learn how to

Efficient Portfolio
Formation
Presented by Group 2:
1. Aliya Binti Khoeriyah (2010631030046)
2. Lia Najwa Sholihah (2010631030087)
Table of contents
1. Efficient Portfolio Concept
2. Utility Function and Indifference Curve
3. Formation of an efficient portfolio
* Combination of risky securities, without short sales
* Combination of risky securities, with short sales
* Combination of risky and risk-free securities
4. Portfolio selection
 BASIC CONCEPTS
Forming a portfolio can result in:

Reducing risk (effective if the correlation

coefficient between shares is low) → efficient
portfolio.

Investment combinations that dominate

certain stocks→ provide lower risk and higher
expected returns
BASIC CONCEPT
Definition of an efficient portfolio:
A portfolio that provides the highest return with a
certain risk.

*A collection of efficient portfolios is called an

efficient set/efficient frontier.

*There are several conditions:

1. Combination of risky securities, without short
sales
2. Combination of risky securities, with short sales
3. Combination of risky and risk-free securities
 Utility Functions
★ The utility function can be interpreted as a
mathematical function that shows the value of all
available alternative choices.

★ The utility function shows an investor's

preferences for various investment options with
their respective risks and expected levels of
return.

★ The utility function can be depicted graphically

as an indifference curve.
Indifference Curves
💰 The indifference curve describes a
collection of portfolios with respective
combinations of expected return and risk
that provide the same utility for investors.

💰 The positive slope of the indifference

curve illustrates that investors always want
greater returns as compensation for higher
risks.
Choose the Optimal Portfolio
◆ An efficient portfolio is a portfolio that
provides maximum returns for investors
with a certain level of risk.

◆ An investor's optimal portfolio is the

portfolio that the investor chooses from the
many choices contained in an efficient
portfolio
Portfolio Management
★Making asset allocation decisions
★Determining the portion of funds to be
invested in each asset

★ Selection of assets from the chosen

asset class.
Combination of 2 Risky Securities,
No Short Sales

Without short sales, the maximum funds in a

security are 100% and the minimum is 0%.

If short sales are not permitted, in a

portfolio with two securities, the funds
invested in A and B will be 100%.
Short Sales
Definition:
Selling shares that are not owned (= debt)

★ Generally done on shares that are expected to

give negative returns in the future.

★Example:
Investor X estimates that BBNI shares will be in
decline currently has a market price of Rp10,000,00
per sheet, will fall in value to Rp7,000,00 at the end
of the year.
Shares and estimated dividend of Rp2,000,00
at the end of the year.
Combination of 2 risky securities,
short sales allowed
💰 It is possible for investors to invest a
negative proportion of their funds in shares
subject to short sales.

💰 Investors make short sales if the expected

level of profit in the future is negative.
Combination of More Than 2 Risky Securities,
With Short Sales
The calculation formulation can be found with
the equation:

* Can be solved with quadratic programming.

Combination of Risky and
Risk-Free Assets
💸 The efficient frontier will experience
changes.

💸 By entering Rf, the efficient frontier will

form a straight line connecting Rf with the
risky asset portfolio chosen by the investor.

💸 Combination options
- Investing risk-free funds
- Borrowing risk-free funds
 ASSETS AT RISK
★ The more risk averse an investor is, the
more likely their investment choices will be
in risk-free assets.

★ Risky assets are assets whose actual rate

of return in the future still contains
uncertainty.

★ One example of a risky asset is shares.

RISK FREE ASSETS

◆ Risk free assets are assets whose future level

of return can be ascertained at this time, and
is indicated by a return variance that is equal
to zero.

◆ One example of a risk-free asset is a short-

term bond issued by the government, such as
a Bank Indonesia Certificate (SBI).
 Markowitz Portfolio
Model
PORTFOLIO THEORY WITH THE MARKOWITZ MODEL IS BASED ON
SOME ASSUMPTIONS, NAMELY:

1. Single investment period, for example 1 year.

2. There are no transaction fees.
3. Investor preferences are based solely on expected
return and risk.
4. There are no loans and free savings risk.
Selecting the Optimal Portfolio
The efficient frontier is the combination of assets that
form an efficient portfolio.
Optimal portfolio selection is based on investor
preferences for expected returns and risks indicated by
the indifference curve.
selecting the optimal
portfolio
Line E is included in the Efficient
Frontier, for a certain level of risk
it will produce a greater level of
profit at the minimum variance
set.
Investors make decisions which
are referred to as asset allocation
decisions.
This decision concerns the
selection of asset classes that will
be used as investment options.
Portfolio Management
Make allocation decisions
Determine the proportion of funds
invested in each asset class (asset class:
grouping assets based on asset types)
Selection of assets from each asset class
of his choice
A portfolio that also consists
of risk-free assets
By entering Rf in the Markowitz model, the
efficient surface will turn into a straight line
connecting Rf and the optimal portfolio
point chosen by the investor.

E(Rp) = Wrf.Rf + (I-Wrf).E(RL)

SDp = (I-Wrf) SDL

Note:
E(Rp) = Expected Return Portfolio
SDp = Standard Deviasi Portfolio
Problem example
Portfolio A offers an expected rate of return of 30% with a
standard deviation of 8%. Meanwhile, risk-free assets
offer a return of 10%. Investors want to invest their funds
in risk-free assets with a proportion of 50% and the
remainder in portfolio A.

Answer:
E(Rp) = Wrf. Rf + (1-Wrf). E (RL)
= 0,5 (0,1) + 0,5. (0,3) = 0,20

SDp = (1-Wrf) SDL = 0,5 (0,08) =0,04

Next, if the remaining 25% of
assets are risk-free, portfolio L ..

E(Rp) = Wrf. Rf + (1-Wrf). E (RL)

= 0,25 (0,1) + (1-0,25). (0,3)
= 0,25

SDp = (1-Wrf) SDL

= (1-0,25) 0,08
= 0,06
 Portfolio using borrowed funds to
increase investment capabilities
1. If investors use additional investment funds that come from loans,
investors will have the possibility of getting a higher desired
return, but of course the risk will also increase along with the
increase in expected return.
2. Assuming the loan funds are as large as the previous funds

E(Rp) = -1. Rf + 2. E (RL)

SDp = 2. SDL
problem example
Portfolio L offers an expected return of 30% with a standard deviation of 8%.
Meanwhile, risk-free assets offer a return of 10%. Investors want to increase
investment funds by using a loan equal to the previous funds.

Answer:
E(Rp) = -1. Rf + 2. E (RL)
= -1. 0,1 + 2 (0,3)
=0,5

SDp = 2. SDL
= 2. 0,8
=0,16
 Sample case
Assuming investors borrow funds equal to previous
funds. The investor plans to invest his funds in Portfolio
ABC which offers an expected rate of return of 35% with
a standard deviation of 10%. Meanwhile, risk-free assets
offer a return of 7%. Calculate the expected return and
its standard deviation.

Answer:
E(Rp) = -1. Rf + 2. E(RL)
= -1 . 0,07 + 2 . 0,35
= 0,63

SDp = 2. SDL
= 2 . 0,1
= 0,20
sample case 2
The investor plans to invest his funds in Portfolio ABC
which offers an expected rate of return of 25% with a
standard deviation of 10%. Meanwhile, risk-free assets offer
a return of 6%.
Calculate the expected return and standard deviation
based on the following investment scenario:

1. 100% portion of funds in risk-free assets

2. 40% portion of funds in risk-free assets and 60% in risky
assets
3. 35% portion of funds in risk-free assets and 65% in risky
assets
4. 100% portion of funds in risk assets
sample case 2
E(Rp) = Wrf. Rf + (1-Wrf). E (RL)
SDp = (1-Wrf) SDL

Answer:
Scenario 1 Scenario 3
E(Rp) = 1 . 0,06 + (1-1) . 0,25 E(Rp) = 0,35 . 0,06 + (1-0,35) . 0,25
= 0,06 = 0,18

SDp = (1-1) . 0,1 SDp = (1-0,35) . 0,1

=0 = 0,065
Scenario 2 Scenario 4
E(Rp) = 0,4 . 0,06 + (1-0,4) . 0,25 E(Rp) = 0 . 0,06 + (1-0) . 0,25
= 0,17 = 0,25

SDp = (1-0,4) . 0,1 SDp = (1-0) . 0,1

= 0,06 = 0,10
 Refrence
Christiana, Irma. “ANALISIS PEMBENTUKAN PORTOFOLIO YANG
EFISIEN PADA PERUSAHAAN KERAMIK, KACA DAN PORSELEN
YANG TERDAFTAR DI BURSA EFEK INDONESIA DENGAN MODEL
MARKOWITZ”.
Elton & Gruber.Modern portofolio theory and investment analysis.
John Wiley & Sons,Inc. Tandelilin Analisi investasi dan manajemen
portofolio. BPFE yogyakarta Hartono, jogiyanto Analisi investasi
dan manajemen portofolio. BPFE yogyakarta
Fransiscus - 2003 - Analisis Pembentukan Portofolio yang Efisien
(Studi Kasus pada Perusahaan Limun Sari Cola, Batusangkar,
Sumatera Barat) -
file:///C:/Users/User/Documents/UNSIKA/Semester%207/Analisis%2
0Sekuritas%20dan%20Portofolio/Refrence/982114137_Full%20(1).pdf
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