The document discusses various aspects of portfolio management including the phases, approaches, traditional and modern theories. It describes the steps in traditional approach as analyzing constraints, determining objectives, selecting portfolio, assessing risk and return, and evaluation/diversification. The modern approach focuses on asset allocation based on calculated risk and return. Key modern portfolio theories discussed are Markowitz theory, Sharpe's single index model, and Capital Asset Pricing Model (CAPM). It also covers portfolio revision, constraints, and strategies like passive and active management, as well as formula plans.

1. Dr. NGPASC
COIMBATORE | INDIA 1

2. Dr. NGPASC
COIMBATORE | INDIA 2

3. Dr. NGPASC
COIMBATORE | INDIA
Phases of Portfolio Management
3

4. Dr. NGPASC
COIMBATORE | INDIA
Security
Analysis
Portfolio
Analysis
Portfolio
selection
Portfolio
revision
Portfolio
Evaluation
Phases of Portfolio Management

5. Dr. NGPASC
COIMBATORE | INDIA
Approaches in Portfolio Construction
5

6. Dr. NGPASC
COIMBATORE | INDIA
Modern
Approach
Traditional
Approach
Approaches
Approaches in Portfolio Construction
6

7. Dr. NGPASC
COIMBATORE | INDIA 7

8. Dr. NGPASC
COIMBATORE | INDIA
Steps in traditional approach
8
Analysis of constraints
Determination of objectives
Selection of portfolio
Assessment of risk and
return
Evaluation/Diversification

9. Dr. NGPASC
COIMBATORE | INDIA
1. Analysis of Constraints
Income Needs
Liquidity
Safety of the Principal
Time Horizon
Tax Consideration
Temperament
9

10. 2. Determination of objectives
Dr. NGPASC
COIMBATORE | INDIA
Current Income
Growth in Income
Capital Appreciation
Preservation of capital
10

11. 3. Selection of Portfolio
Dr. NGPASC
COIMBATORE | INDIA
Objectives
and asset
mix
Growth of
income
and asset
mix
Capital
appreciation
and asset
mix
Safety of
Principal
and asset
mix
11

12. 4. Risk and Return Analysis
Dr. NGPASC
COIMBATORE | INDIA
High Risk
Low Risk
Higher Return
Lower Return
12

13. 5. Diversification
Dr. NGPASC
COIMBATORE | INDIA
Selection of Industries
Selection of Companies in
the industry
Determining the size of
participation
13

14. Assumptions
Dr. NGPASC
COIMBATORE | INDIA
The market is inefficient.
The fundamentalists can take advantage of market
inefficiency situation.
The fundamentalists can earn quick profits.
The fundamentalists will expect the growth of a particular
company for predicting the future trend of the share prices.
14

15. Dr. NGPASC
COIMBATORE | INDIA 15

16. Modern Approach
Dr. NGPASC
COIMBATORE | INDIA
Select group of
shares
Calculates
risk
and return
Asset
allocation
16

17. Assumptions
Dr. NGPASC
COIMBATORE | INDIA
It is based on assumption of free and perfect flow
of information.
It believes that markets are perfect and absorbs all
information quickly.
The riskiness of a financial asset in portfolio is to be
seen in the context of market related risk or portfolio
risk, but not in isolation.
17

18. Dr. NGPASC
COIMBATORE | INDIA

19. Difference Between Traditional and Modern Portfolio Theory
Dr. NGPASC
COIMBATORE | INDIA
Traditional
Theory
• It deals with the evaluation of
return and risk conditions in
each security.
• It is based on measurement of
standard deviation of particular
scrip.
• It assumes that market is
inefficient.
• It gives more importance to
standard deviation
Modern Theory
• It deals with the maximization of
returns through a combination of
different types of financial
assets.
• It is based on mainly
diversification process.
• It assumes that market is perfect
and all information is known to
public.
• It gives more importance to
Beta.
19

20. Managing the portfolio
Dr. NGPASC
COIMBATORE | INDIA
Managing the
portfolio
Passive
Approach
Active
Approach
20

21. Dr. NGPASC
COIMBATORE | INDIA
Modern Theory

22. Modern Portfolio Theories
Dr. NGPASC
COIMBATORE | INDIA
Markowitz
Theory of
Portfolio
Management.
Sharpe’s
Theory of
Portfolio
Management.
Capital
Asset
Pricing
Model.
Modern
Portfolio
Theories
22

23. Dr. NGPASC
COIMBATORE | INDIA
Markowitz Theory of
Portfolio Management.

24. Harry Markowitz is considered the father of modern
portfolio theory, mainly because he is the first person
who gave a mathematical
diversification.
model for portfolio
optimization and
Modern Portfolio theory is a theory of finance that
attempts to maximize portfolio expected returns for a
given amount of risk, or minimize the risk for a given
level of expected return
Markowitz Theory advise investors to invest in
multiple securities rather than pulling all eggs in one
basket.
Dr. NGPASC
COIMBATORE | INDIA
MARKOWITZ THEORY

25. Dr. NGPASC
COIMBATORE | INDIA
MARKOWITZ MODEL-PORTFOLIO

26. Dr. NGPASC
COIMBATORE | INDIA
Efficient Frontier

27.  Risk of a portfolio is based on the variability of returns
from the said portfolio.
 An investor is risk averse.
 An investor prefers to increase consumption.
 Analysis is based on single period model of investment.
 An investor either maximizes his portfolio return for a
given level of risk or maximizes his return for the
minimum risk.
 An investor is rational in
nature.
Dr. NGPASC
COIMBATORE | INDIA
ASSUMPTION OF MARKOWITZ THEORY

28. Investors Utility Analysis
Dr. NGPASC
COIMBATORE | INDIA
utility
return
A
B
C
Marginal Utility and Return
28

29. Investors Utility Analysis
Dr. NGPASC
COIMBATORE | INDIA
Indifference Curves of the risk fearing
utility
return
I1
I2
I4
I3
29

30. Investors Utility Analysis
Dr. NGPASC
COIMBATORE | INDIA
utility
return
I1
I2
I3
I4
Indifference curves of the risk loving
30

31. Investors Utility Analysis
Dr. NGPASC
COIMBATORE | INDIA
utility
return
I1
I2
I4
I3
Indifference curves of the less risk Fearing
31

32. Dr. NGPASC
COIMBATORE | INDIA

33.  CAPM is used to determine a theoretically appropriate
require rate of return of an asset, if that asset is to be
added to an already well diversified portfolio, given
that assets non-diversifiable risk.
 Model starts with the idea that individual investment
contains two types of risk.
 Those are as follows:
Dr. NGPASC
COIMBATORE | INDIA
CAPITAL ASSET PRICING MODEL

34. Systematic risk:
This are market risk that cannot be diversified away.

Interest rate, recession & wars are example of
systematic risk.
Un-systematic risk:
Also known as specific risk. This risk is specific to
individual
investors
portfolio.
stock and can be diversified away as the
his
the
increases the number of stocks in
In more technical terms, it represent
component of a stocks return i.e. not correlated with
general market moves.
Dr. NGPASC
COIMBATORE | INDIA

35. Dr. NGPASC
COIMBATORE | INDIA
Assumption of CAPM
Risk-return assessments measured in terms of expected returns
and standard deviation ofreturn.
It cannot affect prices.
Infinitely divisible unit.
There are no transaction costs.
Investors share homogeneity of expectations.
The investor can sell short any amount of any shares.
The investor can lend or borrow any amount of fund desired at a rate of interest equal to
the rate of risk less securities.
There are no personal income taxes.
35

36. Dr. NGPASC
COIMBATORE | INDIA
Lending and Borrowing
𝑅𝑝 = 𝑅𝑓 𝑋𝑓+ 𝑅 𝑚(1 − 𝑋𝑓)
R p= portfolio return
X p= the proportion of funds invested in risk free assets
1-Xp= the proportion of funds invested in risky assets.
R f =risk free rate of return
R m= return on risky assets.
This formula can be used to calculate the expected returns for different situations, like
mixing riskless assets with risky assets, investing only in the risky assets and maximizing
the borrowings with risky assets.
36

37. If we assume the expected market risk premium to be 8% and the risk of return to be 7%, we
can calculate expected return for A,B,C, and D securities.
E(Ri)= Rf+βi (E(Rm)-Rf)
If beta is =1, E(R)= 7+1(8) =15%
Security A, Beta = 1.10
E(R)=7+1.10(8) =15.8
Security B, Beta = 1.20,
E(R)= 7+1.20(8) =16.8=16.6
Security C, Beta= 0.7,
E(R)= 7+0.7(8) =12.6
Dr. NGPASC
COIMBATORE | INDIA
Security Market Line
37

38. Dr. NGPASC
COIMBATORE | INDIA
Security Market Line

39. Dr. NGPASC
COIMBATORE | INDIA
SHARPE SINGLE
INDEX MODEL

40. SHARPE SINGLE INDEX MODEL
Dr. NGPASC
COIMBATORE | INDIA
• This model was developed by William Sharpe. He
simplified the method of diversification of portfolios.
Sharpe published a model simplifying the
mathematical calculations done by the Markowitz
model.
• According to Sharpe’s model, the theory estimate, the
expected return and variance of indices which may be
one or more and are related to economic activity.
• This theory has come to be known as market model.
40

41. Assumptions
Dr. NGPASC
COIMBATORE | INDIA
The securities returns are related to
each other.
The expected return and variance of
indices are the same.
The return on individual securities is
determined by unpredictable factors.
41

42. Single index model:
Ri= αi+βiRm+ei
Where Ri= expected return on security i αi=intercept of the
straight line or alpha co-efficient
βi = slope of straight line or beta co-efficient Rm=the rate of
return on market index
ei=error term
Dr. NGPASC
COIMBATORE | INDIA
Single index model
42

43. The single index model is based on the assumption that stocks vary
together because of the common movement in the stock market and there
are no effect beyond the market. The variance of the security has two
components systematic risk and unsystematic risk.
Total risk= systematic risk + unsystematic risk
Total risk= β 2 𝜎2 +e2
Systematic risk= β2 * variance of market index
Unsystematic risk = total variance – systematic risk.
e2 = 𝜎2 − 𝛽2 𝜎2
Dr. NGPASC
COIMBATORE | INDIA
Single index model
𝑖 𝑖 𝑚
i m i
i
i
43

44. Dr. NGPASC
COIMBATORE | INDIA 44

45.  A portfolio is a mix of securities selected from a vast
universe of securities.
 Two variables determine the composition of a portfolio.
 Portfolio revision involves changing the existing mix of
securities.
 Portfolio revision thus leads to purchase and sales of
securities.
 Maximizing the return for a given level of risk or
minimizing the risk for a given level of return.
Dr. NGPASC
COIMBATORE | INDIA
Portfolio Revision
45

46. • Portfolio management would be an incomplete
exercise without a periodic review.
• The portfolio, which is once selected, has to
be continuously reviewed over a period of
time and if necessary revised depending on the
objectives of investor.
• Thus, portfolio revision means changing the
asset allocation of a portfolio.
Dr. NGPASC
COIMBATORE | INDIA
Portfolio Revision

47. • However, the frequency of review depends upon the
size of the portfolio, the sum involved, the kind
of securities held and the time available to the
investor.
The review
examination
• should include a careful
of investment objectives, targets
obtaine
d
for
portfolio performance, actual results
and
The
and
analysis of reason for variations.
followed by suitable• review should be
timely action.
Dr. NGPASC
COIMBATORE | INDIA

48. Dr. NGPASC
COIMBATORE | INDIA
Need for Portfolio Revision
48
§ Availability of additional
funds for investment
§ Change in risk tolerance
§ Change in the investment
goal
§ Need to liquidate a part of
the portfolio to provide funds
for some alternative use

49.  Investors buy stock according to their objectives and
return-risk framework.
 These fluctuations may be related to economic
activity or due to other factors.
 Ideally investors should buy when prices are low
and sell when prices rise to levels higher than their
normal fluctuations.
 The investor should decide how often the portfolio
should be revised.
 If revision occurs to often, transaction and analysis
costs may be high.
Dr. NGPASC
COIMBATORE | INDIA
Techniques of Portfolio Revision

50. Dr. NGPASC
COIMBATORE | INDIA
Constraints in portfolio revision
50
Constraints
Transaction
Cost
Intrinsic
difficulty
Taxes
Statutory
Stipulations

51. -2 ± ..r:;-;;
2
-2 ± Jo -
22
- -2
2
Portfolio Revision Strategies
Dr. NGPASC
COIMBATORE | INDIA

52. •
• It is a process of holding a well diversified
portfolio for long term with the buy and hold
approach.
It also refers to the investor’s attempt to
construct a portfolio that resembles the overall
market returns.
For e.g.- If Reliance Industry’s stock
constitutes 5% of the index, the fund also
invests of 5% of its money in Reliance
Industry Stock.
•
•
Dr. NGPASC
COIMBATORE | INDIA
Passive Management

53. •
• It is holding securities based on the forecast
about the future.
The portfolio managers vary their cash
position or beta of the equity portion of the
portfolio based on the market forecast.
For e.g.- IT or FMCG industry stocks may be
given more weights than their respective
weights in the NSE-50.
•
•
Dr. NGPASC
COIMBATORE | INDIA
Active Management

54. The formula plans provide the basic rules and
regulations for the purchase & sale of securities.
These predetermined rules call for specified
actions when there are changes in the securities
market.
In this, the investor divide his investment funds
into 2 portfolios i.e. one aggressive(portfolio
consists of equity shares)& other conservative or
defensive ( bonds & debentures)
•
•
•
Dr. NGPASC
COIMBATORE | INDIA
Formula Plans

55. 1. Formula plans require the investor to divide
his investment funds in two portfolios i.e.
aggressive & Conservative (defensive)
2. The volatility of aggressive portfolio must be
greater than that of conservative portfolio, the
larger the difference between the two, the greater
the profits the formula plan can yield.
3. The conservative (defensive) portfolio must
include high- grade bonds having a high degree of
safety and stability of the returns.
Dr. NGPASC
COIMBATORE | INDIA
Basic Rules of Formula Revision

56. 4. The conservative portfolio tends to decline during
periods of prosperity, owing to falling interest rates.
While the stock prices are rising, therefore, the
aggressive portfolio also rises.
5. The basic premise of formula plans is that stock
bond prices of the portfolios move in opposite
and
direction. If they move in same direction then this
phenomenon certainly impairs profitability of the
formula plans.
6. The formula plans do not deal with the selection of
stocks or bonds
Dr. NGPASC
COIMBATORE | INDIA

57. Dr. NGPASC
COIMBATORE | INDIA
Assumptions of formula plan
1.Fixed income securities and common stocks.
2.If the market moves higher, the proportion of
stocks in the portfolio may either decline or
remain constant.
3.There is a significant change in the price.
4.Strictly follow the formula plan once he chooses
it.
5.The investor should select good stocks that move
along with the market.
57

58. Dr. NGPASC
COIMBATORE | INDIA
Advantages of formula plan
1.Basic rules and regulations for the purchase and sale of
securities are provided.
2.The rules and regulations are rigid and help to overcome
human emotion.
3.The investor can earn higher profits by adopting the plan.
4.A course of action is formulated according to the investor’s
objective.
5.It controls the buying and selling of securities by the investor.
6.It is useful for taking decision on the timing of investments.
58

59. Dr. NGPASC
COIMBATORE | INDIA
Disadvantages of formula plan
1.The formula plan does not help the selection of the
security.
2.It is strict and not flexible with the inherent problem of
adjustment.
3.The formula plan should be applied for long periods,
otherwise the transaction cost may be high.
4.Even if the investors adopts the formula plan,
he needs forecasting. Market forecasting helps him to
identify the best stocks.
59

60. Different types of Formula Plans are-
•
•
•
•
Rupee Cost Averaging
Constant Rupee Plan
Constant Ratio Plan
Variable Ratio Plan
Dr. NGPASC
COIMBATORE | INDIA
Types of formula plans

61. Any
Questi
on

62. 62