Portfolio Theory And Its Application

Portfolio management is an important factor that determines the performance of the portfolio. To perform well in the portfolio, it is not only essential to develop personal investment strategies, but analyzing current financial trend is also vital. Stock Trak is an online portfolio simulation that allows students to try out different investment strategies, and also get a hand on experience in what the real market trading conditions are. By managing the portfolio, I have acquired some new knowledge of investment strategies and also become more familiar with the current market by following closely to the financial headlines.

The extracted data used includes monthly returns from January 1972 to July 2011. The assets are selected so that the portfolio contains the largest, most liquid, and most tradable assets. The choice of such a variety of assets across several markets was used in order to generate a large cross sectional dispersion in average return. It helped to reveal new factor exposure and define a general framework of the correlated value and momentum effects in various asset classes.

With Reference to this statement, describe, discuss and illustrate the principles of portfolio theory. Your essay should include coverage of the Markowitz Efficient Frontier and the Capital Market Line.

Week 1 – Introduction – Financial Accounting (Review) Week 2 – Financial Markets and Net Present Value Week 3 – Present Value Concepts Week 4 – Bond Valuation and Term Structure Theory Week 5 – Valuation of Stocks Week 6 – Risk and Return – Problem Set #1 Due Week 7* – Midterm (Tuesday*) Week 8 - Portfolio Theory Week 9 – Capital Asset Pricing Model Week 10 – Arbitrage Pricing Theory Week 11 – Operation and Efficiency of Capital Markets Week 12 – Course Review – Problem Set #2 Due

The goal of this paper is to explain why CCM’s aggressive program is a good alternative to any investor looking to diversify its portfolio. The paper will be divided into three distinct parts: the operational analysis, the quantitative analysis and a comparison against its peers (including the impact of CCM in a traditional portfolio).

Portfolio and project management are similar and sometimes thought of as being one another. Between the project and portfolio management the goals and the intended strategic action is similar. The process between the portfolio management includes and involves the resources that list a process, which includes the evaluation, selection, and prioritization. Portfolio management and strategic management assist with the organizations missions and goals. These lay out the objective in the continuous planning and monitoring that assist with reaching the goals.

UNIVERSITY OF ILLINOIS AT CHICAGO Liautaud Graduate School of Business Department of Finance Professor Hsiu-lang Chen 1 Practice Problem I

To find the asset Beta (βa), we need to find the weighted average β of equity and the weighted average β of debt. We consider the β of debt to be 0, as debt has no relationship with market risk and it is evident from the balance sheet that Ameritrade had no interest bearing debt in 1997[1].

The success of the model is attributed to Yale’s ability to combine both quantitative analysis (mean-variance analysis) with market judgments to structure its portfolio. In addition, Yale also uses statistical analysis to actively test their models with factors affecting the market, therefore understanding the sensitivity of their portfolio in response to various market changes. Yale also follows and forecasts the cash flow of private equity and real assets in its portfolio to decide the need for hedging.

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.

For estimation of betas, the above equation was run for the period from Jan, 2003 to Dec, 2006. Based on the estimated betas we have divided the sample of 63 stocks into 10 portfolios each comprising of 6 stocks except portfolio no.1, 5 and 10 having seven stocks each. The first portfolio 1 has the 7 lowest beta stocks and the last portfolio 10 has the 7 highest beta stocks. The rationale for forming portfolios is to reduce measurement error in the betas.

According to the CAPM model:R_i=α+βR_m+ε, α represent the abnormal return gained by the portfolio. If the market is efficiency, the α has to be zero.

As indicated by the case study S&P 500 index was use as a measure of the total return for the stock market. Our standard deviation of the total return was used as a one measure of the risk of an individual stock. Also betas for individual stocks are determined by simple linear regression. The variables were: total return for the stock as the dependent variable and independent variable is the total return for the stock. Since the descriptive statistics were a lot, only the necessary data was selected (below table.)

The objective of studying this case is to understand the concepts of diversification and the efficient frontier by analyzing Harvard Management Company’s application of portfolio theory for managing the endowment of Harvard University. Please read the case carefully and be prepared to discuss the following questions in class on Monday, October 11.

Even though there are flaws in the CAPM for empirical study, the approach of the linearity of expected return and risk is readily relevant. As Fama & French (2004:20) stated “… Markowitz’s portfolio model … is nevertheless a theoretical tour de force.” It could be seen that the study of this paper may possibly justify Fama & French’s study that stated the CAPM is insufficient in interpreting the expected return with respect to risk. This is due to the failure of considering the other market factors that would affect the stock price.