Porfolio Construction

Portfolio Construction
Investment Analysis and

Portfolio Management
Prof. Rana Abdul Qudous
Value Averaging
month
Jan-09
Feb-09
Mar-09
Apr-09
May-09
Jun-09
Jul-09
Aug-09
Sep-09
Oct-09
Nov-09
share
price total value
4.64
100
4.38
200
4.56
300
4.25
400
3.81
500
3.19
600
2.99
700
3.6
800
4.7
900
4.41
1000
4.34
1100
share to
own share to buy/sell investment
21.55
21.55
-99.99
45.66
24.11
-105.60
65.79
20.13
-91.78
94.12
28.33
-120.39
131.23
37.12
-141.41
188.09
56.85
-181.36
234.11
46.03
-137.62
222.22
-11.89
42.81
191.49
-30.73
144.44
226.76
35.27
-155.53
253.46
26.70
-115.87
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
Dec-10
5.26
4.54
5.38
7.47
7.39
6.31
7.07
6.48
7.07
6.96
5.05
5.8
Jan -11
5.06
1300
1400
1500
1600
1700
1800
1900
2000
2100
2200
2300
2400
247.15
308.37
278.81
214.19
230.04
285.26
268.74
308.64
297.03
316.09
455.45
413.79
-8.72
61.22
-29.56
-64.62
15.85
55.22
-16.52
39.90
-11.61
19.06
139.35
-41.65
45.84
-277.95
159.03
482.71
-117.14
-348.44
116.80
-258.56
82.10
-132.67
-703.74
241.58
413.79
2093.78
-1684.03
Dollar Cost Averaging
Month
Jan-09
Feb-09
Mar-09
Apr-09
May-09
Jun-09
Jul-09
Aug-09
Sep-09
Oct-09
Nov-09
Dec-09
ShareInvestmen Shares to Shares

Total
Pricet
Buy
Owned
Value
4.64
100
21.55
21.55
100
4.38
100
22.83
44.38
194
4.56
100
21.93
66.31
302
4.25
100
23.53
89.84
382
3.81
100
26.25
116.09
442
3.19
100
31.35
147.43
470
2.99
100
33.44
180.88
541
3.6
100
27.78
208.66
751
4.7
100
21.28
229.93
1081
4.41
100
22.68
252.61
1114
4.34
100
23.04
275.65
1196
4.69
100
21.32
296.97
1393
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
Dec-10
5.26
4.54
5.38
7.47
7.39
6.31
7.07
6.48
7.07
6.96
5.05
5.8
11-Jan
5.06
100
100
100
100
100
100
100
100
100
100
100
100
19.01
22.03
18.59
13.39
13.53
15.85
14.14
15.43
14.14
14.37
19.80
17.24
315.98
338.01
356.60
369.99
383.52
399.37
413.51
428.94
443.09
457.45
477.26
494.50
1662
1535
1919
2764
2834
2520
2924
2780
3133
3184
2410
2868
494.5
2502
2400
Average
5.18
4.85
Markowitz Portfolio Selection
Markowitz provided a comprehensive framework for analysis of portfolio
Portfolio of securities is an integrated whole, each securities complementing the
other
Consider both the characteristics of individual security and the relationship
between these securities.
Investors like return and dislike risk
Find the set of portfolio that
Provides the minimum risk for every possible level of return.
The Efficient Set
Investor select from the efficient set that meets his/her requirements
Maximize the expected return

Minimize the variance
Minimize portfolio Risk
Subject to:
A Stated Expected Return
Covariance measures the extent to which two securities tend to move, or not move,
together.
The variance of an individual security is the sum of the probability-weighted
average of the squared differences between the securitys expected return and its
possible returns.
The standard deviation is the square root of the variance. Both variance and
standard deviation measure of total risk, including both systematic and specific risk.
Correlation Co-efficient
A correlation of +1.0 would indicate perfect positive correlation, and a value of 1.0
would mean that the returns moved in a completely opposite direction. A value of zero
would mean that the returns had no linear relationship, that is, they were uncorrelated
statistically.
Month
Closing Price X
Closing Price Y
Dec-00
40
20
Jan-01
44
22
Feb-01
50.6
24.64
Mar-01
51.62
25.38
Apr-01
54.7
23
Month
Closing Price X Return X
Closing Price Y Return Y
Dec-00
40
20
Jan-01
44
.10
22
.10
Feb-01
50.60
.15
24.64
.12
Mar-01
51.62
.02
25.38
.03
Apr-01
54.7
.06
23
-.09
Return X
Return Y
.10
0.10
.15
0.12
.02
0.03
.06
-0.09
0.33
0.16
A.M x = 0.33/4
A.M x = 0.0825
A.M y =. 016/4
A.M y = 0.04
Return X Average
Return
Dx
Return Y
Average
Return
Dy
dx.dy
.10
0.0825
0.01750
0.10
.04
0.06
0.00105
.15
0.0825
0.0675
0.12
.04
0.08
0.0054
.02
0.0825
-0.0625
0.03
.04
-0.01
0.000625
.06
0.0825
-0.0225
-0.09
.04
-0.13
0.002925
0.33
0.16
0.01
Covariance = sum of dx*dy /n

=
=.01 /4
=
.0025
Return X
Return Y dx
dy
dx2
dy2
.10
0.10
0.01750
0.06
0.000306
0.0036
.15
0.12
0.0675
0.08
0.004556
0.0064
.02
0.03
-0.0625
-0.01
0.003906
0.0001
.06
-0.09
-0.0225
-0.13
0.000506
0.0169
0.33
0.16
0.009275
0.027
Variance X
=.
0.009275 / 4
0.00231875
SDx
0.00231875
SDx
0.048153
Variance Y
=.
027 / 4
0.00675
SDy
0.00675
SDy
0.082158
S.D x
0.048153
0.082158
S.Dy
Correlation coefficient
r=
cov
sdx*sdy
0.0025
r=
0.048153 * 0.082158
r=
0.631919
COCA-COLA
DATE PRICE
HOME DEPOT
RETURN
RETURN
DIVIDEND
(%) PRICE DIVIDEND
(%)
Dec-00
60.938
45.688
Jan-01
58.000
-4.82 48.200
5.50
Feb-01
Mar-01
53.030
45.160
-8.57 42.500
-14.50 43.100
-11.83
1.51
Apr-01
46.190
2.28 47.100
9.28
May-01
Jun-01
47.400
45.000
2.62 49.290
-4.68 47.240
4.65
-4.08
Jul-01
44.600
-0.89 50.370
Aug-01
48.670
9.13 45.950
Sep-01
46.850
Oct-01
Nov-01
47.880
46.960
Dec-01
47.150
0.18
0.18
0.04
0.04
6.63
0.04
-8.70
0.18
-3.37 38.370
-16.50
0.18
2.20 38.230
-1.55 46.650
-0.36
22.16
0.40 51.010
0.05
9.35
Average Return
Coca Cola
= 17.61/12
= 1.47
Home Depot
= -21.75/12
=1.81
Deviation
COCA-COLA HOME
Deviation (i)*Deviation
DATE (Ri)
DEPOT (Rj) Deviation (i) (j)
(j)
Jan-01
-4.82
5.50
-3.01
4.03
-12.13
Feb-01
-8.57
-11.83
-6.76
-13.29
89.81
Mar-01
-14.50
1.51
-12.69
0.04
-0.49
Apr-01
2.28
9.28
4.09
7.81
31.98
May-01
2.62
4.65
4.43
3.18
14.11
Jun-01
-4.68
-4.08
-2.87
-5.54
15.92
Jul-01
-0.89
6.63
0.92
5.16
4.76
Aug-01
9.13
-8.70
10.94
-10.16
-111.16
Sep-01
-3.37
-16.50
-1.56
-17.96
27.97
Oct-01
2.20
-0.36
4.01
-1.83
-7.35
Nov-01
-1.55
22.16
0.27
20.69
5.52
Dec-01
0.40
9.35
2.22
7.88
17.47
AR(i)= -1.81
Covij = 76.42/12 = 6.37
AR(j)= 1.47
76.42
DATE
Jan-01
Feb-01
Mar-01
Apr-01
May-01
Jun-01
Jul-01
Aug-01
Sep-01
Oct-01
Nov-01
Dec-01
COCA-COLA
Deviation
Sq. Deviation
-3.01
9.05
-6.76
45.65
-12.69
161.01
4.09
16.75
4.43
19.64
-2.87
8.24
0.92
0.85
10.94
119.64
-1.56
2.42
4.01
16.09
0.27
0.07
2.22
4.92
Sum = 404.34
Variance = 404.34/12 = 33.69

Standard Deviation = sqrt(33.69) =5.80
Home Depot
DATE
Jan-01
Feb-01
Mar-01
Apr-01
May-01
Jun-01
Jul-01
Aug-01
Sep-01
Oct-01
Nov-01
Dec-01
Deviation Sq. Deviation

4.03
16.26
-13.29
176.69
0.04
0.00
7.81
61.06
3.18
10.13
-5.54
30.74
5.16
26.61
-10.16
103.28
-17.96
322.67
-1.83
3.36
20.69
428.01
7.88
62.08
Sum = 1240.90
Variancej = 240.90/12 = 103.41
Standard Deviationj =sqrt (103.41) = 10.17
Expected Return and Standard Deviation of Two stocks is given below
E(R1) = 0.20
1 = 0.10
E(R2) = 0.20
2 = 0.10
Both the assets have equal weight i.e. (W1 = 0.50; W2 = 0.50).
Correlation co-efficient between Stock 1 and 2 is as follows:
a.
b.
C.
d.
e.
1,2
1,2
r
r
r
0.50
1,2
0.00
1,2
-0.50
1,2
-1
Calculate Portfolio Risk under all the five conditions
Both the assets have equal weight i.e. (W1 = 0.50; W2 = 0.50).
.
You are considering two assets with the following characteristics:
E(R1) = .15
E(R2) = .20
1 = .10 W1 = .5
2 = .20 W2 = .5
Compute the mean and standard deviation of two portfolios if r1,2 = 0.40 and 0.60,
respectively.
Given: E(R1) 0 .10
E(R2) 0 .15
1 = .03
2 = .05
Calculate the expected returns and expected standard deviations of a two-stock
portfolio in which Stock 1 has a weight of 60 percent under the following conditions:
a. r1,2 = 1.00
b. r1,2 = 0.75
c. r1,2 = 0.25
d. r1,2 = 0.00
e. r1,2 = 0.25
f. r1,2 = 0.75
g. r1,2 = 1.00
The standard deviation of Shamrock Corp. stock is 19 percent. The standard
deviation of Baron Co. stock is 14 percent. The covariance between these two
stocks is 100. What is the correlation between Shamrock and Baron stock?
You are a UK-based investor evaluating the effect upon your domestic equity
portfolio of allocating 25% of assets to the newly independent Republic of
Turkmanistan. Turkmanistan is an emerging market and you believe expected
returns from investment there will average 20% per year for the foreseeable future.
You also expect substantial volatility, up to 30% in annual standard deviation of
returns. Countering this risk, however, is your belief that the fortunes of
Turkmanistan are only modestly correlated with those of the UK, and you estimate
the correlation coefficient to be only 0.25. If domestic equity shares are expected to
return 10% annually, with 15% annual standard deviation of returns, what is the
expected return and risk for a portfolio combining 75% domestic equity and 25%
shares from Turkmanistan?

Porfolio Construction

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Porfolio Construction

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Portfolio Construction

Investment Analysis and

Dollar Cost Averaging

ShareInvestmen Shares to Shares

Maximize the expected return

Minimize portfolio Risk

Closing Price X Return X

Closing Price Y Return Y

Covariance = sum of dx*dy /n

Variance = 404.34/12 = 33.69

Deviation Sq. Deviation

Calculate Portfolio Risk under all the five conditions

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