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Portfolio Theory 1

PORTFOLIO INVESTMENT AND MANAGEMENT

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Portfolio Theory 2

Portfolio Theory

Portfolio refers to a combination of assets held by an investor, specifically for purposes

of investment. The reason as to why investors will tend to hold assets together is to seek to

benefit from the possible synergy created as a result of holding more than one. Typically

investors prefer risky ventures due to high return associated with them. Risk is therefore an

inherent part of a higher reward. Based on the statistical measures such as variance and

correlation, an individual’s investment is not as important as the behavior trend in the context of

the entire portfolio. Portfolio theory therefore helps investors on the best way through which they

can maximize assets returns, while diversifying or minimizing risks. It is important to note that

that there is a synergy that exists when assets are combined as opposed to when they work in

seclusion.

The expected Return for the Portfolio

As had been stated earlier, once assets are combined, the expected return becomes high

due to synergy produced. In this case, the initial investment of $ 1,000,004 investment is to be

spread in three industries, whose stock are traded in the Financial Times Stock Exchange (FTSE)

market. The prices for the traded stocks has charged at average price of $ 25.51.Percentage of

investment and fraction thereof is as follows:

Power Industry = 1/3 or 33.3%

Retail and personal consumption = 1/3 or 33.3%

Technology and communication = 1/3 or 33.3%.

Standard Deviation for the Portfolio

This is statistical tool which measures the risk of combining assets. The portfolio

standard deviation is not weighted average of assets which are held in isolation. This statistical

Portfolio Theory 3

tool is therefore used only in the event that assets are held in a combination, due to the

interrelatedness of assets, when they are held together. The interrelatedness is measured using

correlation coefficient, which lies between -1and and +1. This is to mean that assets which are

held together can either be positively correlated or negatively correlated. Since the assets are

three in number, the returns for the three assets is calculated as follows:

Return for asset A, B and C = 1/3(33.3) +1/3(33.3) +1/3(33.3)

11.1+11.1+11.1= 33.3%

The expected return when the assets are combined is 33.3%. This is due to the fact that they are

combined at an equal rate. Standard deviation is therefore derived using the overall rate of return

expected from the assets done in the excel sheet. The results of standard deviation shown the

level of consistency trend shown in combination of this assets.

From the results in the excel sheet, the results are: 1.11, 2.44 and 0.78 for companies 1, 2

and 3 respectively. As has been mentioned above, standard deviation is used to measure

consistency, which is not evident in the results gotten. This therefore means that the consistency

of these investments is in doubt.

Covariance and Correlation of the Portfolio

Covariance measures the variation of assets being combined, the possible returns and the

tendency to move up and down .Due to the fact that the investment is distributed equally in the

various three industries, the probabilities of the assets will be 0.333, 0.333, and 0.333.

Covariance is therefore calculated as follows:

Combination for these three assets, for the grouping of companies is done as shown below

Covariance A and B, Covariance of B and C, Covariance of A and C, which is

0.333 (0) + 0.333 (0) +0.333 (0)

Portfolio Theory 4

Covariance = 0

The covariance amongst these assets is zero, meaning that the three assets do not have

correlation. Covariance is used by investors in determining which asset to include in the

portfolio. However, these three assets have not correlation, hence it is not possible to determine

which one to include in the portfolio. The result further reveals that the assets neither move in the

opposite direction or on the same direction. It is therefore difficult to determine when to

maximize on a particular asset so as to diversify risks, associated with this portfolio investment.

Valuation of Shares

Valuation of shares is dependent on the trends in the stock market, economic

performance and performance of the listed companies. From the investment portfolio, the

company’s share price was between $ 22 and $ 23. This however, is proven to be dependent on

the trend that is displayed in the stock price throughout the week. However, every time that a

sale occurred, then the price of shares showed a positive growth. This can be attributed to the act

of speculators and risk taking inventors in security markets. Besides, it can be attributed to the

instability that the economy of United States faces currently due to its high level of incorporation

with its neighbors. It is worth to note that economic instability is one of the key factors

influencing share price volatility in the stock market. Besides, economic instability also affect

negative movement of share price index.

Though the above stated economic can be attributed to the slight movement of shares on

the positive and negative sides, the nature of the combined assets can also be attributed to this

movement. The covariance of these three assets which have been invested equally in three

industries is zero. Meaning that they do not have any correlation at all, movement of one asset on

the top either side does not guarantee movement of the other one on either side. This could be the

Portfolio Theory 5

reason as to why the share price of these three assets does not any uniform movement. The price

range at the end of every week as well as at the end of trading period, displays a variation of

between $ 0.005 and $1. Which is an insignificant movement to influence decision by other

investors to buy these companies’ shares. However, on the positive side, it is evident that the

shares of these companies generally remained stable throughout the trading period. This could be

the reason as to why risk averse investors would want to remain owners of this company.

Performance of the Companies in the Sectors Chosen

The three companies that were selected from the three sectors of the economy that were

selected for investment are: Gas, water and multi-utility company, General retail business and

travel and leisure companies. As had been stated above, in United States and other European

continent countries, the various sectors of the economy are interrelated. Performance of these

companies were generally uniform, but with slight variation as explained below.

General Retailers Business

United States has a very prime economy with, a very high population and a good

domestic per capita of $ 39,899.39.This amount leaves the citizens with very high disposable

income. Consequently, this increases demand for goods and services. This is the reason behind

the thriving business for the general retail business.

Leisure and Travel Companies

This is an industry with a seasonal demand in the United States. Demand becomes high during

peak season and low during off-peaks. Towards Easter holiday, the demand for this service was

very high. This led to an increase in performance as compared to the early days of the month,

when demand remained generally low.

Portfolio Theory 6

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