...Theory Investment/Portfolio M3: Assignment 1 Discussion B6201-P Roger Thornhill What makes for good diversification in a portfolio investment? How do you achieve diversification? Portfolio diversification is a necessity for risk minimized investing. Things that can happen to an undiversified investor were seen through the 401k vested employees of Enron before and after their scandal. During the 1990’s and early 2000’s before it was discovered that Enron’s accounting practices where fraudulent, they encouraged their employees to invest in their 401k program that consisted of 100% Enron stock. At that time, Enron’s stock was growing at an astronomical rate. There were no apparent devaluation signs and Enron investors thought they had found their future nest egg. Thousands of employees saw the opportunity and dumped frequent payments and, at times, their full retirement savings into Enron stock and Enron’s 100% stock 401k plan. They should have diversified. By solely investing in Enron stock, 100% of the unsystematic risk remained with Enron’s success or failure. Although, at the time, the risk associated with Enron’s failure was at a minimum, the fundamental idea that no stock is risk free, even the best of them, was a prevailing factor. When Enron’s scandal went public in 2001, the stock plummeted from as high as $90 to $0.12 per share and never recovered. Both 100% stock portfolios and 401k investment plans became worthless – investors and employees lost billions...
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...Efficient Diversification 1. So long as the correlation coefficient is below 1.0, the portfolio will benefit from diversification because returns on component securities will not move in perfect lockstep. The portfolio standard deviation will be less than a weighted average of the standard deviations of the component securities. 2. The covariance with the other assets is more important. Diversification is accomplished via correlation with other assets. Covariance helps determine that number. 3. a and b will have the same impact of increasing the Sharpe ratio from .40 to .45. 4. The expected return of the portfolio will be impacted if the asset allocation is changed. Since the expected return of the portfolio is the first item in the numerator of the Sharpe ratio, the ratio will be changed. 5. Total variance = Systematic variance + Residual variance = β2 Var(rM) + Var(e) When β = 1.5 and σ(e) = .3, variance = 1.52 × .22 + .32 = .18. In the other scenarios: a. Both will have the same impact. Total variance will increase from .18 to .1989. b. Even though the increase in the total variability of the stock is the same in either scenario, the increase in residual risk will have less impact on portfolio volatility. This is because residual risk is diversifiable. In contrast, the increase in beta increases systematic risk, which is perfectly correlated with the market-index portfolio and therefore has a greater impact on portfolio risk. ...
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...Diversification A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio. Diversification strives to smooth out/reduces unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated. Advantages and disadvantages of diversification Diversifying your investment portfolio can protect you from localized fall in the market, but it can also prevent you from making big money. The question of what breadth of diversification is appropriate is an ongoing conversation among financial professionals. Finding the right diversification level for yourself involves an analysis of your assets and your tolerance of risk. Advantages Risk reduction When your assets are widely diversified, your portfolio tends to perform in a similar way to the market as a whole. If you own stocks in 20 different areas and one of them takes a dive, it's unlikely that your portfolio will suffer terribly. Diversification is the best way to increase the stability of your investments and decrease your risk of losing money in the event that a single area decreases in value...
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...Introduction The averaging out of independent risks in a large portfolio is called diversification. The principle of diversification is used routinely in the insurance industry. In this paper I will talk about two different types of home insurance and talk about the different risks associated with each. Discussion A portfolio is used to describe a collection of securities. In finance, the risk of an individual security differs from the risk of a portfolio composed of similar securities. In order to help us understand why, Chapter 10 in the book gave a great example on insurance companies. Let’s consider two types of home insurance: theft insurance and earthquake insurance. Lets also suppose that the risk of these two hazards is similar for a given home in a given area. Based on this information we would know that the risks of the individual policies are similar, however, the risks of the portfolios might be drastically different. For example, if the chance of theft in a given home is 1%, the insurance company would expect about 1% of the 100,000 homes in the area to experience a robbery. Thus the number of claims would be around 1,000 per year. If the insurance company holds reserves sufficient to cover roughly 1,000 claims, it will have enough to meet its obligations on its theft insurance policies. The portfolio for the earthquake insurance is a little riskier. For example, if in a given area, the risk of an earthquake is 1%, the risk of having an earthquake so low...
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... We are required to collect stock prices of 35 public listed companies. There are 20 Malaysia, 5 United State, 5 United Kingdom, 5 Indonesia and KLCI index for the period of 2006 until 2013 based on weekly basis. Malaysia stock prices in this project based on Bursa Saham Malaysia. The stock prices of 20 Malaysia public listed company named by Prostaco, Raya International, Tiong Nam, Tong Herr, Toyo Ink, TSH, Turiya, United, Vitrox, UPA Corporation, Zecoon, Yokohama Industries, Woodlandoor, Wong Engeenering, White Horse Berhad, Whelcal Holding, Weida, Warisan TC Holding, Yinson Holding Berhad and YTL Power. While, the stock prices of 5 United State public listed company named by Adobe System INC, Alaska Air Group INC, Apple INC, The Aes Corporation and The NewYork Mellon Corporation. For stock prices of 5 United Kingdom public listed company named by Barclay, Bg Group, Big Yellow Group, Black Mount and Bovis Homes and lastly for the stock prices of 5 Indonesia public listed company named by Astra International, Bank Central Asia, Bank Danamon Indonesia, Kimia Farma and Unilever Indonesia. We also are required to demonstrate and explain the computations of annual return, risk, Sharpe ratio, return, covariance, beta, Treynor Ratio, portfolio standard deviation, and build a graph. THEORETICAL CONCEPTS In this assignment, we used the formula of Variances, Annual, Standard Deviation, Covariance, Correlation Coefficient, Beta, Variance Of Portfolio, Risk, Sharpe Ratio, Treynor Risk...
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...Modern Portfolio Theory in the Modern Economy: MPT During the Credit Crisis 0f 2008 Abstract There are various theories of risk and return as it pertains to measuring and predicting investment return in a portfolio- one of the oldest and most prominent being Modern Portfolio Theory .An example of a hypothetical portfolio utilizing the principles of MPT invested during the credit crisis of late 2008/early 2009 will be utilized in part. In direct application, does Modern Portfolio theory hold strong during a major financial crisis? Past research will be compared to present the mechanics and applications of MPT order to answer the questions poised and to create hypothetical portfolios based on past fund performance during the time period of 2007 -2010. It is expected that a portfolio using MPT would not have performed significantly better than any other less diversified investment. Contents Introduction……………………………………..........................................................................4-7 Credit Crisis Thesis Statement Modern Portfolio Defined Prior Research Prediction Method…………………………………………………….........................................................8-9 Parameters/ Source of Portfolios Results……………………………………………………......................................................10-19 A. Application/ graphs Conclusion…………………………………………...............………………………............19-20 Restatement of Thesis Discussion of Results Limitations Recommendation References……………………………………………………………………...
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...Introduction Diversification / Risk Internationalizing Portfolio National Markets / Performance Mini Case Summary International Portfolio Theory and Diversification Group 5 Kristin Hanselmann, Anna Ivaniuk, Lalita Pongpitakwises, Christian Seemann Fachhochschule Mainz - MA.IB International Finance March 2013 K. Hanselmann, A. Ivaniuk, L. Pongpitakwises, C. Seemann International Portfolio Theory and Diversification 1/35 Introduction Diversification / Risk Internationalizing Portfolio National Markets / Performance Mini Case Summary Introduction Christian Seemann International Portfolio Theory and Diversification 2/35 Introduction Diversification / Risk Internationalizing Portfolio National Markets / Performance Mini Case Summary Agenda Introduction International Diversification and Risk Internationalizing the Domestic Portfolio National Markets and Asset Performance Mini Case Summary 1 2 3 4 5 6 Christian Seemann International Portfolio Theory and Diversification 3/35 Introduction Diversification / Risk Internationalizing Portfolio National Markets / Performance Mini Case Summary Introduction Multinational Business Finance Part 5 - Foreign Investment Decisions Chapter 17 Pages 432 – 451 Christian Seemann International Portfolio Theory and Diversification 4/35 Introduction Diversification / Risk Internationalizing Portfolio National Markets / Performance ...
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...Abstract Like any other form of business or enterprise, investing internationally is a risk that can be turned into opportunity once well managed. There is a veritable sea of benefits in international portfolio investment. These include participation in the growth of other countries, hedging against exchange rate exposure to risk, diversification benefits and advantages (abnormal returns) of market segmentation on a global scale. However, we cannot be so overwhelmed by the payoff of international portfolio investment as to overlook the bitter side of it. In an international environment, financial investments are not only subject to currency risk and political risk, but also to many institutional constraints and barriers. What are crucial in international portfolio investment are optimal portfolio allocation and the associated market and currency risks. Diversification into multiple securities can practically eliminate potential severe losses from any individual security. However, domestic diversification cannot remove systematic market risk due to high correlations among most domestic securities. Since market risk differs from country to country, international diversification can reduce substantially the overall risk exposure of investment portfolios. Introduction and Overview Increased global competition and opportunity have attracted many national economies and individual domestic businesses to the international markets. In recent...
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...Lecture 1 -‐ Arithmetic Average 1. Ignores compounding; 2. Does not represent an equivalent, single quarterly rate for the year; 3. Is the best forecast of performance for the next quarter without information beyond the historical sample. -‐ Geometric Average 1. Also called a time-‐weighted average return-‐ignoring the quarter-‐to-‐quarter variation in funds under management; 2. Mutual funds are required to publish this as a measure of past performance. -‐ Dollar-‐weight Return 1. Similar to a capital budget problem 2. Accounting for varying amounts of capital under management form quarter to quarter 3. Less than time-‐weighted return of 7.19% -‐ Risk free assets: an asset with a certain rate of return (often taken to be short term T-‐bills) -‐ Scenario analysis: l Determine a set of relevant scenarios and associated investment outcomes and assigns probability to each l l -‐ Compute mean return and variance However, ...
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...FINANCE PORTFOLIO ANALYSIS FINAL WORK DESCRIPTIVE ANALYSIS AND APPLICATION OF THE PORTFOLIO THEORY Abstract The main objective of the work is to construct, through application of the Portfolio theory, an efficient frontier which represents a set of portfolios with optimum risk-return ratio for ten companies from Mexican IPC. The sample used in this work is composed of the most representative companies in this index. A descriptive analysis of the behavior of the stocks included in this study is carried out using the binomial risk-return, which significantly contributes in selecting the most suitable stocks to be included in the portfolio. The work is concluded with finding an optimal portfolio for a risk adverse investor. The main conclusions from study are the poor performance of the construction sector, which holds the lowest returns, the highest risk and negative performance ratios, and the usefulness of the theory of portfolios to get a set of portfolios with higher returns and lower risk than the general Mexican IPC index that represents the market. The importance of diversification of assets is also noted. Keywords: Portfolio theory, Efficient Frontier, Risk-Return, Minimum Variance, Portfolio Contents 1. Introduction 6 1.1 Introduction 6 1.2 Goals 7 1.3 Methodology 7 1.4 Structure 9 2. Theoretical Framework 11 2.1 Risk and Return 11 2.1.1 Portfolio’s Expected Return 12 2.1.2 Portfolio Risk (Standard Deviation) 13 2.2 Diversification...
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...their portfolios. Government bonds, especially those issued by the federal government, have the least amount of default risk and the lowest returns, while corporate bonds tend to have the highest amount of default risk but also higher interest rates. Bonds with a lower chance of default are considered to be investment grade, while bonds with higher chances are considered to be junk bonds. * Business Risk: This is the risk that issuers of an investment may run into financial difficulties and not be able to live up to market expectations. For example, a company’s profits may be hurt by a lawsuit, a change in management or some other event. * Interest Rate Risk: The risk caused by changes in the general level of interest rates in the marketplace. This type of risk is most apparent in the bond market because bonds are issued at specific interest rates. Generally, a rise in interest rates will cause a decline in market prices of existing bonds, while a decline in interest rates tends to cause bond prices to rise. For example, say you buy a 30-year bond today with a 6% annual yield. If interest rates rise, a new 30-year bond may be issued with an 8% annual yield. The price of your bond drops because investors aren’t willing to pay full value for a bond that yields less than the current rate of interest. * Market Risk: The risk that the value of your investment will decline as a result of market conditions. This type of risk is primarily associated with stocks. You might...
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...Project in FPS 4 Why is important to continuously manage and control your portfolio? It is important to manage and control my portfolio is one of the most difficult things about maintaining a portfolio is that, even if you don't touch it, it's always evolving. A change in the value of one type of investment tends to affect the dollar-value proportion of other asset classes. If you own more than one security, you have an investment portfolio. You build the portfolio by buying additional stocks, bonds, mutual funds, or other investments. Your goal is to increase the portfolio's value by selecting investments that you believe will go up in price. According to modern portfolio theory, you can reduce your investment risk by creating a diversified portfolio that includes enough different types, or classes, of securities so that at least some of them may produce strong returns in any economic climate. Be sure that your portfolio is diversified. Diversification can help reduce your portfolio’s market risk under various market conditions. It can also dampen the impact of a volatile market. Diversification cannot assure a profit or protect against loss in a declining market. Why is important to continuously manage and control your portfolio? It is important to manage and control my portfolio is one of the most difficult things about maintaining a portfolio is that, even if you don't touch it, it's always evolving. A change in the value of one type of investment tends to...
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...1) An Evaluation of Client Objectives and Constraints for the South Carolina State Pension Fund South Carolina State Pension Fund’s key objectives can be summarised below: Provide an asset pool sufficient to meet the long-term pensions and benefits liabilities Achieve a certain rate of return on the current pension assets for a given level of risk As a government pension plan, the fund has some understandable constraints, which are: Need to invest in mature and stable large companies Only a certain percentage of the fund could be invested in equities, meant to grow by +10% every year up to 40% The remainder (up to 60%) to be invested in bonds Their objective of achieving a certain rate of return is a necessary step to ensure the pension fund is able to meet its future pension liabilities. However, having unrealistic expectations can prove to be harmful where in their case a 1.5% discrepancy in expectations had led to a 120% increase in unfunded liability! The investment constraint of having a pension fund made up majority of bonds can prove to be problematic. While it is true that bonds provide a steady income in terms of coupon plus the opportunity for capital appreciation; the fact that bond prices are inversely proportional to interest rates prove to be a risk for pension funds. Indeed, that is the case for South Carolina pension fund where in April 1996 the fund has lost $400mln due to a rise in interest rates. Also their constraint of investing in...
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...Risk & Return Analysis: Analyzing an equally weighted portfolio of investments in Amazon, Inc., Yahoo! Inc., and Direct TV stock compared to the S&P 500 Introduction: Every day, millions of investors spend countless hours following the stock market in the hopes of striking it rich. Making the right moves at the right moments is crucial when one looks to make large returns in the market. While luck affords many investors the opportunity to make lucrative returns in the stock market, this reward does not come without risk. In order to balance their returns and the amount of risk that they are exposed to, many investors create an investment portfolio as a means to mitigate risks in the market at the expense of foregoing potentially higher returns on their investment. To illustrate the effects that a diversified portfolio can have on the amount of risk an investor takes on as well as the returns that the investment generates, a sampling of three random stocks and the S&P 500 index was created to examine the effects that diversification has on investment risk. Investments: For this analysis, monthly stock data from December 1, 2009 – December 1, 2014 was compiled on three stocks and the S&P 500. The three investments chosen for the portfolio were Amazon.com Inc. (AMZN), Yahoo! Inc. (YHOO), and DirectTV. (DTV), and each represent 25% of the portfolio. In order to analyze the risks associated with each stock, a Risk-Free rate of interest must be established in order...
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...The assets, combined in this portfolio, have been chosen from three different industries – banking, retail and drug manufacturing industry. Each industry has its own characteristics and distinguishes from one another, for the purpose of creating a diversified portfolio. Factors, affecting the banking sector and Barclays Bank (the chosen asset) are related to the current economic crisis, interest rates and the policy led by the government (either encouraging spending or saving). On the other hand the retail industry, represented by Marks and Spencer in this portfolio, is affected by the current economic climate in term of disposable and discretionary income. The final industry, drug manufacturing, which is most dependent on research and development, which incur high input costs and require a lot of testing (meaning the business process is time-consuming), is represented by GlaxoSmithKline. The three industries can be affected by completely different factors in nature. 1.2. PORTFOLIO CONSTRUCTION This portfolio was constructed by stocks, listed only on the London Stock Exchange (LSE), with no interaction with emerging markets. Although international diversification is not present, the unsystematic risk is lower due to the investment in already developed market (LSE), allowing enough liquidity and establishing fair price of the assets. The three companies (Barclays Bank, Marks and Spencer and GlaxoSmithKline) are all blue chips, with none of the stocks being defensive, due to the...
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