Finance and Portfolio Construction

This report discusses portfolio construction and diversification strategies for investors. Investment statistics are analyzed to create a portfolio of equities and 4 funds with lower risk and better return. The report also suggests diversifying the investment exposure by investing in bonds, government securities, cash equivalents, and currencies. The constructed portfolio has an annualized return of 3.14% and a 0.3 beta. References and an appendix are included.

Running Head: Finance and Portfolio Construction
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Project Report: Finance and Portfolio Construction

Finance and Portfolio Construction 2
Contents
Introduction.......................................................................................................................3
Investment Statistics.........................................................................................................3
Diversify the investment exposure...................................................................................4
Portfolio construction.......................................................................................................5
Conclusion........................................................................................................................6
References.........................................................................................................................7
Appendix...........................................................................................................................8

Finance and Portfolio Construction 3
Introduction:
Portfolio is a group of financial assets which may include stocks, commodities, bonds,
cash equivalents, currencies etc. Portfolio is prepared by the investors and the financial
analyst in order to reduce the risk level and customize the investment on the basis of the
investors. Portfolio construction is a process in which optimal mix of the stocks is selected in
order to achieve the maximum return through reducing the level of risk1. In the report, the
portfolio of 4 securities has been created through reducing the associated risk of investment.
Investment Statistics:
On the basis of the available data of 4 funds and the historical data of MSCI world
equity index, the investment statistics tools have been applied to measure the stock
performance in the market. Below table represents the outcome of different statistics:
Equities Fund 1 Fund 2 Fund 3 Fund 4
Mean 0.48% 1.05% 0.52% 0.69% 0.78%
Variance 0.18% 0.23% 0.10% 0.05% 0.08%
Standard
Deviation 0.042 0.048 0.032 0.023 0.029
Covariance
-
0.034% 0.053% 0.051% 0.046%
Beta -0.1897 0.29899 0.28559 0.26026
Correlation:
Fund 1 Fund 2 Fund 3 Fund 4
Fund 1 1
Fund 2 0.429473 1
Fund 3 0.326296 0.684874 1
Fund 4 0.147471 0.789101 0.706411 1
1 Grzegorz Michalski. "Operational Risk in Current Assets Investment Decisions: Portfolio
Management Approach in Accounts Receivable (Agro Econ-Czech: Operační Risk v
Rozhodování o Běžných Aktivech: Management Portfolia Pohledávek)." (2008).

Finance and Portfolio Construction 4
On the basis of the above table, it has been found that the average return of Fund 1 is
higher in the market and all the funds are doing better than the market index. Along with the
return, the beta of the stock has also been evaluated and it has been found that the associated
risk with fund 3 is lowest. If all the funds are taken into concern than it has been found that
the stock risk of each of the fund is average and it is almost similar with the stock risk of
market index. The correlation and covariance study has also been done to measure the
relation of each of the stock with index and each other.
On the basis of the investment statistics analysis, it has been found that all the stocks
are performing well in the market and the investment into those stocks would offer better
return to the investment parties.
Diversify the investment exposure:
Portfolio diversification is a balance among the over-diversification and
concentration. According to the given case, it has been found that the current portfolio consist
100% equities in the portfolio which could be diversified by the business through investing in
other financial assets such as commodities, bonds, cash equivalents, currencies etc. the below
is the preference to diversify the portfolio construction of the business:
1. Investment in the bonds:
Investment in the bonds is one of the common and preferred strategies by the financial
analyst because in this investment, a fixed amount of interest could be got by the investors on
periodically basis2.
2. Investment in the government securities:
Investment in the government securities is preferred by most of the financial analyst
and the investors in order to assure that the minim return is always got from the investment,
no matter how bad the market position is. It is one of the common strategies which is used by
the financial analyst because in order to maintain the risk position of the strategy.
3. Investment in cash equivalents:
2 Stilling Blichfeldt, Bodil, and Eskerod Pernille. "Project portfolio management–There’s
more to it than what management enacts." International Journal of Project Management 26,
no. 4 (2008): 357-365.

Finance and Portfolio Construction 5
Further, the investment in the cash equivalents is also among the diversified staregies of
portfolio construction by the financial analyst and the investors because in this investment,
lower risk is assoviated with the investment along with the lower market return. The choices
of the strategies depend on the requirement and need of the investors3.
4. Investment in currencies:
Lastly, the investment in the currencies is also among the diversified strategies of
portfolio construction by the financial analyst and the investors. This investment is quite
riskier; however, the associated return from this investment is also huge. The fluctuations in
the currently price is huge and thus it must be evaluated by the analyst that which currency is
performing well in the market in current scenario.
These few are the other strategies which could be used by the business in order to
diversify the equity portfolio and improve the overall performance of the business.
Portfolio construction:
On the basis of the investment statistics and the performance of the market, a portfolio
of equities and 4 funds have been carted in such an order that the risk level of the portfolio
could be lower along with the better return. The below portfolio has been constructed:
Particulars Fund 1 Fund 2 Fund 3 Fund 4
Weightage 30.00% 30.00% 30.00% 10.00%
Variance 0.18% 0.23% 0.10% 0.05%
Weightage^2 9.00% 9.00% 9.00% 1.00%
Variance^2 0.00% 0.00% 0.00% 0.00%
Correlation 42.95% 68.49% 70.64% 14.75%
Formula
w2A*σ2(RA) + w2B*σ2(RB) +w2B*σ2(RC)+
2*(wA)*(wB)*(wC)*Cov(RA, RB)
Beta 3.00%
Market Risk
Premium 7.50%
Risk Free Rate 2.83%
Portfolio
Expected Return 3.14%
3 Grzegorz Michalski. "Portfolio management approach in trade credit decision
making." arXiv preprint arXiv:1301.3823(2013).

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The portfolio represent that the annualized portfolio return of the business is 3.14%
along with the .3 beta of the portfolio. It represents that if the stock prices are volatile to 0.3
than the total return from the investment would be around 3.14%4. It indicates that the
investment must be done 30%, 30%, 30% and 10% in fund 1, fund 2, fund 3 and fund 4 by
the investors respectively to improve the overall position of the business.
Conclusion:
To conclude, portfolio is one of the better strategies to make investment. It is
constructed on the basis of the demand of the investors so that the better combination of
financial assets could be prepared. The main aim of the portfolio is to assure that the
associated risk of the investment is lower and the return from the portfolio is higher. To
conclude, the current portfolio constructed for fund 1, fund 2, fund 3 and fund 4 is quite
better as it would improve the total return of the investment and reduce the risk of the
investment.
4 Rodney Turner. Handbook of project-based management. Vol. 92. New York, NY:
McGraw-hill, 2014.

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References:
Blichfeldt, Bodil Stilling, and Pernille Eskerod. "Project portfolio management–There’s more
to it than what management enacts." International Journal of Project Management 26, no. 4
(2008): 357-365.
Michalski, Grzegorz. "Operational Risk in Current Assets Investment Decisions: Portfolio
Management Approach in Accounts Receivable (Agro Econ-Czech: Operační Risk v
Rozhodování o Běžných Aktivech: Management Portfolia Pohledávek)." (2008).
Michalski, Grzegorz. "Portfolio management approach in trade credit decision
making." arXiv preprint arXiv:1301.3823(2013).
Turner, J. Rodney. Handbook of project-based management. Vol. 92. New York, NY:
McGraw-hill, 2014.

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Appendix:
Check the attached spreadsheet.