Advantages Of Portfolio Optimization

This paper will assess my ability to maximize my personal return on investment with an allocation of $1,000,000. The overall goal of this exercise is to obtain the highest return possible within the next 12 months. I am limited to the following asset classes for allocation of all investments:

“The Benefits of diversification are clear. Portfolio theory has played a crucial role in explaining the relationship between risk and return where more than one investment is held. It also enables us to identify optimal and efficient portfolios.”

(b) The mean excess return, standard deviation, and portfolio weights for the optimum (maximum Sharpe ratio) portfolio.

Harry Markowitz 1991, developed a theory of “Portfolio choice”, that allows the investors to examine the risk as per the expected returns. In modern World, this theory is known as Modern portfolio theory (MPT). It attempts to attain the best portfolio expected return for a predefined portfolio risk, or to minimise the risk for the predefined expected returns, by a careful choice of assets. Though it’s a widely used theory, still has been challenged widely. The critics question the feasibility of theory as a strategy for

Students can learn to manage that data responsibly by taking into account the aspects in writing such as content, the language use, organization, vocabularies, and mechanic.

In order to find the optimal portfolio allocation, the group needs to find the portfolio structured with lowest risk under a given return. This can be achieved by applying Mean-Variance Theory and Markowitz model find the efficient frontier, which yields the most optimal portfolio under given returns. It can be expressed in mathematical terms and solved by quadratic programming. [Appendix A]

To reduce a firm’s specific risk or residual risk a portfolio should have negative covariance or rather it should have no variance at all, for large portfolios however calculating variance requires greater and sophisticated computing power. As such, Index models greatly decrease the computations needed to calculate the optimum portfolio. The use of such Index models also eliminates illogical or rather absurd results. The Single Index model (SIM) and the Capital Asset Pricing Model (CAPM) are such models used to calculate the optimum portfolio.

a. Objective(s). It is out of doubt that no matter how diversified the portfolio is, systematic risk can never be eliminated. The risk associated with individual stocks can be reduced, but general market risks affect almost every stock. So it is important to diversify between different asset classes and industries as well. The key is to find a medium between risk and return. The objective of this paper is to discuss importance of diversification of investment portfolio within industries and project the theory on the example of two portfolios. The first portfolio tends to be undiversified and consists of shares of companies from banking sector. The undiversified portfolio is as follows:

Recent studies show that they are different definitions and purpose of asset allocation within different groups of investors. For professional investors, asset allocation usually means (i) calculating the rates of return between various asset classes, (ii) running these variables to select asset mixes with different risk and return profiles; and (iii) analyzing and implementing the desired asset allocation. Whilst

It was also discovered in a Bowen article, that Markowitz allocation portfolio theory requires a large data volume and pointed out on the difficulty in covariance estimation. He doubted in the reliability of the model predictions and deduced, that existed statistical barriers do not let an average portfolio manager to use only this model in his day-to-day activities. (Bowen 1984:21)

MPT correlates the distribution of assets to the risk of investments. This theory also acknowledges an investors aversion to risk and required return rates (Geambasu, Sova, Jianu, & Geambasu, 2013). Moreover, MPT emphasizes the importance of diversifying as much as possible to eliminate risk. In order to measure the risk of an investment MPT relies on the standard deviation of all returns (Chambers, 2010). However, due to new analysis suggesting that MPT produces inefficient portfolios, financial experts have adapted the theory, creating the Post Modern Portfolio Theory (PMPT). The PMPT improves upon MPT by refining the risk calculations and using the standard deviation solely on negative returns. As such, PMPT acknowledging an investor’s expectation and recognizes that the standard deviation measurement in MPT poorly measures how humans experience and asses risk (Swisher & Kasten, 2005). Therefore, the standard deviation is an important analysis used in divarication financial theory’s to asses and ultimately avoid risk.

Firstly, portfolio theory has become an essential strategy in the modern investment market. In general, according to Elton (2011), it is a common situation that each person may possess a portfolio which is combined with real assets such as a vehicle or a house, including financial assets such as stocks and bonds. An investment portfolio is a series of chosen securities for investing purpose. In order to avoid risks or pursue for profits, investors are faced with enormous number of choices. If one is considering structuring an investment portfolio, the alternative composition of various assets seems overwhelming. So how to make a decision and what is a good , even best portfolio are the points in the first part.

Our target client is someone looking to invest in a risk averse portfolio that provides stable returns with an expectation for capital gain. We have carried out extensive economic research in order to forecast future market conditions. This research is then used in combination with specific stock screens in order to

Discuss the general features, differences, advantages and disadvantages of active and passive portfolio strategies and their link with the theory of efficient capital markets.

In 1952 the basic concept of the modern portfolio theory was written by Harry Markowitz, in which he explained that assets in an investment portfolio are not only to be selected on the basis of its merit but also by how it’s price changes relative to every other asset in the portfolio. Investment can be stated as a trade-off between expected return and risk, the riskier the investment the higher the return and vice versa. It allows us to make a decision to choose between the portfolio with either the highest rate of return or the lowest amount of risk. The risk of different stocks can be reduced if a portfolio consists of stocks with different risks and returns for example; if stock A has high risk and stock B has low risk, the overall portfolio risk is less, as it is the weighted average of both risks. Owning different shares with different risks in a portfolio is known as diversification. Markowitz hence developed the efficient frontier of portfolio, the efficient set in which investors choose the most suitable portfolio for them. This concept gave birth to the Capital asset pricing model by William Sharpe in 1964 and linter 1965; they state that there are two types of risk, systematic risk and unsystematic risk. The former is the market risk that cannot be diversified while the latter is the risk associated with individual stocks which can be reduced through diversification as stated by the MPT (Investopedia, 2003) Investors basically invest by delaying consumption now