FIN630 - INVESTMENT ANALYSIS AND PORTFOLIO MANAGEMENT

ASSIGNMENT – SPRING 2009

Student ID/Login ID: mc070401585
Student Name: Daniyal Zaheer Bajwa

Questions
1. Which method of portfolio selection is better, Mr. Tom's or Mr. John's? Which
requires more effort? Are the expected rewards different for Mr. Tom's method than Mr.
John's method? Explain why?

Ans: I think the better method for selecting portfolio of Mr. David is Mr. John’s
recommendation. Mr. Tom’s selection is based on random diversification which simply
means choosing securities randomly from a large number of securities without taking
consideration of its characteristics such as expected return and company classification
whereas Mr. John’s selection is based on non-random diversification based on Markowitz
principle that takes into consideration of inputs like expected return, variance and
covariance in choosing securities which lacks in random diversification. From this
selection, Mr. David can reduce its portfolio risk and gain expected returns.

Mr. John’s recommendation will require more hard work and effort because it has to
choose the security upon the inputs like expected return, variance and co movements of
securities with one another whereas Mr. Tom’s recommendation does not require any
consideration of inputs.

Expected rewards of Mr. John’s method will be much better than Mr. Tom’s method
because Mr. John’s recommendation is measured on important points of inputs which are
described in Markowitz theory while Mr. Tom’s recommendation is not.

2. Describe the various features that Mr. John must observe in a security before adding
it to the portfolio

Ans: Mr. John has to workout inputs like expected return which is different from realized
return, is estimated return of a security and variance is the individual risk of a security
which only contribute market risk and covariance is the co movements of security with
one another and study the correlation of securities.

3. Do you think Mr. John can completely eliminate risk from Mr. David’s portfolio if he
adds more and more stock to the portfolio? Justify your answer with reasons.

Ans: No, I don’t think Mr. John can completely eliminates risk from Mr. David’s
portfolio because he will only eliminate un-systematic risk also called company-specific
risk which is based on company classifications not the market risk. Market risk or
systematic risk is un-avoidable because the risk is due to the market behavior which
includes interest rate risk, market and inflation risk.