PORTFOLIO THERORY INVESTMENT

Portfolio Theory Investment



Portfolio Theory Investment

Task 2: Portfolio Optimization and Performance Evaluation

Part A: Selection of Stocks

Following are the ten stocks that we have chosen for developing and optimizing the portfolio:

Santander

RBS

BBA

Easyjet

Sainsbury

Morrison

Vodafone

B SKY B

Salamander Energy

Serica Energy

Part B: Construct the portfolio efficient frontiers for the 10 assets

Harry Markowitz efficient frontier theorized in a seminal article published in 1952, led to the modern portfolio theory. Within a universe of risky investments, Markowitz focused on how to build the best combination of investments. By convention, we will refer from now on asset classes to describe investments with similar characteristics in terms of performance and risk: actions are an asset class, bonds are another. Within equities, we can more finely segmented in U.S. equities, European Equity, Asian Equity, Emerging Markets Equity, etc. "It is a subset of the minimum variance. The efficient frontier also is known as the set loci efficient and effective and sometimes called the Markowitz efficient frontier. In terms of H. Markowitz, the locus of mean-variance space defined by those portfolios for a given risk will provide the investor maximum performance or, equivalently, for a given return the risk which is minimal in store. " (The great encyclopedia of the economy).

The Efficient Frontier, we find the best returns for a risk determined, classified as corresponding to a higher risk greater profitability. Depending on the degree of risk aversion, the investor will be placed in a reasonable one point or another line of the efficient frontier. Any other point would be irrational. However, in practice the model has some degree of complexity. First, the weight of statistical development and to find the covariance matrix is necessary to relate all values ??two to two and calculate variances and covariances, complicated for portfolios with a number significant actions. Second, the data to account are the

historical returns and risks and assumes that in the future will be similar.

This assumption is too strong in most cases because it is it be assumed that the market is total inertia in the future. However, this conflict have all models of market behavior. As shown in Figure (1), the risk is measured on the horizontal axis and the expected return on the vertical axis. Points below the curve are different combinations of risk and expected return.

It is possible to assign expected returns and volatilities for each asset class, as well as correlations between asset classes. For example, France Shares are expected average annual return of 7% during the next 8 years, with a volatility of 14%. The same exercise is repeated for each of the asset classes used. Finally, we assign an expected correlation for pairs of asset classes: for example, the expected correlation between Shares and France Eurozone is 0.92.

From these estimates, we can also calculate the expected return and risk of all combinations of different asset classes available in the efficient frontier. For performance, the calculation is simple: it is simply the weighted average expected returns of each asset class. For example, a portfolio composed of 50% equities Europe whose expected return is 8% and 50% bonds in Europe whose expected ...