Harry Markowitz Model ~ full covariance mode! Harry Markowitz model shor Developed by Harry Markowitz in 1952 {Lanalvses the various possible portfolios of given number of secur 5 and identifies most efficient ® portfoli i ities and identi fic ti ai ber of les and Harry Markowitz introduced new concept of rsk measurement which are te useful while selecting i i i i i portfolios, are quite useful while selecting tly known as HM model, He took the idea of risk aversion of average investor. Average investor wishes to maximize the return with least risk. Markowitz related his model to the anal He found that objective of investors vari Tequirements, financial means etc 'ysis of risk and return and their inter-relationship, ies in terms of risk tolerance, asset preference, investment Assumption Investors are generally rational Market is efficient and all investors have a complete knowledge about the market. Tiss possible because investors have a correct and precise information on risk and return Investment decision taken by investors are based on the expected rate of return. Variance and standard deviation of these returns is the important parameter for ascertaining the worthiness of the investment, Security return are correlated in such a way that an investor could get maximum returns ata given levelof risk. Before selecting any portfolio, the factors to be considered are () returns (i) standard deviation (i) coefficient of correlation The markets are so efficient that they can absorb the information quickly and perfectly, Investors are risk-averse and they attempt to minimize risk and maximize return The investor can reduce his risk if he adds more investments to his portfolio,Features of Markowitz mode! 1, Investment portfolio criteria ‘There isa relationship between expected return and level of risk in a portfolio. = This forms the criteria for selecting optimal portfolio 2. Efficient portfoli3, Portfolio selection ‘Comparison of indifference curve | Risk-Indifference Curves | torifferent Rsk Tolerances |Tangency Point and Efficient Portfolio Finding the Best Portfolio — No Borrowing or Lending B Expected Return Efficient Frontier Indifference curve tangent to Efficient Frontier, Standard Deviation' 4 invested Rs.50, 000 in a portfolio of shares. It has invested 30% in shares of A Ltd and balance in shares of B. Ltd. The expected returns from these two companies are 15% and 12% respectively. Find ee ercorpere and in absolute amount.sn characteristics ofthe projects are shown below: x Y a 20% | Tsk 3% Te | As investor plans to invest 80% of its avalable funds in project X and 20% in project ¥. The correlation coefficient ‘between the returns ofthe project is +1.0 find out the risk and return of the portfolio of X and ¥. tclilten -aiaainesieienatianeinaa 3) An investor has created a portfolio ofS securities about which the following information is available: Security |Current Value in Rs. (TO) Expected Value in Rs. (T1) i 2500 4000 W “4000 5000 1 Ww 10000 12000 7 ‘5000 7000 v Z 3500 5000 Total 25000 33000 Find out the expected rate of return of the portfolio.at) An investor is interested to construct a potflio of two investment, Si and Si. He has gathered the following information about these investments: 3 [ Si l Sa ] Expected return 2% I 20% | ‘Standard deviation of return 10% 1 18% | Correlation coeficient Coefficient correlation between $1 and 52 as follows i) All funds invested in St il) 50% of fund invested in each S:and S2 i) 75% of fund in Ssand 25% in Ss iv) 25% of fund in S:and 75% in Se vy) Allfunds invested in S> Find out (1) expected return under different portfolios, (2) risk factors associated with these portfolios, (3) which portfolio is best for him from the point of risk, and (4) which portfolio is best for him from point view of return5) following information is available in respect of two securities. Thin and Fat: Thin Fat ) | Expected return 15% 20% | [Standard deviation 10% 15% veight 50% 50% Covariance is 100 Find out the risk and return of the portfolio. Also find out the correlation between the returns of thin and fat. ieee= 667 Q6) The following information is available from MZ in respect of his portfolio: ~ Weight Expected return ‘Standard deviation 50% 20% 28% 50% 12% a Tivd or to correo; be treay he ETF ance ts ot src Find out the standrd deviation ofthe portfolio comprising A&B nthe rate of 2596 and 75% respectively.ae Q7) calculate expected return and standard deviation of the investment ‘A’ and ‘8’, What will be the return if total investment is divided one half in each? Economie Condition probability [Return froma | Retumnfroma% | Dull 0.2 10 I 6 +] stable 05 14 15 [Grow 03 20 FT J ‘Also calculate the covariance and correlation. Solution:.Q8) The following are the expected return R, and the risk, 0, of two securities A and B. ‘Securities R o A 10% 20% (aes 5 mal 12% 25% The correlation coefficient between the return of A and B is 0.5. An investor is to decide about the portfolio of A and B as 75% + 25% or 259% + 75%. Which one should be accepted?‘Q9) Sunil owned five securities at the begianin 1g of the year in the following amount and with the following Surrent and expected price end of the year. Security |" Share Amount (Rs.) |" Current Price | Expected year end price (Re) A 150 40 5 8 100 30 40. c 85 20 Eg al D 30 0 Pay 35 (neste: 325 [530 40 45 \What is the expected return on Sunil’ portfolio forthe year?