PORTFOLIO MANAGEMENT AND INVESTMENT

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PORTFOLIO MANAGEMENT AND INVESTMENT

• PORTFOLIO THEORY

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MARKETS FOR SECURITIES

• Margin Trading Example
• If Zaid enter into transaction for 1,000 shares
  each at a price of Rs.20, an amount of Rs.20,000
  is required.
• Zaid has decided to provide 50 (as per the
  regulations) of the cash with the broker. The
  margin account of Zaid with the broker reflects
  following details
• Stock Rs.20,000 Debt Rs.10,000
• Equity Rs.10,000
• Margin 10,000 / 20,000 0.5 50
• If the stock falls gradually and the value of
  the share reaches Rs.17.00
• The value of the stock will reach Rs.17,000
• The Margin Account of Zaid will reflect as
  follows
• Stock Rs.17,000 Debt Rs.10,000
• Equity Rs.7,000
• New Margin 7,000 / 17,000 0.412 41.20
• It is Important to note that
• The shock of the falling price needs to be
  absorbed by the customer
• The lenders (brokers) risk is rising as the
  borrowed funds are more than the equity.

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MARKETS FOR SECURITIES

• Margin Trading Example (Continued)
• If the stock continues to fall, it will further
  increases the brokers risk. However, the broker
  will stop at a point, perhaps as per the
  regulations, and will ask the customer to raise
  his/her equity. The point at which the broker
  will ask to raise his equity can be worked out as
  follows
• Loan
• Market value of securities
  --------------------
• 1-Cut off Margin
• Let us consider that the cut-off margin is 30,
  the broker will ask the customer to deposit
  additional equity when
• Loan 10,000
• Market value of securities --------------
  ------- Rs.14,286
• 1-Cut off Margin (1-0.3)
• If the maintenance margin falls below 30, the
  broker will send a margin call to the customer
  asking to to additional deposit of funds within a
  certain time frame

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MARKETS FOR SECURITIES

• Margin Trading Example (Continued)
• Consider If the stock continues to fall further
  and the share value reached at Rs.13, the new
  Margin can be worked out as follows
• Stock Rs.13,000 Debt Rs.10,000
• Equity Rs.3,000
• 3,000
• Margin ------- 23
• 13,000
• To lift the margin to 30 maintenance level
  requires equity of 30 of Rs.13,000 which is
  equal to Rs3,900. This will lead to a further
  deposit of Rs.900 by the customer.
• 3,900
• New Margin ------- 30
• 13,000

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MARKETS FOR SECURITIES

• Margin Trading Example (Continued)
• Consider If the stock continues to fall further
  and the share value reached at Rs.12, the new
  Margin can be worked out as follows
• Stock Rs.12,000 Debt Rs.10,000
• Equity Rs.2,000
• 2,000
• Margin ------- 16.67
• 12,000
• To lift the margin to 30 maintenance level
  requires equity of 30 of Rs.12,000 which is
  equal to Rs3,600. This will lead to a further
  deposit of Rs.1600 by the customer.
• 3,600
• New Margin ------- 30
• 12,000

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COMMON ERRORS IN DECISION MAKING

• (a) Inadequately comprehension of return and
  risk (b) Vaguely formulated investment policy
  (c) Naïve extrapolation of the past (d) Cursory
  decision making (e) Misplaced love for cheap
  stocks (f) Over-diversification and
  under-diversification
• (g) Buying shares of familiar companies (h)
  Wrong attitude towards losses and profits (i)
  Tendency to speculate

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CALCULATING EXPECTED RATES OF RETURN

• Risk is the uncertainty that an investment will
  earn its expected rate of return.
• An investor determines how certain the expected
  rate of return on an investment is by analyzing
  estimates of expected returns.
• The investor assigns probability values to all
  possible returns.
• These probability values range from zero, which
  means no chance of the return, to
• One, which indicates complete certainty that the
  investment will provide the specified rate of
  return.
• These probabilities are typically subjective
  estimates based on the historical performance of
  the investment or similar investments modified by
  the investors expectations for the future.

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CALCULATING EXPECTED RATES OF RETURN

• In an alternative scenario, suppose an investor
  believed an investment could provide several
  different rates of return depending on different
  possible economic conditions.
• As an example, in a strong economic environment
  with high corporate profits and little or no
  inflation, the investor might expect the rate of
  return on common stocks during the next year to
  reach as high as 20 percent.
• In contrast, if there is an economic decline with
  a higher-than-average rate of inflation, the
  investor might expect the rate of return on
  common stocks during the next year to be 20
  percent.
• Finally, with no major change in the economic
  environment, the rate of return during the next
  year would probably approach the long-run average
  of 10 percent.
• The investor might estimate probabilities for
  each of these economic scenarios based on past
  experience and the current outlook.

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MEASURING THE RISK

• The measures of risk for an investment are
• Variance of rates of return
• Standard deviation of rates of return
• Coefficient of variation of rates of return
  (standard deviation)
• Covariance of returns with the market portfolio
  (beta)

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HOLDING PERIOD YIELD FOR A PORTFOLIO
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Expected Return of a portfolio

• Combined portfolio weights will always 1

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EXPECTED RETURN FOR A PORTFOLIO OF RISKY ASSETS
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Portfolio Expected Return

• Securities ER W
• A 12 0.20
• B 15 0.30
• C 18 0.30
• D 20 0.20
• What is the Expected Return on Portfolio?

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Variance
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Standard Deviation
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EXPECTED RETURN FOR AN INDIVIDUAL RISKY ASSET
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COMPUTATION OF THE VARIANCE OF THE EXPECTED RATE
OF RETURN FOR AN INDIVIDUAL RISKY ASSET
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Portfolio Risk - Covariance
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