presentation on portfolio construction explaining taditional and modern approach.

2. • Portfolio is a combination of securities such as stocks, bonds, and
money market instruments.
• The process of blending together the broad classes so as to
obtain return with minimum risk is called PORTFOLIO
CONSTRUCTION.
• Diversification of investments helps to spread risk over many
assets and thus reduces unsystematic risk.

3. • TRADITIONAL APPROACH: investors need’s in terms of income
and capital appreciation are evaluated and appropriate
securities are selected to meet the needs of investor.
• MARKOWITZ EFFICIENT FRONTIER APPROACH: portfolios are
constructed to maximise the expected return for a given level of
risk as it views portfolio construction in terms of expected return
and the risk associated.

4. • It deals with two major decisions :-
(a) Determining the objectives of the portfolio.
(b) selection of securities to be included in the portfolio.

5. 2) 3) Selection of
1) Analysis of Determination portfolio
constrains of objective
5) 4) Assessment
diversification of risk and
return

6. • Income needs
a) Need for current income.
b) Need for constant income.
• Liquidity
• Safety of the principal
• Time horizon
• Tax consideration
• temperament

7. • Current income
• Growth in income
• Capital appreciation
• Preservation of capital

8. • Objectives and asset mix
• Growth in income and asset mix
• Capital appreciation and asset mix
• Safety of principal and asset mix

9. • Tradition approach has some basic assumption like the investor
prefers larger to smaller return from securities which requires
taking risk.
• The risk are namely interest rate risk, purchasing power risk
,financial risk and market risk.
• The ability to achieve higher return is dependent upon his/her
ability to judge risk and his ability to take specific risk.

10. Selection of
• Top quality bonds can industries
minimise financial risk while
stocks provide better
inflation protection.
Selection of
company in industry
• Depending on the
preference and needs of
investor appropriate
combination is selected. Determining the size
of participation

11. • Harry Markowitz put forward this model in 1952.
• It assists in the selection of the most efficient by analysing
various possible portfolios of the given securities. By choosing
securities that do not 'move' exactly together, the HM model
shows investors how to reduce their risk.

12. • Assumptions
i. Risk of a portfolio is based on the variability of returns from
the said portfolio.
i. An investor is risk averse.
ii. An investor either maximizes his portfolio return for
a given level of risk or maximizes his return for
the minimum risk.

13. • To choose the best portfolio from a number of possible
portfolios, each with different return and risk, two separate
decisions are to be made:
1. Determination of a set of efficient portfolios.
2. Selection of the best portfolio out of the efficient set.

14. • A portfolio that gives maximum return for a given risk, or
minimum risk for given return is an efficient portfolio.
Thus, portfolios are selected as follows:
(a) From the portfolios that have the same return, the investor will
prefer the portfolio with lower risk, and
(b) From the portfolios that have the same risk level, an investor
will prefer the portfolio with higher rate of return.

15. • The shaded area PVWP
includes all the possible
securities an investor can
invest in. The efficient
portfolios are the ones that
lie on the boundary of
PQVW.
• The boundary PQVW is
called the Efficient
Frontier.

16. • Figure in right shows the
risk-return indifference
curve for the investors.
• Each curve to the left
represents higher
utility or satisfaction.

17. • The investor's optimal
portfolio is found at the
point of tangency of the
efficient frontier with the
indifference curve.
• R is the point where the
efficient frontier is tangent
to indifference curve C3,
and is also an efficient
portfolio.

18. • All portfolios so far have been evaluated in terms of risky
securities only, and it is possible to include risk-free securities in
a portfolio as well.
• A portfolio with risk-free securities will enable an investor to
achieve a higher level of satisfaction. This has been explained
further.

19. • R1 is the risk-free return.
• R1PX is drawn so that it is
tangent to the efficient
frontier and known as
the Capital Market
Line (CML).
• The P portfolio is known as
the Market Portfolio and is
also the most diversified
portfolio.

20. RP = IRF + (RM - IRF)σP/σM
• Where,
RP = Expected Return of Portfolio
RM = Return on the Market Portfolio
IRF = Risk-Free rate of interest
σM = Standard Deviation of the market portfolio
σP = Standard Deviation of portfolio
(RM - IRF)/σM is the slope of CML. (RM - IRF) is a measure of the risk
premium, or the reward for holding risky portfolio instead of risk-free portfolio.
σM is the risk of the market portfolio. Therefore, the slope measures the reward
per unit of market risk.

21. • The portion from IRF to P, is
investment in risk-free assets
and is called Lending
Portfolio. In this portion, the
investor will lend a portion at
risk-free rate.
• The portion beyond P is
called Borrowing
Portfolio, where the investor
borrows some funds at risk-
free rate to buy more of
portfolio P.

22. • It requires lots of data to be included. An investor must obtain
variances of return, covariance of returns and estimates of
return for all the securities in a portfolio.
• There are numerous calculations involved that are complicated
because from a given set of securities, a very large number of
portfolio combinations can be made.
• The expected return and variance will also have to computed
for each securities.