an introduction to portfolio management

An Introduction To Portfolio Management

Mercy A. Medalla

Mercy A. MedallaBSBA-IV

An Introduction To Portfolio Management Mercy A. Medalla

• Portfolio management is the art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against performance.

What is Portfolio Management?

An Introduction To a Portfolio Management

Mercy A.Medalla

• Portfolio management is all about determining strengths,weaknesses,opportunities and threats in the choice of debt vs.equity,domestic vs.international,growth vs.safety,and many other trade-offs encountered in the attempt to maximize return at a given appetite for risk.

An Introduction To a Portfolio Management Mercy A. Medalla

• Portfolio management refer to managing an individual’s investments in the form of bonds,shares,cash,mutual funds etc so that it earn the maximum profits within the stipulated time frame.

An Introduction To a Portfolio Management Mercy A.Medalla

• A probability or threat of damage, injury, liability, loss, or any other negative occurrence that is caused by external or internal vulnerabilities, and that may be avoided through preemptive action.

•Risk


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• Risk averse is a description of an investor who, when faced with two investments with a similar expected return (but different risks), will prefer the one with the lower risk.

•Risk Averse


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1. Market Portfolio

2. Zero Investment Portfolio

•Kinds of Portfolio Management


• A market portfolio is theoretical bundle of investments that includes every types of asset available in the world financial market, with each asset weighted in proportion to its total presence in the market.

•What is Market Portfolio?


• A group of investments which, when combined, create a zero net value. Zero investment portfolio can be achieved by simultaneously purchasing securities and selling equivalent securities. This will achieved lower risk/gains compared to only purchasing or selling the same securities.


•What is Zero Investment Portfolio?

• Active Portfolio Management.

• Passive Portfolio Management.

• Discretionary Portfolio Management Services.

• Non-Discretionary Portfolio Management Services.

•Types of Portfolio Management


• In an active portfolio management service, the portfolio managers are actively involved in buying and selling of securities to ensure maximum profits of individuals.

•Active Portfolio Management


• In a passive portfolio management, the portfolio manager deals with a fixed portfolio designed to match the current market scenario.

•Passive Portfolio Management


• In discretionary portfolio management services, an individual authorizes a portfolio manager to take care of his financial needs on his behalf.

•Discretionary Portfolio Management services


• In Non-Discretionary Portfolio Management Services, the portfolio manager can merely a the advise the client what is good and bad for him but the client reserves full right to take his own decisions.

•Non-Discretionary Portfolio Management Services


• There are numerous potential measures of risk.

1. This measure is somewhat intuitive.

2. It is correct and widely recognized risk measure.

3. It has been used in the most of the theoretical asset pricing models.

•Alternative Measures of Risk


• Expected Rates of Return Computation of the Expected Return for an Individual Asset:

Probability Possible Rate of Return (percent)

Expected Security Return (percent)

0.35 0.08 0.02800.30 0.10 0.03000.20 0.12 0.02400.15 0.14 0.0210

E(R)=0.1030

An Introduction To Portfolio Management Mercy A.Medalla

• Computation of the Expected Return for a Portfolio of Risky Assets

Weight(w₁)(percent of portfolio)

Expected Security Return(R₁)

Expected PortfolioReturn(w₁ x R₁)

0.20 0.10 0.02000.30 0.11 0.03300.30 0.12 0.03600.20 0.13 0.0260

E(Rport)=0.1150


• Portfolio variance is the measurement of how the actual returns of a group of securities making up a portfolio fluctuate. Portfolio variance looks at the standard deviation of each security in the portfolio as well as how those individual securities correlate with the others in the portfolio. In other words, portfolio variance looks at the covariance or correlation coefficient for the securities in the portfolio.

•Variance(Standard Deviation) of Returns for an Individual Investment


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Possible Rate of Return (R₁)

Expected Security Return E(R₁)

R₁-E(R₁)

[R₁-E(R₁) ]2

P₁ [R₁-E(R₁)2P₁

0.08 0.103 -0.023 0.0005 0.35 0.0001850.10 0.103 -0.003 0.0000 0.30 0.0000030.12 0.103 0.017 0.0003 0.20 0.0000580.14 0.103 0.037 0.0014 0.15 0.000205

0.000451

• Computation of the Variance for an Individual Risky Asset


Two basic concepts in statistics:

1. Covariance

2. Correlation

•Variance(Standard Deviation) of Return for a Portfolio


•What is Covariance?

•Covariance is a measure of the degree to which returns on two risky assets move in tandem. A positive covariance means that asset returns move together, while a negative covariance means returns move inversely. Covariance is calculated by analyzing at return surprises (standard deviations from expected return), or by multiplying the correlation between the two variables by the standard deviation of each variable.An Introduction To a Portfolio Management Mercy A. Medalla

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What is Correlation?

•Correlation is a statistical measure that indicates the extent to which two or more variables fluctuate together. A positive correlation indicates the extent to which those variables increase or decrease in parallel; a negative correlation indicates the extent to which one variable increases as the other decreases.


• Portfolio standard deviation is the standard deviation of a portfolio of investments. It is a measure of variability of the expected returns from a portfolio.

•Standard Deviation of a Portfolio


•The Efficient Frontier

•The efficient frontier is the set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a given level of expected return. Portfolios that lie below the efficient frontier are sub-optimal, because they do not provide enough return for the level of risk. Portfolios that cluster to the right of the efficient frontier are also sub-optimal, because they have a higher level of risk for the defined rate of return.


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