F010403T

Investment Analysis & Portfolio Management

Dr. Pravin Kumar Agrawal

Assistant Professor
Department of Business Management
Ph.D. (Finance)
Syllabus
Beta of a Portfolio

• Add up the value (number of shares multiplied by the share price) of each stock
you own and your entire portfolio.

• Based on these values, determine how much you have of each stock as a
percentage of the overall portfolio.

• Multiply those percentage figures by the appropriate beta for each stock. For
example, if Infosys makes up 25% of your portfolio and has a beta of 1.43, it has a
weighted beta of 0.3575.

• Add up the weighted beta figures.

 Beta of a Portfolio
Share of Weighted
Stock Value (Rs.) Portfolio Beta Beta
Infosys 25,000 0.25 1.43 0.3575
HDFC 22,000 0.22 0.63 0.1386
Tata Steel 20,000 0.2 1.51 0.302
SBI 18,000 0.18 0.6 0.108
ITC 9,000 0.09 0.42 0.0378
HUL 6,000 0.06 1.22 0.0732
1.0171

That means this portfolio’s volatility is very much in line with the Nifty 50 or market
Portfolio
• The portfolio is a collection of investment instruments like shares,
mutual funds, bonds , FDs and other cash equivalents, etc. Portfolio
management is the art of selecting the right investment tools in the right
proportion to generate optimum returns with a balance of risk from the
investment made.

• When different assets are added to the portfolio the total risk tends to
decrease. In the case of common stocks, diversification reduces the
unsystematic risk.

• Analysts opine that if 15 stocks are added to the portfolio of an investor

the unsystematic risk can be reduced to zero but at the same time if the
number exceeds 15, additional risk reduction cannot be ensured.

• However diversification cannot reduce this systematic risk

Portfolio Management

• The process of selecting the right financial products to maximize

returns while minimizing risks is known as portfolio management. It
considers individual requirements to achieve an ideal portfolio mix.
Objectives of Portfolio management

• Creating wealth through capital appreciation

• Protecting your earnings from market volatility
• Maximizing returns on investment (ROI)
• Offering flexibility within your investment portfolio
• Improving the efficiency of your investments
• Allocating available resources optimally
• Optimizing the risk
Importance
• Helps in rebalancing the asset composition so that
investors can get the most out of their existing
investments.

• Enables quick customization based on immediate

financial needs and market conditions.

• Mitigating investment-oriented risks and increases the

scope to generate higher returns.
Importance
• The best way to build a strong investment portfolio is to determine its
financial objective and rebalance its components frequently.
Thereafter, investors should focus more on diversifying their resources
to obtain the best possible rewards at manageable risks in all
situations.

• To know which investments work best in which market conditions and

how to distribute resources across different asset classes.
Markowitz Portfolio
Theory
History

• Harry Markowitz came up with MPT and won the Nobel Prize for

Economic Sciences in 1990 for it.

Definition
• It is an investment theory based on the idea that risk-averse investors
can construct portfolios to optimize or maximize expected return
based on a given level of market risk, emphasizing that risk is an
inherent part of higher reward.
How it works
• MPT assumes that investors are risk averse, meaning that given two
portfolios that offer the same expected return, investors will prefer
the less risky one. Thus, an investor will take on increased risk only if
compensated by higher expected returns.

• Conversely, an investor who wants higher expected returns must

accept more risk. The exact trade-off will be the same for all investors,
but different investors will evaluate the trade-off differently based on
individual risk aversion characteristics.
The Markowitz Model

• Most people agree that holding two stocks is less risky than holding one for
example holding stocks of textile, banking and IT companies is better than
investing all the money in a textile companies stock. But building up an optimal
portfolio is very difficult. Markowitz provides an answer by analyzing the risk and
return relationship.
Assumptions of the Model

• An investors decision is based solely on the expected return and

variance of returns

• For a given level of risk, an investor prefers higher returns to lower

returns likewise for a given level of Return and investor prefers lower
risks to higher risks
Diversification

• An investor can reduce portfolio risk simply by holding combinations

of instruments that are not perfectly positively correlated.
Expected Return of a Portfolio

• The expected return of a portfolio of assets is simply the weighted

average of the return of the individual securities held in the portfolio.

• The weight applied to each return is the fraction of the portfolio

invested in that security
Example
• Let us consider a portfolio of two equity shares P and Q with
expected returns of 15 per cent and 20 per cent respectively.

• If 40 per cent of the total funds are invested in share P and the
remaining 60 per cent, in share Q, then the expected portfolio
return will be: (0.40 x 15) + (0.60 x 20) = 18 per cent

• The formula for the calculation of expected portfolio return

may be expressed as shown below:
Formula
i=n

E (Rp )= ∑XiRi i=1

Rp= Return on the Portfolio

Xi = Proportion of Total Portfolio Invested in Security i
Ri = Expected Return on Security i
Computation of the Expected Return for a Portfolio of Risky Assets

Weight (Percent of Expected Return Expected Portfolio

Portfolio) (Security) Return
Xi ‘s Ri Xi Ri

0.20 .10 0.0200

0.30 .11 0.0330
0.30 .12 0.0360
0.20 .13 0.0260
E(Rp) = 0.1150
Covariance

• Covariance is an absolute measure of interactive risk between two securities. To

facilitate comparison, covariance can be standardized.

• Dividing the covariance between two securities by product of the standard

deviation of each security gives such a standardized measure. This measure is
called the coefficient of correlation. This may be expressed as:
Correlation Coefficients

• The correlation coefficients may range from - 1 to 1. A value of -1

indicates perfect negative correlation between security returns, while
a value of +1 indicates a perfect positive correlation. A value close to
zero would indicate that the returns are independent.
Variance of a Portfolio

• The variance of a portfolio with only two securities in it may be calculated with
the following formula.
Numerical
• Two securities P and Q generate the following sets of expected returns, standard
deviations and correlation coefficient:

P Q
r = 15 percent 20 percent
σ = 50 percent 30 percent

r = -0.60

A portfolio is constructed with 40 per cent of funds invested in P and the remaining
60 per cent of funds in Q.
Numerical
• Let us consider a portfolio with four securities having the following characteristics
Solution
• The expected return of this portfolio may be calculated using the
formula:
Numerical

• Calculate the expected return and variance of a portfolio comprising two

securities, assuming that the portfolio weights are 0.75 for security 1 and 0.25 for
security 2. The expected return for security 1 is 18 per cent and its standard
deviation is 12 per cent, while the expected return and standard deviation for
security 2 are 22 per cent and 20 per cent respectively. The correlation between
the two securities is 0.6.
Numerical Done

• Consider two securities, P and Q, with expected returns of 15 per cent and 24 per

cent respectively, and standard deviation of 35 per cent and 52 per cent

respectively. Calculate the standard deviation of a portfolio weighted equally

between the two securities if their correlation is -0.9.

Numerical Done
• A portfolio is constituted with four securities having the following
characteristics:

Calculate the expected return of the portfolio.