AIS Elect 1:
Lesson 2: PORTFOLIO MODELS
PORTFOLIO
group of assets such as stocks and
bonds held by an investor
collection of investment securities
PORTFOLIO MANAGEMENT
process of creation and maintenance of
investment portfolio
a complex process which tries to make
investment activity more rewarding and
less risky.
refers to the art of managing various
financial products and assets to help an
individual earn maximum revenues with
minimum risks involved in the long run
helps an individual to decide where and
how to invest his hard earned money for
guaranteed returns in the future.
example: If you owned stock in General
Motors, Exxon Mobil, and IBM, you would be
holding a three-stock portfolio. Because
diversification lowers risk without sacrificing
much, if any, expected return, most stocks
are held in portfolios.
FOUR MAJOR TASKS
1. Taking decisions about investment mix
and policy
2. Matching investments to objectives
3. Asset allocation for individuals and
institution
4. Balancing risk against performance
5 PHASES OF PORTFOLIO MANAGEMENT
1. Security Analysis
2. Portfolio Analysis
3. Portfolio Selection
4. Portfolio revision
5. Portfolio evaluation
PHASES OF PORTFOLIO MANAGEMENT
1. Security Analysis.
- evaluation and analysis of risk return
features of individual securities
2. Portfolio Analysis
- By selecting the different sets of securities
and varying the amount of investments in
each security, various portfolios are
designed. After identifying the range of
possible portfolios, the risk-return
characteristics are measured and
expressed quantitatively.
3. Portfolio Selection
- The portfolios that yield good returns at a
level of risk are called as efficient
portfolios. The set of efficient portfolios is
formed and from this set of efficient
portfolios, the optimal portfolio is chosen for
investment. The optimal portfolio is
determined in an objective and disciplined
way by using the analytical tools and
conceptual framework provided by
Markowitz’s portfolio theory.
4. Portfolio Revision - After selecting the
optimal portfolio, investor is required to
monitor it constantly to ensure that the
portfolio remains optimal with passage of
time. Due to dynamic changes in the
economy and financial markets, the
attractive securities may cease to provide
profitable returns. These market changes
result in new securities that promises high
returns at low risks. In such conditions,
investor needs to do portfolio revision by
buying new securities and selling the
existing securities. As a result of portfolio
revision, the mix and proportion of securities
in the portfolio changes.
5. Portfolio Evaluation - regular analysis
and assessment of portfolio performances in
terms of risk and returns over a period of
time - During this phase, the returns are
measured quantitatively along with risk
born over a period of time by a portfolio. The
performance of the portfolio is compared
with the objective norms. Moreover, this
procedure assists in identifying the monthly return rWMT,t is defined as
weaknesses in the investment processes.

BASIC NOTATIONS:

Two things to note about this return

calculation:
COMPUTING RETURNS
1. Use of the continuously compounded
EXAMPLE: WALMART AND TARGET return on the stock. An alternative would
have been to use the discrete return,
PWMT,t/PWMT,t−1 − 1.

2. the return data incorporate the dividends

into the prices

Assumption:

- return data for the 60 months represent

the distribution of the returns for the coming
month.

The covariance and the correlation

coefficient, which is derived from it)
measures the degree to which the returns on
These data give the closing price at the end the two assets move together.
of each month for each stock and make an
appropriate adjustment for dividends. First
we calculate the monthly return for each
stock. This is the percentage return that where M is the number of points in the
would be earned by an investor who bought distribution (in our case, M= 60).
the stock at the end of a particular month t
− 1 and sold it at the end of the following
month. For Walmart’s stock in month t, the