Portfolio Management

Portfolio Management Mrunal Joshi

B.R.C.M. College of Business Administration Mrunal Joshi

Portfolio and Portfolio Management • Portfolio is group of securities considered for the investment. • It is basket of investment or assets held by an individual or a corporate body, or any economic unit. • Portfolio management deals with the analysis of individual securities as well as with the theory and practice of optimally combining securities into portfolio. • Portfolio management comprises all the processes involved in the creation and maintenance of an investment portfolio. It deals specifically with security analysis, portfolio analysis, portfolio selection, portfolio revision and portfolio evaluation. • Analysis consists of examining the risk-return characteristics B.R.C.M. College of Business Administration Mrunal Joshi

Risk - Return • Return means whatever output generated from Investment made. Return may be positive or negative. • Basically return may be in two form: income and capital gain. • Income generally consist regular income like dividend (on share) and interest (fixed interest bearing fund like bond, deposit etc.). • Capital gain is basically the difference between sale price and purchase price of investment. Total yield of the investment is called return, which includes both of above kind • Expected return and Realised return B.R.C.M. College of Business Administration Mrunal Joshi

• Risk and Uncertainty • Risk is uncertainty of the income/capital appreciation or loss of both into an investment. • Possibility of variation of the actual return from the expected return is termed risk. “Risk is the potential for variability of returns.” • Low risk = fairly stable returns e.g. Government securities. • High risk = significant fluctuation in returns e.g. Equity shares. • Two major types of factors cause the risk. 1. external to a company – uncontrollable. 2. internal to company – controllable. • The risk produce by the first group of factors is known as systematic risk and by the second group is know as B.R.C.M. College of Business Administration Mrunal Joshi unsystematic risk.

Types of Risk • Systematic Risk – Interest Rate Risk – Market Rate Risk – Purchasing Power Risk

• Unsystematic Risk – Business Risk – Financial Risk – Default risk / Insolvency risk • Other types • Political risk • Marketability risk


Risk and Return relationship

RISK TAKEN BY INVESTOR B.R.C.M. College of Business Administration Mrunal Joshi

Calculation of Return • Return is generally measured in form of percentage(Important aspect about this percentage is that it should be annualized). For example if we have purchased security at Rs. 100 received dividend of Rs. 10 and after one year investor has sold that security at Rs. 105 than his return percentage will be as follow. • Total return Percentage = (Income + Price change)*100/Purchase Price • Hence in this case Return Percentage = [10+(105-100)* 100]/100 = 15% B.R.C.M. College of Business Administration Mrunal Joshi

• For calculation of expected return we need to consider past data. • on the basis of that we can use statistical techniques i.e. central tendency to predict future return. • In central tendency basically we can use mean value of past return. • For calculation we have two types mean generally we can use: Arithmetic Mean and Geometric Mean. • Arithmetic Mean or average = 𝑋ത = ∑xi/n – If probability is given, Mean = ∑xi.pi

• Geometric Mean G = [(1+R1)(1+R2)(1+R3)…….(1+Rn)]1/n – 1 B.R.C.M. College of Business Administration Mrunal Joshi

Calculation of Risk • Expected returns are insufficient for decisionmaking. The risk aspect should also be consider. • The most popular measure of risk is the variance or standard deviation – if probability is given


Systematic and Unsystematic Risk • Systematic risk is the variability in security returns caused by changes in the economy or the market. • The average effect of a change in the economy can be represented by the change in the stock market index. • The systematic risk of security is measured by a statistical measure called Beta. • Two methods to calculate Beta, correlation method or regression method B.R.C.M. College of Business Administration Mrunal Joshi

The Correlation method: 𝛽𝑖𝑚 =

𝑟𝑖𝑚 𝜎𝑖 𝜎𝑚

2 𝜎𝑚 rim = correlation coefficient between the returns of stock i and the returns of the market index. σi = standard deviation of returns of stock i. σm = standard deviation of return of the market index σ2m = variance of the market returns B.R.C.M. College of Business Administration Mrunal Joshi

The regression method: Y = 𝛼 + 𝛽𝑖𝑚 𝑋 + e where, Y = Dependent variable (stock return). X = Independent variable (market return). 𝛼 and 𝛽 are constants. e = random error in estimation B.R.C.M. College of Business Administration Mrunal Joshi

Stock Return

Slop = Beta

Beta

Alpha (Positive)

Market Return (or Market index) B.R.C.M. College of Business Administration Mrunal Joshi

Stock Return

Beta

Slop = Beta

Alpha (negative)


Stock Return

Slop = Beta

Beta

Alpha (Zero)


Alpha (α) α or Alpha is the distance between the horizontal axis and line’s intersection with y-axis. It measures the unsystematic risk of the company. If α is a positive return, then that scrip will have higher returns. If α = 0, then the regression line goes through the origin and its return simply depends on the Beta times the market return

Beta (𝜷) B or Beta describes the relationship between the stock’s return and the Market index return. This can be positive and negative. It is the percentage change in the price of the stock regressed (or related) to the percentage changes in the market Index. If Beta is 1, a one percentage change in Market index will lead to one percentage change in price of the stock. If Beta is zero, stock price is unrelated to the Market index. B.R.C.M. College of Business Administration Mrunal Joshi

n = Number of items 𝑌ത = Mean value of the dependent variable scores 𝑋ത = Mean value of independent variable scores. Y = Dependent variable scores (stock return) X = Independent variable scores (market return)


References: Avadhani, V. A. (2016). Securities Analysis and Portfolio Management: Himalaya Publishing House. Bhalla, V. K. (2011). Investment Management Security Analysis and Portfolio Management (17th Revised ed.). New Delhi: S.Chand & Company Ltd. Kevin, S. (2009). Security Analysis and Portfolio Management. New Delhi: PHI Learning Private Limited.
