Portfolio Theory Notes

PORTFOLIO ANALYSIS

[pic]

Portfolios which are the combinations of securities may or may not take the aggregate characteristics of their individual parts. Portfolio analysis considers the determination of future risk and return in holding various blends of individual securities. An investor can sometimes reduce portfolio risk by adding another security with greater individual risk than any other security in the portfolio. This seemingly curious result occurs because risk depends greatly on the covariance among returns of individual securities. An investor can reduce expected risk level of a given portfolio of assets if he makes a proper diversification of portfolios.

There are two main approaches for analysis of portfolio

• Traditional approach.

• Modern approach.

TRADITIONAL PORTFOLIO APPROACH:

The traditional approach basically deals with two major decisions. Traditional security analysis recognizes the key importance of risk and return to the investor. Most traditional methods recognize return as some dividend receipt and price appreciation over a forward period.

But the return for individual securities is not always over the same common holding period nor are the rates of return necessarily time adjusted.

An analysis may well estimate future earnings and a P/E ratio to derive future price. He will surely estimate the dividend. In any case, given an estimate of return, the analyst is likely to think of and express risk as the probable downsize rice expectation (either by itself or relative to upside appreciation possibilities). Each security ends up with some rough measures of likely return and potential downside risk for the future

Portfolios or combinations of securities are thought of as helping to spread risk over many securities may specify only broadly or nebulously....