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16 MARCH, 2011
PORTFOLIO CONSTRUCTION SECURITIES
COURSE NO. F-407
DR. MAHMOOD OSMAN IMAM PROFESSOR DEPARTMENT UNIVERSITY
PREPARED BY: TASLIMA A TAR ROLL NO. 1!-170 B.B.A. - 1!TH BATCH SEC- B DEPARTMENT OF FINANCE UNIVERSITY OF DHA A
16 MARCH, 2011
To Dr. Mahmood Osman Imam Professor Department of Finance University of Dhaka
Subject: Submission of report on “optimum portfolio construction”
Dear Sir, Here is a report on “Submission of report on “efficient portfolio construction. In this report i have included the various tools and techniques to find out efficient portfolio and optimum wei ht allocated to each securit! to find out efficient portfolio. I ac"nowled e the contributions to our course teacher for the uidance he rendered. I have tried to use m! academic "nowled e on real life. I am pleased to be ranted this vital opportunit! and rateful for !our versatile assistance. I hope that m! wor" will please !ou .I shall be available in the presentation for further e#planations.
$aslima %"tar &inance '(th batch Department of finance )niversit! of Dha"a
*nclosure: $he +eport
,e were assi ned to ma"e a report on portfolio construction. &or this purpose we collected data from DS*. ,e "now, portfolio is the combination of securities of an individual. the oals of investment var! with man to man, institutions to institutions based on their financial conditions, economic stabilit!, and ris" tolerance, need of income stream, a e, and job status. +e ardless of the ultimate oal, all face the same set of challen es that e#tend be!ond just the choice of what asset classes to invest in. Here our main objective is to find out optimum portfolio conver ence with individual and institutions investment polic! objectives. -! portfolio approach I mean evaluatin individual securities in relation to their contribution to the investment characteristics of the whole portfolio. Here we have ta"en '. companies that are listed in Dha"a stoc" e#chan e from different industries. ,e want to ma#imi/e the theta and want to minimi/e ris". ,e use solver function throu h e#cel wor"sheet to find out portfolio wei ht to be complied with iven si# situation. $hese are, '. 0a#imi/in $heta allowin short sell 1. 0a#imi/in $heta b! not allowin short sell (. 0inimi/in +is" 2Standard Deviation3 b! allowin short sell 4. 0inimi/in +is" 2Standard Deviation3 b! not allowin short sell 5. 0inimi/in +is" 2Standard Deviation3 b! allowin short sell for a iven return 6. 0inimi/in +is" 2Standard Deviation3 b! not allowin short sell for a iven return %fter doin different mathematical and statistical tools and techniques finall! I et that portfolio wei ht for each situation. Here I have seen that if short sellin is allowed individual can et hi hest theta with minimum ris" than that of an! other combinations
INTRODUCTION: Market portfolio is com ination of all sec!rities that trade in the market. "mon# all the sec!rities choosin# t$o or more sec!rities for individ!al investment is called optim!m investment portfolio. %e can also refer optim!m investment portfolio as efficient portfolio that offer hi#her ret!rn in a #iven risk level or lo$er risk at a #iven &et!rn level. " 'raph is (ho$n )elo$ $here $e can see a c!rve called as opport!nity set. The point Minim!m *ariance Portfolio is a portfolio $ith lo$est risk. " ove part of Minim!m *ariance Portfolio is +alled ,fficient Frontier. &f is the risk free rate. " line startin# from the ori#in at risk free rate tends !p$ard y to!chin# the efficient frontier is kno$n as +M- .+apital market line/. The
Minim!m variance portfolio
There are many factors that $ork
ehind the determination of portfolio.
(!ch as economic condition4 inside information4 the investors o 5ective and constraints4 risk tolerance etc. 6ere $e have tried to create a portfolio on the asis of the Market Price Data and the Dividend ad5!stments. %e have collected last 0 years data from D(,. 1. Planning process: Here I am iven different objectives to find out the optimal portfolio construction. 2. A""#$ %&&'(%$)'*: 6ere4 I o serve the risk and ret!rn characteristics of the availa le investments. 6ere I analy7e f!ndamental and technical analysis to find o!t the est performin# ind!stry and from those I have
chosen the individ!al companies. 6ere I try to follo$ one famo!s ma9im that don:t p!t yo!r all e##s in one asket. S#&#($)'* '+ %""#$: To diversify the risk it is etter to invest in different types of asset. That is $hy I have selected companies in different ind!stries or asset class. (!ch as; )ank +ement +hemical 2on ankin# financial instit!tions .2)FI/ ,n#ineerin# Pharmace!ticals Te9tile.
I have selected the companies $hich are< listed in D(, listed on or efore = >an!ary 2??8 @": +ate#ory sec!rities.
S#&#($#, ('-.%*)#": =. 2. 3. 4. 0. 8. B. C. E. ") )ank Uttara )ank "ramit +ement I+) Midas finance Aohinoor chemical &on#p!r Fo!ndary (D!are pharma (D!are te9tile
=?. )e9imco te9tile
6ere I have chosen B ind!stries to #et the enefit of diversification and optimi7e the ret!rn. 7ow I would li"e to describe what companies I have selected from each industr!. B%*/: The total stock e9chan#e pFe ratio is =B.=E $here the ank ind!stry:s pFe m!ltiple is only ==.8C $hich is the lo$est amon# all ind!stries. That means i can cover or #et my principle investment $ithin ==.8C years if I invest in ankin# ind!stry and $hich is l!crative also. Moreover there is hi#h #ro$th potential for the ankin# ind!stry and here there is no threat of entry as #overnment imposes restriction !pon ne$ entry. N'* B%*/ +)*%*()%& )*"$)$0$)'*": 2on ank financial instit!tions are most promisin# sector of )an#ladesh. "s )an#ladesh is a developin# co!ntry there are potential chances for #ro$th of these instit!tions. Increasin# importance of merchant ankin#4 #oin# p! lic4 and risin# of p! lic conscio!sness leads to hi#h #ro$th of this sector. T#1$)&#" )*,0"$23: "s the te9tile ind!stry is the key of o!r economy4 the attraction of investors are increasin# day y day to$ards the ind!stry. %e invest here in the lon# r!n $e can e9pect a handsome ret!rn from it. P4%2-%(#0$)(%&" I*,0"$23: Pharmace!ticals companies are prod!cin# inelastic #oods $hich are also the important contri !tor to o!r economy as $e e9port dr!#s thro!#ho!t the $orld. Moreover the rep!tations and profita ility and class of e9chan#e are 'ood compare to other ind!stries. C#-#*$ I*,0"$2)#" In the recent trend of &eal ,state (ector )oom and the Infrastr!ct!ral improvement in )an#ladesh4 the +ement Ind!stry is doin# $ell in their !siness. "mon# the profit makers "&"MIT is one of the common names. The face val!e is Tk. =?? $hich is c!rrently ein# traded at Tk. 1,591.00.
First of all I have collected past 0 years price data and dividend data of the selected companies. "fter p!ttin# those data on e9cel sheet4 #athered monthly closin# price of each companies from the year 2??8<2?=? and ad5!sted those price $ith the dividend paid d!rin# the month.
1 2 3 4 5 6 370.25 326.25 324.25 273.25 351.50 364.25
+ash Div "mo!n t ? ? ?
+ash Div "d5!ste no. of d Price )F& shares 3B?.20 = 328.20 = 324.20 = =? ? 2B3.20 G =.= ? 30=.0? = ? 384.20 =
S$'(/ D)5 A,60"$ #, P2)(# 3B?.20 328.20 324.20 3??.0B 0 30=.0 384.20
Then $e calc!lated ret!rn of each companies from fe r!ary 2??8 to decem er 2?=?. %e !sed the form!la to calc!late the monthly ret!rn4 + 8 972:t;:t<'3
$hen I calculated mean return b! addin return of 5= months and dividin b! 5=. I calculated mean return for each compan!. $hus I ot '. mean returns.
R)"/ +2## 2%$#:
F)702# 1: 2#$02* (%&(0&%$)'*
F)702# 2: 2)"/ +2## 2#$02* (%&(0&%$)'* To #et risk free rate I take )an#ladesh ank Treas!ry ill rate for five years and then $e ad5!st the price y m!ltiplyin# each rate y t$elve and divide the res!lt y t$elve and for the year 2??8 I divide the $hole y == eca!se for the first year I #ot == moths )an#ladesh ank treas!ry rate. Then y avera#in# I finally #et the avera#e risk free rate if return. that is ...46>5.
$hen I calculated *#cess return b! subtractin ris" free return from 0ean return. $he equation is, *#cess +eturn 8 +mʹ<+f
F)702# !: #1(#"" 2#$02* (%&(0&%$)' V%2)%*(# C'5%2)%*(# M%$2)1: $hen I calculated ?ariance and covariance of each compan! usin ?%+ and @A?%+ function.
F)702# 4: ('5%2)%*(# ,#$#2-)*%$)'* Here I put equal wei ht on each securit!, which is '.B. $hat means I invest '.B of m! asset on ever! securities irrespectivel!.
E1(#"" P'2$+'&)' R#$02*: $hen @alculated *#cess portfolio returns b! multipl!in each e#cess return with respective wei ht and addin all.
F)702# 8: .'2$+'&)' 2#$02* (%&(0&%$)'*
P'2$+'&)' V%2)%*(#: $hen I calculated the portfolio variance HpI usin the theor! of matri# .,e "now in variance we need to multipl! individual variance covariance with wei ht square. So, m! multiplication was li"e followin <
H=I4H=24H=34 HpI 8 C,',,1,,(,,4,DDDD..,,'.EF JJJJJJ4H==? H=24H2I4 H234 JJJJJJJ4H2=? H=34 H234 H3I4 JJJJJJ4H3=?
. . . . . . . . . . . .
%= %2 %3 %4 %0 %8 %B %C %E %=?
H==?4 H2=? H3=?4
P'2$+'&)' S$%*,%2, D#5)%$)'*: ,e "now portfolio standard deviation Hp is the square root of standard deviation. $hatGs wh! we calculated the square root of the portfolio standard deviation.
F)702# 6: "$%*,%2, ,#5)%$)'* (%&(0&%$)'*
7e#t I calculated the theta. ,e "now< Ɵ 8 2+mʹ H+f3; Hp *#cess +eturn 8 +mʹ H+f So, Ɵ 8 *#cess +eturn ; Hp
F)702# 7: THETA CALCULATION
U"# '+ "'&5#2 +0*($)'*:
Finally I !sed the solver f!nction to find the optim!m $ei#ht for follo$in# si9 sit!ations. The sit!ations are<
B. Ma9imi7in# Theta allo$in# short sell C. Ma9imi7in# Theta y not allo$in# short sell E. Minimi7in# &isk .(tandard Deviation/ y allo$in# short sell =?. Minimi7in# &isk .(tandard Deviation/ y not allo$in# short sell ==. Minimi7in# &isk .(tandard Deviation/ y allo$in# short sell for a #iven ret!rn =2. Minimi7in# &isk .(tandard Deviation/ y not allo$in# short sell for a #iven ret!rn
These sit!ations are descri ed elo$<
M%1)-)9)*7 T4#$% :3 *'$ %&&';)*7 "4'2$ "#&&:
In this sit!ation I ma9imi7ed theta y not allo$in# short sell. In this sit!ations the constrains are< =. K%i L = 2. %i ML ?
F)702# <: MA=IMI>ING THETA BY NOT ALLO?ING SHORT SELL
6ere my findin#s are<
(o4 I don:t need to invest in ") )ank4 UTT"&" )ank4 ),1T,1 "2D (!are pharma. 6ere my theta $ill e 3CG.
M%1)-)9)*7 T4#$% %&&';)*7 "4'2$ "#&&: "llo$in# short sell means the investor can sell certain sec!rity of others in an e9pectation that the price $ill #o do$n in near f!t!re4 then the investor $ill !y ack the sec!rity and ret!rn to the real o$ner. In first sit!ation I allo$ed short sale. The only constraint $as< =.K%i L =
F)702# @: -%1)-)9)*7 $4#$% :3 %&&';)*7 "4'2$ "#&&
My findin#s is I have to short sell< In Uttara ank =2G4 ),1T,1 y =CG4 (D!are Pharma y 20G. I sho!ld invest all of my investment in other sec!rities. "t this option I $ill #et ma9im!m theta of 42G. M)*)-)9)*7 R)"/ AS$%*,%2, D#5)%$)'*B :3 *'$ %&&';)*7 "4'2$ "#&&:
Then I tried to find the $ei#hts in $hich risk $ill e minim!m. I have not allo$ed short sell. +onstraints are< =. K%i L = 2. %i ML ?
F)702# 10: -)*)-)9)*7 "$%*,%2, ,#5)%$)'* :3 *'$ %&&';)*7 "4'2$ "#&&
6ere my findin#s are<
I don:t need to invest in Uttara )ank4 "&"MIT +ement4 ),1T,14 I+). Th!s my standard deviation $ill e minim!m. M)*)-)9)*7 R)"/ AS$%*,%2, D#5)%$)'*B :3 %&&';)*7 "4'2$ "#&&:
Then I allo$ed short sell to #et the $ei#ht at minim!m risk. The only constraint is =. K%i L =
6ere I sho!ld allo$ short sell in case of Uttara ank4 "&"MIT cement4 ),1T,14 I+) at minim!m level of standard deviation 8.40G. M)*)-)9)*7 R)"/ AS$%*,%2, D#5)%$)'*B :3 *'$ %&&';)*7 "4'2$ "#&& +'2 % 7)5#* 2#$02*:
Then I considered a sit!ation in $hich I can earn a monthly ret!rn of CG and my risk $ill e minim!m. I have also not allo$ed short sell. My constraints are< =. K%i L = 2. %i ML ? 3. Monthly ret!rnLCG
F)702# 11: -)*)-)9)*7 $4# 2)"/ :3 *'$ %&&';)*7 "4'2$ "#&& %$ 7)5#* 2#$02*
6ere I fo!nd that to #et CG ret!rn I have no need invest in Uttara ank4 "&"MIT4 ),1T,14 I+).
"ll my investment sho!ld e in other companies. M)*)-)9)*7 R)"/ AS$%*,%2, D#5)%$)'*B :3 %&&';)*7 "4'2$ "#&& +'2 % 7)5#* 2#$02*:
Then I considered a sit!ation in $hich I can earn a monthly ret!rn of 3.0G and my risk $ill e minim!m. I have also allo$ed short sell. My only constraint is< =. K%i L =
F)702# 12: -)*)-)9)*7 2)"/ :3 %&&';)*7 "4'2$ "#&&
From the !pper ta le $e #et information that4 to #ain a CG ret!rn I can short sell decision for Uttara ank4 "&"MIT4 ),1T,14 and I+) at minim!m risk level of 8.40G.
&rom above calculation I have shown that b! allocatin different wei hts to different securities the investor can ma#imi/e his return. He can also "eep his ris" at desire level as well as he can achieve e#pected return. Here I have show that if short sellin is possible the theta and return can be ma#imi/ed than if short sellin is not allowed. -ut there is also disadvanta e of short sellin that is when mar"et falls , short sellin mechanism creates pressure to price fall which is not e#pected for share mar"et. $hatGs wh! in -an ladesh short sell is not allowed.
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