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The Capital Markets: Portfolio Construction In Practice

Understand portfolio theory, risk-return trade-offs, asset allocation, efficient frontiers, and optimum portfolio construction in practice with Prof. Ian Giddy from New York University. Learn how to balance returns and risks when investing in treasuries and equity funds.

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The Capital Markets: Portfolio Construction In Practice

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  1. New York University/ING Barings The Capital Markets: Portfolio Construction In Practice Prof. Ian Giddy New York University

  2. The Risk-Return Trade-Off E(R) CAPITAL ALLOCATION LINE 14% 12% SLOPE IS THE RISK-RETURN TRADE-OFF 5% SD 20% 24% 0%

  3. The Risk-Return Trade-Off If this is my indifference curve E(R) then that’s the portfolio I would pick 14% 12% 5% SD 20% 26% 0%

  4. Capital Allocation Possibilities:Treasuries or an Equity Fund? Expected Return THE EQUITY FUND E(rS) =17% S 10% rf=7% TREASURIES 7% S=27% Risk

  5. Capital Allocation Possibilities:Treasuries or an Equity Fund? E(R) ONE PORTFOLIO: 30% Bills, 70% Fund E(R)=.3X7+.7X17=14% SD=.7X27=18.9% C.A.L. SLOPE=0.37 17% 14% rf=7% 18.9% 27% SD

  6. If E(rS)=15%, S=22%,rf=7% • Allocate your money between t-bills (y) and a stock fund (1-y). Then: • rp = yrs + (1-y)rf • E(rp)= rf + y[E(rs - rf] = 7 + y[15 - 7] = 7 + y8 • p = ys = y22

  7. We Can Buy Some T-bills and Some of the Risky Fund... Expected Return E(rS) =15% S 8% rf=7% 7% S=22% Risk

  8. ...Or Buy Two Risky Assets E(r) A B

  9. Portfolio Return... To compute the return of a portfolio: use the weighted average of the returns of all assets in the portfolio, with the weight given each asset calculated as (value of asset)/(value of portfolio). The portfolio return E(Rp) is: E(Rp) = (w1k1)+(w2k2)+ ... (wnkn) =  wj kj where wj = weight of asset j, kj = return on asset j

  10. Measuring Portfolio Risk The variance of a 2-asset portfolio is: where wAand wBare the weights of A and B in the portfolio.

  11. Case Study: A Portfolio

  12. Portfolio Return Computation

  13. Portfolio Risk Computation

  14. The Minimum-Variance Frontier of Risky Assets E(r) “Efficient frontier” Individual assets Global minimum-variance portfolio

  15. Given Return, Find Lowest-Risk Compositions

  16. Plotting the Efficient Frontier

  17. The Efficient Frontier of Risky Assets with the Optimal CAL E(r) CAL(P) Efficient frontier

  18. Optimal Overall Portfolio E(r) Indifference curve CAL Opportunity set P Optimal complete portfolio

  19. Finding the Optimal Portfolio:Computations

  20. www.giddy.org Ian Giddy NYU Stern School of Business Tel 212-998-0332; Fax 212-995-4233 ian.giddy@nyu.edu http://www.giddy.org

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