PORTFOLIO CONSTRUCTION PORTFOLIO IS A COMBINATION OF SECURITIES SUCH AS STOCKS, BONDS AND MONEY MARKET INSTRUMENTS THE PROCESS OF BLENDING

NG TOGETHER THE BROAD ASSET CLASSES SO AS TO OBTAIN OPTIMUM RETURN WITH MINIMUM RISK IS CALLED PORTFOLIO CONSTRUCTION

APPROACHES IN PORTFOLIO CONSTRUCTION 1. 2. TRADITIONAL APPROACH MARKOWITZ APPROACH

TRADITIONAL APPROACH

1. ANALYSIS OF CONSTRAINTS A. INCOME NEEDS B. LIQUIDITY C. SAFETY OF PRINCIPAL D. TIME HORIZON E.TAX CONSIDERATION F. TEMPERAMENT 2. A. B. C. D. 3. A. B. C. D. 4. DETERMINATION OF OBJECTIVES CURRENT INCOME GROWTH IN INCOME CAPITAL APPRECIATION PRESERVATION OF CAPITAL SELECTION OF PORTFOLIO CURRENT INCOME AND ASSET MIX GROWTH OF INCOME AND ASSET MIX CAPITAL APPRECIATION AND ASSET MIX SAFETY OF PRINCIPAL AND ASSET MIX RISK AND RETURN ANALYSIS

5.

DIVERSIFICATION

SIMPLE DIVERSIFICATION PORTFOLIO RISK CAN BE REDUCED BY SIMPLEST KIND OF DIVERSIFICATION THE NAVE KIND OF DIVERSIFICATION IS KNOWN AS SIMPLE DIVERSIFICATION IN SIMPLE DIVERSIFICATION SECURITIES ARE SELECTED RANDOMLY AND NO ANALYTICAL PROCEDURE IS USED. TOTAL RISK OF ANY PORTFOLIO CONSISTS OF SYSTEMATIC RISK AND UNSYSTEMATIC RISK AND THIS TOTAL RISK IS MEASURED BY VARIANCE OF RETURNS OVER TIME.

 MANY STUDIES SHOW THAT SYSTEMATIC RISK COMPRISES OF ONE QUARTER OF TOTAL RISK THE SIMPLE RANDOM DIVERSIFICATION REDUCES THE UNSYSTAEMATIC RISK BUT IT FAILS TO REDUCE THE SYSTEMATIC RISK.

PROBLEMS OF VAST DIVERIFICATION PURCHASE OF POOR PERFORMERS INFORMATION ADEQUACY HIGH RESEARCH COST HIGH TRANSACTION COST

MARKOWITZ MODEL BASED ON MINIMISING PORTFOLIO RISK BY TAKING LIMITED NO OF SECURITIES OR BY

TAKING TWO SECURITIES OF NEGATIVE CORRELATION.

ASSUMPTIONS: THE INDIVIDUAL INVESTOR ESTIMATES RISK ON THE BASIS OF VARIABILITY OF RETURNS I.E VARIANCE OF RETURNS FOR A GIVEN LEVEL OF RISK, INVESTOR PREFERS HIGHER RETURN TO LOWER RETURN. LIKEWISE FOR A GIVEN LEVEL OF RETURNS INVESTOR PREFERS LOW RISK THAN HIGH RISK.

FINDINGS: PORTFOLIO RISK IS NIL IF THE SECURITIES ARE RELATED NEGATIVELY

 RISK CAN BE ELIMINATED IF THE SECURITIES ARE PERFECTLY NEGATIVELY CORRELATED THE STANDARD DEVIATION OR RISK OF PORTFOLIO IS SENSITIVE TO 1. THE PROPORTION OF FUNDS DEVOTED TO EACH STOCK 2. THE STANDARD DEVIATION OF EACH SECURITY 3. COVARIANCE BETWEEN TWO STOCKS.