PORTFOLIO ANALYSIS

PORTFOLIO MANAGEMENT
 Portfolio is a combinations of assets held by the
investors. These combinations may be of various asset
classes like equity and debt of different issuers like
Government and/or corporates.

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 A combination of such securities with different risk-
return characteristics will constitute the portfolio of
the investor.

 Thus, a portfolio is a combination of various assets

and/or instruments of investments. The combination
may have different features of risk and return,
separate from those of the components. 2
 The portfolio is also built up out of the wealth or
income of the investor over a period of time, with a
view to suit his risk or return preferences to that of
the portfolio that he holds.

The portfolio management is an analysis of the risk-

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
return characteristics of individual securities in the
portfolio and changes that may take place in
combination with other securities due to interaction
among themselves and impact of each one of them on
others.

 The traditional Portfolio Theory aims at the selection

of such securities that would fit in well with the asset
preferences, needs and choices of the investor. Thus, a
retired executive invests in fixed income. 3
PHASES OF PORTFOLIO
MANAGEMENT
 Portfolio management is a process of encompassing
many activities aimed at optimizing the investment
of one’s funds.

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 Five phases can be identified in this process:
 Security Analysis
 Portfolio Analysis
 Portfolio Selection
 Portfolio Revision
 Portfolio Evaluation

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SECURITY ANALYSIS
 Security analysis is the initial phase of the
portfolio management process. This step consists
of examining the risk and return characteristics

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of the individual securities.

 There are two alternative approaches to security

analysis, namely fundamental analysis and
technical analysis.

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SECURITY RETURN
 Types of Return:
 Book Value Return Vs. Market Value Return

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 Single Period Return Vs. Multi Period Return
 Ex Ante (Expected) Return Vs. Ex Post (Realized) Return
 Security Return E(Ri) Vs. Portfolio Return E(Rp)

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SECURITY RISK
 The future return expected from a security is variable and
this variability of returns is termed as Risk.

 Types of Risk:

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 Systematic Risk: It is non diversifiable risk caused due to
external factors and can not be controlled by the company.
 Components of Systematic Risk:
 Market Risk
 Interest Rate Risk
 Purchasing Power Risk

 Unsystematic Risk: It is diversifiable risk caused due to factors

which are specific, unique and related to a particular company.
 Components of Unsystematic Risk:
 Business Risk
 Financial Risk 7
 Total Risk = Systematic Risk + Unsystematic Risk
or
Total risk = Market risk + Unique risk

The Market risk of a stock represents that portion of

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
its risk which attributes to economy-wide factors

 The Unique risk of security represents that portion of

its total risk which stems from firm-specific factors.

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 Measures of Risk:
 Standard Deviation ()

 Variance (2)

 Coefficient of Variation [(σ/μ) *100)]

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 Skewness

 Probability Distribution

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PORTFOLIO ANALYSIS

 Any number of portfolio can be constructed from a

given set of securities. A rational investor attempts to
find the most efficient of these portfolios.

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 The efficiency of each portfolio can be evaluated only
in terms of the expected return and risk of the
portfolio as such.

 Thus determining the expected return and risk of

different portfolios is a primary step in portfolio
management. This step is called as portfolio analysis.
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PORTFOLIO RETURN
 When portfolio consists of several securities the return
on the portfolio is given by weighted average of the
returns of individual securities consisting the portfolio.

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 Expected Return on Portfolio:
n
E(RP) =  Wi E(Ri)
i=1
where,
E(RP) = Expected Portfolio Return
Wi = Weight assigned to Security i
E(Ri) = Expected Return on Security i
n = Number of Securities in the Portfolio
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PORTFOLIO RISK
 The variance of the portfolio, σp2 is defined as sum of
the squared deviations from the expected value
multiplied by the probability of occurrence.

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 These statistics measure the extent to which returns
are expected to vary around an average over a period of
time.

 Risk of Portfolio of two securities:

 Variance of Return:
(p)2 =a2 . Wa2 + b2 . Wb2 + 2 Wa.Wb (a . b .rab)

 Standard Deviation of Returns: 12

p = √a2 . Wa2 + b2 . Wb2 + 2 Wa.Wb (a . b .rab)
COVARIANCE
 Portfolio variance is determined by covariance of the
securities apart from the individual variances of each
security consisting the portfolio.

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 Covariance is the statistical measure that indicates
the interactive risk of a security relative to the other in
a portfolio of securities.

n
Cov(R 1 , R 2 ) = ∑ p i (R1 - R1 )(R 2 - R 2 )
1
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COEFFICIENT OF CORRELATION
 Covariance is absolute measure of interactive
risk between two securities. To facilitate
comparison, covariance can be standardized.

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 Dividing the covariance between two securities
by product of standard deviation of each security
gives standardized measure. This measure is
called as Coefficient of correlation.

 rab= Covab
a x b 14
 Q.1. Calculate return of Ganeshan’s portfolio if he has
a portfolio of 5 securities, the expected return and
amount of investment in each security is given below:
Security ER (%) Amount
invested

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P 40 20,000
Q 8 10,000
R 15 30,000
S 9 25,000
T 12 15,000

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 Q.2. Calculate expected return and variance of a
portfolio comprising of two securities, assuming that
the portfolio weights are 75% for security A and 25%
for security B. The expected return for security A is
18% and standard deviation is 12%, while expected
return for security B is 22% and standard deviation

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is 20% respectively. The correlation between two
securities is 0.7.

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 Q.3. Following data is available for security A and B:
Calculate the expected return on the portfolio and the
risk associated with the portfolio. If the proportions of
A and B is 60% and 40% respectively.

Probability Sec A Sec B

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0.2 -10 5
0.4 25 30
0.3 20 20
0.1 10 10

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 Q.4. Given the following variance-covariance matrix
for three securities, as well as the percentage of the
portfolio that each security comprises, calculate the
portfolio’s standard deviation.
Security A B C

A 425 -190 120

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B -190 320 205
C 120 205 175
Weights 0.35 0.25 0.40

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 Q.5. The estimates of the standard deviations and
correlation co-efficient for three stocks are given: If a
portfolio is constructed with 15% of stock A, 50% of
stock B and 35% of stock C, what is the portfolio’s
standard deviation.
Standard Correlation with Stocks

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Stocks Deviation A B C
A 32 1.00 -0.80 0.40
B 26 -0.80 1.00 0.65
C 18 0.40 0.65 1.00

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 Q.6. In light of the global recession, the market analyst
predicts that the chance of having a booming stock market
is 25%. The strong fundamental in the economy offer hopes
of normal market performance for 50% of the time. But
there is always a 25% possibility of a downtrend. Mr.
Anand has bought Hightech and Rapid Info stocks in the
IT sector. He has also bought the stocks of Comfo Life

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which operates in the consumer’s goods sector. The rate of
return in the worst scenario of recession is 9% for Comfo
life, 10% for Hightech, and 14% for Rapid Info. In case of
Normal performance, the anticipated return will be Comfo
life 13%, Hightech 14% and Rapid Info 12%. If boom
condition prevails in the market Comfo life will earn 18%,
Hightech 16% and Rapid Info 10%. Apply mean variance
criterion to the individual stocks. If Mr. Anand invests one
third of his resources in each stock what will be his
portfolio return and risk be?
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 Q.7. From the following portfolio, calculate the
mean rate of return and standard deviation:
Sec Prop Price(Begi Increase/Dec Dividen Stand
urit ortio nning of rease during d ard
y n the year) year Rs. Deviat
Rs. Rs. ion
(%)

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X 0.35 25 3 1.5 5

Y 0.25 63 -4 0 1

Z 0.40 38 5 3.0 10

Correlation Coefficient
 X and Y = 0.01

 X and Z = -0.20

 Y and Z = 0.70
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 Q.8. Calculate expected return and standard
deviation of two security portfolio with following
data if:
 (i) r = 0.6 (ii) r = -0.6 (iii) r = +1 (iv) r = -1 (v) r = 0

Sec A Sec B

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Expected 15% 20%
Return
Standard 30% 50%
deviation
Proportion of 40% 60%
fund invested

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 Q.9. Corporation X and Y presents the following
expected risk and return for coming year:
 Rx = 15% Ry = 18% x2 = 16 y2 = 25
 rxy = 0.6

 The portfolio risk for a portfolio of 50% in each asset is

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4.03. Determine the correlation coefficient that will be
necessary to reduce the level of portfolio risk by 75%.
What is expected return of equally weighted portfolio?

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 Q.10. From the following information calculate
standard deviation of the portfolio if investment
is in the ratio of 30:40:30
Probability Sec A Sec B Sec C
0.05 15 8 12
0.20 20 18 17

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0.50 25 26 24
0.20 30 34 36
0.05 35 44 42

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