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A market portfolio is an assumed or virtual portfolio where every available type of asset is included in proportion to its market value. An investment portfolio is a group of investments that are owned and managed by one individual or organization. A typical investment portfolio may include numerous types of assets, but usually, it does not include all asset types. A market portfolio, however, virtually includes every asset that is available in the market.How is the market portfolio managed?A market portfolio is created to have the right mix of asset classes to maximize the returns from the investment and to ... Read More
The Capital Asset Pricing Model (CAPM) has some assumptions upon which it is built. Here are the five most influential assumptions of CAPM −The investors are risk-averseCAPM deals with risk-averse investors who do not want to take the risk, yet want to earn the most from their portfolios. Diversification is needed to provide these investors more returns.Choice on the basis of risks and returnsCAPM states that Investors make investment decisions based on risk and return. The return and risk are calculated by the variance and the mean of the portfolio. CAPM reinstates that rational investors discard their diversifiable risks or ... Read More
Portfolio Risk and ReturnThe general standard deviation (SD) of a portfolio is related to −The weighted mean average of each individual variance, andThe generally weighted covariances between all assets in the portfolio of investment.When a new asset is added to a large basket of portfolios with many assets, the new asset alters the portfolio's SD in two ways. It affects −The new asset's own variance, andThe covariance between the new asset and each of the other assets in the portfolio.The net effect of the numerous covariances will be more important than the effect of the asset's own variance. The more ... Read More
Portfolio standard deviation is the general standard deviation of a portfolio of investments of more than one asset. It shows the total risk of the portfolio and is important data in the calculation of the Sharpe ratio.It is a well-known principle of finance that "more the diversification, less is the risk." It is true unless there is a perfect and well-established correlation between the returns on the portfolio investments. To achieve the highest benefits of diversification, the standard deviation of a portfolio of investments should be lower than the general weighted average of each standard deviation of the individual investments.In ... Read More
The slope of a capital market line of a portfolio is its Sharpe Ratio. We know that the greater the returns of a portfolio, the greater the risk. The optimal and the best portfolio is often described as the one that earns the maximum return taking the least amount of risk.One method used by professionals to increase returns taking minimal risks is the eponymous "Sharpe Ratio". The Sharpe ratio is a calculation of risk-adjusted returns of how good is the investment return vis-a-vis the amount of risk taken. An increased Sharpe ratio for an investment means a better risk-adjusted return.How ... Read More
A minimum variance portfolio is an investing method that helps you minimize risk and maximize returns. This often involves diversifying the assets used in the investments.Minimum Variance Portfolio: Definitions and ExamplesThe aim of having a minimum variance portfolio is to diminish the volatility arising out of singular investments. By volatility, we want to measure a security's price movement in the share markets.It is a proven fact that the greater the volatility, the higher the market risk. So, in case someone wants to minimize risk, they should want to minimize the ups and downs. This means a greater chance of slow ... Read More
The portfolio separation theorem is an economic theory that tells that the investment decisions or choices of a firm are not related to the investment preferences of the firm’s owners. It postulates that a firm should try to maximize profit rather than trying to diversify the decisions of the firm’s owners. The separation theorem also states that irrespective of the preferences of a firm’s shareholders, the firm should choose optimal production measures that will bring more profits to the investment portfolio.Note − The portfolio separation theorem states that the total number of portfolios that are required to create an optimum ... Read More
The process of combining numerous securities to reduce risk is known as diversification. It is necessary to consider the impact of covariance or correlation on portfolio risk more closely to understand the mechanism and power of diversification.Let’s study the issue category-wise −when security returns are perfectly positively correlated, when security returns are perfectly negatively correlated, andwhen security returns are not correlated.Security Returns Perfectly Positively CorrelatedWhen net assets returns are perfectly and positively correlated, the given correlation coefficient between the two securities will be +1. Thus, the returns of the two securities will move up or down together. The portfolio variance ... Read More
Diversification in InvestmentIf the market conditions are normal, diversification is an efficient way to reduce risk. Holding just one type of investment can potentially pose a threat to your investment if the securities of your industry fail. In such conditions, you could lose all of your money. A well-diversified portfolio with a variety of different investments will save you when one investment performs badly in the market. As it is unlikely that all of the investments will perform badly at the same time, the profits you earn on the investments of other assets that perform well will offset the losses ... Read More
Unsystematic risk is related to the internal risk factors of the organization. It is also called specific risk, idiosyncratic risk, diversifiable risk, or residual risk. An unsystematic risk occurs due to any event for which the business is not prepared, and which disrupts the general and smooth functioning of the firm’s business.Some of the factors that lead to unsystematic risk are −The inefficiency of the managementChanges in the capital structureLiquidity crunch in the businessFlaws in the business modelProduction of non-desirable productsLabour strikesUnsystematic risk can be diversified and so can be avoided. It is a fact that one can diversify their ... Read More