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Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
Modern portfolio concepts ppt @ bec doms
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Modern portfolio concepts ppt @ bec doms

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Modern portfolio concepts ppt @ bec doms

Modern portfolio concepts ppt @ bec doms

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  • 1. Modern Portfolio Concepts
  • 2. Modern Portfolio Concepts <ul><li>Learning Goals </li></ul><ul><ul><li>Understand portfolio objectives and the procedures used to calculate portfolio return and standard deviation. </li></ul></ul><ul><ul><li>Discuss the concepts of correlation and diversification, and the key aspects of international diversification. </li></ul></ul><ul><ul><li>Describe the components of risk and the use of beta to measure risk. </li></ul></ul>
  • 3. Modern Portfolio Concepts <ul><li>Learning Goals (cont’d) </li></ul><ul><ul><li>Explain the capital asset pricing model (CAPM) – conceptually, mathematically, and graphically. </li></ul></ul><ul><ul><li>Review the traditional and modern approaches to portfolio management. </li></ul></ul><ul><ul><li>Describe portfolio betas, the risk-return tradeoff, and reconciliation of the two approaches to portfolio management. </li></ul></ul>
  • 4. What is a Portfolio? <ul><li>Portfolio is a collection of investment vehicles assembled to meet one or more investment goals. </li></ul><ul><li>Growth-Oriented Portfolio : primary objective is long-term price appreciation </li></ul><ul><li>Income-Oriented Portfolio : primary objective is current dividend and interest income </li></ul>
  • 5. The Ultimate Goal: An Efficient Portfolio <ul><li>Efficient portfolio </li></ul><ul><ul><li>A portfolio that provides the highest return for a given level of risk, or </li></ul></ul><ul><ul><li>Has the lowest risk for a given level of return </li></ul></ul>
  • 6. Portfolio Return and Risk Measures <ul><li>Return on a Portfolio is the weighted average of returns on the individual assets in the portfolio </li></ul><ul><li>Standard Deviation of a portfolio’s returns is calculated using all of the individual assets in the portfolio </li></ul>
  • 7. Return on Portfolio
  • 8. Correlation: Why Diversification Works! <ul><li>Correlation is a statistical measure of the relationship between two series of numbers representing data </li></ul><ul><li>Positively Correlated items move in the same direction </li></ul><ul><li>Negatively Correlated items move in opposite directions </li></ul><ul><li>Correlation Coefficient is a measure of the degree of correlation between two series of numbers representing data </li></ul>
  • 9. Correlation Coefficients <ul><li>Perfectly Positively Correlated describes two positively correlated series having a correlation coefficient of +1 </li></ul><ul><li>Perfectly Negatively Correlated describes two negatively correlated series having a correlation coefficient of -1 </li></ul><ul><li>Uncorrelated describes two series that lack any relationship and have a correlation coefficient of nearly zero </li></ul>
  • 10. Figure 5.1 The Correlation Between Series M, N, and P
  • 11. Table 5.3 Correlation, Return, and Risk for Various Two-Asset Portfolio Combinations
  • 12. Why Use International Diversification? <ul><li>Offers more diverse investment alternatives than U.S.-only based investing </li></ul><ul><li>Foreign economic cycles may move independently from U.S. economic cycle </li></ul><ul><li>Foreign markets may not be as “efficient” as U.S. markets, allowing true gains from superior research </li></ul><ul><li>Study done between 1984 and 1994 suggests that portfolio 70% S&amp;P 500 and 30% EAFE would reduce risk 5% and increase return 7% over a 100% S&amp;P 500 portfolio </li></ul>
  • 13. International Diversification <ul><li>Advantages of International Diversification </li></ul><ul><ul><li>Broader investment choices </li></ul></ul><ul><ul><li>Potentially greater returns than in U.S. </li></ul></ul><ul><ul><li>Reduction of overall portfolio risk </li></ul></ul><ul><li>Disadvantages of International Diversification </li></ul><ul><ul><li>Currency exchange risk </li></ul></ul><ul><ul><li>Less convenient to invest than U.S. stocks </li></ul></ul><ul><ul><li>More expensive to invest </li></ul></ul><ul><ul><li>Riskier than investing in U.S. </li></ul></ul>
  • 14. Methods of International Diversification <ul><li>Foreign company stocks listed on U.S. stock exchanges </li></ul><ul><ul><li>Yankee Bonds </li></ul></ul><ul><ul><li>American Depository Shares (ADS’s) </li></ul></ul><ul><ul><li>Mutual funds investing in foreign stocks </li></ul></ul><ul><ul><li>U.S. multinational companies (typically not considered a true international investment for diversification purposes) </li></ul></ul>
  • 15. Components of Risk <ul><li>Diversifiable (Unsystematic) Risk </li></ul><ul><ul><li>Results from uncontrollable or random events that are firm-specific </li></ul></ul><ul><ul><li>Can be eliminated through diversification </li></ul></ul><ul><ul><li>Examples: labor strikes, lawsuits </li></ul></ul><ul><li>Nondiversifiable (Systematic) Risk </li></ul><ul><ul><li>Attributable to forces that affect all similar investments </li></ul></ul><ul><ul><li>Cannot be eliminated through diversification </li></ul></ul><ul><ul><li>Examples: war, inflation, political events </li></ul></ul>
  • 16. Beta: A Popular Measure of Risk <ul><li>A measure of nondiversifiable risk </li></ul><ul><li>Indicates how the price of a security responds to market forces </li></ul><ul><li>Compares historical return of an investment to the market return (the S&amp;P 500 Index) </li></ul><ul><li>The beta for the market is 1.00 </li></ul><ul><li>Stocks may have positive or negative betas. Nearly all are positive. </li></ul><ul><li>Stocks with betas greater than 1.00 are more risky than the overall market. </li></ul><ul><li>Stocks with betas less than 1.00 are less risky than the overall market. </li></ul>
  • 17. Beta: A Popular Measure of Risk Table 5.4 Selected Betas and Associated Interpretations
  • 18. Interpreting Beta <ul><li>Higher stock betas should result in higher expected returns due to greater risk </li></ul><ul><li>If the market is expected to increase 10%, a stock with a beta of 1.50 is expected to increase 15% </li></ul><ul><li>If the market went down 8%, then a stock with a beta of 0.50 should only decrease by about 4% </li></ul><ul><li>Beta values for specific stocks can be obtained from Value Line reports or online websites such as yahoo.com </li></ul>
  • 19. Interpreting Beta
  • 20. Capital Asset Pricing Model (CAPM) <ul><li>Model that links the notions of risk and return </li></ul><ul><li>Helps investors define the required return on an investment </li></ul><ul><li>As beta increases, the required return for a given investment increases </li></ul>
  • 21. Capital Asset Pricing Model (CAPM) (cont’d) <ul><li>Uses beta, the risk-free rate and the market return to define the required return on an investment </li></ul>
  • 22. Capital Asset Pricing Model (CAPM) (cont’d) <ul><li>CAPM can also be shown as a graph </li></ul><ul><li>Security Market Line (SML) is the “picture” of the CAPM </li></ul><ul><li>Find the SML by calculating the required return for a number of betas, then plotting them on a graph </li></ul>
  • 23. Figure 5.6 The Security Market Line (SML)
  • 24. Two Approaches to Constructing Portfolios <ul><li>Traditional Approach </li></ul><ul><li>versus </li></ul><ul><li>Modern Portfolio Theory </li></ul>
  • 25. Traditional Approach <ul><li>Emphasizes “balancing” the portfolio using a wide variety of stocks and/or bonds </li></ul><ul><li>Uses a broad range of industries to diversify the portfolio </li></ul><ul><li>Tends to focus on well-known companies </li></ul><ul><ul><li>Perceived as less risky </li></ul></ul><ul><ul><li>Stocks are more liquid and available </li></ul></ul><ul><ul><li>Familiarity provides higher “comfort” levels for investors </li></ul></ul>
  • 26. Modern Portfolio Theory (MPT) <ul><li>Emphasizes statistical measures to develop a portfolio plan </li></ul><ul><li>Focus is on: </li></ul><ul><ul><li>Expected returns </li></ul></ul><ul><ul><li>Standard deviation of returns </li></ul></ul><ul><ul><li>Correlation between returns </li></ul></ul><ul><li>Combines securities that have negative (or low-positive) correlations between each other’s rates of return </li></ul>
  • 27. Key Aspects of MPT: Efficient Frontier <ul><li>Efficient Frontier </li></ul><ul><ul><li>The leftmost boundary of the feasible set of portfolios that include all efficient portfolios: those providing the best attainable tradeoff between risk and return </li></ul></ul><ul><ul><li>Portfolios that fall to the right of the efficient frontier are not desirable because their risk return tradeoffs are inferior </li></ul></ul><ul><ul><li>Portfolios that fall to the left of the efficient frontier are not available for investments </li></ul></ul>
  • 28. Figure 5.7 The Feasible or Attainable Set and the Efficient Frontier
  • 29. Key Aspects of MPT: Portfolio Betas <ul><li>Portfolio Beta </li></ul><ul><ul><li>The beta of a portfolio; calculated as the weighted average of the betas of the individual assets the portfolio includes </li></ul></ul><ul><ul><li>To earn more return, one must bear more risk </li></ul></ul><ul><ul><li>Only nondiversifiable risk (relevant risk) provides a positive risk-return relationship </li></ul></ul>
  • 30. Key Aspects of MPT: Portfolio Betas Table 5.6 Austin Fund’s Portfolios V and W
  • 31. Figure 5.8 Portfolio Risk and Diversification
  • 32. Figure 5.9 The Portfolio Risk-Return Tradeoff
  • 33. Table 5.1 Expected Return, Average Return, and Standard Deviation of Returns for Portfolio XY
  • 34. Table 5.2 Expected Returns, Average Returns, and Standard Deviations for Assets X, Y, and Z and Portfolios XY and XZ
  • 35. Table 5.5 The Growth Fund of America, August 31, 2005

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