A substitute and concurrent theory to the Capital Asset Pricing Model (CAPM) is one that incorporates multiple factors in explaining the movement of asset prices. The arbitrage pricing model (APT) on the other hand approaches pricing from a different aspect. It is rarely successful to analyse portfolio risks by assessing the weighted sum of its components. Equity portfolios are far more diverse and enormously large for separate component assessment, and the correlation existing between the elements would make a calculation as such untrue. Rather, the portfolio’s risk should be viewed as a single product’s innate risk. The APT represents portfolio risk by a factor model that is linear, where returns are a sum of risk factor returns. … Read the rest
Average investors are risk averse. Therefore, they will be ready to invest into securities under the presumption of an adequate compensation for risk taking. The compensation for the risk taken should be in the form of minimal rate of return for the invested financial assets, and the rate is named the required rate of return. It has two components:
- Delayed consumption compensation (investors could have purchased goods and services with the assets they are to invest) and
- Risk acceptance compensation.
Diversification is used to stabilize the potential return, and thus increase the value of the investment. Diversification stands for he investment of capital into several different securities or projects, all together called the portfolio.… Read the rest
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
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
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
The benefits of diversification are well perceived by portfolio managers, that many in developed countries started investing in foreign bonds, stocks and other instruments. They found that can extend diversification principle to foreign stocks, bonds etc, to improve returns for a given risk by adopting proper techniques of diversification.
Need of International Diversification:
- The size and character of international Equity and bond markets are widely varying that it will increase the scope for larger investment and larger diversification.
- The returns in local currencies of some foreign countries are higher than in domestic markets. Thus, for example in Singapore, Malaysia, Taiwan and India the returns in local currencies are higher than in U S economy.