Fin 630

FIN630 - INVESTMENT ANALYSIS AND PORTFOLIO MANAGEMENT ASSIGNMENT – SPRING 2009 Student ID/Login ID: mc070401585 Student Name: Daniyal Zaheer Bajwa Questions 1. Which method of portfolio selection is better, Mr. Tom's or Mr. John's? Which requires more effort? Are the expected rewards different for Mr. Tom's method than Mr. John's method? Explain why? Ans: I think the better method for selecting portfolio of Mr. David is Mr. John’s recommendation. Mr. Tom’s selection is based on random diversification which simply means choosing securities randomly from a large number of securities without taking consideration of its characteristics such as expected return and company classification whereas Mr. John’s selection is based on non-random diversification based on Markowitz principle that takes into consideration of inputs like expected return, variance and covariance in choosing securities which lacks in random diversification. From this selection, Mr. David can reduce its portfolio risk and gain expected returns. Mr. John’s recommendation will require more hard work and effort because it has to choose the security upon the inputs like expected return, variance and co movements of securities with one another whereas Mr. Tom’s recommendation does not require any consideration of inputs. Expected rewards of Mr. John’s method will be much better than Mr. Tom’s method because Mr. John’s recommendation is measured on important points of inputs which are described in Markowitz theory while Mr. Tom’s recommendation is not.

2. Describe the various features that Mr. John must observe in a security before adding it to the portfolio Ans: Mr. John has to workout inputs like expected return which is different from realized return, is estimated return of a security and variance is the individual risk of a security which only contribute market risk and covariance is the co movements of security with one another and study the correlation of securities. 3. Do you think Mr. John can completely eliminate risk from Mr. David’s portfolio if he adds more and more stock to the portfolio? Justify your answer with reasons. Ans: No, I don’t think Mr. John can completely eliminates risk from Mr. David’s portfolio because he will only eliminate un-systematic risk also called company-specific risk which is based on company classifications not the market risk. Market risk or systematic risk is un-avoidable because the risk is due to the market behavior which includes interest rate risk, market and inflation risk.