Summary: Portfolio Management
Portfolio Management
Risk
Standard deviation(σ)*
OR
Variance (σ2)**
Overall risk
*Normally calculate Std. Dev.(σ) for overall risk.
plus **Consider variance as overall risk at the time of
calculation of systematic and unsystematic risk.
Systematic Risk
= β2security X σ2market
(It cannot be diversified because
it depend upon economy)
Even β is a systematic risk, we
do not calculate β when question
ask for calculation of systematic
risk. Because we have to
calculate systematic risk in “%”
term. But β is in times term.
Suppose EBT is 1.5 times of
EAT, and EAT is 12% then what
is EBT?
Here, EBT = EBT X EAT
i.e. EBT = (1.5 X 12%) = 18%.
CA. Nagendra Sah
Unsystematic Risk
= σ2Security - Systematic risk
(It Can be diversified because
it is specific to firm)
OR we can say,
σ2Security = Systematic +
unsystematic risk
Return
Required return (CAPM) Available Return
(When return considers risk factor) (When return do not considers risk factor)
Required return = RF + β security (RM - RF) Dividend + Value appreciation
Return = Price at beginning
Where, RF = Return Risk free
RM = Return Market OR
β security = systematic risk (in time) D1 + (P1 - P0)
= P0
When, CAPM< Available Return = Buy
CAPM>Available Return = Sell
CAPM = Available Return = Hold
i.e. Expected Return (or Average Return)
Security Market line is a graphical representation of CAPM.
On Security On Portfolio
(Say, Security A) [Say, Portfolio consists of Security “A” and “B”]
Alternative-1: Alternative-1:
(When different possible Returns are given with their probabilities)
[when information about proportion of investment
Expected or Average Return on security “ A” = has been given]
(Possible Return-1 X Probability-1)
+ (Possible Return-2 X probability-2) R portfolio = (RA WA + RB WB)
+ (Possible Return-3 X probability-3)
+ ( … … ………… X …………..) Where, RA & RB = Return on security A & B.
WA = Proportion of security A with Total
Alternative-2 investment.
(When different possible Returns are given without probabilities) WB = Proportion of security B with Total
investment.
Expected or Average Return on security = Alternntive-2:
(when no information about investment given)
Email: ca_npsah@icai.org
 Summary: Portfolio Management
For Second Method see, (Possible Return-1 + possible Retunr-2 + possible R.-3 + ….) RA + RB + … …
Correlation coefficient Return Portfolio
No. of Return No. of return
=

Standard Deviation (σ)

On one Security On Portfolio

[Say, Portfolio consists of Security “A” and “B”]
σ portfolio = √ Variance (σ )
2

Alternative-1: Alternative-1:
(When different possible Returns are given with their probabilities)
σ portfolio = √(σA WA) + (σB WB) + 2 (σA WA) (σB WB) rAB
Variance (σ2) = (Possible Return 1 - mean return) X Probability-1
Where, σA & WB = Standard deviation of security A and B,
+ (Possible Return 2 -mean return) X probability-2
+ (Possible Return 3 -mean return) X probability-3 WA & WB = Proportion of Security A and B,
+ ( … … ……… - …………….. .) X …………
Alternative-2: rAB = Correlation coefficient of A with B.
(When different possible Returns are given without their probabilities)
(Possible R 1-Mean R) + (Possible R 2 - Mean R) + … … … Alternative 2: (when, rAB = +1)
No of items σportfolio = (σA WA) + (σB WB)
Alternative 3: (when, rAB = -1)
σportfolio = (σA WA) - (σB WB)

Co-variance :

Correlation coefficient (r):

The value of Correlation Coefficient (r) must fall between -1 to +1.
If “rAB” is positive it will signify that returns in security A are increasing while in the security B also they are increasing.
If “rAB” is Negative it will signify that returns in security A are increasing while in the security B they are decreasing.
If correlation is “-1” i.e. perfect negative, overall risk can be brought to “nil”

CA. Nagendra Sah Email: ca_npsah@icai.org

Summary: Portfolio Management
And in this case proportion of one security =
σ one security
σ one security + σ other security

If correlation is other than “-1” i.e. say +0.5, -0.2, 0, +1 etc. overall risk can not be brought to nil but it can be minimize,
And in this case proportion of one security =
σ one security - Co-variance (one with other)
σ2 one security + σ2 other security - 2 Co-variance (one with other)

Coefficient of determination (r2):

According to sharp, Variance explained by the market index is systematic risk and unexplained variance is the unsystematic risk.
Coefficient of determination shows that, “(r2) %” of variance in security is explained by Market index.
Hence we can say that, Systematic risk = r2 X σ2 security and Unsystematic risk = (1- r2) X σ2security

Beta:

On Security On portfolio Project

Market line

Security market line Capital market Line Characteristic line

 Security Market line is a graphical representation of CAPM. Expression:
Expression: Character line (required return) = Alpha + β security X RM
Required return = RF + β security (RM - RF)

Variable fix Variable fix Variable fix fix variable

i.e. Ans is in this form: Req. Return = 10 + β security X 5 i.e. Ans is in this form: Character line(Req. Return) = 4 + 1.5 X R M

CA. Nagendra Sah Email: ca_npsah@icai.org

Summary: Portfolio Management
Alpha:
Alternative-1: Alternative-2:
(When Risk free return given) (When Risk free return not given)
Alpha = Available Return Security - Required return CAPM Alpha = Available Return Security - β security X RM
i.e. Available return - {RF + β security (RM -RF)} i.e. Available return - { RF + β security (RM - RF)}

CA. Nagendra Sah Email: ca_npsah@icai.org