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Charles P. Jones and Gerald R. Jensen, Investments: Analysis and Management, 13th Edition, John Wiley & Sons

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309 views16 pages

Charles P. Jones and Gerald R. Jensen, Investments: Analysis and Management, 13th Edition, John Wiley & Sons

Uploaded by

Cikini Menteng
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Chapter 8

Charles P. Jones and Gerald R. Jensen,


Investments: Analysis and Management,
13th Edition, John Wiley & Sons

8-1
 Diversification is key to risk management
 Asset allocation most important single decision
 Using Markowitz Principles
◦ Step 1: Identify optimal risk-return combinations
using the Markowitz analysis
 Inputs: Expected returns, variances, covariances

◦ Step 2: Choose the final portfolio based on your


preferences for return relative to risk

8-2
 Optimal diversification takes into account
all available information
 Assumptions in portfolio theory
◦ A single investment period (one year)
◦ Liquid position (no transaction costs)
◦ Preferences based only on a portfolio’s
expected return and risk

8-3
 Efficient Frontier – represents the set of all
mean/variance efficient (optimal) portfolios
◦ Optimal portfolio has maximum return for a
given level of risk or minimum risk for a
given level of return
◦ Portfolios on the efficient frontier dominate
all other portfolios
◦ No portfolio on the efficient frontier
dominates another portfolio on the frontier
 Efficient frontier or
Efficient set (curved
line from A to B)
B  Global minimum
x variance portfolio
E(R) (represented by
A point A)
 Portfolios on AB
y
C dominate those on
Risk =  AC

8-5
 Portfolio weights are the output from Markowitz
analysis
 Assume investors are risk averse
 Indifference curves (ICs) help select individual’s
optimal portfolio
◦ IC, description of preferences for risk and return
◦ IC reflects portfolio combinations that are equally
desirable
◦ ICs match investor preferences with portfolio
possibilities

8-6
Investor 2 indifference/utility curves
Investor 1 indifference curves

Efficient Frontier
•

Goal is to achieve highest (most NW) attainable curve)


 International diversification unlikely to offer as
much risk reduction as in the past
 Markowitz portfolio selection model
◦ Assumes investors use only risk and return to
decide
◦ Generates a set of equally “good” portfolios
◦ Does not address the issues of borrowed money or
risk-free assets
◦ Cumbersome to apply

8-8
 Another way to use Markowitz model is with
asset classes
◦ Allocation of portfolio to asset types
 Asset class rather than individual security is most
important for investors
◦ Can be used when investing internationally
◦ Different asset classes offer various returns and
levels of risk
 Correlation coefficients may be quite low

8-9
 Includes two dimensions
◦ Diversifying between asset classes
◦ Diversifying within asset classes
 Asset classes include:
◦ Equities – foreign and domestic
◦ Bonds
◦ Treasury Inflation-Protected Securities (TIPS)
◦ Alternative assets – real estate, commodities,
private equity, hedge funds, etc.

8-10
 Correlation among asset classes must be
considered
 Correlations change over time
 For investors, allocation depends on
◦ Time horizon
◦ Risk tolerance
 Diversified asset allocation does not
guarantee against loss

8-11
 Index Mutual Funds and ETFs
◦ Cover various asset classes: domestic and foreign
stocks (all investment styles), alternative assets
(e.g. real estate, commodities), bonds of all types
 Life Cycle Analysis
◦ Varies asset allocation based on investor age
◦ Life-cycle funds (target-date funds) vary allocation
as investor ages
 No one “correct” approach to allocation

8-12
Total = Systematic + Unsystematic
Risk Risk Risk

p2 = Systematic + Unsystematic


Variance Variance

The variance (risk) of a portfolio, or a single


security, consists of both systematic risk
and unsystematic risk
 Systematic risk is not diversifiable

◦ Systematic risk - risk of an overall movement


in the market
 nondiversifiable  systematic  market
 Unsystematic risk is diversifiable
◦ Unsystematic risk - risk of an event that is
unique to the asset or a small group of assets
 diversifiable  unsystematic  unique
p %
Total risk
35
Diversifiable (nonsystematic) risk

20
Nondiversifiable (systematic) risk

0
10 20 30 40 ...... 100+
Number of securities in portfolio
8-13
Copyright 2016 John Wiley & Sons, Inc.

All rights reserved. Reproduction or translation of


this work beyond that permitted in section 117 of
the 1976 United States Copyright Act without
express permission of the copyright owner is
unlawful. Request for further information should be
addressed to the Permissions Department, John
Wiley & Sons, Inc. The purchaser may make back-
up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages
caused by the use of these programs or from the
use of the information herein.

8-16

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