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9/5/2014
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IAPM
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IAPM
PGP17
Session 1
Course Mechanics Grading
Components Weightage(%)
Quizzes 15%
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Quizzes 15%
Mid Term Exam 35%
End Term Exam 50%
Roadmap of Investment Analysis
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A little history In March 1952, Harry Markowitz, a 25 year old graduate student from
the University of Chicago, published ”Portfolio Selection” in the Journal of Finance.
Th ith ”Th f l ti tf li b The paper opens with: ”The process of selecting a portfolio may be divided into two stages. The first stage starts with observation and experience and ends with beliefs about the future performances of available securities. The second stage starts with the relevant beliefs about future performances and ends with the choice of portfolio”.
Thirty eight years later, this paper would earn him a Nobel Prize in economic sciences.
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Risk Return tradeoff Portfolio theory is based upon two principles
We want to maximize the expected return
We want to minimize risk (variability of the return, probability of large losses etc )of large losses etc.)
However riskier assets generally have a higher expected returns
There are some optimal compromises between return and risk. What are these?
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Available opportunities
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Mean Variance Analysis One risky asset and one risk‐free asset: A simple model. We will see later that to get an optimal portfolio
Find an “optimal” mix of risky assets (portfolio T) Find an optimal mix of risky assets (portfolio T)
Find the appropriate mix of T and risk free asset
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Naive diversification Simple diversification of holding more stocks in the portfolio leads to reduced risk as compared to holding a single stock.
Breaking risk into market risk (systematic Breaking risk into market risk (systematic, nondiversifiable) and firm specific risk.
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Two risky assets Can we do better than naive diversification (equally weighted portfolios)?
Consider this example
A AAsset1 Asset2
Exp return 8% 13%
Stdev 12% 20%
Corrln 0.3
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Try thisStocks A, B and C have the same expected return and stdev with the following corrln.s: ρ(A,B) = 0.9,
ρ(A,C) = 0.1 and ρ(B,C) = ‐ 0.4. Given this informtion, the portfolio having the lowest risk will bethe portfolio having the lowest risk will be
a. Equally invested in A and B
b. Equally invested in B and C
c. Equally invested in A and C
d. Totally invested in C
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Minimum variance portfolio What is the lowest stdev for a given corrln?
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Bringing return into the picture Portf opportunity set
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Efficient Frontier: Set of Efficient portfolios, or more precisely mean‐variance efficient portfolios
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Optimal CAL and the Optimal Risky Portfolio Tangency portfolio (P)
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Problems Ch.7 P4, P5, P16, CFA P4, CFA P10
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