It is always nice

to see you all with

lot of POSITIVITY
AND ENERGY!
Let’s start with
some pieces of
wisdom from
Stock Market.
Wall Street people learn nothing and forget everything.
---Benjamin Graham

“Don’t try to buy at the bottom and sell at the top. It can’t be
done except by liars.”
-Bernard Baruch
Let’s move to next item of
our agenda!
 PORTFOLIO ……???

A set of securities combined in some

proportion is called portfolio.

While modeling Portfolios, we must
understand the issues in the construction
of portfolio.

 What should be the security set from which securities

are to be selected?

 In what proportion the securities are to be combined?

 How to evaluate a portfolio?

 How to select the optimum portfolio?

Let’s learn and understand…

THE MATHEMATICS AND

STATISTICS OF PORTFOLIO
 Let’s understand some of Diversification
Mathematics
(Below {xj} or {xk} are portfolio proportions (constants) and {Rj}, {Rk} are
random security rates of return of securities j and k

E(x1R1 + x2R2) = x1E(R1) + x2E(R2)

Cov(Rj, Rj) = Var(Rj)

Cov(x1R1, x2R2) = x1x2 Cov(R1, R2)

Var(x1R1+ x2R2) = x21 Var(R1) + x22 Var(R2) + 2 x1x2 Cov(R1, R2)

 THE MATHEMATICS AND STATISTICS OF
PORTFOLIO - SOME RESULTS
 The expected return on a portfolio is the portfolio-weighted average of the expected returns of the
individual shares in the portfolio. n
Rp =  xi Ri
i =1

 The variance of a portfolio is n n

 2
=   xi x j  ij
i =1 j =1
Or
n n
 2
=   xi x j ij  i j
i =1 j =1
 Given positive portfolio weights on two shares, the lower the correlation between them, the lower
the variance of the portfolio.
THE MATHEMATICS AND STATISTICS OF
PORTFOLIO – MATRIX FORM

 The expected return on a portfolio is -

Rp = W T R

 The variance of a portfolio is -

 2 = W T W
 MINIMUM VARIANCE PORTFOLIOS - SOME
THEOREMS

 A portfolio with two shares will have minimum variance if the

weight of one of the shares in the portfolio will be

 2 2 − 1 2
x= 2
 1 +  2 2 − 2 1 2

 A portfolio of a group of shares that minimizes the return variance

is the portfolio that has an equal covariance with every share
return.
What
next?
Recall the challenges that we
have put before ourselves
regarding portfolio…
While modeling Portfolios, we must
understand the issues in the construction
of portfolio.

 What should be the security set from which securities

are to be selected?

 In what proportion the securities are to be combined?

 How to evaluate a portfolio?

 How to select the optimum portfolio?

Our efforts to resolve these issues
about portfolio takes us to the
portfolio theory …… A Quick Review
MARKOWITZ MODEL
Markowitz said that
since a security is evaluated in terms
of Risk and Return parameters, a
portfolio should also be evaluated in
terms of Risk and Return.
Return and Risk of a Portfolio

n
E (RP ) =   i E (Ri )
i =1

n n n
 (RP ) =   i  i +    i j Cov (Ri , R j )
2 2

i =1 i =1 j =1

i j

Where
E(RP) = Expected Return of the Portfolio
(RP) = Standard Deviation of return on a portfolio
i = Proportion of ith security in the portfolio
i2 = Variance of ith security
E(Ri) = Return on ith security
Cov(Ri,Rj) = Covariance between the return of ith security and the return of the jth security
Markowitz said - “it is the nature and
the degree of covariances existing
among securities that determine
whether risk in a portfolio could be
reduced”.
Are we searching for an OPTIMUM PORTFOLIO ……???

 If YES!? Then, first, look for an efficient set of portfolios.

 A set of portfolios is called an efficient set if all the portfolios in it are

non-dominated portfolios in the sense of mean-variance dominance
principle.

 MEAN - VARIANCE DOMINANCE PRINCIPLE says that a portfolio is a dominating over

the other portfolio if

 for the same or more expected return a portfolio is having same or less risk.

 for the same or less risk a portfolio is having more expected return.
MINIMUM VARIANCE SET OF PORTFOLIOS?

If two or more portfolios

from minimum variance
set are combined, then the
resultant portfolio also has
minimum variance.

O Standard Deviation
MINIMUM VARIANCE
PORTFOLIOS – TWO SECURITIES

 A portfolio with two shares will have minimum variance if the

weight of one of the shares in the portfolio will be

 2 2 − 1 2
x= 2
 1 +  2 2 − 2 1 2
 If two securities are having perfect negative correlation then the
weight of the first security will be –
𝜎22
𝑥1 =
𝜎1 + 𝜎2
EFFICIENT FRONTIER ……???
F
Expected Return Y

X
If two or more efficient
A B C portfolios are combined,
then the resultant portfolio
is also efficient portfolio.

Standard Deviation
OPTIMUM SELECTION OF A PORTFOLIO DEPENDS UPON RISK
- RETURN TRADE - OFF!!!
F

Expected Return
P

OPTIMUM
PORTFOLIO

Standard Deviation
It is enough for the day!
ENJOY AND
HAVE FUN!

THANK
YOU
VERY
MUCH