Reading Material for P4122 students

MODERN PORTFOLIO THEORY

Harry Markowitz received the Nobel Prize for Economics in 1990, along with William Sharp and Merton Miller, for their contributions to financial economics and investment field. Modern Portfolio Theory, has been developed by Markowitz in 1950s which illustrates how investment risks in the financial market can have a maximized return.

His first article on “Portfolio Selection,” which explains his theory in early 1952. Markowitz utilized mathemetics and computer methods applied to realistic problems, such as uncertainty in business decisions. In 1989, he was awarded the Von Neumann Prize in Operations Research Theory by the Operations Research Society of America and The Institute of Management Sciences.

Modern portfolio theory (MPT) is a theory of investment that attempts to maximize portfolio expected return for a given amount of portfolio risk, and minimizing risk for a given level of expected return, by carefully choosing the proportions of various assets thats available in the market. His idea normally proposed  inventors should select portfolios as their investment strategy intead of invest in individual securities/stock.

Efficient Frontier:  Refers to the optimal portfolios plotted along the curve with the highest expected return possible for the given amount of risk. (the set of all portfolios that will give the highest expected return for each given level of risk.) These concepts of efficiency were essential to the development of the Capital Asset Pricing Model to find the Security Market Line.


Figure 1


 Figure 1 
As shown in this graph, the best investment option for investor to make is when the efficient frontier touch the market line. Any combination of investments below the market line or below efficient frontier may give higher risk, since the instruments are 'over valued'.  Therefor, portfolio's below the curve are not efficient, because at the same risk level, investor could achieve a greater return, e.g. invest in  Risk-Free Asset.









Figure 2:

Figure 2: Figure shown the relationship between risks and returns for every portfolio combinations.  The higher the returns, will expose investors to higher levels of risk. 

As a conclusion, portfolio will give advantages to the investors to eliminate some risks in their investment, but they have to make sure that the combination of portfolio is well diversified, meaning to say, investors should invest in various industries and avoid the over-valued assets as shown in the above Figure.



QUIZ 1 : SAMPLE

Dear students, attached here with, sample for the Quiz 1.  All the best.

Quote of the day:
"The relationship between risk and return can be classified as a "positive" or "direct" relationship, by this mean; investors will set a higher return to compensate the higher level of risk in their portfolio. Alternatively, if an investment offers relatively lower level of risk, then, investors should satisfied with a lower returns.

Since the level of risk and return are based on expectation, so the proper analysis needs to be done. Normally, investors will look into both past year return/risk and the expected economic conditions in the future.
Comparison between various instruments in the market is one of the crucial factor to determine the best asset/s to be invested in. Investors also have to consider about setting up a well-diversified portfolio to minimize the unsystematic risk, since the market risk is beyond their control."

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CHAPTER 2 - RISK & RETURN

I N V E S T O R S'     P R O F I L E

When we discuss on investment, investors have to consider the RISK! Or the uncertainty of income/profit on their investment. But, is it not to invest is the best way to avoid risk? Actually, not investing your money is also risky. For instance, keeping your money under the mattress may invite losing money, and it might reduced our purchasing power when there is inflation in economic.

Risk and return have a direct relationship between them. Normally, the higher the risk, the higher the potential return. Hence, investing all your money in valuables that carry large returns, it may leads you to a financial trap if something doesn’t go as what you have planned.
Understanding the risks is useless unless you know what type of investor you are. The risk you can tolerate depends on many factors such as your:-

i. investment objectives- long/short term or the maturity period.

ii. the amount of money you have to invest.

iii. the size of your portfolio.

iv. and the time left for your investments.


Figure 1: Investors’ Profile / Type of Investor

Different instrument will expose investors to different level of risks, invest in stock market will lead to higher risk as compared to unit trust. But, normally it will compensate with higher return (even sometimes lost).
The best way to eliminate risk is by performing portfolio which mean, invest in different assets rather than put all your money in single asset for example, investors may invest both in capital and money market in order to profit from any economic changes they might have to face.

LEARNING KIT

GOOD NEWS and GREAT DEALS to all P4122 students, the software will available by this TUESDAY (28 December 2010) complete with student's handbook and lectures' notes, include with CD's with no extra cost. 

TQVM

CHAPTER 2: PART 2 (EXPECTED RATE OF RETURN)

Chapter 2: Risk & Return

• Expected Rate of Return for Single Asset
• Standard Deviation (Risk) for Single Asset

CHAPTER 2 - PART 1 (ARITHMETIC & GEOMETRIC MEAN)

Chapter 2: Arithmetic & Geometric Mean

For further explaination, refer to lecturers note (will be update soon...come back again guys).TQVM

EXERCISE: CHAPTER 2 - PART 1 (HPR, HPY, annual HPY)

All the best....

TO ALL P4122 STUDENTS

Please

LEARNING KIT

CHAPTER 2: RISK & RETURN

Chapter 2: Risk & Return
Calculation on Holding Period Return, Holding Period Yield, annual Hoding Period Return, Mean Arithmetic & Mean Geometric.

CHAPTER 1: ASSIGNMENT

Assignment 1: Date: 20 December 2010
Chapter 1
Date of submission: 24 December 2010.

1.  Briefly discuss the main difference(s) between:-

• a:  Marketable securities and non-marketable securities.
• b: Money Market vs Capital Market (give example for each market).

2.  Speculation is one of investment strategy, what is the differences between Speculation, Gambling and Investment.


3.  Derivatives is widely used by sophisticated investors to manage various form of investment risk.  Briefly eleborate the Derivatives Market in Malaysia.


4. Define the type of return in investment.


References:

1.  Lecturer Note: P4122 Investment Management by: Suhairi Yunus
2.  Redcliff R. C. (1997). Investment Concept, Analysis, Strategy. 5th Edition.Westley Publication. United State.
3.  Reilly F.K. and Brown K.C. (2003). Investment Analysis & Portfolio Management. 7th Edition. Thompson South-Western. Ohio.

CHAPTER 1: INTRODUCTION TO INVESTMENT (Lecturer Presentation)

Lecturer Presentation for Chapter 1; Complete note/presentation available in P4122 Investment Management Learning Kit.

TQVM

CHAPTER 1: INTRODUCTION TO INVESTMENT (LECTURER PRESENTATION)

CHAPTER 1: INTRODUCTION TO INVESTMENT (Lecturer Presentation)

CHAPTER 1: INTRODUCTION TO INVESTMENT

Sub topics:  Defines investment and speculation; Type of securities investment; Investment concept in Money Market and Capital Market; Funds for investment; Characteristics of the share market; Malaysian Security Act.

Investment :
"Investment is the commitment of money or capital to the purchase/buy any financial instruments or assets to gain profitable returns in the form of interest, dividend income , or appreciation (capital gains) of the value of the instrument in the future."

Speculation:

"The process of selecting investments with higher risk in order to profit from an anticipated price movement of investment instruments in short or long term."



Speculation is differ from gambling, as speculators do make an informed decision (based on analysis) before take any position. Additionally, speculation cannot be categorized as a traditional investment because the acquired risk is higher than average.

Money Market:A segment of the financial market with high liquidity and very short maturities are traded (with a maturity of one year or less and often 30 days or less).  Money market securities consist of negotiable certificates of deposit (CDs), bankers acceptances, U.S. Treasury bills, commercial paper, municipal notes, federal funds and repurchase agreements (repos).
Normally, the investment risk is slightly lower compared to Capital Market, therefor, the return for this market also lower than the return offered by Capital Market.

Capital Market: refers to investment in long term financial intruments such as shares/stocks and bonds market.  Since this instruments have long term maturity period so the risk of this investment is likely higher compared to Money Market instruments.  As to compensate with the higher risk, the higher return often been offered to attract potential investors to put their money in Capital Market.