Professional Documents
Culture Documents
Introduction To
Portfolio Management
Theory
What is a Portfolio ?
A portfolio refers to a collection of investment tools such as stocks, shares, mutual funds, bonds, cash and so
on depending on the investors income, budget and convenient time frame. Following are the two types of
Portfolio:
Market Portfolio
Harry Markowitz developed the portfolio model. This model includes not only expected return, but
also includes the level of risk for a particular return. Markowitz assumed the following about an
individual's investment behaviour:
Given the same level of expected return, an investor will choose the investment with the lowest
amount of risk.
For each investment, the investor can quantify the investment's expected return and the
probability of those returns over a specified time horizon.
Investors make decision based on an investment's risk and return, therefore, an investor's utility
curve is based on risk and return.
Research has shown that the two are linked in the capital
markets and that generally, higher returns can only be
achieved by taking on greater risk.
Risk isnt just the potential loss of return, it is the potential
loss of the entire investment itself (loss of both principal
and interest).
Risk
Premium
R
F
Real Return
Expected Inflation Rate
Risk
UNSYSTEMATIC RISK
SYSTEMATIC RISK
A model that describes the relationship between risk and expected return and that is used in the pricing of
risky securities.
CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus
a risk premium.
Capital asset pricing model was developed by building on the portfolio theory pioneered by Markowitz.
William Sharpe in 1964, John Lintner in 1965, and Jan Mossin in 1967 laid the basis for the capital asset
pricing model (CAPM).
Price-Earnings Ratio (P/E): This number tells you how many years worth of profits youre
paying for a stock and you calculate it by dividing earnings per share by the stock price.
The lower the P/E the better.
Benjamin Graham, the legendary investor and Warren Buffetts teacher at Columbia
University, postulated that stocks should trade for a P/E multiple equal to 8.5 times
earnings plus two times the growth rate of earnings.
The average P/E since 1935 is 15.86, suggesting the market is a bit pricey.
Thank
You