RISK AND RETURN ANALYSIS FOR EFFICIENT PORTFOLIO SELECTION
Keywords: Efficient allocation, Risk and return, Return on investment, Expectations, Investment
1. INTRODUCTION
All investment decisions necessitate consideration of the required return, the expected return, and the estimated risk. Markowitz (1952; 77) states 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.
The risk to which a company is exposed can be classified into two distinct categories, business and financial risk. According to Rajwade (2000; 303) risk is the uncertainty of outcome, arising from circumstances outside the control of the business, and leading to destabilization of cash flows. Correia et al. (2011; 3-3) states the term risk in financial management, indicates that there is an expectation that there actual outcome of a project may differ from expected outcome.
Risk is the measure of uncertainty about whether an investment will earn its expected rate of return. Risk may also be viewed as uncertainty about future outcomes or the probability of an unfavourable outcome. Risk is present whenever investors are not certain about the outcome an investment will produce.
Return refers to the sum of cash dividends, interest and capital appreciation or loss resulting from an investment. Return on an investment is the financial outcome for the investor. Holding period return (HPR) or holding period yield (HPY) may be used to measure Historical returns
2. PROBLEM STATEMENT
Investors desire an ...
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...incurred by them.
4.3 Statistical analysis / User requirements analysis
The data will be obtained will be analysed through statistical modelling. The method of analysis will be structured as following:
Linear programming formulation and prediction: β as a risk measure
Fund Selection under uncertainty: Variance and Standard deviation
References
1. Correia C. et al (2011), Financial Management 7th Edition, Juta and Company, Lansdowne, Cape Town.
2. Ho W.J, Tsai C., Tzeng G., and Fang S., 2011. Combined DEMATEL technique with a novel MCDM model for exploring portfolio selection based on CAPM, http://www.elsevier.com/locate/eswa. Date of access: 1 May 2014.
3. Markowitz H.M, Portfolio selection, Journal of Finance 7 (1952) 77.
4. Rajwade A.V. (2000), Foreign Exchange International Finance Risk Management 3rd Edition, Academy of Business Studies, New Delhi
Bodie, Zvi, Alex Kane, and Alan J. Marcus. Essentials of Investments. Ninth ed. N.p.: McGraw, 2013.
With that, it is time for the investor set a goal. Is the goal that of short or long term success? Is there a specific rate of return you wish to achieve? Or do you simply wish to come out ahead? Once the goals are put into place it is time for investment strategies. The investors goals will be key in helping plan the strategies for the investor.
Brigham, Eugene F., and Houston, Joel F. Fundamentals of Financial Management. Second ed. Dryden, New York, © 1999.
Ross, S.A., Westerfield, R.W., Jaffe, J. and Jordan, B.D., 2008. Modern Financial Management: International Student Edition. 8th Edition. New York: McGraw-Hill Companies.
This assignment is concerned with your understanding of the key issues relative to portfolio analysis and investment. In completing this assignment you are to limit your scope to the US stock markets only. Use the Cybrary, the Internet, and course resources to write a 2-page essay which you will use with new clients of your financial planning business which addresses the following issues and/or practices:
The author begins the article by defining the concept of modern portfolio theory (MPT). Modern portfolio theory can be defined as a theory on how investors can have optimal portfolios that generate the heights expected return based on a given level of risk. In other words, it is possible to build efficient frontier of optimal portfolios that generate maximum expected return at a given level of risk. The article presents the optimization process in the theory by its inputs and outputs. The first inputs is the expected returns for each security, which can be estimated using historical returns. The second input is the covariance matrix that includes the correlation coefficient, the standard deviation, and the variance of each security. The last input is the constraints in the selection of portfolio such as the turnover of the portfolio or liquidity. On the other hand, the optimization process has to outputs. The first is the efficient frontiers that represent the risk-return trade-off portfolios. The second output is the choice of portfolio that has the risk and return optimization for the investor.
The MDA model also showed potential to ease some problems in the selection of securities for a portfolio, but further investigation was recommended.
Other types of exchange rate risks are translation risk and so-called hidden risk. The translation risk relates to cases where large multinational companies have subsidiaries in other countries. On the financial statement of the whole group, the company may have to translate the assets and liabilities from foreign accounts into the group statement. The translation will involve foreign exchange exposure. The term hidden risk evolves around the fact that all companies are subject to exchange rate risks, even if they don’t do business with companies using other currencies. A company that is buying supplies from a local manufacturer might be affected of fluctuating foreign exchange rates if the local manufacturer is doing business with overseas companies. If a manufacturer goes out of business, or experience heavy losses, it will affect all the companies it does business with. The co...
Hensel, C. R., Ezra, D., & Ilkiw, J. H. (1991). The Importance of the Asset Allocation Decision.
Analyzing in terms of investment, if a private investor puts money into a company he has an expectation of both risk and return on the investment. Given a particular level of risk, the investment needs to be expected to have a particular level of return. For example, investment in a start-up needs to have the potential for a very high return, given the higher risk of failure, while investment in a large established business can be coupled with a lower expected return, given the lower risk of failure.
Block, S. B., & Hirt, G. A. (2005). Foundations of financial management. (11th ed.). New York: McGraw-Hill.
Finance can be regarded as the core of the modern business market, and investment analysis is an important role that is broadly carried out by investors for their investment decisions. Investment analysis is defined as the study of how an investment is likely to perform and how suitable it is for a given investor, thus being the key to any sound portfolio management strategy. Moreover, it is the analysis of past investment decisions through looking back at previous investment decisions and the processes of making those decisions. Through this analysis, investors can look make optimal decisions for their specified investment. Particularly with the recent economic recession, investment analysis is proving to play an important role in the world of finance. All things considered, I have no doubt MSc Investment Analysis can quench my thirst of knowledge in this field.
Risk is the potential loss resulting from the balance of threat, vulnerabilities, countermeasures, and value. ...
The Modern portfolio theory {MPT}, "proposes how rational investors will use diversification to optimize their portfolios, and how an asset should be priced given its risk relative to the market as a whole. The basic concepts of the theory are the efficient frontier, Capital Asset Pricing Model and beta coefficient, the Capital Market Line and the Securities Market Line. MPT models the return of an asset as a random variable and a portfolio as a weighted combination of assets; the return of a portfolio is thus also a random variable and consequently has an expected value and a variance.
Here, the risks should be appraised to how and to what level it will impact on the operations of the business in question. The business risk normally considers the standard and the effectiveness of the assets. The performance risk influences the income statement analysis whereby the financial risk influences the liabilities that are capitalize by the assets.