The Role of Portfolio Management in an Efficient Market

You have learned that a basic principle in portfolio management is the  diversification of securities. Even if all stocks are priced fairly, each still poses firm-specific risk that can be eliminated through diversification. Therefore, rational security selection, even in an efficient market, calls for the selection of a well-diversified portfolio, providing the systematic risk level that the investor wants. Even in an efficient market investors must choose the risk-return profiles they deem appropriate.

The efficient market hypothesis (EMH) states that a market is efficient if security prices immediately and fully reflect all available relevant information.   If the market fully reflects information, the knowledge of that information would not allow an investor to profit from the information because stock prices already incorporate the information.  … Read the rest

Modern Portfolio Theory – Markowitz Portfolio Selection Model

Markowitz Portfolio Theory

Harry Markowitz developed a theory, also known as Modern Portfolio Theory (MPT) according to which we can balance our investment by combining different securities, illustrating how well selected shares portfolio can result in maximum profit with minimum risk. He proved that investors who take a higher risk can also achieve higher profit. The central measure of success or failure is the relative portfolio gain, i.e. gain compared to the selected benchmark.

Modern portfolio theory is based on three assumptions about the behavior of investors who:

  • wish to maximize their utility function and who are risk averse,
  • choose their portfolio based on the mean value and return variance,
  • have a single-period time horizon.
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Bond Duration and Portfolio Immunization

Bond Duration

Duration is a significant measurement of how sensitivity the change in price of a bond in the change of interest rate. It is broadly linked to the length of time before the bond is mature. Duration assists investors during the investment decision making process by expressing the relation between interest rate and price variables of the bond. Therefore, duration is useful measurement for investors because it protects investment from interest rate risk. When the duration of bond is lower that means investors can obtain the cash earlier and reinvest it at prevailing interest rate. As a result, the lower the duration of a bond, the lesser sensitive changes in the interest rate.… Read the rest

Portfolio Revision Strategies in Investment Portfolio Management

Meaning of Portfolio Revision

A portfolio is a mix of securities selected from a vast universe of securities. Two variables determine the composition of a portfolio; the first is the securities included in the portfolio and the second is the proportion of total funds invested in each security.

Portfolio revision involves changing the existing mix of securities. This may be effected either by changing the securities currently included in the portfolio or by altering the proportion of funds invested in the securities. New securities may be added to the portfolio or some of the existing securities may be removed from the portfolio.… Read the rest

Formula Plans in Portfolio Management

The investor uses formula plans to facilitate him in making investment decisions for the future by exploiting the fluctuations in prices. The formula plans have sketched the basic rules and regulations for purchasing and selling of investments. The formula plans make the average investors superior to others. These formula plans in portfolio management  are based on the fact that the investors will not have the problem of forecasting fluctuation in stock prices and will continue to act according to formula.

So, formula plans are a type of investment strategy that makes use of pre-determined rules for the nature and timing of change in one’s investment portfolio as the market rises or falls.… Read the rest

Sub Categories of Active Equity Management

Some of the major sub categories of the two major style of active equity management (top down and bottom up) are listed below;

  1. Growth managers: Growth managers can be classified as either top-down or bottom-up. The growth managers are either divided into large capitalization or small capitalization. The growth managers buy securities that are typically selling at relatively high P/E ratios, due to high earnings growth rate, with the expectation of continued high earnings growth. The portfolios are characterized by high P/E ratios, high returns, and relatively low dividend yields.
  2. Market timers: The market timer is typically a set category of top-down investment style and comes in many varieties.
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