Portfolio theory and invesntment analysis Assignment

Portfolio theory and invesntment analysis - Assignment Example In fact, it is required to estimate current investment strategy of the charity and then to propose actions for its improvement. Let us suppose that the portfolio has stocks. Structure of is determined by weights of stocks, . Per se, efficient portfolio allows the charity to obtain high expected values of return under tolerable value of risk. Efficient portfolio is determined by optimal weights of stocks, . In general, portfolios with high values of allow to achieve well optimized and efficient solutions but such portfolios are expensive to operate and difficult to analyze and manage. On the other hand, portfolios with small values of are cheap to operate and easy to manage but often such portfolios are too weakly diversified to be able to track the entire market or to beat the market index. Let us consider by examples how to determine optimal values of and weights and how to analyze structure of efficient portfolio . The present portfolio of the charity is concentrated in equity shares in leading U.K. companies. So, it is reasonable to suppose that each of them is in the top of the FTSE 100 Index, a capitalization-weighted index of the 100 most highly capitalized U.K. companies traded on the LSE. For instance, let us select1 the 7 largest constituents of the FTSE 100 Index. As of 9 December 2007, these ones were RDSA.L & RDSB.L, BP.L, HSBA.L, VOD.L, GSK.L, RIO.L, and RBS.L. Then, let us consider values of their market capitalization and also betas vs. UKX: Company Symbol Market Cap (millions ) Fraction (%) Beta vs. UKX Royal Dutch Shell PLC RDSA.L, RDSB.L 127,532.881 20.48 0.934, 0.983 BP PLC BP.L 117,355.224 18.85 1.056 HSBC Holdings PLC HSBA.L 101,548.136 16.31 0.723 Vodafone Group PLC VOD.L 98,199.053 15.77 1.068 GlaxoSmithKline PLC GSK.L 72,271.602 11.61 0.643 Rio Tinto PLC RIO.L 57,299.112 9.20 1.353 Royal Bank of Scotland Group PLC RBS.L 48,380.050 7.77 1.083 It is known that around 40% of the charity's portfolio is invested in one of these stocks, say, BP.L; the investment in each of the others is around 10%. In case of passive investment strategy the charity uses tracking portfolio, in which each of 7 fractions must reflect (sic!) market capitalization of appropriate leading company; e.g. see Focardi & Fabozzi (2004). Inasmuch as real market fractions of top 7 U.K. companies are distributed quite otherwise than in the charity's portfolio, we may conclude that the charity uses rather active than passive investment strategy. It seems that such choice of the investment strategy is quite reasonable. In case of passive investing the charity attempts at least "track" the market which is characterized, say, by the FTSE All-Share Index. If the market is down in a given period, the charity with an indexing strategy will also find investment performance reflecting that decline. Of course, such investing is a low-cost strategy due to reduced security analysis and insignificant start portfolio management costs. However, there are certain tracking errors when the tracking portfolio can not follow