# Harry Markowitz’s Portfolio Theory Model

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NAME ROLL NO.

Tushar Joshi Pratiksha Pandya Komal Fulekar Mandar Panchal

14 30 09 28

investors should select portfolios not individual securities.deviation.  In a nutshell." which appeared in the 1952. investors should focus on selecting portfolios based on their overall risk-reward characteristics. .  Prior to Markowitz's work.  Markowitz proposed that with the help of std. covariance.Introduction To Portfolio Theory  Modern portfolio theory was introduced by Harry Markowitz with his paper "Portfolio Selection. investors focused on assessing the risks and rewards of individual securities in constructing their portfolios. correlation.

the risk may be reduced. An investor is risk averse. If investors will purchase no. . An investor prefers to increase consumption. An investor is rational in nature. of shares of different companies.Assumptions while developing the HM model Risk of a portfolio is based on the variability of returns from the said portfolio.

5 each return 14 Variance 9 36 6 Standard deviation 3 .Return On Portfolio Stock ABC Return % Probability Expected Return 11 or 17 0.5 each return 14 Stock XYZ 20 or 8 0.

5(20-14) ² + .5 x 11+ .ABC expected return: .5x17= 14 XYZ expected return: .5(17-14) ²= 9 XYZ variance= .5(11-14)² + .5x8= 14 ABC variance = .5 x 20+ .5(8-14) ²= 36 ABC standard deviation= 3 XYZ standard deviation= 6 .

Now ABC and XYZ have same expected return of 14 % but XYZ stock is much more risky as compared to ABC because the standard deviation is much more high. . R₁= expected return of security 1. Suppose the investor holds 2/3 of ABC and 1/3 of XYZ the return can be calculated as follows: Rp=∑X₁ R₁ Rp= return form portfolio X₁= proportion of total security invested in security 1.

. than by holding either of security individually  Holding two securities may reduce portfolio risk too.Let us calculate the expected return for both possibilities  possibility 1 : 2/3 x 11 + 1/3 x 20 = 14  possibility 2: 2/3 x 17 + 1/3 x 8 = 14  In both the cases the investor stands to gain if the worst occurs.

X2 = proportion of total portfolio in stock 2. σ1. r12 = correlation co-variance of X1 and X2. X1 = proportion of total portfolio in stock 1. σ1 = standard deviation of stock 1.Risk on Portfolio according to Markowitz model σ p=√[(X1)²(σ1) ²] + [(X2)²(σ2) ²] + 2X1X2(r12 . . σ2 = standard deviation of stock 1. σ2) where.

. R2 = Return percentage on stock 1 . R2 . R1 = Return percentage on stock 1 . (R2 – R2) 2 i=1 where . R1 .r 12 = covariance of X12 σ1 σ2 n covariance of X12 = 1 ∑ (R1 – R1) .

5 each return Stock XYZ 20 or 8 0.Example : Return % Probability Stock ABC 11 or 17 0.5 each return Expected return Variance Standard deviation 14 9 3 14 36 6 .

Solution : n covariance of X12 = 1 ∑ (R1 – R1) . (R2 – R2) 2 i=1 = 1 [(11-14)(20-14) + (17-14)(18-14)] 2 = -18 r 12 = covariance of X12 σ1 σ2 = -18/ (3 X 6) = -1 .

σ p = √[(X1)²(σ1) ²] + [(X2)²(σ2) ²] + 2X1X2(r12 . σ1. σ2) = √[(2/3)² x 9] + [(1/3)² x 36] + [2 x (2/3) x (1/3) x (-1 x 3 x 6)] = √ 4 + 4 + (-8) =0 .

LIMITATIONS .

CONCLUSION .