Finance Portfolio Management

Running Head: Finance Portfolio Management
Finance Portfolio Management
PC-LE0327

Contents
Introduction...........................................................................................................................................2
1. Portfolio Construction...................................................................................................................2
2. Application of Modern Portfolio Theory in Portfolio Construction...............................................3
Sharpe Ratio......................................................................................................................................8
Treynor Ratio....................................................................................................................................9
Jensen’s Alpha...................................................................................................................................9
3. Performance of Portfolios in January-February 2019..................................................................12
4. Limitation....................................................................................................................................13
5. Conclusion...................................................................................................................................13
References...........................................................................................................................................14
Appendix.............................................................................................................................................15
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Introduction
At the time of making an investment decision the main motives of the investors are to receive
a higher return on the amount invested and to reduce the risk of loss. Usually, there are
investors who prefer to receive a fixed amount of return on their invested amount which may
include a pensioner, salaried person planning a marriage, education of his son/daughter or
future travel plans (Forbes, 2019). Then, there are people who have the capability of taking
more and more risk to get a good sum of return. Such persons usually have a good amount of
money which usually increases their risk taking capability. The profit or loss on investment
depends highly upon the selection of stocks which ultimately forms a portfolio. There are
certain parameters which are considered at the time of forming a portfolio which includes the
political, economic, environmental etc. factors and the most important parameter which
influences a portfolio is the risk attached with the stock and its sector. The main motive
behind the portfolio construction is nothing but is to diversify this risk at the maximum level.
Apart from this it is always advisable to look both risk return together at the time of
evaluating portfolio.
1. Portfolio Construction
As we know there are two kinds of investors: first those investors who want to get a stable
return from the amount invested and they are usually risk averse and then there are those
investors who love to take risks but expect a higher rate of return from the market.
There are stocks which give a stable return over a period of time and are less volatile. Also,
there are stocks which are highly volatile and give a high return, however the risk in such
stocks are on a higher side. For the investors who believe in taking more risk for a higher rate
of return on their money, they usually opt for such stocks.
At the time of forming stable return portfolio, the betas of individual stocks were considered
and the ones with the lower beta were selected like Admiral Group Plc., Auto Trader Group
Plc. and Pearson Plc. have beta of 0.54, -0.02 and 0.7 respectively. Also, the standard
deviations and returns of the stocks were calculated and the stocks with lowest risk and
lowest returns were chosen for stable return portfolio as shown in Table A.
In case of high return portfolio, the stocks with higher betas were chosen because such
volatile stocks usually give a higher return. The betas for high return portfolio are 1.36, 1.12
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and 0.66 for Ocado, J Sainsbury plc. and Evraz plc. respectively. Also, the stocks with higher
risk and higher returns were considered and we could find the figures in Table A.
In Table A, we could see that the stocks of stable return portfolio have lower return and lower
risk as compared to the stocks of high return portfolio which are having higher return and
higher risk.
Table A: Mean and Standard Deviation of Stocks of Portfolios
Stable Return
Portfolio Mean Standard
Deviation
High Return
Portfolio Mean Standard
Deviation
Admiral 5.57% 18% Ocado 68.42% 61.00%
Auto Trader 23.48% 28% J Sainsbury Plc. 7.98% 25.00%
Pearson Plc. 18.43% 21% Evraz 31.94% 46.27%
2. Application of Modern Portfolio Theory in Portfolio Construction
The theory of modern portfolio was given by Harry Markowitz which got published in the
year 1952 in Journal of Finance. He was the person who actually quantified the way of
forming portfolio at a given level of risk (U.S.News, 2018). The investors use this theory for
maximising their expected return on the formed portfolio. (Hawley and Lukomnik, 2018).
There are certain assumptions on which this theory works, like no transaction costs are
involved in buying/selling the securities, no tax are paid, risk is only considered at the time of
investing in any security, investors are allowed to take any position irrespective of its size and
type because the market is considered to be infinitely liquid, taxes and dividends are not
considered by the investor at the time of making an investment decision, investors are risk
adverse and rational along with the full knowledge of risk involved in the investment etc.
 Three Asset Portfolio Formula
 Covariance Formula
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