From April 2004 to August 2005, the ten-year Government Bond rised by 250 basis points and is continuing to rise from thereafter. Many banks have profited handsomely from this rise in interest rates. Since interest rates cannot continue to rise indefinitely, there can be a question, Is the banking system adequately prepared for a scenario with change in interest rates?In this paper investigation has been made on the effects of interest rates volatility on stock market returns using daily returns on stocks of 32 selected Commercial Banks which includes 16 Public sectors and 16 Private sector Banks over the period from 1st April 2004 to 31st Aug 2005.In this paper, 'Augmented market model' has been used to estimate, the elasticity of returns on the stock against returns on the stock market. The repressor used in this model can be interpreted as the return on a portfolio where the long bond is purchased, using borrowed funds at the short rate. The return on selected banks and market return required for the study are obtained from the NSE website. We created time-series of notional bond returns on the 28-day and the 10-year zero coupon bond, priced off the NSE Zero Coupon Yield Curve for short term and long term returns respectively.The results indicate that interest rates have a strong positive power for stock returns and. weak predictive power for volatility. It has been found that for 10 out of 32 banks in our sample would be gained or lost 30% of equity capital in the event of a 250 bps move in the yield curve. The stock market sensitivities suggest that there is strong heterogeneity across banks in India in their interest rate exposure. The stock market is unaware of interest rate risk when valuing bank stocks.