security

1. Module 2
SAPM

2. CONTENTS – Module 2
 Lesson 1: Diversification & Stochastic
Dominance
 Lesson 2: Diversification & Markowitz Model
 Lesson 3: Problems - Diversification
 Lesson 4: InvestmentTheories
 Lesson 5: Models In Investment
 Lesson 6: Introduction – Introduction to
Bonds & Bond Theorems
 Lesson 7: Problems using excel – Duration &
Portfolio Risk
 Lesson 8: Real Estate Investment & Summary

3. Lesson 1
 Goals:
 1. Understand the concept of
diversification
 2. Evaluate various types of Risk behavior
 3. Concept of Stochastic Dominance and
its application
Module 2: SAPM Lesson 1

4. DIVERSIFICATION
“ DON’T PUT ALLYOUR EGGS IN ONE
BASKET”

5. Fieldstein andYitzhaki (2000)
 Indicated that Corporate stock owned by
high income individuals appreciated
substantially faster than that of investors
with lower incomes.
 Higher income individuals have larger
portfolios and devote more time and
resources to their investments.

6. What happens if you invest all your
money in a single stock ?
1. Success
2. Stagnant
3. Failure

7. TYPES OF RISK BEHAVIOUR
 Risk Averse
 Risk taker
 Risk Neutral

8. Stochastic Dominance
 Investor Preference
 Stochastic
 Dominance
 First order Stochastic Dominance
 Second Order Stochastic Dominance
 Process of Stochastic Dominance with an
example.

9. INVESTOR PREFERENCE
Regardless of their attitude towards risk,
investors prefer higher returns to lower
returns.

10. Stochastic
 It denotes the process of selecting from
among a group of theoretically possible
alternatives those elements or factors
whose combination will most closely
approximate a desired result.

11. FSD
Cumulative distribution A will be preferred over
cumulative distribution B if every value of distribution A
lies below or on distribution B, provided the two
distributions are not identical.
A
B
Returns %
Cumul
ative
probab
ility

12. Explanation of FSD
 The probability that investment avenue A
will generate a given level or less than the
given level of returns is lower than that of
B.
 It implies A dominates B.

13. SSD
Alternative A is preferred to alternative B if the
cumulative probability of B minus the cumulative
probability of A is always non negative.
Returns
Cumul
ative
probabi
lity +ve
-ve
A
B

14. PROCESS
1. Select Portfolios or alternatives for
comparison
2. Develop frequency distribution
3. Develop relative frequency distribution
4. Develop cumulative frequency distribution of
less than type.
5. Plot.

15. Class Illustration
 1.The following are the returns from two
funds. Find whether Fund A has SSD over
fund B.
 year fund A fund B
 1 46 63
 2 16 13
 3 36 19
 4 9 37
 5 7 12
 6 19 30
 7 72 39

16. Solution
0
0.2
0.4
0.6
0.8
1
1.2
18 40 62
cf1
cf2
SSD
x CI A B rfA rfB cf1 cf2
18 7-29 4 3 0.57 0.43 0.57 0.43
40 29-51 2 3 0.28 0.43 0.85 0.86
62 51-73 1 1 0.15 0.14 1 1

17. Summary
 Diversification reduces risk
 Investors can be risk aversive, risk neutral
or risk taking in nature.
 Regardless of their attitude towards risk
Investors prefer higher returns over
lower returns.
 Stochastic dominance is a process of
selecting alternatives which gives the
desired return.

18. Thank you