Week 6_09 - Practical Portfolio Theory_posted

Week 6_09 - Practical Portfolio Theory_posted - A Practical...

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A Practical Approach to Modern Portfolio Theory Practical Topics in Investment Management
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Practical Topics in Investment Manageme 2 Agenda Background The Four Basic Rules of Portfolio Management Benchmark Selection Analysis Risk Management The Human Element Q & A
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Practical Topics in Investment Manageme 3 Background Har ry Markowitz Father of Modern Portfolio Theory – Nobel Prize in Economics 1990 With Merton Miller and Bill Sharpe Mean Variance Optimization There will be no math!
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Practical Topics in Investment Manageme 4 Background Investment theories long before Harry Markowitz – Diversification around since middle ages William Shakespeare preaches diversification in the Merchant of Venice – 1920’s: John Burr Williams used the Present Value Model Discounted cash flow using dividends 1930’s: Ben Graham used Price/Earnings Model in Security Analysis Value investing – looked for PE’s < 15 – 1940’s: Arthur Wiesenberger’s Investment Companies Performance records for large number of diversified portfolios 1950’s: Harry Markowitz expanded on existing concepts Developed Modern Portfolio theory 1960’s: William Sharpe and others expanded on Markowitz’s theory 1965 – Eugene Fama published his “Random Walk” paper
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Practical Topics in Investment Manageme 5 Background Harry Markowitz work in the 1950’s – Measured risk as standard deviation of expected returns Random mix of investments is less risky than one stock – Theory maximizes returns for stated level of risk Or conversely, minimizes risk for stated level of expected returns Efficient frontier is graphical representation of the continuum of all efficient portfolios
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Practical Topics in Investment Manageme 6 A Layman’s Guide to Modern Portfolio Theory Four Basic Rules of Portfolio Management Select a benchmark Determine appropriate Time Horizon and Investment Objectives (required return) For benchmarks with equivalent expected returns, chose lowest expected risk Analyze components Analyze all of the components of the benchmark and assign expected risks and expected returns Blend dissimilar securities Blend components with low or negative correlations so return is greater and risk is lower than the sum of the individual parts, thus maximizing the likelihood of beating the benchmark Always could be wrong … so you never veer from the first three rules!
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Week 6_09 - Practical Portfolio Theory_posted - A Practical...

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