Portfolio Management
Unit – 1
Assignment
1. How would you describe the portfolio approach to investing?
Answer
According to the portfolio perspective, individual investments should be judged in the context of how much risk they add to a portfolio rather than on how risky they are on a stand-alone basis.
•
A Portfolio is a group of securities held together as investment.
•
Investor invests their funds in a portfolio of securities rather than in a single security because they are risk averse.
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A grouping of financial assets such as stocks, bonds and cash equivalents, as well as their mutual, exchange-traded and closed-fund counterparts.
•
Portfolios are held directly by investors and/or managed by financial professionals.
•
Individuals investment their savings into various Portfolio Securities:
Stocks, Bonds, Mutual Funds, Derivatives, Real Estates, etc.,
First, professional investment practice began to recognize the importance of the portfolio perspective in achieving investment objectives.
Second, Modern Portfolio Theory helped spread the knowledge and use of quantitative methods in portfolio management.
Today, quantitative and qualitative concepts complement each other in investment management practice.
The third related development was the professionalization of the investment management field.
2. Why do you think investment management is essential?
Answer
•
Establishing Investment Policy
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Selecting a Portfolio Strategy:
–
Active applies information and forecasting techniques
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Passive diversifies to match a market index
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Choosing a Strategy
•
Selecting the Assets
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Measuring and Evaluating Performance
•
Structure of the Money Management Process

3. How do you broadly classify the Investment Strategies?
Answer a) In a passive investment approach, portfolio composition does not react to changes in capital market expectations ( passive means ‘‘not reacting’’).
Indexing, a common passive approach to investing refers to holding a portfolio of securities designed to replicate the returns on a specified index of securities. A second type of passive investing is a strict buy-and-hold strategy, such as a fixed, but non-indexed, portfolio of bonds to be held to maturity. b) An active investment approach, a portfolio manager will respond to changing capital market expectations. Active management of a portfolio means that its holdings differ from the portfolio’s benchmark or comparison portfolio in an attempt to produce positive excess risk-adjusted returns, also known as positive alpha.
c) The semiactive, risk-controlled active, or enhanced index approach, seeks positive alpha while keeping tight control over risk relative to the portfolio’s benchmark. As an example, an index-tilt strategy seeks to track closely the risk of a securities index while adding a targeted amount of incremental value by tilting portfolio weightings in some direction that the manager expects to be profitable.
4. Can you make distinction between Portfolio Selection and Portfolio Optimization?
Answer
Portfolio selection/composition decision: In the execution step, the manager integrates investment strategies with capital market expectations to select the specific assets for the portfolio. Portfolio managers initiate portfolio decisions based on analysts’ inputs, and trading desks then implement these decisions.

Portfolio optimization
—quantitative tool as well as a technique for combining assets efficiently to achieve a set of return and risk objectives. It objectives—plays a key role in the integration of strategies with expectations.

5. What are the four different types of costs involved in execution stage in portfolio management process?
Answer
•
Transaction costs
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All costs of trading, including explicit transaction costs, implicit transaction costs, and missed trade opportunity costs.
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Explicit transaction costs - include commissions paid to brokers, fees paid to exchanges, and taxes.
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Implicit transaction costs - include bid-ask spreads, the market price impacts of large trades
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Missed trade opportunity costs arising from price changes that prevent trades from being filled, and
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Delay costs arising from the inability to complete desired trades immediately due to order size or market liquidity.
6. An investor purchased Rs.1,000 of a mutual fund's shares. The fund had the following total returns over a 3- year period :
Year 1: 5%, Year 2: (-)8%, Year 3: 12%.
Calculate the value at the end of the 3 -year period, the holding period return, the mean annual return, and the geometric mean annual return.
Answer:
Ending Value = Rs.1,000 x 1.05 x 0.92 x 1.12 = Rs. 1,081.92
Holding Period Return = (1.05) x (0.92) x (1.12) – 1 = 0.08191 (or) 8.192 %
Arithmetic mean Return = (5%-8% +12%) /3 = 3 %
Geometric Mean Return =
3
√(1.05)(0.92)(1.12) - 1 = 0.02659 (or) 2.66%
3
(or) = √1 + 𝐻𝑃𝑅
3
- 1 = √1.08192
- 1 = 2.66%
7. What would you think ethical responsibilities of a Portfolio Manager?
Answer
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Professional standards for managers
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Standards of competence and
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Standards of conduct
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Connection to individuals and their welfare is always present
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Code of ethics
8. How would you classify types of investors and distinctive characteristics and needs of each?

Answer:
Investor
Individuals
Banks
Endowments
Risk Tolerance Investment
Horizon
Depends on individual
Depends on
Individual
Low
High
Short
Long
Liquidity needs
Depends on
Individual
High
Low
Income Needs
Depends on
Individual
Pay interest
Spending level
Insurance Low Long – Life
Short – P & C
High
Depends on fund Depends on fund High Mutual Funds
9. Describe the steps in the portfolio management process.
Low
Depends on fund
Answer
I. Planning Step – Stages:
a). Identification and specifying the Investor’s Objectives and Constraints
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Investment Objectives – Desired investment Outcomes
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Constraints – Limitations (Internal & External)
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Internal – Client’s Specific Liquidity needs, time and unique
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External – Tax issues and legal & regulatory requirements
b). Creating the Investment Policy Statement
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Governing document for all investment decision making
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Includes –
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Brief client description
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Purpose of establishing policies and guidelines
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Duties and responsibilities of parties
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Statement of investment goals, objectives and constraints
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Schedule of review
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Performance measures
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Guidelines for rebalancing the portfolio on feedback
c). Forming Capital Market Expectation
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Long run forecast
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Risk and return characteristics
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Asset classes
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Maximize expected return and minimize risk d). Creating the Strategic Asset Allocation
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Determine target asset class weights
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Combine IPS and Capital market expectations
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Specification of risk control mechanism (Single-period and Multi-period perspectives)

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Single period – Advantage of Simplicity
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Multi-period – Liquidity and Tax considerations
II.
Execution Step
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Portfolio Selection
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Portfolio Optimization
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Tactical Asset Allocation
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Transaction Costs
III. Feedback Step
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Monitoring
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Feedback to manage ongoing exposures to available investment opportunities
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Client’s current objectives and constraints continue to be satisfied.
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Rebalancing
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To bring the portfolio back into compliance with investment policy
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Rebalancing decision is a crucial one that must take into account many factors,
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Transaction costs and taxes (for taxable investors).
10. How do you distinguish between investor’s ability to take risk and Investor’s willingness to bear the risk?
Answer
Investor’s ability to take risk
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Even if an investor is eager to bear risk,
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Practical or financial limitations often limit the amount of risk
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Risk in terms of the volatility(unpredictability) of asset values
– short-term loss scenarios can take more risk.
– long-term wealth targets or obligations can take more risk.
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An institution may face legally promised future payments to beneficiaries (liabilities) and an individual may face future retirement spending needs
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The ability to increase the savings/ contribution level if the portfolio can increase the ability.
• Investor’s financial strength.
Investor’s willingness to bear the risk
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Risk tolerance, the capacity to accept
•
• risk, is a function of both an investor’s willingness and ability to do so.
Risk tolerance can also be described in terms of risk aversion, legitimate reasons for choosing a lower-risk strategy.
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The investor needs to have a clear understanding of the eventual consequences of the decision to effectively spend down excess wealth over time. the degree of an investor’s inability and unwillingness to take risk.
• The investor’s specific risk objectives are formulated with that investor’s level of risk tolerance in mind.
An investor with an above-average ability to assume risk may have

11. Compute Variance and Standard deviation. Give your comment about the three scenarios
Probability (Pi)
0.20
Return (Ri)
4%
Expected Return
12%
0.45
0.20
16%
23%
12%
12%
Answer:
Probability
Pi
0.2
0.45
0.2
Return
Ri
0.04
0.16
0.23
Expected Return
E(R)
0.12
0.12
0.12
[Ri - E(R)]2
0.0064
0.0016
0.0121
Variance
Standard Deviation
Pi(Ri) - E(R)2
0.00128
0.00072
0.00242
0.00442
0.066483
6.65%
Case Let
12.
Computation of Liquidity Requirement
A). An individual expects to save Rs. 50,000 during the coming year from income from non-portfolio sources, such as salary. She will need Rs. 95,000 within the year to make a down payment for a house purchase. What is her liquidity requirement for the coming year?
Answer:
A). The liquidity requirement for this individual is her need for cash in excess of her savings during the coming year. Therefore, her liquidity requirement is Rs. 95,000 –
Rs.50,000 = Rs. 45,000.
B). Endowments are funds that are typically owned by nonprofit institutions involved in educational, medical, cultural, and other charitable activities.
Classified as institutional investors, endowments are almost always established with the intent of lasting into perpetuity.

The Vivekananda Endowment was established in the Kolkata to provide financial support to Vivekananda College. An endowment’s spending rate defines the fraction of endowment assets distributed to the supported institution.
The Vivekananda Endowment has established a spending rate of 4 percent a year; the endowment follows the simple rule of spending, in a given year, an amount equal to 4%× (Market value of the endowment at the end of the prior year). This amount is committed to the budgetary support of the college for the coming year. At the end of the prior year, the market value of the
Vivekananda Endowment’s assets stood at Rs.75,00,000. In addition, the
Vivekananda Endowment has committed to contribute Rs.10,00,000 in the coming year to the construction of a new student dormitory. Planners at the endowment expect the endowment to receive contributions or gifts (from alumni and other sources) of Rs.4,00,000 over the coming year.
What is the anticipated liquidity requirement of the Vivekananda Endowment for the coming year?
B. Endowment required for construction of a
new Student dormitory
– Rs. 10, 00, 000
Less: Contribution or gifts (from alumni and other sources) - Rs. 4, 00, 000
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Liquidity requirement -Rs. 6, 00, 000
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Note:
The amount of 4% × Rs.75,00,000 = Rs.3 Lakhs, as provided for in the spending rule, is fully committed to budgetary support; thus this amount is not available to help meet the endowment’s planned contribution to the building project.
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