Portfolio Theory : Risk, Return, Preferences And Opportunities

Markowitz (1952, 1956) pioneered the development of a quantitative method that takes the diversification benefits of portfolio allocation into account. Modern portfolio theory is the result of his work on portfolio optimization. Ideally, in a mean-variance optimization model, the complete investment opportunity set, i.e. all assets, should be considered simultaneously. However, in practice, most investors distinguish between different asset classes within their portfolio-allocation frameworks.

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.

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

B. can take on negative values C. is related to the covariance of a share D. All of the given answers. 11. Portfolio risk is heavily based on: A. a simple average of the variance of the stocks in the portfolio B. a weighted average of the variance of the stocks in the portfolio C. a weighted average of the covariance of the stocks in the portfolio D. the standard deviation of the stocks 12. When an investor alters the mix of their portfolio to reflect market changes, this is called _____ asset allocation A. market timing B. passive

For the three consecutive days of teaching reading and writing, the student will complete a mini portfolio to prepare for student teaching portfolio expectations. For this assignment you will be required to:

Systematic risk or market risk is the risk that affects a large number of assets. Examples of systematic risk are inflation or increasing the interest rate, or any uncertainties in the economy but not the company 's performance. Unsystematic risk is the risk that mainly associated with specific companies or may be some competitors and suppliers. The systematic risk affects the whole market and cannot be controlled by investors. Unsystematic risk however affects the company and is controlled by the company 's performance. When investors invest money into a company they must research all aspects of that company so they are aware of the unsystematic risks they may encounter.

Systematic risk results from factors that affect all stocks. The risk of a project from the viewpoint of a well-diversified shareholder. This measure takes into account that some of the project’s risk will be diversified away as the project is combined with the firm’s other projects, and, in addition, some of the remaining risk will be diversified away by shareholders as they combine this stock with other stocks in their portfolios.” (Keown PG, 510)

a portfolioA is dominated by another portfolio if it has a greater expected gain and a lesser risk than A. So, for those six assets in table1, the main reason which caused the discrepancies are the value of risks and returns.

Portfolio management supports an organization’s mission and goals by ensuring the program is managed properly and the timing is on a set schedule. Portfolio management supports the accomplishments and the preferred outcomes. The tools and techniques involved assist with the efficiency and the effectiveness. The portfolio management supports in the organization utilizes the resources where they can be applied throughout the organization. Portfolio management assists with creating the operational needs throughout the period of the project. The portfolio management achieves with the vision, mission, and goals and even identify the risk. The time cost and all resources that would be required help identifying within the goals.

CAPM results can be compared to the best expected rate of return that investor can possibly earn in other investments with similar risks, which is the cost of capital. Under the CAPM, the market portfolio is a well-diversified, efficient portfolio representing the non-diversifiable risk in the economy. Therefore, investments have similar risk if they have the same sensitivity to market risk, as measured by their beta with the market portfolio.

b. Plot the CAL along with a couple of indifference curves for the investor type identified above. c. Use Excel’s solver to maximize the investor’s utility and confirm that you get a 50% allocation in stocks. 3. You can invest in a risky asset with an expected rate of return of 20% per year and a standard deviation of 40% per year or a risk free asset earning 4% per year or a combination of the two. The borrowing rate is 9% per year. a. What is the range of risk aversion for which a client will neither borrow nor lend, that is, for which the allocation to this risky investment is 100%? b. Draw the Capital Allocation Line. Indicate the points corresponding to (i) 50% in the risk-less asset and 50% in the risky asset; and (ii) -50% in the riskless asset and 150% in the risky asset. c. Compute the expected rate of return and standard deviation for (i) and (ii). d. Suppose you have a target risk level of 50% per year. How would you construct a portfolio of the risky and the riskless asset to attain this target level of risk? What is the

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.

Notice, in the above lemma we have dropped the individual index on the shares of assets. This is a direct consequence of the homothetic preferences and the assumption of unpredictable, and thus permanent, idiosyncratic shocks. The latter assumption it is consistent with a large body of empirical evidence found in the literature. For instance, in cite{Deaton1994} consumption inequality, within a given cohort, increases over the life-cycle. This patter can be naturally supported by a permanent idiosyncratic component in individual consumption process. More recently cite{Meghir2004} or cite{Storesletten2007} among others, empirically document a similar permanent uninsurable risk to individual earnings. Accordingly, the assumption of unpredictable idiosyncratic risk although it seems strong it is supported empirically.