Effect of Diversification of Portfolio and

its Efficient Frontier

By

Tushar 10DM-168
Saurabh 10FN-102
Srikanth 10FN-109
Tushar 10FN-115
Vikram 10FN-118
Nikhil 10FN-121

18 stocks were chosen from various sectors of Indian equity market. Their
monthly prices were extracted from CMIE data base for the past 60 months (July
2006-July 2011), on the basis of which monthly returns were calculated for each
stock. Mean and standard deviation of returns of 60 months for all 18 stocks
were calculated. Also mean and standard deviation was calculated on an annual
basis for all the stocks.
Next using the excel correlation tool, correlation was calculated for all pair of
stocks. On the basis of correlation and annual standard deviations calculated,
covariance was calculated for all the pairs of stocks.
Then a portfolio was created with equal weight age given to all the stocks i.e.
5.5%. Total portfolio covariance was calculated by summing up the individual
covariance of stocks in the given portfolio. Also the portfolio mean and standard
deviation was calculated.
Lastly using the values calculated above and using the solver function of excel,
the weight of each stock in the portfolio was calculated so as to minimize the risk
at a given required rate of return.
Following is the graph showing the relationship between risk and return for the
portfolio derived from solver analysis.

45.00
40.00
35.00
30.00
25.00

Porfolio retrun %

20.00
15.00
10.00
5.00
0.00
5

10

15

20

25

30

35

40

45

Portfolio Risk %

The above graph in which the portfolio risk is plotted against the portfolio return
shows the efficient frontier. Here each point represents the minimum risk that
can be achieved for a given percentage of required return. It can be observed
that portfolios with returns less than 24% are having a greater risk than the
portfolio which gives a 24% return. Hence they are undesirable and wont be
preferred by a risk averse investor. The portfolio which gives a 24% return is also
called the global efficient frontier. The portfolios giving a return higher than 24%

50

carry risk that is higher than the risk carried by the portfolio that gives 24%
return. Hence depending on the risk appetite of the investor he could choose the
portfolio that suits him the best.
So, whats there in it for an investor?
Our Efficient Market Frontier will suggest an appropriate portfolio based on the
above stocks to meet the desired expected return of investor at the lowest
possible level of risk or to maximize the returns at a quoted level of risk by the
investor.
As portfolio managers, we will be continuously monitoring the correlations
between specified stocks as well as the performance of individual stocks and
accordingly make necessary changes to the portfolio for meeting risk-return
demands of our investors.