Portfolio Management

Final Project

Group Members:
1. Awais (011-17-0040)
2. Hafsa Ahmed (013-17-0024)
3. Qubra Hassan (013-17-0011)
4. Din Muhammad (013-17-0099)

Submitted with: Sir Raja Shahzad

Date: 31st July, 2021.

Page 1
 Table of Contents
Investment Policy Statement....................................................................................................3
Security Selection Process........................................................................................................4
Markowitz Optimal Portfolio Model.........................................................................................5
Return, Variance and Sharpe Ratio...................................................................................5
Variance and Covariance matrix.......................................................................................6
Portfolio with Short Sale...................................................................................................7
Portfolio without short sale..............................................................................................8
Global Minimum Variance Portfolio..................................................................................9
Optimal Risky Portfolio...................................................................................................10
Optimal Portfolio with Risky and Risk Free Assets..................................................................11
With Short selling............................................................................................................11
Without Short selling......................................................................................................12
 Investment Policy Statement

Client Name: Harry Potter

Date: 31st July, 2021.
Amount: $2,000,000

Statement Of Your Financial Objectives

Thank you for trusting Awais & Co. For your portfolio management. Our goal is to
establish a managed portfolio that achieves real growth, after inflation, with a level
of risk that is appropriate for your return. Following are the objectives for your
portfolio:
• To earn a reasonable return net of inflation while minimizing exposure to the stock
market fluctuations.
• To generate a significant amount of portfolio income.

Based upon our conversations and the information you provided, and given the long
term nature of your objectives, following is an overview of your investment policy.

Portfolio Description:
The portfolio would be based on stocks from the companies in NASDAQ 100 and S&P
500 Index. It would contain ten securities which might be changed from time to time
based on your preferences. The portfolio will also have treasury securities from the
money market so that you receive a return even in the worst situations.

Portfolio Rate of Return:

This portfolio recommendation is designed to generate an average, expected rate of
return of 2.5-3.5% above inflation, net of fees and costs. Based on current
projections, this equates to a current nominal return of 5.5-6.5%.

Investment Period:
The investment period is five years because increasing the time duration of
investment in stock market reduces the portfolio’s volatility and keeps us focused on
long term objectives instead of focusing on fluctuating short term market situations.

Risk Tolerance:
Your risk tolerance is a maximum, aggregate loss of 5% over a one-year time frame.
To mitigate with your risk aversion and fear of loss, we have added US treasury
securities with a current risk free rate of 4.34% annually, which are default free and
will always give you returns in the worst of situations too.

Portfolio Tax Strategies:

For now, the portfolio is not taxable.
Security Selection Process
The securities have been selected from The New York Stock Exchange (NYSE). The
companies have been selected from the index, S&P 50 Index. Top ten companies from every
sector have been selected and portfolio will consist of these companies. It is done to
maximize the return of an investor and reduce the risk because this would reduce the
correlation among the companies hence diversifying the portfolio. Which would result in
returns even when the overall market is in loss or not performing well.

Company Name Symbol Industry Sector

Cardinal Health,Inc CAH Health
FedEx Corporation FDX Transportation
Forward industries, Inc FORD Automotive
Merck & Company, Inc MRK Pharmaceuticals
Cisco Systems, Inc CSCO Telecom Hardware Manufacturing
Chevron  CVX Oil and Gas
Microsoft MSFT Technology
DuPont DD Chemicals
Sysco SYY Food service
American International Group AIG Insurance
The analysis is based on monthly returns ranging from price changes from July 2016 to June
2021.
We have selected securities only from the stock market and not any other kind of asset like
bonds or derivatives. Whereas, we will buy treasuries to make the portfolio balance
between risk free and risky assets. But, initially, the portfolio would be evaluated on the
basis of only containing the risky assets.
Markowitz Optimal Portfolio Model

Return, Variance and Sharpe Ratio

We started the Markowitz analysis by extracting data from the NYSE website. We extracted
monthly data from July 2016 to June 2021 of each company’s stock.
As we know that we should have Average Return, Variance, Sharpe Ratio and Risk free rate
for the Markowitz’s calculations. So, all of these parameters have been calculated in this
table below, taken from our excel computations.

Average
Monthly Monthly Average
Return Variance Std Rf Sharpe
CAH -0.0195% 0.007045832 8.39% 0.01% -0.0036
FDX 1.5458% 0.007968441 8.93% 0.01% 0.1720
FORD 2.5970% 0.036059468 18.99% 0.01% 0.1362
MRK 0.9299% 0.002536911 5.04% 0.01% 0.1825
CSCO 1.4421% 0.004686027 6.85% 0.01% 0.2091
CVX 0.7136% 0.006281757 7.93% 0.01% 0.0887
MSFT 2.9363% 0.002185566 4.68% 0.01% 0.6258
DD 0.6490% 0.008675884 9.31% 0.01% 0.0685
SYY 1.2684% 0.00728396 8.53% 0.01% 0.1474
AIG 0.5247% 0.009350698 9.67% 0.01% 0.0532
Table 1: Graph of basic parameters about the individual securities

These are all monthly computations and not annually.

The first column tells us about the average returns which are computed by subtracting
consecutive month prices, earlier from later, and dividing it by earlier. Then average of all
those values is taken.
Another column shows monthly variance. The variance of the rate of return (σ^2 ) is a
measure of volatility. It measures the dispersion of possible outcomes around the expected
value. Volatility is reflected in deviations of actual returns from the mean return. And from
this data we can see that the greatest monthly volatility is of Ford’s stock hence it also has a
higher return as compared to other stocks. However, Microsoft has a greatest return with
lower risk than Ford’s stock.
In order to prevent positive deviations from canceling out with negative deviations, we
calculate the expected value of the squared deviations from the expected return. The higher
the dispersion of outcomes, the higher will be the average value of these squared
deviations. Therefore, variance is a natural measure of uncertainty. From this data, it can be
seen that the highest dispersion is of Ford’s stock, 18.99% whereas the lowest deviation is of
Microsoft’s stock.
The risk free rate is calculated monthly with annual rate of 1.273% which is the rate of 10-
ear US treasury bill.
The importance of the trade-off between reward (the risk premium which will be calculated
by subtracting risk free rate from expected return of the stock) and risk (as measured by
standard deviation) suggests that we measure the attraction of a portfolio by the ratio of its
risk premium to the SD of its excess returns. This reward-to-volatility measure was first used
extensively by William Sharpe and hence is commonly known as the Sharpe ratio. It is widely
used to evaluate the performance of investment managers.
Risk premium
Sharpe ratio =
SD of excess return
Those securities are marked favourable whose Sharpe ratio is greater than the other
because their return would be greater than their risk. From the array of our securities, the
most favourable security with highest Sharpe Ratio is of Microsoft because of the factors
discussed above.

Variance and Covariance matrix

CAH FDX FORD MRK CSCO CVX MSFT DD SYY

CAH 0.007046 0.002946 0.004026 0.001441 0.003085 0.002385 0.001189 0.002624 0.0

FDX 0.002946 0.007968 0.001990 0.001035 0.001153 0.002263 0.001356 0.003080 0.0

FORD 0.004026 0.001990 0.036059 0.001217 0.001003 0.001751 0.002453 0.002718 0.0

MRK 0.001441 0.001035 0.001217 0.002537 0.001086 0.001210 0.000401 0.000994 0.0

CSCO 0.003085 0.001153 0.001003 0.001086 0.004686 0.002633 0.000958 0.002974 0.0
0.006281 0.001424 0.004386 0.0
CVX 0.002385 0.002263 0.001751 0.001210 0.002633 757 877 116
0.001424 0.002185 0.002245 0.0
MSFT 0.001189 0.001356 0.002453 0.000401 0.000958 877 566 705
0.004386 0.002245 0.008675 0.0
DD 0.002624 0.003080 0.002718 0.000994 0.002974 116 705 884
0.004685 0.001764 0.004015 0.0
SYY 0.001580 0.002481 0.001679 0.001219 0.002058 978 504 151
0.004571 0.001306 0.004274 0.0
AIG 0.003168 0.002921 0.002639 0.000079 0.002518 505 588 692
Table 2: Variance-Covariance Matrix of Securities

The diagonal shows the variance of the securities and other values in the matrix show the
covariance between the securities. Positive covariance shows the positive relationship
between the securities that is the security’s value increase or decrease simultaneously. And
negative shows the negative relationship, that is both securities move in opposite direction.
From our data, we could see that there is not a single security which moves negatively to the
other one, which means these securities have a positive correlation to each other. Hence, in
the time of good economic growth, the securities would generate profits, and in the time of
recession, all would bear losses.
Portfolio with Short Sale
3.00%

2.50%

2.00%
E (Rp)

1.50%

1.00%

0.50%

0.00%
3.00% 3.50% 4.00% 4.50% 5.00% 5.50% 6.00%
Standard Deviation

Graph 1: this is the graph of all the portfolios made with increasing returns and their standard
deviations.
Sharpe
Return Risk Ratio
Portfolio 1 0.10% 5.38% -0.0011
Portfolio 2 0.20% 5.23% 0.0180
Portfolio 3 0.30% 5.08% 0.0382
Portfolio 4 0.40% 4.93% 0.0596
Portfolio 5 0.50% 4.79% 0.0823
Portfolio 6 0.60% 4.65% 0.1062
Portfolio 7 0.70% 4.52% 0.1315
Portfolio 8 0.80% 4.39% 0.1581
Portfolio 9 0.90% 4.27% 0.1860
Portfolio 10 1.00% 4.15% 0.2153
Portfolio 11 1.10% 4.04% 0.2457
Portfolio 12 1.20% 3.94% 0.2774
Portfolio 13 1.30% 3.85% 0.3100
Portfolio 14 1.40% 3.77% 0.3434
Portfolio 15 1.50% 3.69% 0.3773
Portfolio 16 1.60% 3.63% 0.4115
Portfolio 17 1.70% 3.58% 0.4457
Portfolio 18 1.80% 3.53% 0.4793
Portfolio 19 1.90% 3.50% 0.5121
Portfolio 20 2.00% 3.48% 0.5437
Portfolio 21 2.10% 3.48% 0.5736
Portfolio 22 2.20% 3.48% 0.6016
Portfolio 23 2.30% 3.50% 0.6274
 Portfolio 24 2.40% 3.53% 0.6507
Portfolio 25 2.50% 3.57% 0.6715
Portfolio 26 2.60% 3.62% 0.6897
Portfolio 27 2.70% 3.68% 0.7054
Table 3: this is the summary of those portfolios plotted in graph.

Portfolio without short sale

3.00%

2.50%

2.00%
E (Rp)

1.50%

1.00% Portfolio

0.50%

0.00%
2.50% 1002.50% 2002.50% 3002.50% 4002.50%
Standard Deviation

Graph 2: This is the graph of all the portfolios made to maximize return but not allowed to
short sell.
Target
Return σ Sharpe
Portfolio 1 0.10% 7.52% -0.0008
Portfolio 2 0.20% 6.86% 0.0137
Portfolio 3 0.30% 6.24% 0.0311
Portfolio 4 0.40% 5.68% 0.0518
Portfolio 5 0.50% 5.20% 0.0758
Portfolio 6 0.60% 4.82% 0.1025
Portfolio 7 0.70% 4.57% 0.1300
Portfolio 8 0.80% 4.43% 0.1565
Portfolio 9 0.90% 4.31% 0.1842
Portfolio
10 1.00% 4.32% 0.2069
Portfolio
11 1.10% 4.08% 0.2693
Portfolio
12 1.20% 3.98% 0.3012
Portfolio
13 1.30% 3.89% 0.3339
Portfolio
14 1.40% 3.82% 0.3667
Portfolio
15 1.50% 3.75% 0.4001
Portfolio
16 1.60% 3.70% 0.4330
 Portfolio
17 1.70% 3.66% 0.4642
Portfolio
18 1.80% 3.64% 0.4950
Portfolio
19 1.90% 3.64% 0.5226
Portfolio
20 2.00% 3.64% 0.5489
Portfolio
21 2.10% 3.68% 0.5714
Portfolio
22 2.20% 3.72% 0.5907
Portfolio
23 2.30% 3.79% 0.6067
Portfolio
24 2.40% 3.88% 0.6186
Portfolio
25 2.50% 3.99% 0.6266
Portfolio
26 2.60% 4.12% 0.6312
Portfolio
27 2.70% 4.27% 0.6329
Table 4: This is the summary of portfolios not allowed to short sell but to maximize return

Global Minimum Variance Portfolio

GMVP Computation
Assets Short Sale Without Short Sale
CAH -6.60% 0.00%
FDX 3.28% 0.07%
FORD -1.38% 0.00%
MRK 44.57% 41.18%
CSCO 12.00% 5.40%
CVX -1.03% 0.00%
MSFT 55.03% 47.94%
DD -10.02% 0.00%
SYY -7.63% 0.00%
AIG 11.77% 5.41%
Total Weight 100% 100.00%
μ 2.11% 1.90%
RF 0.11% 0.11%
0.0012 0.0013
σ 3.48% 3.63%
The table above shows that these are the combinations of the assets which combine
together to form a portfolio with minimum possible variance and standard deviation out of
all possibilities and combinations of the assets by their weights.
The securities, like, CAH, FORD, DD, and SYY will have short position in order to achieve the
lowest possible standard deviation.
So, with short position the portfolio has a greater return and smaller risk/standard deviation.
Whereas, when the short selling is not allowed, the return is also lower while the risk is
higher. So, it is beneficial for the manager of the portfolio to short sell securities if allowed
by the client.
Optimal Risky Portfolio
Portfolio Risk & Return (Sharpe Maximize)
Assets Short Sale Without Short Sale
CAH -27.25% 0.00%
FDX 8.74% 0.00%
FORD 0.31% 0.00%
MRK 21.46% 10.71%
CSCO 26.91% 0.18%
CVX -4.58% 0.00%
MSFT 103.82% 89.10%
DD -25.21% 0.00%
SYY -10.23% 0.00%
AIG 6.05% 0.00%
Total Weight 100.0% 100.0%
μ 3.49% 2.72%
0.0020 0.0018
σ 4.47% 4.30%
RF 0.01% 0.01%
Sharpe 0.7780 0.6306
Table 5: Optimal Risky Portfolio with and without Short selling

This table indicates optimal risky portfolio which means that the portfolio with highest
Sharpe ratio. These allocation of weights would be the most perfect one to maximize the
Sharpe ration in both conditions. This portfolio also suggests that with short sale the
portfolio will give greater returns but higher standard deviation/risk whereas when the short
sell is not allowed will give smaller returns and risk smaller than the one without short sale.
Optimal Portfolio with Risky and Risk-Free Assets

With Short selling

4.00% 3.90%

3.50% 3.40%

3.00% 2.90%

2.50% 2.40%

2.00% 1.90%
Erp

CAL
1.50% 1.40% Optimal Portfolio
GMVP
1.00% 0.90%

0.50% 0.40%

0.00% -0.10%
0.25% 1.25% 2.25% 3.25% 4.25% 5.25%
SD

Graph 3: This is the graph showing Capital Allocation Line and Optimal Portfolio

Weight in risky Asset 75.66%

Weight in risk Free Asset 24.34%
Portfolo Return 2.67%
Portfolio Risk/STD 3.38%
Table 6: This table is the summary of the weights assigned to Risky and Risk free Assets
from the fund of $2,000,000.
Total Fund USD 20,000,000
Investment in Risk Free USD 4,867,564.56
Investment in Risky USD 15,132,435.44
Investment in Indivisual
Asset Amount
CAH USD (4,124,275.87)
FDX USD 1,322,312.49
FORD USD 46,156.67
MRK USD 3,246,747.16
CSCO USD 4,071,511.05
CVX USD (693,303.68)
MSFT USD 15,710,236.96
DD USD (3,814,399.50)
SYY USD (1,548,182.71)
AIG USD 915,582.93
Total USD 15,132,450.56
Table 7: This table shows the total breakdown summary of all the assets to be allocated in the
particular asset class, risk free, and each security of the risky asset.
Without Short selling

Tangency Portfolio Without Short Sale

6.0000%

5.0000%

4.0000%

CAL
3.0000%
ERp

Optimal Portfolio
GMVP

2.0000%

1.0000%

0.0000%
0.19% 1.19% 2.19% 3.19% 4.19% 5.19% 6.19% 7.19% 8.19% 9.19%

SD

Graph 4: This is graph of optimal portfolio including risk-free and risky assets plotted against
Capital Allocation Line (CAL)
Weight in risky Asset 100.0%
Weight in risk Free Asset 0.00%
Portfolo Return 2.719%
Portfolio Risk/STD 4.295%
Table 8: summary of assets allocated in risk-free and risky assets
Total Fund USD 2,000,000
Investment in Risk Free USD -
Investment in Risky USD 2,000,000.00
Investment in Individual
Asset Value
CAH 0
FDX 0
FORD 0
MRK 214224.6116
CSCO 3697.844598
CVX 0
MSFT 1782077.549
DD 0
SYY 0
AIG 0
Total USD 2,000,000.01
Table 9: Summary of assets allocated in optimal Risky Portfolio when short sale is not
allowed.
Single Index Model
The systematic factor affects the rate of return on all stocks, the rate of return on a
broad market index can plausibly proxy for that common factor. This approach leads to an
equation similar to the single-factor model which is called a single-index model because
it uses the market index to stand in for the common factor. The general equation for Single-
index model is written below.
r i=E (r i )+ βi m+ ei
The regression equation for the Single-index model is written below.
The intercept of this equation (denoted by the Greek letter alpha, or α) is the security’s
expected excess return when the market excess return is zero. It is the vertical intercept.
The slope of the line in the figure is the security’s beta coefficient, βi . Beta is the amount by
which the security return tends to increase or decrease for every 1% increase or decrease in
the return on the index, and therefore measures the security’s sensitivity to the market
index. E(i )is the zero-mean, firm-specific surprise in the security return in month t, also
called the residual.
Multifactor Model:
In addition to Markowitz Model and Single Index Model we also used Multifactor Model to
determine optimal portfolio and risk and return on that. For practicality of this model we
were required to analyze and select those factors which have large impact on our portfolio,
as there are so many macroeconomic factors which has impact on portfolio but we can not
employee each and every factor given time and resources. This is why we selected only two,
the most factor which has severe impact on portfolio’s risk and return. These factors are
change in GDP and interest rate over the time.

Shown in excel table our analysis of multi-factor model begins with using monthly GDP
growth rates and interest rates and finding changes in time series of both factors.

In second step, we found Betas of each security with respect to these factors. Beta of GDP is
found by determine slope between change in GDP growth rates and return on security and
this process is repeated in finding the Beta of interest rate for each security.
In third step, using weights already found from Markowitz we found portfolio beta of both
factors. And then we found overall expected return on portfolio employing both factors
beta. Results are shown below:

Given share price we can purchase following number of shares from the Multi-factor
Analysis.
Group Task Done:
Awais: Markowitz Model, Single Index Model, Multiple Index Model
Din Muhammad: Multifactor Model, written Report
Hafsa: IPS, Written report, Markowitz Model, Single Index Model
Kubra: Single Index Model and coordinated the group tasks