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Amity University Jharkhand: Assignment of Personal Financial Planning (FIBA311)

The document discusses portfolio construction and the traditional approach. It explains that a portfolio is a combination of different securities that helps diversify risk to maximize returns. The traditional approach involves 4-6 steps: 1) Analyzing investor constraints, 2) Determining objectives like income, growth, capital appreciation, 3) Selecting securities based on objectives and risk tolerance, 4) Analyzing risk and return of securities, and 5) Assigning weights and diversifying the portfolio across different asset classes. The modern portfolio theory introduced by Harry Markowitz formalized focusing on overall portfolio risk-return rather than individual securities. It involves calculating expected returns, risks, and correlations to identify the efficient frontier of portfolios with optimal risk-reward balance.

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Ayush Kesri
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144 views

Amity University Jharkhand: Assignment of Personal Financial Planning (FIBA311)

The document discusses portfolio construction and the traditional approach. It explains that a portfolio is a combination of different securities that helps diversify risk to maximize returns. The traditional approach involves 4-6 steps: 1) Analyzing investor constraints, 2) Determining objectives like income, growth, capital appreciation, 3) Selecting securities based on objectives and risk tolerance, 4) Analyzing risk and return of securities, and 5) Assigning weights and diversifying the portfolio across different asset classes. The modern portfolio theory introduced by Harry Markowitz formalized focusing on overall portfolio risk-return rather than individual securities. It involves calculating expected returns, risks, and correlations to identify the efficient frontier of portfolios with optimal risk-reward balance.

Uploaded by

Ayush Kesri
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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AMITY UNIVERSITY JHARKHAND

Assignment of personal financial planning (FIBA311)

Submitted By: Submitted to: Hemchandra Tiwari

Name :Ayush Kumar

Enrollmentno. : A36106418076

Course/Sem. : BBA ‘4B’

Batch: 2018-21
 What is portfolio? Explain the steps of portfolio construction in
traditional approach.

 Portfolio is a combination of different securities for hedging the risk and


maximizing the return. Different securities have their own quantum of risk
therefore the investor who is not willing to bear huge risk create portfolio.
Portfolio is created by combining or joining different securities ( equity, debt
instrument, government bond etc). The main purpose of the portfolio is to
diversify the risk on different securities that risk can be hedged at a great
extent and return can be maximized because diversifying one’s investments
helps to spread the risk over many assets. Diversification of securities in a
portfolio assures the anticipated return.

Approaches in portfolio constructions.

Commonly there are two approaches of portfolio construction

 Traditional approach
 Markowitz efficient frontier approach.

Traditional approach
The traditional approach basically deals with two major decisions. They are:

 Determining the objectives of the portfolio.


 Selection of securities to be included in the portfolio.

Normally this is carried out in four to six steps. Before formulating the objectives,
the constraints of the investor should be analyzed. Within the given frame work of
constraints, objectives are formulated. Then based on the objectives, securities are
selected. After that, risk and return of the securities should be studied. The investor
has to assess the major risk categories that he is trying to minimize. Compromise
on risk and non risk factor has to be carried out. Finally the relative portfolio
weights are assigned to securities like bonds, stocks and debentures and then
diversification is carried out.

Steps in traditional approach

Analysis of constraints

a. Income needs (current income and constant income)


b. Liquidity
c. Safety of principal
d. Time horizon
e. Tax considerations
f. Temperaments of the investors.

Determination of objectives
a. Current income
b. Growth in income
c. Capital appreciation
d. Preservation of capital

Selection of portfolio
a. Selection of portfolio depends upon various objectives of investors.
b. A Objective and asset mix.
c. Growth of income and asset mix.
d. Capital appreciation and asset mix.
e. Safety of principal and asset mix.

Risk and return analysis:

The traditional approach to portfolio building has some basic assumptions. First,
the individuals prefers larger to smaller returns from securities. To achieve these
goal investors has to take more risk. The ability to achieve higher returns is
dependent upon his ability to judge risk and his ability to take specific risk. These
risks may be interest rate risk, purchasing power risk, financial risk and market
risk.
Diversification:

Once the asset mix is determined and risk and return are analyzed, the final step is
the diversification of portfolio. Financial risk can be minimized by commitments to
top quality bonds, but these securities offer poor resistance to inflation. Stocks
provide better inflation protection than bond but are more vulnerable to financial
risks. Investors have to select industries appropriate to his investment objectives.
Each industry corresponds to specific goals of the investors. Likewise investors has
to select two or more companies in each industries as a part of diversification In
the stock portfolio, he has to adopt the following steps which are shown as.

Modern approach:

Modern portfolio theory (MPT)—or portfolio theory —was introduced by Harry


Markowitz with his paper "Portfolio Selection," which appeared in the 1952
Journal of Finance. Thirty-eight years later, he shared a Nobel Prize with Merton
Miller and William Sharpe for what has become a broad theory for portfolio
selection. Prior to Markowitz's work, investors focused on assessing the risks and
rewards of individual securities in constructing their portfolios. Standard
investment advice was to identify those securities that offered the best
opportunities for gain with the least risk and then construct a portfolio from these.
Following this advice, an investor might conclude that railroad stocks all offered
good risk-reward characteristics and compile a portfolio entirely from these.
Intuitively, this would be foolish. Markowitz formalized this intuition.
Detailing mathematics of diversification, he proposed that investors focus on
selecting portfolios based on their overall risk-reward characteristics instead of
merely compiling portfolios from securities that each individually has attractive
risk-reward characteristics. In a nutshell, inventors should select portfolios not
individual securities.

If we treat single-period returns for various securities as random variables, we can


assign them expected values , standard deviations and correlations. Based on these,
we can calculate the expected return and volatility of any portfolio constructed
with those securities. We may treat volatility and expected return as proxies for
risk and reward. Out of the entire universe of possible portfolios, certain ones will
optimally balance risk and reward. These comprise what Markowitz called an
efficient frontier of portfolios. An investor should select a portfolio that lies on the
efficient frontier.

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