Portfolio Theory

Portfolio Theory – some salient points

• Risk of the average is not equal to the average of the risk
• shifting the efficient frontier to North west , the portfolio can be optimised to an extent
• efficient frontier :- standard way of showing return and risk relationship
• Expand the universe of investible asset classes to produce a new efficient frontier
• correlation
• strategic asset allocation ( defined by objectives ) and tactical asset allocation ( depends upon investment policy )
• Rebalance Portfolio if financial markets have different expected returns
• MPT ( modern Portfolio Theory ) by Markowitz in 1952 – portfolio needs to be diversified
• Distribution of returns ( can be derived by change in prices )
• Metric used for measuring dispersion – standard deviation ( from the average )
• scatter plot for measuring correlation ( -1 to 1 ) – measure for dependence
• Three measures :- Expected return , standard deviation and Correlation
• optimal Portfolio creation need the above three measures only
• variance = STD * STD
• covariances – correlation * std1 * std2 – can take any value
• Value appreciation vs. risk undertaken ( risk / return trade off )
• efficient frontier : highest return at a specific level of risk