the right security is chosen to meet the needs of investors.In the modern approach, the Markowitz model is used for securities selection based on risk and return analysis.Markowitz laid the groundwork for quantifying risk, and his contribution is widely described as “modern portfolio theory.”He provides analytical tools for analysing and selecting the best portfolio.He won the Nobel Prize in Literature in 1990, which is his contribution to portfolio management. However, William Sharpe extends the work done by Markowitz.He calculates the Market Index while analysing the portfolio.He simplified the required data and input data to analyse the portfolio.Several complicated estimates was made easy to get the optimal portfolios.These computations have developed a single index model for the creation of a simple portfolio.Until today, the fund managers use this model in analysing and analysing portfolios.The main goal of investment is to get risk adjustment returns.The principle of diversification is to try to set up all the many bints. So maintaining all the investments in a single asset is brilliant and dangerous.This increases the portfolio idea.
A portfolio consists of a series of securities such as shares, bonds and money market instruments.Combining these asset classes to achieve the highest possible return with a minimal risk is called portfolio construction. Portfolio is a series or portfolio of individual assets or securities, and portfolio theory provides a standardised method. This is based on the assumption of risk aversion among investors.This means that investors have well diversified portfolios instead of investing their entire assets in one or a few assets. Investors who are risk averse, refuse investment portfolios that are fair or worse.Risk averse investors are prepared to consider only risk-free or speculative prospects with positive risk premiums.A rational investor is a person who wants to maximise his return with less risk of investing in a portfolio.This means that there is a need for an efficient portfolio minimum risk for a given expected return.
A very difficult task is to find good investments between different types of investments. In the optimal portfolio, each investor needs the maximum profit and the lowest return.This process is accomplished by establishing an optimal investment portfolio.
Portfolio management focuses attention over the years. The skill of managing a successful portfolio management does not depend solely on Rational’s investment decision, but also on a variety of unbiased ideas.spite of this, it is done with care and discretion to build and allocate property for different asset classes.
There is a process of portfolio management.The securities are selected first and the portfolio is created.After that the portfolio should be managed and the optimum return should be obtained.Portfolio management means creating a portfolio with the appropriate allocation of assets to reach the investors’ return, while evaluating investor constraints during the period of risk and asset allocation.Portfolio managers have to work with modern portfolio theory to achieve optimum results for more traditional methods or financial analysis.
James Tobin, winner of the Nobel Prize in Economics in 1981, said the investment process could be separated into two distinct steps -(1) Building an effective portfolio, as described by Markowitz, and (2)The decision to combine this effective portfolio with risk is less than investment.This two-step process is the famous separation theory.The method of finding the optimal risk portfolio in the Markowitz model depends on the quality of the expected security revenue estimates and the common variance matrix.
The assumption of rationality means that a person always wants to maximise his return with minimal risk or reduce his risk at a certain level of return.For this purpose the investor seeks to build an ideal portfolio with different categories of assets.Identifying the optimal portfolio within the asset class (say stocks) can be achieved with a single index model suggested by Sharp.Basically the model is an improvement on the theory of the modern Markowitz portfolio that considers a large number of estimates to calculate the variance matrix. Single index model assumes that fluctuations in the value of shares in a portfolio depend on a number of common factors that are only an indicator.This means that in the case of a large diversified portfolio, there is only one risk factor, as represented by beta of an asset that influences the return.That is why it is better to calculate the covariance with the return on an index instead of comparing covariance for each share as in the Markowitz model.This reduces computational requirements in case of a large number of stocks. Thus the covariance data requirement reduces from (N2 – N)/2 under the Markowitz model to only N measures of each security as it relates to the index.