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CHAPTER 7.edited. Portfolio management

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4 views

CHAPTER 7.edited. Portfolio management

Uploaded by

Tadele Bekele
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER SEVEN

PORTFOLIO MANAGEMENT
7.1 What is Portfolio Management?
Portfolio management is the process of combining securities in a portfolio according to the investor’s
preferences and needs, monitoring that portfolio, and evaluating its performance.
In other word, portfolio management is the strategic decision guides the investor in a method of selecting
the best available securities that will provide the expected rate of return for a given degree of risk and also
to reduce the risk.
7.2 Portfolio Management Process

In setting out to master the concepts and tools of portfolio management, we first need a coherent
description of the portfolio management process. The portfolio management process is an integrated set of
steps undertaken in a consistent manner to create and maintain an appropriate portfolio (combination of
assets) to meet clients’ stated goals.
The process of managing an investment portfolio never stops. Once the funds are initially invested
according to the plan, the real work begins in monitoring and updating the status of the portfolio and the
investor’s needs. Three elements in managing any business process are planning, execution, and feedback.

7.2.1 The Planning Step


i) Identifying and Specifying the Investor’s Objectives and Constraints
ii) Creating the Investment Policy Statement (IPS)
iii) Forming Capital Market Expectations
iv) Creating the Strategic Asset Allocation
7.2.2 The Execution Step
The execution step is represented by the ‘‘portfolio construction and revision’’.
7.2.3 The Feedback Step
In any business endeavor, feedback and control are essential elements in reaching a goal. In portfolio
management, this step has two components: monitoring and rebalancing, and performance evaluation.
i) Monitoring and Rebalancing: Monitoring and rebalancing involve the use of feedback to
manage ongoing exposures to available investment opportunities so that the client’s current
objectives and constraints continue to be satisfied. Two types of factors are monitored:
investor-related factors such as the investor’s circumstances, and economic and market input
factors.
ii) Performance Evaluation: Investment performance must periodically be evaluated by the
investor to assess progress toward the achievement of investment objectives as well as to
assess portfolio management skill.
7.4 Portfolio Management Policies

Policies followed in management of portfolio differ from investor to investor. The following are the basic
policies which are most commonly followed in the portfolio management.

1
1) Aggressive Policy: is a policy that assumes the market is strong and rising. Common stock is the
best alternative investment for the portfolio in rising market.

2) Defensive Policy: According to this policy, the securities which resist a decline in price are chosen
for investment. Since common shares are more risky (because it’s residual claim), bonds and
preferred shares are defensive type securities.

3) Aggressive-Defensive Policy: This type of policy safeguards the investor against any
possible rise or fall in the stock market. If the market is in rising trend, equity stock would
bring a large income. If the market is affected by recession, preferred stocks, bonds,
debentures will protect the investor.
4) Income vs. Growth Policy: The income policy focuses on maximization of current income,
but does not consider capital gains. This policy suggests bonds and debentures. The growth
policy gives priority to capital appreciation of the portfolio. It is followed by the investors
who favour stocks, promising substantial capital appreciation.
In general, the income Vs growth policy emphasizes that both income and growth factors should be given
due importance while constructing investment portfolio which will assure the investor current income as
well as increase in its capital value.

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