INTRODUCTION

❖Harry Markowitz (1927– ) is a Nobel Prize winning economist who

devised the Modern Portfolio Theory (MPT).
❖Markowitz introduced MPT in his article, "Portfolio Selection," which
appeared in The Journal of Finance in 1952.
❖His work, in collaboration with Merton H. Miller and William F.
Sharpe, changed the way that people invested.
❖These three intellectuals shared the 1990 Nobel Prize in Economics.
MODERN PORTFOLIO THEORY (MPT)
Essence of Markowitz Model
“Do not put all your eggs in one basket”
CONCEPT
In developing the model, Markowitz has given up the single stock portfolio and introduced
diversification. The single stock portfolio would be preferable if the investor is perfectly
certain that his expectation of higher return would turn out to be real. But in this era of
uncertainty most of the investors would like to join Markowitz rather than single stock.
We all agree that holding two stocks is less risky as compared to one stock. But building the
optimal portfolio is very difficult.
ASSUMPTIONS
❖ An investor has a certain amount of capital he wants to invest over a single time
horizon.
❖ He can choose between different investment instruments, like stocks, bonds, options,
currency, or portfolio.
❖ The investment decision depends on the future risk and return.
❖ The decision also depends on if he or she wants to either maximize the yield or
minimize the risk.
❖ The investor is only willing to accept a higher risk if he or she gets a higher expected
return.
VARIABILITY CALCULATION
❖The greater the variability of returns, the greater is the risk. Thus, the investor chooses assets
with the lowest variability of returns.
FOR EXAMPLE:
Taking the return as the appreciation in the share price, if TELCO shares price varies from Rs.
338 to Rs. 580 (with variability of 72%) and Colgate from Rs. 218 to Rs. 315 (with a variability
of 44%) during 1998, the investor chooses the Colgate as a less risky share.

FORMULA FOR VARIABILITY:

VARIABILITY= new value - previous value *100
previous value
BENEFITS OF MPT
❖MPT is a useful tool for investors trying to build diversified portfolios.
❖MPT can be used to reduce the volatility.
❖Modern portfolio theory allows investors to construct more efficient portfolios. Every
possible combination of assets that exists can be plotted on a graph, with the portfolio's
risk on the X-axis and the expected return on the Y-axis. This plot reveals the most
desirable portfolios. For example, suppose Portfolio A has an expected return of 8.5%
and a standard deviation of 8%. Further, assume that Portfolio B has an expected return
of 8.5% and a standard deviation of 9.5%. Portfolio A would be deemed more efficient
because it has the same expected return but lower risk.