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# Predicting Portfolio Investment Returns Essay

2323 words - 10 pages

Portfolio is grouping of financial assets such as stocks, bonds and cash equivalents. It is a collection of different securities that are combined and considered as a single asset by an investor.
Portfolios are held directly by the investors and managed by financial professionals altogether. The risk-return characteristics of the portfolio are different than the characteristics of assets that make up that portfolio especially with regard to risk.
This process of mixing together the broad classes to obtain return with minimum risk is called portfolio construction

CAPITAL ASSET PRICING MODEL
This model is used for prediction that how an investment returns is determined in an efficient capital market and it breaks up the riskiness of each security into two components namely the market related risk which cannot be diversified at all called systematic risk measured by the beta coefficient and other which can be eliminated through diversification is called unsystematic risk.
CAPM expected return of security is given is:
E(R) = Rf + ß (ERm - Rf )
E(R) = expected return of security
ß = beta of security
Rf = risk free rate
ERm = expected return of market portfolio

Applications of CAPM model is as follows:
• Optimum portfolio depends upon market risk-return and individual investors differences in risk.
• Relation between expected return and risk is linearly related for all the portfolios and individual assets.
o High beta portfolios earn high risk premiums.
o Low beta portfolios earn low risk premiums.
• Stock price beta measures risk for all securities.

MARKOWITZ THEORY:
This theory is widely used in the construction of portfolio. Theory explain that for the given level of expected return in a group of securities one security dominates and assumes that investor want maximum return at minimum risk. Efficient portfolio is one which gives maximum return at given risk or can be minimum risk for a given return.
Risk can be minimized through diversification. Risk is of two types systematic and unsystematic and diversification helps in eliminating or reducing the unsystematic risk.
The potential of an asset is to diversify a portfolio which is dependent on the degree of movement of returns of the asset with those other assets that make the portfolio.

FUNDAMENTAL ANALYSIS
Fundamental analysis can be seen as a method of evaluating a security or an asset by the way to measure its intrinsic value by seeing relative economic as well as financial and other qualitative and quantitative factors all together. It is to study everything that can affect the security's value including macro-economic factors and individual factors.
The combination of the data can be used to establish the current value of the underlying asset which can be used to determine whether they are over or under valued and thus can help to predict the future value of such asset based on the information so concluded.
Importance of Fundamental Analysis
Fundamental analysis helps to identify...

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