Outside Investment

TOI= Loan & Advances + Bill Purchased + Discounted+ All Types of

Investment

6. Investment on Share and Debenture to Total Outside

Investment
This ratio shows the bank investment in share and debenture of
subsidiary and other companies. This ratio is calculated by dividing
investment on share and debenture by total outside investment.
Investment on Share and Debenture
Total Outside Investment

7. Return on Government Securities

This ratio indicates how efficiently the bank has employed its resources to earn
good return from government securities. This ratio is computed by dividing

62
interest income on government securities by government securities. This can be
expressed as;
Interest Income on Government Securities
Government Securities

8. Return on Loan and Advances

This ratio indicates how efficiently the bank has employed its resources to earn
good return from provided loan and advances. This ratio is computed by
dividing interest income on loan and advances by loan and advances. This
can be expressed as;

Interest Income on Loan and Advances

Loan and Advances

9. Return on Share and Debentures

The return on share and debenture considers dividend yield and capital gain
yield. The dividend yield is only a partial indication of the return hence, return
on share and debenture significantly depends on the change in its share
price. It is calculated as follows

Return on Share and Debenture = Capital Gain Yield + Dividend Yield

Pt  Pt 1
Return on Share and Debenture (Rs) =  D1
Pt 1

Where Pt and Pt-1 are the average closing price of year t and t-1
Dt = Dividend per share (all types of dividend)

II. Risk on Individual Assets

The risky ness of assets depends on the variability of rates of return, which is
defined as the extent of the deviation of individual rates of return from
the average rate of return. Risk on individual assets can be calculated as;


 ( R  R) 2

n 1

63
Where
 = Standard deviation or Risk
R = average rate of return on individual assets
R = rate of return on individual assets
n = no. of years

III. Return on Portfolio

The return of a portfolio is the weighted average of the returns of the individual
assets in the portfolio. The weights are proportion of the investors wealth
invested in each asset, and sum of the weights must be equal one.

Portfolio Return ( R p )  Wi Ri  W jW j  ................WN WN

Where
R p =Portfolio Return

Wi = Weight of investment invested in stock ‘i’

W j = Weight of investment invested in stock ‘j’

Ri = Return for stock ‘i'

R j = Return for stock ‘j'

IV. Risk on Portfolio

The portfolio risk is measured by either variance or standard deviation of
returns. The portfolio risk is affected by the variance of return as well as
the covariance between the return of individual assets included in the portfolio
and respective weights.

The portfolio risk can be calculated in term of its standard deviation as;

WA RA  WB RB  WC RC  2Cov AB  WA  WB  2Cov AC  WA  WC
2 2 2 2 2 2


 2CovBC  WB  WC

64
V. Co-Variance
The covariance measure how two variables co-vary. It is a measure of the
absolute association between two variables. How the returns of individual
stocks and market co-vary measured by covariance between the return of
individual stocks and market return. If two variables are independent, their
covariance will zero. It computed as;
Symbolically Covi j  Pi j . i . j

VI. Coefficient of Variation

We know that standard deviation is the absolute measure of dispersion of rate
of return. The relative measure of dispersion based on the standard deviation is
known as the coefficient of standard deviation.
i
C.V . 
Ri

Where,
i= Standard deviation of securities i.

Ri = Average return on securities i.

The CV thus defines the risk associated with each dollar of expected
return in terms of ratio of the standard deviation of return to the
expected return (Pradhan, 2000:250).

VII. Portfolio Performance Measure

Sharpe’s Portfolio Performance Measure
Portfolio performance evaluation on the basis of return only will be
insufficient; therefore, it is necessary to consider both risk and return. The
Sharpe ratio measures the amount of return from an investment portfolio for a
given level of risk. It does this by dividing a measure of portfolio variability
(the standard deviation of its returns over a specific period) into the excess
returns generated by the portfolio over a risk free rate of return for the same
period. The higher the resulting number (index), the better is the portfolio
performance. This ratio is used to rank the performance of investment funds.

65
 Risk Premium ri  R
Si  or Si 
Total Risk i

Where,
ri = Average Return of Assets i.

 i = Standard Deviation of Return.

R = Risk less Rate of Return.

S i = Sharpe’s Index of Portfolio Performance.

b) Statistical Tools
The process of analyzing and evaluating various data statistical tools has
been used. In this study, statistical tools such as standard deviation,
mean, coefficient of variation, coefficient of correlation between different
variables, trend analysis as well as hypothesis test have been used, which are
as follows;

I. Karl Person’s Coefficient of Correlation

Correlation Coefficient is statistical tools for measure of the relative
association between two variables series; it describes how much linear co-
movement exits between two variables. Karl Person’s measure, known as
personas correlation coefficient between two variables (series) X and Y
usually denoted by r(X, Y) or r xy or simply r can be obtained as

N  xy   x  y
r
N  x 2  ( x 2 ) . N  y 2  ( y 2 )

The value of correlation coefficient ‘r’ lies between -1 to +1

If r = 1 there is perfect positive relationship
r = -1 there is perfect negative relationship
r = 0 there is no correlation at all

66
The closer the value of ‘r’ is 1 or -1, the closer the relationship between
the variables and the closer ‘r’ is to 0, the less close relationship.

II. Mean
It can also be denoted by AM or simply a mean of a set of observations is the
sum of all the observation divided by the number of observations. AM is also
known as the arithmetic average. AM is the most popular one among the
different measures of the averages. e.g. the AM of X of N observation
x1 , x 2 , x3 ...............x N is given by

1
x ( x1  x 2  x3  ...............x N )
N

or x 
x
N

III. Trend Analysis

The straight line trend implies that irrespective of the seasonal and
cyclical swings and irregular functions, the trend values increases or
decreases by absolute amount per unit of time. It is computed as follows
Y  a  bx
Where,
Y = The value of dependent variable
a = Intercept of trend line
b = Slope of trend line
x = Value of the independent variable

Following two equations can be developed putting the above values in normal
equation

 y  Na  b x
 xy  a x  b x 2

y  xy
Since x  0, a  or b 
N x 2

67
The constant ‘a’ is simply equal to the mean Y value and constant ‘b’ gives the
rate of change.

This is a mathematical method which is widely used in practice. It is applied

for finding out a trend line for those series which changes periodically in
absolute amount.

3.6 Limitations of the Methodology

The methodology deployed in this research cannot be different from the
common limitations of same types of thesis. However, in analyzing portfolio
risk and return of the selected samples, the tools applied cannot best
describe the relationships between the variables under study since portfolio
analysis tools are based on various assumptions. In choosing samples,
purposive and judgmental sampling method has been adopted. The reliability,
accuracy and validity of the research findings depend on these samples.

The primary data and information is collected through questionnaires

and direct interviews with the personnel. Validity of the study more depends
on the primary information provided by the higher level personnel.

The study of portfolio management is a vague and difficulty in realistic

analysis of current practices. So, to make it ease portfolio theory are used to
analyze. Portfolio theory is not free from biasness because of its assumptions.

68
 CHAPTER – IV
DATA PRESENTATION AND ANALYSIS

The main theme of this chapter is to analyze and interpret the data by using
financial and statistical tools. In this chapter, the concern is given in the
presentation and analysis part of data in detail. As data presentation and
analysis is the crucial part of any research, the purpose is to organize
the collected data so that it can be used for interpretation whereas analysis
of the data is to convert it from a crude form to an easy and understandable
presentation. It is so obvious that the presentation of the data and its
analysis help us to draw valid conclusion.

There are a number of methods which can be used to simplify the data.
It is being felt that the easiest way to understand the data is by examining it
through charts, tables and graphs. Necessary tables and figures are presented to
achieve the objectives of the study. Here, all possible data are collected from
Nepal Stock Exchange (NEPSE) and Security Board (SEBO). Similarly, some
of the data are also collected from Internet, Journals and other concerned
sources.

For the title of the thesis, the investment portfolio of CBs is analyzed with the
help of following tools;
 Ratio analysis
 Investment operations of CBs
 Risk and return analysis of individual securities and portfolio
investment
 Financial performance of individual as well as portfolio investment
 Trend analysis

69
4.1 Investment Operations of CBs
Investment is the most important functions of CBs because investment policy
provides several inputs, through which banks can handle their investment
operation efficiently and maximize return with, minimize risk which is the
success path for the banks. CBs must mobilize it funds to profitable, secured,
and marketable sector, so that it can earn more profit. CBs must fulfill the
credit needs of various sectors of the economy including industry,
commercial, social service, securities and agriculture sector.

Nowadays most of the banks depend upon the investment strategies. By which
the CBs are playing the vital role in the economic development of
the country. This chapter investment operation of CBs deals with the
pinpointing analysis related to the investment of the CBs of Nepal in
government securities, share and debentures and loan and advances prepared in
various economic sectors.

4.1.1 Investment on Government Securities

The investment of the CBs on government securities includes the
investment on treasury bills, development bonds, national savings bonds,
insurance bond etc. In some extent all CBs seem to be interested to use their
deposits by purchasing government securities.
Table 4.1
Structure of Investment on Government Securities Held by CBs
(Rs. in ‘000’)
FY NIBL NABIL EBL CBs
2004/05 1,948,500 2413939 2100289 6,462,728
2005/06 2,522,300 2301463 3322443 8,146,206
2006/07 3,256,400 4808348 3614541 11,679,289
2007/08 3,155,000 4646861 4821684 12,623,545
2008/09 2,531,300 3706102 5146845 11,384,247
Total 13,413,500 17876713 19005802 50,296,015
Average 2682700 3575342.6 3801160.4 10059203
Source: Annual Reports of CBs from FY 2004/05 to 2008/09

70
 Table 4.2
% Share of Investment on Government Securities of each Banks
FY NIBL NABIL EBL
2004/05 30.15 37.35 32.50
2005/06 30.96 28.25 40.79
2006/07 27.88 41.17 30.95
2007/08 24.99 36.81 38.20
2008/09 22.24 32.55 45.21
Total 136.22 176.14 187.64
Mean 27.24 35.23 37.53
S.D. 3.63 4.95 5.89
C.V. 13.34 14.06 15.69
Source: Table 4.1 and Appendix 1. (c)

Figure 4.1
Percentage Coverage of Government Securities Held By CBs

NIBL
27%
EBL
38%
NIBL
NABIL
EBL

NABIL
35%

The above table reveals that most of the CBs made investment on
government securities. The investment on government securities of EBL is
highest among other banks. The NIBL has been found to have investment on
govt. securities lower comparative to other banks. Similarly the EBL covers
more shares i.e. 37.53% of the total investment on govt. securities made by
CBs. NABIL be on 2nd position by investing 35.23% of the total investment on
govt. securities made by CBs. Similarly the lowest C.V. of NIBL shows the
more consistency in investment.
71
EBL has highest CV which means there is high variability in
investment on govt. securities. From above analysis about the
investment structure of CBs on the govt. securities reveal there is no similar
trend of investment on govt. securities made by CBs. Some banks 3% of total
investment while some covers more than that (i.e. nearly half parts) of total
investment on govt. securities. From average mean and CV analysis, it is clear
that EBL and NABIL are the banks which mobilize maximum funds
comparative to other banks on govt. securities. NIBL stood at the last position
sharing average 27.24% in total investment.

4.1.2 Investment on Share and Debenture

Commercial banks are interested to invest its funds on share and
debentures of other companies. Commercial banks invest their resources in
finance, banks, rural micro finance company, companies, and regional
development banks. Some companies whose shares are hold by
commercial banks are Nepal Oil Corporation, Nepal housing development
finance co. ltd., NIDC capital market, Insurance Corporation, rural
development banks etc. the investment structure of commercial banks on share
and debentures are shown in table below.

Table 4.3
Structure of Investment on Shares and Debentures Held by CBs
(Rs. in ‘000’)
FY NIBL NABIL EBL CBs
2004/05 17738 27363 19387 64488
2005/06 17738 27363 19387 64488
2006/07 35253 57853 19082 112188
2007/08 59,945 323236 101152 484333
2008/09 64,270 354,930 102034 521234
Total 194944 790745 261042 1246731
Average 38988.8 158149 52208.4 249346.2
Source: Annual Reports of CBs from FY2004/05 to 2008/09

72
 Table 4.4
% Share of Investment in Shares and Debentures of each Banks
FY NIBL NABIL EBL
2004/05 27.51 42.43 30.06
2005/06 27.51 42.43 30.06
2006/07 31.42 51.57 17.01
2007/08 12.38 66.74 20.88
2008/09 12.33 68.09 19.58
Total 111.14 271.26 117.60
Mean 22.23 54.25 23.52
S.D. 9.16 12.59 6.13
C.V. 41.19 23.21 26.08
Source: Table No.4.3
Figure 4.2
Percentage Coverage of Share and Debentures Held by CBs

EBL NIBL
24% 22%

NIBL
NABIL
EBL

NABIL
54%

The above table shows that CBs made very low parts on Shares and Debentures
of other companies. The investment of Nepalese CBs on other companies’
shares shows NABIL has been investing highest among other CBs i.e. 53.86%.
Similarly, NIBL has least mean, which say that NIBL invest lowest amount
in share and debenture, its investment is more consistent than other banks.
73
It has been revealed that there is no any proper trend of investing on share and
debenture of CBs. But all banks take part in such investment.
Among the above three listed commercial banks, it is quite clear that NABIL
covers highest shares i.e. 53.86% and NIBL covers lowest shares i.e.
22.39% of total investment on shares and debentures made by CBs.

4.1.3 Investment on Loan and Advances

Commercial banks are financial institutions that collect scattered
savings of community and invest them into most desirable and high
return sectors of economy. Pace of economic development is directly related
to the quality and quantity of the credit. Commercial banks invest their
funds in various sectors like industry, agriculture, commercial sector etc.
Commercial banks should invest its collected funds as loan and advance not to
keep it as cash and bank balance for mobilize its fund. Investment structure of
loan and advances of CBs are tabulated below.

Table 4.5
Structure of Investment on Loan and Advance Held by CBs
(Rs. in ‘000’)
FY NIBL NABIL EBL CBs
2004/05 9933084 10465266 7589332 27987682
2005/06 12613561 12681666 9770919 35066146
2006/07 17010464 15305910 13623689 45940063
2007/08 27,529,304 21,759,460 18836431 68125195
2008/09 36,827,157 27,999,012 24469555 89295724
Total 103913570 88211314 74289926 266414810
Average 20782714 17642262.8 14857985.2 53282962
Source: Annual Reports of CBs from FY 2003/04 to 2008/09

74
 Table 4.6
% Share of Investment on Loan and Advances of each Bank
FY NIBL NABIL EBL
2004/05 35.49 37.39 27.12
2005/06 35.97 36.16 27.86
2006/07 37.03 33.32 29.66
2007/08 40.41 31.94 27.65
2008/09 41.24 31.36 27.40
Total 190.14 170.17 139.69
Mean 38.03 34.03 27.94
S.D. 2.22 2.51 1.10
C.V. 5.83 7.38 3.94
Source: Table 4.5

Figure 4.3
Percentage Coverage of Loan and Advances of Different CBs

EBL
28%
NIBL
38%

NIBL

NABIL

EBL

NABIL
34%

From the above table no. 4.5 and 4.6 shows that NIBL has the highest shares
i.e.38.03% on loan and advances among three CBs throughout the review
period from 2004/05 to 2008/09. NABIL takes at the second position and
EBL take last position covering 27.94% respectively loan and advances

75
among three CBs. EBL has less CV which indicates the consistency of
investment on loan and advances.

It is clear that NIBL is the best bank among three banks on the basis of
utilization of resources in the field of loan and advances. In other hand the
fluctuating trend of investment on loan and advances shows that there is a lack
of any scientific approach towards investment on loan and advances of CBs.

4.2 Investment Portfolio Analysis

Commercial banks cannot utilize whole of its fund raised through deposit and
borrowings into loans and advance. In order to fulfill the gap between
borrowings and lending banks rather goes for investment on such as
government securities, shares and debenture, NRB bond etc.

The portfolio of making investment by three commercial banks i.e. NIBL,

NABIL, EBL, has been analyzed in the table. (Detail on Appendix 2.a)

Table 4.7
CBs Average Investment Portfolio in Percentage
Name of Government Share & NRB
Banks Securities Debentures Bond
NIBL 44.80 55.20 0.00
NABIL 44.76 55.24 0.00
EBL 92.19 5.81 0.00
Industry Average 60.58 38.75 0.00
Source: Banking and Financial Statistics, NRB, Mid July 2009 No.49

76
 Figure 4.4
CBS Average Investment Portfolio in Percentage

NRB Bond
0%
Govt. Securities
Share & Deb.
Share & Deb. NRB Bond
39%

Govt. Securities
61%

The above table shows the average investment portfolio of three commercial
banks. NIBL is investing 44.80% on government securities, 55.70% of fund
on shares and debentures and 0% of its fund in NRB bond. It shows that
NIBL is investing its more funds on shares & debentures [government
securities], some of its fund on share and debenture and not any fund on NRB
bond.

NABIL is not investing any fund on NRB bond i.e. 0%. It is investing high
amount on share and debenture. The mean percentage investment on share and
debenture is 55.24% and the mean percentage investment on government
securities is 44.76%.

EBL is not investing its any amount of funds in NRB bond so its mean
percentage ratio investment in NRB bond is 0%. EBL is investing higher
amount of funds on government securities. Its mean percentage ratio
investment on government securities is 92.19% and it is investing very low
amount of its fund on share and debenture, its mean percentage ratio
investment on share and debenture is 5.81%.

77
4.3 Loan and Advance Portfolio Analysis
Commercial bank provides loan and advance form the money which it receives
by way of the person against the personal security of borrowers or against
the security of movable and immovable properties. The major portion of short
term investment of CBs is the loan and advance provided to various sector
of the market. Mainly commercial banks are providing their funds to
government enterprise, private sectors and foreign bills purchase and discount.
The portfolio of making loans and advance by three banks NIBL, NABIL and
EBL has been analyzed in the table (Detail on Appendix 2.b)

Table 4.8
CBs Average Loan and Advances Portfolio in Percentage
Name of Banks Govt. Entp. Pvt. Sector For. Bill P&D
NIBL 2.46 94.66 2.88
NABIL 0.62 97.64 1.74
EBL 2.57 95.63 1.80
Industry Average 1.88 95.98 2.14
Source: Banking and Financial Statistics, NRB, Mid July 2009 No.49
Figure 4.5
CBs Average Loan and Advances Portfolio in Percentage

For. Bill P&D Govt. Entp.

2% 2%

Govt. Entp.
Pvt. Sector
For. Bill P&D

Pvt. Sector
96%

The above table shows the average loans and advance portfolio of three
commercial banks. NIBL is providing a very high amount of its loans and

78
advances to the private sector. The mean percentage of loans and advances
to the private sector is 94.66%. It has given second priority to foreign bills
P&D. The mean percentage on it is 2.88%. And finally it invests on
government enterprise with mean percentage of 2.46%.

NABIL has provided very high amount of its loans and advances to
private sector. The mean percentage of loans and advances to private sector is
97.64%. It has given a second priority to foreign bills P&D. The mean
percentage of loans and advances to foreign bills P&D is 1.74% which is
the highest as compared to other commercial banks. Lastly it has given a
priority in providing loans and advances to government securities with
mean percentage of 0.62%.

EBL is providing very high amount of its loans and advances to the
private sector. The mean percentage of loans and advances to the private
sector is 95.63%. EBL has given second priority to government enterprise. The
mean percentage of government enterprise is 2.57%. The bank has finally
given priority to foreign bills P&D with the mean percentage of 1.80%.

4.4 Analysis of Ratios

An arithmetical relationship between two figures is ratio. In other words, the
relationship between two accounting figures expressed in mathematical
terms is known as financial ratios. A ratio is always calculated by dividing
one item of the relationship with other. As a tool of financial analysis, ratio
can be expressed in terms of %. Ratio analysis is a very important tool of
financial analysis.

From the help of ratio analysis, the qualitative judgment can be done very
easily and timely regarding financial performance of the firm. It establishes the
significant relationship between the times of financial statements to provide
a meaningful understanding of the performance and financial position of a

79
firm. Ratio analysis serves as a stepping stone for an inter-firm comparison to
take remedial measures. In this chapter only important ratios are analyzed.

a. Investment to Total Deposit Ratio

This ratio Investment to Total Deposits is used to measure to which the
banks are successful in mobilizing the total deposits on investment or not.
CBs may mobilize its bank deposit by investing its fund in different
securities issued by government and other financial or non financial
companies. Normally CBs are investing their funds in govt. securities such
as treasury bills, development bonds, national saving bonds, special bonds
etc. shares to other companies. It is computed as;
Total Investment
Total Deposit

High ratio is the indicator of high success to mobilize the banking funds as
investment and vice-versa. The ratio of investment to total deposit of NIBL,
NABIL and EBL are shown in table below;
Table 4.9
Investment to Total Deposits Ratio (%)
FY NIBL NABIL EBL
2004/05 27.60% 29.27% 21.08%
2005/06 29.60% 31.95% 30.44%
2006/07 26.57% 38.32% 27.41%
2007/08 19.95% 31.14% 21.10%
2008/09 15.85% 28.99% 17.85%
Total 119.57% 159.67% 117.88%
Mean 23.91% 31.93% 23.58%
S.D. 5.78% 3.78% 5.17%
C.V. 24.18 11.84 21.93
Source: Appendix 1 (e, f)
Industry Average Mean = 26.47% Industry Average CV = 19.32%

80
 Figure 4.6
Total Investment to Total Deposit Ratio

35.00% 31.93%

30.00%
23.91% 23.58%
25.00%

20.00%
Mean
15.00%

10.00%

5.00%

0.00%
NIBL NABIL EBL

From the above listed comparative table and figures reveals that the ratio of
investment to total deposits of CBs are in fluctuating trend throughout the
review period i.e. from the FY 2004/05 to 2008/09. The mean investment to
total deposit of NABIL is the highest at the 3193%. Similarly NIBL and
EBL has second and third highest ratio of investment to total deposit with
23.91% and 23.58%. From the point of view of average ratio it can be said that
the NABIL capacity to mobilize its deposit on investment is better than
others because their mean ratio are higher than average ratio on CBs 32.47% on
the other hand EBL, NIBL mobilized their deposit on investment is not so
good as compare to overall CBs.

But the coefficient of variation in the ratio of NABIL is the lowest i.e. 11.84%.
Similarly the CV in the ratio of NIBL is the highest i.e. 24.18%
indicates more inconsistent among other. So, it is clear that NABIL is the
most successful in utilizing its resources on investment among other three
banks. Similarly EBL moderate in utilizing its resources on investment.

b. Loan and Advance to Total Deposit Ratio

The loan and advance is also one of major sectors of an investment. This ratio
81
measures extend to which bank are successful to mobilize their deposits
fund to earn profit by providing fund to outsiders in the form of loan and
advances. The higher ratio represents the greater efficiency of the firm in
utilizing fund and vice-versa. This ratio is calculated by dividing loans and
advance by total deposit. This can be stated as
Loan and Advances
Total Deposit

Where, loan and advances included loans to government enterprises, private

sectors, foreign bills purchase and discount. Total deposit included current
deposit, fixed deposit, saving deposit, money at call deposit and other deposit.

The following table shows the ratios of loan and advances to total
deposit ratio of various CBs.
Table 4.10
Loan and Advance to Total Deposit Ratio (%)
FY NIBL NABIL EBL
2004/05 69.68% 71.75% 75.16%
2005/06 66.64% 65.55% 70.79%
2006/07 69.46% 65.57% 74.91%
2007/08 79.91% 68.18% 78.56%
2008/09 78.86% 74.96% 73.43%
Total 364.55% 346.01% 372.85%
Mean 72.91% 69.20% 74.57%
S.D. 6.04% 4.10% 2.83%
C.V. 8.29% 5.92% 3.79%
Source: Appendix 1 (d, f)
Industry Average Mean = 72.23% Industry Average CV = 6%

82
 Figure 4.7
Loan and Advances to Total Deposit Ratio

75.00% 74.57%

74.00%
72.91%
73.00%

72.00%

71.00%
Mean
70.00%
69.20%
69.00%

68.00%

67.00%

66.00%
NIBL NABIL EBL

In the above table, the mean loans and advances to total deposit ratio of EBL is
highest i.e. 74.57% and NABIL is lowest ratio i.e. 60.20% among three
commercial banks. NIBL have a mean ratio of 72.91% respectively. The
industrial average mean ratio is 72.23%. It can be said that NIBL and EBL
capacity to mobilize its deposit on loan and advance is better than
average ratio of CBs.

The CV ratio of EBL is lowest i.e. 8.79% among three commercial banks
which indicates that the investment as EBL is the most uniform. NABIL has
the highest CV ratio i.e. 8.29% among three commercial banks, it indicates that
the investment of NABIL is more fluctuating. The lowest CV is better then
highest CV. The industrial average CV ratio is 6%. NABIL and EBL have a
lowest CV than industrial average CV. So it can be concluded that EBL is the
most effective, NABIL is moderate effective and NIBL is least effective to
mobilize its deposit on loan and advances.

c. Government Securities to Total Deposit Ratio

The Government securities are also one of major sectors of an
83
investment. This ratio measures that how banks has mobilize its deposit
on government securities. Though investment in government securities
yields less return but it is considered as more secure investment. The
higher ratio represents the more secure investment of the firm in utilizing fund
and vice-versa. This ratio is calculated by dividing investment in government
securities by total deposit. This can be stated as:

Investment on Government Securities

Total Deposit

Where, investment in government securities included purchasing of

government bonds, treasury bills etc. The following table shows the
government securities to total deposit ratio of various CBs.

Table 4.11
Government Securities to Total Deposit Ratio (%)
FY NIBL NABIL EBL
2004/05 13.67% 16.55% 20.80%
2005/06 13.33% 11.90% 24.07%
2006/07 13.30% 20.60% 19.88%
2007/08 9.16% 14.56% 20.11%
2008/09 5.42% 9.92% 15.45%
Total 54.88% 73.53% 100.31%
Mean 10.98% 14.71% 20.06%
S.D. 3.62% 4.15% 3.08%
C.V. 32.97% 28.23% 15.35%
Source: Appendix 1 (a, f)
Industry Average Mean = 15.25% Industry Average CV = 25.51%

84
 Figure 4.8
Government Securities to Total Deposit Ratio(%)

25.00%

20.06%
20.00%

14.71%
15.00%
10.98%
Mean
10.00%

5.00%

0.00%
NIBL NABIL EBL

In the above table, the mean Government securities to total deposit ratio
of EBL is highest i.e. 20.06 and NIBL is lowest ratio i.e. 10.98% among three
commercial banks. Other bank NABIL has mean ratios of 14.71%. The
industrial average mean ratio is 15.25%. It can be said that EBL have secure
investment (i.e. investment in government securities) than the rest of the banks.

The CV ratio of EBL is lowest i.e. 15.35% among three commercial banks
which indicates that the investment of EBL is the more secure.

NIBL has the highest CV ratio i.e. 32.97% among three commercial banks; it
indicates that the investment of NIBL is unsafe. The lowest CV is better then
highest CV. The industrial average CV ratio is 25.51%. EBL have a lowest CV
than industrial average CV. So it can be concluded that EBL has the secure
investment than that of other banks and NIBL is more risky than that of other
banks.

d) Return on Total Assets

This ratio measures the effectiveness of the banks in using its overall resources.

85
It measured in terms of relationship between net profit and total assets. The
higher the ratio represents the efficient of the bank utilizing its overall
resources and vice-versa. This ratio is calculated by dividing net profit after tax
by total assets. This can be stated as

Net profit After Tax

Total Assets

The net profit after tax represents that profit available to common
stockholder and total assets includes the total assets of balance sheet item.

The following table shows the ratios of net profit after tax to total assets
ratio of various CBs.
Table 4.12
Return on Total Assets (%)
FY NIBL NABIL EBL
2004/05 1.43% 3.19% 1.05%
2005/06 1.64% 2.98% 1.11%
2006/07 1.82% 2.44% 1.07%
2007/08 1.92% 1.79% 1.16%
2008/09 1.94% 1.69% 1.20%
Total 8.75% 12.09% 5.59%
Mean 1.75% 2.42% 1.12%
S.D. 0.21% 0.68% 0.06%
C.V. 12.27% 28.02% 5.56%
Source: Appendix 1 (g, h)
Industry Average Mean = 1.76% Industry Average CV = 15.29%

86
 Figure 4.9
Return on Total Assets Ratio

3.00%
2.42%
2.50%

2.00% 1.75%

1.50% Mean
1.12%
1.00%

0.50%

0.00%
NIBL NABIL EBL

The comparative table and figure shows that commercial banks has mixed
trend on their return to total assets ratio. Among three CBs, NABIL has the
highest mean return and EBL has the lowest return on total assets i.e. 2.42%
and 1.12%. The overall average mean of CBs is 1.76%. However NIBL mean
return is less than average mean of CBs i.e. 1.76%.

Similarly looking at CV among the three CBs, EBL has the lowest CV i.e.
5.56% which is the most consistent than other banks. And, the highest CV in
the ratios of NABIL i.e. 28.02% shows, the return on total assets of NABIL is
highly variable among three banks.

Lastly, it is concluded that NABIL is the best bank in relation to return on total
assets ratio because it utilized overall resources efficiently than other
bank. The profitability position of EBL is the weakest in relation to return on
total assets during study period among three CBs.

e. Investment on Share and Debenture to Total outside Investment

The ratio between investment on share and debenture and total outside
investment reflects the extent on which the banks are successful to mobilize

87
their total outside investment on purchase of shares and debenture of other
companies to generate income.

This ratio is calculated by dividing total outside investment this can be stated
as,
Investment on Share and Debenture
Total Outside Investment

Where,
TOI = Loan $Advances + Bill Purchased + Discounted + All Types of
Investment

A high ratio indicates more portion of investment on share and

debentures out of total outside investment and vice-versa.

The following table shows the ratios of investment on share and

debentures to total outside investment ratio of various CBs.
Table 4.13
Investment on Share and Debenture to Total outside Investment Ratio (%)
FY NIBL NABIL EBL
2004/05 0.13% 0.18% 0.20%
2005/06 0.10% 0.14% 0.14%
2006/07 0.15% 0.24% 0.10%
2007/08 0.18% 1.03% 0.43%
2008/09 0.15% 0.92% 0.34%
Total 0.71% 2.51% 1.21%
Mean 0.14% 0.50% 0.24%
S.D. 0.03% 0.43% 0.14%
C.V. 20.77% 86.65% 57.44%
Source: Appendix 1(c, i)

Industry Average Mean = 0.30%

Industry Average CV = 54.95%

88
 Figure 4.10
Investment on Share and Debenture to Total Outside Investment Ratio

0.60%

0.50%
0.50%

0.40%

0.30% Mean
0.24%

0.20%
0.14%

0.10%

0.00%
NIBL NABIL EBL

The comparative table shows that CBs has fluctuating trend on their
investment on share and debentures to total outside investment. In share
and debenture very low portion of the total outside investment is invest.
Among three commercial banks NABIL has invested higher amount on share
and debenture i.e. 0.50% of total outside investment while NIBL has invested
lower amount on share and debenture i.e. 0.14% only.

NIBL has the lowest CV i.e. 20.77% among the three CBs, which shows that
the variability of the ratios between investment on share and debenture
and total outside investment is most uniform among the other CBs.
Similarly, NABIL has the highest CV i.e. 86.65% which shows that it has
mover variability in investment on share and debenture to total outside
investment.

It is concluded that the CBs are not successful to mobilize their

resources in the field of share and debenture of other companies. NABIL invest
highest portion of total investment into share and debenture on the basis of
mean. On the other hand EBL is the most consistent bank in investing its
total outside investment on share and debenture.
89
f. Investment on Government Securities to Total Outside Investment
This ratio is very useful to know in which extent the CBs are successful in
mobilizing their total outside investment on different types of government
securities to maximize the income. Since government securities are highly
liquid, to some extent, CBs seem to be interested to utilize their deposits by
purchasing government securities.

This ratio is calculated by dividing investment on government securities by

total outside investment this can be stated as
Investment on Government Securities
Total Outside Investment

A high ratio indicates better mobilization of fund as investment on

government securities and vice-versa.

The following table shows the ratios of investment on government securities to

total outside investment ratio of various CBs.
Table 4.14
Investment on Government Securities to Total Outside Investment Ratio
(%)
FY NIBL NABIL EBL
2004/05 13.86% 16.25% 21.55%
2005/06 13.72% 12.05% 23.73%
2006/07 13.69% 19.63% 19.38%
2007/08 9.31% 14.84% 20.61%
2008/09 5.80% 9.65% 17.25%
Total 56.38% 72.42% 102.52%
Mean 11.28% 14.48% 20.50%
S.D. 3.62% 3.84% 2.42%
C.V. 32.08% 26.52% 11.79%
Source: Appendix 1(a, i)
Industry Average Mean = 15.42%
Industry Average CV = 23.46%

90
 Figure 4.11
Investment on Government Securities to Total Outside Investment Ratio

25.00%

20.50%
20.00%

14.48%
15.00%
11.28%
Mean
10.00%

5.00%

0.00%
NIBL NABIL EBL

The comparative table shows that there is highly invest in government

securities than in other investment portion because of secured on it. On
government securities EBL has the highest invest on government securities to
total outside investment i.e. 20.50% among three CBs. Similarly NIBL invest
lowest parts of total outside investment to government securities because it
has lowest investment on government securities to total outside investment i.e.
11.28%.

NIBL has the highest CV among three CBs which shows the least
consistent. But EBL has the lowest CV which shows the most consistent
among three CBs.

From above analysis, it can be concluded that the mobilization of total outside
investment into government securities of EBL is higher among three CBs
which is proved by highest ratio and lowest CV. Similarly NABIL have
moderate position. Likewise NIBL has weakest position for mobilization of
total outside assets into government securities.

91
4.5 Investment Portfolio Risk and Return Analysis of CBs
Risk and Return are two crucial phenomenons in world of investment. There is
always linear relationship between risk and return. Nobody will take to invest
in risky assets unless he is assured of adequate compensation for the
assumption of risk. Generally in a market, higher risk will command higher
premium.

The main purpose of risk and return analysis is to appraise investment

performance and to explore combinations of investments that maximize
returns, minimize risk or achieve both. The risk minimization, in
particular is not possible by holding only one asset or only one type of assets.
What makes possible to minimize risk is the diversification of investments.
Therefore, the analysis of risk of an investment in isolation is not very
meaningful for understanding the risk minimization process. Risk plays a
central role in the analysis of investments. CBs or investors generally do not
invest their money in only one risky asset. Instead they hold a portfolio of
many assets with the hope of diversifying the investment risk. In the context of
portfolio, the contribution of each asset to the portfolio risk is the
portion of relevant risk of the asset.

The portfolio of assets usually offers the advantage of reducing risk

through diversification. The standard deviation of the returns on the portfolio
may be less than the sum of the standard deviation of the returns from the
individual assets. The portfolio return is the straight weighted average of
returns from the individual assets. But the portfolio risk is not the weight
average of the variance of return of individual assets. The portfolio risk
is affected by the variances of return as well as the covariance between
the returns of individual assets included in the portfolio and their respective
weights. In reality, one will find an asset held in the portfolio to be
relatively less risky than when it is held in isolation. This is because when an
asset is held in a portfolio, the unsystematic risk is totally or at least

92
partly eliminated. Therefore, the portfolio standard deviation is not just the sum
of variances of assets held in the portfolio.

4.5.1 Risk and Return on Individual Investment

Risk and return are two crucial phenomenon in world of investment. There is
always linear relationship between risk and return. As the return goes on
increasing, the risk also increases. Hence a rational investor has to consider the
various aspects relating to R&R associated with investment while taking an
investment decision. In the following section various aspects of R&R
have been briefly explained in responses to the three selected banks. Risk
is a complicated subject and needs to be properly analyzed. The expected
return on an investment is the mean value of the probability distribution of its
possible returns. The higher the probability that actual return will be far
below the expected return, the greater the risk associated with owing an asset.
When analyzing investments, analysis of tightness of return is most
necessary one such measure is the standard deviations and another useful
measure of risk is the coefficient of variation. Therefore standard
deviations and coefficient of variation are taken as the measuring tools of
risk and return.

Risk and Return on Government Securities

Governments often need to finance their expenditures by borrowing. To meet
govt. expenditure, revenue surplus alone is not enough foreign grants as
well as foreign and internal loans have to mobilize to meet such expenditures.
Unlike business, govt. can not sell equity shares. Hence, they increase their
required fund from internal loan by issuing treasury bills, treasury bonds,
development bonds, national saving bonds etc. CBs also invest their funds by
purchasing such govt. securities.

The risk and return on govt. securities is calculated by dividing interest income
on govt. securities by total investment on govt. securities which is shown

93
 below;
Interest Income on Government Securities
Return on govt. securities (Rg) 
Total Investment on Government Securities
n

R
t 1
g
Average rate of return(R g ) 
n

 R 
n
2
g  Rg
t 1
Risk on Government Securities(σ g ) 
n 1
σg
Coefficient of Variation(CVg ) 
Rg

Table 4.15
Calculation of Risk and Return on Government Securities of Nepalese CBs
Investment on Interest Income on Return on

FY
Government Government Government R g  Rg 
2

Securities Securities Securities

“000” “000” (%) ( Rg)
2004/05 6,462,728 285607 4% * 0.017
2005/06 8,146,206 309889 3.80% 0.11
2006/07 11,679,289 339288 2.91% 1.49
2007/08 12,623,545 478651 3.79% 0.12
2008/09 11,384,247 699648 6.15% 4.08
Total 50,296,015 2113083 20.65% 5.82
Source: Appendix 1 (a) (j) and (l)
* (4-4.13)2=0.017

94
 Figure 4.12
Return on Government Securities of CBs

14,000,000 7%

12,000,000 6%

10,000,000 5%

8,000,000 4%

6,000,000 3%

4,000,000 2%

2,000,000 1%

0 0%
2004/05 2005/06 2006/07 2007/08 2008/09

Investment on HMG Securities Interest Income on HMG Securities

Return on HMG Securities (%)

Here,

R g  20.65
n5

Rg 
R g

20.65
 4.13%
n 5
Now,

 R 
n
2
g  Rg
t 1
Standard deviation on Government Securities(σ g ) 
n 1

5.82
  1.21%
5 1
σg 1.21
Hence Coefficient of Variation(CVg )    0.29
Rg 4.13

95
From above table, it can be concluded that, in average the return on investment
on govt. securities made by CBs is 1.143. Standard deviation is 1.21% which
indicates risk on govt. securities. In general concept there is no any risk on
government securities but the result of standard deviation and coefficient of
variation shows there is risk on such securities. It is mainly due to the more
fluctuating nature on investment on government securities. There is no fixed
trend to invest on government securities such as treasury bills, national saving
bonds, development bonds etc. by CBs its fund on treasury bills and the
treasury bills are purchased directly at auction. Hence the returns on
government securities are more volatility.

It is concluded that the higher variability of return on investment made on govt.

securities is due to lack of proper investment on various securities.

Risk and Return on Loan and Advances

Loan and advances are the main sources of CBs. The facility of granting loan
and advances is one of the main services which customers of the CBs
can enjoy. In order to realize their objectives CBs invest in various sectors like
industry, service sector, agriculture, commercial sectors and other sectors. The
risk and return on investment in the form of loan and advances can be
calculated as follows;

Interest Income on Loan and Advances

Return on Loan and Advances (RL)=
Total Investment on Loan and Advances

Average return on Loan and Advances (R L ) 

R L

n
Where n = no. of historical year

 R 
n
2
L  RL
t 1
Standard deviation on return on loan & advances (σ L ) 
n 1
σL
Coefficient of Variation(CVL ) 
RL

96
 Table 4.16
FY Investment on Interest Income on Return on Loan R g  Rg 
2

Loan and Advances Loan and Advances and Advances

“000” “000” (%) (RL )
2004/05 27987682 2264650 8.09% * 2.62
2005/06 35066146 2721746 7.76% 1.66
2006/07 45940063 3436554 7.48% 1.02
2007/08 68125195 3034123 4.45% 4.08
2008/09 89295724 4071302 4.56% 3.65
Total 266414810 15528375 32.35% 13.03
Source: Appendix 1 © (k) and (m)
* (9.09-6.47)2=2.62
Figure 4.13
Return on Loan and Advances of CBs
100000000 9.00%
90000000 8.00%
80000000 7.00%
70000000
6.00%
60000000
5.00%
50000000
4.00%
40000000
3.00%
30000000
20000000 2.00%
10000000 1.00%
0 0.00%
2004/05 2005/06 2006/07 2007/08 2008/09

Investment on Loan and Advances Interest Income on Loan and Advances

Return on Loan and Advances

Now, the average rate of return on loan and advances of CBs in Nepal is

RL 
R L

32.35
 6.47%
n 5
Again,

 R 
n
2
L  RL
13.03
L  t 1
  1.80%
n 1 5 1
 L 1.80
Hence CV L    0.28
R L 6.47

97
From the above table and figure reveals that the return on investment on loan
and advances has no any fixed trend. During the period 2004/05 to 2008/09 the
highest return is 8.09%in 2004/05 and lowest return is 4.45% in 2007/08. The
average return 6.47% means that in average the CBs generate 9.05% return on
its investment made in loan and advances. The standard deviation 1.16% and
coefficient of variation 28.1% show the risk of return on loan and
advances. The variability on return on loan and advances seems to be less than
return on government securities.

Risk and Return on Share and Debentures

The return on share and debenture considers dividend yield and capital gain
yield. The information about dividend received and capital yield by CBs is not
available properly. Due to information disclosure by the concern banks
regarding return from share and debenture is insufficient for the calculation
purpose. The general assumption has been established to calculate the
necessary return on share and debenture by using market return. The
market return on share and debenture for this purpose is the average
return of the sample companies listed in NEPSE. 5 companies are selected for
the study.

The risk and return on investment in share and debenture of the CBs can be
calculated as follows;

Return on share and debenture = Capital gain yield + Dividend yield

Pt  Pt 1
Return on share and debenture (Rs)=  D1
Pt 1

Where Pt and Pt-1 are the average closing price of year t and t-1

Dt = Dividend per share (all types of dividend)

98
  R 
n
2
S  RS
t 1
Risk on Share and Debenture (σ S ) 
n 1
σS
Coefficient of Variation(CVS ) 
RS

Table 4.17
Estimates of Market Parameter
Selected 2004/05 2005/06 2006/07 2007/08 2008/09
Companies Pt Dt Pt Dt Pt Dt Pt Dt Pt Dt
NABIL 1505 70 2240 85 5050 100 4899 5275 35
EBL 870 20 1379 25 2430 40 2455 3132 30
NIBL 800 12.5 1260 20 1729 5 1388 2450 20
Total 3175 4879 9209 8742 10857
No. of
3 3 3 3 3
Observation(n)
Average
1058.3 1626.3 3069.7 2914 3619
(P )t
Source: Trading Report Vol. 2 to10, NEPSE and Annual report of SEBO and
NEPSE 2000 to 2009`
Table 4.18
Dt
Calculation of Dividend Yield
Pt

Selected Companies 2004/05 2005/06 2006/07 2007/08 2008/09

NABIL 4.65 3.79 1.98 1.22 0.66
EBL 2.30 1.81 1.65 0.81 0.96
NIBL 1.56 1.59 0.29 0.54 0.82
Total 8.51 7.19 3.92 2.58 2.44
No. of observation (n) 3 3 3 3 3
Average Dividend Yield 2.84 2.40 1.31 0.86 0.81
Source: Table no. 4.17

99
 Table 4.19
Calculation of Capital Yield and Dividend Yield on Share
and Debentures of CBs
% Change Avg. Return on
Avg.
Fiscal
year
Closing
in Price
(Capital
Dividend
Dt
Share and
Debentures
R S  RS 
2

Price (Pt ) Yield

Yield) Pt (Rs)
2004/05 1058.3 24.07 2.84 26.91 97.22
2005/06 1626.3 53.67 * 2.4 56.07 ** 296.87
2006/07 3069.7 88.75 1.31 90.06 2630.66
2007/08 2914 -5.07 0.86 -4.21 1847.28
2008/09 3619 24.19 0.81 25.00 189.61
Total 193.84 5061.64
Source: Table No. 4.16 and 4.17

1626.3  1058.3
*  53.67 ** 53.67+2.4=56.07
1058.3
Figure 4.14
Capital Yield, Dividend Yield and Return on Share and Debentures

100.00 100.00

80.00 80.00

60.00 60.00

40.00 40.00

20.00 20.00

0.00 0.00
2004/05 2005/06 2006/07 2007/08 2008/09
-20.00 -20.00

% Change in Price (Capital Yield) Avg. Dividend Yield Dt/Pt

Return on Share and Debentures Rs

100
The average closing prize in year 2004/05 is calculated on the basis of Nepse
index and 2004/05 average closing price.

The average rate of return from Share and Debentures for CBs is;

Rs 
R s

193.84
 38.77
n 5

 R 
n
2
S  RS
5061.64
Again,  S    35.57
t 1

n 1 5 1

 S 35.57
Now, CV S    0.92
R S 38.77

Return on share and debenture is the sum of capital yield and dividend yield.
This is present in the above figure.

It can be observed from above table and figure that the annual rate of return of
investment on share and debenture of CBs shows wide fluctuation,
ranging from 26.91% in 2004/05 to -4.21% in year 2007/08. These
fluctuations in returns are caused mainly by volatility of the share prices in the
market. The change in dividends also contributed to the variability of the
shares return in some extent.

The average rate of return of investment on share and debenture of CBs

for five years during 2004/05 to 2008/09 is 38.77%. Similarly the annual
rate of return of investment on share and debenture show a high degree of
variability, they deviated on an average by 35.57% from the average rate
of 38.77%. This is also revels by the 92% coefficient of variation.

101
4.5.2 Risk and Return on Investment Portfolio
Portfolio Return on Investment
The return of a portfolio depends on (i) the expected rate of return of each
security contained in the portfolio and (ii) the amount invested in each security.
The portfolio return is the weighted average expected return of the
individual stock in the portfolio, with weights being the proportion of
investment on each security in the portfolio equation. CBs invest their
funds in government securities, share and debenture and loan and advance. The
weight of the investment on various assets and their average rate of returns are
presented below;

Table 4.20
Calculation of Weight of Investment on Various Assets
Investment Proportion Average
S.
Assets Amount Rs. Weight Rate of
No.
‘000’ (w) Return (R)
1 Government Securities 10059203 0.37 * 4.13
2 Share and Debenture 1246731 0.08 38.77
3 Loan and Advance 15528375 0.58 6.47
Total 26834309
Source: Appendix 1(a), (b), (c), (l), (m) and Above Table

10059203
*  0.37
26834309

Calculation of Portfolio Return (RP)

p

RP   W  R

= 0.37 × 4.13% + 0.08 × 38.77% + 0.58 × 6.47%

= 1.528 + 3.102 + 3.752
= 8.38%
Hence, Portfolio Return on Investment of CBs (RP) = 8.38%

102
 Portfolio Risk on Investment
We measure the risk of a portfolio by the variance or standard deviation
of the return of the portfolio. The risky ness of the portfolio expresses the
extent to which the actual return may deviate from the expected return.
However, its calculation is not as straight forward as the calculation of the
expected return of portfolio. The portfolio risk is affected by the association of
movement of returns of two securities. Hence, by combining the measures
of individual asset risk, relative asset weights and the co-movement of assets
returns (covariance) the risk of the portfolio can be estimated. Therefore
before calculating portfolio risk on investment covariance between two
assets return should be calculated.

Table 4.21
Calculation of Correlation Coefficient and Covariance between Various
Assets
Standard Correlation
S.N Assets Covariance Weight (w)
Deviation Coefficient
1 Government Securities (g) 1.21 -0.46 -0.008278 0.37
2 Share and Debenture (s) 35.57 0.65 0.002763 0.08
3 Loan and Advance (l) 1.8 -0.58 -0.006101 0.58
Sources: Appendix 3 and Above Page

Where,
Cov gs  R gs   g   s = -0.46 – 0.0121 – 0.3557 = -0.8276

Cov sl  R sl   s   l = -0.65 – 0.3557 – 0.0180 = 0.2763

Cov gl  R gl   g   l = -0.58 – 0.0121 – 0.0180 = -0.6101

Rgs, Rsl and Rgl are the correlation coefficient between government securities
and share and debenture, share and debenture and loan and advance,
government securities and loan and advance respectively.

103
The standard deviation of portfolio investment  P be

 P  W g   g  W s   s  Wl   l  2Cov gs  W g W  2Cov sl  W sWl  2Cov gl  W g Wl

2 2 2 2 2 2

= (0.37)  (1.21)  (0.08)  (35.57)  (0.58)  (1.8)  2  (0.008278)  0.37  0.08

2 2 2 2 2 2

 2  (0.002763)  0.08  0.58  2  (0.006101)  0.37  0.58

= 0.35%

Portfolio risk and return on investment made by CBs in various assets, which is
calculated above is important to note that the expected risk of the portfolio is
considerably less than the expected risk of investment on government
securities, loan and advances and share and debenture. Due to the negative
correlation between return of investment on loan and advances and share
and debenture and investment on government securities and share and
debentures investment portfolio has considerably reduced. Lower the
correlation co-efficient, lower the risk of the portfolio i.e. combining
assets with negative correlation will significantly reduce the risk of the
portfolio. Risk can be reduced by investing wealth in more than one asset.

The expected return on portfolio 8.38% is less than that of average rate
of return of individual investment on share and debentures (38.77%) and
investment on loan and advances (6.47%). But investing the total
funds in share and debentures and loan and advances is more risky than
that of investment on portfolio.

4.6 Test of Investment Portfolio Performance

The portfolio of assets usually offers advantage of reducing risk through
diversification. The portfolio risk is depending upon weight of funds invested
in various assets, risk of individual assets, the tendency of two variables to
move together etc. In this topic, the efforts have been made to explore in
which extent the CBs are able to utilize portfolio concept in their
investment.

104
To test the portfolio performance, this study uses three portfolio
performance models, which have been given below;

Sharpes’ Portfolio Performance Measure

Portfolio performance evaluations on the basis of return only will be
insufficient; therefore, it is necessary to consider both risk and return. William
F. Sharpe devised an index of portfolio performance denoted which
measures the slope of the line starting at risk less rate R and running out to
asset is defined as below;

Risk Premium ri  R
Si  or Si 
Total Risk i

Where,
ri = Average Return of Assets i.

 i = Standard Deviation of Return.

R = Risk less Rate of Return.

S i = Sharpe’s Index of Portfolio Performance.

The portfolio on investment is better than investment on other asset or not is

determinant by the above model, which is used to test whether the portfolio in
investment made by Nepalese CBs is appropriate or not.

Performance of government securities, share and debentures, loan and

advances and portfolio is calculated in table below.

105
 Table 4.22
Performance of Various Investment Assets
S. No. Investment Assets Average Standard Sharpe's
Annual Deviation Measure of
Return (%) Annual Performance
ri Return ri  R
Si  , R=7%
i i
1 Government Securities (g) 4.13 1.21 -2.37
2 Share and Debenture (s) 38.77 35.57 0.89
3 Loan and Advance (l) 6.47 1.8 -0.29
Source: From Above Calculation
Risk less rate of interest (R) = 7% (Economic Survey 2008)

From the above calculation Ss > Sl > Sg which indicates that the investment on
share and debentures is better than the investment on loan and advances,
the investment on loan and advances is a better performer than government
securities So, portfolio made by the CBs among various investment assets is
not so satisfactory. The lower Sharpe’s portfolio performance than that of
investment on share and debentures indicates that the commercial banks are
not fully successful to utilize their resources on various assets by using
portfolio concept to reduce risk and increasing return on assets. This is mainly
to lack of well scientific approach towards diversification
of funds among different assets.

4.7 Trend Analysis

The purpose of this topic is to analysis the trend of total investment, total
deposits and investment on various assets such as government securities, share
and debenture and loan and advance of the CBs and projection for next four
years.
Method of least squares is used to determine trend value. Under this variable y
and independent variable x be represented by,

Y = a + bx

106
Where,
a = y intercept
b = slope of the trend line or amount of change that comes in y for a unit
change in x.

To make calculation easier, the deviation of the independent variables i.e. time
are taken from the middle of the time period so that x=0 then, the value of a
and b can be easily calculated by using following formula

a
y and b 
 xy
N x 2

4.7.1 Trend Analysis of Total Investment and Total Deposit

The effort has been made to analyze trend of total investment and total
deposit of the CBs for six years and forecast of the same for next four years.
The following table shows the trend values of total investment and total deposit
of CBs (calculation details in appendix 4).

Table 4.23
Trend Value ( Yc  a  bx ) of Total Investment and Total Deposit of CBs
(Rs. in million)
Year (t) X=t-2006.5 Total Investment Total Deposit
Trend Actual Trend Actual
Value* Value Value** Value
2004 -2.5 9054.07 9568.08 18047.64 21353.56
2005 -1.5 12257.10 10332.779 36568.54 38938.874
2006 -0.5 15460.13 15984.847 55089.44 52077.15
2007 0.5 18663.15 20436.111 73610.34 66017.398
2008 1.5 21866.18 21873.351 92131.24 90343.068
2009 2.5 25069.21 24174.67 110652.14 117369.301
2010 3.5 28272.23 129173.05
2011 4.5 31475.26 147693.95
2012 5.5 34678.29 166214.85
2013 6.5 37881.31 184735.75
Source: Appendix 1(e) and (f)

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Trend line for Total Investment of CBs
* Yc = 17061.64 + 3203.03x
Trend line for Total Deposit of CBs
** Yc = 64349.89 + 18520.9x

Figure 4.15
Trend and Actual Value of Total Investment of CBs

40000

35000

30000

25000
Trend Value
20000
Actual Value
15000

10000

5000

0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Fiscal year

Figure 4.16
Trend and Actual Value of Total Deposit of CBs
200000.00
180000.00
160000.00
140000.00
120000.00

100000.00 Trend Value

Actual Value
80000.00
60000.00
40000.00
20000.00
0.00
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Fiscal year

108
From the above table and figure it is clear that CBs total investment has been
increasing by Rs. 3203.03 million each year and is expected to reach Rs.
37881.31 million at the end of year 2013. Likewise total deposit of CBs are in
increasing trend and which have been increasing by Rs. 18520.9 million
every year and is expected to reaches Rs. 184735.74 at the end of year
2013. Other thing remaining the same the ratio of total investment and
total deposit will be 20.51% (37881.31/184735.74) in year 2013 which is
moderate ratio. This shows that deposit utilization position in relation to
investment to total deposit ratio is appropriate.

4.7.2 Trend Analysis of Investment on Various Assets

Only three assets are taken i.e. government securities, share and debenture
and loan and advance are taken for analysis. For analyze total investment
on various assets of CBs for six years and forecast of the same for next four
years till 2013.

The following table shows the trend values of 10 years from 2004 to 2013 of
CBs investment on different assets i.e. government securities, share and
debentures and loan and advances.

109
 Table 4.24
Trend Value ( Yc  a  bx ) of Investment on Government Securities, Share
and Debentures and Loan and Advances of CBs.
(Rs. in million)
Year X=t- Investment on Investment on Share Investment on Loan
(t) 2006.5 Government Securities and Debentures and Advances
Trend Actual Trend Actual Trend Actual
Value* Value Value** Value Value*** Value
2004 -2.5 5544.44 5345.672 -41.83 57.1 15006.54 22666.7
2005 -1.5 7036.11 6462.728 61.82 64.488 28276.02 27987.68
2006 -0.5 8527.78 8146.206 165.48 64.488 41545.50 35066.15
2007 0.5 10019.45 11679.289 269.13 112.188 54814.98 45940.06
2008 1.5 11511.12 12623.545 372.79 484.333 68084.46 68125.2
2009 2.5 13002.79 11384.247 476.44 521.234 81353.95 89295.72
2010 3.5 14494.46 580.10 94623.43
2011 4.5 15986.12 683.75 107892.91
2012 5.5 17477.79 787.40 121162.39
2013 6.5 18969.46 891.06 134431.87
Source: Appendix 1(a), (b) and (c)

Trend line of Investment on Government Securities of CBs is,

* Yc = 9273.61+1491.67x

Trend line of Investment on Share and Debentures of CBs is,

** Yc = 217.31+103.65x

Trend line of Investment on Loan and Advances of CBs is,

*** Yc = 48180.24+13269.48x

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 Figure 4.17
Trend and Actual Value of Investment on Govt. Securities

20000.00
18000.00
16000.00
14000.00
12000.00
Trend Value
10000.00
Actual Value
8000.00
6000.00
4000.00
2000.00
0.00
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Fiscal Year

Figure 4.18
Trend and Actual Value of Investment on Share and Debentures

1000.00

800.00

600.00

Trend Value
400.00
Actual Value

200.00

0.00
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

-200.00
Fiscal Year

111
 Figure 4.19
Trend and Actual Value of Investment on Loan and Advances

160000.00

140000.00

120000.00

100000.00
Trend Value
80000.00
Actual Value
60000.00

40000.00

20000.00

0.00
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Fiscal Year

From the above table and figure, it is clear that the CBs investment on
government securities, share and debenture and loan and advance all are in
increasing trend. The investment on government securities, Share and
debenture and loan and advance are increasing by Rs. 1491.67 million, Rs.
103.65 million and Rs. 13269.48 million per year respectively. If other thing
remaining same, the investment on government securities, share and debenture
and loan and advance in 2013 will be Rs. 18969.46 million, Rs. 891.06 million
and Rs. 134431.87 million respectively, where as such investment in year 2009
is Rs. 11384.247 million, Rs. 521.234 million and Rs. 89295.724 million
respectively.

Hence, it can be concluded that the investment of CBs on various assets

like government securities, share and debenture and loan and advance all are
increasing per year. In comparison, increasing ratio in government securities is
3.42 times (18969.46/5544.44), in share and debenture is 21.30 times
(891.06/41.83) and in loan and advance is 8.96 times (134431.87/15006.54).
It shows that investing on government securities is increasing mere rapidly than
share and debenture and share and debenture increasing more rapidly than loan
and advance during the period of 2004 to 2013.
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4.8 Major Finding
Based on the analysis of the various data remarkable findings are drawn
up. The major findings are as follows;

Investment Portfolio
 In investment portfolio, the industry average investment on
government securities is 60.58%, among the CBs, EBL has invested
the highest amount of funds on govt. securities i.e. 92.19% and
NABIL has invested lowest 44.76%, other bank NIBL have investing
highest amount of funds on government securities among CBs i.e.
44.80% and EBL have invested lowest amount of funds on S&D
i.e.5.81%. The industry average in this case is 38.75%, on which
NIBL and NABIL is invested higher than industry average i.e. 55.20%
and 55.24% respectively. In case of NRB bonds no one banks are
investing. There is zero amount of investment.

Loan and Advances Portfolio

 In loan and advances portfolio, the industry average investment on Govt.
enterprises is 1.88%, Among the CBs, NIBL and EBL has invested the
highest amount of funds on Govt. enterprises i.e. 2.46 and 2.57%
respectively. The industry average investment on Private Sector is
95.98%. NABIL is investing highest amount of funds on private sector
among CBs i.e. 97.64% and NIBL and EBL have invested below the
industry average on private sector i.e. 94.66% and 95.63% respectively.
NIBL is investing the highest amount of funds on for Bills P& D as
compared to other CBs i.e. 2.88%. The industry average in this case is
2.14%. NABIL and EBL has invested lower than the industry average i.e.
1.74% and 1.80% respectively.
Portfolio Risk and Return on Investment
 There is positive correlation coefficient between return on investment
made by CBs in Share and debenture i.e. 0.65. And there is negative

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 correlation coefficient between return on investment made by CBs in
Govt. securities and loan and advance i.e. -0.46 and 0.58 respectively.
This shows the low degree of negative relationship between assets. Such
assets are very useful to make portfolio combination, So that the risk of
the portfolio will be significantly reduced.
 According to the calculation, portfolio return is lesser than the
individual return of S&D but higher then individual return of Govt.
securities. And portfolio risk is less than and S&D but very lower
risk than securities. This is due to negative correlation between assets,
which shows that the portfolio reduce risk.

Ratio Analysis
 The total investment to total deposits ratio of selected CBs shows
that NABIL is the most successful in utilizing its resources on investment
than others CBs. The mean ratio and CV also revels that EBL are
moderate in utilizing its resources on investment. While NIBL is not so
successful in better utilizing their total deposits on investment of
various assets.
 The loan and advance to total deposit ratio of selected CBs shows
that EBL is the most successful in utilizing its resources on L&A than
other CBs. The mean ratio and CV also revels that NIBL is moderate in
utilizing its resources on L&A. while NABIL are not so successful in
better utilizing their total deposits on L&A.
 The return on total assets ratio of selected CBs shows that, NABIL
utilized its overall resources efficiently than other banks. EBL is the
low profitability position among the 3 CBs but NIBL is in moderate in
profitability position.
 The ratio between investment on S&D and total outside investment
reflects the extent on which the NABIL invest highest portion of total
investment into share and debenture on the basis of mean. On the
other hand EBL is the most consistent bank in investing its total outside

114
 investment on share and debenture. But NIBL have low portion of
investment on S&D to total outside investment.
 The ratio between investments on Govt. securities and total outside
investment reflects the extent on which the EBL is higher among
three CBs which is proved by highest ratio and lowest CV.
Similarly NABIL have moderate position. Likewise NIBL has weakest
position for mobilization of total outside assets into government
securities. EBL are better mobilization of fund as investment on Govt.
securities and NIBL has weakest position for mobilization of funds as
investment on Govt. securities.
 NABIL is the best bank among three CBs on the basis of
exploitation of resources in the field of govt. securities, on the basis of
S&D EBL is the best bank among 3 CBs and EBL is the best bank
among 3 banks on the basis of exploitation of resources in the field
of loan and advances.
 On the basis of investment amount, the CBs gives first priority to invest
their resources on loan and advances, then to govt. securities and
lastly to share and debentures. Therefore CBs invest highest part of the
resources to loan and advances.

Risk and Return

 The average return on govt. securities is 4.13% and its
coefficient of variation is 0.29 which is very low return among
other investment but lower risk than L&A investment.
 In broad hypothesis, there is less risk on investment on govt.
securities but here is high risk due to the consideration of difference
of year to year return on govt. securities as risk factors. CBs wants to
invest in short term basis which return is not fixed because its return is
resolute by demand and supply so return is volatile with demand and
supply.
 CBs make faltering to invest on long term govt. securities that provide

115
 usual constant return. So that CV of government securities is
privileged.
 The average rate of return and CV of loan and advances is higher
than the government securities i.e. 6.47% and 0.28 respectively which
shows that the investment on L&A have more fixed trend than govt.
securities due to flat interest rate charged to clients on L&A.
 The average rate of risk and return are higher than other assets on S&D.
The average return on S&D of CBs shows wide fluctuations due to
transform in shares price. This is exposed by the high degree of CV.
 Rate of return of S&D is high but the risk is also high so that loan
and advances is advanced than government securities and govt. securities
are advanced than S&D according to the individual risk and return.

Test of Portfolio Performance

 By using Sharpe’s portfolio performance test, it indicates that investment
on loan and advances is the superior performance than that of
investment on share and debentures, portfolio and govt. securities.
 The portfolio has lower performance than loan and advances, which
shows that the CBs are not properly using portfolio concept to reduce
risk and increase return from their investment.
 It shows that the CBs are not use proper diversification of funds among
various assets.

Trend Analysis
 The total investment, total deposit and investment on S&D, L&A and
govt. securities of CBs are increasing per year. In trend analysis the
investment of CBs on S&D is increasing more rapidly than govt.
securities and govt. securities is increasing more rapidly than L&A
during the period on the study.

116
 CHAPTER - V
SUMMARY, CONCLUSION AND RECOMMENDATION

This chapter is an accomplished specific and indicative enclose which contains

summary, major finding and conclusion of finding and
recommendations. Brief introduction to all chapters of the study and
genuine information of the present situation under the topic of the study
is defined on summary. Conclusions and Findings are analysis of applicable
data by using various financial and statistical tools, which presents strengths,
weakness, opportunities and threats of the CBs. And suggestions are obtainable
in recommendation, which is arranged on the based from finding and
conclusions.

5.1 Summary
Any country depends upon the economic development for developing the
country. To strengthen, the economy of any country both the private and public
sector should play a great role, which contributing to our nation. The process
of the economic development depends upon various factors, however
economists are now convinced that capital formation and its proper
utilization plays a paramount role for rapid economic development. All the
economic activities of each and every country are greatly influenced by the
commercial banking business of the country.

Banks are an essential part of the business activities which are established
to safe guard people’s money and there by using the money in making
loans and investments. CBs collects scattered financial resources from
the masses and invests them among those engaged in commercial and
economical activities of the country. CBs are those financial institutions
deal in accepting deposits to persons and institutions and giving loans
against securities and it also provide technical and administrative assistance to

117
industries, trade and business enterprises. CBs are defined as a bank is a
financial institution, which performs widest range of economic and financial
functions of any business firm in the economy. CBs plays vital role for
development of a developing country. Banks provides internal resources for
developing country’s economy.

The evolution of the organized financial system in Nepal has a more

recent history than in other countries of the world. In Nepalese content,
the history of development of modern banks started from the establishment of
Nepal bank limited in 1937 A.D. nowadays there are 23 CBs operating in
Nepal financial market which is in increasing due to the country moved
towards economic liberalization, financial scenario has changed, and foreign
banks were invited to operate in Nepal. For the better performance of CBs,
successful formulation and effective implementation of investment policy is the
prime requisite. Nowadays there is a very high competition in the banking
industries but very less opportunity to make investment. The opportunities
are hidden. Thus these CBs should take initiative action in search of the
new opportunities. So, that they can easily survive in this competitive banking
business world and earn profit. A bank manager its investment has a lot to do
with the economic health of the country because the bank loans support the
growth of new business and trade empowering the economic activities of the
country.

Investment portfolio refers to an investment that combines several assets.

Investment portfolio is one which the income or profit of the banks
depend upon directly. Investment portfolio usually offers the advantage of
reducing risk through diversification of risk from risky investment to less
risky investment. The objective of portfolio is to develop a portfolio that has
the maximum return at whatever level of risk. The investment portfolio is the
tool which helps to reduce risk and maximize return. The banks should never
invest its funds in those securities; difference may cause a great loss. The bank

118
should accept that type of securities which are commercial, durable, marketable
stable, transferable and high market price.

Generally the investment of the CBs include the investment on government

securities, like treasury bills, development bonds, national saving bonds,
foreign government securities, shares on government owned companies and
non government companies and investment on debentures, similarly the CBs
used their funds as loan and advances. Most of the banks are interested to
invest their funds in more liquid and less risky sector. Nepalese CBs don’t
have their own clear vision towards investment portfolio. The investment
planning of the CBs in Nepal heavily depend upon the rules and
regulation provided by the central banks. The composition of asset portfolio
of the banks is influenced by the policy of the central bank. NRB’s directives,
unsecured climate created by political situation, government policy, Maoists
problems etc are the most important problem for banking sectors in investment.

The researcher has tried to explore investment of CBs in various assets,

portfolio management and risk return, risk and return on assets, relationship
between various factors of CBs with various investment assets, performance
of CBs towards investment for the study of ‘Investment portfolio analysis
of Nepalese CBs’. For the fulfillments of the objectives of the study many
analysis has been done such as operation of CBs, investment and loan and
advance portfolio, risk and return analysis, portfolio risk and return on
investment, ratio analysis, trend analysis, portfolio performance test and
hypothesis test. For the analysis mainly secondary data are used, which is
collected from concerned banks, NRB, NEPSE, SEBO and different
library and different information also provided from there. Financial and
statistical tools are used to reckoning and secondary data were compiled,
processed, tabulated and graphed for better presentation from which various
finding and conclusion have been drawn which are presented as below.

119
5.2 Conclusion
Commercial banks have been operating efficiently and have been successful in
becoming the pillars of economic system of the country. These banks are
performing as financial intermediaries, which provided a links between
borrowers and lenders by mobilizing the scattered resources towards
productive investments. It is not possible to achieve such goal without using
portfolio concept on the investment strategies, which helps to reduce risk and
increase return on investment. Most of the CBs are fascinated to invest their
resources in more liquid and less risky sectors. CBs are unsuccessful to use the
investment portfolio management to balanced investment opportunities.

From the analysis of risk and return of individual investment resources, it is

conclude that the loan and advances is much better than investment on
share and debentures and govt. securities. It is due to the fixed interest income
on loan and advances. So that the CBs are eager to invest their maximum
part of investment on loan and advances in different sectors due to
return from loan and advances seems less explosive than other resources.
The average rate of return and risk on share and debentures are advanced than
other assets so that the CBs are invested very low portion of resources into
share and debentures of other companies which terminate that the CBs are
investment on less risky sectors by which CBs can reduced risk but
reduced on return also. From the various ratios relating with the
utilization of resources on investment it can be accomplished that NABIL is
the bank which shows better performance on their investment strategies
while EBL imitate moderate performance in utilization of overall resources.
And NIBL is the weakest bank to mobilize its total resources in various
investment assets among five CBs.

While comparing the investment portfolio weight set up by the CBs with
directives given by the central banks, the banks have not followed the
directives. Directives direct not to invest more than 50% in one sector

120
but most of the banks have invested more than 90% of their funds into
one sector. From investment portfolio analysis, it is accomplished that
the CBs are given first priority to invest their funds in the govt. sector due to
less risky and second priority given to the share and debentures of other
companies. And in the case of investment on loan and advances portfolio
CBs are concentrated in the private sector due to high return from them and
given second priority to bills P & D and lastly on the govt. enterprises due to
the less return from them. CBs flow their funds from higher level of return to
lower level of return.

From the negative correlation coefficient between various investment

assets, the CBs can reduce total risk at minimum level and increase
profit at higher level. From the study it can be accomplished that CBs are not
able to diversify their resources efficiently, which is proved by the financial
performance test. According to the Sharpe’s portfolio performance test, it can
terminate that the Nepalese CBs do not utilize portfolio concept efficiently in
their investment.

The trend analysis of the CBs accomplished that investment on share and
debentures, investment on loan and advances, investment on govt. securities
are ever-increasing per year.

5.3 Recommendation
On the basis of the analysis, findings and conclusion, the following
recommendations are suggested to overcome limitation, disorganization as well
as exploit opportunities and to improve the present fund mobilization and
investment portfolio of Nepalese CBs

In investment portfolio, except NABIL other two CBs are focusing on govt.
securities for their investment as a result of various factors, amongwhich the
important ones are government policy and regulation framework of the central

121
banks. Therefore, investment on govt. securities should be decreased and
investment on other investment should be increase.
 The profitability position of EBL is the weakest in relation on return on
assets. So, the bank should utilize its overall resources effectively to gain
the peak profit margins.
 From the analysis of investment operation of CBs, EBL increases its total
investment by increasing total deposit and increasing investment on
government securities.
 NABIL are not successful in better utilizing their total deposits on loan
and advances so that it is recommended that NABIL should increase the
amount of loan and advances.
 Among the three CBs, EBL is the most excellent bank which is utilizing
the investment in various assets and its best position on ratio analysis. The
lowest investment on S&D to total outside investment and L&A to
total deposit of EBL is insufficient to reduce existing total risk. So that
SCBL is to raise the investment on S&D of other companies and
increased in loan and advances.
 Nepalese CBs have not formulated their investment policy in organized
manner. They don’t diversify the investment. Hence,
 CBs need to change their investment policy and investment in
different sector not only high percentage on risk free assets but also on
risky assets. From risky sectors there is a great opportunity for
CBs to get higher return by using portfolio concept.
 Portfolio condition of a bank should be regularly revised from time to
time. It should always try to maintain the balance in the portfolio
condition of the bank. Risk can be minimized by invest in more than one
assets not on only one assets. CBs are not pretty booming to invest their
funds in various assets. CBs are invest most of the funds on only
L&A but lower part of their funds in govt. securities and S&D.
Commencing above study, correlation coefficient between investment
assets are in –ve, which shows the fair opportunities for the CBs to

122
 minimize risk by investing in assets in suitable part. So, CBs must
diversify appropriate proportion of their funds in the field of share and
debentures along with govt. securities.
 It is clear from the above study that some CBs are able to exploit
portfolio management concept in the field of investment, which is not
satisfactory to reduce risk and maximize return in the finest level. So
that CBs should used portfolio management concept usefulness and
extend opportunities for exercising the portfolio management in
investment.

123
 APPENDICES

Appendix - 1
Arrangement & Tabulation of Available Financial
Data of Various CBs

a) Total Investment (Rs. in ‘000’)

FY NIBL NABIL EBL CBs
2004/05 3934189 4269658 2128932 10332779
2005/06 5602869 6180658 4201320 15984847
2006/07 6505680 8945311 4985120 20436111
2007/08 6,874,023 9,939,771 5059557 21873351
2008/09 7,399,811 10,826,379 5948480 24174670
Total 30316572 40161777 22323409 92801758
Average 6063314.4 8032355.4 4464681.8 18560351.6

b) Total Deposit (Rs. in ‘000’)

FY NIBL NABIL EBL CBs
2004/05 14254574 14586609 10097691 38938874
2005/06 18927306 19347399 13802445 52077150
2006/07 24488856 23342285 18186257 66017398
2007/08 34451726 31915047 23976295 90343068
2008/09 46698100 37348255 33322946 117369301
Total 138820562 126539595 99385634 364745791
Average 27764112.4 25307919 19877126.8 72949158.2

c) Net Profit (Rs. in ‘000’)

FY NIBL NABIL EBL CBs
2004/05 232147 518636 170808 921591
2005/06 350537 635263 237291 1223091
2006/07 501399 673960 296409 1471768
2007/08 746,468 696,731 451218 1894417
2008/09 1,031,053 900,619 638732 2570404
Total 2861604 3425209 1794458 8081271

124
 Average 572320.8 685041.8 358891.6 1616254.2

d) Total Assets (Rs. in ‘000’)

FY NIBL NABIL EBL CBs
2004/05 16274064 16274064 16274064 48822192
2005/06 21330138 21330138 21330138 63990414
2006/07 27590845 27590845 27590845 82772535
2007/08 38873306 38873306 38873306 116619918
2008/09 53040803 53040803 53040803 159122409
Total 157109156 157109156 157109156 471327468
Average 31421831.2 31421831.2 31421831.2 94265493.6

e) Total Outside Investment (Rs. in ‘000’)

FY NIBL NABIL EBL CBs
2004/05 14060244 14855828 9747603 38663675
2005/06 18379076 19101076 14001823 51481975
2006/07 23792106 24491088 18648397 66931591
2007/08 33870681 31304824 23398642 88574147
2008/09 43641017 38416312 29833153 111890482
Total 133743124 128169128 95629618 357541870
Average 26748624.8 25633825.6 19125923.6 71508374

f) Interest Income on Government Securities (Rs. in ‘000’)

FY NIBL NABIL EBL CBs
2004/05 56550 151064 77993 285607
2005/06 82420 130197 97272 309889
2006/07 78493 132229 128566 339288
2007/08 99991 198442 180218 478651
2008/09 140697 269187 289764 699648
Total 458151 881119 773813 2113083
Average 91630.2 176223.8 154762.6 422616.6

g) Interest Income on Loan and Advances (Rs. in ‘000’)

FY NIBL NABIL EBL CBs
2004/05 769195 861830 633625 2264650
2005/06 964689 986231 770826 2721746
2006/07 1302121 1167255 967178 3436554
2007/08 1249470 989764 794889 3034123
2008/09 1569180 1483042 1019080 4071302

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 Total 5854655 5488122 4185598 15528375
Average 1170931 1097624.4 837119.6 3105675
h) Return on Government Securities
FY NIBL NABIL EBL CBs
2004/05 2.90% 6.26% 3.71% 4%
2005/06 3.27% 5.66% 2.93% 3.80%
2006/07 2.41% 2.75% 3.56% 2.91%
2007/08 3.17% 4.27% 3.74% 3.79%
2008/09 5.56% 7.26% 5.63% 6.15%
Total 17.31% 26.20% 19.57% 21%
Average 3.46% 5.24% 3.91% 4.13%

i) Return on Loan and Advances

FY NIBL NABIL EBL CBs
2004/05 7.74% 8.24% 8.35% 8.09%
2005/06 7.65% 7.78% 7.89% 7.76%
2006/07 7.65% 7.62% 7.10% 7.48%
2007/08 4.54% 4.55% 4.22% 4.45%
2008/09 4.26% 5.30% 4.16% 4.56%
Total 31.84% 33.49% 31.72% 32.34%
Average 6.37% 6.70% 6.34% 6.47%

j) Investment on Government Securities

FY NIBL NABIL EBL CBs
2004/05 1,948,500 2413939 2100289 6,462,728
2005/06 2,522,300 2301463 3322443 8,146,206
2006/07 3,256,400 4808348 3614541 11,679,289
2007/08 3,155,000 4646861 4821684 12,623,545
2008/09 2,531,300 3706102 5146845 11,384,247
Total 13,413,500 17876713 19005802 50,296,015
Average 2682700 3575342.6 3801160.4 10059203

126
k) % (percentage) Share of Investment on Government Securities of each
Banks
FY NIBL NABIL EBL
2004/05 30.15 37.35 32.50
2005/06 30.96 28.25 40.79
2006/07 27.88 41.17 30.95
2007/08 24.99 36.81 38.20
2008/09 22.24 32.55 45.21
Total 136.22 176.14 187.64
Mean 27.24 35.23 37.53
S.D. 3.63 4.95 5.89
C.V. 13.34 14.06 15.69

l) Structure of Investment on Shares and Debentures Held by CBs

FY NIBL NABIL EBL CBs
2004/05 17738 27363 19387 64488
2005/06 17738 27363 19387 64488
2006/07 35253 57853 19082 112188
2007/08 59,945 323236 101152 484333
2008/09 64,270 354,930 102034 521234
Total 194944 790745 261042 1246731
Average 38988.8 158149 52208.4 249346.2

m) % (percentage) Share of Investment on Shares and Debentures Held by

CBs
FY NIBL NABIL EBL
2004/05 27.51 42.43 30.06
2005/06 27.51 42.43 30.06
2006/07 31.42 51.57 17.01
2007/08 12.38 66.74 20.88
2008/09 12.33 68.09 19.58
Total 111.14 271.26 117.60
Mean 22.23 54.25 23.52
S.D. 9.16 12.59 6.13
C.V. 41.19 23.21 26.08

127
n) Structure of Investment on Loans and Advances
FY NIBL NABIL EBL CBs
2004/05 9933084 10465266 7589332 27987682
2005/06 12613561 12681666 9770919 35066146
2006/07 17010464 15305910 13623689 45940063
2007/08 27,529,304 21,759,460 18836431 68125195
2008/09 36,827,157 27,999,012 24469555 89295724
Total 103913570 88211314 74289926 266414810
Average 20782714 17642262.8 14857985.2 53282962

o) % (percentage) Share of Investment on Loans and Advances

FY NIBL NABIL EBL
2004/05 35.49 37.39 27.12
2005/06 35.97 36.16 27.86
2006/07 37.03 33.32 29.66
2007/08 40.41 31.94 27.65
2008/09 41.24 31.36 27.40
Total 190.14 170.17 139.69
Mean 38.03 34.03 27.94
S.D. 2.22 2.51 1.10
C.V. 5.83 7.38 3.94

128
 Appendix 2

a) Investment Portfolio Analysis (%)

Fiscal Year 2004/05 2005/06 2006/07 2007/08 2008/09 Total Mean
NIBL
Govt. Securities 49.52 44.46 49.96 45.86 34.20 224.00 44.80
Share & Deb. 50.48 55.54 50.04 54.14 65.80 276.00 55.20
NRB Bond 0.00 0.00 0.00 0.00 0.00 0.00 0.00
NABIL
Govt. Securities 56.53 38.42 59.86 35.00 34.00 223.81 44.76
Share & Deb. 43.47 61.58 40.14 65.00 66.00 276.19 55.24
NRB Bond 0.00 0.00 0.00 0.00 0.00 0.00 0.00
EBL
Govt. Securities 98.65 84.46 95.82 95.00 87.00 460.93 92.19
Share & Deb. 1.35 15.54 4.18 5.00 3.00 29.07 5.81
NRB Bond 0.00 0.00 0.00 0.00 0.00 0.00 0.00

b) Loan and Advances Portfolio Analysis (%)

2004/05 2005/06 2006/07 2007/08 2008/09 Total Mean
NIBL
Govt. Entp. 2.58 0.90 3.47 0.80 4.55 12.30 2.46
Pvt. Sector 93.74 95.83 94.20 96.33 93.22 473.32 94.66
For. Bill P&D 3.68 3.27 2.33 2.87 2.23 14.38 2.88
NABIL 0.00
Govt. Entp. 0.65 0.64 0.47 0.65 0.70 3.11 0.62
Pvt. Sector 97.49 98.11 97.91 97.39 97.31 488.21 97.64
For. Bill P&D 1.86 1.25 1.62 1.96 1.99 8.68 1.74
EBL
Govt. Entp. 4.23 2.72 0.38 1.96 3.55 12.84 2.57
Pvt. Sector 94.47 95.63 98.23 95.48 94.34 478.15 95.63
For. Bill P&D 1.30 1.65 1.39 2.55 2.10 8.99 1.80

129
 Appendix 3
Calculation of Correlation between Various Investment Securities of CBs
Year Return on Government Return on Share Return on Loan
Securities (Rg) and Debentures (Rs) and Advances(Rl)
2004/05 4 26.91 8.09
2005/06 3.8 56.07 7.76
2006/07 2.91 90.06 7.48
2007/08 3.79 -4.21 4.45
2008/09 6.15 25.00 4.56

Correlation Coefficient between Rg and Rs

Rg Rs
Rg Pearson Correlation 1 -.46*
Sig. (2-tailed) . .736
N 5 5
Rs Pearson Correlation -.46 1
Sig. (2-tailed) .736 .
N 5 5
* Correlation is significant at the 0.05 level (2-tailed).

Correlation Coefficient between Rs and Rl

Rs Rl
Rs Pearson Correlation 1 .65
Sig. (2-tailed) .5 .233
N 5
Rl Pearson Correlation .65 1
Sig. (2-tailed) .233 .
N 5 5

Correlation Coefficient between Rg and Rl

Rg Rl
Rg Pearson Correlation 1 -.58
Sig. (2-tailed) . .039
N 5 5
Rl Pearson Correlation -.58 1
Sig. (2-tailed) .039 .
N 5 5

130
 Appendix 4
A Sample Calculation of Straight Line Trend
Let straight line trend between dependent variables (total investment) y and
independent variable (time) x be

Y = a + bx

Where,
a = y intercept
b = slope of the trend line or amount of change that comes in y for a unit
change in x.

for finding value of a and b, we have

a
y and b   xy it is only when x=0
N x 2

Deviation are taken from middle of the years

Trend line by Least Square method

Trend for Total Investment of CBs (Rs. in million)
Total Investment of
Year(t) x = t-2006.5 xy x2
CBs (Y)
2004 9568.08 -2.5 -23920.2 6.25
2005 10332.779 -1.5 -15499.1685 2.25
2006 15984.847 -0.5 -7992.4235 0.25
2007 20436.111 0.5 10218.0555 0.25
2008 21873.351 1.5 32810.0265 2.25
2009 24174.67 2.5 60436.675 6.25
Total 102369.838 0 56052.965 17.5

x=0
a=y/n =102369.838/6=17061.64
b=xy/x2 =56052.965/ 17.5=3203.03

Hence, the straight line trend for total investment of CBs be;

131
Yc = a + bx
= 17061.64 + 3203.03x
Trend for Total Deposit of CBs (Rs. in million)
Total Investment of x = t-
Year(t) xy x2
CBs (Y) 2006.5
2004 21353.56 -2.5 -53383.9 6.25
2005 38938.874 -1.5 -58408.311 2.25
2006 52077.15 -0.5 -26038.575 0.25
2007 66017.398 0.5 33008.699 0.25
2008 90343.068 1.5 135514.602 2.25
2009 117369.301 2.5 293423.2525 6.25
Total 386099.351 0 324115.7675 17.5

x=0
a= y/n =386099.351/6=64349.89
b= xy/x2 =324115.7675/17.5=18520.9

Hence, the straight line trend for total deposit of CBs be;
Yc = a + bx
= 664349.89 + 18520.9x

Trend for Investment on Govt. Securities of CBs (Rs. in million)

Total Investment of x = t-
Year(t) xy x2
CBs (Y) 2006.5
2004 5345.672 -2.5 -13364.18 6.25
2005 6462.728 -1.5 -9694.092 2.25
2006 8146.206 -0.5 -4073.103 0.25
2007 11679.289 0.5 5839.6445 0.25
2008 12623.545 1.5 18935.3175 2.25
2009 11384.247 2.5 28460.6175 6.25
Total 55641.687 0 26104.2045 17.5
x=0
a= y/n =55641.687/6=9273.61
b= xy/x2 =26104.2045/17.5=1491.67
Hence, the straight line trend for Investment on Govt. Securities of CBs be;
Yc = a + bx
= 9273.61 + 1491.67x

132
 Trend for Investment on Share and Debentures of CBs (Rs. in million)
Year(t) Total Investment of x = t- xy x2
CBs (Y) 2006.5
2004 57.1 -2.5 -142.75 6.25
2005 64.488 -1.5 -96.732 2.25
2006 64.488 -0.5 -32.244 0.25
2007 112.188 0.5 56.094 0.25
2008 484.333 1.5 726.4995 2.25
2009 521.234 2.5 1303.085 6.25
Total 1303.831 0 1813.9525 17.5
x=0
a= y/n =1303.831/6=217.31
b= xy/x2 =1813.9525/17.5=103.65

Hence, the straight line trend for Investment on Share and Debentures of CBs
be;
Yc = a + bx
= 217.31 + 103.65x

Trend for Investment on Loan & Advances of CBs (Rs. in million)

Year(t) Total Investment of CBs x = t- xy x2
(Y) 2006.5
2004 22666.65 -2.5 -56666.625 6.25
2005 27987.682 -1.5 -41981.523 2.25
2006 35066.146 -0.5 -17533.073 0.25
2007 45940.063 0.5 22970.0315 0.25
2008 68125.195 1.5 102187.7925 2.25
2009 89295.724 2.5 223239.31 6.25
Total 289081.46 0 232215.913 17.5
x=0
a= y/n =289081.46/6=48180.24
b= xy/x2 =232215.913/17.5/17.5=13269.48

Hence, the straight line trend for Investment on Loan and Advances of CBs be;
Yc = a + bx
= 48180.24 + 13269.48x
133
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